Congratulations! Your franchise system has opened multiple locations across the state, region or maybe even country.  Now, how can you protect against a former franchisee competing with your other locations (besides the franchisee’s old location)?

Copyright: andreyuu / 123RF Stock Photo
Copyright: andreyuu / 123RF Stock Photo

In a recent case, AAMCO Transmissions, Inc. v. Romano, franchisor Aamco Transmissions, Inc. (“AAMCO”) sought to enforce a non-competition provision in its franchise agreement that was intended to protect against this scenario.  No. 13-5747 (E.D. Pa. March 1, 2016).  However, the federal court held AAMCO’s non-competition provision unenforceable under Pennsylvania law.

AAMCO is a franchisor of transmission repair centers operating throughout the United States and Canada. The defendants were former AAMCO franchisees, who had operated an AAMCO franchise in Hollywood, Florida.  The parties ended the franchise amicably and the former franchisees moved over 90 miles away.  There, within 5 months of terminating their franchise, they opened Treasure Coast Transmissions (“Treasure Coast”), a transmission and automotive repair business.

The parties’ franchise agreement prohibited the defendants from engaging in the transmission repair business for two years after the termination of the franchise agreement within a radius of 10 miles from (i) their former location or (ii) any other AAMCO center. By this method, AAMCO sought to protect all locations from competition with former franchisees – not just the location where the former franchisees operated.

Treasure Coast was situated within 10 miles of an AAMCO franchise and AAMCO brought suit to enforce the non-compete.

Pennsylvania law disfavors non-competes, but they are considered appropriate where the restrictions imposed are

  1. incident to an employment relationship;
  2. reasonably necessary for the protection of the employer; and
  3. reasonably limited in duration and geographic extent.

The first two prongs were satisfied given the franchise agreement and AAMCO’s investment of time, resources and training in its franchisees, which created a protectable interest in the “franchise itself.”

However, AAMCO’s attempt to protect all of its franchise locations rendered the non-compete unreasonable in its geographic scope. First, the restriction was unduly burdensome on the former franchisees, who did not take any former customers and were not competing with their prior location.  The court specifically noted that the defendants had invested significant time, effort and money in their business during the litigation. (AAMCO did not file for preliminary injunctive relief, i.e., try to stop them from running their business during the litigation.)

Second, the restriction was not tailored to protect the “franchise itself”, which the court interpreted to mean only the franchisees’ former location – not the system as a whole. The new business, 90 miles away, was too far removed to compete with the original location.  The court modified the non-compete to apply only within 10 miles of AAMCO locations in the franchisees’ prior county, instead of system-wide.Red Car Crash

Reasonableness cases often turn on their particular facts. Here, the defendants were experienced in transmission repairs prior to becoming franchisees, hurting AAMCO’s argument that they had received “specialized training.”  AAMCO’s franchising success may have also worked against it – the court noted the non-compete was “overbroad because it applies everywhere AAMCO operates, across the United States and Canada.”  A different case could have ended differently.

A few takeaways:

  • Franchisors will likely think there is no difference between a franchisee competing against its former location or another system location. But a court may find a distinction. Communicating the business reality of a dispute can often be as important as (and sometimes even harder than) arguing the law.
  • This case also shows the importance of filing for a preliminary injunction when appropriate. Here the defendants ignored AAMCO’s cease and desist order and operated their business throughout the two year litigation. This ultimately worked to their advantage when the court determined that enforcing the non-compete would be unduly burdensome because of their investment of time and money.
  • Mature and successful franchise systems with many locations will want to take particular note of the outcome and consider whether non-competes should include every location, or merely a subset.