Antitrust Law Daily Wrap Up, FRANCHISING & DISTRUTION—EDPa: Former Tanning Salon Franchisee and Principals Enjoined from Operating Competing Business, (Jan 23, 2013)

By Peter Reap, J.D., LLM

A former tanning salon franchisee, West Coast Tans of PA, LLC (“West Coast Tans”), one of the franchisee’s two principals and guarantors, Donald Weiss, two businesses set up by the principals, and a close friend of the principals, Christopher Connors, were enjoined from performing tanning services and selling related skin care products from a competing tanning business the principals established, pursuant to the noncompete covenant in agreements that the franchisee and guarantors entered into with franchisor Tantopia Franchising Company, LLC, the federal district court in Philadelphia has ruled (Tantopia Franchising Co., LLC v. West Coast Tans of PA, LLC, January 22, 2013, Rueter, T.)

The other principal and guarantor of the franchisee, Richard Weiss, has filed for bankruptcy relief and was currently protected by the automatic stay. If Richard Weiss was not protected by the automatic stay, the injunctive relief ordered by the court would apply equally to him, the court noted.

Background

West Coast Tans ceased operating as a business more than two years prior to the expiration of its agreement with Tantopia without informing the franchisor that it went out of existence or ceased operating the salon. Donald and Richard Weiss then proceeded to create two new businesses which the tanning equipment of the former franchise was transferred to. Through one of those new businesses and Christopher Connors, Donald and Richard Weiss began operating a new tanning business, the Southampton Salon.

The franchise agreement contained a noncompete provision that prohibited the direct or indirect operation of a competing business in the protected territory of the franchise or within ten miles of any of the franchisor’s other franchises for a period of two years from the expiration of the agreements. The guarantee agreements executed by Donald and Richard Weiss contained almost identical noncompete clauses.

After discovering the existence of the Southampton Salon, and learning that it would offer tanning services as provided by its franchisees, in addition to massage and anti-aging services, Tantopia brought suit. The Southampton Salon is located 3/10 of a mile from one of Tantopia’s franchises, and within 5 miles of a second Tantopia franchise.

Analysis

Probability of success on the merits. Tantopia demonstrated a reasonable probability of success on the merits of its claim of violation of the noncompete covenant in the franchise agreement, according to the court. Under Pennsylvania law, a non-compete covenant was enforceable if: (1) the covenant relates to either a contract for the sale of good will or other subject property; (2) the covenant is supported by adequate consideration; and (3) the application of the covenant is reasonably limited in both time and territory.

The defendants did not contest the first two factors above. The defendants also did not urge that the non-compete covenant was unreasonable in time or territory. Rather, they asserted that the “restrictive covenant is overbroad to the extent that it seeks to enjoin any party from providing assistance to [the company started to run the Southampton Salon] in the organization of its business.”

Donald Weiss and Richard Weiss were operating the Southampton Salon through its operating company and Connors, the court determined. Connors was inexperienced in running a business and would have been unable to enter into the contracts required to open and run the Southampton Salon without assistance from Donald Weiss and Richard Weiss.

The defendants asserted that Donald Weiss and Richard Weiss should be permitted to provide advice to Connors. However, the noncompete provided otherwise, the court held. The noncompete specifically provided that Donald Weiss and Richard Weiss could not “provide assistance to” a competing business. Courts considering this issue have held that the purpose of restrictive covenants was to protect against the use of capital in a competing business as well as the skill and expertise of the individual in question.

The actions of Donald and Richard Weiss amounted to nothing more than mere subterfuge to avoid their obligations under the noncompete covenant, the court ruled. Moreover, the evidence weighed in favor of finding that the Southampton operating company Connors were a mere continuation of, or straw man for, Donald and Richard Weiss, and their other companies. For these reasons, Tantopia demonstrated a reasonable probability of success on the merits of its claim for violation of the noncompete.

Irreparable harm. Tantopia demonstrated that it would suffer irreparable harm if the preliminary injunction was denied. Tantopia had an interest in the goodwill its franchise had created. The goodwill in Tantopia’s franchise allowed it to maintain a recognizable and respected name in the marketplace, provide uniform services to its customers, and increase the marketability of the Tantopia name to potential franchisees.

Tantopia also had an interest in being able to place a new franchise in the area where the goodwill had been created. The presence of a competing tanning salon within the geographic area protected by the noncompete covenant reduced the value of the Tantopia mark to a potential new franchisee who might consider opening a Tantopia business within the area.

Tantopia also suffered irreparable harm to the extent that the Southampton Salon intended to offer tanning services that would directly compete with the services offered by its franchisees. Pennsylvania courts have held that interference with customer relationships satisfied the irreparable harm requirement.

Lastly, Tantopia demonstrated that it would suffer irreparable harm in that permitting former franchisees to violate terms of a franchise agreement would set poor precedent for other franchisees. At the time of the Hearing, Tantopia had three franchisees whose franchise agreements were set to expire in the near future. If Tantopia failed to enforce the noncompete, other franchisees would be encouraged to violate such covenants.

Harm to defendants. In considering harm to the defendants, the court had to balance the hardships to the respective parties. The defendants argued that they would suffer lost revenue if prevented from performing tanning services. However, any harm suffered by defendants with respect to this injunction was created or caused by their decision to open the Southampton Salon within the protected territory of the noncompete covenant. Moreover, any hardship would be mitigated because the court would require Tantopia to post a security bond. Further, the massage and anti-aging services the Southampton Salon would provide would not be enjoined and would mollify any potential losses to the defendants.

In balancing the hardships to the parties, any injury the defendants could suffer as a result of the issuance of the preliminary injunction was significantly outweighed by the irreparable harm Tantopia would continue to suffer as a result of defendants’ violation of the noncompete.

Public interest. The public interest supported contractual enforcement by preventing competition in violation of a valid restrictive covenant. Thus, the public interest weighed in favor of granting the preliminary injunction.

Scope of injunctive relief. The court noted that the defendants agreed not to use the Tantopia Mark or the same colors as traditionally used in Tantopia salons, addressing the majority of Tantopia’s pretrial concerns regarding its trademark and trade dress claims. Furthermore, the injunction entered today eliminated most, if not all, of the vitality of these claims since defendants will not be operating a business similar to Tantopia’s. Thus, the court did not consider Tantopia’s claim for trademark infringement set out in Count 1 of its Complaint.

Surety bond. The defendants’ counsel suggested that the revenue from the Southampton Salon’s tanning operations would constitute 50 percent its overall income. Thus, as security, the court required Tantopia to provide a security bond of $30,000, which represented 50 percent of the amount used to fund the expenses of starting the business.

The case is Civil Action No. 12-6700.

Attorneys: Steven Kapustin (Chernow Katz, LLC) for Tantopia Franchising Company, LLC. Jeffrey S. Cianciulli (Weir & Partners, LLP) for Donald Weiss.

Companies: Tantopia Franchising Co., LLC; West Coast Tans of PA, LLC

Cases: FranchisingDistribution PennsylvaniaNews