Court Watch

In February 2007, Restoration Dry Cleaning Network moved for a temporary restraining order and for a preliminary injunction in the Federal District Court for the Eastern District of Michigan, requesting that the court enforce the parties' noncompete agreement. In response to the motion, the defendant claimed that it was not operating a 'restoration dry cleaning business,' and therefore the terms of the noncompete agreement did not apply. The district court denied the motion, finding that the plaintiff had not demonstrated a substantial likelihood of success on the merits. Restoration Dry Cleaning Network appealed.

The Sixth Circuit considered the four factors for granting a preliminary injunction and determined that Restoration Dry Cleaning Network was entitled to the requested injunction. The court first considered the plaintiff's likelihood of success on the merits. In evaluating this factor, the court disagreed with the district court's determination that the noncompete clause was ambiguous. To find an ambiguity, the district court apparently accepted the defendant's argument that it was not operating a 'restoration dry cleaning business,' which the defendant defined as a business that specializes in restoration dry cleaning. Instead, the defendant argued, it was operating an ordinary dry cleaning business that offers restoration cleaning as just one of its many services. The Sixth Circuit did not agree that defendant's argument was a reasonable reading of the clause, and therefore did not render the clause ambiguous. The court concluded that this limited reading of the noncompete clause 'would undermine the purpose of the non-compete clause ' which is probably why Defendants have proposed it ' and would lead to absurd results.'

The court then considered the reasonableness of the noncompete clause to determine its enforceability. It noted that under Michigan law, courts examine the noncompete's duration and geographic scope, the type of activity prohibited, and
the reasonableness of the competitive business interests justifying the clause. It further noted that protecting customer goodwill and preventing the anti-competitive use of confidential information are legitimate business interests that support restrictive covenants. Because Restoration Dry Cleaning Network had a reasonable business interest in preventing its former franchisee from using the confidential information it learned as a franchisee to gain a competitive advantage, there was a strong likelihood that the noncompete clause was enforceable. Moreover, the clause was reasonable in its duration, geographic scope, and the limited type of business prohibited ' the provision of restoration dry cleaning services. Therefore, the Sixth Circuit held that the district court erred as a matter of law in finding that the plaintiff had not demonstrated a likelihood of success on the merits.

The court then considered the other three factors for a preliminary injunction ' irreparable harm to the plaintiff, potential harm to others, and the public interest. The court found that the potential loss of customers, goodwill, and fair competition constitutes irreparable harm to Restoration Dry Cleaning Network. On the third factor, it found no substantial harm to third parties if it granted the injunction. With regard to the public interest factor, it held that enforcement of contractual duties benefits the public interest.

Finally, because material facts were not in dispute with respect to the issuance of a preliminary injunction, the appellate court rejected the franchisee's argument that the district court should have held an evidentiary hearing. Where there are material facts in dispute, an evidentiary hearing is required before issuance of a preliminary injunction. Where the issuance of a preliminary injunction turns on legal issues, however, no evidentiary hearing is required. The district court found that no material facts were in dispute and properly denied an evidentiary hearing.

The Sixth Circuit held that the district court abused its discretion in denying the requested preliminary injunction. It reversed the district court's decision and remanded the case with instructions to issue the requested preliminary injunction.

Appeals Court Backs Court's Rejection of Volvo Dealer Termination

In Volvo Trademark Holding Aktiebolaget v. Clark Machinery Co., 510 F.3d 474 (4th Cir. 2007), the Fourth Circuit Court of Appeals held that a manufacturer violated the Arkansas Franchise Practices Act ('AFPA') by terminating a dealer without 'good cause.' The case involved termination of the dealer agreement between Volvo and Clark. The case had a lengthy procedural history, in which the Fourth Circuit had previously determined that the AFPA applied to Clark's case, despite a South Carolina choice-of-law provision. In that decision, the Fourth Circuit determined that the South Carolina choice-of-law provision should not be enforced because the AFPA embodied a fundamental state policy of the State of Arkansas. The case was then remanded to the district court for determination of whether Volvo possessed 'good cause' under the AFPA to terminate Clark's dealer agreement.

On remand, the district court granted summary judgment to Clark on its AFPA claim, finding that Volvo had terminated the dealer agreement without good cause. A damages trial was held, and the jury returned a verdict finding that Clark had suffered no damages. The district court denied Clark's motions for a new trial and for attorneys' fees. Volvo appealed the summary judgment decision, and Clark appealed the court's denial of its motions for new trial and for attorneys' fees.

