Franchise 101: Court Remediates Damage to Restoration Franchisor; and Fitness Franchisee Exercises Poor Judgment

Franchisor 101: Court Remediates Damage to Restoration Franchisor

A federal court in Nashville granted summary judgment on breach of contract claims in favor of a damage restoration franchisor’s lawsuit with a former California franchisee.

A Servpro franchisee had a territory in Los Angeles. Servpro terminated the franchise agreement due to customer complaints, including price gouging, overbilling, excessive demolition, charges for work not performed and intimidation. The franchisee continued its business practices even after being notified of the complaints.

The franchisor sued the franchisee for violating post-term obligations, including failure to transfer client phone numbers, social media accounts and confidential company information to Servpro, and continued use of Servpro’s trademark on a van. The franchisee countersued.

The franchisee challenged Servpro’s right to terminate the franchise under a clause that let Servpro terminate if it determined in good faith that the franchisee’s actions had “a materially unfavorable effect on Servpro’s reputation.” The court dismissed this claim, holding that the contract’s plain meaning permitted Servpro to terminate.

Based on the frequency and severity of customer complaints, including threatened litigation and complaints from national and regional accounts, the court concluded Servpro adequately established reputational damage.

Next, the court looked at Servpro’s breach of contract claim for the franchisee’s failure to honor post-termination obligations, which required the franchisee to stop using the trademark, de-identify and return confidential documents. The court rejected the franchisee’s argument that its use of the van with Servpro’s logo was personal, not for business, finding that driving the van in public with the logo equated to an advertisement for services. The court granted summary adjudication for the franchisee’s failure to transfer a phone number and confidential information after the franchisee admitted breaching these requirements. The court found material issues of fact regarding another phone number and social media account allegations.

Franchisors must protect their brand’s reputation. When a franchisee’s business practices threaten the brand’s reputation, the franchisor should document complaints and request the franchisee to correct its damaging behavior. If the behavior continues and termination is necessary, the franchisor may need to rigorously police post-termination obligations of the ex-franchisee to continue to protect the brand.

Franchisee 101: Fitness Franchisee Exercises Poor Judgment

A federal court in Denver granted Fitness Together Franchise, LLC a preliminary injunction against the owner of three former franchisees, three former franchisee entities and three additional entities formed to operate a competing business at the former franchise locations in Ohio.

The non-compete provision in each franchise agreement barred the owner and any “Bound Party” from having an interest in a competing business within a three-mile radius for two years after expiration or termination of the agreements.

The franchise owner told the franchisor she intended to close her franchises and start a competing brand. When she asked the franchisor to waive the non-compete restriction, the franchisor declined. The parties later executed a termination agreement in which the franchisor agreed to reduce the non-compete term from two to one year in exchange for $48,000. The franchisee opened competing fitness studios prior to the end of one year. The franchisor sued in Colorado.

The new entities of the competing fitness studios (owned by the individual who owned the three former FTF franchisees) argued that the court lacked jurisdiction over the new entities since they were not parties to the franchise agreements. The court agreed with the franchisor, that the entities were each a “Bound Party” under the “closely related” doctrine, which provides for non-signers to be bound by a contract’s forum clause if the parties or claims are closely related to the agreement. The court also found personal jurisdiction based on successor liability, principal agency liability, and estoppel.

The court granted injunctive relief against the individual and entities of the competing fitness studios. Though Colorado law disfavors non-compete provisions, they can be enforced when reasonable, included in the agreement to protect trade secrets and limited to executives and management. The franchisor could prove the non-compete clause was violated because the former franchise owner set up new entities to run a competing fitness business at the same locations as the former FTF businesses, and the balance of harms favored the franchisor. The court noted that shutting someone’s business down was a significant harm, but the franchisee brought the problem on herself by intentionally breaching the franchise agreements and termination agreement.

Franchisees should consult a franchise attorney before taking action during or after the term of the franchise that could breach the non-compete agreement and risk the competing business being shut down by a court. It is not uncommon that a franchisee, after learning the franchisor’s system and business, tries to start a competing business, often to save payment of the royalty and advertising fees. Franchisors are aware of this risk which is part of the reason for including restrictive covenants and post-term obligations in franchise agreements.