IP Law Daily, TRADE SECRETS—W.D. Pa.: Liberty Tax suit against former franchisee pared but not dismissed, (Sep 20, 2023)

By E. Darius Sturmer, J.D.

Because Liberty lacked due diligence in discovering the franchisee’s ongoing breaches of non-solicitation and non-competition agreements, there is no basis for extending those since-expired pacts via injunctive relief.

JTH Tax LLC, better known as Liberty Tax Service, can no longer enforce the non-competition and non-solicitation covenants of its franchise agreement with a Pennsylvania franchisee, the federal district court in Erie, Pennsylvania, has ruled. The court therefore dismissed with prejudice the franchisee’s request for injunctive relief to enforce those covenants. It also dismissed a conversion claim on statute of limitations grounds. However, the court denied the franchisee’s motion to dismiss the entirety of Liberty’s suit for lack of subject matter jurisdiction, and it further held that whether the rest of the breach of contract claim is time-barred—and whether a laches defense applies with respect to Liberty’s request for the return of its materials—are questions of fact that could not be decided at the dismissal stage (JTH Tax LLC v. Foster, September 12, 2023, Lanzillo, R.).

The defendant franchisee entered into the relevant franchise agreement with Liberty in September 2015. In addition to the parties’ exchanges of licenses, training, and royalties that are typical in franchise agreements, the franchisee also committed to certain obligations upon termination of the contract. These included covenants not to compete or to solicit Liberty customers, found in Sec. 10 of the agreement, as well as a promise “to refrain forever” from interfering or attempting to interfere with Liberty’s business relationships and from using or disclosing Liberty’s confidential information and/or trade secrets. The latter provision, in Sec. 12 of the agreement, contained a pledge to maintain confidentiality of all such information and to adopt and implement procedures to prevent unauthorized use or disclosure.

Liberty alleges that on May 27, 2020, it learned that Foster had breached the franchise agreement by failing to pay monies owed, failing to open the franchise for business pursuant to the schedule set forth in the contract, and failing to actively operate her Liberty office. Liberty says that it notified the franchisee of the breaches the same day, offering her options to cure them. On June 9, 2020, Liberty terminated the franchise agreement, concluding that she had failed to cure the breaches.

Liberty further avers it “recently discovered” that the franchisee began operating a competing tax service, “Foster Tax Services,” in or before January 2020, openly soliciting Liberty’s clients while she was still a Liberty franchisee. Liberty asserts that Foster Tax submitted more tax returns in 2021 than the franchisee had submitted in the 2020 tax season and that Foster Tax continued to operate out of the same Grove City location in 2022, with the same telephone number, advertising on its website that it has serviced customers “for nearly five years” and “offers the same friendly and accurate service” despite its name change.

Claims and litigation history. Liberty’s complaint, filed on January 23, 2023, has four counts. Count I, breach of contract, alleges breaches both of the franchise agreement and of promissory notes executed by the franchisee between 2015 and 2018. More specifically, Liberty claims the franchisee breached the franchise agreement by failing to pay amounts due, failing to transfer the phone number associated with the franchise back to Liberty, offering competing services at the same location as her former franchise within the non-compete period, failing to return the operations manual and using Liberty’s trade secrets and confidential information to unlawfully compete with Liberty, and failing to use good faith efforts to ensure that no one would offer tax preparation services at that location for two years after termination. Count II asserts that the defendant violated the Defend Trade Secrets Act of 2016 (“DTSA”) by failing to return Liberty’ confidential information and instead using it to operate Foster Tax. Count III claims conversion, and Count IV unjust enrichment, based on that same conduct.

Liberty seeks injunctive relief and an order of court directing the defendant to transfer the phone number associated with the former franchise back to Liberty and to turn over all copies of the operations manual, all customer lists and contact information, and all customer tax returns and related files.

Subject matter jurisdiction. The court first rejected the defendant’s challenge to subject matter jurisdiction, holding that while the complaint was insufficient to establish diversity jurisdiction, it supports federal question jurisdiction based on its DTSA claim and its supporting allegations regarding the nationwide extent of Liberty’s business and its confidential information and trade secrets. The court explained that for Liberty’s DTSA claim to support federal question subject matter jurisdiction, the complaint must allege facts to support a direct nexus between its goods or services and interstate commerce. Liberty’s assertions surrounding its tax service system and its franchised income tax preparation service centers located throughout the United States were sufficient to demonstrate this required nexus.

Statute of limitations. Next turned away by the court was the defendant’s contention that Pennsylvania’s statute of limitations barred Liberty’s claim for breach of the promissory notes. The court acknowledged that if the state’s four-year statute of limitations for actions upon bonds, notes, and similar instruments—42 Pa. Const. Stat. §5527(a)(7)—applied to Liberty’s claims on the promissory notes, those claims would be barred. Further, a six-year limitations period provided by a different statute would not save the claims because they were not “negotiable instruments” within the meaning of that statute. However, the notes could be sealed instruments subject to the 20-year statute of limitations provided in §5529(b)(1).

The court remarked that whether an instrument is under seal or not is a question of law for it to decide, but a question of fact. The defendant’s assertion that she had rejected Liberty’s request for her to include a seal with her signature on the promissory notes at issue was plausible, but it could not be determined from the complaint alone whether the assertion was sufficient to rebut the presumption that the defendant adopted the seal. Accordingly, the motion to dismiss these claims on the notes based on time limitations was denied without prejudice to the defendant’s right to raise the defense later in the proceedings.

However, the court said, Liberty’s conversion claim was time-barred, owing to the state’s two-year statute of limitations for that cause of action.

Non-competition, non-solicitation covenants. The court found that Liberty’s request for enforcement of the non-competition and non-solicitation covenants beyond their contractual expiration date of June 9, 2022, was unsustainable under Virginia law, which governed the franchise agreement. The court added, though, that the franchisor’s request for the return of property may survive the former franchisee’s laches defense. No factor outside of Liberty’s control caused its delay in filing the action, so Virginia Law would not permit enforcement of the covenants beyond their contractual expiration date. Liberty’s “recent discovery” of the covenant violations did not constitute a factor beyond its control, the court said, observing that the delay in discovering the violations “in and of itself reflects Liberty’s lack of due diligence in monitoring and enforcing its contractual rights.” Thus, the interests of equity would make injunctive relief beyond two years impermissible.

But whether laches barred Liberty’s claim for return of property could not be determined based on the complaint alone, the court found. Although Liberty could not reasonably contend that it was unaware of the terminated franchisee’s failure to return its property in accordance with the franchise agreement and the termination notice, and its delay in commencing the action “reflects a lack of due diligence in monitoring and enforcing its contractual rights[,]” the court concluded that the equities relating to the request for return of its property “differ somewhat from those associated with its request for enforcement of the non-competition covenants beyond their contractual expiration.” The request was “relatively simple and straightforward” and was not certain to affect matters of proof. Moreover, Liberty might be able to rebut the presumption of prejudice sufficient to overcome a laches defense as to this discrete request for equitable relief.

The Case is No. 1:23-cv-00005-RAL.

Attorneys: Peter G. Siachos (Gordon & Rees LLP) for JTH Tax LLC d/b/a Liberty Tax Service. Bryan G. Baumann (Knox McLaughlin Gornall & Sennet, P.C.) for Melissa Foster d/b/a Foster Tax Services.

Companies: JTH Tax LLC d/b/a Liberty Tax Service; Melissa Foster d/b/a Foster Tax Services

Cases: TradeSecrets PennsylvaniaNews