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Licensing, Technology Transfers,
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As so many franchise systems are perceived to be of degraded value due to life cycle stage, poor franchise system support or management, and especially attempts by franchisors to raise royalties and reduce benefits every time a franchise agreement comes up for renewal, franchiseesÕ desire to leave the system and go independent increases. Often it is only the threat to put them out of business by enforcement of the post termination covenant not to compete that keeps them bound to the franchise. My review of the cases in which such covenants have been enforced tells me that lawyers for franchisees in many situations simply do not understand how to conduct litigation to overcome such covenants. Frequently, a lawyer representing a franchisee will not have much experience dealing with unfair competition issues, which is essentially what a covenant not to compete case is all about. And so, many highly relevant avenues of probative evidence are simply never recognized and never pursued.
If you are a franchisee with this kind of problem, and you do not have access to a lawyer with a great deal of experience dealing with covenants not to compete, you may refer your attorney to this guide for assistance.
The intent of this guide is to provide your attorney with a compendium of covenant issues, with some discussion of the significance of each. How to actually obtain and prepare the evidence required to prevail is another story. This tutorial assumes that, once your lawyer knows the issue and its importance, obtaining and presenting the required evidence in an admissible format is something the lawyer already knows how to do. Knowing what to look for and where to look for it and how to present it to the court is a trial lawyerÕs stock in trade. If your lawyer does not know how to do that, you need to get another lawyer.
Your franchise agreement has non-competition covenants that apply while the franchise agreement is in force and that apply in the event of termination of the agreement or its expiration without being renewed. In-term covenants are usually enforced if they have any reasonable scope at all. Post-term covenants are another matter. In some states, like California, post-term covenants not to compete in franchise agreements are unenforceable per se, by statute. One must look at the statute law in the states where your franchise is located and at the statute law in the state that the franchisor has chosen as its choice of law state. Usually a franchisor will choose the law of its home state as the law of the contract in order to have uniform construction of the contractÕs terms. Choice of law provisions are valid so long as there is some rational connection between the business being done and the state that is chosen. The exception to that rule is the instance in which the choice of law for a covenant not to compete may not conform to the public policy of the state in which its enforcement is sought. A franchisor that chooses Florida law for the covenant not to compete has a very franchisor friendly statutory enforcement rationale that may not be allowed when it is sought to be enforced against a franchisee from another state. A Florida franchisor could not obtain enforcement of a post-term covenant not to compete against a California franchisee because of CaliforniaÕs statutory prohibition of its enforcement. Neither, for instance would the covenant be construed according to Florida law in states that, though having no prohibitory statute, have a common law approach to such covenants which is very inhospitable. Texas is an example of that. In such cases the covenant may be construed by a court to be enforceable only to the extent permitted by that local stateÕs law, if at all. In some states the courts will not rewrite the covenant to make it reasonable. Each stateÕs law must be analyzed to arrive at the proper approach to trying the case.
Even in states where covenants not to compete are frowned upon, a covenant in an agreement to buy or sell a business is usually enforced if its temporal scope is reasonable. The purchase and sale of a business is viewed differently from the end of a franchise term, as the seller is deemed to have been compensated by the selling price for the period of proscription of the covenant not to compete.
Covenants not to compete are solely to prevent unfair competition. If the departing franchisee can be shown to have and to be in danger of using the franchisorÕs "proprietary" operating system, which could not have been obtained without having been the franchisee of that franchisor, a court may find that it would be an unfair competitive imposition upon that franchisor and its other franchisees to permit the departing franchisee to continue to operate independent of the franchise obligations while having that advantage. The burden is almost always upon the party seeking to enforce the post term covenant not to compete to show that there is a proper basis for its enforcement
The mere fact that your franchise agreement contains a post term covenant not to compete and that you signed the contract are not enough of a basis for its enforcement. Any agreement to limit competition is inherently against the public policy of practically every state, and requires for its enforcement the showing of a need to prevent unfair competition. Unfair competition may consist of the departing franchiseeÕs having a competitive advantage that would be unfair to the franchisor and to the franchisorÕs other franchisees to permit the departing person to retain without being a member of that franchise system. The usual standard of proof for obtaining an injunction to enforce the covenant is that the party seeking the injunction must show a potential for great harm if the covenant is not enforced. Just how great that harm must be will vary from case to case. If the harm cannot reasonably be compensated by a money award, or if the harm cannot be eliminated by some form of injunctive relief short of putting someone out of business, the covenant will probably be enforced by the issuance of an injunction.