The issue of whether Volvo had good cause to terminate the dealer agreement under the AFPA raised a question of statutory construction not previously considered by Arkansas courts. The specific question was whether the AFPA's list of eight occurrences that constitute good cause was exclusive, as found by the district court. Volvo acknowledged that none of those specific 'good cause' circumstances were present in this situation, but argued that the list is not exclusive. The Fourth Circuit agreed with the district court that the language of the AFPA is clear and that the express designation in the AFPA of eight occurrences which constitute good cause preclude any other circumstance from qualifying as good cause for termination.

Volvo next argued that under Central GMC, Inc. v. General Motors Corp., 946 F.2d 327 (4th Cir. 1991), any good cause requirement that does not allow either market withdrawals or the protection of the franchisor's business interests to constitute good cause violates the dormant commerce clause. The circumstances in Central GMC, Inc. are distinguishable from this case because Volvo terminated its entire dealer agreement with Clark, not just one product line that was part of a larger dealer agreement, as in Central GMC. The court held that there were no commerce clause concerns, and Volvo's reliance on Central GMC was misplaced. The court affirmed the summary judgment award on the issue of good cause.

Spinks Investments v. The Krystal Company

In Spinks Investments v. The Krystal Co., CCH ' 13,787 (D. S.C. Dec.
20, 2007), the U.S. District Court for the District of South Carolina enforced an arbitration provision against non-signatories of two restaurant franchise agreements pursuant to guaranty agreements. The plaintiff, Spinks Investments, Inc., had entered into two franchise agreements with the defendant franchisor in 2004 for the operation of two Krystal restaurants. At the same time, plaintiffs Steve Spinks, Jeff Spinks, and Whitney Spinks signed guaranty agreements, agreeing to be 'personally bound by … each and every provision in the Franchise Agreement.'

In April and June 2007, Spinks Investments abandoned its franchised restaurants. The defendant initiated arbitration, seeking damages for the abandonment of the two franchises. The plaintiffs then filed suit in state court in South Carolina, seeking a declaration that the guaranty agreements were void and unenforceable, the individual guarantors were not responsible for the acts of Spinks Investments, and the arbitration provision could not be enforced against them. The defendant removed the case to federal court, moved to dismiss the case, and moved to compel arbitration.

After removal, the Federal District Court for the District of South Carolina considered whether to compel arbitration. South Carolina recognizes five theories for binding non-signatories to arbitration agreements: 1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alter ego; and 5) estoppel. Because the guaranty agreements state that they were entered into 'in consideration of, and as an inducement to, the execution of' the franchise agreements and that the guarantors 'agree to be personally bound by … each and every provision in the Franchise Agreement,' the court found that the arbitration provisions in the franchise agreements had been incorporated into the guaranty agreements, making them enforceable against the non-signatory guarantors.

The plaintiffs also argued that the arbitration provision could not be enforced against them because they signed the guaranty agreements not in their individual capacity but as officers of Spinks Investments. The court rejected this argument because 'the very nature of a guaranty is to bring into existence the obligation of the guarantor in addition to the obligation of the debtor thereby sought to be secured.'

The court also considered whether the defendant had waived its right to compel arbitration by participating in the legal proceedings by removing the case to federal court and moving to change venue. The court found that these activities are not inconsistent with the defendant's desire to arbitrate and did not prejudice the plaintiffs. The defendant had not waived its right to compel arbitration, and the court granted the motion to compel arbitration and dismiss the case.

Cynthia M. Klaus is an attorney at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or (952) 896-3392.

Sixth Circuit Upholds Noncompete Injunction

A franchisee's attempt to inject ambiguity into a noncompete clause in a franchise agreement was rejected by the Sixth Circuit in Certified Restoration Dry Cleaning Network, LLC v. Tenke Corp. , 511 F.3d 535 (6th Cir. 2007). The plaintiff franchisor, Certified Restoration Dry Cleaning Network, and the defendant franchisee, Tenke Corp. and owner Stephen Dubasik, had entered into a franchise agreement in June 2002. The franchisor's business is a restoration dry cleaning system 'for cleaning smoke, water, and/or odor damaged clothing and other soft goods from insured casualties, such as house fires.' Restoration Dry Cleaning Network enters into franchise relationships with persons who already own dry cleaning establishments and want to add restoration services to their existing business. In November 2006, Restoration Dry Cleaning Network terminated Dubasik's franchise for failure to make required payments under the franchise agreement.

