Court Watch

Immediately after the termination, Darwich Brothers sold the assets of the business to a new company formed by Belal Darwich, Mazh, LLC, which began operating a quick oil-change business in the same location as the former franchise. At the insistence of the landlord, Darwich Brothers remained the tenant on the lease.

Victory Lane commenced a lawsuit against Darwich Brothers, Magid Darwich, Belal Darwich, and Mazh for breach of the non-compete agreement and trademark infringement, and it moved for a preliminary injunction. On the non-compete claim, the defendants argued that the competing business was owned by Belal Darwich and his new company, which were not signatories to the franchise agreement. The court quickly rejected this argument, finding that because Darwich Brothers was still the tenant on the lease and was allowing the competing company to operate at the same location, it was “connected with,” had an “interest in,” or was “assisting” a competing business in violation of the non-compete agreement. Therefore, Victory Lane was likely to prevail on its non-compete claim.

The trademark infringement claim was not based on use of the same or a similar name because Belal Darwich had changed the name of the business to “Saline Quick Lube.” Victory Lane's Lanham Act claims were based, instead, on the similarities of the logo for Saline Quick Lube to Victory Lane's trademarked logo. Defendants had continued to use a checkered flag graphic surrounding the company name, a design that has been used by Victory Lane and its franchisees for many years.

The court considered whether there was a likelihood of confusion between the two logos. Many of the eight factors for a finding of likelihood of confusion were easily met. For example, the parties conceded that the Victory Lane mark was strong and that the two businesses offered the same type of services. The court also easily determined that the businesses were likely to use the same marketing channels and that the degree of purchaser care in the oil-change business was low. Most of the likelihood of confusion analysis was spent deciding whether the logos were similar, a factor that was disputed by the parties. The court noted that it must determine whether the marks were similar enough to confuse customers and that this analysis focused on the overall impressions, and not individual features, of each logo. It found that despite the different names, the checkered flag graphic gave a similar overall look and impression.

The court also noted that it was clear the defendants knew about the Victory Lane mark before selecting their mark, which would support a claim of intentional infringement. The court concluded that the use of the checkered logo was likely to cause confusion, and Victory Lane was highly likely to succeed on its Lanham Act claims.

Franchisee Association Found to Have Standing to Sue Franchisor

Can franchisees who are subject to arbitration clauses in their individual franchise agreements bypass arbitration and proceed to court against the franchisor by banding together to form a franchisee association that becomes the plaintiff in the action? That is one of the questions raised by the recent decision in EA Independent Franchisee Association, LLC v. Edible Arrangements International, Inc., No. 3:10'cv'1489, 2011 WL 2938077, (D. Conn., July 19, 2011).

In that case, a franchisee association representing more than 170 franchisees of Edible Arrangements was seeking a declaratory judgment on behalf of its members that Edible Arrangements had violated federal regulations by failing to disclose certain relationships with designated vendors and certain fees in connection with an online purchasing system. Further, franchisees alleged that the franchisor had breached their franchise agreements, violated the implied covenant of good faith and fair dealing, and violated the Connecticut Unfair Trade Practices Act by improperly imposing new rules requiring longer hours of operation and the purchase of supplies from only certain vendors.

First, however, the court had to deal with the question raised by the franchisor on a motion to dismiss of whether the franchisee association had standing to sue the franchisor on behalf of its individual members, or “associational standing.” The U.S. District Court for the District of Connecticut applied a three-prong test. On the first element, which considers whether the members would otherwise have standing to sue in their own right, the court found in favor of the association after only a brief discussion. The franchisor had argued that the individual members of the association lacked individual standing, which would require them to show an injury that was concrete, actual, or imminent, particular to them, and traceable to the defendant's actions. However, the court found that because the action sought only a declaratory judgment, not damages, the association did not need to identify individual franchisees who had suffered specific injury as a result of the franchisor's actions. As to the franchisor's argument that there was no “redressibility” without individual injury and damages, the court found that the declaration sought by the association would specifically address the franchisor's conduct and thus meet standards for redressibility in a declaratory judgment action.

Since the defendant did not challenge that the interests the association sought to protect were “germane to the organization's purpose,” the court easily concluded that the association had met this second prong of the associational standing test.

The primary focus of the court was as to the third element of the test: providing that “neither the claim asserted nor the relief requested required the participation of individual members in the lawsuit.” Although there were at least three different versions of the franchise agreements to which the franchisees were parties, the court found that because each version contained the relevant provisions, individual franchisee participation was not required in order for the court to find in a declaratory action that the franchisor had breached the franchise agreement and the applicable law. Moreover, even though the impact of the changes mandated by the franchisor and the alleged corresponding injury caused by those changes differed among the individual franchisees, the court concluded that in an action which sought only a declaration and not damages, the association was not required to demonstrate the degree to which any individual franchisee suffered from the franchisor's actions; therefore, no individual franchisee's participation was required.

