A Reminder To Know Your Local Franchising Remedies

By May 16, 2016 Articles, Business
Know Your Local Franchising Remedies

I read two tales of franchise terminations. In both cases, the franchisee had been caught with their hand in the convenience store cash register, using different iterations of register-opening keys to misrepresent sales, from “no sale” and “safe drop,” “cancel age verification,” to “beer non-tax.” Lots of different tricks. The franchisees booked thousands of transactions with unreported or underreported income. In fact, one of the franchisees admitted under oath that he used the cancel age verification modus on as many as 4,000 sales of cigarettes over an 18-month period. But in both cases, the franchisor caught on, by way of detailed audits and surveillance, and notices of franchise termination were served.

Now what?

In these cases, 7-Eleven v. Kapoor Bros [1] and 7-Eleven v. Grewal [2], the franchisor 7-Eleven filed a lawsuit, seeking an immediate order from the court to prevent the franchisees from continuing to infringe its federally registered trademarks and service marks: 7-Eleven®, Slurpee®, and Big Gulp®, as well as to prevent continued operation of the stores in violation of non-competition provisions. The results were surprising. 7-Eleven, a sophisticated franchisor with a well-crafted franchise agreement, achieved an order granting in full a preliminary injunction against the franchisee in Florida — and a lesser result on the same facts in Massachusetts.

These cases teach us that franchisors and franchisees should see their favorably-negotiated agreement as the baseline, the bare minimum. Even more, business owners should plan ahead and know the law of their jurisdiction in connection with pivotal events like termination and renewal.

THE KAPOOR BROS. AND GREWAL CASES

In Kapoor Bros., the Middle District of Florida granted injunctive relief for the franchisor, prohibiting both trademark infringement and operating a competing business. Differently, in Grewal, the District Court of Massachusetts granted injunctive relief, prohibiting trademark infringement, but denying injunctive relief to enforce the non-compete clause. Thus, both courts agreed that franchisor was entitled to preliminary injunction to stop trademark infringement, to prevent harm and preserve status quo through trial. But in Kapoor Bros, the court found that the franchisor would suffer irreparable harm if the franchisee operated a competing business until a trial on the merits could be held, while the court in Grewal found no irreparable harm or balance of harms in favor of the franchisor, denying a preliminary injunction to shut down the franchisee’s operations.

You find at least three key distinctions between these opinions, namely the courts’ consideration of: [1] the franchisees’ continued trademark infringement, [2] the franchisees’ hardship and whether it can be considered in connection with the preliminary injunction, and [3] the economic gap between a large franchisor and an individual franchisee.

First, the Florida court assumed that the franchisee would continue to illegally employ the 7-Eleven trademarks, while the Massachusetts court took as given that the franchisee’s continued competition would be without the use of those marks, assuming that the franchisee would comply with the injunction on trademark infringement. Specifically, the Florida court emphasized that the franchisee was, “operating stores under 7–Eleven’s brand without its permission,” and was “pirating the goodwill associated with 7–Eleven and causing it immeasurable damage.” While the Massachusetts court said that 7-Eleven’s brand would not lose any goodwill in the community because, “Customers would have no reason to associate [franchisee’s] convenience store with the 7–Eleven brand after 7–Eleven’s marks are removed from the premises, assuming [franchisee’s] convenience store continues to operate in accord with this order.” This assumption certainly changes the nature and magnitude of possible harm to the franchisor.

Second, both courts considered a Florida statute, Section 542.335(1)(j), which provides for a presumption of irreparable harm for the violation of an enforceable restrictive covenant. Citing that statute, the Florida court said that a preliminary injunction is, “the common and preferred remedy.” Differently, citing the Kapoor Bros. case, the Massachusetts court found that this Florida law further “prohibits the court from considering individualized economic or other hardship that might be caused to the person against whom enforcement is sought” when determining the enforceability of a restrictive covenant. Massachusetts does not have a similar statute. And so, the Massachusetts court reasoned that the Florida court did not look at the hardship to the franchisee, which was central to the Grewal analysis in Massachusetts.

