A particularly vexing issue for franchisors is enforcing the post-termination obligations against the former franchisee, and against others acting in concert to usurp the benefits of the franchise relationship after it has expired or terminated. The issue usually arises where a restrictive covenant prohibiting competition exists, and the covenantor attempts to circumvent the restriction by having a trusted party continue in the business. A recent decision in New Jersey federal court provides some insight on how to address these issues.
In Jackson Hewitt v. Barnes Enterprises, 2013 U.S. Dist. LEXIS 111390, D. NJ No. 10-cv-05108 (August 2, 2013), the U.S. District Court for the District of New Jersey again had the opportunity to address post-termination enforcement against signatories to a franchise agreement. In the previous 2011 decision, the franchisor alleged a former franchisee was planning on using his father to operate 15 competing tax-preparation businesses to circumvent a covenant against competition. The court agreed to enforce the covenant against the nonsignatory father. The court held that injunctions of this type are generally broad enough to encompass nonparties who have actual knowledge of the prohibited acts and are seeking to nullify the decree by aiding and abetting the prohibited acts. In 2013, the parties filed cross-motions for summary judgment.
The defendant franchisee and its personal guarantor sought dismissal of the claim that they had infringed on the Jackson Hewitt trademark after termination. They argued that "Customers First," a company owned by the guarantor's wife, was the post-termination operator of the businesses that used the Jackson Hewitt signage at the former locations. The defendants moved for summary judgment because they did not operate the business under the Jackson Hewitt signs after termination and therefore were not infringers.
The court denied summary judgment based on the theory that the defendants could be liable for trademark violations as secondary infringers. This is apparently a novel theory in the franchise context. The district court cited U.S. Court of Appeals for the Third Circuit precedent from AT&T v. Winback & Conserve Program, 42 F.3d 1421 (3d Cir. 1994), quoting Inwood Laboratories v. Ives Laboratories, 456 U.S. 844 (1982), which held that a manufacturer or distributor can be secondarily liable for infringement if it continues to supply products with knowledge of the infringement. The district court reasoned that the defendants' failure to remove signage from the previous Jackson Hewitt franchise locations, compounded by the defendants' actual knowledge that consumer confusion could exist while Customers First operated, demonstrates a genuine issue of fact for trial whether defendants were secondary infringers.
The district court also found as triable facts whether the defendants actually used the marks themselves after termination, whether plaintiff suffered any damages, whether defendants adopted plaintiff's marks, whether any customer confusion resulted from any delay in removing the signage and whether plaintiff suffered any trademark dilution.
The Barnes decision did not disclose whether the franchisor was seeking future lost profits for the unexpired term of the franchise agreement. If so, then the trademark claim would tend to duplicate the quantum of damages. It is also possible that a claim for future lost profits or royalties might have been denied, waived or simply not asserted. The plaintiff's theory of holding the original signatories liable for their successor's trademark violations is noteworthy because of the paucity of decisions on the issue.
Neighboring states vary in the enforceability of restrictive covenants against nonsignatories. The general rule under New York law is that a person is not bound unless the person signs in his or her individual capacity. Nevertheless, where the husband of the franchisee's principal owned the successor operation and the franchisee was involved in the post-termination operation, the court would enjoin the nonsignatory, as in Singas Famous Pizza Brands v. New York Advertising LLC, (S.D.N.Y. Feb. 10, 2011), aff'd No. 11-1038-CV. (2d. Cir. Mar. 19, 2012). Similarly, Pennsylvania courts have long enforced covenants not to compete against nonsignatories where the nonsignatories were close family relatives of the covenantors. (See Stone v. Stone, 64 Pa. Super. Ct. 392 (1916).)
Other methods of enforcement involve asserting claims for future lost royalties, aiding and abetting tortious liability, fraudulent conveyances, trade secret violations and unfair competition. Few trials have occurred using these theories so it is difficult to assess the ultimate efficacy of asserting such claims. These theories have successfully survived motions to dismiss in a variety of courts and remain potent weapons to deter post-termination violations of a franchise agreement.
In summary, the Barnes case is helpful in holding the franchisee liable for the consequences it sets in motion when it allows a related party to succeed in the business in violation of the franchise agreement.
Craig R. Tractenberg is the team leader of the franchise practice at Nixon Peabody and an adjunct professor of franchise law at Temple University's Beasley School of Law.