Court Watch

The appellate court reviewed the trial court's denial of the plaintiff's motion for preliminary injunction for abuse of discretion. Rather than reviewing all of the factors a court must consider when deciding whether to issue a preliminary injunction, the appellate court focused on whether the plaintiff was able to show that it would suffer irreparable harm if the injunction was not granted. The appellate court cited Novus's failure to seek injunctive relief for over 17 months after the defendant stopped paying royalties as proof that any harm Novus thought it would suffer was not imminent, certain or very great. The court further questioned whether Novus's alleged potential loss of customers and customers' goodwill was truly irreparable in the sense it could not be compensated for by money damages if Novus prevailed at trial.

Novus had argued that Minnesota law presumes that irreparable harm will occur when a breach of a valid and enforceable non-compete clause occurs. In response, the defendant argued that the presumption of harm from such a breach was undermined by the United States Supreme Court in eBay, Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006), a patent case in which, the defendant argued, the principle should be applicable in all “presumption of harm” cases, such as this. The court in Novus did not reach that argument, citing its finding that actual irreparable harm was absent in the case before it.

In Outdoor Lighting Perspectives Franchising, Inc. v. Harders, et al., CCH Bus. Fran. Guide '15,104 (North Carolina Court of Appeals, Aug. 6, 2013), a franchisor of outdoor lighting products appealed the refusal of a state trial court to issue a preliminary injunction to enforce a covenant against competition in a franchise agreement that was not renewed upon its expiration by the franchisee. Following the expiration of his agreement, the former franchisee operated a lighting business that included both indoor and outdoor lighting products. He did not use the names or marks of his former franchisor.

Outdoor Lighting's franchise agreement's non-compete clause specified that that upon the termination or expiration of the agreement the franchisee promised not to have any type of interest in a “Competitive Business” within 100 miles of the franchisee's territory or the territory of any other franchisee, the franchisor or any affiliate of the franchisor. Realizing that the 100-mile restriction was probably going to be found to be excessive, the franchisor, as was allowed by the franchise agreement, unilaterally reduced the noncompetition area to the specified territories and not the additional 100-mile areas. This alteration was made on the day the motion for preliminary injunction was filed. The trial court required the defendant to return various material, manuals, customer lists, etc., to the plaintiff but refused to enforce the modified covenant not to compete.

The appellate court reviewed de novo the trial court's refusal to enforce the noncompetition covenant and focused on whether the plaintiff was likely to succeed on the merits of its case ' a key element in determining whether a preliminary injunction will issue. The initial issue was whether the court should review the disputed provision using cases dealing with covenants against competition in employment contracts or those dealing with the sale of a business, with the latter being allowed a broader scope than the former. The court recognized that it was dealing directly with neither type of transaction, but rather with a “hybrid situation” which did not fit within either the employment or the sale of business categories. As such, it elected to deal solely with the reasonableness of the restriction as between the plaintiff and the defendant in the case before it. The court stated: “[W]e conclude that the ultimate issue which we must decide in resolving such disputes among franchisors and franchisees is the extent to which the non-competition provision contained in the franchise agreement is no more restrictive than is necessary to protect the legitimate interests of the franchisor, with the relevant factors to be considered in the making of this determination to include the reasonableness of the duration of the restriction, the reasonableness of the geographic scope of the restriction, and the extent to which the restriction is otherwise necessary to protect the legitimate interests of the franchisor.”

Geographic Restrictions

The first problem the court ran into when making the required determination was that the clause at issue prohibited the former franchisee from engaging in business in the territories of the affiliates of the franchisor, whether or not those affiliates were engaged in a business similar to that of the franchisor. In this case, the franchisor had affiliates engaged in other lines of business. The court found that prohibiting the former franchisee from operating in areas in which the affiliates operated had no bearing on the interests of the franchisor and, as such, was unreasonable. The court also found that the prohibition against the former franchisee having any involvement in a business in competition with an outdoor lighting business or any similar business was too broad, conceivably prohibiting the former franchisee, among other things, from working at a large home improvement store that sells outdoor lighting products.

In light of its findings, the court upheld the trial court's refusal to enjoin the former franchisee from engaging in competing activities since the concerned provision was too broad in scope and did not, in reality, serve to protect a legitimate business interest of the franchisor.

Interestingly, the court in Harders refused to “blue pencil” the clause in order to make it, at least to some extent, enforceable, stating there was nothing pointed out to it in the franchise agreement that would have allowed it to do so. It stated that it was not the court's job to find justification for changing the terms of an otherwise overly broad noncompetition clause. This comment in a footnote to the opinion is especially telling in light of Outdoor Lighting Perspectives Franchising, Inc. v. Home Amenities, Inc., et al, CCH Bus. Fran. Guide '14,765 (USDC W.D. North Carolina, Jan. 18, 2012).

