Tax Franchisee Terminated for Sharing Space With CannaBiz

by Matthew J. Soroky
818-907-3022

In Devore v. H&R Block, the franchisor H&R Block was found to have lawfully terminated a franchisee for violating an in-term non-compete covenant, because the franchisee permitted its office manager and prior operator of the franchised business to offer tax return preparation services as part of his separate cannabis consulting business, all within the same office space as the franchised business, for multiple years.

When the prior operator, Gordon Gates, sold the H&R Block office to the franchisee, he agreed to accept a portion of the purchase price during a three-year “earn out period” and to remain the office manager of the H&R Block until the purchase price was paid in full.  During those three years, the franchisee permitted Gates to operate “Cannabiz Accounting” from the H&R Block office. The business focused on cannabis consulting, but generated approximately 50 to 60 tax returns. None of the revenue generated by Cannabiz Accounting was reported to H&R Block.

Gates eventually relocated offices, but he kept the franchisee’s principals and other employees of the H&R Block offices listed on his company website, which was then renamed “Gates & Associates.” The discovery of the franchisee’s names prompted the franchisor to terminate the franchisee, and to demand an accounting and payment of royalties due as a result of the breach.

Gates’ relationship with the franchisee was found to be a clear violation of the franchise agreement’s prohibition against direct or indirect engagement in a competing business. That section prohibited the franchisee from “engag[ing] directly or indirectly…in any business which offers any product or service the same or similar to [income tax preparation services] … within 45 miles of the Franchise Territory.”

The franchisee argued that it did not engage in the competing Cannabiz Accounting business because it neither controlled nor received revenue from it. The trial court rejected this argument because it was undisputed that the franchisee breached the agreement by providing Gates with office space.

An in-term non-compete covenant in a franchise agreement is typically broad enough to prohibit all conceivable forms of direct and indirect competition with the franchisor. Franchisees may be surprised to learn there are other, more subtle ways a franchisee may indirectly breach this covenant.

Matthew J. Soroky is an attorney in our Franchise and Distribution Practice Group.

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