Tax service franchisor, H&R Block, was recently vindicated in having terminated a franchisee for violating an in-term non-compete covenant. A United States District Court granted the franchisor summary judgment in Devore v. H&R Block Tax Services. LLC.

The franchisee in this case let its office manager and prior operator of the franchised business share business space to offer tax return preparation services alongside a separate cannabis consulting business. The previous operator, Gordon Gates, agreed to a portion of the purchase price over a three-year “earn out period” and to stay on as office manager of the H&R Block until the price was paid in full. During the three years, the franchisee permitted Gates to operate “Cannabiz Accounting” from the H&R Block office. But revenue generated by Cannabiz Accounting for tax services was not reported to the franchisor. H&R Block eventually discovered the franchisee’s arrangement with Gates and initiated termination proceedings. The franchisor also demanded an accounting and payment of royalties due as a result of the breach, and the franchisee’s employment agreements of its supervisors and tax return preparers.

Gates’ relationship with the franchisee was found to be a violation of this prohibition against engaging in a competing business. The non-compete provision prohibited the franchisee from “directly or indirectly” engaging “in any business which offers any product or service the same or similar to” income tax preparation services “within 45 miles of the Franchise Territory.”

The Court rejected franchisee's argument that it did not engage in the competing Cannabiz Accounting business. Plaintiffs claimed they did not control Cannabiz Accounting, nor did they profit from the business. But the Court found that sharing the office space with a competing business definitely breached the franchise agreement with H&R Block; and that the franchisee also breached by failing to provide the accounting and employment agreements that H&R Block demanded in its termination notices.

The franchisee was not entirely without recourse. H&R Block must still defend the franchisee’s secondary claim that it tortiously interfered with the franchisee’s lease by breaking into the office to change the locks. This conduct, the Court found, was separate and distinct from H&R Block’s otherwise lawful act of termination.

A franchise agreement’s in-term non-compete covenant is typically broad enough to prohibit all forms of direct and indirect competition with the franchisor. Franchisees may be surprised to learn there are other, more subtle ways a franchisee may indirectly breach this covenant.

Devore v. H&R Block Tax Services, LLC, Case No. CV 16-946 DSF (AFMx) (C.D. Cal. Mar. 29, 2018)