A Physical Jolt – When Franchise Agreements Falter

Article written by: Thomas Huthwaite    |   Thursday 4th April 2013

On 8 February 2013, gym members in Auckland were given a physical jolt recently when they found three “Club Physical” gyms completely rebranded “Jolt Fitness”.  The rebranding resulted from a falling out between Stuart Holder the sole director of Colven Botany, Colven Three Kings and Colven Westgate Limited (collectively “the franchisee”) and franchisor, Health Club Brands.

The franchisee entered into the three franchise agreements incrementally between 2009 and 2011.  On 8 February 2013, the franchisee issued notices terminating each of the three franchise agreements, claiming that Health Club Brands had failed to fulfil its contractual obligations to provide on-going business development assistance.

Health Club Brands in return accepted the termination of the franchise agreements and applied to the New Zealand High Court for an interim injunction, seeking to restrain the franchisee from conducting any health and fitness business within 5 kilometres of their previous premises.  This would mean shutting down the new gyms, despite having been rebranded as Jolt Fitness.

Restraint of trade

In its application for an interim injunction, Health Club Brands relied on restraint of clauses in each of the franchise agreements.
In return, the franchisee claimed that the restraints of trade were:

  • not properly completed because the parties failed to indicate the duration and geographical reach of the restraint;
     
  • were unreasonable; and
     
  • that the enforceability of any restraint were nullified by the Health Club Brands’ own breaches of contractual obligations

The verdict

Justice Winkelmann issued her interim decision on 7 March 2013[1].

While Justice Winkelmann acknowledged that two of the three restraint of trade clauses had incompletely indicated an appropriate duration and geographical reach, Health Club Brands could at the very least seek to enforce the provisions of another clause requiring the assignment of the lease of each of the premises.  In other words, even if the restraints were inconclusive, a separate clause provided that Health Club Brands was to be assigned the franchisee’s three leases.

In her decision, Justice Winkelmann agreed with Health Club Brands’ argument that if the franchisee were allowed to continue trading in competition with Club Physical, it would be impossible for another Club Physical franchise to be re-established in the same geographical areas.

She also considered it a reasonable assumption that, although no longer using the Club Physical brand, the franchisee would continue to trade on the goodwill of the Club Physical business body by operating from the existing premises.

Further although she was reluctant to deliberate over factual disputes at an interim hearing level, Justice Winklemann appeared to be sceptical of the merits of the franchisee’s case.

Evidence from the franchisee asserted that that Health Club Brands’ did not provide direct assistance, offering a “total lack of support”. This conflicted with other complaints of disruption caused by Health Club Brands “continuing to exert influence over the gym” through continuous site visits. Justice Winkelmann wryly observed that Health Club Brands did appear to have provided business development advice and assistance, even if the franchisee chose not to be receptive to it.

Further, the franchisee’s accusations of breach focused largely on failures to evaluate membership pricing and arguably distasteful marketing campaigns.  Justice Winkelmann quite rightly concluded that the terms of the franchise agreements did not stipulate that the franchisee held control over pricing and marketing matters. Rather the franchisee had contracted to conform to the franchise system at all times, including cooperating with the marketing strategy, and obtaining prior approval from Health Club Brands regarding any changes in membership options or prices.

The decisive stroke against the franchisee’s case was its decision to purchase two further franchises after the initial purchase. Justice Winkelmann opined that if the allegations that the franchise was dysfunctional over a three year time span were true, it would be commercially illogical of the franchisee to persevere with further expansion of such a problematic franchise.

The result was that Health Club Brands’ application was successful: the franchisee was restrained from operating a health and fitness business from each of the three premises, and from within 5km of the Three Kings premises.

The franchisee applied for a counter interim injunction order from the High Court to prevent Health Club Brands from contacting members of the rebranded Jolt Fitness gyms. Health Club Brands was able to do so only through accessing a contacts database with details collated prior to the termination of the franchise agreements. This counterclaim was dismissed by Justice Winkelmann. The franchise agreements expressly contemplated that, upon termination, the franchisee would immediate cooperate with Health Club Brands to ensure a smooth transition so as not to disrupt the customers of the business. To ensure the business transitions were effected smoothly, Justice Winkelmann considered it a practical necessity for Health Club Brands to access details of existing customers and to be free to contact them.

Further development

The day following the decision however, Justice Winkelmann granted a stay of the interim injunction, allowing the franchisee to operate Jolt Fitness gyms in the premises while the parties pursued potential settlement discussions. 

On 27 March 2013, the parties reached an amicable agreement, with Health Club Brands set to take over the leases of the franchisee’s Jolt Fitness gyms, purchase the Jolt Fitness equipment, and retain most of the Jolt Fitness staff.  Most importantly, the three gyms will be rebranded back to Club Physical.

Take home messages

The case highlights a number of important points for brand owners.  First, it is a good idea to obtain legal advice for your intellectual property agreements – particularly where they involve complex legal elements such as a franchising relationship or a restraint of trade.  This applies to those drafting an agreement as well as those entering an agreement.  If in doubt, parties should at least make a record of their shared understanding of the agreement. This can help to resolve any ambiguities in both written and oral agreements. 

Second, brand owners should remember that there are two important elements to any trade mark that is being used: (a) the legal ownership of the trade mark, and (b) beneficial ownership, or ownership of the goodwill accruing as a result of the use of the trade mark. 

More complex trade mark cases involve the separation of these elements, resulting in a situation where one party is the legal owner of the mark (here, Health Club Brands) and the other party has assisted in the accrual of goodwill by using the mark (here, the franchisee).  In this case, even though the businesses were rebranded to Jolt Fitness, there was a residual goodwill in the premises that had previously been occupied by the Club Physical gyms.  If the franchisee were permitted to trade as a health and fitness centre from the same premises, it would be misappropriating that goodwill.

Businesses generally require a substantial investment.  Both franchisees and franchisors are advised to adequately insure themselves from the risks involved in making such an investment.
 
 


[1]Health Club Brands Limited v Colven Botany Limited [2013] NZHC 428

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