Home Amenities, also a North Carolina case but one in federal court, provides an interesting contrast to Harders. It also concerned a motion for preliminary injunction by Outdoor Lighting seeking to enforce its Franchise Agreement's noncompetition clause ' the one with the two-year, 100-mile restrictions. The Home Amenities court upheld the clause by finding that enforcing the clause would protect the franchisor's goodwill and reputation and would preserve the integrity of the franchise system, stating that if one franchisee were allowed to ignore the clause others would also do so. It also stated that allowing a former franchisee to compete in the market where its franchise was operated would tend to preclude the franchisor from re-entering the market with another franchisee since a competitor with knowledge equal to that of the new franchisee would already be there. The court found that the 100-mile restriction was not necessary to protect the franchisor's interests and, relying on a provision in the franchise agreement that allowed the court to “modify [the clause] to the extent it deems necessary to make such a provision enforceable under applicable law,” struck the 100-mile language and limited the provision to the actual territories of the franchisor and its other franchisees ' no mention being made of “affiliates.”

We do not know whether the Harders franchise agreement contained the authority for a court to modify the noncompetition covenant, although the agreements in both cases seem to be of the same vintage. Assuming it did, and based also on its cryptic footnote, the provision either was not raised with the court or the court just did not want to compel the former franchisee in that case to comply with the clause. The Home Amenities court was not so sympathetic. While recognizing that such a clause would be a burden to the former franchisee, it stated that “any hardship suffered by Defendants is a direct result of [their] decision not to renew the Franchise Agreement and violate the post-termination provisions to which they agreed.”

Conclusion

The lesson of these cases? It may depend on whether a case is filed in state or federal court, in which state the matter is brought, the extent of the duration and geographic area of the clause, as well as its other provisions. The more narrow the clause, the better its chance of being enforced, at least in those states where enforcement is possible. And if a franchisor wants to enforce its noncompetition clause, it should act fast since delay may cause a court to find there is no immediate or significant harm it needs to prevent.

Darryl A. Hart is an attorney with Bartko, Zankel, Bunzel & Miller in San Francisco. He can be contacted at 415-956-1900 or [email protected].

Covenants Against Competition Find Disfavor In Recent Cases

A state appellate court case from North Carolina and a U.S. Court of Appeals case from Minnesota have considered noncompetition clauses in franchise agreements and found them wanting.

Both Outdoor Lighting Perspectives Franchising, Inc. and Novus Franchising, Inc. have been quite active in seeking to enforce the noncompetition provisions of their franchise agreements against former franchisees. Aspects of two of these cases have recently been decided. In Novus Franchising, Inc. v. Dawson, et al, 725 F.3d 885, CCH Bus. Fran. Guide '15,110 (8th Cir. Aug. 5, 2013) the franchisor, Novus, appealed a U.S. District Court's refusal to enforce the covenant against competition contained in the defendant's franchise agreement after the agreement was terminated. The franchisor did not terminate the franchise agreement until a year after the defendant franchisee stopped paying royalties and did not file suit to enforce the post-termination provisions of the agreement until 16 months after the royalties stopped. The franchisor's motion for preliminary injunction seeking, among other things, to enforce the noncompetition covenant was filed over 17 months after royalty payments ceased. The part of the motion seeking enforcement of the noncompetition covenant was denied. Novus appealed that part of the district court's decision to the Eighth Circuit.

The appellate court reviewed the trial court's denial of the plaintiff's motion for preliminary injunction for abuse of discretion. Rather than reviewing all of the factors a court must consider when deciding whether to issue a preliminary injunction, the appellate court focused on whether the plaintiff was able to show that it would suffer irreparable harm if the injunction was not granted. The appellate court cited Novus's failure to seek injunctive relief for over 17 months after the defendant stopped paying royalties as proof that any harm Novus thought it would suffer was not imminent, certain or very great. The court further questioned whether Novus's alleged potential loss of customers and customers' goodwill was truly irreparable in the sense it could not be compensated for by money damages if Novus prevailed at trial.

Novus had argued that Minnesota law presumes that irreparable harm will occur when a breach of a valid and enforceable non-compete clause occurs. In response, the defendant argued that the presumption of harm from such a breach was undermined by the United States Supreme Court in eBay, Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006), a patent case in which, the defendant argued, the principle should be applicable in all “presumption of harm” cases, such as this. The court in Novus did not reach that argument, citing its finding that actual irreparable harm was absent in the case before it.

In Outdoor Lighting Perspectives Franchising, Inc. v. Harders, et al., CCH Bus. Fran. Guide '15,104 (North Carolina Court of Appeals, Aug. 6, 2013), a franchisor of outdoor lighting products appealed the refusal of a state trial court to issue a preliminary injunction to enforce a covenant against competition in a franchise agreement that was not renewed upon its expiration by the franchisee. Following the expiration of his agreement, the former franchisee operated a lighting business that included both indoor and outdoor lighting products. He did not use the names or marks of his former franchisor.

