Restrictions in Franchise Agreements Narrowly Construed

more+
less-

Virginia’s public policy in favor of freedom of contract is well established. It may be most conspicuously evidenced by the Supreme Court of Virginia’s increasingly narrow construction of post-contract employment restrictions contained in non-competition agreements.  It is probably not surprising to find the Fourth Circuit applying a similar standard in refusing to enforce restrictive language contained in a franchise agreement.  Hamden v. Total Car Franchising Corporation was decided in November 2013 and recorded in an unpublished opinion.

The Case

Total Car Franchising (“TCF”), a South Carolina-based business operating in Virginia and other states, offers franchisees an opportunity to use TCF’s proprietary techniques in providing auto repair and restoration services including paint restoration and paintless dent repair.  Hamden entered into a franchising agreement in 1996. The term of the agreement was fifteen years, with a right of renewal held by Hamden. 

The agreement assigned a specific geographical area to Hamden and provided that he could not participate in a “paint restoration business” for two years after “termination” of the agreement “for any reason.”  The parties also executed a non-competition agreement which stated that “if the Franchise Agreement is terminated before its expiration date, or if you assign or transfer your interest” in it, then you will not engage “in any business engaged in the same or similar type of appearance technology” within the geographical area established in the franchise agreement. 

Finally, the parties endorsed a non-disclosure agreement providing that “[d]uring the term of the Franchise Agreement and thereafter” you will not “divulge…or use for your benefit” TCF’s confidential information and “if there is any termination of this agreement, You agree that you will never use our confidential information or trade secrets in the design, development or operation of a [competing] business.”

Hamden’s franchise agreement expired on May 9, 2011.  Unaware that the term had ended, Hamden continued working as a franchise until October of 2011 when he received a letter from TCF informing him that his agreement had expired and offering him an opportunity to renew.  By the end of November, Hamden decided to pursue his own competing business.  TCF responded by filing suit seeking an injunction and damages.  Hamden sought a declaratory judgment asking the Court to determine the parties’ respective rights and obligations.  The District Court ruled that since the franchise agreement had expired, and not been terminated,  Hamden was not bound by the restrictive covenants. 

On appeal, the case turned on the meaning on the word “terminate.”  TCF advanced the theory that “termination” encompassed the “natural end of the contract” by whatever means, but Hamden countered by pointing out that both “termination” and “expiration” were used in the agreement and that “the use of both indicates a different meaning for the terms.”  Hamden pointed out that since one section of the agreement referred to “expiration” as the natural end of the fifteen year agreement, “termination” had to mean something else.

The Decision

Ultimately, the Court noted that “termination correlates to an affirmative act” and that “the Franchise Agreement’s failure to indicate that termination arises passively through expiration… indicates that expiration does not trigger the restrictive covenants.”  With one exception, the Court held that all of the post-franchise agreement restrictions were unenforceable because the Agreement had not been terminated.

The Court, however, did find that the first restriction contained in the non-disclosure agreement – restricting Hamden’s right to divulge or use TCF’s proprietary and confidential trade secrets “[d]uring the term of the Franchise Agreement and thereafter” was enforceable because its application was not triggered by termination.

The Court commented, without apparent concern, that “thereafter denotes indefinite continuance in the future.” One would assume that the infinite duration of the restriction would have caused the Court concern, and this may be an issue to be raised on another day.  It also may reflect a Court unhappy with the result the law required, and seeking to enforce the spirit of the agreement.  

On the other hand, TCF’s difficulties were hardly a matter of semantic distinction.  Because TCF drafted the franchise agreements, the documents were to be construed against them. Sloppy and inconsistent language seldom begets a good result.

Topics:  Franchise Agreements, Franchises, Non-Compete Agreements, Restrictive Covenants

Published In: Civil Procedure Updates, Civil Remedies Updates, General Business Updates, Franchise Updates, Labor & Employment Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Bean, Kinney & Korman, PC | Attorney Advertising

Don't miss a thing! Build a custom news brief:

Read fresh new writing on compliance, cybersecurity, Dodd-Frank, whistleblowers, social media, hiring & firing, patent reform, the NLRB, Obamacare, the SEC…

…or whatever matters the most to you. Follow authors, firms, and topics on JD Supra.

Create your news brief now - it's free and easy »