It is critical, therefore, that evidentiary issues going to the issue of unfair harm to the franchisor and its other franchisees be fully understood and that evidence relating to them be obtained and presented in an admissible format. For example, if the harm is that the franchiseeÕs building appearance (trade dress) is so distinctive that the public will tend to believe the franchisee continues to be affiliated with that franchise system just from the look of it, regardless of what the sign out front says, changing the look of the building would tend to alleviate the harm, making it unnecessary to put the former franchisee out of business in order to prevent the harm.
In the usual franchise setting, the franchisor will have sold the franchisee training and system operations support as part of the franchise transaction. Each franchisor claims that its operating system and its programs are "proprietary", unique to that franchise system and not available anywhere else. The argument goes that it would be unfair to permit the departing to go out as an independent possessed with such knowledge and compete against other franchisees of that franchisor. This argument assumes that the knowledge is indeed unique and that it is of substantial competitive advantage. These claims must be attacked if the covenant is to be overcome.
An important factor in this context is the age of the franchise system and the maturity of the business that is the subject of the franchise. In the case of mature businesses, the technology has become known and there are other franchised and many non-franchised competitors in it. There may also be a trade association that specializes in that very business. An example of this is the printing business. There are many print shop franchises. There are also thousands of independent print shops. There is the National Association Of Quick Printers (NAQP). There are several manufacturers of printing equipment. The association has its own training and resources library. Much of what any printing franchisor has by way of so-called "proprietary" information that it gave or sold to its franchisees is readily available from the NAQP. This is just one example. Many businesses that have been around for a long time have similar characteristics. If the business that is the subject of the covenant not to compete dispute has been around for a long time, these characteristics of the business provide abundant material of seriously valuable evidentiary significance. Even though specialized training and system support may at one time have been of special competitive value, in this stage of a businessÕs life cycle, the information has probably long since come into the public domain. As it can be had from several different sources, it can be shown that the franchisorÕs information and system have become generic to the trade and no longer justify enforcement of a covenant not to compete. Many companies have equivalent information, and the large number of competitors out there competing effectively without franchise affiliation is evidence of this. If others are out there competing with equivalent systems and information, your having it as an independent does not represent unfair competition which should be prevented by enforcing a covenant not to compete.
To the extent that thousands of businesses are out there competing for the same business, or maybe dozens or hundreds in the franchiseeÕs market area, the elimination of one ex-franchisee competitor will not provide any competitive protection for the franchisor or for that franchisorÕs other franchisees. It is the "drop in the bucket" theory. One drop more or less in a large bucket does not have any measurable effect that would justify taking someoneÕs business away.
In older businesses, franchisors tend to buy up competing chains and to make available to them all the training, expertise and support that they claimed was specific to this franchise when they sold it to you. If your franchisor, having acquired competing businesses in your market, is sharing that information with them and permitting them to use it to compete against you, there cannot really be said to be danger of unfair competition if you go independent. This is especially so if the acquired franchisees have stores in your market area. Where franchisors have done this, there is ample evidence of the "proprietary" information no longer being specific to your franchise.
Another avenue of attack exists where the franchisor has failed to enforce covenants not to compete against other departed franchisees. Where that has happened and the franchisor cannot be shown to have lost franchisees or suffered any enormous loss of business because of it, it probably cannot be shown that there would be enormous negative consequences if you were not put out of business. The covenant should not be enforced under such circumstances. Where the franchisor has a history of settling covenant not to compete cases for substantial cash consideration, that shows that the enforcement of the covenant is not to prevent unfair competition, but to extract large settlements in the litigation opportunity that the covenant presents. Such is not the stuff of which covenant enforcement is made.
Where the franchisor continues to sell franchises in a state like California, where post term covenants not to compete are not enforceable, and the California franchisees are not being put out of business by departed franchisees using the knowledge they obtained while they were franchisees, that is very strong evidence that significant harm from unfair competition is not even expected by the franchisor. The franchisorÕs system rolls right along where no covenant enforcement is available. Its enforcement is not, therefore, anything to justify taking someoneÕs business away.
Does the franchisor require its franchisees to make their employees who use the "proprietary" information sign confidentiality agreements and agree to covenants not to compete in their employment arrangements with the franchisees. As such persons change jobs regularly, taking this information with them willy nilly, it can hardly be said that the information remains "proprietary" and that a business must be shuttered to protect it. In most cases the franchisor has not even made its own employees sign covenants not to compete, or pursued them with covenants enforcement when they left to go to work for someone else in the industry. Just how seriously the franchisor protects the "uniqueness" or claimed "proprietary" nature of such information in the context of its running of its own business is compelling evidence of lack of need for covenant enforcement.
