Franchisor's Non-Compete Upheld In New Jersey

Failure to Comply

Since September 2001, the defendant had operated various tax preparation businesses pursuant to two franchise agreements with the plaintiff JHI. Four years later, in November 2005, the defendant terminated the franchise agreements by abandoning his franchised businesses. He then began operating a competing tax-preparation business in the same location. In September 2007, the plaintiff inspected the defendant's business and determined that he continued to operate a competing business. The defendant also failed to comply with his post-termination obligations related to confidential and proprietary information.

In March 2006, JHI filed an action for breach of post-termination covenants, along with a motion for preliminary injunction. Two days later, the defendant filed for bankruptcy. The court then administratively terminated the action pending the outcome of the bankruptcy. In December 2006, the court reopened the matter.

In analyzing the summary judgment motion, the court first found that the defendant's liability was not in question. There was no dispute that he was in breach of the post-termination obligations of the franchise agreements.

Finding Similarities

The court then considered the enforceability of the covenant not to compete. Although New Jersey courts have not analyzed covenants not to compete in the franchise context, they have addressed them in both employment and sale-of-business contexts. Under New Jersey law, covenants not to compete ancillary to a sale of a business are freely enforceable and are afforded far more latitude than in employment situations. The court found that covenants not to compete in franchise agreements are similar to those that are ancillary to the sale of a business and should be analyzed similarly. Thus, the only consideration is the reasonableness of the covenant.

The court determined that the covenant not to compete was reasonable because it protected the legitimate interests of the franchisor, including protection of confidential information and customer relationships. A main purpose for the covenant was to ensure that the franchisee's customers would be transferred to other JHI franchisees after termination. The covenant was also reasonable in duration and geographic scope and, therefore, imposed no undue hardship on the defendant.

Finding that the post-termination covenants were enforceable and were breached by the defendant, the court concluded that the franchisor was entitled to a permanent injunction. As further support for the injunction, the court noted that an injunction was the only available remedy because the franchisor's claims for damages had been discharged in bankruptcy. Although the 24-month term of the non-compete covenant was triggered when the franchisee abandoned the franchise in November 2005, the court recognized that the defendant frustrated JHI's ability to obtain injunction relief earlier by filing for bankruptcy. Therefore, the court found that equity required that the covenant be extended to run for 24 months beginning with the date the defendant began complying with it.

Cynthia M. Klaus is an attorney at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392.

A franchisor of tax preparation franchises was entitled to a 24-month injunction beginning from the time of the former franchisee's compliance with a non-competition covenant. Jackson Hewitt Inc. v. Childress, Bus. Franchise Guide (CCH) ' 13,849 (D. N.J., Jan. 22, 2008). The permanent injunction was ordered when the court granted the plaintiff franchisor's motion for summary judgment.

Terms of Agreements

The franchise agreements obligated the defendant franchisee to comply with certain post-termination covenants, including covenants not to compete and not to use the franchisor's confidential and proprietary information. Under the covenant not to compete, the defendant agreed that for a period of 24 months after termination, he would not 'directly or indirectly prepare or electronically file individual tax returns, teach tax courses, offer Bank Products, or own, engage in, operate [or] manage … a Competing Tax Business … within the Territor[ies] or within an area ten (10) miles outside the boundaries of the Territor[ies].' The confidentiality provision required that after termination, the franchisee would return all trade secret, confidential, and proprietary information. Lists of customers of the franchised businesses were specifically set out as the franchisor's confidential and proprietary information.

Failure to Comply

Since September 2001, the defendant had operated various tax preparation businesses pursuant to two franchise agreements with the plaintiff JHI. Four years later, in November 2005, the defendant terminated the franchise agreements by abandoning his franchised businesses. He then began operating a competing tax-preparation business in the same location. In September 2007, the plaintiff inspected the defendant's business and determined that he continued to operate a competing business. The defendant also failed to comply with his post-termination obligations related to confidential and proprietary information.

In March 2006, JHI filed an action for breach of post-termination covenants, along with a motion for preliminary injunction. Two days later, the defendant filed for bankruptcy. The court then administratively terminated the action pending the outcome of the bankruptcy. In December 2006, the court reopened the matter.

In analyzing the summary judgment motion, the court first found that the defendant's liability was not in question. There was no dispute that he was in breach of the post-termination obligations of the franchise agreements.

Finding Similarities

The court then considered the enforceability of the covenant not to compete. Although New Jersey courts have not analyzed covenants not to compete in the franchise context, they have addressed them in both employment and sale-of-business contexts. Under New Jersey law, covenants not to compete ancillary to a sale of a business are freely enforceable and are afforded far more latitude than in employment situations. The court found that covenants not to compete in franchise agreements are similar to those that are ancillary to the sale of a business and should be analyzed similarly. Thus, the only consideration is the reasonableness of the covenant.

The court determined that the covenant not to compete was reasonable because it protected the legitimate interests of the franchisor, including protection of confidential information and customer relationships. A main purpose for the covenant was to ensure that the franchisee's customers would be transferred to other JHI franchisees after termination. The covenant was also reasonable in duration and geographic scope and, therefore, imposed no undue hardship on the defendant.

Finding that the post-termination covenants were enforceable and were breached by the defendant, the court concluded that the franchisor was entitled to a permanent injunction. As further support for the injunction, the court noted that an injunction was the only available remedy because the franchisor's claims for damages had been discharged in bankruptcy. Although the 24-month term of the non-compete covenant was triggered when the franchisee abandoned the franchise in November 2005, the court recognized that the defendant frustrated JHI's ability to obtain injunction relief earlier by filing for bankruptcy. Therefore, the court found that equity required that the covenant be extended to run for 24 months beginning with the date the defendant began complying with it.

Cynthia M. Klaus is an attorney at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392.