October 2014 Archives

In this series of blog posts, we have examined the use of injunctive relief in state and federal courts in response to employees who have misappropriated confidential information and trade secrets, who have solicited clients and employees, or who have violated non-compete agreements.

In our last three posts, we identified best practices for ensuring that a company's house is in order, including the use of narrowly tailored restrictive covenant agreements (Part I); adopting a company culture and behaviors that protect its information (Part II); and why and when to seek injunctions and temporary restraining orders (Part III). In this, our fourth and final blog post in the Watch Your Assets series, we discuss the use of key injunction strategies.

A.  Who to Sue?

One of the first and most important decisions to make when seeking an injunction is who will be named as a defendant--the former employee alone or the employee and his or her new employer.  Suing the employee alone can be an effective "divide and conquer" strategy. That is, by suing the employee alone, the new employer is forced to decide whether it wants to inject itself into the proceedings or take a hands-off "wait-and-see" approach.

Generally, if the new employer has been complicit in some wrongdoing (e.g., has assisted with the misappropriation of confidential information) or has a significant monetary interest in seeing an employee avoid a non-compete (e.g., a sales employee with a significant book of business), it will team up with the employee and provide legal and other assistance. Many employers in these circumstances will also step back and suspend an offer of actual employment and tell the employee he or she must resolve the matter themselves before employment may begin.

Conversely, suing the new employer at the outset can force that employer and the former employee onto the same team, which will mean that the former employee may have company-provided legal representation and other resources available that would not have been available otherwise. It is important to think through each of these scenarios and outcomes before filing a lawsuit.

As part of the process, employers should perform due diligence about the potential adverse company, including its appetite for lawsuits, involvement in restrictive covenant cases, its outside counsel (which may inform, at least by general reputation, its level of aggressiveness), etc.

B.  Timing is Everything

As a general rule, seeking injunctive relief, especially a temporary restraining order (TRO), requires an employer to act as soon as it sees any realistic threat to its interests.

Thus, there is usually a significant amount of work required in a short period of time to gather the facts and relevant documents; examine any legal weaknesses with the contracts or claims; develop the necessary affidavits and exhibits; draft the complaint and injunction pleadings; and schedule and conduct an injunction hearing.

Of course, there are times when it makes sense to avoid a TRO and simply file a complaint with a request for a preliminary injunction, such as when there are potential enforcement issues with an agreement or other problems that can affect your ability to demonstrate a likelihood of success on the merits. In those instances, it may make sense to file a complaint with a request for a preliminary hearing but not set the hearing to put the other side back on its heels and allow you to examine the situation in more detail or try to negotiate a resolution.

Of course, taking a wait-and-see approach can be fatal to an award of temporary injunctive relief, because the other side will argue that the wait is proof of the lack of a threat of imminent harm or an otherwise adequate remedy at law.

Further, while sending a cease and desist letter prior to filing suit and waiting for a response saves expense and may possibly lead to an early compromise, there is significant risk that the former employees and competitors will take advantage of the notice period to prepare and file a declaration action in another jurisdiction before the company has an opportunity to file suit. This gives them the strategic benefit of choosing the venue and of controlling the language of the action.

The best approach is dictated by considerations of available monetary resources, likelihood of success, judgment of the litigation preparedness, and willingness of the other side, etc.

C.  Notice--Who, When, and How?

In order to secure an injunction, the requesting party will have to demonstrate to the court that it has made reasonable attempts to notify the other side that it is going before the court to seek equitable relief. This is generally not a problem with a preliminary injunction hearing, as these are usually set with the full participation of the court and the other party (who is typically already represented by counsel that has been identified in early stages of the case).

However, a TRO hearing is generally decided on very short notice without the appearance or participation of the other side, which is why the court will usually require the requesting party to provide a bond that will protect the other side from damage from an improperly issued injunction.

