Trading Secrets : Trade Secrets Lawyers & Attorneys : Seyfarth Shaw Law Firm : Computer Fraud, Confidentiality Agreements, Corporate Espionage

Throughout 2010, Seyfarth Shaw LLP’s dedicated Trade Secrets, Computer Fraud & Non-Competes practice group hosted a series of webinars that addressed key issues facing clients today in this important and ever changing area of law. The series consisted of five webinars: The Computer Fraud and Abuse Act: What You Need to Know, Protecting the Secrets in Your Employees’ Heads, Trade Secret Litigation and Protection in California, Franchise and Dealer Relations: Protecting Your Trade Secrets and Brand, and Protecting Your Trade Secrets in the Global Economy: Non-Compete and Trade Secret Considerations In Europe and Asia. As a conclusion to this well-received 2010 webinar series, we have compiled a list of key takeaway points for each of the webinars. If you were not able to attend the webinars, we invite you to request the archived recordings of the webinars by contacting your Seyfarth Shaw LLP attorney. We are also pleased to announce that Seyfarth Shaw LLP will continue its webinar programming in 2011 and has several exciting topics lined up.

The Computer Fraud and Abuse Act

Our first webinar this year, led by Seyfarth attorneys James Yu, Michael Elkon, and Carolyn Sieve, was entitled The Computer Fraud and Abuse Act: What You Need to Know. The Computer Fraud and Abuse Act (CFAA) is a federal statute that has been used for almost a decade to obtain injunctive relief against, and impose liability on, employees and hackers who steal or interfere with a company’s electronic information. This webinar covered the essential points that employers need to know about the CFAA and its potential uses in protecting electronic assets.

·         CFAA claims often turn on what an employee was authorized to do on an employer’s computer system. Therefore, handbooks, IT policies, sign-in screens, and other materials that cover IT authorization should address what an employee is (and is not) allowed to do on the system. 

·         The CFAA is not limited to employees. An employer should consider what authorization instructions it provides to clients, vendors, potential business partners, and contractors. It should also carefully monitor the security protections for its website and internal servers as hackers remain a continuous threat. 

·         There is a split among federal courts regarding whether the CFAA applies to employees who are initially provided access to company data but then either exceed that authorization or otherwise act in a manner that revokes the initial authorization. Some courts have limited the use of the CFAA to unauthorized users such as hackers. Therefore, the location of a possible violation of the CFAA is important.

Inevitable Disclosure

The second webinar of the 2010 series, led by Erik von Zeipel, Jason Stiehl, and David Countiss, focused on Inevitable Disclosure, an evolving doctrine recognized in a large number of jurisdictions that may prevent an employee from accepting employment when the employee’s duties cannot be performed without the disclosure of a former employer’s trade secrets. This discussion covered what employers need to know about the Inevitable Disclosure Doctrine, including jurisdictions which have adopted the doctrine and its application to both exiting and incoming employees. The panel also discussed best practices for handling the hiring and termination of employees in such jurisdictions.

·         Understand the state of the law regarding inevitable disclosure in your jurisdiction. Injunctive relief may be easier to obtain if your jurisdiction has adopted the doctrine.

·         Require new employees to sign agreements acknowledging their obligation to protect company’s trade secrets, as well as acknowledging that they understand that they need to respect their prior employer’s trade secrets and any related agreements. Be prepared to marshall any breaches of these agreements if litigation ensues.

·         When an employee departs, sequester technology assets, conduct exit interviews and have the employee acknowledge agreements and covenants protecting trade secrets.

California Trade Secrets Law

This third webinar, conducted by Robert Milligan, Robert Niemann, and Jim McNairy, focused on how California trade secret law is similar and diverse from other jurisdictions, including a discussion of the California Uniform Trade Secrets Act, trade secret identification requirements, remedies, and the interplay between trade secret law and Business and Professions Code Section 16600, which codifies California’s general prohibition of employee non-compete agreements. The webinar also covered effective California trade secret protection policies and practices.

·         Aside from a few narrow exceptions, non-competition agreements are presumed void under California law in the typical employment context and recent cases hold that most non-solicitation of customer clauses are synonymous with non-compete agreements and are therefore also unlawful. It remains to be seen whether the so-called “trade secret exception” will be a viable exception to California’s general prohibition against non-competition agreements. Employers should keep these developments in mind when assessing such agreements and make sure that their agreements comport with the recent developments in the law. Failure to do so places employers at risk for unlawful business practice suits. 

