Court Watch

Despite the fact that the contract did not reserve a specific right for the franchisor to terminate or not renew the agreement, about six months before the renewal term was to expire, Block gave the franchisee notice of its intent not to renew and promptly filed an action for declaratory relief to uphold its actions.

The Court of Appeal applied Missouri case law, under which an agreement in perpetuity was only to be found if the agreement was “adamantly clear” on that issue. Even though the agreement appeared to be clear that it ran in perpetuity ' i.e., it was automatically renewed unless the franchisee gave notice of termination ' the court held that such intent was best shown if the word “perpetuity” or similar terms like “eternity” or “everlasting” were used. In fact, as noted by the court, the fact that the agreement was automatically renewed every five years meant it was not in perpetuity because a contract that runs forever has no need to be renewed.

A dissenting opinion was issued pointing out that the court was effectively rewriting a contract that gave only the franchisee the right to terminate at will and limited the franchisor to terminating for cause. Further, the franchisor by so terminating was able to take advantage of the franchisee and obtain valuable material without compensating the franchisee. While a perpetual agreement imposes a burden on a franchisor, the franchisor drafted the agreement without specifically reserving a right not to renew or terminate at will. Thus, according to the dissent, the franchisor should be bound by the language it drafted.

This case is in line with other jurisdictions which support the view that perpetual agreements are against public policy and will not be presumed unless they clearly provide they will be in perpetuity. On the other hand, what about the doctrine that requires contracts to be interpreted against the drafter if there is any ambiguity? The Eight Circuit simply chose to ignore that standard and also that the contract did not give the franchisor the unfettered right to terminate.

Franchisor Strikes Out Enforcing Post-Termination, Non-Compete

In Hamden v. Total Car Franchising Corp., 2012 WL 3255598, Bus. Fran. Guide (CCH) ' 14,789 (W.D. Va. Aug. 7, 2012), a franchisee whose franchisee agreement expired sought declaratory relief with respect to the enforceability of post-termination non-compete, non-solicitation and non-disclosure agreements. After a one-day trial, the district court ruled that the bulk of these provisions did not apply because the agreement expired and was not terminated. The franchisor unsuccessfully argued that expiration meant the same as termination and cited several cases in support. In the abstract, the two terms could mean the same thing: the contract coming to an end. The district court ruled that those cases must be confined to their facts, and, in the context of the franchise agreement at issue, the two terms clearly had different meanings. For example, the post-termination non-compete provision in the franchise agreement, which was contained in a section that was headed “Rights and Duties of Parties Upon Expiration, Termination or Non-Renewal,” provided that the franchisee could not compete “for 2 years following termination of this Agreement.” The separate Non-Competition Agreement prohibited any competition during the “term” of the franchise agreement, and if the franchise agreement was “terminated” before “expiration,” the two-year ban would apply “after termination.” The non-disclosure provision was a bit different in that it prohibited disclosure of trade secrets during the “term” of the agreement and “thereafter.”

Given these various provisions, the franchisor had an uphill battle convincing the district court that they applied to post-expiration events, other than the non-disclosure provisions. The district court did not consider any argument based on the heading in the non-compete agreement that the provision was intended to encompass expiration as well as termination (and an argument can certainly be made that it shows the parties' intent to include expiration as part of termination). The court also did not refer to any provision in the franchise agreement that dealt with “expiration.” However, it is clear that in the key provisions, the parties used “expiration” and “termination” to denote different events. The court, in distinguishing the cases cited by the franchisor, also relied upon the extent that the agreement detailed how the agreement could be terminated as indicative that it had a meaning separate from expiration. It could not thus be argued that the parties were simply trying to define the “end” of the agreement by using either term.

The case is illustrative of how more careful drafting might have changed the result. In drafting franchise agreements, the draftsmen must be ever conscious of using specific terms and separately defining them. Also, it would have been easy to simply include expiration in the various provisions. While we might often think that expiration and termination mean the same thing, a court may not agree.