The tactical advantages associated with an ex parte hearing are many, not the least of which is the absence of any opposition to the motion. However, before the court will grant a TRO (and, in some jurisdictions, before it will even allow a hearing on a TRO), it will want to be satisfied that the requesting party made reasonable attempts to provide notice to the other side.

Courts are also adept at seeing attempts to game the system, such as a call to the other side from the courthouse steps when the company has been aware of the new employment for days or weeks. In general, a requesting party will want to show that it has provided at least 24 hours notice of the hearing or have a credible explanation about why it could not do so (e.g., the former employee has a copy of a trade secret formula that it is shopping to competitors or is out of town meeting with the company's biggest client in an attempt to pirate the business). Proof of attempts to provide notice of a hearing should be put in an affidavit that is submitted to the court with the injunction pleadings showing the calls, mail, service of pleadings, or other provisions of notice.

D.  Costs--Injunctive Relief Is Expensive

Securing injunctive relief can be very expensive because it requires the requesting party and its attorneys to work full speed on very short notice to review documents and interview witnesses, perform the necessary legal research, draft a complaint and a motion for an injunction with supporting affidavits and exhibits, and prepare for a hearing.

A preliminary injunction hearing usually operates like a mini (or sometimes full) trial on the merits where the parties will present live testimony, have an opportunity to cross-examine witnesses, provide opening and closing arguments, and argue the merits of the motion.

As with a regular trial, the parties will have to invest a significant amount of time, effort, and financial resources, including taking crucial employees away from their daily tasks to focus on the injunction hearing, to make a convincing argument.

As with any other expenditure of company resources, companies should engage in a significant cost-benefit analysis before committing to the injunction process. This can be difficult because these situations are usually highly emotional, which can temporarily cloud judgment.

E.  Venue--Familiarity with Local Courts, Rules, and Judges Is Key

Deciding where to sue and seek injunctive relief can be one of the most important decisions a company can make when seeking injunctive relief. Ultimately, the decision to award injunctive relief is made by a judge.

So, knowing and understanding the local judiciary can be the difference between getting an injunction or not. If federal jurisdiction is available, based either on the diversity of the parties or the existence of a federal claim with original jurisdiction, there may be a tactical advantage to suing in federal court where the judges may be more capable of managing complex facts and legal theories.

However, federal courts can be more reluctant to provide ex parteTROs and can be slower to schedule preliminary injunction hearings. Whereas in state court, you may be able to go before a judge simply by waiting in the halls of the courthouse until one will see you.

There may also be tactical advantages in forcing the other side to deal with removal or remand issues, and federal courts are widely perceived as controlling the parties and the discovery process better and being less patient with uncooperative counsel and frivolous arguments.

Ultimately, a good understanding of the local courts, judges, rules, and practice is critical when deciding when and where to seek injunctive relief.

F.  The Documents Should Never Be an Afterthought

Courts have very little time--even less than the parties in putting the documents together--to review, evaluate, and decide a TRO injunction motion and its underlying complaint.

Thus, the most critical element of success for obtaining injunctive relief is for the company to present clear, persuasive, and focused documents to the court, including the complaint and memorandum in support. The documents should marshal all of the key facts and law in persuasive, easy, and consumable bites for the court so that it (and its law clerk) has very little to do to understand and agree with the company's position.

Filing the best possible papers at the beginning of the suit also furthers the company's ability to win the credibility contest that is always front and center as the court makes initial determinations.

John C. Glancy is a shareholder in the Greenville office of Ogletree Deakins, and he co-chairs the firm's Unfair Competition and Trade Secrets Practice Group. Tobias E. Schlueter is a shareholder in the Chicago office of Ogletree Deakins, and he is on the Steering Committee for the firm's Unfair Competition and Trade Secrets Practice Group.

A franchisee who sued his franchisor for fraud learned the hard way why it's important to read the Franchise Disclosure Document, cover to cover, before buying a franchise.

A California franchisee of Big O Tires sued the company in California court, alleging that Big O defrauded him when it sold him a franchise.

The California Court of Appeals ruled against him because the disclosure document Big O gave to the franchisee before he bought contradicted each and every one of his claims.