Third, the courts treated differently the disparate economic strength between a large franchisor and an individual franchisee. The Massachusetts court saw 7-Eleven, who had 50,000 stores, as big enough to absorb any harm that the franchisee could inflict. And the court sympathized with the franchisee, who used “a very significant portion of her personal capital,” testified to be $100,000, to fund the initial franchise fee. Specifically, the Massachusetts court stated:

“[W]hen the value of one (or even two) year(s) of lost profit from one of 7–Eleven’s 50,000 worldwide franchise establishments is viewed in proportion to the company’s total annual profit, the losses would likely be miniscule. Additionally, denying this portion of 7–Eleven’s preliminary injunction certainly would not cause it to lose its indisputably competitive position in the market.”

On the other hand, the Florida court reviewed other facets of harm to the franchisor that the Massachusetts court didn’t consider — recognizing that 7–Eleven “will have difficulty entering the market served by the former franchisees” and also that other 7-Eleven franchisees will take a lack of enforcement as a concession to the breach.

All in all, Florida and Massachusetts law produced two different results on essentially the same facts, with the same franchisor and same franchise agreement. Certainly, 7-Eleven would have sought a premium on its business with franchisees in Massachusetts, had it known that the local court would likely not grant a preliminary injunction to enforce its non-competition provision.

With that context, let’s look at a couple drafting points for franchise agreements.

APPLICATION: FRANCHISE AGREEMENT NUTS & BOLTS

Fundamentally, the first step is to negotiate favorable restrictive covenants in the Franchise Agreement. Generally, franchisors aim to restrict the franchisee, preventing them from competing with the franchisor during the franchise term, plus a period of time after expiration or termination of the franchise agreement. The franchisor will also restrict the franchisee from soliciting employees of the franchisor or other franchisees. Franchisees, on the other hand, try to resist or limit the duration of any competition restrictions, seeking a narrow and precise definition of the restricted activities, as well as the geographic scope of the restriction.

In Kapoor Bros. and Grewal, the 7-Eleven covenant not-to-compete provision prohibited the franchisee for one year after termination from “maintain[ing], operat[ing], engage[ing] in, or hav[ing] any financial or beneficial interest in, adverts[ing], assist[ing], mak[ing] loans to, or leas[ing] a Competitive Business” located at the leased premises or at the site of any former 7-Eleven store within two years of it being operated as a 7-Eleven store. The term “Competitive Business” was defined as, “any business that is the same as or similar to a 7-Eleven Store…, including a convenience store or other store not designated as a convenience store in which the product mix is fifty percent (50%) or more of goods or services substantially similar to those then-currently offered by a 7-Eleven Store.”

Further, the 7-Eleven agreement stated that, “[A]ny breach of any of the terms of the [non-compete provision] will result in irreparable injury to us and that we are entitled to injunctive relief to prevent any such breach.” And the franchisees agreed that the restriction, “contains reasonable limitations as to time, geographical area and scope of activity to be restrained and does not impose a greater restraint than is necessary to protect our goodwill or other business interests.” And the franchisees agreed that its claims against 7-Eleven would not be a defense to enforcement of the non-compete clause.

All of those terms favored 7-Eleven, the franchisor, and those terms are commonly found in franchise agreements.

Therefore, Kapoor Bros. and Grewal demonstrate that, even with the right contract language, whether and how a court grants immediate relief for injunction against franchisee could turn on specific state statutes and body of common law.

What’s at stake?

In the context of restrictive covenants and injunctive relief, it is the franchisor’s ability to immediately shut down franchisee operations and use of its trademarks, post-termination of the franchise agreement. Without it, litigation could stretch out for years before the franchisor receives a judgment, and the franchisor could be exposed to significant harm in the meantime. Overall, business owners should consider how relevant state laws will apply in critical situations. A comprehensive franchise agreement might not be enough. If the law in your jurisdiction is unclear or unfavorable, you might seek additional protection or compensation to bear the legal risk.

[1] 7-Eleven, Inc. v. Kapoor Bros. Inc., 977 F. Supp. 2d 1211 (M.D. Fla. 2013).

[2] 7-Eleven, Inc. v. Grewal, 60 F. Supp. 3d 272 (D. Mass. 2014).