Court Watch

In 2009, the franchisor launched an Internet store, “caus[ing] a backlash among its franchisees.” Id., at 4. When several franchisees sent a demand for mediation related to the franchisor's Internet sales, the franchisor filed suit against those franchisees, including the plaintiff franchisee in Newpaper, alleging tortious interference. Id. Several months later, purportedly as a part of the settlement of the franchisor's lawsuit, the plaintiff franchisee and other franchisees executed addenda to their franchise agreements, affirming the franchisor's right to sell products online in exchange for a share of revenue from Internet sales made within a three-mile radius of each franchised retail location. Id. Approximately three years after executing the addenda to the franchise agreements, the plaintiff franchisee filed suit against the franchisor, alleging, among others, that the franchisor: 1) breached the exclusivity clause of the Agreement by conducting online sales through an online “store”; 2) breached the covenant of good faith and fair dealing; and 3) converted the franchisee's property interest in the territory by selling products online. Id., at 5. After removal of the lawsuit to federal court, the franchisor moved to dismiss the claims. Id., at 5-6.

Dismissing the franchisee's claim for breach of the exclusivity clause of the Agreement for failure to state a claim, the federal district court held that the Agreement “unambiguously and unqualifiedly states [the franchisor] shall have the right to sell its goods 'by or through the Internet.'” Newpaper, at 13. The district court furthered the explanation by indicating that the franchisee's handwritten identification in the addenda of the “territory” subject to compensation for Internet sales did not alter the material terms of the contracts between the parties, and it dismissed the franchisee's claim for compensation for Internet sales for its entire exclusive geographic territory, instead of the more limited three-mile radii defined in the addenda. Id., at 15-16.

In dismissing, in part, the franchisee's claim for breach of the duty of good faith and fair dealing on the basis that the franchisor forced the franchisee to accept customer returns for online purchases, used the franchisee's ad fund contributions to promote the Internet store, and undercut the franchisee's retail prices via the online store, the district court held that the franchisee's complaint failed to state a claim on most of those theories. Id., at 26. The district court held that the addenda expressly required the franchisee to accept Internet returns and that the ad fund claim should not have been stated as a breach of the covenant of good faith and fair dealing claim, but rather as a breach of contract claim. Id., at 26-28. However, with respect to the allegation that the franchisor was underpricing its franchisees, the court declined to dismiss the claim ' asserting that, if true, the franchisor “may be using its website, and its own products, to compete against franchisees, who are also largely buying and then selling the same products. Such competition could amount to an evasion of the spirit of the bargain'.” Id., at 30.

Newpaper provides strong support for franchisors facing claims of breach of exclusivity agreements by franchisees resulting from the operation of online retail stores. Franchisors are advised to articulate in their agreements the right to operate online retail stores or other distribution channels and also articulate whether franchisees will assume any obligations from these alternate forms of distribution, such as accepting returns or contributing advertising funds that may benefit an online store. Franchisors should similarly exercise caution when pricing goods for sale online so as not to undermine its franchisees and subject itself to claims for breach of the covenant of good faith and fair dealing, among others.

Federal Court Declines'To Enjoin Franchisee from'Violating Non-Compete

The United States District Court for the District of Maryland recently denied a pizza restaurant franchisor's motion for injunctive relief to enforce a franchisee's post-termination covenant not to compete, holding that the court's grant of an injunction to prohibit the franchisee's trademark infringement effectively protected the franchisor and precluded a finding of irreparable harm with respect to the restrictive covenant claim. Ledo Pizza System, Inc. v. Singh, No. WDQ-13-2365, Bus. Franchise Guide (CCH) ' 15,145 (D. Md. Oct. 10, 2013).

In Ledo Pizza System, a franchisor terminated a franchisee after several defaults by the franchisee. Id., at 2. Upon expiration of two agreed-upon forbearance periods, the franchisee continued to operate its franchised restaurant after termination and continued to use the franchisor's trade name and trademarks. Id. The franchisor moved to immediately restrain the franchisee from further trademark infringement and to enforce the franchisee's post-termination obligations not to compete with the franchisor. Id.