·         Because non-compete agreements are typically unenforceable in California, employers typically pursue trade secret misappropriation claims against former employees who steal proprietary company information. In such suits, the employer has the burden of showing that the information is a trade secret, including showing that reasonable secrecy measures were in place to protect the information. Accordingly, prudent companies should consider investing the time and money to conduct a trade secret audit. A trade secret audit generally assesses what company information may be protectable as a trade secret and the security measures the company has in place to protect such information. The results of a successful audit are clearly identified trade secrets with adequate protection measures (including updated trade secret protection agreements) in place: the existence of which are essential to success in trade secret litigation, as well as to ensure that key company assets are adequately protected.

·         Conduct a thorough investigation prior to filing a trade secret misappropriation suit to ensure that the claim can be supported from all lines of attack to enable the court to issue appropriate injunctive relief and award damages. This includes obtaining evidence of the trade secret’s existence and the efforts used to protect it. Employers will need to dedicate the time and resources to arm their counsel with this essential information before and during the litigation. Trade secret plaintiffs are also required to identify their trade secrets with particularity before discovery commences in the case, so be prepared to have a trade secret identification statement prepared in advance of serving your discovery.

Trade Secrets and Franchise Law

The fourth webinar of the 2010 series, led by Andrea Okun, Jim McNairy, and Marcus Mintz, discussed how to protect trade secrets, trademarks, trade dress, and goodwill while maintaining and enhancing successful franchises and dealerships. These are often the core assets of a franchise or dealership, and this webinar presented an overview of what assets are protectable, how those assets can be protected, what state and federal laws can be used to protect these assets, and what can be done if these assets are threatened.

·         One of the best ways to protect trade secrets, trademarks, trade dress and goodwill is by entering into clear, enforceable agreements at the outset of the business relationship. These agreements should clearly identify the assets (such as confidential information and intellectual property) that are being shared/licensed and expressly state the receiving party’s agreement to (a) not make unauthorized use or disclosure of those assets, (b) return all assets at the termination of the relationship, and (c) the need for injunctive relief should the receiving party breach the agreement.

·         In addition to the federal Lanham Act, know the law of your jurisdiction(s). 46 out of 50 states plus the District of Columbia have adopted some variation of the Uniform Trade Secrets Act protecting highly confidential information. Of the remaining 4 states, Massachusetts, New Jersey, and New York have introduced their own versions of the Uniform Trade Secrets Act (only Texas has no trade secret act in place or pending). The franchise acts in Illinois, Indiana, Iowa, Louisiana, Michigan and Minnesota make mention of the enforceability of non-competes. Further, Alabama, California, Colorado, Florida, Georgia, Hawaii, Michigan, Montana, New York, South Dakota, and Texas all have statutes specifically dealing with non-competes.

·         When drafting restrictive covenants and seeking injunctive relief, do not overreach. Drafting overly broad agreements or seeking injunctive relief beyond the scope of legitimate business needs may result in invalidation of the agreements at issue and denial of any form of injunctive relief. Be careful not to assume that every jurisdiction will blue pencil or re-write your restrictive covenants to make them enforceable. Many will not.

International Trade Secrets and Non-Compete Law

The final webinar of the 2010 series, led by Marjorie Culver, Dominic Hodson, and Robert Milligan, focused on non-compete and trade secret considerations from an international perspective. The webinar involved a discussion of non-compete and trade secret issues in Europe and Asia, including the threats to trade secrets and confidential information in these regions. The similarities and differences in approach among the various jurisdictions were discussed and compared to the United States. The panel discussed drafting considerations for confidential/trade secret protection and non-compete agreements as well as appropriate policies in these regions, along with a discussion of sources of protection other than written agreements and policies. This webinar provided valuable insight for companies who compete in the global economy and must navigate the legal landscape in these regions and ensure protection of their trade secrets.

