Whose Protectable Interest Matters Most?

The sine qua non of franchise post-term non-competition covenants is whether the franchisor can demonstrate a “protectable interest.” If it can, the trier of fact proceeds to evaluate whether the covenant is reasonably limited in duration and geographic or customer scope or whether it is overbroad and presents too much of a hardship on the former franchisee and perhaps the former franchisee’s family or key managers.

If the covenant is suspect, the trier considers (depending on state law) whether the trier can and if so desires to either blue line (cross out words) or rewrite a covenant to make it enforceable. All of these issues and more are addressed most valuably in the succession of Forum publications in this century, Covenants Not to Compete in Franchise Agreements. The Fourth edition is due to be published soon after this article is written, and like the others, will be a required text for the franchise lawyer, whether transactional or litigation.

As if that were not enough, as this article goes to press, the Federal Trade Commission issued a “Notice of Proposed Rulemaking” to bar non-competes in employment agreements. It would ban existing and future such non-competes. It encompasses also “worker” protections also from clauses with similar impacts, such as non-solicitation provisions and certain non-disclosure provisions.

The news for franchising is that this 3-1 decision expressly excludes the franchisor-franchisee relationship. However, the commissioners invited comments in the 60-day comment period noting the franchise relationship raises concerns that may be analogous.

In sum, the rationale for post-term non-competes in franchising is on the table, not just in litigation but in the national regulatory debate. This article addresses, state by state, the principal “protectable interests” the courts recognize for the existence, and enforcement of post-term non-competes in franchising.Franchisors advance various justifications for these restraints, including protection of trade secrets and confidential information, protection of their accumulated goodwill, investment in training and promotion, and protection of opportunities to replace former franchisees with new franchisees in the same market. But the crucial distinction between franchising and employment, apart from the fact that franchising is an independent contractor relationship, is this: non-competes protect the entire franchise System and the investment and sweat equity of both franchisors and franchisees. As stated by Chief Judge Motz in ATL Int’l, Inc. v. Baradar, a case involving no trade secrets or confidential information, the non-compete not only protects a franchisor’s goodwill, but failure to enforce a non-compete sends a signal to other franchisees and could cause the unraveling – the destruction – of the entire franchise System.

Alabama

A protectable interest includes trade secrets, confidential information, and customer, patient, vendor, or client goodwill associated with numerous businesses including franchising.

Arizona

Two cases particularly recognize legitimate interests of the franchisor. They are ReBath LLC v. New England Bath Inc., and Furniture Medic, L.P. v. Jantzen.

California

As is well known, California Business & Professions Code § 16600 provides that covenants not to compete are void except in sales of businesses. This includes franchising. Recent case law has not materially changed that. But trade secrets are protected, regardless.

Colorado

In general, Colorado recognizes a franchisor’s legitimate interests in non-competes. This is true regarding its trade secrets and its goodwill.

Connecticut

Connecticut recognizes, de facto, a franchisor’s protectable interests in the integrity of its System, business practices and customers, and trade secrets and goodwill.

Florida

Florida amended its law in 1996 and now requires that all restrictive covenants or non- compete agreements be supported by a “legitimate business interest.” Such interests include trade secrets, valuable confidential business or professional information, substantial relationships with specific prospective or existing customers, and customer goodwill related to marks, locations and trade areas, and special training. Franchisor-franchisee relationships qualify as stated in Peterbrooke Franchising of Am, LLC, v. Mia Chocolates.

Georgia

Georgia’s Code requires proof of a legitimate business reason. The factors are exactly those of the Florida statute. A pro-Code case focussed on whether the franchisee was herself crucial to the business and gained knowledge the franchisor had a right to protect.

Idaho

Idaho has but one important case, over 50 years old, but it recognizes the franchise System itself is the protectable interest.
Illinois

Protection of the franchise System itself was the linchpin of enforceability in a classic early case. So too are trade secret protection and also customer relations and the ability to refranchise the location.

Indiana

The franchisor’s protectable interest include customers attracted to the franchisee by the franchisor’s name, the marks, the System, and the interest in refranchising.

Iowa

The protection of the System and its goodwill were crucial in Casey’s Gen. Stores, Inc. v. Campbell Oil Co., Inc.

Louisiana

There is a paucity of Louisiana authority but one case recognized the franchisor’s interest in its proprietary information.

Maryland

As reflected above, the U.S. District Court in Maryland directly addressed the legitimate interests of a franchisor in enforcing the covenants to prevent ex-franchisee competition in ATL v. Baradar. The Court held that enforcement of the franchisor’s post-term non-compete was necessary because non-enforcement threatened the franchisor’s customer goodwill, would send a signal to other disgruntled franchisees, and could cause the destruction of the entire franchise System.

