Court Watch

7-Eleven also argued that a prior stipulated order should be modified to permit it to cease financing the store operations. While the court would not grant this without a separate hearing, it did order the plaintiff to post a $500,000 bond to protect 7-Eleven, likely an undertaking that the franchisee might not meet, as evidenced by the franchisee's recent attempt to obtain a lower bond amount.

The court did conclude that the public would be confused as to the source of the products sold post-termination, but that was apparently not enough, even though the likelihood of confusion can also amount to irreparable harm. More importantly, irreparable harm is usually found due to the franchisor's inability to control use of the trademark once the license is terminated and the franchisee continues to use it. This was the holding in another 7-Eleven case, decided on the opposite coast, which was cited to the court in Sodhi. See, 7-Eleven, Inc. v. Dhaliwal, Bus. Fran. Guide (Wolterskluwer) '14.956 (E.D. Cal. Nov. 20, 2012). ( Note: Co-author Charles Miller was counsel for 7-Eleven in the Dhaliwal case.) In Dhaliwal, the court found that to the extent a plaintiff must produce evidence of irreparable harm, it did so by showing lack of control over its trademarks resulting from termination of the franchise agreement. The Sodhi court chose to ignore this argument.

It is also questionable whether the Sodhi court was correct in dismissing the argument of irreparable harm based on the uniqueness of real property in order to return possession of the property to 7-Eleven. eBay may have disallowed the use of presumptions that flow from patent violations, which has rippled down to trademark violations in subsequent lower court cases. But it certainly has not put an end to using presumptions that have other sources unrelated to trademark or patent violations. It is a universally accepted proposition that real property is unique, which has nothing to do with whether a trademark is involved. This alone should have supported a finding of irreparable harm, entitling 7-Eleven to a preliminary injunction.

Noncompetition Covenant Not Enforced Where Franchisor Will Not Open Again in Area

A recent case from Ontario, Canada, provides an interesting take on the frequently litigated issue of the enforceability of covenants against competition. In MEDIchair LP v. DME Medequip Inc., 2016 ONCA 168 (Can LII) (Court of Appeals for Ontario, Feb. 29, 2016), the Ontario appellate court considered an appeal from a lower court judgment finding the noncompetition covenant in a franchise agreement enforceable against a former franchisee and the franchisee's guarantors.

MEDIchair LP, the franchisor, franchises stores that sell and lease home medical equipment. The franchised store in contention was located in Peterborough, Ontario. A covenant in the franchise agreement provided that the franchisee and its principals, officers, etc., were not to engage in a similar business within 30 miles of its formerly franchised location or the nearest MEDIchair store for a period of 18 months after the franchise agreement ended. When the franchise agreement term ended in 2015, the franchisee de-identified its business premises, but continued to offer the same merchandise, using the same employees as they did under the franchise. The franchisor sued to enforce the covenant and was successful in the lower court. An appeal followed.

In Ontario, covenants against competition, as with other restraints of trade, are judged based on their reasonableness as between the parties but also with reference to the public interest. The public interest in such matters is the discouragement of unreasonable restraints of trade and the maintenance of free and open competition. However, where the restraints are reasonable and freely bargained for by parties of equal bargaining power, they will be enforced. The reasonableness as between the parties depends on the protection of a franchisor's legitimate interests, as well as the reasonability of the duration of the restriction and its geographical boundaries. Here, the appellate court was not concerned with the equality of the bargaining power of the parties, but rather with the basic question of whether the franchisor had a legitimate protectable interest justifying the covenant.

The court acknowledged that a franchisor has a legitimate interest in protecting the goodwill of its system, as well as its trade secrets, method of operation, contacts and the other benefits obtained by its franchisees. That protection could be jeopardized by competition from one no longer in the system operating a similar business since, among other things, it could discourage the franchisor from opening another franchised store in the territory.

The twist in this case was that the franchisor, MEDIchair LP, was sold, then resold, to an entity that also had a competing chain, Motion Specialties, which dealt in the same merchandise as the MEDIchair stores. The ultimate owner, Birch Hill Equity Partners, decided to concentrate on the Motion Specialties stores to the alleged detriment of the MEDIchair stores. There was a Motion Specialties store in Peterborough. The evidence before the lower court indicated that Birch Hill would not put a new MEDIchair store in Peterborough since it would compete with the Motion Specialities store there. The lower court decided that this did not reduce the importance of the covenant since holding otherwise may embolden franchisees to walk away from their franchises under similar conditions, thus jeopardizing the integrity of the franchise system. However, the appellate court found to the contrary since the franchisor no longer had a legitimate interest to protect in the specified territory absent another of its stores being likely in the concerned area. The error of the lower court, according to the appellate court, was that it considered the franchise system as a whole rather than just the area described in the concerned covenant. If a franchisee prematurely terminated its franchise agreement employing the lower court's reasoning, a suit for damages could result.

One wonders whether the result would have been the same if the covenant specified that it applied not only to the specified franchise, but also to any other similar business owned by the franchisor or its affiliates. It may be more appealing to consider such a limitation if other brands owned by the franchisor operated using the systems and trade secrets also employed by a brand-specific franchise. While a covenant against competition should not be used as a punitive measure, a fact sometimes lost on some franchisors, if the legitimate interests of an entity owning a franchise system extends to other businesses owned by that entity, it is possible courts would extend the protections of such a covenant to the related businesses.

Charles G. Miller, a member of this newsletter's Board of Editors, is shareholder and director of Bartko, Zankel, Bunzel & Miller in San Francisco. Darryl A. Hart is an attorney with the firm.