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Federal Court Rules in Favor of Colorado Franchisor and Results in Enforcement of its Post-Termination Covenants

11/12/2020

On October 16, 2020, the District Court for the District of Colorado issued a ruling in Fitness Together Franchise, LLC v. EM Fitness, LLC, 2020 WL 6119470, holding that entities controlled by former franchisees were bound by the forum selection clauses in the franchisees' terminated franchise agreements, signaling the Court's willingness to enforce specifically negotiated restrictive covenants.  

Defendant Mellinger, individually and on behalf of the affiliated defendant franchisee entities, operated three Fitness Together studios pursuant to franchise agreements, each of which contained non-competition clauses that barred Ms. Mellinger and "Bound Parties"  (e.g., directors and owners of the franchised studios, her spouse, and immediate family members) from having an interest in a gym for the restricted period. Ms. Mellinger, on behalf of herself and the affiliated defendant franchisee entities, negotiated a termination of the franchise agreements. Per the termination agreements, the clauses regarding non-competition, governing law, and dispute resolution survived the franchise agreements' termination. Despite the restrictive covenants, the defendant franchisee entities immediately formed new entities and began operating gyms in violation of the non-competition clauses. 

Fitness Together brought suit to enjoin defendants from operating the gyms, and the non-franchisee entity defendants moved to dismiss for lack of personal jurisdiction on the basis that they were not signatories to the franchise agreements. The Court enforced the forum selection clause in the franchise agreements against the non-franchisee entity defendants under the "closely-related" doctrine, whereby  "non-signatories to a contract are subject to its valid forum selection clause if they, or the claims they bring, are closely related to the contractual relationship." 

The "closely-related" doctrine has been accepted by at least five circuits outside of the Tenth Circuit, in part because it prevents parties to contracts from using evasive means to escape contractual obligations, as defendants had attempted to do here. Even though the non-franchisee entity defendants were not signatories, they had been formed by a signatory to engage in activities covered by the franchise agreements. The Court noted that not only were the non-franchisee entity defendants bound by the forum selection clause under the "closely-related" doctrine, they were also bound under the more traditional doctrines of estoppel, successor liability, and principal-agent liability. The Court also granted Fitness Together's motion for a preliminary injunction, enforcing the non-competition clauses of the franchise agreements against both the franchisee entity defendants and the non-franchisee entity defendants. 

This ruling is significant because it gives Colorado franchisors a legal roadmap to enforcing confidentiality and non-competition covenants against entities controlled by former franchisees if a former franchisee creates a new entity to operate a competing business to avoid complying with the non-compete provision.

For questions related to this case or its implications, please connect with Lynne Hanson or Niki Vinod Scwhab

ABOUT THE AUTHOR

Lynne M. Hanson

Attorney

Niki Vinod Schwab

Attorney