Why Franchisors Should be Concerned With Massachusetts HB4045
If passed in its present form, virtually all noncompete provisions in franchise agreements with franchisees located in Massachusetts could be rendered null and void.
On April 10, 2014, Massachusetts Gov. Deval Patrick proposed legislation titled “An Act to Promote Growth,” introduced as House Bill 4045. The proposed legislation is ambitious in its scope and includes provisions adopting the Uniform Trade Secrets Act in Massachusetts. Unfortunately, appended to the Uniform Trade Secret Act is language that does not appear in any other state’s version of the Uniform Act. Section 11 of the proposed Uniform Trade Secret Act includes a provision making virtually all noncompete agreements “void and unenforceable” in the state of Massachusetts.
Specifically, the proposed legislation states:
Any written or oral contract or agreement arising out of an employment or independent contractor relationship that prohibits, impairs, restrains, restricts, or places any condition on, a person’s ability to seek, engage in or accept any type of employment or independent contractor work, for a period of time after an employment or independent contractor relationship has ended, shall be void and unenforceable with respect to that restriction.
(HB4045 @ L.1239-1243)
Franchise Agreements in the Crosshairs
Most, if not all, franchise agreements state that the relationship between the franchisor and the franchisee is that of independent contractor. That puts all franchise agreements for units located in Massachusetts firmly in the crosshairs of this legislation. As with most statutes that prohibit noncompete agreements, it does include exceptions, such as: restrictions on the solicitation of other employees; solicitation of customers of the employer; nondisclosure agreements; noncompetition agreements made in connection with the sale of a business or substantially all the assets of the business; forfeiture agreements and agreements not to reapply for employment to the same employer after termination. Finally, the statute includes an exception for “noncompetition agreements outside of an employment relationship.” At first glance, most franchisors might assume that this exception would apply to their franchise agreements, which are clearly outside the employment relationship. However, Massachusetts is unique in its definition of “employees” in the franchise context.
In March 2010, a federal court in Massachusetts ruled that the franchisees of the Coverall franchise system were misclassified and were actually “employees” under Massachusetts General Laws Chapter 149, Section 148B. Awuah v. Coverall North America, Inc., 707 F. Supp. (D. Mass. 2010). (Now on appeal to the First Circuit Court of Appeals.) Recall that the judge in this case likened the business of franchising to a “modified Ponzi scheme.” While it is true that there are some unique aspects to the Coverall system, the analogy is unduly provocative when applied to the vast majority of franchisors that collect a percentage of revenue as a franchise fee. Regardless, the ruling stands for now.
Because a Massachusetts court has ruled that at least one franchisor’s franchisees are “employees,” it should give all franchisors pause to believe that the exception for “noncompetition agreements outside of an employment relationship” will protect them from the proposed ban on all noncompetition agreements in Massachusetts. To remove any doubt on this issue, the legislation includes a provision stating that “For the purposes of this section, Chapter 149, Section 148B shall control the definition of employment.” This is the same code section cited by the Awuah court to support its characterization of franchisees as employees. All franchisors with franchisees located in Massachusetts should be concerned about the proposed legislation.
Even if the bill’s prohibition was limited to bona fide employment relationships, it would eliminate a franchisee’s ability to enforce a noncompete agreement against its employees. In those situations where the franchisor is named as a third-party beneficiary of those noncompete agreements, the legislation would leave both the franchisor and franchisee vulnerable to the competitive activities of departing employees and undermine the ability to protect confidential information and operational intelligence.
To make matters worse, the proposed legislation also includes a provision making it applicable to “all contracts and agreements, including those executed before the effective date of this chapter.” If passed in its present form, virtually all noncompete provisions in franchise agreements with franchisees located in Massachusetts could be rendered null and void. This obviously would have substantial and serious consequences for thousands of current and future franchise relationships in Massachusetts.
Noncompete Prohibition’s Possible Opposite Effect
The irony of the proposed legislation is its stated objective: “to promote growth and opportunity.” While some of the bill’s other provisions relating to economic development and job training may further that objective, the noncompete prohibition could have the exact opposite effect.
Franchisors may decline to expand in Massachusetts if they are unable to protect their franchise concepts from post-termination or post-expiration competitive activities by former franchisees or their employees. Without enforceable noncompete covenants, franchisors would be training and equipping future competitors, which would limit the opportunity to maintain a presence in former franchise markets. This would be especially true for franchisors that have short-term agreements, such as five years. If a franchisee elects not to renew, the legislation proposed by Gov. Patrick would allow the franchisee to operate a directly competitive business at the same location after only five years of operation. In many instances, the franchisor will have yet to recoup its initial investment in equipping and training the franchisee. These negative consequences have the potential to diminish growth and opportunity as franchisors may decline to expand in Massachusetts in favor of other markets where the state laws do not hinder the franchisor’s ability to protect its business system after termination or expiration of the relationship.
Michael R. Gray, CFE, is an attorney with the Minneapolis-based law firm Gray Plant Mooty and co-editor of Covenants Against Competition In Franchise Agreements, 3d ed., American Bar Association, 2012. Find him at fransocial.franchise.org.