Tag: Non-competitive

Signal 88 Security case illustrates the Challenge of Obtaining A Preliminary Injunction to Enforce a Franchise Non-Compete

August 4th, 2017

A covenant not to compete is typically included in a franchise agreement to ensure that customer goodwill, once developed in the name of franchise, is not destroyed by former franchisees. The ultimate weapon for a franchisor to enforce a covenant not to compete is obtaining a preliminary injunction against the former franchisee. However, many courts place a heavy burden on the franchisor to prove that a preliminary injunction is proper.  The recent case of Colorado Security Consultants, LLC v. Signal 88 Franchise Group,  decided in March 2017 by the U.S. District Court for the District of Nebraska, illustrates how difficult that burden can be to meet under unfavorable facts.

Colorado Security Consultants, LLC (CSC), had a three year franchise agreement with franchisor, Signal 88 Franchise Group, Inc., to provide on-site security guard services within a territory in Colorado Springs. CSC also had a right of first refusal over additional franchises to be added within a radius of Colorado Springs. At the end of the initial term, the franchisor and franchisee continued the franchise agreement on a month-to-month basis, subject to 30-day notice of termination.  Signal 88 informed CSC that another person, Rebecca Resendes, wished to enter into a franchise agreement for a territory in the right of first refusal area where CSC had developed contracts with some customers.  Resendes and CSC negotiated for several months over her either purchasing CSC’s franchise or compensating CSC for customers it had developed in her contemplated territory.  When no agreement was reached Resendes signed a direct franchise agreement with Signal 88.  After additional negotiations between CSC and Resendes failed, Signal 88 told CSC that it had to stop serving customers in Resendes’ territory and then terminated CSC’s franchise entirely.  CSC began providing security services under the name “Guardhail”, and then Signal 88 sued CSC for violation of the 2 year post termination non-compete and sought an injunction to stop it from providing any security services.

To obtain an injunction Signal 88 had to demonstrate the following: (a) without an injunction it would suffer irreparable harm greater than the harm the franchisee would suffer from its issuance; (b) it had more than 50% likelihood of demonstrating violation of an enforceable non-compete by CSC, and (c) the injunction would serve the public interest.

Signal 88 alleged that CSC was causing it irreparable harm because it “contacted Signal 88’s customers, undercut Signal 88 on price, and caused a number of customers to cancel contracts with Signal 88.” CSC responded that it did not use “any of the names or trademarks of Signal 88” nor did they use any confidential materials.  All customer contracts in the Signal 88 system are entered into in the name of the franchisor, which also does billing and collection. So if Guardhail sought to continue to serve the customers that CSC recruited for Signal 88 (as seems likely) then CSC would have had to utilize the customer contact information and likely would have made offers that were more attractive than the pricing offered under the franchise.

Nevertheless, in declining to issue a preliminary injunction, the Court determined that Signal 88 failed to show that the “harm is certain and great and of such imminence that there is a clear and present need for equitable relief,” because Signal 88 failed to show that in the harm of CSC’s actions “threatened the very existence” of Signal 88’s business. Accordingly, even if there is a loss of customers and revenue for Signal 88, money damages would still suffice without the “extraordinary” measure of a preliminary injunction.

Signal 88 also argued that failing to enforce the non-compete would cause “irreparable harm to its franchise system”, presumably by encouraging other franchisees to not renew and to flout the non-compete. The court said that Signal 88 had no evidence to back up that general supposition.  Since a preliminary injunction would effectively put CSC out of business and would moot the parties’ claims before addressing the merits of the case, including CSC’s breach of contract counterclaim, the court found that the balance of hardships heavily favored CSC.

