Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. Colo.: Terminated Steak n Shake franchisees enjoined from continuing to operate restaurants; noncompete partially enforced, (Sep 5, 2013)

By Peter Reap, J.D., LL.M.

Restaurant franchisors Steak n Shake Enterprises, Inc. and Steak n Shake, LLC were entitled to a preliminary injunction against two corporate franchisees, an area development company, and several individuals, requiring them to immediately cease operating their two existing restaurants as Steak n Shake restaurants and to cease use of all of the franchisor’s trademarks, the federal district court in Denver has decided (Steak n Shake Enterprises, Inc. v. Globex Co., LLC, September 3, 2013, Moore, R.). In addition, the defendants were ordered to comply with the post-termination obligations set forth in their various agreements and to comply with the noncompetition covenant in the parties’ agreements, but only to the extent that the defendants were enjoined from operation a Competing Business (as defined in the agreements) within five miles of the franchisor’s lone other Colorado restaurant or other Steak n Shake restaurants outside of Colorado for a period of two years.

Background. The franchisor’s lawsuit arose from: (1) Defendants Globex Company, LLC’s and Springfield Downs, LLC’s (collectively, “Franchisees” ) alleged breaches of certain written franchise and license agreements (collectively, “Agreements”) which allowed the Franchisees to operate as Steak n Shake restaurants; and (2) Defendant Control, LLC’s alleged breach of a written area development agreement (“ADA”) which required Control to establish 13 franchised Steak n Shake restaurants as scheduled. Three individual Defendants (“Gaurantors”) allegedly breached their personal guarantees of the Franchisees’ obligations.

Specifically, the dispute centered around the franchisor’s introduction of its 2013 Summer promotion which required all of its franchisees to offer various items to customers off of a new $4 menu. Shortly after the promotion began the franchisor began receiving complaints that the Franchisees were overcharging customers and not using the $4 menu. An investigator sent by the franchisor discovered that the Franchisees were serving the $4 meals from the new $4 menu, but at higher prices. Both restaurants were missing the promotional materials the franchisor had distributed to all of its franchisees which advised the customers that there was a new selection of meals available at a price of under $4.

Moreover, the prices being offered by the Franchisees were not randomly generated. What they were doing instead involved a manipulation of the POS system. Rather than entering a meal when one was ordered by the customer, the Franchisees were ringing in the meal items as a la carte items thereby generating a higher price for the meal.

On May 23, 2013, the franchisor remotely disabled the a la carte functionality in the Franchisees’ POS systems so that customers could not be charged for combo meals at higher prices than those established by Steak n Shake (i.e., the maximum prices) and shown on its authorized menus. Subsequently, the franchisor discovered that the Franchisees simply stopped handing out to every customer the authorized $4 menu.

By letter dated July 3, 2013, the franchisor notified the Franchisees and Guarantors via personal delivery of the termination of the franchise and license agreements effective immediately. Notice was provided pursuant to the Agreements based on the Franchisees’: (1) intentional deviation from menu prices; (2) alteration of marketing materials; and (3) failure to cure the violations outlined in an earlier, June 18, 2013 letter. In a separate July 3, 2013, letter, the franchisor notified Control and the Guarantors that the ADA was terminated effective immediately for failure to develop and open a third Steak n Shake location by June 2, 2013.

The franchisor alleged that, after advising the Franchisees of various defaults and providing a gratuitous, and ultimately unaccepted, opportunity to cure, they terminated the Agreements for cause, but the Franchisees continued to use the Steak n Shake name and marks and to hold their restaurants out to the public as Steak n Shake restaurants. The franchisor further alleged that it terminated the ADA for cause based on Control’s failure to open a third franchised Steak n Shake as scheduled. The Franchisees and Control then failed to comply with their post- termination obligations, such as the cessation of the use of the Steak n Shake marks, according to the franchisor.

Preliminary injunction standard. A party seeking injunctive relief must establish four factors: (1) it will suffer irreparable harm if the injunction is not granted; (2) the threatened injury outweighs the harm caused to the opposing party as a result of the injunction; (3) the injunction, if issued, is not adverse to the public interest; and (4) it has a substantial likelihood of success on the merits of the case. Where the injunction sought is one of three types of disfavored injunctions, however, the modified standard is inapplicable. Additionally, the movant must make a heightened showing to demonstrate entitlement to relief.

The heightened standard for injunctive relief applied in this case, the court held. Unlike some other cases referenced by the parties in argument, this was not a case where the occurrence giving rise to the right to termination was uncontested. Here, the parties disputed the occurrence of the necessary conditions as well as the overall “wrongfulness” of termination. The last peaceable status quo between the parties was pre-termination at the latest, in the court’s view. And the Plaintiffs sought to alter that status quo.