Franchisor's Method of Preparing Pizza Is Not a Trade Secret for Preliminary Injunction Purposes

In Little Caesar Enterprises, Inc. v. Sioux Falls Pizza Company, Inc. et al., Bus. Fran. Guide (CCH) ' 14,880 (USDC D. S. Dakota Aug. 3, 2012), Little Caesar Enterprises sought a temporary restraining order or a preliminary injunction enjoining the defendants, a former Little Caesars franchisee and its owner, from offering all-day, every-day, ready-for-pick-up pizzas on the grounds that the system for making those items constitutes a trade secret of Little Caesars. For the reasons discussed below, the motions for a TRO or a preliminary injunction were denied. While the case is somewhat fact-based and a trial on the merits is likely and may result in a different outcome, the case provides a good review of trade secret law that is instructive to franchisors who may erroneously believe that their operating system or other system aspects constitute a protectable trade secret.

The franchisee and Little Caesar Enterprises had been embroiled in various legal disputes since 2004. When the concerned franchise agreement expired after 20 years in June 2012, the franchisee changed the name of its pizza business, the recipes for its products, its product mix and certain aspects of the appearance of its store. A substantial part of its business remained the selling of all-day, every-day, ready-for-pick-up pizza, an offering substantially similar to that of Little Caesars' “Hot-N-Ready” pizzas. The Little Caesars' method for preparing all-day, every-day, ready-for-pick-up pizza determines what store operators must prepare on a daily and hourly basis and how to prepare each product so that it is ready whenever a customer arrives. Little Caesar Enterprises maintained in support of its motion to restrain the defendants from continuing to sell all-day, every-day, ready-for-pick-up pizza that its system amounted to a trade secret that was being misappropriated by the defendants.

In order to evaluate the plaintiff's motion, the court had to determine whether the plaintiff was likely to prevail on the merits, whether there was a threat of irreparable harm to the plaintiff, the balance between the threatened harm to the moving party, the harm an injunction would cause to the other parties, and whether there was a public interest that had to be protected. The most important factor, stated the court, was the likelihood that the moving party would prevail on the merits at trial. The burden of persuading the court on these issues is on the moving party.

The definition of “trade secret” under South Dakota law is that of the Uniform Trade Secret Act, an act adopted by almost all of the states. Under the Act, a “trade secret” is defined as “information, formula, pattern, compilation, program, device, method, technique or process that (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

In order to justify an injunction, the trade secret sought to be protected must be identified with specificity. Long lists of general information which may contain one or more unidentified trade secrets will not suffice. Even if information is not known to the public at large, if it is generally known within an industry it will not amount to a trade secret. In this case, Little Caesars provided information on its system for making and determining quantities of all-day, every-day, ready-for-pick-up pizza. However, the court could not determine what, if anything, in this information was not generally known in the industry. Further, Little Caesars did not show how its system had economic value other than as generally known information on how to run a pizza restaurant.

The second factor required to determine whether a trade secret exists is whether reasonable efforts were undertaken to maintain the secrecy of the alleged trade secret. In this case, Little Caesars franchisees were required to sign a confidentiality agreement covering the Little Caesars system and business practices, but the franchisees' employees, those who actually employed the system and practices, were not. As such, those with detailed knowledge of the Little Caesars system were under no duty, and made no promise, to keep confidential the information they learned on the job.

In light of the above, and after balancing the harms, which tipped in favor of the defendants who would probably have gone out of business if enjoined, the court denied the motion.

The case illustrates the problems most franchisors will face when seeking to protect their claimed trade secrets. As a practical matter, there are precious few real secrets out there, especially in food businesses. While many franchisors proclaim their system is based on valuable information unknown to others, if that contention is put to the test, most would be found wanting. Even if a trade secret or two does exist within a franchise system, protecting those secrets in a reasonable manner is essential to establish a case of misappropriation.

Charles G. Miller is a shareholder and director, and Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.

Franchise Agreement That Automatically Renews Every Five Years Is Not a
Perpetual Agreement

In H&R Block Tax Services, LLC v. Franklin, 2012 WL 3870574 (8th Cir. Sept. 7, 2012), the Eight Circuit held, under Missouri law, that the franchise agreement in issue was not a perpetual agreement and thus the franchisor could decide to terminate it and not renew. The agreement provided:

The initial term of this Agreement shall begin on the date hereof and, unless sooner terminated by Block [for cause] as provided in paragraph 6, shall end five years after such date, and shall automatically renew itself for successive five-year terms thereafter (the “renewal terms”); provided, that Franchisee may terminate this Agreement effective at the end of the initial term or any renewal term upon at least 120 days written notice to Block prior to the end of the initial term or renewal term, as the case may be.