Most significantly, perhaps, the court had to address the franchisor's argument that the franchisees were subject to arbitration clauses in their individual franchise agreements and should not be permitted to circumvent their arbitration clauses by forming an association to bring suit against the franchisor. In this regard, the court found that the association had no obligation to arbitrate on behalf of its members and concluded that it did not lack standing just because its individual members were subject to arbitration clauses. Because the association only sought declaratory judgment, relief could be granted without the participation of the individual franchisees subject to the arbitration clause.

The decision, at least at this early stage of the litigation, permits the franchisee association to proceed in court to establish the case for a declaration of wrongdoing by the franchisor using only expert testimony and the franchisor's documents. If the association is successful in securing such a declaration, then, presumably, individual franchisees could proceed in arbitration with the declaratory judgment in hand. A franchisor under such circumstances could reasonably expect a proliferation of individual claims.

CA Bankruptcy Court Finds Bankruptcy Discharge Does Not Prohibit Enforcement of Non-compete Agreement

In a recent California bankruptcy case, the debtor, Steven Quattrin, was a franchisee in the Total Car Franchising system. In re Quattrin, No. 09-13410, 2011 WL 2112415, (Bkrtcy. N.D. Cal. 2011). The franchise agreement had a two-year non-compete provision after termination. The franchise agreement was terminated during the bankruptcy case. After the bankruptcy discharge, the franchisor attempted to enforce the non-compete agreement against Quattrin. The bankruptcy court did not decide whether the agreement was enforceable under California law, and considered only whether its enforcement was prohibited by the bankruptcy discharge.

The court noted that some bankruptcy courts have held that non-compete agreements cannot be enforced after a bankruptcy discharge. The Sixth and Seventh Circuit Courts of Appeal, however, have held the other way. The court did not find any Ninth Circuit opinions on this issue, and in the absence of Ninth Circuit authority, concluded it should follow other appellate courts. Therefore, it held that, to the extent the non-compete is enforceable under California state law, it was not discharged in bankruptcy. Of course, the next issue will be whether the non-compete agreement is enforceable under California state law, which will certainly be an uphill battle for the franchisor.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Pamela N. Merkle is special counsel at Larkin Hoffman, and she can be contacted at [email protected].

Franchisor Was Likely to Succeed on Non-compete Claim and Trademark
Infringement

A preliminary injunction was granted against a new oil-change business, operating in the same location as a former franchised business, based on non-compete and Lanham Act violations, despite the fact that it had not signed the franchise agreement and had changed the name of the business. Victory Lane Quick Oil Change, Inc. v. Darwich, No. 11-11786, 2011 WL 2581183 (E.D. Mich. June 29, 2011).

The dispute arose out of a franchise agreement between Victory Lane, a franchisor of quick oil-change businesses, and Darwich Brothers, LLC. Magid Darwich was the personal guarantor for the Darwich Brothers' franchise. During the term of the franchise agreement, Victory Lane learned that Belal Darwich, who was not a signatory to the franchise agreement, was operating two competing oil-change businesses. Victory Lane believed that Magid Darwich and Darwich Brothers were involved in those businesses, in violation of the non-compete agreement. Based on this and other alleged breaches, Victory Lane terminated the franchise agreement.

Immediately after the termination, Darwich Brothers sold the assets of the business to a new company formed by Belal Darwich, Mazh, LLC, which began operating a quick oil-change business in the same location as the former franchise. At the insistence of the landlord, Darwich Brothers remained the tenant on the lease.

Victory Lane commenced a lawsuit against Darwich Brothers, Magid Darwich, Belal Darwich, and Mazh for breach of the non-compete agreement and trademark infringement, and it moved for a preliminary injunction. On the non-compete claim, the defendants argued that the competing business was owned by Belal Darwich and his new company, which were not signatories to the franchise agreement. The court quickly rejected this argument, finding that because Darwich Brothers was still the tenant on the lease and was allowing the competing company to operate at the same location, it was “connected with,” had an “interest in,” or was “assisting” a competing business in violation of the non-compete agreement. Therefore, Victory Lane was likely to prevail on its non-compete claim.

The trademark infringement claim was not based on use of the same or a similar name because Belal Darwich had changed the name of the business to “Saline Quick Lube.” Victory Lane's Lanham Act claims were based, instead, on the similarities of the logo for Saline Quick Lube to Victory Lane's trademarked logo. Defendants had continued to use a checkered flag graphic surrounding the company name, a design that has been used by Victory Lane and its franchisees for many years.

The court considered whether there was a likelihood of confusion between the two logos. Many of the eight factors for a finding of likelihood of confusion were easily met. For example, the parties conceded that the Victory Lane mark was strong and that the two businesses offered the same type of services. The court also easily determined that the businesses were likely to use the same marketing channels and that the degree of purchaser care in the oil-change business was low. Most of the likelihood of confusion analysis was spent deciding whether the logos were similar, a factor that was disputed by the parties. The court noted that it must determine whether the marks were similar enough to confuse customers and that this analysis focused on the overall impressions, and not individual features, of each logo. It found that despite the different names, the checkered flag graphic gave a similar overall look and impression.