·         One size does not fit all when it comes to drafting employment restrictive covenants for employers operating in international countries. Local jurisdictions take an active interest in agreements that restrict employees from competition as a matter of public policy. Companies must be mindful of the legal requirements for valid non-competes and non-solicits where the employees predominantly provide services or where the employees are likely to later compete. Even where the parties agree on a governing law or forum, the courts in the local jurisdiction often apply local law requirements and void restrictive covenants that do not comply.   

·         Trade secrets: default statutory protections only go so far. Though many countries make trade secret misappropriation unlawful (similar in some respects to the U.S.), this protection may not be helpful unless a company takes active measures to define and protect its proprietary information. Companies should execute confidentiality agreements adequately defining what a company considers confidential and proprietary and also put in place technological and security protocols to restrict access to the company’s most valuable proprietary information. Failure to take such measures can undermine a company’s claim that the information constitutes a trade secret. Companies must also be mindful that their security precautions do not interfere with employees’ privacy rights, particularly in Europe.

·         Non-competes: are they worth the effort in every instance? In some jurisdictions, non-competition restrictions require payment to the former employee during the restrictive period. And, in some cases, even an employer who no longer wishes to oblige the employee cannot waive the non-compete and the obligation to pay. Additionally, injunctive relief may not be available in some countries, making a non-compete the least expedient means for protecting the company from unfair competition. Across the board use of non-competes may not be the most cost-effective or efficient way to protect a company’s competitive position or trade secrets. Rather, companies should formulate a thoughtful strategy that only utilizes non-competes with employees for which there is a legitimate business and legal justification.

2011 Trade Secrets Webinar Series

Beginning in January 2011, we will begin another series of Trade Secret webinars. Planned topics for the 2011 series include Trade Secrets in the Financial Services Industry, Georgia’s New Non-Compete Statute, Choosing the Right IP Protection: Patent or Trade Secret, The Anatomy of a Trade Secret Audit, and Maintaining Trade Secrets in the New World of Cloud Computing. For notifications concerning our upcoming webinars, please sign up for our Trade Secrets, Computer Fraud & Non-Competes mailing list by clicking here.

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In a battle of competing noodle franchises, a federal district court in Arizona recently granted a franchisee’s motion to compel arbitration in a trade secret and breach of contract dispute with its franchisor.   

Apart from its colorful facts, the court’s ruling is significant.  First, it demonstrates that franchisors that include arbitration provisions in their franchise agreements may be precluded from obtaining immediate injunctive relief in court against their franchisees, particularly where they include provisions that only permit the franchisor to obtain injunctive relief outside the arbitration proceeding (at least under Arizona law). Next, it demonstrates that a nonsignatory to a franchise agreement may be permitted to compel arbitration in the Ninth Circuit where the signatory’s claim against the nonsignatory involves a dispute that is “intertwined with the contract providing for arbitration.” The decision is also a reminder that although binding arbitration with franchisees may be beneficial, franchisors must keep abreast of the ever-changing law in the governing jurisdiction(s) to ensure that arbitration rather than litigation in the courts is the appropriate dispute resolution forum for their business objectives.  Simply put, if a rogue franchisee’s actions put a franchisor’s system in jeopardy, a franchisor may not be willing to put the fate of its misappropriated intellectual property in the hands of an arbitrator. 

In Noodles Development, LP v. Latham Noodles, LLC, 2009 WL 2710137 (D. Ariz. August 26, 2009), a federal district court in Arizona (District Judge Neil V. Wake, presiding) granted the franchisee’s motion to compel arbitration and stayed the civil action initiated by the franchisor.

The plaintiff, a franchisor owing the rights to the “Nothing But Noodles” franchise of restaurants, entered into a franchise agreement with the defendant franchisee which permitted the franchisee to open a franchise in New York. See id. at *1.

The franchise agreement provided that “any dispute or claim relating to or arising out of this Agreement must be resolved exclusively by mandatory arbitration by and in accordance with the Commercial Arbitration Rules of the American Arbitration Association (“AAA”) or another arbitration service agreed to by the parties.”  See id.

The franchise agreement also provided the franchisor with the right to petition a court of competent jurisdiction for the entry of temporary and permanent injunctions of specific performance enforcing the provisions of the franchise agreement relating to “(a) Franchisee's use of the Marks or the System ...; (d) Franchisee's violation of the provisions of this Agreement relating to confidentiality and the covenants not to compete; and (e) any act or omission by Franchisee or Franchisee's employees that ... (2) is dishonest or misleading to the guests or customers of the Franchised Restaurant or other Nothing But Noodles Restaurants ..., or (4) may impair the goodwill associated with the Marks or the System.” Id.at *1.

