Friday, September 21, 2007

In-Term Noncompete Pact in Trademark License Was Unenforceable

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

In a decision of great interest to the franchise bar, the U.S. Court of Appeals in San Francisco held that an arbitrator manifestly disregarded California law by enforcing an in-term restrictive covenant in a trademark license agreement to prevent a comedy club operator from opening or running any other comedy clubs in the United States until 2019 or the termination of the parties’ agreement.

Accordingly, a federal district court was ordered to vacate the arbitrator’s award of injunctive relief to trademark licensor Improv West as to any county where the operator did not currently operate an Improv West branded club. The district court was further ordered to uphold an award of injunctive relief in those counties where the operator currently had Improv West clubs.

Dramatic Geographic and Temporal Scope

As interpreted by the arbitrator, the noncompete covenant applied geographically to the contiguous United States, and did not end until the agreement expired in 2019. Thus, the covenant not to compete had dramatic geographic and temporal scope, the appellate court commented.

Combined with the arbitrator's ruling that the operator, by breaching the agreement, had forfeited its rights to use the Improv West marks license in any new location, the practical effect of the award was that, for more than 14 years, the entire contiguous United States’ comedy club market, except for the operator's seven current Improv West clubs, was off limits to the operator. Thus, the arbitrator's ruling foreclosed competition in a substantial share of the comedy club business, according to the appellate court.

Foreclosing Competition

Under California Business and Professions Code Section 16600, an in-term covenant not to compete in a franchise-like agreement was void if it foreclosed competition in a substantial share of a business, trade, or profession, the court noted. California courts were less willing to approve in-term covenants not to compete outside a franchise context because there was not a need to protect and maintain the franchisor's trademark, trade name, and goodwill.

The operator's relationship with Improv was, in essence, a franchise agreement as the operator contracted with Improv West to use its trademarks and open comedy clubs modeled on Improv West's clubs.

Weighing the operator's right to operate its business against Improv West's interest in protecting and maintaining its trademark, trade name, and goodwill, the balance tilted in favor of Improv West with regard to counties where the operator was operating an Improv West club, the court held. However, under the restraint of Section 16600, California law did not permit an arbitrator to foreclose the operator's competition in opening comedy clubs throughout the United States.

The September 7 decision in Comedy Club, Inc. v. Improv West Associates appears at CCH Business Franchise Guide ¶13,703.Petition for Rehearing

Following extensive discussion of the decision on the ABA Forum on Franchising listserv, Katherine J. Galston of Irell & Manella LLP in Los Angeles wrote to inform the franchise bar that Improv West had submitted a petition for rehearing, with a request for rehearing en banc, to the Ninth Circuit. Interested persons may submit an amicus brief in connection with the petition through October 1.

Among other points, the petition argued that “[p]rior to the Panel’s decision, every court to consider the issue had held that a franchisor can lawfully restrict a franchisee from directly competing with it and its other franchisees during the term of a franchise agreement.” The decision “will have serious consequences for California businesses,” the petition claimed.

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