Let’s review the status of activity restrictions in franchise agreements. Do they serve the purpose intended? Are they enforceable? Are they worth it? The Pennsylvania Supreme Court’s decision in Pittsburgh Logistics Systems v. Beemac Trucking,No. 31 WAP 2019 (PA 4/29/2021) applies an analysis usually used to evaluate covenants not to compete, and concludes that on the facts presented, the no-poach clause was unenforceable as written. The case is instructive for all franchisors because its reasoning will be followed in other states.

No-poach clauses and no-solicitation clauses are post-employment restrictions against competition. In franchise agreements, these clauses usually are drafted to prevent franchisees from raiding the employees of other franchisees or of the franchisor. Sometimes, these clauses appear in agreements with critical vendors and business partners, so that no raids will cannibalize the staff. Application of the clauses stabilize the staff of the contracting parties but restricts the mobility of their employees. These employees did not agree to these restrictions, nevertheless, an invisible hand eliminates their opportunities.

Covenants not to complete are restrictions on competition, both during the term of the franchise agreement and after. These are evaluated based on the scope of the restriction, the period of the restriction and the geographic scope of the restriction. The in-term covenant against competition usually precludes engaging in competitive activity that would be disloyal to the franchisor or would impact the franchised business, and with a few exceptions, need not be limited in geographic scope. The post-term covenant precludes competition against the franchisor or other franchisees, and to be enforceable, must be reasonably limited in scope, time and geography.

As restrictions on competition, these clauses may be regulated by federal antitrust laws, state antitrust laws and state common law. Certain states, like California and Washington, prohibit the enforcement of such restrictions as against public policy, subject to certain exceptions. For example, Washington state entirely prohibits no-poach agreements as anticompetitive. The attorney general of Washington negotiated the nationwide elimination of no-poach agreements with over 200 franchisors if they wanted to continue to do business in the state of Washington. California has a statute that states that noncompete agreements are unenforceable, but exceptions exist for very narrow restraints in franchise agreements and for protection of trade secrets. See Bamboo Franchising v. Nguyen, (N.D. Cal. May 7, 2021) (Enforcing noncompete under the trade secret exception).

The jurisprudence in this area is changing rapidly. The Department of Justice and the Federal Trade Commission in 2019 concluded that no-poach clauses should be analyzed under a rule of reason analysis because of pro-competitive benefits of such clauses. Antitrust attack on no-poach agreements are difficult because of proving the necessary elements of antitrust damages, and these are expensive cases to prepare and try.

That is why the decision in Pittsburgh Logistics Systemsprovides a helpful analogue to franchising. The case involves a no-poach clause sought to be enforced by the current employer, Pittsburgh Logistic Systems (Systems), against four employees of Beemac Trucking, doing business with Systems. The four employees all left Systems to work at Beemac, and Systems sought to enforce the noncompete clause in the employment agreements with the employees. A temporary injunction was initially entered against the employees, but ultimately the injunction was vacated as being unreasonable.

Systems then sought to enforce the no-poach clause against Beemac, which would prevent Beemac from employing the four employees who’s noncompete agreements could not be enforced. As the case wound it way through the courts, the judges and counsel astutely identified the dilemma of indirectly restricting the activities of the employees that they did not agree to make for themselves. In attempting to address the issues, the Pennsylvania Supreme Court did review the law in several states and noted that while California and Wisconsin held no-poach clauses per se unenforceable, Texas, Virginia and Illinois do enforce the clauses. In fact, the Attorney General of Pennsylvania filed an amicus brief in the case urging a blanket rule against the enforcement of no-poach agreements.

The Pennsylvania Supreme Court weighed the legitimate business interest of Systems in preventing its business partners from raiding its trained employees against the public harm that the restriction caused. The court determined that the no-hire provision at issue was overbroad because it was not limited to Systems employees who had worked with Beemac. The court concluded that the no-poach provision was likely to impair the employment opportunities and job mobility of all Systems employees. The court also found that the restriction undermined free competition in the shipping and logistics industry labor market and thus harmed the public. The court refused to apply a per se rule, and applied the existing reasonableness analysis applied to noncompete agreements in Pennsylvania to affirm the lower court’s decision not to enforce the no-poach clause.

The Pennsylvania analysis will likely guide courts in other states regarding the interplay of no-poach, no-hire, no-solicitation and noncompete enforcement in other states. The lessons learned from the decision tell us that:

• Activity restrictions in existing franchise agreements need to be re-evaluated in light of changing jurisprudence.
• No-poach agreements in many instances will be difficult to enforce, and even the inclusion of such a provision in a franchise agreement may lead a court to conclude that the franchisor is overreaching in other aspects of the franchise relationship.
• Franchisors with legitimate business interests requiring activity restrictions should be able to link the provisions to protection of confidential information and to tailor the provisions as narrowly to demonstrate reasonableness.
• Geographic reasonableness and nonsolicitation should be reviewed and tailored in light of social networking and technological advancements.

Activity restrictions in franchise agreement protect the branding, the uniqueness, the competitive advantages through innovation, and the secrets of success of the franchisor. Now is the time to reappraise the tools being used to protect these most important assets.

Reprinted with permission from the June 17 issue of The Legal Intelligencer. (c) 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.