Franchisee 101: Fitness Franchisee Exercises Poor Judgment

Lewitt Hackman

A federal court in Denver granted Fitness Together Franchise, LLC a preliminary injunction against the owner of three former franchisees, three former franchisee entities and three additional entities formed to operate a competing business at the former franchise locations in Ohio.

The non-compete provision in each franchise agreement barred the owner and any “Bound Party” from having an interest in a competing business within a three-mile radius for two years after expiration or termination of the agreements.

The franchise owner told the franchisor she intended to close her franchises and start a competing brand. When she asked the franchisor to waive the non-compete restriction, the franchisor declined. The parties later executed a termination agreement in which the franchisor agreed to reduce the non-compete term from two to one year in exchange for $48,000. The franchisee opened competing fitness studios prior to the end of one year. The franchisor sued in Colorado.

The new entities of the competing fitness studios (owned by the individual who owned the three former FTF franchisees) argued that the court lacked jurisdiction over the new entities since they were not parties to the franchise agreements. The court agreed with the franchisor, that the entities were each a “Bound Party” under the “closely related” doctrine, which provides for non-signers to be bound by a contract’s forum clause if the parties or claims are closely related to the agreement. The court also found personal jurisdiction based on successor liability, principal agency liability, and estoppel.

The court granted injunctive relief against the individual and entities of the competing fitness studios. Though Colorado law disfavors non-compete provisions, they can be enforced when reasonable, included in the agreement to protect trade secrets and limited to executives and management. The franchisor could prove the non-compete clause was violated because the former franchise owner set up new entities to run a competing fitness business at the same locations as the former FTF businesses, and the balance of harms favored the franchisor. The court noted that shutting someone’s business down was a significant harm, but the franchisee brought the problem on herself by intentionally breaching the franchise agreements and termination agreement.

Franchisees should consult a franchise attorney before taking action during or after the term of the franchise that could breach the non-compete agreement and risk the competing business being shut down by a court. It is not uncommon that a franchisee, after learning the franchisor’s system and business, tries to start a competing business, often to save payment of the royalty and advertising fees. Franchisors are aware of this risk which is part of the reason for including restrictive covenants and post-term obligations in franchise agreements.

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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