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Question about franchise non compete agreements.

Scottsdale, AZ |

If an unmarried couple was interested in a franchise, and in this situation one person was going to pay cash for the business and own it, fully, while the other would become familiar with the business and manage day to day operations, while the owner continued with their regular profession, could they sell this business after a couple of years and launch a similar concept of their own, this time the business being owned by the person who was the manager of the franchise venture, not the owner, without being affected by any possible non compete agreement the owner of the franchise concept may have had to sign upon becoming a franchisee? What if they were to get married at some point in all of this? Thank you for any insight.

This question is in good faith and we are just wondering what the laws are regarding a situation like this. The scenario is completely hypothetical at this point. Interested in learning how to run a business in a particular field before launching own concept, a concept that we have already developed but would like the advantage of learning in a more controlled environment.

Attorney Answers 6

Posted

The answer partially depends on the laws in your state, but generally that is a very risky strategy, for three reasons. First, non-compete language in franchise contracts is typically very expansive, so that the restricted person would be breaching his or her contract by having ANY involvement in, or assisting with, a competitive business. Second, courts that have looked at this issue have in most instances held that the signatory to the non-compete cannot attempt to avoid the non-compete's application by trying to compete through a closely-related person. Third, and outside of the non-compete, the business owner under the circumstances you describe could be determined to have "unfairly competed" with the franchisor by using trade secrets and confidential information / methods that were obtained or learned from the former franchisor. Most states have adopted the Uniform Trade Secrets Act, and the type of activity you have described above could very well violate the UTSA.

But again, the answer to your question could change based on state law (for example, the answer could be different if you live in California). I would recommend consulting an experienced franchise attorney to help you determine your options.

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Asker

Posted

Thank you for your speedy reply and for this useful information. I appreciate it. Out of curiosity, without too much detail, as I know your time is valuable, would you describe California as more lenient in a situation like this or more stringent?

Matthew J. Kreutzer

Matthew J. Kreutzer

Posted

Broadly speaking, California law is more favorable to franchisees than are the laws of most states. When it comes to the enforcement of covenants not to compete, that is especially true. California has a statute expressing a "strong public policy" of the State that covenants not to compete will not be enforced, except in certain limited circumstances. If you would like to discuss this in greater detail, please feel free to give me a call. I would be happy to talk through your situation with you.

Asker

Posted

Thank you again for the information. Very helpful. I have saved your information in case I should decide to explore this route any further. Adding your blog to my favorites as well.

Posted

As a franchise attorney , who has actually walked the walk, owning and operating a very successful franchise, and a court-accepted, testifying franchise expert, I agree with my colleague.

I only add a common practice among franchisors is to have the manager and other employees of the franchisee sign non-disclosure (and in some cases non-compete) agreements in favor of the franchisor. Believe me, they've carefully considered this scenario, applicable law and plan accordingly.


Kevin B. Murphy, B.S., M.B.A., J.D.
Franchise Attorney & Franchise Expert
Director of Operations - Mr. Franchise
FRANCHISE FOUNDATIONS APC

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Posted

Thank you for taking the time to address my question and your valuable insight as an experienced franchise owner yourself. I was wondering whether or not a manager would be obligated to sign a non compete as well and this answers that question. Much appreciated. I do realize a company that has been successful enough to become franchised is going to have pretty intense language that restricts franchisee's from competing against them, I was just wondering where the line was at and how far such an agreement could possibly reach.

Kevin Brendan Murphy

Kevin Brendan Murphy

Posted

Saw you posted additional info. If you contact me, I can discuss a couple ideas that may be very beneficial. I prefer not to post them on a public forum like this one.

Posted

Most franchise agreements require that not only the franchisee enter into a non-compete, but all related parties, including general management of the franchisee. This is likely the case in your situation. Therefore, it is likely that the non-owner would be precluded by the non-compete as well as the owner. However, without reviewing your franchise agreement and the accompanying non-compete, it would be impossible to advise you definitively.

This response does not create an attorney-client relationship and is not intended to provide legal advice for your specific situation.