The district court granted the franchisor's motion for injunctive relief with respect to the franchisor's trademark infringement claims, but denied to grant the motion for preliminary relief with respect to the enforcement of the post-termination covenant not to compete. Id., at 6-7. Applying Maryland law, the district court held that the franchisor failed to establish imminent irreparable harm on the basis that, because the court granted the franchisor's request for immediate injunctive relief on the trademark infringement claims, any continued operation of a restaurant without the franchisor's name or trademarks is not likely to harm the franchisor. Id., at 6. The district court refused to distinguish the harm argued to be suffered by the franchisor by the former franchisee's continued operation of a pizza restaurant, with or without the franchisor's trade name and trademarks, indicating that the franchisor failed to show how the violation would prevent the franchisor from soliciting new franchisees, “given that the defendant is prohibited from associating any new future restaurant with the Ledo pizza brand.” Id. The district court further indicated that the grant of injunctive relief on the trademark claims will “prohibit the defendant from offering 'products and services in essentially the same manner'” as it had before, thereby not causing harm to the franchisor's reputation. Id., at 6-7. In so ruling, the district court appeared to disregard the franchisor's arguments that “the ability of a franchisee to terminate a franchise agreement and continue to offer products and services similar to the franchisor is likely to send a clear signal to other franchisees that they can terminate their franchise agreements and continue to [offer] such products and services in essentially the same manner.” Id., at 6.

Ledo Pizza System serves as yet another reminder to franchisors of the high burden placed on franchisors to prove irreparable harm when seeking preliminary injunctive relief. Courts will occasionally refuse to distinguish between the harm caused by trademark infringement and the separate harm caused by violation of a covenant not to compete, such as the signal sent to other franchisees that they can easily thwart their post-termination obligations or the continued association of the franchisee or the franchisee's business location in the mind of the public, undermining a franchisor's goodwill and reputation. Franchisors and their counsel are encouraged to articulate the different forms of irreparable harm faced by franchisors when seeking preliminary relief for both trademark infringement and violations of covenants not to compete.

Cynthia M. Klaus is a shareholder and Susan E. Tegt is an associate with Larkin Hoffman. Ms. Klaus can be contacted at [email protected], and Ms. Tegt can be contacted at [email protected].

Franchisor's Operation of Online Store does not Violate Exclusivity

The United States District Court for the District of Minnesota recently granted in part a franchisor's motion to dismiss a franchisee's claims for breach of contract and breach of the duty of good faith and fair dealing, holding that the franchisor acted within the bounds of the franchise agreements between the parties when the franchisor commenced the operation of an online store. Newpaper, LLC v. Party City Corp., No. 13-1735 ADM/LIB, 2013 U.S. Dist. LEXIS 137796, at 16 (D. Minn. Sept. 25, 2013).

In Newpaper, a party supply retail franchisee operating 25 Party America retail locations entered into an agreement (the “Agreement”) to convert its Party America locations to Party City stores, also agreeing to terminate all of its Party America franchise agreements and execute new Party City franchise agreements. Id., at 2. Said conversions were the result of the sale of Party America Corporation and Party City Corporation to a parent company. Id. The Agreement granted to the franchisee the exclusive right to operate Party City retail stores in Minnesota, Iowa, North Dakota, South Dakota, and 12 Wisconsin counties bordering Minnesota and Iowa. Id., at 3. In the Agreement, the franchisor reserved the right to sell its products as well as products sold by the franchisee through other distribution channels, including the Internet. Id.

In 2009, the franchisor launched an Internet store, “caus[ing] a backlash among its franchisees.” Id., at 4. When several franchisees sent a demand for mediation related to the franchisor's Internet sales, the franchisor filed suit against those franchisees, including the plaintiff franchisee in Newpaper, alleging tortious interference. Id. Several months later, purportedly as a part of the settlement of the franchisor's lawsuit, the plaintiff franchisee and other franchisees executed addenda to their franchise agreements, affirming the franchisor's right to sell products online in exchange for a share of revenue from Internet sales made within a three-mile radius of each franchised retail location. Id. Approximately three years after executing the addenda to the franchise agreements, the plaintiff franchisee filed suit against the franchisor, alleging, among others, that the franchisor: 1) breached the exclusivity clause of the Agreement by conducting online sales through an online “store”; 2) breached the covenant of good faith and fair dealing; and 3) converted the franchisee's property interest in the territory by selling products online. Id., at 5. After removal of the lawsuit to federal court, the franchisor moved to dismiss the claims. Id., at 5-6.

Dismissing the franchisee's claim for breach of the exclusivity clause of the Agreement for failure to state a claim, the federal district court held that the Agreement “unambiguously and unqualifiedly states [the franchisor] shall have the right to sell its goods 'by or through the Internet.'” Newpaper, at 13. The district court furthered the explanation by indicating that the franchisee's handwritten identification in the addenda of the “territory” subject to compensation for Internet sales did not alter the material terms of the contracts between the parties, and it dismissed the franchisee's claim for compensation for Internet sales for its entire exclusive geographic territory, instead of the more limited three-mile radii defined in the addenda. Id., at 15-16.

