During the last 12 months or so, franchise precedents rendered in the areas of covenants of noncompetition and trademark infringement have been numerous. There have been over 15 opinions issued covering this subject—an unusually large number. And there have been three nonsignatory precedents issued. Not a large number in itself, but opinions addressing whether a nonsignatory to the franchise agreement can be bound to the terms of the agreement are generally rare. Let’s examine a couple of the cases from each of these categories.
Noncompetes and Trademark Infringement Cases
When someone purchases a franchise, he becomes a member of a special club. He becomes a licensee with the right to use the franchisor’s marks and systems. He also is entitled to any other rights granted under his franchise agreement, but he also becomes subject to the responsibilities of an ex-franchisee when the franchise agreement expires or otherwise is terminated in accordance with its terms. Two of these responsibilities are cessation of the use of the franchisor’s trademarks, and forfeiture of the right to use the franchisor’s system.
Enforcement of these responsibilities typically involves eliminating all of the franchisee’s uses of the franchisor’s trademarks and other trade dress, and requiring the franchisee not to compete with the franchisee’s former franchisor and its remaining franchisees.
As for continued use of the franchisor’s marks, such conduct violates Section 43(a) of the Lanham Act, resulting in trademark infringement, and in all likelihood, violates one or more of the post-term obligations of the franchisee under its franchise agreement as well. In these circumstances, the result of a claim of trademark infringement because of unauthorized use of franchisor’s marks, should be a no-brainer—the ex-franchisee invariably loses any suit by the franchisor if the marks are identical. If the marks are not exactly identical, the results of any suit by the franchisor become less predictable, but if there is a reasonable likelihood of confusion in the market place, the franchisor’s suit should be successful.
As for noncompetes, the predictability of whether the franchisee continuing the same or similar business constitutes a breach of a contractual obligation is less certain. Black letter law says a noncompete must be reasonable in scope, duration and territory. The governing law regarding noncompetes can be found in the common law, judicial and public policy, general codification of the black letter law, and the laws known as franchise relationship laws. To determine the enforceability of a noncompete, the court must look at these laws together, determine whether the state’s policy treats noncompetes as being more similar to an employment situation or more like the sale of goodwill in association with the sale of a business, and on these bases ultimately decide whether or not to enforce the noncompete.
As noted above, in the last twelve months or so, overall there have been a very small number of major, important franchise decisions, but in the franchise arena, a surprising number of cases involving noncompetes and trademark infringements. During this period there were at least 15 cases that fall within these subjects. Why so many?
Take a look at some of the relevant cases that fall in this area and ask yourself, would you have been eager to defend a case that fits this description? What motivation would there be in accepting this kind of representation and what should the franchisee’s expectations be?
Of course, there always may be factors that do not come to the surface when you read published opinions, but most of us who are familiar with these subjects probably could predict with substantial accuracy the outcome. So, what can we learn from the most recent precedents in this area?
Three cases that fell in this category came out poorly for the franchisee. In Red Roof Franchising v. Riverside Macon Group, No. 2:18-CV-16, 2018 WL 558954 (S.D. Ohio Jan. 25, 2018), the facts showed that the defendant’s franchise agreement had been terminated, but the franchisee continued to operate his franchise as though there had been no termination. There were no changes made to the physical appearance of the hotel, and the franchisee continued to operate the hotel under the Red Roof flag. Even invoices issued by the former franchisee contained the Red Roof name. An injunction against the franchisee was granted by the court, enjoining the franchisee from using franchisor’s marks as well as operating a hotel at its current location.
In the second case, Dickey’s Barbecue Pit v. Celebrated Affairs Catering, No. 4:17-CV-00127, 2017 WL 1079431 (E.D. Tex. Mar. 22, 2017). The facts were similar to those in Red Roof. The franchisor was granted a preliminary injunction to enjoin a former franchisee from using the franchisor’s registered marks and from operating a barbecue restaurant within a five-mile radius of the franchisee’s two locations that were previously franchises. A visit by a representative from the franchisor showed that the franchisee continued to operate as he did prior to the termination. Thus, an injunction was issued in favor of the franchisor, the court having found that the franchisor was likely to win on the trademark infringement and noncompete claims.
