Recent Litigation Developments: Arbitration, No-Poaching, and Post-Term Non-Competes
We noticed a few interesting cases this summer regarding the dismissal of no-poaching claims, the enforceability of arbitration agreements, and post-term covenants not to compete. In Ogden v. Little Caesar Enterprises, Inc., the U.S. District Court for the Eastern District of Michigan became the first federal court to grant a franchisor’s motion to dismiss claims alleging class injuries suffered by its franchise agreements’ no-poaching provisions. Campbell Investments, LLC v. Dickey's Barbecue Restaurants, Inc. shows that there are in fact limits to federal courts’ presumptive favor of arbitration agreements, namely, not signing the franchise agreement. Finally, AMV Holdings, LLC v. Am. Vapes, Inc. is a reminder of the importance of drafting non-compete provisions that are reasonable in geographic scope and duration because courts may be unwilling to apply the “blue pencil doctrine” to save them from being unenforceable.
No-Poaching Claims
Regulators are not the only ones focused on franchise agreements’ no-poaching provisions (see the above article on Washington’s issuance of Civil Investigative Demands). Numerous plaintiffs have filed class actions against franchisors seeking to recover damages for alleged wage suppression, claiming that franchise agreements’ no-poaching clauses violate anti-trust laws. As we wrote earlier this year, several federal courts have allowed these claims to proceed to discovery.
Earlier this summer, in Ogden v. Little Caesar Enterprises, Inc., 2019 WL 3425266 (E.D. Mich. July 29, 2019), the U.S. District Court for the Eastern District of Michigan became the first federal court to grant a franchisor’s motion to dismiss such claims. The court held that the plaintiff had failed to allege facts that could support any violation of anti-trust laws, whether under the full “rule of reason” framework, the intermediary “quick look” analysis, or as a per se violation.
The court likened the plaintiff’s allegations to the anti-trust claims at issue in Bell Atlantic v. Twombly, which established the modern “plausibility” pleading standard, explaining that “a complaint does not sufficiently set forth any plausible claim for relief where it alleges facts that are entirely as consistent with innocent, merely parallel conduct as they are with an illegally pernicious conspiracy.” As the court explained, “the franchise agreements here allegedly were part of the overall scheme of ‘legitimate collaboration’ between franchisees operating under the umbrella of the same brand.”
Franchisors have many strong defenses to anti-trust claims arising from no-poaching provisions, but the risk of litigation and the prospect of expensive discovery will almost certainly outweigh any benefit that most franchisors will have from including them in franchise agreements. Franchisors who still have anti-poaching clauses in their franchise agreements should talk to their counsel about the reasons for including them to determine whether those reasons outweigh the risks.
Arbitration
Federal courts rarely decline to enforce arbitration agreements. However, earlier this month in Campbell Investments, LLC v. Dickey's Barbecue Restaurants, Inc., 2019 WL 4235345 (10th Cir. Sept. 6, 2019), the Tenth Circuit rejected a franchisor’s motion to compel arbitration because the franchisee never signed a franchise agreement for the location at issue.
The franchisee had signed a development agreement requiring it to open two new locations. The franchisee had also signed a franchise agreement for one of the proposed locations. Both agreements contained arbitration clauses.
The franchisee, however, did not open either planned location. Instead, the franchisee purchased an existing location from another franchisee. While the existing location had been operated pursuant to a franchise agreement between the franchisor and the previous franchisee, the new franchisee did not expressly assume the franchise agreement, nor did it sign a new one.
When the business relationship soured and litigation ensued, the franchisor sought to compel the franchisee to arbitrate the dispute. The franchisee argued that it never signed an agreement to arbitrate the dispute, while the franchisor argued that the franchisee assumed the obligation to do so when it purchased and proceeded to operate the previous franchisee’s existing location.
The court rejected the franchisor’s arguments, explaining that the purchase agreement made no mention of any assumption of the franchise agreement. The court pointed to the Federal Arbitration Act’s requirement that an arbitration agreement must be a “written provision” in a contract, concluding the arbitration agreement cannot be assumed through conduct or course of dealing. Finally, the court held that the parties’ claims did not fall within the scope of the development agreement’s arbitration clause.
Post-Term Non-Competes
Post-term non-compete agreements are essential to protecting the franchise system from those who leave and try to steal the know-how, goodwill, and customer relationships for their own competing businesses. The majority of courts outside of California will enforce franchise agreements’ non-compete terms so long as their geographic scope and duration are reasonably tailored to protect legitimate business interests. Even when a post-term non-compete provision is unreasonably broad as written, courts in many states will enforce it anyway against a narrower set of circumstances, effectively modifying its scope under a doctrine commonly referred to as “blue-penciling.”
Unfortunately, franchisors cannot always rely on courts to exercise this equitable remedy in their favor. This summer, in AMV Holdings, LLC v. Am. Vapes, Inc., 2019 WL 3406315 at *8 (W.D.N.C. July 26, 2019), the court denied the franchisor’s motion for a preliminary injunction to enjoin the franchisee’s violations of its covenant not to compete and refused to apply the “blue pencil” doctrine to save it from being unenforceable.
The franchisee owned eight e-cigarette stores, which it continued to operate after the franchise agreement’s termination, not only using marks that infringed upon those of the franchisor, but also in violation of the franchise agreement’s post-term non-compete provisions, which prohibited the franchisee from operating a competitive business in the two states where its stores were located for a period of two years after the franchise agreement’s termination. The franchisor moved for a preliminary injunction to enjoin both the infringement and the violations of the non-compete.
The court enjoined the infringement, but declined to enjoin the violations of the non-compete provisions, holding that the franchisor had not established a likelihood of success on that claim. The court explained that the scope of the non-compete was not reasonably tailored to protect the franchisor’s legitimate business interests because the franchisee’s territory only encompassed “a working population of approximately 15,000 (essentially the neighborhood of a large city or single small town).” As a result, the court held that “a covenant not to compete that extends to an entire state with a population of millions or multiple states is plainly overbroad.” The court further held that “blue penciling” the non-compete “cannot remedy the overbreadth of the covenant at this stage of the proceedings,” and refused to review or modify the scope of the non-compete beyond how it was written.
The geographic scope and duration of a non-compete necessary to protect a franchisor’s legitimate business interests will vary from system to system. Likewise, the acceptable geographic scope and duration of a non-compete can vary from jurisdiction to jurisdiction. Drafting a non-compete that is overly broad not only fails to protect legitimate interests, but it also risks making an otherwise enforceable non-compete provision unenforceable when it is needed the most. Franchisors should consult with legal counsel to consider the facts and law relevant to drafting enforceable non-compete provisions because courts may not always be willing to exercise their equitable powers to correct restrictions that are overly broad as written.