Where franchisees of this franchisor have to be responsive to competitive behavior on the part of others in the business, such as pricing, delivery and other aspects of customer service, and there has been significant price competition with its margin eroding effects, it can be shown that no matter what the franchisor claims the competitive significance of its information to be, it does not confer any meaningful advantage in insulating anyone from the vicissitudes of normal market forces. It just isnÕt that special. Is the franchisor competing with its own franchisees through e-commerce? If so, that competition is no more unfair to its franchisees than their independent competition would be to the franchisor after they leave the system. It may be perfectly lawful for the franchisor to compete via the internet with its franchisees. However, the issue of the unfair competition status of post term competition by a departed franchisee is not the same issue. The argument is that the former franchiseeÕs doing business with its knowledge obtained from the franchisor is no more unfair in the unfair competition sense than the franchisorÕs competing against its own franchisees using that same knowledge. Is the franchisor selling the products or services that are the subject of the franchise through unfranchised channels of trade? Are the things that used to be "exclusive" to the franchisees now showing up in supermarkets and discount stores? Where the franchisor has done an end run around the franchisees in this manner, a court can readily understand that the "proprietary" identification value of the name and the products and services has been destroyed. Businesses are not forced to close in these situations. While such conduct may not excuse breach of contract by the franchisee that terminates the agreement before its term has run out, it probably would, and certainly should, prevent enforcement of a post term covenant not to compete.
The franchisorÕs situation is not the only focus of attention in covenant not to compete enforcement matters. Essentially, you have a franchisee who chose to sign an agreement with a covenant not to compete contained in it, who is asking that he not be bound to what he signed. That is, in contemplation of common law principles, and in the practice of judging, an unusual request to say the least. If the franchisee can be shown to have engaged in unfair competition already, since the end of the franchise term, that will count very severely against the franchiseeÕs position.You can be sure that, on the day after the franchise term ends, agents of the franchisor will be calling the franchiseeÕs business to see whether they are still using the franchisorÕs name. "Is this the Acme Auto Shop?" If the answer is "Yes we are", that franchisee is violating the franchisorÕs rights. If there is any signage or paperwork on the premises with the franchisorÕs name on it, anything at all, that is a violation of the franchisorÕs rights and an act of unfair competition on the part of the former franchisee. The non-renewing franchisee must assure that on the last day of the franchise term the signage is completely changed; the business paperwork is completely changed to the new business name; the telephone is answered in the new business name, and the person on the phone, when asked if this is an Acme shop, states clearly that it is no longer an Acme shop but the [new name] shop. If they are asked if they used to be an Acme shop, they can say yes. If they are asked if they still do auto repair, they can say yes. If they ask whether there has been a change of ownership, the true answer should be given.
This is an absolute requirement. No ifs. No ands. No buts. Either do it right or suffer the consequences. If the former franchisee is infringing upon the franchisorÕs name, not reporting, not paying royalties, not complying with the franchise agreement, non-renewing, he is misappropriating the franchisorÕs property and the court will treat him like someone who has been shown to be willing to take what is not rightfully his. Also, the operations manual must have been sent back to the franchisor on the last day of the term, with no copies retained. The operations manual is universally recognized to be the exclusive property of the franchisor. The franchise agreement says that it is the franchisorÕs sole and exclusive property. There is no right to keep it or to copy any part of it. In a rare case it has been shown that the franchisor himself purloined the manual from another company in the same business, but that is not likely to be provable and very expensive even if proofs are out there somewhere.
There is a problem with telephone listings in the white and yellow pages and in the metro and suburban phone books. They do not all change on the same dates, and certainly not on the date on which the franchisee changes his business identity. Moreover, the deadlines to get in the new books under oneÕs new name are substantially in advance. A franchisee coming up on the end of his franchise term and contemplating non-renewal must take steps to get the listings changed at the earliest possible moment. In some cases the court will allow a former franchisee to continue using the numbers presently in the phone books under the franchisorÕs name until the new books come out, if the franchisee has been shown to have done everything humanly possible to prevent any post term use of the franchisorÕs name and has done it all by the numbers and by the book. Any deviation from the correct and prompt actions required endangers the telephone listings and the numbers that go with them. To be on the safe side, arrangements should be made to have new numbers listed for the new business name in the next editions of the phone books. In that way, even if the worst happens, there are listings for that business. It is better than no listings at all.
It is at times like this that any bad history of the franchisee will be trotted out to try to show that the former franchisee is undeserving of any consideration. If there has been any under reporting of sales, that is evidence of serious dishonesty, and it may be considered by the court in making its decision. In times like these, one does reap what has been sown. Dirty tricks always come to light, and they weigh heavily upon equity issues.
