Non-compete agreements within the context of a franchise relationship pose a unique problem. On the one hand, the covenants are still a restraint of trade and therefore must be analyzed under the rule of reason. On the other, the nature of the protectable interest at stake is far more malleable than rules associated with employment non-compete agreements. It is, in fact, almost identical to the protectable interest associated with a sale-of-business non-compete. But unlike sellers of a business, franchisees often have little bargaining power.
The recent case of Bad Ass Coffee Co. of Hawaii, Inc. v. JH Nterprises, LLC demonstrates why the traditional employee non-compete test does not, or should not, apply to covenants in franchise agreements, and why - effectively - courts seem to apply a sale-of-business analysis instead.
The franchisor, Bad Ass Coffee Company, is a purveyor of gourmet coffee through various franchise locations in the United States. Each franchisee enters into an agreement with a personal and corporate restrictive covenant, preventing it from opening a similar business within a certain geographic area of the assigned franchise store. In this case, the restricted territory was construed under the governing agreement as the City of Jacksonville, Florida.
When the franchisee's agreement with Bad Ass Coffee expired in February, the franchisor gave it the opportunity to renew the contract without paying an additional fee. However, almost immediately after the franchise term expired, the franchisee converted the store to "Java Cove", selling the same products from the same suppliers. The drinks were even sold under the same names.
Bad Ass Coffee filed suit seeking injunctive relief and prevailed with relative ease. The court applied the four-part test in Utah to assess the validity of the restrictive covenant. It did not distinguish the case from a traditional employment case, but this oversight had no impact on the outcome. The only issue concerning the validity of the covenant was the nature of the interest Bad Ass Coffee sought to protect by way of the non-compete. And it was clear the court effectively looked at the same factors that would be discussed in a sale-of-business case.
The court described the goodwill of the franchisor that was at risk from being impaired through the franchisee's conduct. Specifically, the court found that "Defendants' actions in opening Java Cove are likely to send negative messages about [Bad Ass Coffee] to the market and to other ... franchisees....Defendants' overnight switch to Java Cove may signal to potential customers that the Defendants lost faith in the [Bad Ass Coffee] brand. To other franchisees, Defendants' conduct might set an example that they can leave the ... franchise and immediately start competing if they are unhappy with [Bad Ass Coffee]." These factors are nearly identical to what courts would deem important when analyzing a sale-of-business covenant.
Courts, though, often are not clear about which test to apply. In Utah, there are so few non-compete cases in the reported decisions, the court in Bad Ass Coffee may not have had much to work with. But it still should have distinguished the type of interest at issue from those raised in employment cases.
In fact, courts ought to begin with a rebuttable presumption that the covenant protects a franchisor's goodwill and demand a franchisee introduce evidence to the contrary. The focus of such covenants should be on the element of reasonableness. In this case, the court found a citywide limitation was reasonable, and that the covenant was not intended to prevent the defendants from opening, for instance, a gas station which also happened to sell coffee as an incidental product.
Court: United States District Court for the District of Utah
Opinion Date: 7/2/09
Cite: Bad Ass Coffee Co. of Hawaii, Inc. v. JH Nterprises, LLC, 636 F. Supp. 2d 1237 (D. Utah 2009)