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Competitive Clauses

‘Don’t be too greedy’ is one tip when drafting non-competes


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Some non-compete cases are outrageous, while others turn on the finer points. While a majority of such claims are decided for the franchisors, attorneys still advise careful drafting and enforcement of the covenants.

In 2005, Kamini Vadhan opened a Singas Famous Pizza franchise in Manhattan while her husband, Aran, continued to operate their Indian restaurant in Jackson Heights, New York. Five years later, Aran wanted his own Singas franchise, but owners of the longtime concept, based in Elmhurst, New York, turned down his location.

Undeterred, Aran borrowed pizza pans, recipes, menus and a cook named Jose from his wife and set up a restaurant he called Singas Pizza Express in Jackson Heights. Jose even cut Aran’s pizzas with a small machete, a tool that had been a Singas Famous mainstay since 1967. And Aran designed ads featuring both his wife’s real franchise and his renegade one. 

The case is an extreme example of violating a non-compete clause, attorneys say, and the franchisor successfully used the covenant to shut down the pair. Other recent cases show this area of the law isn’t always so cut-and-dried.

Clauses are for protection

The legal instrument designed to stop such acts is called a non-compete clause and it’s found in almost all franchise agreements. “The non-compete covenant protects a franchisor’s legitimate business interests by stopping competition,” said Mark VanderBroek, chairman of Troutman Sanders’ franchise practice group and the recent co-author of an article on non-competes for the Franchise Law Journal.

In-term non-compete clauses prohibit franchisees from having any ownership or business interest in a competing business while operating a franchise. Post-term non-competes prohibit a franchisee leaving a system from operating a competing business within a stated geographic territory for a defined period of time. Such covenants protect the franchisor and other franchisees in the system by preventing someone from stealing a company’s trade secrets, training methods, reputation and customers, and creating confusion in the marketplace.  

When  franchisors discover renegade franchisees, they ask courts for preliminary injunctions to close them down. For many years, VanderBroek said, state courts “used to lump franchise non-competes with employment non-competes and struck many of them down. Today, our lawyers are doing a better job of explaining the unique nature of franchising and we are doing better in court.”

Michael Gray, of Gray Plant Mooty in Minneapolis, who recently surveyed non-compete cases for the American Bar Association’s Franchise Forum, said 70 percent to 80 percent of reported cases are won by the franchisor. 

Tutor Time decided for franchisee 

That’s what happened for Michael Einbinder of Einbinder & Dunn in New York. He represented Singas Famous in the Vadhan case and won injunctions that closed down Aran’s fake franchise and terminated Kamini’s real one. 

But in a different case late in 2012, Einbinder won a non-compete case on behalf of the franchisees.

In that case, Tutor Time Learning Centers of Novi, Michigan, asked for injunctions to close down two New York franchises operated by the same group, in Queens and on Staten Island. Tutor Time’s attorney, Stuart Slotnick, of Buchanan Ingersoll & Rooney in New York, argued that the operators had taken over the Staten Island location from another franchisee, but never signed a franchise agreement and, after their contract for the Queens location had expired, the group continued to operate a childcare center there.

But in court, Einbinder argued that Tutor Time’s request for an injunction on the Staten Island location was invalid because the franchisees had never signed one in the first place and because the franchisor had waited two years before filing it. Einbinder said an injunction for the Queens location was not appropriate because Tutor Time had failed to enforce non-competes against other former franchisees that also set up competing business. “We advise our franchisor clients that they must enforce their non-competes or they will lose that ability,” Einbinder said.

In Georgia, all franchisors lost the ability to enforce non-competes until a new law there was drafted and went into effect on May 11, 2011. Only non-competes signed after the law are valid and VanderBroek and his Georgia colleagues helped franchisors design covenants that would be accepted by state courts there and throughout the country. 

VanderBroek offered the following advice on drafting non-compete agreements:

1. The time restraint on prohibiting a former franchisee from competing must be reasonable. In Georgia, the time is three years or less.

2. The geographic area must be restricted to “areas in which the franchisor does business.” 

3. The scope of prohibited business must also be reasonable. “State in the franchise agreement itself the legitimate business interests that justify the agreement’s restrictive covenants,” VanderBroek said.

Under Georgia law, VanderBroek said, courts have the right to modify or “blue pencil” covenants they feel are overly broad. Courts in some other states have similar rights. 

In a recent Lawn Doctor case, for example, a New Jersey judge agreed with the franchisee that the geographic prohibitions in a non-compete were too broad and changed them. Those restrictions stated that a former franchisee could not set up a lawn care business within 50 miles of any other Lawn Doctor franchisee.

However, the judge did support the franchisor when the former franchisees asked for permission to continue their lawn irrigation business because “irrigation services” were not mentioned in their franchise agreement. Such services, the judge said, come under the scope of a landscape business, whether they are spelled out or not.

Finally, VanderBroek advises franchisors, “Do not be too greedy in drafting non-compete clauses. Judges may be reluctant to modify covenants if they conclude the franchisor did not even try to be reasonable in limiting their scope.” 

 

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