Mr. Hailemariam purchased his Big O Tires franchise in February 2008. Before he bought the franchise, he received Big O's Uniform Franchise Offering Circular ("UFOC"). The UFOC was similar in content and structure to the Franchise Disclosure Document that franchisors are now legally required to give prospective franchisees.

After operating a store for little more than a year, Mr. Hailemariam closed it down due to financial difficulties. 'In August 2009, Mr. Hailemariam sued Big O in California state court alleging that the franchisor fraudulently induced him into purchasing a franchise.

Specifically, the franchisee alleged that Big O:

(1) told him (falsely) that he did not need experience to operate a tire store;

(2) provided exaggerated earnings claims;

(3) concealed from him that many of its franchisees had failed;

(4) told him that it would sell him tires at competitive prices, when the same tires were often available for less money from other sources;

(5) falsely stated that it develops new products and services; and

(6) had expertise in locating and outfitting stores.

Big O moved for summary judgment on the franchisee's claims. Based on a Colorado choice-of-law provision in the franchise agreement, the trial court held that Colorado law (and not California law) applied.

Reasonable Reliance

Under Colorado law, the Court said that a plaintiff claiming that he was defrauded must be able to show that he reasonably relied on the defendant's misrepresentation (or on the material facts that the defendant purposefully concealed).

Courts in Colorado apply the concept of "inquiry notice" when considering whether a plaintiff's reliance on alleged fraudulent statements was reasonable.

Quoting the Colorado Supreme Court, the Court summarized the doctrine as follows:

[W]hatever is notice enough to excite attention, and put the party upon his guard, and call for inquiry, is notice of everything to which such inquiry might have led. . . .

When a person has sufficient information to lead him to a fact, he shall be deemed conversant of it. . . . . The presumption is that, if the party affected by any fraudulent transaction or management might, with ordinary care and attention, have reasonably detected it, he reasonably had actual knowledge of it.

[As a result] [w]here the means of knowledge are at hand and equally available to both parties, and the subject of purchase is alike open to their inspection, if the purchaser does not avail himself of these means and opportunities, he will not be heard to say that he has been deceived by the vendor's representations.

Quoting Cherrington v. Woods 290 P.2d 226, 228 (Colo. 1955).

In other words, a person who receives a franchise disclosure document is supposed to read it. If he doesn't read the document, he can't later complain that he didn't know what was in it when he signed the franchise agreement. Moreover, if there was enough information in the disclosure document to allow the person to investigate the truth of the other party's claims, he can't later complain if he failed to do so.

The Franchisee's Fraud Claims

The Court held that statements made in the UFOC received by Mr. Hailemariam before he bought his Big O Tires franchise should be considered when determining whether he had access to those facts. Applying Colorado law to the facts, the Court examined each of the franchisee's fraud claims.

1. Exaggerated Earnings Claims

Regarding Mr. Hailemariam's claim that Big O exaggerated earnings claims in Item 19 of the UFOC, the Court examined Big O's UFOC, which stated: "BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER."

Big O also pointed to the actual language of Item 19, which included data from 211 stores. The data from the 211 stores supported Big O's own estimate of the average sales per store.

In Item 19 of the UFOC, Big O stated that it would provide substantiation for the data upon the franchisee's request, and stated that a franchisee should conduct an independent investigation of the information by contacting existing and former franchisees of the system that were listed in Item 20 of the UFOC.

But Mr. Hailemariam did neither of those things, and the Court found it significant that he failed to make those inquiries.

2. Concealing Failed Franchises

Regarding the franchisee's claim that Big O concealed from him the failure rate of its franchisees, Big O again pointed out that Item 20 of the UFOC contradicted Mr. Hailemariam's claim.

Specifically, Big O showed that the UFOC specifically listed the number of transferred, cancelled, and terminated franchises during the periods specified in the UFOC - and that if Mr. Hailemariam had bothered to read the UFOC, he would have known exactly what the failure rate was.

