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The importance of choice of law and choice of forum clauses in
franchise agreements is clearer than ever in the wake of two recent
arbitration decisions involving Paul Green School of Rock Music
Franchising (“School of Rock”). One of those decisions
was recently affirmed by the U.S. Court of Appeals in Paul
Green School of Rock v. Smith, underscoring the necessity
to make choice of law and forum decisions carefully and strategically.
The two cases involved disputes between School of Rock and two
of its franchisees—Smith and the Giammarrusco’s, who
together conspired to repudiate their franchise agreements to
start a competitor, Rock Nation (the “Smith”
and “Rock Nation” cases respectively). The
cases share largely identical facts. Each involved California
franchisees, breach of the respective franchise agreements, and
similar claims including non-payment of royalties to School of
Rock. Both cases also involved franchise agreements that contained
arbitration and non-compete clauses. The major difference between
them is that the franchise agreement in Smith provided
for arbitration in Pennsylvania pursuant to Pennsylvania law,
while the franchise agreement of the Giammarrusco’s in Rock
Nation required arbitration in California under California law.
Unlike Pennsylvania law, California law considers covenants not
to compete to violate public policy—an important distinction
between the two states. California law generally prohibits such
covenants, and California courts rarely enjoin competition, doing
so only when necessary to protect trade secrets.
The Smith case proceeded to arbitration in Pennsylvania.
Ultimately, the arbitrator ruled that Smith must pay $401,743
in damages including attorneys fees and future lost profits to
School of Rock, and that he was bound by the non-compete clause
in the franchise agreement. The arbitrator was not bound by the
prohibition on restrictive covenants found in California. In contrast
to Smith, School of Rock’s arbitration award in
Rock Nation awarded $100,000 in damages for unfair competition
with no damages for future lost profits. The arbitrator also refused
to uphold the non-compete clause as against California’s
public policy but is increasing the award to add costs and counsel
fees.
These cases provide franchisors with an important guide for constructing
franchise agreements for use in California. However, the extent
to which clauses choosing non-California law are enforceable in
California franchise disputes is not completely clear. Prior to
the arbitration in Smith, Smith objected to the choice
of law and forum provisions in a California court, arguing that
the provisions were unconscionable. However, the court found that,
since Smith’s California rights would be recognized in Pennsylvania,
the provisions should be enforced. Notably, not all California
cases since Smith have been similarly decided. Recently, in Bridge
Fund Capital Corp. v. Fastbucks Franchise Corp., the court
refused to follow Smith. The court found that the choice
of forum and law provisions in the franchise agreement, which
designated Texas and Texas law, were not enforceable since there
was no evidence that the franchisee’s California-based rights
would be recognized in Texas.
Regardless of the uncertainty created by Fastbucks, Smith
still provides a useful guide on how to avoid California’s
prohibitions of non-compete covenants, and for how franchisors
in California can obtain the greatest possible protection if disputes
arise. Smith and Rock Nation prove that strategically
choosing the governing law and forum can make all the difference
in franchise dispute resolution results, and selecting non-California
law in the franchise agreement will likely provide better protection
to franchisors.
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Nixon Peabody Franchise Law Alert, August 20, 2010.
Reprinted with permission. |
CHOICE
OF LAW AND CHOICE OF FORUM PROVISIONS IN FRANCHISE AGREEMENTS:
JURISDICTIONAL DIFFERENCES IN ENFORCING THE COVENANT NOT TO COMPETE