Despite the case being heard in Signal 88’s hometown of Omaha and the franchise agreement stating that Nebraska law governed, the Court held that Colorado had a greater material interest in the franchise agreement and therefore its laws regarding non-competes applied. Under Colorado law non-compete provisions are disfavored except to protect trade secrets or if issued when selling one’s business. The Court found that the evidence presented did not demonstrate CSC’s use of Signal 88’s trade secrets with any specificity.  Moreover, CSC argued that, as Signal 88’s selling and servicing agent when dealing with the customers, its principals were Signal 88’s employees – an allegation that, if proven, would cause the non-compete being held to very strict scrutiny under applicable law.  Since that determination is fact-specific the Court would not make such a decision at the preliminary injunction stage.

It is likely that these factors heavily influenced the Court’s denial of the preliminary injunction: (a) CSC recruited and developed the Signal 88 security customers in Colorado Springs, probably through the sales efforts of its owners more than franchisor-provided marketing; (b) accordingly CSC was not provided a customer list and did not inherit a list of long-standing Signal 88 customers, so the Colorado Springs customer list was not trade secret provided by Signal 88; and (c) Signal 88 terminated its relationship with CSC, apparently without cause, and allowed new franchisee Resendes to service all of CSC’s contracts without requiring her to pay for the goodwill that CSC had developed in them.

As this case shows, absent favorable facts it is very difficult for a franchisor to obtain a preliminary injunction enforcing a non-compete. Accordingly, certain franchisors may be well-served by adding a provision requiring a former franchisee that violates a post-expiration covenant not to compete to pay 2 years’ worth of continuing franchise fees.  Such a liquidated damages provision is more easily enforced and represents a fair compromise between franchisor’s interest in retaining customer goodwill and franchisees’ interests in making sure that the franchisor’s brand and business system continue to provide value.

New California Franchise Law Provides More Rights to Franchisees, Burdens for Franchisors

May 22nd, 2016

by David L. Cahn and Jordan M. Halle

Effective for franchise agreements entered into or renewed this year, new amendments to the California Franchise Relations Act impose significant restrictions on franchisor’s termination or refusal to renew franchise agreements, increase franchisor’s post-termination obligations, and bolster franchisees’ rights to sell their franchised business. These changes make California a somewhat more risky state in which to use franchising as a growth strategy, while arguably bolstering the security of franchisees’ investments in mature brands.

Restrictions on Termination:  a franchisor must have “good cause” to terminate a franchise, and “good cause” for termination is limited to a franchisee’s failure to “substantially” comply with the lawful requirements of the parties’ franchise agreement.  Generally franchisors must provide at least 60 days, but not more than 75 days, to cure a material default.  Franchisors may still terminate for certain “serious” defaults with less than 10 days’ notice, such as failure to pay fees, abandonment, and repeated defaults.  New sanctions available to franchisees terminated or refused renewal without good cause include damages in the amount of the fair market value of the franchised business and assets, and preliminary and injunctive relief for a franchisor’s violation of the statute.  Expect plenty of litigation over whether there was “substantial” noncompliance and a “material” default by a terminated franchisee.

Post-termination repurchase obligation: California always has been a state where franchisors had to approach a decision to terminate with caution, because of a California statute that prohibits enforcement of covenants not to compete as well as case law making it difficult to collect lost future profit damages from terminated franchisees.  Now, absent certain exceptions, a franchisor must buy from the terminated franchisee all inventory, supplies, equipment, fixtures and furnishings that the franchisee had purchased due to a franchise agreement requirement – even if termination is due to the franchisee’s material default.  Any money owed by the franchisee to the franchisor may be offset against the repurchase price for such items.  Notable exceptions to the repurchase requirement are if the franchisee declined the franchisor’s renewal offer, or if the franchisor permits the former franchisee to retain control of the business location after termination.

Right to Transfer:  Franchisors now may not prevent a franchisee from selling the business’s assets or an interest in the business, except if the buyer does not meet the franchisor’s standards for new franchisees or if the franchisee and buyer fail to comply with other reasonable requirements of transfer in the franchise agreement.  The franchisor must provide the franchisee and prospective buyer with written standards by which it determines whether a prospective franchisee is acceptable, and if denying transfer approval on the basis of non-suitability must explain why the proposed buyer does not meet one or more of the standards.  Franchisors may enforce right of first refusal provisions in the franchise agreement, provided that the franchisor pays equal to or greater than the price offered by the prospective buyer.

