Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION LAW—E.D. Pa.: Preliminary injunction issued against terminated pretzel shop franchisees, (Oct 9, 2013)

By John W. Arden, J.D., LL.M.

The federal district court in Philadelphia has granted a franchisor of soft pretzel shops a preliminary injunction enforcing the franchise agreement’s noncompetition, confidential information, and equipment buy-back provisions against terminated franchises (Soft Pretzel Franchise Systems, Inc. v. Taralli, Inc., October 4, 2013, Surrick, R.).

Soft Pretzel Franchise Systems, Inc. franchises retail businesses offering “South Philadelphia” soft pretzels freshly baked on premises. It licenses its franchisees to use its trademarks, trade names, trade dress, business system, and proprietary equipment.

On December 21, 2006. Soft Pretzel Franchise Systems entered into a franchise agreement with Taralli, Inc., which paid $20,000 and agreed to a royalty fee of six percent of weekly gross sales. Contemporaneously, the owners of Taralli executed a contract, agreeing to guarantee Taralli’s obligations under the franchise agreement.

The franchise agreement required the franchisee to operate for 10 years in accordance with the standards of operations and to purchase, install, and use certain fixtures and equipment made specifically for Soft Pretzel and its franchisees. The franchise agreement required Soft Pretzel to provide the right to operate under its trademark and goodwill, with confidential and proprietary information. Soft Pretzel was allowed to unilaterally terminate the franchise agreement without notice if the franchisee failed to pay sums due Soft Pretzel, its affiliates, or its suppliers.

Upon termination, a franchisee is required to cease operations, stop using the confidential information, return the operations manual, and adhere to the noncompetition clause. The noncompetition clause barred the franchisee and its principles from engaging in any business similar to that of the franchise for a period of two years within 10 miles of the location of any Soft Pretzel territory. Soft Pretzel was authorized to purchase from the franchisees any equipment or personal property within 15 days after termination for the book value of the property.

Soft Pretzel alleged that Taralli and its owners were in default of the franchise agreement for failing to pay royalties on a weekly basis, declining customers’ credit cards, and refusing to offer pepperoni pretzel melts. On January 11, 2013, Soft Pretzel’s counsel sent a notice of default for failure to operate in compliance with standards and specifications; failure to report gross sales and pay royalties and advertising fees from December 9 through the date of the notice; failure to use require credit card terminals; failure to accept credit cards; failure to use the required cheese pump; failure to have employees wear the required Philly Pretzel Factory uniforms; and failure to offer the pepperoni pretzel melts. The franchisee was given 15 days to cure the monetary defaults.

On February 4, 2013, Soft Pretzel sent a notice of termination for failure to cure monetary defaults. The franchise was terminated as of June 14, 2013. On June 12, 2013, Soft Pretzel notified the terminated franchisees that it intended to exercise its right to purchase the franchise equipment. On the same day, the franchisees’ attorney notified Soft Pretzel that they intended to operate a retail store not affiliated with Soft Pretzel and would not sell its equipment to Soft Pretzel.

Soft Pretzel brought this action, alleging that the franchisees continued to sell pretzels at the franchise location, in violation of the non-compete provision of the franchise agreement, and refused to sell the machines to Soft Pretzel, in violation of the equipment buy-back provision of the franchise agreement. It moved for a preliminary injunction.

Preliminary Injunction

In determining whether to issue a preliminary injunction, a court must consider four factors: (1) the likelihood of the moving party to succeed on the merits; (2) the extent to the moving party will suffer irreparable harm without injunctive relief, (3) the extent to which the nonmoving party will suffer irreparable harm if the injunction is issued, and (4) the public interest.

Probability of success on merits. The franchisees claimed that Soft Pretzel could not establish a likelihood of success on the merits because it did not have good cause for termination under the New Jersey Franchise Practices Act. However, the district court disagreed.

“SPF presented evidence that it terminated Defendants’ franchise because Defendants were not in compliance with the Franchise Agreement,” the court found. “Specifically, Defendants had not paid amounts obviously due under the Franchise Agreement including royalties, and Defendants were not operating the franchise in accordance with the Franchise Agreement by not accepting credit cards and not selling pretzel melts. Defendants did not present evidence that they cured their monetary defaults within 15 days, as required by Paragraph 12.1.2 of the Franchise Agreement. Defendants also presented no credible evidence to suggest they had cured all other defaults that SPF brought to their attention within 60 days of the Notice of Default.”

According to the court, Soft Pretzel was likely to be able to enforce the noncompete provision of the franchise agreement because the provision was (1) ancillary to the sale of a legitimate business interest (a franchise), (2) supported by adequate consideration, and (3) reasonable as to duration of time and geographical scope under Pennsylvania law.

Soft Pretzel further was likely to be able to enforce the equipment buy-back provision, which provided an option to purchase the equipment within 15 days of termination of the franchise. The franchise was terminated on June 14, 2013, and Soft Pretzel timely exercised its option to purchase the equipment.

Irreparable harm if injunction not granted. The irreparable harm requirement is met if a plaintiff cannot be adequately compensated by money damages, the court observed. In this case, Soft Pretzel maintained that it had an interest in capitalizing on its goodwill by placing a franchise in the area as soon as possible, that its reputation could be irreparably harmed by a former franchisees’ operation at its former franchise location, and that use of its proprietary equipment could impair its ability to sell further franchises and may result in loss of market share. In light of these considerations, the district court found that Soft Pretzel would suffer irreparable harm if the injunction were not granted.

Balance of harms. The court found that harm to Soft Pretzel if the injunction were not issued outweighed any harm to the franchisees caused by the issuance of the injunction. The franchisees were aware of any potential harm when they signed the franchise agreement and then opened a competing shop following termination. While they might suffer monetary harm from lost revenue as a result of the enforcement of the restrictive covenant and equipment buy-back provisions, “their self-inflicted harm is outweighed by the irreparable harm SPF will suffer should an injunction not be issued.”

Public interest. The public interest is served by fulfilling contractual interests of parties and maintaining the viabilities of franchise systems, in the court’s view. Thus, the public interest was served by enforcing the noncompetition and equipment buy-back provisions of the franchise agreement, “so as to maintain the viability of SPF’s franchise.”

Injunction bond. The court required Soft Pretzel to post an injunction bond in the amount of $20,000 to cover damages the franchisees might suffer if they are wrongfully enjoined.

The case is Civil Action No. 13-3790.

Attorneys: Jeffrey A. Zucker (Fisher & Zucker LLC) for Soft Pretzel Franchise Systems Inc. Daniel M. Baker (The Baker Law Group LLC) for Taralli, Inc.

Companies: Soft Pretzel Franchise Systems Inc.; Taralli, Inc.

Cases: FranchisingDistribution PennsylvaniaNews