Franchise 101: Not at Liberty to Compete; and Bar-B-Q Blues — A Tale of Friendship, Partnership, and Deceit

FRANCHISOR 101: Not at Liberty to Compete

A federal district court in Michigan granted a preliminary injunction in favor of tax preparation franchisor, Liberty Tax Service (JTH Tax, Inc. v. Magnotte, E.D. Mich., ¶16,575), finding it was likely to succeed on its breach of contract claims against a former franchise.

There were several franchise agreements. Each had a two-year post-term covenant not to compete within 25-miles of the franchisee’s territory. The relationship soured and the franchisor terminated the agreements. Ignoring the post-term obligations, the former franchisee continued operating a tax preparation business, from the same location, but used a new name. They continued using the franchisor’s client lists and operating manual. The franchisor sued to enforce the non-compete covenants.

The court granted a preliminary injunction against the former franchisee. The court found the franchisor was likely to succeed on its breach of contract claim and the damage, such as loss of customer goodwill, lost profits, and loss of competitive advantage, was irreparable. The court found the franchisor was suffering actual harm, and the injuries were irreparable because loss of customer goodwill is difficult to quantify and not fully compensable by money damages. The franchisor’s injuries were likely to worsen absent immediate injunctive relief. Two more injunctive relief factors—harm to others and public interest—also favored a preliminary injunction. The court ordered the former franchisee to transfer phone numbers, return all confidential materials, and enjoined them from using any confidential information obtained from the franchisor in any future tax preparation business.

A franchisor’s use of a well-written, reasonable non-compete provision in its franchise agreement can be a useful tool in preventing former franchisees from starting a competing business after they leave the franchise system. Non-compete clauses are sensitive because courts are reluctant to restrict someone from working to earn a living. Franchisors should consult with franchise counsel to review their non-compete language to make sure it is well drafted and improve the chances it will be enforceable.

FRANCHISEE 101: Bar-B-Q Blues — A Tale of Friendship, Partnership, and Deceit

A federal appeals court reversed dismissal of a claim against a barbeque restaurant franchisor. The court found that, despite having signed releases in favor of the franchisor, a former franchisee had valid claims for interference with contract, breach of contract, breach of the covenant of good faith and fair dealing and unfair and deceptive trade practices (Musselwhite v. Mid-Atlantic Restaurant Corp., 2020 WL 1873330).

Two partners, through their corporate entities, operated four Smithfield’s Chicken ‘N Bar-B-Q franchises. The partners, through separate entities, also owned the properties of each location. Each franchisee paid rent.

After several years of operations, the franchisor told the franchisees it wished to operate the franchises itself. The franchisees agreed and the parties executed termination agreements and amendments to franchise agreements, all containing broad releases of the franchisor. The amendments allowed continued operation for a few more years and said the franchisor would lease the premises from the partners on taking over operations. After executing the agreements, the relationship of one of the partners with the franchisor deteriorated. The franchisor ultimately terminated the amended franchise agreements. The termination caused a rift among the two partners.

According to one partner, the franchisor pressured the other partner to end his co-ownership in the franchises and in the real-estate companies that owned the premises. The franchisor allegedly said the partner would not get revenue from leasing the premises if the other partner remained a co-owner of the properties. Based on these representations, the partners entered into a buyout agreement.

The seller partner sued his former partner in state court, claiming he was defrauded into the buyout. The court disagreed and ruled for the buyer partner. The seller partner then sued the franchisor in federal court, which dismissed the action. The federal court found the claim was barred by rulings already made earlier in the state court. The claims for breach of contract, breach of the covenant of good faith and fair dealing, and unfair and deceptive trade practices were barred by releases in the franchise agreement amendments.

The federal appellate court reversed. The court let the interference claim proceed, finding the state court ruling did not involve a necessary element (malice). The appellate court found error in the lower court’s reliance on the releases. While the releases were valid, they did not bar the action. The franchise agreement amendments did not terminate any agreement. The alleged acts giving rise to the claims arose after the amendments were signed.

Franchisees who may have claims against their franchisors should carefully review the language of their contracts and any amendments to see if they signed a release of claims and the scope of any release. Franchisees, in consultation with their franchise counsel, should carefully consider any common law claims they may want to make prior to bringing an action in court.

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