Conclusion: The new California laws generate issues with the franchise agreement, franchisor operations, and franchisor/franchisee relations that any franchisor selling franchises in California should have reviewed and addressed by an attorney.  Please contact us for further information and advice.

Recent Franchise Non-Compete Cases Show Unpredictability of Enforcement

December 20th, 2013

Summary: Recent cases involving attempted enforcement of covenants not to compete by franchisors show the unpredictability of the results in such cases. However, careful reading of the factual circumstances of the cases also supports the adage that “bad facts make bad law.” So it behooves franchisors to check whether they have a sympathetic case on the facts when trying to enforce their non-competes.

In July 2013, in the case of Golden Crust Patties, Inc. v. Bullock, Case No. 13-CV-2241, the U.S. District Court for the Eastern District of New York “threw the book” at a recently terminated Golden Krust Caribbean Bakery & Grill Restaurant franchisee. The franchise was terminated because the franchisee was “not only selling the competitor’s products (i.e., frozen Caribbean-style patties), but were selling those products using Golden Krust packaging.” Thus, the franchisee was engaging in a classic form of trademark piracy, likely to cause harm to the brand. Despite receiving an immediate termination notice, the franchisee only stopped using the trademarks after Golden Krust filed suit. Even then, rather than adopting a new name it put up a sign reading, “Come in. We are Open. Nothing has Changed Only Our Name”; and another sign that read: “Open. Same Great Food, Same Great Service. Thanks for Your Support!!! Come Again.”

Under those circumstances, the court enjoined the former franchisee and her son, who had managed the restaurant, from continued operation of a Caribbean-style restaurant. In its order the court, acting under New York law, enjoined such operations at the former franchised location and within 4 miles of it (rather than 10 miles, as written in the contract), or within 2.5 miles of any other Golden Krust restaurant (rather than 5 miles, as written in the contract). While giving them a bit of a break on the geographic extent of the non-compete, the court overall had no sympathy for the franchisee’s arguments of harm to their livelihood, including the possibility that their landlord would not allow them to operate a different type of restaurant at the leased premises; rather, the court found that to be a harm of the former franchisee’s own making.

In September of this year, in the case of Steak ‘N Shake Enterprises, Inc. v. Globex Company, LLC, the U.S. District Court for the District of Colorado found that the franchisor had good cause to terminate and force its Denver franchisee to cease use of the trademarks, but did not find cause to enjoin the former franchisee from violating the covenant not to compete. The cause for termination was that the franchisee refused to comply with the franchisor’s demand that it offer a “$4 value menu” and instead insisted on charging higher prices. The court held that Steak ‘N Shake had good cause to terminate the franchise and enjoined continued use of the Steak ‘N Shake trademarks, trade dress and menu item names.

However, the court did not order the former franchisee to refrain from operating a similar restaurant, finding that, because the next closest Steak ‘N Shake restaurant was in Colorado Springs (about 100 miles away) and the franchisor had no prospects to open up any Denver area locations in the near future, it could not prove irreparable harm if the former franchisee continued to operate. This decision does not preclude the franchisor from seeking damages due to violation of the covenant not to compete later in this case. While not expressly stated in the opinion, it is quite possible that the court may have been swayed by the fact that Steak ‘N Shake was requiring that an enormous number of meals be offered for $3.99, which likely would mean little or no profit to the franchisee on those sales. In other words, Steak ‘N Shake had a right to insist that restaurants using its name follow its pricing demands, but if it chose to terminate on those grounds it would have to suffer repercussions.