The franchisor challenged the franchisee’s motion on the grounds that 1) the agreement did not encompass the claims that it had brought against the franchisee; 2) it need not first arbitrate the substantive merits of its claims because pursuant to the franchise agreement it may bring an action for injunctive relief before the court and principles of judicial economy should allow it to litigate its damages claims in court as well; and 3) it need not arbitrate with one of the co-defendants because he was not a signatory to the franchise agreement.  The court rejected all three of the franchisor’s arguments.  See id. *1-*4.

First, the court stated that the franchisee agreement requires arbitration of “any dispute or claim relating to or arising out of this Agreement.”  The noted that the Ninth Circuit has observed that the phrase “arising out of or relating to” creates an arbitration clause that is “broad and far reaching” in scope.  Id. at *1 (citing Chiron Corp. v. Ortho Diagnostic Sys., Inc., 207 F.3d 1126, 1131 (9^th Cir. 2000)).  The court found that an arbitration clause with a broad and far reaching scope “reaches every dispute between the parties having a significant relationship to the contract and all disputes having their origin or genesis in the contract.”  Id. at *1 (citing Simula, Inc. v. Autoliv, Inc., 175 F.3d 716, 719 (9^th Cir. 1999)).

The court stated to require arbitration, the factual allegations of the complaint “need only ‘touch matters' covered by the contract containing the arbitration clause.” Id. (quoting Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 624 n. 13 (1985)).

The court found that all of the facts alleged in franchisor's complaint have a significant relationship to the franchise agreement.  The court noted that the complaint alleges trademark and trade dress infringement, misappropriation of trade secrets, and breach of contract.  The court reasoned that the factual predicate of these claims was the franchisee's alleged misuse of the Nothing But Noodles marks and system.  Because the franchisee's use of the Nothing But Noodles marks and system was the core subject of the franchise agreement, the court found that the franchisor's claims have a significant relationship to the franchise agreement and must be arbitrated.  See id. at *2.

The court also noted that the franchisor alleged that franchisee tortiously interfered with its business relationships.  The court found that the claim was significantly related to the confidentiality clauses and covenants not to compete in the franchise agreement and an area development agreement signed by the parties, which also contained an arbitration clause.  The area development agreement provided the franchisee with the right to sell new franchises on behalf of the franchisor.  The court stated that the franchisor alleged that the franchisee had instead been soliciting existing Nothing But Noodles franchises to re-brand their restaurants under another mark.  See id.

The court found that the facts of this allegation were significantly related to the franchisee's duties as a representative of franchisor under the area development agreement, especially those provisions relating to confidentiality and competition.  The court found that the franchise agreement therefore required arbitration of the tortious interference claim.  See id.

In sum, the court found that the substance of each claim asserted by the franchisor in its complaint was covered by the arbitration agreement and therefore could not be adjudicated by the court.  See id. at *2.

Next, the court acknowledged that the franchise agreement does, however, reserve to the franchisor the ability to seek preliminary or permanent injunctive relief in court for certain types of claims. The court remarked that typically courts in our circuit [Ninth Circuit] may not grant preliminary injunctive relief where interim relief is available from an arbitral tribunal.  See id.

The court found, however, that the terms of the agreement control the scope of the arbitration clause in the suit.  The franchise agreement specifically permitted the franchisor to seek injunctive relief from the court despite the availability of such relief under the rules of the American Arbitration Association.  See id.

However, the court found that the franchise agreement did not specify whether the franchisor may seek permanent injunctive relief in court before obtaining a substantive determination of the merits of its claims from an arbitral tribunal.  The franchisor argued that it need not first arbitrate the substantive merits of its claims and that because it may bring an action for injunctive relief before the court, principles of judicial economy should allow it to litigate its damages claims in court as well.  See id. at *3.

The court found that such an interpretation nullified the arbitration clause because once the court decided the merits of the franchisor's claims, there was little purpose in involving an arbitral tribunal.  The court found that the franchisor’s interpretation conflicted with the parties' demonstrated intent to have an arbitral tribunal, not a court, decide the merits of “any dispute or claim arising out of or related to” the franchise agreement.  See id. at *3.