Shortly after the termination, Restoration Dry Cleaning Network discovered that the defendant had not discontinued all of its restoration dry cleaning services as required by the post-termination noncompete clause in the franchise agreement. The noncompete clause stated: 'For a period of 24 months from the time of expiration or termination of this Agreement, you promise not to engage ' in any [] capacity in any restoration dry cleaning business' within 25 miles of the franchised territory.

In February 2007, Restoration Dry Cleaning Network moved for a temporary restraining order and for a preliminary injunction in the Federal District Court for the Eastern District of Michigan, requesting that the court enforce the parties' noncompete agreement. In response to the motion, the defendant claimed that it was not operating a 'restoration dry cleaning business,' and therefore the terms of the noncompete agreement did not apply. The district court denied the motion, finding that the plaintiff had not demonstrated a substantial likelihood of success on the merits. Restoration Dry Cleaning Network appealed.

The Sixth Circuit considered the four factors for granting a preliminary injunction and determined that Restoration Dry Cleaning Network was entitled to the requested injunction. The court first considered the plaintiff's likelihood of success on the merits. In evaluating this factor, the court disagreed with the district court's determination that the noncompete clause was ambiguous. To find an ambiguity, the district court apparently accepted the defendant's argument that it was not operating a 'restoration dry cleaning business,' which the defendant defined as a business that specializes in restoration dry cleaning. Instead, the defendant argued, it was operating an ordinary dry cleaning business that offers restoration cleaning as just one of its many services. The Sixth Circuit did not agree that defendant's argument was a reasonable reading of the clause, and therefore did not render the clause ambiguous. The court concluded that this limited reading of the noncompete clause 'would undermine the purpose of the non-compete clause ' which is probably why Defendants have proposed it ' and would lead to absurd results.'

The court then considered the reasonableness of the noncompete clause to determine its enforceability. It noted that under Michigan law, courts examine the noncompete's duration and geographic scope, the type of activity prohibited, and
the reasonableness of the competitive business interests justifying the clause. It further noted that protecting customer goodwill and preventing the anti-competitive use of confidential information are legitimate business interests that support restrictive covenants. Because Restoration Dry Cleaning Network had a reasonable business interest in preventing its former franchisee from using the confidential information it learned as a franchisee to gain a competitive advantage, there was a strong likelihood that the noncompete clause was enforceable. Moreover, the clause was reasonable in its duration, geographic scope, and the limited type of business prohibited ' the provision of restoration dry cleaning services. Therefore, the Sixth Circuit held that the district court erred as a matter of law in finding that the plaintiff had not demonstrated a likelihood of success on the merits.

The court then considered the other three factors for a preliminary injunction ' irreparable harm to the plaintiff, potential harm to others, and the public interest. The court found that the potential loss of customers, goodwill, and fair competition constitutes irreparable harm to Restoration Dry Cleaning Network. On the third factor, it found no substantial harm to third parties if it granted the injunction. With regard to the public interest factor, it held that enforcement of contractual duties benefits the public interest.

Finally, because material facts were not in dispute with respect to the issuance of a preliminary injunction, the appellate court rejected the franchisee's argument that the district court should have held an evidentiary hearing. Where there are material facts in dispute, an evidentiary hearing is required before issuance of a preliminary injunction. Where the issuance of a preliminary injunction turns on legal issues, however, no evidentiary hearing is required. The district court found that no material facts were in dispute and properly denied an evidentiary hearing.

The Sixth Circuit held that the district court abused its discretion in denying the requested preliminary injunction. It reversed the district court's decision and remanded the case with instructions to issue the requested preliminary injunction.

Appeals Court Backs Court's Rejection of Volvo Dealer Termination

In Volvo Trademark Holding Aktiebolaget v. Clark Machinery Co. , 510 F.3d 474 (4th Cir. 2007), the Fourth Circuit Court of Appeals held that a manufacturer violated the Arkansas Franchise Practices Act ('AFPA') by terminating a dealer without 'good cause.' The case involved termination of the dealer agreement between Volvo and Clark. The case had a lengthy procedural history, in which the Fourth Circuit had previously determined that the AFPA applied to Clark's case, despite a South Carolina choice-of-law provision. In that decision, the Fourth Circuit determined that the South Carolina choice-of-law provision should not be enforced because the AFPA embodied a fundamental state policy of the State of Arkansas. The case was then remanded to the district court for determination of whether Volvo possessed 'good cause' under the AFPA to terminate Clark's dealer agreement.