Despite the fact that the contract did not reserve a specific right for the franchisor to terminate or not renew the agreement, about six months before the renewal term was to expire, Block gave the franchisee notice of its intent not to renew and promptly filed an action for declaratory relief to uphold its actions.

The Court of Appeal applied Missouri case law, under which an agreement in perpetuity was only to be found if the agreement was “adamantly clear” on that issue. Even though the agreement appeared to be clear that it ran in perpetuity ' i.e., it was automatically renewed unless the franchisee gave notice of termination ' the court held that such intent was best shown if the word “perpetuity” or similar terms like “eternity” or “everlasting” were used. In fact, as noted by the court, the fact that the agreement was automatically renewed every five years meant it was not in perpetuity because a contract that runs forever has no need to be renewed.

A dissenting opinion was issued pointing out that the court was effectively rewriting a contract that gave only the franchisee the right to terminate at will and limited the franchisor to terminating for cause. Further, the franchisor by so terminating was able to take advantage of the franchisee and obtain valuable material without compensating the franchisee. While a perpetual agreement imposes a burden on a franchisor, the franchisor drafted the agreement without specifically reserving a right not to renew or terminate at will. Thus, according to the dissent, the franchisor should be bound by the language it drafted.

This case is in line with other jurisdictions which support the view that perpetual agreements are against public policy and will not be presumed unless they clearly provide they will be in perpetuity. On the other hand, what about the doctrine that requires contracts to be interpreted against the drafter if there is any ambiguity? The Eight Circuit simply chose to ignore that standard and also that the contract did not give the franchisor the unfettered right to terminate.

Franchisor Strikes Out Enforcing Post-Termination, Non-Compete

In Hamden v. Total Car Franchising Corp., 2012 WL 3255598, Bus. Fran. Guide (CCH) ' 14,789 (W.D. Va. Aug. 7, 2012), a franchisee whose franchisee agreement expired sought declaratory relief with respect to the enforceability of post-termination non-compete, non-solicitation and non-disclosure agreements. After a one-day trial, the district court ruled that the bulk of these provisions did not apply because the agreement expired and was not terminated. The franchisor unsuccessfully argued that expiration meant the same as termination and cited several cases in support. In the abstract, the two terms could mean the same thing: the contract coming to an end. The district court ruled that those cases must be confined to their facts, and, in the context of the franchise agreement at issue, the two terms clearly had different meanings. For example, the post-termination non-compete provision in the franchise agreement, which was contained in a section that was headed “Rights and Duties of Parties Upon Expiration, Termination or Non-Renewal,” provided that the franchisee could not compete “for 2 years following termination of this Agreement.” The separate Non-Competition Agreement prohibited any competition during the “term” of the franchise agreement, and if the franchise agreement was “terminated” before “expiration,” the two-year ban would apply “after termination.” The non-disclosure provision was a bit different in that it prohibited disclosure of trade secrets during the “term” of the agreement and “thereafter.”

Given these various provisions, the franchisor had an uphill battle convincing the district court that they applied to post-expiration events, other than the non-disclosure provisions. The district court did not consider any argument based on the heading in the non-compete agreement that the provision was intended to encompass expiration as well as termination (and an argument can certainly be made that it shows the parties' intent to include expiration as part of termination). The court also did not refer to any provision in the franchise agreement that dealt with “expiration.” However, it is clear that in the key provisions, the parties used “expiration” and “termination” to denote different events. The court, in distinguishing the cases cited by the franchisor, also relied upon the extent that the agreement detailed how the agreement could be terminated as indicative that it had a meaning separate from expiration. It could not thus be argued that the parties were simply trying to define the “end” of the agreement by using either term.