The court stated that the franchise agreement's injunction provision may simply be intended to preserve the availability of a court to impose an injunctive remedy, rather than decide the merits of the claims.  “In other words, it may allow Franchisor to seek preliminary injunctive relief to maintain the status quo during arbitration and to seek permanent injunctive relief if the arbitral tribunal rules in its favor.”  Id. at *3.  The court found that this interpretation was equally as plausible, if not more plausible than the franchisor's interpretation.  The court held that the ambiguous relationship between the franchise agreement’s arbitration clause and the injunction provision must be reconciled in favor of arbitration.  See id. at *3.

The court found that the franchisor may seek emergency injunctive relief to preserve the status quo while it arbitrates, but it must obtain a substantive determination of the merits of its claims from an arbitral tribunal before applying for a permanent injunction from the court.  The court noted that the franchisor had not yet moved for any emergency injunctive relief.  See id.

The court also stated that at least one court had recently held that, under Arizona law, an arbitration agreement that reserves the right to seek judicial injunctive relief to only one party is substantively unconscionable.  See id. (citing Wernett v. Serv. Phoenix, LLC, 2009 U.S. Dist. LEXIS 62593 at *26-28, 2009 WL 1955612 at *8 (D.Ariz. July 6, 2009)).  The court stated that should the franchisor seek preliminary injunctive relief from the court instead of from the arbitral tribunal, it will first have to address the validity of the franchise agreement’s “one-sided injunction provision under Arizona law.”  Id.at *3. (emphasis added).

Lastly, the franchisor argued that it need not arbitrate with one of the co-defendants because he was not a signatory to the franchise agreement.  The court stated that a nonsignatory to an arbitration agreement may estop a signatory from refusing to arbitrate its claim against the nonsignatory where the dispute is “intertwined with the contract providing for arbitration.”  Id. at *3 (citing Mundi v. Union Sec. Life Ins. Co., 555 F.3d 1042, 1047 (9th Cir.2009)). “[A]pplication of equitable estoppel is warranted ... when the signatory to the contract containing the arbitration clause raises allegations of ... substantially interdependent and concerted misconduct by both the non-signatory and one or more of the signatories to the contract.”  Id. at *3 (citing Brantley v. Republic Mortgage Ins. Co., 424 F.3d 392, 396 (4th Cir.2005)). 

The court noted that the complaint alleges that “the Individual Guarantors and [non-signatory] Defendant . . . have contacted Noodles' franchisees and made attempts to induce such franchisees into breaching their respective agreements with Noodles.”  Id. at *3.  The court found that the complaint therefore raises allegations of substantially interdependent and concerted misconduct by the non-signatory defendant and the defendant signatories to the franchise agreement.  Accordingly, the court found that the franchisor was estopped from refusing to arbitrate its claim against the non-signatory defendant.  See id. at *3.

The court stayed the civil action until the arbitration has been completed, having concluded that all claims in the suit were subject to arbitration, but indicated that the franchisor may apply to the court for injunctive remedies.

The court’s decision has a number of general take-aways for franchisors. Franchisors should carefully consider whether to include an arbitration provision in their franchise agreement. Arbitration can provide a number of benefits to franchisors, such as a cost-effective and seemingly uniform method of resolution with franchisees. There can be significant drawbacks though depending upon the applicable governing law, such as having to pay for the costs of the arbitration, losing or having a limited right to seek immediate injunctive relief in a court of law, only having a limited review of arbitration decisions, and having non-signatories to the arbitration agreement made part of the arbitration proceeding. Before including arbitration provisions in their franchise agreements, franchisors should consult counsel to determine the ever changing state of the law in the governing jurisdiction and decide whether arbitration provides an adequate forum to protect any misappropriated intellectual property, such as the franchisor’s system.

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In Atlanta Bread Co. Int’l, Inc. v. Lupton-Smith, S08G1815, 2009 WL 1834215 (Ga. Jun. 29, 2009), the Georgia Supreme Court today confirmed that in-term restrictive covenants are subject to the same strict scrutiny standard applied to post-term covenants and the same reasonableness standards of time, territory, and scope. 