Outdoor Lighting's franchise agreement's non-compete clause specified that that upon the termination or expiration of the agreement the franchisee promised not to have any type of interest in a “Competitive Business” within 100 miles of the franchisee's territory or the territory of any other franchisee, the franchisor or any affiliate of the franchisor. Realizing that the 100-mile restriction was probably going to be found to be excessive, the franchisor, as was allowed by the franchise agreement, unilaterally reduced the noncompetition area to the specified territories and not the additional 100-mile areas. This alteration was made on the day the motion for preliminary injunction was filed. The trial court required the defendant to return various material, manuals, customer lists, etc., to the plaintiff but refused to enforce the modified covenant not to compete.

The appellate court reviewed de novo the trial court's refusal to enforce the noncompetition covenant and focused on whether the plaintiff was likely to succeed on the merits of its case ' a key element in determining whether a preliminary injunction will issue. The initial issue was whether the court should review the disputed provision using cases dealing with covenants against competition in employment contracts or those dealing with the sale of a business, with the latter being allowed a broader scope than the former. The court recognized that it was dealing directly with neither type of transaction, but rather with a “hybrid situation” which did not fit within either the employment or the sale of business categories. As such, it elected to deal solely with the reasonableness of the restriction as between the plaintiff and the defendant in the case before it. The court stated: “[W]e conclude that the ultimate issue which we must decide in resolving such disputes among franchisors and franchisees is the extent to which the non-competition provision contained in the franchise agreement is no more restrictive than is necessary to protect the legitimate interests of the franchisor, with the relevant factors to be considered in the making of this determination to include the reasonableness of the duration of the restriction, the reasonableness of the geographic scope of the restriction, and the extent to which the restriction is otherwise necessary to protect the legitimate interests of the franchisor.”

Geographic Restrictions

The first problem the court ran into when making the required determination was that the clause at issue prohibited the former franchisee from engaging in business in the territories of the affiliates of the franchisor, whether or not those affiliates were engaged in a business similar to that of the franchisor. In this case, the franchisor had affiliates engaged in other lines of business. The court found that prohibiting the former franchisee from operating in areas in which the affiliates operated had no bearing on the interests of the franchisor and, as such, was unreasonable. The court also found that the prohibition against the former franchisee having any involvement in a business in competition with an outdoor lighting business or any similar business was too broad, conceivably prohibiting the former franchisee, among other things, from working at a large home improvement store that sells outdoor lighting products.

In light of its findings, the court upheld the trial court's refusal to enjoin the former franchisee from engaging in competing activities since the concerned provision was too broad in scope and did not, in reality, serve to protect a legitimate business interest of the franchisor.

Interestingly, the court in Harders refused to “blue pencil” the clause in order to make it, at least to some extent, enforceable, stating there was nothing pointed out to it in the franchise agreement that would have allowed it to do so. It stated that it was not the court's job to find justification for changing the terms of an otherwise overly broad noncompetition clause. This comment in a footnote to the opinion is especially telling in light of Outdoor Lighting Perspectives Franchising, Inc. v. Home Amenities, Inc., et al, CCH Bus. Fran. Guide '14,765 (USDC W.D. North Carolina, Jan. 18, 2012).

Home Amenities, also a North Carolina case but one in federal court, provides an interesting contrast to Harders. It also concerned a motion for preliminary injunction by Outdoor Lighting seeking to enforce its Franchise Agreement's noncompetition clause ' the one with the two-year, 100-mile restrictions. The Home Amenities court upheld the clause by finding that enforcing the clause would protect the franchisor's goodwill and reputation and would preserve the integrity of the franchise system, stating that if one franchisee were allowed to ignore the clause others would also do so. It also stated that allowing a former franchisee to compete in the market where its franchise was operated would tend to preclude the franchisor from re-entering the market with another franchisee since a competitor with knowledge equal to that of the new franchisee would already be there. The court found that the 100-mile restriction was not necessary to protect the franchisor's interests and, relying on a provision in the franchise agreement that allowed the court to “modify [the clause] to the extent it deems necessary to make such a provision enforceable under applicable law,” struck the 100-mile language and limited the provision to the actual territories of the franchisor and its other franchisees ' no mention being made of “affiliates.”

We do not know whether the Harders franchise agreement contained the authority for a court to modify the noncompetition covenant, although the agreements in both cases seem to be of the same vintage. Assuming it did, and based also on its cryptic footnote, the provision either was not raised with the court or the court just did not want to compel the former franchisee in that case to comply with the clause. The Home Amenities court was not so sympathetic. While recognizing that such a clause would be a burden to the former franchisee, it stated that “any hardship suffered by Defendants is a direct result of [their] decision not to renew the Franchise Agreement and violate the post-termination provisions to which they agreed.”

Conclusion

The lesson of these cases? It may depend on whether a case is filed in state or federal court, in which state the matter is brought, the extent of the duration and geographic area of the clause, as well as its other provisions. The more narrow the clause, the better its chance of being enforced, at least in those states where enforcement is possible. And if a franchisor wants to enforce its noncompetition clause, it should act fast since delay may cause a court to find there is no immediate or significant harm it needs to prevent.

Darryl A. Hart is an attorney with Bartko, Zankel, Bunzel & Miller in San Francisco. He can be contacted at 415-956-1900 or [email protected].