Finally, on August 6, 2013, in the case of Outdoor Lighting Perspectives Franchising, Inc. v. Patrick Harders, the North Carolina Court of Appeals affirmed a state trial court ruling denying enforcement of a post-expiration covenant not to compete by a North Carolina based franchisor against its former franchisee in northern Virginia. In so doing, the court wrote, “During the time in which Mr. Harders operated as an OLP franchisee, entities holding OLP franchises encountered numerous problems with OLP suppliers. Since [Outdoor Living Brands] purchased [the franchisor] in 2008, numerous franchises have closed and the OLP business model has been devalued. Among other things, [the franchisor] failed to provide its franchisees with adequate support, feedback, and product innovation. Although the information provided to Mr. Harders and OLP-NVA by [the franchisor] was alleged to be proprietary, much of it was publicly available and common knowledge in the industry. Similarly, the training that Mr. Harders had received from [the franchisor] was readily available without charge in many national home improvement stores.

Once the court laid out the facts in this manner, it was obvious that it would rule against the franchisor. It did so in a fairly creative manner, seizing on the fact that the non-compete prohibited the non-renewing franchisee from engaging in a “competitive business” within any “Affiliate’s territory.” At the time of the franchise agreement, the franchisor was only involved in Outdoor Lighting Perspectives, but during the term the franchisor was purchased by OUtdoor Living Brands, which also owned the Mosquito Squad® and Achadeck® franchise systems. While the likely purpose of restricting competition with “affiliates” was to protect Outdoor Lighting Perspective businesses owned by the Franchisor’s corporate siblings, and the franchisor was not seeking to enjoin the former franchisee from competing with later-acquired affiliates in unrelated fields, the literal language of the non-compete supported an argument that it was overbroad in its geographic scope.

The court also found that the definition of a prohibited “Competitive Business” under this non-compete was overly broad. It prohibited involvement in “any business operating in competition with an outdoor lighting business” or “any business similar to the Business.” The provision’s scope could prohibit the former franchisee from operating an indoor lighting business or “obtaining employment at a major home improvement store that sold outdoor lighting supplies, equipment tor services as a small part of its business even if he had no direct involvement” in that part of the operation. The appeals court affirmed the trial court’s decision to read the provision literally and therefore refuse to enforce it in any manner, rather than entering a more limited injunction prohibiting the former franchisee from operating or managing an outdoor lighting business.

Conclusion

These court rulings demonstrate the “bad facts make bad law” truism. The Golden Krust franchisor had a sympathetic case and a franchisee acting badly; in the Steak ‘N Shake case, the parties clearly needed to go their separate ways, but the franchisor’s inflexibility persuaded the court to allow the franchisee to operate independently, at least pending a full trial; and the Outdoor Lighting franchisor, despite litigating in its “home court,” apparently had such an unimpressive franchise system that the court was unwilling to fashion an equitable remedy when confronting an overly broad non-compete. These cases should make franchisors think carefully about the situations in which they seek to enjoin competition by their former franchisees.

Talking to Your Competitors Can Be Risky

September 13th, 2011

Talking to your competitors can be risky

Criminal Price-Fixing Conspiracy Convictions Highlight Dangers

Two recent guilty pleas announced by the U.S. Department of Justice’s Antitrust Division highlight an underappreciated area of serious legal liability – price coordination in violation of the Sherman Act.

On August 24, 2011,the Justice Department announcedthe guilty plea of Great Lakes Concrete, one of four Iowa companies that sell “ready-mix concrete” for construction projects and have plead guilty to reaching agreements regarding their respective price lists and project bids and then accepting payment for those sales at prices artificially increased due to collusion. The press releaseemphasizes the maximum fine that may be imposed for the conviction, which is the greater of $100 million, twice the gain derived from the crime or twice the loss suffered by the victims of the crime. In addition, the president of Great Lakes Concrete was sentenced to serve a year and a day in prison.