On remand, the district court granted summary judgment to Clark on its AFPA claim, finding that Volvo had terminated the dealer agreement without good cause. A damages trial was held, and the jury returned a verdict finding that Clark had suffered no damages. The district court denied Clark's motions for a new trial and for attorneys' fees. Volvo appealed the summary judgment decision, and Clark appealed the court's denial of its motions for new trial and for attorneys' fees.

The issue of whether Volvo had good cause to terminate the dealer agreement under the AFPA raised a question of statutory construction not previously considered by Arkansas courts. The specific question was whether the AFPA's list of eight occurrences that constitute good cause was exclusive, as found by the district court. Volvo acknowledged that none of those specific 'good cause' circumstances were present in this situation, but argued that the list is not exclusive. The Fourth Circuit agreed with the district court that the language of the AFPA is clear and that the express designation in the AFPA of eight occurrences which constitute good cause preclude any other circumstance from qualifying as good cause for termination.

Volvo next argued that under Central GMC, Inc. v. General Motors Corp. , 946 F.2d 327 (4th Cir. 1991), any good cause requirement that does not allow either market withdrawals or the protection of the franchisor's business interests to constitute good cause violates the dormant commerce clause. The circumstances in Central GMC, Inc. are distinguishable from this case because Volvo terminated its entire dealer agreement with Clark, not just one product line that was part of a larger dealer agreement, as in Central GMC. The court held that there were no commerce clause concerns, and Volvo's reliance on Central GMC was misplaced. The court affirmed the summary judgment award on the issue of good cause.

Spinks Investments v. The Krystal Company

In Spinks Investments v. The Krystal Co., CCH ' 13,787 (D. S.C. Dec.
20, 2007), the U.S. District Court for the District of South Carolina enforced an arbitration provision against non-signatories of two restaurant franchise agreements pursuant to guaranty agreements. The plaintiff, Spinks Investments, Inc., had entered into two franchise agreements with the defendant franchisor in 2004 for the operation of two Krystal restaurants. At the same time, plaintiffs Steve Spinks, Jeff Spinks, and Whitney Spinks signed guaranty agreements, agreeing to be 'personally bound by … each and every provision in the Franchise Agreement.'

In April and June 2007, Spinks Investments abandoned its franchised restaurants. The defendant initiated arbitration, seeking damages for the abandonment of the two franchises. The plaintiffs then filed suit in state court in South Carolina, seeking a declaration that the guaranty agreements were void and unenforceable, the individual guarantors were not responsible for the acts of Spinks Investments, and the arbitration provision could not be enforced against them. The defendant removed the case to federal court, moved to dismiss the case, and moved to compel arbitration.

After removal, the Federal District Court for the District of South Carolina considered whether to compel arbitration. South Carolina recognizes five theories for binding non-signatories to arbitration agreements: 1) incorporation by reference; 2) assumption; 3) agency; 4) veil-piercing/alter ego; and 5) estoppel. Because the guaranty agreements state that they were entered into 'in consideration of, and as an inducement to, the execution of' the franchise agreements and that the guarantors 'agree to be personally bound by … each and every provision in the Franchise Agreement,' the court found that the arbitration provisions in the franchise agreements had been incorporated into the guaranty agreements, making them enforceable against the non-signatory guarantors.

The plaintiffs also argued that the arbitration provision could not be enforced against them because they signed the guaranty agreements not in their individual capacity but as officers of Spinks Investments. The court rejected this argument because 'the very nature of a guaranty is to bring into existence the obligation of the guarantor in addition to the obligation of the debtor thereby sought to be secured.'

The court also considered whether the defendant had waived its right to compel arbitration by participating in the legal proceedings by removing the case to federal court and moving to change venue. The court found that these activities are not inconsistent with the defendant's desire to arbitrate and did not prejudice the plaintiffs. The defendant had not waived its right to compel arbitration, and the court granted the motion to compel arbitration and dismiss the case.

Cynthia M. Klaus is an attorney at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or (952) 896-3392.