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Posted

Thank you. I appreciate you taking the time to answer my question. It seems what you describe would be the likely.

Posted

My colleagues have answered much of this for you, in terms of the content of a typical non-compete. You cannot get around the restrictions imposed by such a provision by operating through a family member, friend or other individual you know.

But there are other issues you need to be aware of. For example, the typical term of a franchise is 10 years. A significant number offer 5-year terms instead of 10, but most are still 10. So even if the non-compete clause was not an issue, you still would be locked into the franchise agreement long-term, and could not just walk away from it to start a venture of your own after only a couple of years without paying some financial price imposed by the franchise agreement.

Also, virtually every franchise imposes obligations not to use confidential trade secret information you acquire from the franchise in an unrelated venture you might undertake in the future.

In short, once you sign a franchise agreement, you are committed for an extended time period, usually 10 years. You are prohibited from taking information that is confidential and proprietary and known only to those in the franchise system and trying to use it in a similar, competing venture. And finally, in addition to these 2 other obstacles, you likely will be subject to a non-compete that is very broad and prevents you from trying to get around it.

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Posted

Neal, thank you for bringing the franchise agreement term requirements issue up. I had read about this when researching the idea but hadn't got to that point yet as I was more focused on the non compete clause. Even if there were a way to navigate around that, this would be an even bigger issue. I appreciate your insightful answer and for bringing such an important factor to my attention.

Neal Jonathan Blaher

Neal Jonathan Blaher

Posted

Glad to help. Good luck!

Posted

In general the non-competition agreements in franchise agreements (if not prohibited by state law, like California), do not apply in a transfer situation unless very specifically stated. Generally they apply "upon termination" or "non-renewal" of the franchise agreement, so this is very language specific. But keep in mind even if you are able to sell a franchised concept and start a competing business without issues from your franchisor, the fact is, your buyer will require some sort of non-compete, which is pretty standard and generally part of what the purchase price is paid for. TO deal with this, negotiate your parameters in the buy-sell agreement.This shouldn't be an issue with the Buyer if you start your competing business far enough away, or in some other manner where you do not "steel" the existing clients from the buyer. Feel free to contact me directly for more info janet@janetmartinlaw.com

The foregoing is for informational purposes only and may not be relied on as attorney-client advice.

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Posted

Very interesting. As a buyer this is one of the first things I look for but I had never even thought of it from a selling point of view. Thank you for taking the time to answer my question. Very helpful.

Janet Spiro Martin

Janet Spiro Martin

Posted

ok of course I meant "steal" haha writing too fast. Yes of course any buyer who gets any advice will want a non-complete, but stranger things have happened. You might get a buyer who doesn't think of this, but then again if you do go an set up a competing business and "steal" buyer's customers, you can be subject to a lawsuit for various things, especially if your actions are very intentional appearing. You just need to have an attorney help you correctly document all the parts of this scenario for your protection and interest. Stat with the franchise you are considering purchasing; As a franchise attorney I can tell you most of the provisions are for the benefit of the Franchisor, not you, so it is very important to have THAT document reviewed for you. Most franchise agreements require you to offer the the right of first refusal when you sell, and if THEY buy, you will never get away with competing. Some agreements don't let you sell to a 3rd party at all. Very language intensive. Sometimes the language isn't readily understandable. Trust me I have written these agreements, I know how to decipher them.

Posted

Start by considering basic contract law, where both parties to a contract understand and agree to the planned transaction (in this case a franchise agreement). If you told the Franchisor what you were planning to do, would they sign the agreement and train you in the details of their business? The answer here is a clear no! Your question makes it sound like you are trying to "hide the ball" and trick the Franchisor into something that they would not otherwise agree to. There may be more to your story than you have shared, and you may bring a great deal of value to a franchisor. If you do bring value, and you give value to the franchisor, then it makes sense to discuss how you can work WITH the franchisor not against them to achieve your goals.

I recommend working with an attorney to review your goals and any proposed transactions before you sign a franchise agreement.

Sincerely,

Wayne Carroll

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