On August 31, 2011, the Justice Department announced a guilty plea by a California company, Sabry Lee (U.S.A.) Inc., in “a global conspiracy to fix the prices of aftermarket auto lights.”The company is the U.S. distributor for a Taiwan producer of the auto lights, which are most commonly installed in vehicles after collisions. The alleged conspiracy was apparently between several Taiwan based manufacturers of auto lights and their U.S. distributors, who “met and agreed to charge prices of aftermarket auto lights at certain predetermined levels” and “issued price announcements and price lists in accordance with the agreements reached, and collected and exchanged information on prices and sales of aftermarket auto lights for the purpose of monitoring and enforcing adherence to the agreed-upon prices.” Executives of two of the U.S. distributor companies have pled guilty to price-fixing charges, and the second ranking officer of one of the Taiwan manufacturers was arrested in the U.S. and has been indicted.

While the press release leads one to believe that the executives in these cases knowingly intended to fix prices at artificially high levels, it is quite possible that at least some of them were not completely aware of the legal implications of their conversations. However, any communications between competing companies concerning prices are legally risky.

The Takeaway: Business people should seek pricing intelligence from customers, service providers, or independent websites — but not from direct communications with their competitors. This is particularly true for industries in which formal competitive bidding is common or in which a relatively small number of companies make a large percentage of the total sales.

Beyond that basic rule, certain types of communications and collaborationsbetween competitors are permitted and even encouraged by U.S. antitrust law. Each situation needs to be analyzed based on the particular facts and reasons for your collaborative effort.

Non-Competition Covenants May Apply to Individual Franchise Owners, Even if They Never Agree to be Bound

October 27th, 2009

In a recent case out of the Federal District for the Eastern District of Virginia, it was held that a franchise agreement’s non-competition covenant could be applied to an owner of a corporate franchisee who had not signed the franchise agreement or a personal guarantee of the franchisee’s obligations. The facts of the case make the outcome unsurprising, and highlight a rule of federal law that can serve as an important tool for franchisors facing similar situations.

 The case involved a short-lived Little Caesar’s pizza restaurant in Portsmouth, Virginia. Apparently in ongoing discussions with Little Caesar’s, an individual prospective franchisee, Ms. Ross, worked with her partner, Mr. Krever, to acquire a lease and begin building out the leased space to suit a Little Caesar’s franchise. Ms. Ross approached Little Caesar’s about Mr. Krever also becoming a party to the anticipated franchise agreement, but Little Caesar’s refused.

 Despite this refusal, Ms. Ross and Mr. Krever jointly formed Little Caesar’s VA, Inc., and Ms. Ross entered into a franchise agreement with Little Caesar’s on the corporation’s behalf. While the agreement contained provisions requiring all owners to be approved and to sign a personal guarantee, Little Caesar’s was never made aware of Mr. Krever’s ownership interest.

 The franchisee’s restaurant quickly failed and Mr. Krever took over operations, rebranding the restaurant as “Family Pizza Plus”, but continuing to use Little Caesar’s advertising and ingredients. Little Caesar’s sent a notice of default and termination to Ms. Ross, and sent multiple cease and desist notices to Mr. Krever, the unauthorized partner.

 Following Mr. Krever’s refusal to cease operations of Family Pizza Plus, Little Caesar’s sued the franchisee-entity and both owners in federal court. Among other things, the complaint sought injunctive relief to enforce the franchise agreement’s non-competition provisions against both Ms. Ross and Mr. Krever.

 The court awarded Little Caesar’s the relief sought. Despite never signing the franchise agreement or a personal guaranty, Mr. Krever was found to be subject to the franchise agreement’s non-competition provisions. The court cited two reasons for this result. First, Rule 65(d) of the Federal Rules of Civil Procedure grants federal courts the authority to issue injunctions against parties and their “officers, agents, servants, employees, and attorneys.” Second, the court held that the unauthorized partner should not be permitted to benefit from his own fraud and deception. According to the court, had Mr. Krever’s involvement been made known to Little Caesar’s, he would have been required to agree the franchise agreement’s non-competition provisions. The equities clearly favored Little Caesar’s in this case, and accordingly the court issued an order enjoining Mr. Krever from operating the Family Pizza Plus business at the former Little Caesar’s franchise location.

By: Jeffrey S. Fabian