Bad Ass Injunction Shuts Down Coffee House (Bad Ass Coffee Co. v. JH Nterprises)

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.

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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)
Favors: N/A
Law: Utah

Employee's Declaratory Judgment Claim on Non-Compete Not Ripe for Decision (McKenna v. PSS World Medical)

It is difficult enough these days for employees to go job-hunting, even in their areas of expertise. But that task becomes more complicated if the employee has a non-compete hanging over his head.

For some employees, pursuing a declaratory judgment action regarding the enforceability of a non-compete is an investment worth making. Though expensive, this type of action, if successful, can help an employee escape the shackles of a non-compete and lead to a prosperous job opportunity. New employers may even be willing to subsidize a lawsuit, particularly if it is successful.

However, there is no guarantee an employee's declaratory judgment claim will ever get heard, particularly if the venue is federal court. And this is exactly what happened to Mark McKenna, a medical equipment salesman, who challenged his non-compete only to have a federal court dismiss it on the grounds there was no ripe dispute.

McKenna's claim resembled one I see frequently. An employee has an agreement which is arguably overbroad in its restrictions, and he has identified potential job opportunities which may be available to him but for his non-compete. McKenna filed suit and alleged that not only was he aware of certain opportunities in the medical supply business, but also that "prospective employers [were] unwilling to hire him as a result of the existence" of his non-compete.

McKenna did not allege that he had an offer or conditional offer from a specific new employer. It was this omission that proved fatal. McKenna's former employer removed the action to federal court and argued that the controversy was not ripe for review under the Declaratory Judgment Act.

That statute permits (but does not require) a court to declare the rights of the parties in the case of an "actual controversy." Under the Third Circuit's interpretation of the Act, this requires a court to focus on three factors when determining whether to issue a declaratory judgment:

(1) the adversity of interest;
(2) the conclusivity that the declaratory judgment would have on the legal relationship between the plaintiff and defendant; and
(3) the practical help of the judgment.

The court held that the "adversity of interest" factor did not favor the exercise of jurisdiction, primarily because McKenna never alleged a specific opportunity being foreclosed by his ex-employer's threatened enforcement of the non-compete. If an employee can locate a job opportunity, secure a commitment of some kind regarding his hiring, and demonstrate an effort by the ex-employer to enforce the covenant, the "adversity of interest" factor likely will favor jurisdiction.

The second factor, "conclusivity", also indicated the court would be issuing an advisory opinion. For starters, the court had no set of facts regarding the employment opportunity. Most likely, the court thought it could not apply a "reasonableness" standard to the covenant without any idea of what job McKenna was seeking. The other unspoken factor was that the covenant at issue was a client non-solicitation clause, a restriction that is inherently fact-specific and less broad than an outright prohibition on work in an industry.

Finally, the court held that the "utility" factor was no help to McKenna. The court's reasoning here was curious - it basically said that it could not consider the impact of a ruling on a third party such as McKenna's prospective employers. Arguably, this makes no sense since a person's ability to become employed is totally dependent on the willingness of someone to hire him or her. The court would have been better off ruling that the client-specific nature of the restraints would require the court to consider very specific facts about McKenna's new employment before determining whether the covenant was valid.

Declaratory judgments may indeed be helpful for employees. When the restraint that is subject to challenge is an activity covenant - a non-solicitation or a non-disclosure clause, for instance - the task of declaring a party's rights becomes complicated. Those covenants are always fact-specific, as solicitation of one client may be permissible but another may be improper even under a well-drafted covenant. For general non-compete clauses, the court may have a basis to rule on an agreement without hearing detailed evidence about a specific job opportunity. The law concerning those restrictions is such that a determination on the face of the document may be proper.

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Court: United States District Court for the Western District of Pennsylvania
Opinion Date: 7/9/09
Cite: McKenna v. PSS World Medical, Inc., 2009 U.S. Dist. LEXIS 58292 (W.D. Pa. July 9, 2009)
Favors: Employer
Law: Federal

Executive's Ambiguous Acceptance of Non-Compete Prevents Enforcement by IBM (IBM v. Johnson)

Non-compete disputes almost always turn on whether the agreement is reasonable or supports a legitimate business interest.

Rarely do they depend on whether the contract was signed in the first place. But that was in fact the principal issue in another case involving IBM and a high-level executive. This case involved the departure of David Johnson, IBM's former Vice-President of Corporate Development, who left IBM earlier this year to take a position as Senior Vice-President of Strategy with Dell, Inc.

IBM immediately filed suit seeking preliminary injunctive relief against Johnson for breach of a non-competition agreement that was purportedly signed back in 2005. Johnson defended on the basis that he never properly signed the contract - and never intended to be bound to the same. The district court agreed and denied IBM's request for injunctive relief, opining that IBM faced a near insurmountable case at a trial on the merits.

Johnson, a highly paid and long-time IBM employee, was clearly reticent to sign a non-compete agreement for one overriding reason: he had foregone an opportunity to become a general manager at another technology company in reliance on assurances he received that a similar opportunity would be made available to him at IBM. That opportunity never came to pass.

In 2005, IBM began requiring its executive to sign non-compete agreements as a condition of receiving equity grants. Johnson attempted to buy as much time as possible and delayed signing his contract. Eventually, he pulled what turned out to be a brilliant move - he signed the agreement on the line designated for IBM.

Johnson returned the document to IBM, and it was clear this caused a great deal of confusion among human resources employee and in-house lawyers. In reality, Johnson's move could have backfired because, as the court noted, his ambiguous "acceptance" of the non-compete agreement meant that he assumed the risk of how IBM responded. Put differently, IBM's reaction was critical to determining whether the agreement had ever been truly accepted as a matter of New York contract law.