Massachusetts

The supreme judicial court discussed at length the issue of legitimate business interests of goodwill in the franchise context in Boulanger v. Dunkin Donuts, Inc. The federal court cited protection of “trade secrets, confidential information, and customer goodwill” in granting a fitness franchisor a preliminary injunction against a former franchisee who terminated her franchise agreement and immediately began operating a competing studio.

Michigan

The Court in Certified Restoration Dry Cleaning Network, LLC v. Tenke Corp. identified a number of legitimate interests supporting enforcement of a covenant against competition in a franchise agreement.

Minnesota

Minnesota courts discussing a franchisor’s legitimate interests have held “ it is difficult to attract a new franchisee when a former franchisee is improperly competing within the same area.”

Missouri

Missouri courts have held that a franchisor’s reputation, goodwill, and brand recognition are legitimate interests to be protected in enforcing a covenant against competition. A franchisor has a legitimate interest also in preventing an ex-franchisee from unfairly using assets of its franchise business to compete with the franchisor and obtaining an undue advantage for the ex-franchisee’s competing business.

Nebraska

The Supreme Court reviewed the legitimate interests of a franchisor with respect to covenants not to compete in H & R Block Tax Services, Inc. v. Circle A’ Enterprises, Inc. In upholding a post-term covenant not to compete in a franchise agreement, the court identified protection of the franchisor’s goodwill as a legitimate interest of the franchisor to be protected.

New Jersey

The U.S. District Court for the District of New Jersey has held that a franchisor’s goodwill (which is “reconveyed” to franchisor at termination), its relationship with its customer base, trade secrets, and confidential information all constitute legitimate interests warranting protection. The Third Circuit has held a franchisor has a legitimate interest in maintaining its existing customer base.

New York

Courts have recognized several factors that will support enforcement of a covenant against competition, including a franchisor’s interest in protecting its goodwill, know-how, confidential information, trade secrets, the integrity of the franchise System, customer and referral relationships, and the franchisor’s desire to refranchise the market. See DAR & Assoc. v. Uniforce Services, Inc., Carvel Corp. v. DePaola, and ServiceMaster Residential/Commercial Services, L.P. v. Westchester Cleaning Services, Inc.
Singas Famous Pizza Brands Corp. v. N.Y. Advertising, LLC held that protectable interests include customer information and knowledge imparted by the franchisor, goodwill, and the danger to the franchise System if a former franchisee is allowed to ignore its non- compete obligations.

North Carolina

In Maaco Franchising, LLC v. Boensch, the non-competition covenant was specifically designed to protect Maaco’s protectable interests in its proprietary operating system, its confidential information, and the goodwill associated with its trademarks, service marks, trade name, and trade dress developed through its investment of a substantial amount of time, money, and effort. Similarly, see Meineke Car Care Centers, Inc. v. Quinones. There, the court granted a franchisor’s motion for a preliminary injunction, holding that allowing former franchisees to violate the covenant not to compete would provide them an unfair competitive advantage over legitimate franchisees in the area because “they are able to offer their services for a lower price than the franchisees since they do not have to pay [franchisor’s] royalty or advertising contributions.”

Ohio

The franchisor’s protectable interests are “the need to preserve goodwill associated with (the franchisor’s) registered names and marks and to protect against unfair competition,” as well as protection of goodwill developed under a licensed mark and avoidance of customer confusion, the potential damage that may result to the franchisor’s trade name and reputation, and protection of a competitive advantage arising from the use of a franchisor’s methods of operations, even though those methods may not amount to trade secrets.

Oklahoma

In Oklahoma, a franchisor’s goodwill is protectable. More recently, while a different federal district court declined to find a section of an Oklahoma statute applicable to a franchise agreement, it nonetheless upheld a modified version of a post-term covenant against competition (non-solicitation) in a franchise agreement by applying a different section. Express Services, Inc. v. Averette.

Pennsylvania

The classic case is Piercing Pagoda, Inc. v. Hoffner. There, the Pennsylvania Supreme Court stated that an “existing franchise is a legitimate business interest and therefore protectable.” The court first noted that the franchisee had executed the covenant not to compete in order to secure the “benefits of the franchise,” benefits that were identified to include training, use of the registered trademark of the franchisor, and the right to sell the franchisor’s product. The court concluded that, because the franchisee had received those benefits, all of which the court considered substantial, “continued operation of the [franchisee’s] stores subsequent to the termination of the agreement would adversely affect the ability of the franchisor to secure another franchisee in the same territory. This is a legitimate interest . . . .” The franchisor’s reputation, goodwill and training are all legitimate interests.