Substantial Likelihood of Success on the Merits

The franchise agreements, license agreements, and ADA were properly terminated. Absent a proper termination of the instrument which grants the franchisee the right to use of a mark, the franchisee’s continued use of the trademarks is not unauthorized. Here, the Plaintiffs met the required showing that they properly terminated the franchise agreements which, in turn, supported the termination of the license agreements, the court determined. As to the ADA, there was simply no dispute as to the non-occurrence of the event giving rise to the right to terminate as a third franchise was not established by the requisite date.

The Plaintiffs provided more than substantial evidence demonstrating that, among other things, they set prices for meals in their traditional and $4 menu; they instituted the 2013 summer promotion of which the Franchisees had actual acknowledge; the promotion was mandatory and required Franchisees to provide customers with the authorized $4 menu and display other marketing materials supporting the promotion; the Franchisees received the promotional materials, including the authorized $4 menus; the Franchisees were not using the marketing materials for the summer promotion; the Franchisees sold meals at other than menu prices by substituting a la carte prices for meal prices; and the Franchisees only “offered” the authorized $4 menu to a customer if that customer knew of and asked for such menu. The Plaintiffs’ evidence supported a finding that the Franchisees’ actions were done “knowingly,” according to the court.

Accordingly, the Plaintiffs’ evidence strongly showed a substantial likelihood that they would prevail in establishing that the Franchisees breached the franchise agreements.

The termination survived the defects in the June 18, 2013 letter. The Plaintiffs’ June 18, 2013 letter “offered” the Franchisees an opportunity to cure these breaches. The questions raised were what was the effect of such an “offer” and whether, in light of the making of such “offer,” Plaintiffs’ July 3, 2013 termination notice was nonetheless effective, the court noted.

For alleged breaches of the Agreements that required the franchisor to provide 30-days’ notice and an opportunity to cure (30-Day Termination breaches), the evidence showed the June 18, 2013 letter was defective in that it was e-mailed as opposed to delivered personally or through an overnight service as required by the Agreements, and possibly for other reasons. Those defects could prevent proper termination based on defaults falling within the 30-Day Termination category which required specific types of notice, the court observed.

However, the franchise agreements were terminated on other, wholly valid bases as well, those that allowed the franchisor to terminate immediately and without offering an opportunity to cure (“Immediate Termination breaches”) where no notice of any type as to defaults was required. The franchise agreements allowed the franchisor to terminate for a number of reasons and any failure to comply with notice requirements as to one breach did not invalidate any otherwise valid notice given or action taken for another breach. Thus, the franchisor demonstrated that the terminations of the franchise agreements were proper, the court held. Similarly, effective notices of termination were given for the license agreements and ADA.

Trademark infringement and unfair competition. In order to prevail on Plaintiffs’ trademark infringement claim under Section 32 of the Lanham Act, they must show Defendants used SNS’s Marks in commerce without its consent and that such unauthorized use was likely to cause confusion in the marketplace. The central inquiry was the likelihood of consumer confusion and this same inquiry applied to the Plaintiffs’ unfair competition claim.

It was well established that a terminated franchisee’s continued use of the former franchisor’s trademarks was likely to cause consumer confusion and constituted trademark infringement. The Plaintiffs produced evidence that even post-termination they received various forms of customer complaints about the restaurants which established that customer confusion was not a theory, but a fact. Such evidence was sufficient for the Plaintiffs to establish a strong likelihood of success on the merits of their Lanham Act claims, the court ruled.

Breach of contract and guaranty claims. The Plaintiffs’ breach of contract and guaranty claims were based on the Defendants’ alleged failure to perform post-termination obligations under the franchise and license agreements. Both the proper termination of the various agreements and the post-termination operation of Franchisees’ restaurants as Steak n Shake restaurants triggered the post-termination obligations of the various Defendants. Such evidence showed that the Plaintiffs had a substantial likelihood of success on the merits of their breach of post-termination covenant claims.

As to the more focused claims of breach of the various covenants not to compete, the Plaintiffs showed a substantial likelihood of success on the merits of these claims as well, the court held. There was a rule of reasonableness that applied to both duration and geographic scope of such covenants.

Here, the covenants were properly limited and reasonable both as to scope and duration. As to the Franchisees and their Guarantors, they were limited from operating a Competing Business only within five miles of an existing Steak n Shake or within five miles of the Authorized Locations. As to Control and its Guarantors, the geographic limitation was confined to the Development Area (as defined by the ADA) and was, again, applicable only for two years. As to each covenant, the Plaintiffs had a legitimate interest in the covenants as a means of protecting themselves from unfair competition from the Defendants under all of the circumstances. Thus, the Plaintiffs demonstrated a likelihood of success on the merits as to the covenants not to compete, the court held.