The question presented in Atlanta Bread Company was whether the in-term non-compete covenant in a franchise agreement between Atlanta Bread Company and Sean Lupton-Smith is enforceable under Georgia law. The covenant at issue states as follows:

During the term of this Agreement, neither [Lupton-Smith] nor any Principal Shareholder, for so long as such Principal Shareholder owns an Interest in [Lupton-Smith], may, without prior written consent of Franchisor, directly or indirectly engage in, or acquire any financial or beneficial interest in (including any interest in corporations, partnerships, trusts, unincorporated associations or joint ventures), advise, help, guarantee loans or make loans to, any bakery/deli business whose method of operation is similar to that employed by store units within the System.

During the term of the franchise agreements, Lupton-Smith opened and began operating a P.J.’s Coffee & Lounge in Atlanta, Georgia. Atlanta Bread Company sent a notice terminating the franchise agreement and litigation ensued. The trial court and Court of Appeals both found that the in-term non-compete provision was unenforceable under Georgia law because it failed to “meet[] the reasonableness standards promulgated in Georgia.” 

The Supreme Court rejected Atlanta Bread Company’s argument that the provision is a loyalty provision rather than a non-compete provision, noting that

[a] plain reading of the clause shows that it prohibits the franchisee from engaging in a certain type of business during the term of the parties’ agreement and, thus, it is a partial restraint of trade designed to lessen competition. Such restraints, no matter the nomenclature assigned to them, are disfavored in this state as a matter of public policy.

The Court rejected any contention that a franchise relationship should be treated differently, confirming that the court has held time and again” that franchise agreements and employment agreements are subject to the same strict scrutiny (meaning, among other things, that it cannot be blue-penciled). This analysis removes any doubt that the Court’s analysis in Atlanta Bread Company also will apply to in-term restrictive covenants in an employment agreement. 

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By Robert Milligan & Jim McNairy

After obtaining a sweeping nationwide injunction from an arbitrator that enjoined licensee Comedy Club, Inc. (“CCI”) from opening any new comedy clubs until 2019 pursuant to a trademark license agreement, licensor/competitor Improv West Associates (“Improv”) could not have been in the mood for laughs when the U.S. Court of Appeals for the Ninth Circuit modified the arbitrator’s injunction by significantly narrowing its scope and breadth. The decision is an important one for franchisors because the court indicated that in-term covenants not to compete in franchise like agreements will be void if they foreclose competition in a substantial share of a business, trade, or market.

The Ninth Circuit held in Comedy Club, Inc. v. Improv West Associates that an arbitrator’s injunction based on in-term covenant not to compete in a trademark license agreement, which precluded CCI and its affiliates (including tangential relatives of CCI principals) from competing in the comedy club business (apart from existing licensed “Improv” clubs that CCI continued to operate under the license agreement) until 2019, was not enforceable. Specifically, the court modified the nationwide scope and inclusion of tangential relatives of CCI principles in the arbitrator’s injunction.

The court found that the arbitrator’s injunction violated California Business & Professions Code Section 16600 (“CBPC § 16600”). With respect to the injunction barring affiliates from competing, the court stated:

Moreover, precluding non-party relatives or ex-spouses from opening or operating improv-comedy-related businesses or restaurants violates CBPC § 16600. . . . By restricting non-party relatives and ex-spouses from engaging in a lawful business, the injunctions, with respect to those persons, exceed the arbitrator’s authority.

 Regarding the scope of the nationwide injunction, the court stated that under existing California case law that it was evident that under CBPC § 16600 an in-term covenant not to compete in a franchise-like agreement will be void if it forecloses competition in a substantial share of a business, trade, or market. The court also stated that California courts are less willing to approve in-term covenants not to compete outside a franchise context because there is not a need to protect and maintain the franchisor’s trademark, trade name and goodwill.