Puerto Rico

The Supreme Court in Franquicias Martin’s BBQ, Inc v. García de Gracia provided examples of legitimate interests that a franchisor might have: a unique method or System of doing business, confidential information, business secrets, intellectual property, and a relationship with customers, among others. The court also cautioned however that the franchisee can also have legitimate interests, especially if it invests all its resources in the business and assumes financial or credit risks.

Tennessee

The Tennessee Court of Appeals in Servpro Industries, Inc. v. Pizzillo held that a covenant against competition in a franchise agreement protects the franchisor’s information and goodwill, and the product the franchisor sells—the franchise System. See also ServiceMaster Residential/Commercial Services, L.P. et al. v. Westchester Cleaning Services, Inc. et al., applying Tennessee law, in which the court also recognized the plaintiff franchisor’s interest in its goodwill with its customers, its interest in refranchising the market left vacant by termination of the former franchisee, and its interest in avoiding the danger to the franchise System itself if a franchisee were permitted to avoid its reasonable non-competition obligations.

Texas

The Texas Covenants Not to Compete Act broadly states that “goodwill and other legitimate business interests” are worthy of protection. Texas cases have discussed and accepted specialized knowledge or training and trade secrets as protectable interests in employment and franchise agreement covenants. In Butts Retail, Inc. v. Diversifoods, Inc., the Texas Court of Appeals held that a franchisor’s “business goodwill, trade secrets, or other confidential or proprietary information” are legitimate interests that support the enforcement of a covenant not to compete ancillary to or in a franchise agreement.

Utah

Bad Ass Coffee Company of Hawaii, Inc. v. JH Nterprises, L.L.C. upheld a two-year post-term prohibition against competition, citing the protection of a franchising company’s goodwill as a legitimate interest. The sudden switch to another brand by the ex-franchisee could “signal to potential BACH customers that the [franchisee] lost faith in the BACH brand” or “set an example [to other franchisees] that they can leave the BACH franchise and immediately start competing if they are unhappy with BACH.”

The Utah federal court also listed the protection of a company’s “goodwill, reputation, and franchise System” as legitimate interests justifying enforcement of a non-competition covenant.

Virginia

The court in Brenco Enterprises, Inc. v. Takeout Taxi Franchising Systems, Inc. identified several legitimate interests of the franchisor that it viewed as warranting protection through enforcement of a covenant against competition: goodwill of the business, which belongs to the franchisor at termination, as well as proprietary information, software, customer information, and avoidance of customer confusion. Moreover, absent enforcement, the franchisee would continue to operate the same business in the same area, presenting the franchisor with a high likelihood of permanent loss of former and potential customers to competitors.

Washington

Over four decades ago, in Armstrong v. Taco Time International, Inc., the Washington Court of Appeals affirmed the trial court holding that a franchisor’s legitimate interests include protecting its ability to sell new franchises and protecting its franchisees from competition by a fellow franchisee. See MetroPCS Georgia, LLC v. Metro Dealer Inc.

Wisconsin

The franchisor’s interest in the franchisee’s loyalty and best efforts, advance notice of the franchisor’s marketing strategies, and access to its operating methods and policies were sufficient to support enforcement of an in-term (not post-term) covenant. A Wisconsin circuit court and one Wisconsin appellate court have held that the interests supporting a franchise covenant against competition are the same as would support a sale of a business or employment covenant. This implies a similar approach to post-term covenants.

Conclusion

Assuming the new FTC policy does not ultimately embrace franchise post-term non-competes, the landscape is essentially unchanged.  In fact, the differentiation – survival of franchise post-term covenants from the FTC’s ax – may strengthen them in the eyes of courts.

Protection of trade secrets and confidential information, investment, goodwill, and refranchising are protectable interests. But the gold standard is protection of the franchise System itself – for its franchisees and their franchisor.

By: Allan P. Hillman, Esq.

This publication is for general information purposes only and is not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.

The enclosed article was written in anticipation of FTC action, which is why it was written in early 2023. The principal value of the article then and now is the discussion of “protectable interest” cases, because protection of the franchise System itself, including the huge investments of the parties, is the ground that distinguishes franchising and justified its exemption from the then- proposed and now- enacted FTC Rule largely banning other non – competes.

Connecticut Franchise Law Attorneys

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