Covenants must be limited to a period of time and a narrow geographic scope sufficient only to allow the franchisor to recover and protect its name in the market area where the former franchisee operated. Some covenants in franchise agreements provide for proscription for a period of a year or two within a stated number of miles of the franchiseeÕs former location plus the same distance from the locations of any other franchisee of that franchisor. The usual range is two years and from five to ten miles, but there is substantial variance. One school of drafting teaches that if the law of the state of covenant construction is such that the court will rewrite the covenant that is overly broad, it pays to make it decidedly over broad, as there would be little risk of its being thrown out altogether. A court of equity may, however, react rather inhospitably to such an artifice if it is made aware that cynical opportunism is at work on the part of the franchisor. No opportunity to bring such an occurrence to the courtÕs attention should be missed if that is really what you are dealing with.
One excellent test of the reasonableness of the geographic scope of a covenant is whether the prohibited area of operation is larger than the area of exclusivity that the franchisee enjoyed during the franchise term. There is no reason to provide more space to protect other franchisees of that franchisor than the franchisor decided was necessary to protect the same interests of the departing franchisee. Where the franchisor has no other franchisees in the area of the departing franchisee, it should be argued that the franchisor has no competitive interest to protect through enforcement of the covenant not to compete, as there are no other franchisor affiliated establishments there that could be harmed. Franchisors will claim that they are unable to locate another store in the area because of the departed former franchisee's continued presence. This should be challenged constantly, right up to trial, as a franchisor may direct prospects away from that area for fear that the prospectÕs success there would destroy the franchisorÕs argument that there is danger of harm from unfair competition.
Again,there is a potential avenue of attack where the franchisor competed with the franchisee via e-commerce or through encroachment with other franchisor affiliated locations during the term of the agreement. To be sure, there have been cases in which encroachment was permitted when the franchisor acquired a competing chain of stores, some of which sat cheek by jowl along side those of the acquirerÕs existing franchisees. But those cases involved a dispute about the acquisition itself being a violation of the franchiseesÕ rights of territorial exclusivity, not the enforcement of covenants not to compete. This is an important distinction, as franchisors will always cite such cases for the proposition that the acquisition was lawful and nothing improper was at hand. Franchisors will also rely upon employment contract covenant not to compete cases, and these too should be distinguished for the court. Employment cases usually involved the departing employee having the employerÕs customer lists and an issue of unfair advantage because of that. In a franchise case, the customers are customers of the franchisee, not the franchisor.
It is frequently the case that, if a franchisor has not been able to obtain a preliminary injunction to enforce the covenant during the time before the case comes up for trial, the franchisor will claim that the proscriptive period should be tolled during any period of non-compliance. If that argument is accepted, a two-year covenant could end up running for four years while busy court dockets keep your case from being heard. This represents unfair uncertainty to the franchisee, as during that interim period the franchisor, if it was diligent, could have re-established another franchisor-affiliated store in that area. Largely for this reason, courts are reluctant to take that route. Where they have done so is in cases in which tolling during periods of non-compliance was actually provided for in the franchise agreement.
Many franchise agreements provide that upon termination or expiration of the franchise without renewal, any premises lease that the franchisee is operating in will be assigned to or assumed by the franchisor. If the franchisor has any snap, the consent of the landlord to assignment of the lease to the franchisor was obtained in the lease when it was originally signed. If not, the franchisor may not be able to get the landlordÕs consent. Landlords frequently favor a tenant who has paid promptly, otherwise been a good tenant, and who informs the landlord that he wishes to continue in occupation of the premises. The landlord should be so informed on the last day of the franchise term if the giving of landlord consent was not done when the lease was originally signed. The franchisee will be asked if the landlord was so informed, and it is crucial that the truth be told about it. The franchisor will try to make a big issue out of that, but it really is not an issue in the absence of misconduct. Premises lease assignment clauses are not treated like covenants against competition in the vast majority of cases. They are usually enforced if that is available.
No franchisee was ever "given" anything by any franchisor. The notion that "we gave him access to all our goodies and now he will use that against us" is just silly. Franchisees pay for what they get. There is no donating going on anywhere in the relationship. One should not play the game by rules set by the franchisor. It was at best an armÕs length transaction in which there was a stated term with no obligation on the part of the franchisee to renew. That non-renewal should be cause for putting someone out of business does not make any sense whatsoever. A court should be constantly reminded that only in the presence of much more than anecdotal proof of irreparable harm from unfair competition should enforcement of a post term covenant not to compete in a franchise agreement ever be considered. Franchisor counsel have the rather annoying habit of repeating the words "irreparable harm" with every breath. Such repetition is not a substitute for hard evidence, and this should not be allowed to become a mantra chanted to the court without response.
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