Franchise 101: Injunction Bottleneck; and All in the Family
Matthew J. Soroky in Franchise Law Committee e-Bulletin
”…the U.S. House of Representatives approved by a vote of 282 to 181 the Save Local Business Act, a bill that would amend the National Labor Relations Act and the Fair Labor Standards Act to limit joint employer liability.” How could this bill affect franchisors? Read Matt’s summary in the State Bar of California Business Law Section’s Franchise Law Committee e-Bulletin: U.S. House of Representatives Passes Save Local Business Act
Katherine L. Wallman in Valley Lawyer
“Although the advantages of social media and the digital age are vast, the ever-changing cyber world raises ethical questions attorneys must address before reaping its benefits.” For more, read Kate’s MCLE article: Social Media and Common Ethical Problems
A restaurant franchisor, World of Beer Franchising (“WOB”), recently lost an appeal to enforce a post-termination restriction against a franchisee launching a competing business. Both the trial and appellate court ruled against WOB.
WOB lost because it ignored the franchise agreement requirement to submit the dispute to mediation at the same time as it sought injunctive relief.
WOB and Evan Matz were parties to three franchise agreements to operate World of Beer restaurants. After mutual termination of the agreements, Matz reopened the former franchised locations as competing restaurants. WOB sought to enjoin Matz from using its marks, confidential information, and trade dress and from violating the post-termination non-compete covenant.
A federal district court denied WOB’s request on the basis that the franchise agreements required the parties to first mediate their dispute. WOB appealed, arguing that the district court misinterpreted the agreements’ dispute resolution provisions.
The dispute resolution clauses each said that a preliminary injunction may be sought, as long as the dispute was submitted for arbitration at the same time. But the agreements required nonbinding mediation before bringing arbitration. Another provision said that all disputes, except those concerning the marks, had to be arbitrated. Harmonizing these provisions, the district court ruled that the franchisor was required to submit its grievance with Matz to mediation and arbitration, at the same time as its motion for an injunction.
The Court of Appeals agreed that the provisions required the parties to mediate first, regardless of whether the dispute was arbitrable. The provisions could be reasonably read as requiring contemporaneous submission of the injunction request to both arbitration and mediation, followed by arbitration under the agreements’ injunction clause, if mediation did not resolve the dispute.
The franchisor argued that the dispute was not subject to arbitration, and therefore was also exempt from mediation, because the claim concerned the marks. The courts disagreed, finding that the franchisor’s claims extended beyond the marks. The franchisor alleged infringement, but also claimed violation of the non-compete covenant and use of confidential information and trade dress. The court was likewise unmoved by the franchisor’s attempts to initiate mediation under the dispute resolution clauses.
WOB contended Matz ignored inquiries about whether he preferred mediating through the American Arbitration Association or a private mediator. The franchise agreement expressly required mediation under AAA Commercial Mediation Rules, which permitted the franchisor to submit the dispute to AAA mediation unilaterally, without Matz’s cooperation.
Post-termination covenants are often the franchisor’s last remnant of control over former franchisees. It is preferable for a franchise agreement’s dispute resolution clause to provide a clear path to enforcing the post-termination covenants.
All in the Family
Some creativity can help in passing a former franchised business to the next generation, particularly if the franchisor has no part in the franchisee’s succession plan.
A federal court in Nebraska preliminarily enjoined two former franchisees of The Maids International, a home-cleaning business, and also the franchisees’ daughters and the competing home-cleaning company the daughters established, from continuing to violate post-termination non-compete and non-solicitation provisions of the franchise agreements.
One might think, as the defendants argued, that the daughters and their business could not be enjoined because they didn’t sign the franchise agreements and were part of a separate business entity. According to the franchisees, their daughters’ business – “Two Sisters” – had a new website, new uniforms, and new phone numbers. But under case law in some states, those acting in concert or privity with signatory franchisees may be bound by an injunction for actions that violate franchise agreements, even if they did not sign the agreements.
The court found several indicators that the former franchisees were in privity with their daughters’ home-cleaning business.
The new business operated from the same locations as the former franchise locations. It offered the same services. It kept the franchisor’s logo. It used the same email address. It used two of the same vehicles. And one of the former franchisees was listed as the registrant for the website of his daughters’ business.
Most tellingly, in the court’s view, was that the franchisee’s “retirement letter” to customers made clear that the daughters were “ready to take over,” that “most everything will remain the same,” and that the daughters would continue the franchisees’ business, using the same employees (their daughters), cleaning schedule, cleaning products and insurance. The court added that the defendants failed to comply with other post-termination obligations, such as the return of all confidential and marketing material and stopping use of customer lists, proprietary methods and trade secrets.
Family successors to a formerly franchised business should clearly understand what the franchisor has the power to enforce against them, and franchisees should factor the non-compete provisions of a franchise agreement into their succession plans.