Franchisor 101: Competing With a Non-Compete Covenant?

Lewitt Hackman

A federal court in Louisiana granted a preliminary injunction against a former franchisee of Liberty Tax Service for breaching post-termination covenants under a franchise agreement.

Liberty Tax entered into franchise agreements (the “Franchise Agreements”) for two territories in Louisiana. Liberty Tax provided training in franchise operations, as well as marketing and its business systems. Liberty Tax provided access to and copies of its operations manual, customer lists and other trade secrets.

The Franchise Agreements had five-year terms. They included post-termination covenants not to compete or solicit Liberty Tax customers within 25 miles of each territory for two years following termination or expiration. The Franchise Agreements required the franchisee to return the operations manual, customer lists, and all customer tax returns, files, and records on termination or expiration.

Liberty Tax terminated the Franchise Agreements in April 2019. However, the franchisee continued to operate out of one of the locations, under the name “Tax Service”, solicited prior customers for tax preparation services, and did not return the operations manual. Liberty Tax filed a complaint in 2020, for injunctive relief and damages. The parties agreed the franchisee breached one of the Franchise Agreements by continuing to operate a tax service center in the territory and using Liberty Tax customer information, including its customer lists and operations manual.

At issue was whether the two years when the franchisee prepared tax returns in a manner prohibited by the Franchise Agreements, should be credited against the two-year post-termination covenant. The franchisee argued the convent expired in April 2021, two years after the agreements were terminated. Liberty Tax argued that Virginia law governed the dispute and allows equitable extension of post-termination covenants relating to non-competition and non-solicitation. Liberty Tax argued for a two-year restriction from the date any injunctive order was issued by the court.

The court found that despite almost two years passing between termination of the Franchise Agreements and filing the complaint, Liberty Tax was entitled to a preliminary injunction. The court explained that to decline to extend the covenants an additional two years, as allowed under Virginia law, from the date of the injunctive order would reward the franchisee for breach. The court did, however, reduce the extension from two years to 20 months, because Liberty Tax waited four months after discovering the breach to file the complaint. Breaches of post-termination covenants are a common issue for franchisors. Franchise counsel can advise franchisors how state law can affect interpretation and enforcement of such covenants and recommend courses of action.

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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