What Have You Done for Me Lately?
Why there's no certainty for non-compete decisions by courts
When Joseph Jezewski Jr., a longtime franchisee of a Sylvan Learning Center in Dothan, Alabama, was terminated for not attending mandatory national conferences, Jezewski kept operating anyway, using the same location, sign, phone number, method of operation and client list. The Baltimore-based franchisor filed a lawsuit and won an injunction against Jezewski, forcing him to close his breakaway tutoring center.
But when Fantastic Sam’s franchisee Corda Lester decided to turn her Warrenville, Illinois, salon into Corda’s Hair Design six months before her contract ended, a court allowed her to continue.
Non-competes, the clauses in franchise agreements designed to prevent franchisees from using their franchisors’ know-how to set up competing businesses, are getting harder to enforce.
Roger Schmidt, general counsel for Curves, in Waco, Texas, said enforcement of non-competes “has become a jurisdiction-by-jurisdiction and franchise-by-franchise decision involving many variables.
Several states simply frown upon restrictive covenants, especially non-compete clauses, other states will ‘blue line’ (or change) them and yet other states enforce them across the board.”
Of the 12 non-compete cases summarized in the American Bar Association’s Forum on Franchising’s 2011 update, the score is nine wins for franchisors and three for franchisees.
To further complicate the issue, when the Atlanta Bread Company sued a franchisee for opening a coffee shop in violation of his non-compete, the Georgia Supreme Court ruled the franchisor’s in-term covenant not to compete was unenforceable. An amendment supporting a re-written, non-compete law was adopted in November 2010, by Georgia voters, but as of press time, no one knew for certain when it went into effect. “Until the new law is tested,” said attorney Rupert Barkoff, of Kilpatrick Townsend & Stockton in Atlanta, “trying to enforce a non-compete in Georgia will be a gamble.”
There are some rules, however. Most non-compete clauses forbid terminated or breakaway franchisees from operating similar businesses for a certain amount of time—usually two years, or within a certain territory—often 10-to-20 miles of their previous locations. To stop former franchisees who don’t comply, franchisors like Sylvan ask the courts to impose a preliminary injunction to close down the renegade business. And to obtain a preliminary injunction, a franchisor must generally show:
1. A likelihood of success on merits.
2. Irreparable injury to the franchisor.
3. That the threatened injury to the franchisor outweighs any detriment to the franchisee.
4. That issuing an injunction is not adverse to the public interest.
Today’s courts, say several franchise attorneys, tend to interpret these guidelines quite differently. For example, Jeffrey Haff, a partner with Dady & Gardner in Minneapolis, said, “In the Upper Midwest, federal courts have become a little skeptical of franchisors’ claims of irreparable harm.”
In the Sylvan case, a U.S. District Court judge in Alabama upheld Sylvan’s contention the franchisor had lost control of Jezewski’s location, could not protect its reputation or goodwill and therefore was irreparably harmed by his actions. But a judge in U.S. District Court in Northern Illinois ruled just the opposite in the Fantastic Sam’s case.
Franchisee Corda Lester admitted she “learned everything she knows about running a salon as an employee of a Fantastic Sam’s franchise.”
She started working in 1988 for local franchisees, who made her store manager in 1996. In 2000, she bought the franchise from them, and signed a 10-year agreement with EBN Enterprises of Westchester, Illinois, the Fantastic Sam’s area developer for northern Illinois. But by spring 2009, Lester was having trouble paying her fees and notified EBN she would end her franchise affiliation that June. After she reopened as Corda’s Hair Design, EBN asked for a preliminary injunction to shut her down.
The judge, Sharon Johnson Coleman, agreed with EBN that Lester had breached her contract, but she questioned how the area developer had been harmed. Judge Coleman said running a hair salon requires no secret formula, “just sound business practices and hair-styling techniques.” Since EBN did not offer exclusive territories anyway, she said Corda’s Hair Design was not likely to prevent a future Fantastic Sam’s franchisee from opening nearby.
Corda Lester’s attorney, Robert Riffner, of Riffner Barber in Schaumburg, Illinois, said EBN has appealed the ruling. “I think they’re trying to make an example of Corda,” Riffner said. “We found at least eight other franchisees they let drop out of their system.” The unfair thing, he added, is that most franchisees can’t afford the legal fees to fight these cases. “Just litigating against a preliminary injunction can cost $20,000 or more,” he said. EBN’s attorney did not return phone calls.
Don’t tread on me
So far, brothers Ralph and Armida Felix in California have spent more than $50,000 defending themselves against non-compete lawsuits filed by their franchisor, Big O Tires of Juno Beach, Florida, according to their attorney Isabel Posso of Lakewood, Colorado.
In 1999, the Felix brothers opened a Big O franchise in Quartz Hill, California, and in 2001 opened two more in nearby towns. In 2009, they elected not to renew the franchise on the Quartz Hill location, and continued to operate the store as Budget Tires and Automotive. Big O did not try to stop them, because post-term non-competes are not valid in California. But the franchisor did sue, claiming the Quartz Hill store violated the brothers’ in-term covenants on their remaining two franchises.
Again, a federal judge, Philip Brimmer, of U.S. District Court in Colorado, dismissed Big O’s contention of irreparable harm, because the tire franchisor claimed the brothers’ actions could affect their relationships with other multi-unit franchisees.
The judge ruled that “irreparable harm” must show significant risk and could not be so speculative. Big O appealed.
Attorney Posso noted much of the case is now moot, because the franchise agreements for the other two stores have expired and a second store closed. “I think Big O is trying to coerce my clients into settling with them,” she said.
But Big O’s Denver-based attorney Harold Bruno III, of Robinson Waters & O’Dorisio, claimed his client is entitled to royalties after the Quartz Hill contract expired, because the brothers did not remove Big O’s signs, or change their phone number for several months. Bruno said most non-compete cases are worth pursuing because, “if you let franchisees go independent, you may never be able to sell another franchise in that market. The former franchisees know your system inside out. How can you sell a franchise in good faith to someone new who will have to compete against them?”
Michael Gray, of Gray Plant Mooty in Minneapolis, said he, too, has pursued non-competes on behalf of clients long after their effective dates are over. Gray said, “In one case, we lost an injunction hearing and it took the court two years to conduct a trial on our appeal. By then, the former franchisee had operated as an independent for three years. The court ruled in our favor and ordered the ex-franchisee to shut down for the next two years.”
To avoid such penalties, Boston attorney Eric Karp, of Witmer, Karp, Warner & Ryan, tells franchisee clients who want to challenge non-competes to first weigh their odds of success. Does their franchisor have something proprietary to protect? Are there other franchisees nearby? A franchisor is not allowed to protect an open territory. “I also advise them to jettison all aspects of the system,” Karp said, “including all trademarks, ads and marketing materials and to send back the operations manual.”
Attorney Joel Buckberg of the Nashville office of Baker Donelson Bearman Caldwell & Berkowitz advises franchisors “to know the current law in their home states or where they choose to litigate” before filing a non-compete lawsuit.
That task will soon be easier. Gray is updating the American Bar Association Forum on Franchising’s book on covenants against competition in franchise agreements and said the state-by-state guide will be published this fall.
Despite their “iffy” chances of success, franchisors will continue to try to enforce their non-compete clauses, Buckberg predicted, because franchisees will continue to want to break away.
“Every day,” he said, “franchisees are waking up in the morning and wondering, ‘Why do I continue to pay royalties? What do I need you for?’”