3. Tire Sale Prices

Turning to the allegation that Big O misrepresented to Mr. Hailemariam that it would sell him tires at competitive prices, Big O again referred to the UFOC. Big O argued, and the Court found it significant that, Big O did not guarantee any specific supply of tires, and the franchise agreement did not contain any provision obligating Big O to supply tires to franchisees at competitive prices.

What the franchise agreement did say is that Big O was only required to provide tires to franchisees "to the extent available," and that Big O could set the recommended prices for the tires.

So again, the clear language of the UFOC rebutted Mr. Hailemariam's claims.

4. Store Location

Mr. Hailemariam claimed that Big O misrepresented that it had certain expertise in locating and outfitting stores, when in actuality the site he selected with Big O was not a profitable or good location. In response, Big O noted that the UFOC specifically told Mr. Hailemariam that the "final decision" regarding a store's location was left to him, and that Big O disclaimed any liability for that decision.

Because the UFOC stated that selection of a location was entirely the franchisee's responsibility, and not Big O's, the Court gave no credence to that claim, either.

5. Need For Experience

Considering Mr. Hailemariam's claim that Big O (falsely) told him that a franchisee did not need experience in the tire business, the Court found it significant that the UFOC contained this disclaimer:

BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER.

Mr. Hailemariam acknowledged this disclaimer in his Franchise Agreement, which the Court found significant in overcoming the fraud claim.

Failure To Read The UFOC

With regard to all of the franchisee's fraud claims, the Court found it significant that, on the cover page of the UFOC, Mr. Hailemariam was admonished to read the circular carefully and show it to an accountant. The franchisee admitted that he did neither.

The franchisee's failure to read the UFOC was especially significant because he negotiated with Big O for three years (since 2005) before executing the franchise agreement and consulted with an attorney in obtaining the lease for his store.

Despite this long period of time - and his having sought legal counsel to obtain a lease -- he paid little attention to Big O's franchise offering circular and franchise agreement, and never sought legal advice regarding them.

Under the doctrine of inquiry notice, the Court found that Mr. Hailemariam should be charged with knowing all of the information in those franchise documents.

Last, the Court gave considerable weight to an integration clause in the franchise agreement, where the franchisee acknowledged that he was "not relying on any promises of Big O which are not contained in the Big O franchise agreement . . . [or the] accompanying Franchise Offering Circular."

Based on the disclosures, statements, and disclaimers made in Big O's franchise offering circular and franchise agreement, the Court held that Mr. Hailemariam could not have reasonably relied on any of Big O's alleged misrepresentations or concealed material facts. As a result, the Court granted summary judgment in favor of Big O and against the franchisee. The Court of Appeals affirmed the trial Court's judgment in all respects.

Lessons For Franchisees and Franchisors

If you are considering buying a franchise, this case is a warning of the importance of actually reading your Franchise Disclosure Document before you sign on the dotted line. It also illustrates the importance of hiring an experienced franchise attorney to help you understand your legal obligations before committing to a franchise.

If you are a franchisor, this case shows why it's important to have a well-written and legally compliant Franchise Disclosure Document. Big O was able to win this lawsuit because its UFOC specifically contradicted each one of the franchisee's claims.

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Franchisee association leaders confront potential system wide disputes in many key areas such as:

Note that this list focuses on issues most likely to affect existing franchisees, i.e. your constituent members, under their existing franchise agreements. Claims arising in the sales process, e.g. fraudulent inducement or registration/disclosure violations, may also be system-wide affecting franchisees that purchased in particular time periods.

What is the best way to proceed legally? There are three choices:

1. Class actions
2. Associations as the plaintiff
3. Test cases,

Determining the best way to proceed involves questions of time, effect, and cost, as well as political considerations with respect to your membership:

What is the quickest way to resolve the problem?
What is the least costly way to resolve the problem?
What legal option offers the strongest potential impact?
What legal option will draw the greatest support from the franchisees?