The court indicated that under existing California case law that the franchisor-franchisee context was different from an employment or partnership context. The court stated that CCI’s relationship with Improv was in essence a franchise agreement as CCI contracted with Improv to use Improv’s trademarks and open comedy clubs modeled on Improv’s clubs. Assessing the requirements of California law, the court weighed CCI’s right to operate its business against Improv’s interest “to protect and maintain its trademark, trade name and goodwill.”  The court concluded that “this balance tilts in favor of Improv with regard to counties where CCI is operating an Improv club, but under the restraint of CBPC § 16600 California law does not permit an arbitrator to foreclose CCI’s competition in opening comedy clubs throughout the United States.” Accordingly, the court upheld a more limited injunction that restricted competition by CCI and those persons in active concert or participation with CCI but only in counties where CCI continued to operate comedy clubs using the licensed “Improv” name. Because the parties did not address its application, the court did not address whether the in-term covenant could be upheld under the trade secrets exception to CBPC § 16600.

Lessons from this case include:

1. In-term covenants not to compete may be enforceable in the franchise context “to protect trademarks, trade names, and goodwill of a licensor” if they are narrowly tailored and do not foreclose a party from engaging in its business or trade in a substantial section of the market—the geographic scope should be the territory where the company is or companies are doing business during the agreement. If franchisors can show that the in-term covenant is necessary to protect trade secrets, then they may be able to support a broader covenant. Franchisors should review their agreements to ensure that they comport with the court’s decision. 

2. Businesses should use caution before utilizing any covenants not to compete in California and should assess whether the restriction on competition can be tied to one of the statutory exceptions to California Business and Professions Code section 16600, to the protection of trade secrets, or the court’s in-term “franchise” exception to section 16600. These exceptions to California’s general prohibition against non-compete agreements were recognized by the court.

3. Franchisors should not include overly broad definitions of affiliates in their franchise agreements in California. Courts will not enforce overly broad covenants that restrict non-party relatives and ex-spouses from engaging in a lawful business because such covenants violate Business and Professions Code Section 16600.

4. The court’s decision highlights what the California Supreme Court made clear in its Edwards v. Arthur Andersen opinion: unless falling within one of few exceptions to Business and Professions Code Section 16600, post-term covenants not to compete are invalid in California regardless of whether such covenants are narrowly drawn.

5. The court’s decision places an increased focus on trade secrets. The court’s decision may be seen by some franchisees/employees as allowing greater mobility, even where proprietary information is taken. Auditing your organization’s trade secret protections is a valuable first step toward protecting against this risk, ensuring that your organization’s intellectual capital is adequately protected, and attempting to enforce a non-compete/non-solicit provision under the trade secrets exception to Business and Professions Code Section 16600.

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Earlier this year, the Georgia Court of Appeals made news in Atlanta Bread Company Int'l v. Lupton-Smith, Court of Appeals Case No. A08A0348, when it struck down in-term restrictive covenants of a franchisee on the grounds that the in-term restrictive covenants did not pass the test of reasonableness applied to post-term restrictive covenants.  In this case, the franchisee had opened several allegedly competing stores at the same time that he was operating Atlanta Bread Company franchises.  Atlanta Bread Company then terminated his franchise.   The Court of Appeals ruled that the post-term restrictive covenants and the in-term covenants were inextricably tied and because the post-term restrictive covenants did not pass muster, the in-term covenants also failed. 

The case has sparked great interest within the franchise community, as the International Franchise Association has indicated that the lower court decision would wreak havoc on franchise systems in Georgia by  rendering  "unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia, including many of the most well-known and respected franchises in the world."   The Court of Appeals ruling was cast as opening the door for franchisees potentially to compete with their own franchisors during the term of the franchise agreement.  Georgia applies strict scrutiny review to post-termination restrictive covenants between franchisees and franchisors, which is the same standard applied to such agreements between employees and employers.  As a result, Georgia will not blue pencil such an agreement, even though it will blue pencil a non-competition covenant contained in the sale of a business.  

On October 6, 2008, The Georgia Supreme Court granted Atlanta Bread Company's petition for certiorari.  The Court agreed to hear, in particular, the following questions:

1. Did the [Court of Appeals] err in holding that under Jackson & Coker v. Hart, 261 Ga. 371 (1991), the reasonableness standard applicable to post-termination restrictive covenants also applies to in-term restrictive covenants?

2. Did the [Court of Appeals] err in applying to in-term restrictive covenants in franchise agreements the rule against allowing the blue-pencil doctrine of severability.

The Supreme Court's decision to grant certiorari means that oral argument is mandatory.  The case will proceed on the January 2009 oral argument calendar. 

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