Can I Terminate a Franchise Agreement?
February 21, 2017Franchisees that contact us frequently ask if they can close the franchise and continue operating an independent business in the same industry. The short answer in the majority of cases is, unfortunately, “no.” But with good advice from a franchise lawyer, a franchisee may be able to avoid the non-competition agreement.
Many franchisees do not realize that when they enter into their franchise agreements, they are also signing a non-competition agreement that applies both during the term of the franchise and for a period of (usually) two years after termination or expiration.
Non-competition provisions can have devastating consequences for franchisees. For example, if a franchisee is a plumber by trade and operated independently for years before signing up with a franchise, that plumber may no longer be able to practice his or her trade (for at least some period of time) following termination or expiration of the franchise agreement. In other situations, franchisors will attempt to enforce non-competes on franchisees that operate generic businesses with no discernible trade secrets.
Generally speaking, non-competition agreements can stifle competition and innovation, ultimately harming consumers. In fact, a number of studies suggest that Silicon Valley has emerged as an innovative technology hub because post-termination non-competes are generally not enforceable in California, allowing employees to move from business to business, and to start their own businesses. Nonetheless, franchisors claim that subjecting franchisees to non-competes benefits competition and protects trade secrets or proprietary information. Frankly, a simple confidentiality provision along with perhaps a non-solicitation provision, prohibiting a former franchisee from poaching employees from other franchisees, should suffice.
Unfortunately, if you own and operate a franchise, you will likely, at some point, have to deal with the implications of a post-termination or post-expiration non-compete. These non-competes vary in terms of enforceability depending on the applicable state law, but generally, they are enforceable. Therefore, it is imperative that any person purchasing a franchise take the time to understand the meaning and breadth of the non-compete in the franchise agreement that they are signing.
If you find yourself bound by a non-compete as a franchisee, it is important to discuss and consider its implications before planning an exit from the franchised business. For example, if you are upset that the franchisor failed to provide you with enough support and you want to operate independently, you cannot simply close down and start your own business – you will be subject to the non-compete in the franchise agreement.
That said, there are several ways you may be able to avoid a non-competition agreement.
- If the franchisor has defrauded you or failed to live up to its contractual obligations, you may be able to raise those claims in order to get out of the non-compete. It is important to review your franchise agreement and history of dealings with the franchisor with a franchise lawyer to see if there is a way to get out.
- Some franchisors have sloppily drafted non-competes, leaving you loopholes large enough to drive a truck through. This is not common but does come up on occasion. For example, a franchise agreement may prohibit you from engaging in a competitive business within 10 miles of any “operating” franchise. Once you close your franchise, however, you are no longer “operating” so if no other franchisee is close by, you may not have to worry about enforcement.
- There are some states that will not enforce overly broad non-competes and will refuse to re-write them to make them enforceable. Most courts will “blue pencil” an otherwise unenforceable non-compete to narrow it in scope to make it enforceable but some states refuse to do so. Thus, an overly broad non-compete may not be enforceable because non-competes are enforceable to the extent necessary to protect a legitimate business interest. If it is broader than necessary it may not be enforceable, and as noted, some courts will not revise it to make it enforceable.
- Some states generally do not enforce post-termination or post-expiration non-competes. California, for example, generally does not. Georgia used to have a law that made it difficult to enforce post-termination non-competes but that law changed several years ago and any non-compete entered into after the change of law may still be enforceable.
- Occasionally, franchisors actually lack a legitimate business interest in enforcing non-competes. This analysis will again depend on the applicable state law as well as the facts and circumstances involved, but it may be a reasonable argument for you, particularly if the franchisor lacks trade secrets and confidential/proprietary information. As franchise lawyers, we should be able to advise you on this course of action.
- You may be able to buy your way out of the non-compete. Franchisees, for example, occasionally buy their way out of non-competes by paying the franchisor the present value of royalties that would be due if the franchisee continued operating through the duration of the non-compete.
While non-competition agreements in many franchise contexts violate capitalist notions of free and fair competition among businesses, and while many franchise-related non-competes are distasteful at best, they are something that franchisees have to contend with and it is important to talk to a franchisee attorney about the implications and possible ways out of non-competes.