1. CLASS ACTIONS

Advantages:

Potentially the largest recovery on behalf of all affected franchisees
Potentially the greatest "buy in" from franchisees, who will be members of the class

Disadvantages:

Increased prevalence of class action waivers
Selecting the best named plaintiffs
Costs of notice (possible shifting to defendant)
Delay and difficulty of obtaining class certification
Avoiding conflicts of interest by different subclasses
Pressure to settle by contingent fee attorneys

2. ASSOCIATIONS AS PLAINTIFF

Advantages

Potentially the easiest case to manage.

Disadvantages

Usually the Association cannot claim damages for its members. Claims for declaratory or injunctive relief are more appropriate.
Delay and difficulty establishing association standing:

(i) Whether the members of the Association would have standing to sue in their own names;

(ii) Whether the issues presented are germane to the Association's purpose in protecting and enhancing the economic rights of its members; and

(iii) Whether the claims asserted or the relief requested by the Association requires the participation of individual members.

Franchisors are likely to question whether the Association truly speaks for "all" or "most" franchisees. The courts have discretion to deny association standing for "prudential" reasons going beyond the three-part test above.

3. TEST CASES

Advantages:

Avoids the procedural issues inherent in class actions or association plaintiff cases, hence, may be the quickest and most cost effective solution.
The principle of "offensive collateral estoppel" means that a franchisor can be bound by the result in one case, when other franchisees present similar claims.  Well-suited to renewal issues. Well-suited to "individual impact" cases.

Franchisors are likely to react to these claims and even to potential claims - e.g. the Grill-n-Chill cases.  They may not give the association credit, but they will react!

Disadvantages:

Selecting the right cases.
Getting a franchisee to step up to the plate.
Getting other franchisees to support the funding.
"Offensive collateral estoppel" after arbitration is generally not available.
Statute of limitations concerns.

4. SOME RECENT SUCCESSES FOR FRANCHISEES

A) Protection of Renewing Franchises and Franchisee Assets

In a successful regional lawn care system, the franchise agreements had historically provided that the franchisees themselves owned their customer lists, which is the most important asset of their business. In recent years the franchisor changed the franchise agreement to provide that the franchisor owned the franchisee's customer lists. Long term franchisees coming up for renewal faced these new agreements, as they would be required to sign the "then current" franchise agreement as a condition of renewal.

Upon being retained, we created an independent franchisee association seeking a negotiated solution to protect the franchisee's ownership of their customer lists.

When the franchisor initially refused to negotiate, we filed suit on behalf of two "test case" franchisees alleging that the franchisor had breached its duty of good faith and fair dealing in purporting to require a renewing franchisee to sign a new franchise agreement that would result in the transfer of assets to the franchisor without consideration. After the briefing of cross-motions for summary judgment, the franchisor relented and agreed to new contract language for its renewing franchisees that would protect their equity in the value of their customer lists.

B) Win-Win Settlement for a National Brand Independent Franchisee Association

Following an evidentiary hearing and closing argument in arbitration as lead trial counsel, we have negotiated a win-win settlement that preserves the independent association's ability to attend and monitor all meetings of the franchisee advisory council, which the franchisor sponsors, including the FAC's private dinner meetings and or other executive sessions from which the franchisor had sought to exclude the association's representative.

This settlement achieves the association's key goal of transparency, i.e. that all FAC activities must be transparent for the benefit of all system franchisees, thus creating "checks and balances" to prevent the franchisor from exercising undue influence over FAC members and to keep the FAC from becoming a rubber stamp.

C) Protecting Franchisees When The Franchisor Files Bankruptcy

When Giordano's (a popular Chicago pizza restaurant brand) filed for bankruptcy protection due to financial problems being experienced by its shareholders, the majority of franchisees retained a bankruptcy counsel to protect their interests. The bankruptcy attorney then enlisted CDC to defend the franchisees from the Trustee's complaint that the franchisees had failed to pay royalties and to allege counterclaims in the adversary proceeding, alleging that the franchisor had breached its contracts (and the duty of good faith and fair dealing) by requiring the franchisees to pay above-market prices to a franchisor-owned commissary for basic ingredients such as cheese, sauces and dough.

