Courts are often confronted with the pesky problem of enforcing a covenant against competition against non-signatories to a franchise agreement. Few courts have provided guidance on the enforcement of a restrictive covenant against even a family member who colludes with a terminated franchisee to circumvent the post-contract restrictions against competition. Add to this uncertainty the requirement that an arbitration clause cannot be enforced against a non-signatory. Absent perfect drafting, how should a court address an enforcement of a covenant against competition in an arbitration where the party violating the covenant is in collusion with the former franchisee?

A recent federal court decision from Wisconsin suggests that expansive and formal franchise agreements are a necessary evil. At issue in Everett v. Paul Davis Restoration, 2012 U.S. Dist. LEXIS 133682 (E.D. Wis. Sept. 18, 2012), was whether franchise owner Matthew Everett’s wife, Renee Everett, who did not sign the non-competition covenant was nonetheless bound by it. The franchisor argued the wife was equitably estopped from avoiding the covenant because she actively participated in running the franchise. The wife, not surprisingly, argued she was not bound because she never signed the covenant. Although the court initially issued a preliminary injunction compelling the wife to arbitrate her claims, thereby suggesting she was bound, it subsequently reversed itself and vacated the arbitration award enforcing the covenant against her personally.

On competing motions to confirm and vacate the arbitration award, the court ultimately relied upon Second Circuit case law to hold that equitable estoppel was unavailable because the wife did not “directly” benefit from the franchise agreement and was not seeking relief under the franchise agreement. “In order to hold Ms. Everett to a contract she did not sign, PDRI must show that she benefited directly from the contract, not the business that the contract made profitable.” If mere indirect benefit from a franchise, such as profits from the business, could bind a person individually, “PDRI would have no reason to have the owner of the legal entity operating the franchise separately sign the franchise agreement in his individual capacity.” Here, as demonstrated by the fact that the franchisor required the husband to sign individually, the franchisor understood the importance of binding individuals. Having not secured the wife’s promise not to compete, the court permitted her to continue operating the previously franchised business that the husband “sold” to her.

The Everett court took a very formalistic view of contractual privity because it considered the award in the context of confirming an arbitration award. In Pennsylvania, for instance, no reported cases address the enforcement of covenants contained in franchise agreements against non-signatories. In one case, Stone v. Stone, 64 Pa. Super Ct. 392 (1916), the court enforced the covenant against the brother of the covenantor because the brother benefited from the actual contract, a fact missing from the Everett case. In a case similar to Everett, however, in Suburban Oil Services v. Parker, 63 D & C 2d. 91 (Luzerne Cty. 1973), a covenant which prohibited the husband to compete in a second business also prohibited the wife who benefited from defiantly establishing the second business.

Perhaps Everett is yet merely another example of the law relying upon technicalities to permit that which the parties probably never intended. Even assuming the outcome is easily avoidable by requiring spouses to personally sign non-competition covenants, what about more distant relatives or undisclosed business partners? What is the consideration for a spouse to sign a restrictive covenant in the inception? Is there any way to truly avoid the Everett outcome?

The franchisor should develop methods and articulate reasons why spouses should sign the post-term activity restrictions and find a method to enforce the covenant. Absent a spouse signing the covenant, the privity requirements in arbitration cases that inhibit enforcement against a non-signatory in an arbitration contest. Perhaps the rule is to exclude enforcement of the covenant in an arbitration because the arbitration remedy is so easily evaded where the violator never agreed to arbitrate the dispute, and let a court fashion an equitable remedy. Careful drafting of a judicious enforcement of the arbitration clause against third parties is probably the best method of extending the covenant against competition to non-signatories.

Craig R. Tractenberg is a partner in the Philadelphia and New York offices of Nixon Peabody and an adjunct professor teaching franchise law at Temple University’s Beasley School of Law.

Gregg Rubenstein is a partner in the Boston office of Nixon Peabody