Franchisor 101: Call Option Claim Bends

Lewitt Hackman

A Delaware court found a yoga studio franchisee was entitled to an order requiring the franchisor to buy all of the franchisee’s yoga studios in six states. The court held the franchisor breached its contractual obligation owed to its franchisee. The failure to perform was not excused.

CorePower Yoga, LLC is a franchisor of yoga studios. It exercised the call option in the franchise agreement. This required its franchisee, Level 4 Yoga, LLC, to sell CorePower all its yoga studios operating in six states. The acquisition was stated in an asset purchase agreement (“APA”) signed in May 2019. The deal was to take place in three parts. The first part would close on April 1, 2020. As businesses began to shut down due to COVID-19, CorePower decided to delay or terminate the transaction, which the franchisee refused to do.

CorePower told all franchisees, including Level 4 Yoga, to temporarily close all studios due to COVID-19. On March 26, 2020, CorePower declared the APA was no longer valid because Level 4 Yoga repudiated the contract by closing its studios. CorePower pointed to the Material Adverse Effect (“MAE”) clause and the APA’s requirement that Level 4 Yoga continue to operate its yoga studios in the ordinary course of business. Level 4 Yoga sued CorePower for breach of the APA.

The court found Level 4 Yoga was contractually obligated to sell to CorePower and the parties structured the APA as a “one-way gate” without any closing conditions, termination rights or force majeure clause. Agreeing not to include such conditions in the APA showed the parties’ intent to close the transaction even if either party breached the APA. The court rejected CorePower’s arguments that its performance was excused because Level 4 Yoga repudiated or breached the contract, and that the APA’s purpose was frustrated. The court found Level 4 Yoga complied with CorePower’s direction to temporarily close its studios. Thus, Level 4 Yoga operated its yoga studios in the ordinary course of business when it closed them, as directed by CorePower and as mandated by state and local governments.

Franchisors should have experienced counsel advise and prepare contracts with provisions to protect the parties if a force majeure event or other circumstances make a previously negotiated deal untenable. Experienced franchise counsel can provide guidance early on when considering terms of call options in franchise agreements, and can advise on any subsequent negotiated purchase of a franchisee’s existing locations.

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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