So what did IBM do? They repeatedly tried to get Johnson to sign his agreement again, imploring him on several occasions to return a properly executed contract and threatening to withhold equity grants. In short, IBM clearly believed Johnson had not intended to be bound when he signed the non-compete on the wrong line.

Johnson himself testified he did this simply to buy more time. IBM's general counsel even told Johnson to save any documentation from human resources about its efforts to get him to sign another contract. The facts demonstrated that IBM's reaction to Johnson's ambiguous acceptance was clear. No one believed he had intended to be bound by the non-compete, and no one believed his clever misdirection created a binding contract.

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Court: United States District Court for the Southern District of New York
Opinion Date: 6/26/09
Cite: IBM v. Johnson, 629 F. Supp. 2d 321 (S.D.N.Y. 2009)
Favors: Employee
Law: New York

"Management Personnel" Exception to Colorado Non-Compete Statute Accorded Plain Meaning (DISH Network v. Altomari)

Last week, I wrote on one of the several exceptions contained in Colorado's non-compete statute, which presumptively voids restrictive covenants. That exception permitted reasonable non-competes to protect trade secrets, a curiously worded exception which could swallow the entire rule with some artful contract drafting.

Today, I review a case addressing a more sensible exception, one which finds parallels in other states' non-compete laws. The particular carve-out allows reasonable non-competes for "executive and management personnel and officers and employees who constitute professional staff to executive and management personnel." (As a grammatical aside, never underestimate the power of a group of hack legislators to forget basic comma usage norms.)

At issue in DISH Network v. Altomari was a trial court's ruling which refused to apply this exception to a communications director for DISH Network who supervised about 50 employees. Altomari signed a non-compete in connection with the issuance of stock options and sought to leave for DirecTV, a competitor specifically named as a prohibited entity in the non-compete clause.

The trial court made certain factual findings that Altomari was a mid-level manager and that he had definite management responsibilities. However, it found that he was not the type of management personnel contemplated by the statute.

The Court of Appeals of Colorado reversed, finding the trial court erred by not applying the plain meaning of the legislative exception. The court noted that the General Assembly chose not to define the term "management personnel", and that this required it to apply the term according to its plain meaning. The court then concluded that because the trial court found Altomari to be a mid-level manager vested with decision-making autonomy, he qualified as "management personnel" under the statute.

Other states have gone further than Colorado in defining key employees who are otherwise subject to non-compete arrangements, though sometimes this seems to add to the confusion. In Altomari's case, DISH Network showed he had enough autonomy and controlled enough decisions to fall within the legislative exception.

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Court: Court of Appeals of Colorado, Division One
Opinion Date: 6/25/09
Cite: DISH Network Corp. v. Altomari, 2009 Colo. App. LEXIS 1178 (Colo. Ct. App. June 25, 2009)
Favors: Employee
Law: Colorado

Drafting Non-Competes In Colorado Poses a Different Challenge (Haggard v. Synthes Spine)

In Illinois and many other states, non-competition covenants are often wrapped into broader employment agreements with little risk that this would pose any sort of hurdle to enforcement. But because non-compete law varies so significantly from state to state, this common practice may not be a great idea elsewhere.

Colorado, for instance, is one state where non-competes are regulated by state statute. The governing law generally consideres covenants void unless they meet one of four specific exceptions. Sale of business covenants generally are valid if reasonable, and courts also will uphold covenants given by "executive and management personnel." For salespersons who do not qualify as a key employee under this latter, fact-intensive exception, a covenant still may be valid if it is "for the protection of trade secrets."

Courts in Colorado generally require the purpose of the covenant to be trade secret protection. A recent case involving a dispute between a salesperson and a medical device company illustrates the importance of good, careful drafting. The court in Haggard v. Synthes Spine found that a non-compete met the purpose test in Colorado, noting specifically that the non-compete agreement carefully spelled out the exact type of information the employer sought to protect. The employer also deemed it important that the contract did not contain other provisions related to job responsibilities, pay or salary, or other incidents of the employment relationship.

This rule seems a bit technical, suggesting that a comprehensive employment agreement containing covenants and other promises regarding employment may not satisfy Colorado's statute. In other words, for a non-management employee, an employer may be better off drafting two separate agreements - one focused entirely on trade secrets and any covenants against competition intended to protect those secrets.

The opinion in the Haggard case itself was somewhat simplistic regarding the specific "trade secret" information to which the ex-employee had access. The court, like many, sort of assumed that product knowledge and customer data (e.g., contact persons, preferences) were trade secrets, though opinions are all over the map on this issue with the better reasoned approach being that employers ought to really show this information is more than just "confidential" or general knowledge learned during the course of employment. In view of its conclusion, the court enforced both a client non-solicitation and industry non-compete covenant.

Of course, the type of operational information in Haggard could be considered confidential, given its obvious importance but relatively fleeting lifespan (a fact admitted to by the employer in Haggard), and this may very well justify a covenant not to compete. But the statute requires protection of actual trade secrets - not confidential information - and so an analysis basically assuming that every bit of data about customers or products in development is a trade secret seems overly succinct and kind of silly.

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Court: United States District Court for the District of Colorado
Opinion Date: 6/12/09
Cite: Haggard v. Synthes Spine, 2009 U.S. Dist. LEXIS 54818 (D. Colo. June 12, 2009)
Favors: Employer
Law: Colorado