The third case was Better Homes Realty v. Watmore, No. 3:16-CV-01607-BEN-MDD, 2017 WL 1400065 (S.D. Cal. Apr. 18, 2017), in which the defendant, a terminated franchisee, continued to use the franchisor’s registered trademarks after the franchise expired or was terminated. The court found the infringer’s new mark was sufficiently similar to the franchisor’s such that an injunction against the former franchisee was warranted.
In almost all of the other cases involving noncompetes and trademark infringement, the franchisor proved to be the winner.
Rights and Obligations of a Nonparty
During the period of review, there were three cases addressing the liability of nonparties to franchise agreements. The specific issue was whether a third party was bound by the terms of a franchise agreement to which the third-party was not a signatory.
In H&R Block Tax Services v. Frias, No. 4:18-00053-CV-RK, 2018 WL 576858 (W.D. Mo. Jan. 26, 2018), vacated in part, 2018 WL 934901 (W.D. Mo. Feb. 16, 2018), the defendant-franchisee allegedly violated a post-termination noncompete by opening up an identical tax return preparation services within 25 miles of his former franchise’s location. In this case, the court’s initial ruling also covered his spouse, who had set up a tax return service within the same radius set forth in the franchise agreement. Although the court’s injunction was initially applicable to the former franchisee’s spouse, upon finding that the wife had no contractual obligations to the franchisor with respect to her business as a tax preparer, the wife was not involved in the operation of her husband’s business, and she was not a signatory to her husband’s now-terminated franchise agreement, the court held that she was not subject to the noncompete contained in her husband’s franchise agreement. Hence, the court’s ruling granting a judgment against the spouse, among others, was modified so that she was no longer liable to her husband’s former franchisor for his failure to stop competing.
In another case, a similar argument was raised. In Homewatch International. v. Navin, No. 16-CV-02143-KLM, 2017 WL 416338 (D. Colo. Sept. 20, 2017), the franchisee’s franchise agreement had been terminated, and the franchisor sued to have the noncompete enforced. The defendant franchisee claimed that she was not bound by the noncompete in the original franchise agreement because she was not individually a party to this original franchisee agreement and, therefore, not bound by its terms. The court, however, found that there were sufficient facts to find the former franchisee individually bound by that agreement. But the nail in the coffin was that the former franchisee had signed a guaranty which covered the noncompete requirement.
And in Cajun Global v. Swati Enterprises, 283 F. Supp. 3d 1325 (N.D. Ga. 2017), the court ruled that the defendant was liable to the franchisor for violating a noncompete. In Global, the franchisee had bought the franchise in a franchisee-to-franchisee sale, but no new franchise agreement was signed, nor was there a formal transfer of the franchise. For the remainder of the term of the franchise agreement, the transferee paid all bills with respect to the transferred unit. When the agreement expired, the transferee continued the business but claimed that he was not bound by the covenant not to compete in the franchise agreement, because he never became a party to that document. The court, however, disagreed. Although the franchisee had never signed transfer documents, he performed the franchisee’s obligations for 10 years. There also had been no notice of the transfer given by the former franchisee to the franchisor. The court concluded that the transferee was, in effect, the franchisee, and therefore, should be bound by the covenant not to compete, even though the successor had never signed it.
In short, with the exception of the developments in the area of joint employer liability, it was, relatively speaking, a quiet 12 months in many of the areas of franchise litigation. Will the next 12-month period see a similar quietness in franchising litigation? Let’s check back in a year.
Rupert M. Barkoff is chair of the franchise team at Kilpatrick Townsend & Stockton, and is resident in the firm’s Atlanta office. He is also an adjunct professor at the University of Georgia School of Law.