The case is illustrative of how more careful drafting might have changed the result. In drafting franchise agreements, the draftsmen must be ever conscious of using specific terms and separately defining them. Also, it would have been easy to simply include expiration in the various provisions. While we might often think that expiration and termination mean the same thing, a court may not agree.

Franchisor's Method of Preparing Pizza Is Not a Trade Secret for Preliminary Injunction Purposes

In Little Caesar Enterprises, Inc. v. Sioux Falls Pizza Company, Inc. et al., Bus. Fran. Guide (CCH) ' 14,880 (USDC D. S. Dakota Aug. 3, 2012), Little Caesar Enterprises sought a temporary restraining order or a preliminary injunction enjoining the defendants, a former Little Caesars franchisee and its owner, from offering all-day, every-day, ready-for-pick-up pizzas on the grounds that the system for making those items constitutes a trade secret of Little Caesars. For the reasons discussed below, the motions for a TRO or a preliminary injunction were denied. While the case is somewhat fact-based and a trial on the merits is likely and may result in a different outcome, the case provides a good review of trade secret law that is instructive to franchisors who may erroneously believe that their operating system or other system aspects constitute a protectable trade secret.

The franchisee and Little Caesar Enterprises had been embroiled in various legal disputes since 2004. When the concerned franchise agreement expired after 20 years in June 2012, the franchisee changed the name of its pizza business, the recipes for its products, its product mix and certain aspects of the appearance of its store. A substantial part of its business remained the selling of all-day, every-day, ready-for-pick-up pizza, an offering substantially similar to that of Little Caesars' “Hot-N-Ready” pizzas. The Little Caesars' method for preparing all-day, every-day, ready-for-pick-up pizza determines what store operators must prepare on a daily and hourly basis and how to prepare each product so that it is ready whenever a customer arrives. Little Caesar Enterprises maintained in support of its motion to restrain the defendants from continuing to sell all-day, every-day, ready-for-pick-up pizza that its system amounted to a trade secret that was being misappropriated by the defendants.

In order to evaluate the plaintiff's motion, the court had to determine whether the plaintiff was likely to prevail on the merits, whether there was a threat of irreparable harm to the plaintiff, the balance between the threatened harm to the moving party, the harm an injunction would cause to the other parties, and whether there was a public interest that had to be protected. The most important factor, stated the court, was the likelihood that the moving party would prevail on the merits at trial. The burden of persuading the court on these issues is on the moving party.

The definition of “trade secret” under South Dakota law is that of the Uniform Trade Secret Act, an act adopted by almost all of the states. Under the Act, a “trade secret” is defined as “information, formula, pattern, compilation, program, device, method, technique or process that (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

In order to justify an injunction, the trade secret sought to be protected must be identified with specificity. Long lists of general information which may contain one or more unidentified trade secrets will not suffice. Even if information is not known to the public at large, if it is generally known within an industry it will not amount to a trade secret. In this case, Little Caesars provided information on its system for making and determining quantities of all-day, every-day, ready-for-pick-up pizza. However, the court could not determine what, if anything, in this information was not generally known in the industry. Further, Little Caesars did not show how its system had economic value other than as generally known information on how to run a pizza restaurant.

The second factor required to determine whether a trade secret exists is whether reasonable efforts were undertaken to maintain the secrecy of the alleged trade secret. In this case, Little Caesars franchisees were required to sign a confidentiality agreement covering the Little Caesars system and business practices, but the franchisees' employees, those who actually employed the system and practices, were not. As such, those with detailed knowledge of the Little Caesars system were under no duty, and made no promise, to keep confidential the information they learned on the job.

In light of the above, and after balancing the harms, which tipped in favor of the defendants who would probably have gone out of business if enjoined, the court denied the motion.

The case illustrates the problems most franchisors will face when seeking to protect their claimed trade secrets. As a practical matter, there are precious few real secrets out there, especially in food businesses. While many franchisors proclaim their system is based on valuable information unknown to others, if that contention is put to the test, most would be found wanting. Even if a trade secret or two does exist within a franchise system, protecting those secrets in a reasonable manner is essential to establish a case of misappropriation.

Charles G. Miller is a shareholder and director, and Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. They can be reached at 415-956-1900 or at [email protected] and [email protected], respectively.