The court also noted that it was clear the defendants knew about the Victory Lane mark before selecting their mark, which would support a claim of intentional infringement. The court concluded that the use of the checkered logo was likely to cause confusion, and Victory Lane was highly likely to succeed on its Lanham Act claims.

Franchisee Association Found to Have Standing to Sue Franchisor

Can franchisees who are subject to arbitration clauses in their individual franchise agreements bypass arbitration and proceed to court against the franchisor by banding together to form a franchisee association that becomes the plaintiff in the action? That is one of the questions raised by the recent decision in EA Independent Franchisee Association, LLC v. Edible Arrangements International, Inc., No. 3:10'cv'1489, 2011 WL 2938077, (D. Conn., July 19, 2011).

In that case, a franchisee association representing more than 170 franchisees of Edible Arrangements was seeking a declaratory judgment on behalf of its members that Edible Arrangements had violated federal regulations by failing to disclose certain relationships with designated vendors and certain fees in connection with an online purchasing system. Further, franchisees alleged that the franchisor had breached their franchise agreements, violated the implied covenant of good faith and fair dealing, and violated the Connecticut Unfair Trade Practices Act by improperly imposing new rules requiring longer hours of operation and the purchase of supplies from only certain vendors.

First, however, the court had to deal with the question raised by the franchisor on a motion to dismiss of whether the franchisee association had standing to sue the franchisor on behalf of its individual members, or “associational standing.” The U.S. District Court for the District of Connecticut applied a three-prong test. On the first element, which considers whether the members would otherwise have standing to sue in their own right, the court found in favor of the association after only a brief discussion. The franchisor had argued that the individual members of the association lacked individual standing, which would require them to show an injury that was concrete, actual, or imminent, particular to them, and traceable to the defendant's actions. However, the court found that because the action sought only a declaratory judgment, not damages, the association did not need to identify individual franchisees who had suffered specific injury as a result of the franchisor's actions. As to the franchisor's argument that there was no “redressibility” without individual injury and damages, the court found that the declaration sought by the association would specifically address the franchisor's conduct and thus meet standards for redressibility in a declaratory judgment action.

Since the defendant did not challenge that the interests the association sought to protect were “germane to the organization's purpose,” the court easily concluded that the association had met this second prong of the associational standing test.

The primary focus of the court was as to the third element of the test: providing that “neither the claim asserted nor the relief requested required the participation of individual members in the lawsuit.” Although there were at least three different versions of the franchise agreements to which the franchisees were parties, the court found that because each version contained the relevant provisions, individual franchisee participation was not required in order for the court to find in a declaratory action that the franchisor had breached the franchise agreement and the applicable law. Moreover, even though the impact of the changes mandated by the franchisor and the alleged corresponding injury caused by those changes differed among the individual franchisees, the court concluded that in an action which sought only a declaration and not damages, the association was not required to demonstrate the degree to which any individual franchisee suffered from the franchisor's actions; therefore, no individual franchisee's participation was required.

Most significantly, perhaps, the court had to address the franchisor's argument that the franchisees were subject to arbitration clauses in their individual franchise agreements and should not be permitted to circumvent their arbitration clauses by forming an association to bring suit against the franchisor. In this regard, the court found that the association had no obligation to arbitrate on behalf of its members and concluded that it did not lack standing just because its individual members were subject to arbitration clauses. Because the association only sought declaratory judgment, relief could be granted without the participation of the individual franchisees subject to the arbitration clause.

The decision, at least at this early stage of the litigation, permits the franchisee association to proceed in court to establish the case for a declaration of wrongdoing by the franchisor using only expert testimony and the franchisor's documents. If the association is successful in securing such a declaration, then, presumably, individual franchisees could proceed in arbitration with the declaratory judgment in hand. A franchisor under such circumstances could reasonably expect a proliferation of individual claims.

CA Bankruptcy Court Finds Bankruptcy Discharge Does Not Prohibit Enforcement of Non-compete Agreement

In a recent California bankruptcy case, the debtor, Steven Quattrin, was a franchisee in the Total Car Franchising system. In re Quattrin, No. 09-13410, 2011 WL 2112415, (Bkrtcy. N.D. Cal. 2011). The franchise agreement had a two-year non-compete provision after termination. The franchise agreement was terminated during the bankruptcy case. After the bankruptcy discharge, the franchisor attempted to enforce the non-compete agreement against Quattrin. The bankruptcy court did not decide whether the agreement was enforceable under California law, and considered only whether its enforcement was prohibited by the bankruptcy discharge.

The court noted that some bankruptcy courts have held that non-compete agreements cannot be enforced after a bankruptcy discharge. The Sixth and Seventh Circuit Courts of Appeal, however, have held the other way. The court did not find any Ninth Circuit opinions on this issue, and in the absence of Ninth Circuit authority, concluded it should follow other appellate courts. Therefore, it held that, to the extent the non-compete is enforceable under California state law, it was not discharged in bankruptcy. Of course, the next issue will be whether the non-compete agreement is enforceable under California state law, which will certainly be an uphill battle for the franchisor.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Pamela N. Merkle is special counsel at Larkin Hoffman, and she can be contacted at [email protected].