The right to rescind (or void) a contract is an extraordinary remedy. However, as franchise lawyers know, certain states provide franchisees a right to rescind a franchise agreement in certain situations, particularly where a franchise system fails to properly register a franchise offering in accordance with applicable state registration statutes or where the franchisor makes misrepresentations regarding the franchise offering.
When we talk with clients about the risks of rescission, we often think in monetary terms – namely the right for a franchisee to recoup its initial investment, including paid initial franchise fees and other amounts to the franchisor. The purpose of rescinding a contract is to make the wronged party whole and to put the franchisee back in the place they would have been had the franchise agreement never been executed. We often do not think about the other consequences of a rescinded franchise agreement. The recent case of C21FC LLC v. NYC Vision Capital Inc. reminds us that rescission can also result in the loss of all rights to impose restrictive covenants even where the franchisee has access to confidential, proprietary and sensitive trade secrets of the franchise system.
In the NYC Vision Capital case, the defendant franchisee opened an “Eye Man” retail optical store under a franchise agreement entered into in June 2021. The franchisor provided the defendant with a franchise disclosure document in May 2021. In the spring of 2022, the franchisee sent the franchisor a notice of rescission based on alleged misrepresentations made by the franchisor. The franchisor responded by initiating a lawsuit alleging breach of contract and breach of covenant of good faith and fair dealing. The franchisor also requested injunctive relief to prevent the franchisee from continuing to operate a competitive optical location it opened across the street two months after the franchise agreement was terminated.
The court found the franchisor would be unlikely to succeed on the merits since there was clear evidence that the franchisor failed to properly register the franchise offering in New York, which was a material violation of law. Therefore, the defendants likely validly rescinded the franchise agreement. The court explained that the franchise agreement was void, so “it is as though there was never a non-compete covenant in the first place.”
This is a reminder to franchise lawyers that when you are cautioning your would-be, accidental, start-up or even existing franchise systems about the monetary damage risks associated with franchisee rescission rights under state laws, don’t forget to include the risks of misappropriated trade secrets and confidential information as well! Remember when a franchise agreement is rescinded – all of it is rescinded, including any non-competition provisions.