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How Can I Protect My Franchise from Being Copied By Franchisees?

Question:

I want to franchise my business, but want to protect myself from a franchisee who tries to copy my system. Can I do that?

Answer:

Yes. Your franchise documents should contractually protect your system from renegade franchisees. But first, be reminded of our discussions of designing your franchise system. Recall that in designing your franchise system, your goal was to design a system that would create wildly successful franchisees which recognize the value of your designed franchise system because they are financially successful in operating your system. Remember that your system must be structured so that franchisees would rather purchase the system from you than open a substantially similar concept on their own.

But, even if you do everything right in the franchise system design, you may encounter a renegade franchisee. What should you do? Make sure that your franchise agreement includes a confidentiality and non-disclosure provision that prohibits the use or disclosure of your confidential information and a covenant not to compete that prohibits the franchisee from owning or operating a similar or competing business. Also, make sure that the individual investors, managers, owners, operators, officers, directors and key franchisee staff people each execute a confidentiality and non-disclosure agreement and covenant not to compete. The confidentiality and non-disclosure agreement can prevent (forever) any person who executes the agreement from disclosing or using for that person’s benefit, information of a confidential nature. The covenant not to compete can prevent that person from competing against the franchisor in a similar or competitive business for a limited period of time in a limited geographic territory.

Generally, courts will only enforce covenants not to compete if they are reasonable in geographic and business scope and are reasonable in duration. The Sixth Circuit Court of Appeals enforced a non-compete agreement that had a 2 year duration within a 25-mile radius of any franchised outlet, which limitations were found to be reasonable after the termination of the franchise agreement. See, Certified Restoration Dry Cleaning Network, L.L.C. v. Tenke Corp., 511 F.3d 535, 538-39 (6th Cir. 2007). You can be protected from renegade franchisees, so long as you document these reasonable restrictions early in the relationship.

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At Fahey Schultz Burzych Rhodes PLC, we’ve been helping municipalities, franchised businesses, employers, and more with their legal needs since 2008. We’d love to learn how we can help you, too.