Irreparable Injury

To constitute irreparable harm, an injury must be certain, great, actual and not theoretical. The injury complained of must be of such imminence that there is a clear and present need for equitable relief to prevent irreparable harm. Simple economic losses usually did not constitute irreparable harm as such losses were compensable by monetary damages.

Trademark infringement and unfair competition. The Plaintiffs clearly met their burden of demonstrating irreparable harm, the court held. The evidence showed that, after the July 3, 2013 termination notice, the Franchisees were continuing to operate as Steak n Shake restaurants at the same locations and using Plaintiffs’ brand. As evidenced by the Franchisees’ disregard for Plaintiffs’ publicized promotion and authorized pricing during the term of the franchise agreements, the Franchisees’ restaurants would undoubtedly operate differently from true Steak n Shake restaurants. The Plaintiffs would have no control over those operations and the Plaintiffs’ reputation was endangered by the Franchisees’ use of their brand.

Breach of contract and guaranty claims. For the same reasons which supported irreparable harm from the Lanham Act claims, the Plaintiffs showed that they would suffer irreparable harm if the Defendants were allowed to continue to operate as Steak n Shake restaurants. The Plaintiffs did not, however, show that there would be certain or actual irreparable harm if, until trial on the merits, the Defendants were allowed to continue operating a Competing Business within five miles of the Authorized Locations or the Development Area where such restaurants were stripped of any markings or associations with Plaintiffs or the Steak n Shake brand, according to the court.

Within the entire state of Colorado, there was only a single Steak n Shake restaurant in Colorado Springs which remained following termination of the Franchisees’ restaurants. Accordingly, the Plaintiffs made a strong showing of irreparable harm, and therefore did not need to rely on a presumption, only as it pertained to any Competing Business the Defendants might operate within five miles of the Steak n Shake restaurant in Colorado Springs or other existing Steak n Shake restaurant outside of Colorado.

As to the operation of a Competing Business within five miles of the Authorized Locations or Development Area, the adequacy of the showing was wanting, the court held. As noted, there were no other Steak n Shake restaurants in the Denver metropolitan area. No evidence was presented showing that Steak n Shake planned to resume or continue expansion into the Denver metropolitan area, much less in the Authorized Locations, before a trial on the merits, the court noted.

At most, at this time, any harm caused by having the Defendants operate (or have an interest in) a Competing Business at or within five miles of the Authorized Locations or the Development Area between now and trial was strictly theoretical. And to that extent, prevention of such theoretical harm would not be prevented by injunctive relief, the court explained.

Balance of Harm

This factor required the threatened injury to Plaintiffs to outweigh the harm caused to the opposing party as a result of the injunction.

As the Plaintiffs have shown no irreparable harm in allowing the Defendants to continue to operate Competing Businesses in the Authorized Locations or Development Area, no further discussion was required as to this aspect of the non-compete obligation. The Plaintiffs were, however, entitled to have the non-compete obligations enforced within five miles of the Colorado Springs restaurant and of any existing Steak n Shake restaurant outside of Colorado. And, the Plaintiffs produced sufficient evidence that if an injunction was not entered with respect to the use of the Marks by the terminated Franchisees, the Plaintiffs would be irreparably harmed by customer confusion and the potential loss of goodwill through Franchisees’ continued operation as seemingly authentic Steak n Shake restaurants.

On balance, the threatened injury to the Plaintiffs strongly outweighed the harm caused to the Defendants should an injunction be entered. Accordingly, the Plaintiffs sustained their burden in establishing this prong for injunctive relief, except as noted, according to the court.

Public Interest

This factor also weighed heavily in favor of the Plaintiffs. The unauthorized use of the Steak n Shake brand by the Defendants would likely, if not certainly, cause customer confusion of the very sort the Lanham Act sought to prevent.

Surety

The Plaintiffs’ suggestion of a surety bond in the range of $50,000 to $75,000 was both substantial and reasonable, particularly given the Plaintiffs’ strong showing as to the necessity for granting the requested relief and the Defendants’ testimony that the restaurants were in fact losing money, the court held. Finally, a bond in the neighborhood of that suggested by the Plaintiffs, as opposed to the $5 million bond suggested by the Defendants, was more than consistent with the pre-termination expectation of the parties in light of Section 15.1 of the franchise agreements which provided that in the event the franchisor shall be required to seek preliminary injunctive relief, “Franchisor may seek … preliminary injunctive relief without bond.”

The case is Civil Action No. 13-cv-01751-RM-CBS.

Attorneys: Fredric Adam Cohen (Cheng Cohen, LLC) for Steak N Shake Enterprises, Inc.

Companies: Steak n Shake Enterprises, Inc.

Cases: FranchisingDistribution ColoradoNews