In negotiating with the Trustee, a comprehensive settlement was reached whereby the franchisees will receive significant protection against unfair pricing including the freedom to shop elsewhere and to prepare their own sauces and dough. The franchisees also receive 10-year extensions of their franchise terms and reform of the advertising program.

Lawsuits and arbitrations often sort out disputes in their legal sense.

They rarely sort out disputes in a satisfactory personal, business or financial sense.

Anyone familiar with the litigation and arbitration process can tell you about how unsatisfactory the result was in most instances.

• They cost a fortune.
• Think of the legal fees.
• Think of the administrative costs (court reporters, expert witnesses, transcripts, travel, and the value of company resources wasted in the process).
• Think of how little you achieved compared to what you hoped to achieve.

A few people come out of the process glad that they did it. Many do not.

There are better ways to manage disputes. After fifty years of law practice, I have learned how to avoid them rather than embrace them. The difference is incredibly better.

In any business context people can begin to become unhappy with their relationship.

The reasons for that are almost endless. The buildup of every full blown dispute began substantially before it came to "lawyering up" and the end of it came long after.

A large part of the reason is that people naturally seek to avoid confrontation. They don't want to deal with it. It isn't high on anyone's list. And so in most instances it gets worse rather than better.

Positions are taken that are defensive in the confrontation sense - what if we come to blows kinds of things. People write things, memos, emails, instructions that make matters worse rather than better.

Months and sometimes years are spent in mutual distrust (to put it nicely) and people do all the wrong things, like send each other accusatory emails and far worse.

The value of whatever the relationship may have been intended to be in the beginning is lost, at least to one side of this, but it keeps on going, more weed than flower.

That's how conflict and dispute management usually works. Anyone in business for a long time has probably experienced some or all of this. Not everything we do works out the way we intended.

How can we change the way this is traditionally handled so that the length of its infectious presence is minimized and its cost greatly reduced?

Where do you begin in trying to answer the question whether to try this better way of conflict avoidance?

To begin, one truth needs to be recognized: Anger has a Value of Zero.

If you can convince yourself of the truth that anger has no value, and if you can see that earlier rather than later dispute avoidance effort holds significant potential for favorable results, we can begin to bring costly confrontations to less destructive conclusions more quickly.

At the point at which you are thinking of sending someone an accusatory email, you are about at the end of confrontation avoidance at reasonable economic cost. If you have just received an accusatory email, this is your last practical chance to step back from the brink.

Part of the war persona is the ancient battle boast - I am wonderful and you are terrible.

If someone made you read BEOWULF in high school or college then you know what that ritual is all about. This is a tipping point that people do not recognize. They think it is a beginning. It is way past the beginning. This problem began way before that email, and if you had recognized it well before that moment you might never be sending or receiving it.

When you think of all you spent after that email went out in your last "fight to the death", you will understand the savings of funds and resources associated with my approach.

There is a pigeonhole practice for dispute avoidance called Conciliatory Law Practice.

But, what I am suggesting is way beyond that, far from any touchy feely politically correct exercise. This is hardball played with intellectual acuity rather than with noise.

Specifically, there are always ways to derive valuations of potential conflict results. Among those valuations there is one or more that both you and your potential adversary can live with, no matter what the nature of the dispute. These valuations are not solely derived through accounting exercises.

Accounting is a numbers only game.

If you have ever seen this work you will never handle potential disputes in any other manner?

Can a completely unreasonable person refuse to participate as a matter of irrational obstinacy? Sure. Then you can always go back to wasting resources in all out confrontation with nothing lost by way of positions having been compromised. Is that likely to happen?

Probably not. I have seen very angry people awaken to the realization that this is the best way possible to deal with disagreement. It is how you find the leverage point that makes this work.

Often that requires some very outside the box thinking.