In dismissing, in part, the franchisee's claim for breach of the duty of good faith and fair dealing on the basis that the franchisor forced the franchisee to accept customer returns for online purchases, used the franchisee's ad fund contributions to promote the Internet store, and undercut the franchisee's retail prices via the online store, the district court held that the franchisee's complaint failed to state a claim on most of those theories. Id., at 26. The district court held that the addenda expressly required the franchisee to accept Internet returns and that the ad fund claim should not have been stated as a breach of the covenant of good faith and fair dealing claim, but rather as a breach of contract claim. Id., at 26-28. However, with respect to the allegation that the franchisor was underpricing its franchisees, the court declined to dismiss the claim ' asserting that, if true, the franchisor “may be using its website, and its own products, to compete against franchisees, who are also largely buying and then selling the same products. Such competition could amount to an evasion of the spirit of the bargain'.” Id., at 30.

Newpaper provides strong support for franchisors facing claims of breach of exclusivity agreements by franchisees resulting from the operation of online retail stores. Franchisors are advised to articulate in their agreements the right to operate online retail stores or other distribution channels and also articulate whether franchisees will assume any obligations from these alternate forms of distribution, such as accepting returns or contributing advertising funds that may benefit an online store. Franchisors should similarly exercise caution when pricing goods for sale online so as not to undermine its franchisees and subject itself to claims for breach of the covenant of good faith and fair dealing, among others.

Federal Court Declines'To Enjoin Franchisee from'Violating Non-Compete

The United States District Court for the District of Maryland recently denied a pizza restaurant franchisor's motion for injunctive relief to enforce a franchisee's post-termination covenant not to compete, holding that the court's grant of an injunction to prohibit the franchisee's trademark infringement effectively protected the franchisor and precluded a finding of irreparable harm with respect to the restrictive covenant claim. Ledo Pizza System, Inc. v. Singh, No. WDQ-13-2365, Bus. Franchise Guide (CCH) ' 15,145 (D. Md. Oct. 10, 2013).

In Ledo Pizza System, a franchisor terminated a franchisee after several defaults by the franchisee. Id., at 2. Upon expiration of two agreed-upon forbearance periods, the franchisee continued to operate its franchised restaurant after termination and continued to use the franchisor's trade name and trademarks. Id. The franchisor moved to immediately restrain the franchisee from further trademark infringement and to enforce the franchisee's post-termination obligations not to compete with the franchisor. Id.

The district court granted the franchisor's motion for injunctive relief with respect to the franchisor's trademark infringement claims, but denied to grant the motion for preliminary relief with respect to the enforcement of the post-termination covenant not to compete. Id., at 6-7. Applying Maryland law, the district court held that the franchisor failed to establish imminent irreparable harm on the basis that, because the court granted the franchisor's request for immediate injunctive relief on the trademark infringement claims, any continued operation of a restaurant without the franchisor's name or trademarks is not likely to harm the franchisor. Id., at 6. The district court refused to distinguish the harm argued to be suffered by the franchisor by the former franchisee's continued operation of a pizza restaurant, with or without the franchisor's trade name and trademarks, indicating that the franchisor failed to show how the violation would prevent the franchisor from soliciting new franchisees, “given that the defendant is prohibited from associating any new future restaurant with the Ledo pizza brand.” Id. The district court further indicated that the grant of injunctive relief on the trademark claims will “prohibit the defendant from offering 'products and services in essentially the same manner'” as it had before, thereby not causing harm to the franchisor's reputation. Id., at 6-7. In so ruling, the district court appeared to disregard the franchisor's arguments that “the ability of a franchisee to terminate a franchise agreement and continue to offer products and services similar to the franchisor is likely to send a clear signal to other franchisees that they can terminate their franchise agreements and continue to [offer] such products and services in essentially the same manner.” Id., at 6.

Ledo Pizza System serves as yet another reminder to franchisors of the high burden placed on franchisors to prove irreparable harm when seeking preliminary injunctive relief. Courts will occasionally refuse to distinguish between the harm caused by trademark infringement and the separate harm caused by violation of a covenant not to compete, such as the signal sent to other franchisees that they can easily thwart their post-termination obligations or the continued association of the franchisee or the franchisee's business location in the mind of the public, undermining a franchisor's goodwill and reputation. Franchisors and their counsel are encouraged to articulate the different forms of irreparable harm faced by franchisors when seeking preliminary relief for both trademark infringement and violations of covenants not to compete.

Cynthia M. Klaus is a shareholder and Susan E. Tegt is an associate with Larkin Hoffman. Ms. Klaus can be contacted at [email protected], and Ms. Tegt can be contacted at [email protected].