Franchise 101: Pizza Franchisor’s Release Overcooked; and Court Taxes Franchisor’s Restrictive Covenants

Franchisor 101: Pizza Franchisor’s Release Overcooked

A federal district court denied a pizza franchisor’s motion to dismiss a former franchisee’s complaint, finding the former franchisee sufficiently pleaded the franchisor coerced the franchisee into signing a general release.

The franchisee operated a Marco’s Pizza franchise under a franchise agreement with Marco’s Franchising, LLC. A few weeks prior to expiration of the franchise agreement’s 10-year term, Marco’s sent the franchisee a notice giving the franchisee six weeks to remedy deficiencies in system operating standards. The franchisee was required to cure these deficiencies as a condition of renewal, but was unable to timely cure.

Shortly before the franchise agreement’s expiration, Marco’s representatives visited the restaurant and, again, found many system standard deficiencies. Nevertheless, Marco’s entered into a new franchise agreement with the franchisee and accepted the franchisee’s renewal fee. The new franchise agreement contained a general release of the franchisee’s claims against Marco’s.

Marco’s continued to conduct inspections of the restaurant, finding deficiencies already documented prior to the parties signing the new franchise agreement. Marco’s thereafter terminated the franchise agreement, effective two days after the franchisee’s receipt of the termination notice, unless the franchisee entered into a limited license agreement (LLA), which would allow the franchisee to continue to operate for two months, during which time the franchisee could find a suitable buyer of the franchise. The LLA required a suitable buyer to be a current Marco’s franchisee. The LLA also included a release provision. The franchisee was unable to find a suitable buyer, and the franchise agreement was terminated.

The franchisee sued the franchisor for breach of contract and breach of the implied covenant of good faith and fair dealing. Marco’s moved to dismiss the complaint, arguing the releases signed by the franchisee barred the contract claims. The franchisee responded that the two-day time frame for agreeing to the LLA was coercive, especially because Marco’s renewed the franchise knowing the existence of certain deficiencies, on which Marco’s then based the termination.

The court agreed with the franchisee, concluding the complaint contained sufficient facts to infer the release agreements were procured by Marco’s through duress and/or other wrongful conduct. The court also found the release to be ambiguous, which raised a question of fact as to whether the parties contemplated the franchisee’s current claims against Marco’s at the time of signing the release agreement documents.

Franchisors should have experienced counsel advise on the use and enforceability of general releases. General releases are useful tools but, if used incorrectly, may not be enforceable. Experienced franchise counsel can provide guidance early on when a general release may or may not be enforceable and advise on best practices for using general release agreements.

SC Am., LLC v. Marco’s Franchising, LLC, 2023 U.S. Dist. LEXIS 31043 (N.D. Ohio Feb. 23, 2023)

Franchisee 101: Court Taxes Franchisor’s Restrictive Covenants

The Second Circuit Court of Appeals affirmed a district court’s order denying a franchisor’s request for preliminary injunction against a terminated franchisee to enforce covenants not to compete or solicit former clients.

JTH Tax LLC, franchisor of the Liberty Tax Service brand, entered into several franchise agreements with a franchisee. Liberty subsequently terminated the franchise agreements, claiming the franchisee committed material violations of federal tax laws and regulations in providing tax preparation services. Liberty demanded that the franchisee comply with its post-termination obligations, including non-compete and non-solicitation covenants.

The franchisee and Liberty sued each other, with Liberty moving for a preliminary injunction to enforce post-termination obligations and to enjoin the franchisee from competing and soliciting former clients. Liberty appealed the district court’s denial.

The Second Circuit affirmed. The district court applied the correct standard for issuing a preliminary injunction, which included a heightened standard for showing likely success on the merits and irreparable harm. The Second Circuit agreed that Liberty failed to meet that standard. Liberty failed to establish likelihood of success, as the franchisee’s evidence that she had consistently reached out to Liberty’s compliance team to correct income tax return errors raised questions of fact on whether Liberty properly terminated the franchisee.

Further, Liberty did not show recovering monetary damages was inadequate. Breach of a non-compete covenant does not automatically constitute irreparable harm, and Liberty failed to offer evidence that the franchisee’s competing tax preparation businesses would result in lost customers or profit, or that Liberty intended to maintain its presence in the market through a new corporate-owned or franchised store.

Franchise agreements often have non-compete and non-solicitation covenants. Franchisees considering operating a competing business after leaving a franchise system should consult with franchise counsel to assess strength and enforceability of any non-compete and/or non-solicitation clause in the franchise agreement.

JTH Tax, LLC v. Agnant, 62 F.4th 658 (2d Cir. 2023)




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