Franchisee 101: Blown Dry by the Competition

Lewitt Hackman

A Minnesota bankruptcy court granted Fantastic Sams a preliminary injunction against a former Fantastic Sams franchisee, finding the operation of four new hair salons by the former franchisee was prohibited by enforceable non-compete provisions in the parties’ franchise agreements.

Fantastic Sams entered into several franchise agreements with a franchisee for the operation of Fantastic Sams hair salons. The franchisee had solvency problems and closed two of its locations, ultimately filing for bankruptcy. As part of the bankruptcy proceeding, the franchisee requested that the court reject all of its franchise agreements, which the court agreed to do. The franchisee then began operating new hair salons at four of its prior locations under a different trademark. Fantastic Sams filed a motion for a preliminary injunction to stop the franchisee from operating the salons, arguing the franchisee’s operations violated the franchise agreements’ covenants not to compete.

The court concluded the post-termination covenants not to compete were enforceable. The court found the covenants not to compete reasonable in duration and geographic scope under Minnesota law. The franchisee could not operate a hair care business after termination of the parties’ business relationship for a period of two years from the date of termination, and within five miles of the original franchised salons or a 2.5 mile distance from any other Fantastic Sams franchise location.

The court found that “a franchisor has a just and honest purpose and a legitimate interest in protecting itself from the competition of a former franchisee operating in the same market,” and that non-competes in a business context are not disfavored and not against the public interest in Minnesota.

Franchisees should consult with counsel prior to operating a competing business after leaving a franchise system. A comprehensive review of the non-compete language in the franchise agreement, analysis of applicable law and consideration of whether to seek the franchisor’s consent to the competing business will save franchisees time and money, including defending against possible disputes by its former franchisor for breach of non-compete provisions.

EllDan Corp. v. Steele (In re EllDan Corp.), 2023 Bankr. LEXIS 1278 (Bankr. D. Minn. May 11, 2023)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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