Perhaps without exception, all franchise agreements contain a non-compete covenant. The covenants may vary. The covenants may prohibit you from operating a competing business or any business when you are a franchisee. And after the franchise relationship ends, you may be prohibited from operating a competing business for 1 or 2 years at the franchise location, in your area, and sometimes an even greater geographic area.
When buying a franchise and signing a franchise agreement, the thoughts center on starting and building a great franchise business. It may, however, also be time to take pause. Take time to pause and consider what I am going to do in 10 years when the franchise agreement expires. What if in 5 years, I don’t what to be a franchisee?
Covenant not compete can inhibit your future options. And, say, depending on the covenants, where the franchise business is located, what state law governs the agreement and other things. The covenants not to compete can be enforceable.
Take the case of Novus Franchising, Inc.[“Novus”] v. Superior Entrance Systems, Inc. [“Superior”]. Novus and Superior entered into a franchise agreement. Post its expiration Superior sold its business assets to 3 of its employees. The newly formed employee owned company continued to conduct business, as usual but under a different name. The former franchise provided consultation to the new company and referred customers to the new company.
What is the rub? The franchise agreement contained a non-compete provision. Franchisor sued. The court ordered the former franchisee company owners to either divest all interest and control in the on-going business or ensure that the new company did not offer any competing service. In response to the court’s order, the franchisee discontinued the consultation relationship with the new company, but continued to send business to the newly formed company. The court said this violated the “spirit” of the non-compete and ordered the former franchisee to pay the franchisor $1,000 and to stop referring business. The reaches and breath of the non-compete can be vast and imposing.
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