Wednesday, July 28, 2010

“Technical” Violation of Minnesota Franchise Act Did Not Entitle Franchisee to Rescind Agreement

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A cleaning business franchisor’s sale of a master franchise before its franchise registration was approved—but after its application for registration had been submitted—was a "technical" violation of the Minnesota Franchise Act that did not entitle the franchisee to rescind the franchise agreement in the absence of actual fraud, a federal district court in Minneapolis has decided.

Registration Violation

The franchisor submitted its franchise registration to the state on April 19, 2007, and the state approved the registration on July 26, 2007, the court noted. However, the franchisor entered into an "expedited" version of a master franchise with the franchisee on June 4, 2007, before its franchise registration was approved.

The franchisor argued that the franchisee was not entitled to rescind the parties’ agreements because on August 20, 2007, the parties entered into new franchise and master franchise agreements that explicitly superseded the earlier agreement and that the franchisee had ratified those agreements.

Equitable defenses were available in actions for rescission under the Minnesota Franchise Act, according to the court. To avoid unjust outcomes based on technical violations, absent actual fraud, franchisees did not have an absolute right to rescind a franchise that violated the Franchise Act, the Minnesota Supreme Court held in Clapp v. Peterson (Business Franchise Guide ¶7907).

The franchisor’s registration in the current dispute was just the type of "technical violation" that concerned the Clapp court. Thus, the franchisor’s equitable defenses were available and applicable, the court held.

Noncompete Covenant

Absent rescission of the franchise agreement, the franchisor could enforce the agreement’s noncompete covenant, which restrained the franchisee from unfairly competing against the franchisor for the duration of the agreement plus two years within a 50-mile radius of the franchise location or any other franchise. The covenant’s geographical and durational restrictions were reasonable and not greater than necessary to protect the interests of the franchisor, in the court's view.

Because the noncompete covenant was valid and the requisite elements of injunctive relief were satisfied, the court granted the franchisor’s request for a preliminary injunction prohibiting the franchisee from transferring or diverting customers to any competitor of the franchisor, using the franchisor’s trademarks in association with the competing business, and otherwise violating the terms of the noncompete provision.

The decision is Bonus of America, Inc. v. Angel Falls Services, LLC, CCH Business Franchise Guide ¶14,415.

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