Jul 19, 2015 - Franchise Articles by |

Court Slams Former Franchisees That Steal Franchise Secrets After Franchise Termination

By: Jeffrey M. Goldstein

jgoldstein@goldlawgroup.com

goldlawgroup.com

(202) 293-3947

Post-Term Franchise Restrictive Covenant in Franchise Agreement Haunts Franchisees in Capital Meats, Inc., v. The Meat Shoppe, LLC, 2015 WL 4249166 (D.C. Md. July 9, 2015). In Capital Meats, the United States District Court for the District of Maryland granted in part and denied in part a motion by the franchisee defendants to dismiss the case. The Plaintiff in Capital Meats, Capital Meats, Inc. (“CMI”), sued several entities referred to collectively as “The Meat Shoppe” and several former CMI employees who went to work for The Meat Shoppe (collectively, “defendants”). CMI alleged in nine counts that the defendants, when they resigned en masse to establish and operate a competing business, The Meat Shoppe, carried out the following: violated Virginia contract law; transgressed the Maryland Uniform Trade Secrets Act (“MUTSA”); infringed the post-term restrictive covenant not-to-compete; and committed several Maryland business and competition-related torts.

CMI, a Virginia corporation with its principal place of business in West Virginia, is a wholesale distributor of frozen meat, poultry, and seafood that operates in sixteen states and has eleven warehouse distribution centers. CMI enters into contracts with independent sales representatives (“Retail Dealers”) who sell CMI’s products door-to-door while driving trucks and wearing clothes that display CMI’s logo and name.

 As part of the business, Retail Dealers purchase CMI’s products “on consignment on a daily basis without any up-front payment,” and return unsold product at the end of the day. CMI maintains a “CMI Database” that tracks inventory, sales, payments by customers, and balances owed by Retail Dealers. It was also alleged that the database “provides CMI a competitive advantage and is not available to others outside of CMI’s business.” CMI also maintains an inter-office website (“Call Center Website”) which was alleged to be “a centralized system for customer payment processing.” It was also alleged that both the Database and Call Center Website stored information that the Retail Dealers used to improve their sales through greater efficiency. It appears that one of the individual defendants, Meghan Tunney, had access to the Database and Call Center Website as part of her job as CMI’s Chief Auditor. 

Each of the individual defendants except for Meghan Tunney was a Retail Dealer who signed a Distributorship Agreement with CMI; Section 11 of the Distributorship Agreement included a non-compete and non-solicitation clause (“the restrictive covenant”) which stated:  

Upon termination of this Agreement and for a two (2) year period thereafter, Retail Dealer covenants and agrees not to engage, directly or indirectly, in the business of selling meat, poultry, and seafood products door-to-door in the Territory granted to Retail Dealer pursuant to this Agreement. Retail Dealer further agrees that upon the termination of this Agreement that he shall not solicit, either directly or indirectly, any customers with whom he had dealt while acting as an independent contractor for Supplier for the sale of meat, poultry, seafood, and other food products.

With regard to territories, CMI’s amended complaint acknowledged that the Retail Dealers were not awarded “exclusive rights to sell in any territory”; instead, the Retail Dealers were allowed to sell within any area they could reach during a single day so that they could return unsold product back to CMI’s warehouse for storage. Importantly, and interestingly, Paragraph 2 of the Distributorship Agreement (“Rights and Territories”) was left blank on each of the Retail Dealer defendants’ agreements, except for the contract of Liam Tunney, which had the word “Any” written in each of the blanks.

According to the pleadings, on January 5, 2015, the Retail Dealer defendants did not show up for their regularly-scheduled warehouse pickups, and Meghan Tunney informed CMI that she had resigned effective immediately. CMI asked the defendants to return all of CMI’s property in their possession, including Megan Tunney’s access to the CMI Database which had been installed on her personal computer. Meghan Tunney did not produce the requested property, but instead thereafter provided it to her counsel in February 2015. With regard to specific property, there apparently existed a surveillance video showing the following: Meghan Tunney moving around files inside CMI’s Baltimore office and removing some of them from the office; Combass and Fincham (other defendants) removing documents and property; and shredding of documents by a CMI employee later hired by The Meat Shoppe.

            In turn, following the resignations, the individual defendants and approximately 100 of CMI’s sales force began working (and, CMI alleges, began operating) at competing businesses, all operating under the name, The Meat Shoppe. That entity, a named defendant, was also “a wholesale meat distributor that sells and distributes frozen meat, poultry, and seafood via door-to-door sales in Maryland, the District of Columbia, Delaware, Pennsylvania, Virginia, and West Virginia.” CMI alleged that in addition to such selling, the defendants “engaged in malicious and deceitful actions in an effort to solicit and steal CMI’s customers,” including the making of false statements to customers and CMI employees that CMI is or will be out of business so as to entice them to switch to The Meat Shoppe. Toward its damages claim, CMI alleged that the four CMI regional offices at issue lost significant business to The Meat Shoppe subsequent to the mass resignation on January 5, 2015, which resulted in CMI losing around 70% of its revenue.

            With regard to the alleged breach of the restrictive covenant provision, the Court surprisingly held that, although the clause was supported by legal consideration, it failed to include certain crucial material terms thereby making the restrictive covenant unenforceable. With regard to the consideration issue, the Court noted that under Virginia law, a valid contract requires proof of “an offer, acceptance, and consideration.” With regard to the latter, “Virginia has long followed the ‘peppercorn’ theory of consideration, under which even a peppercorn suffices as consideration.” The Court noted that a peppercorn had been equated with a cent. The Court did point out, however, that if only nominal consideration was provided, Virginia law requires proof that the transaction was indeed a “bargained for exchange” and not a gift. 

Applying these principles of legal consideration the Court found that “the individual Distributorship Agreements reflect a valid, bargained-for contract between CMI and the Retail Dealers.” The Court noted that the Defendants did not dispute that all parties operated under the respective Distributorship Agreements without complaint until the events of January 5, 2015; indeed, they argued that only the restrictive covenant was not supported by consideration. The non-compete clause specifically prohibited the Retail Dealers from selling meat door-to-door “in the Territory granted to them under ¶ 2 of the Distributorship Agreement, Rights and Territories.” Unfortunately for CMI, however, Paragraph 2 was left blank on all but one of the contracts, which, defendants argued, showed that CMI did not provide an exclusive territory to the Retail Dealers in consideration for the non-compete clause.

            The Court then, focusing only on the consideration issue, held that the omission of a defined territory in ¶ 2 did not itself render the non-compete clause invalid for lack of consideration. The Court reasoned that it was impossible to tease out, in a quid-pro-quo manner, each element of consideration associated with each of the prolific promises and obligations in the contract. “Neither side disputes that the relationship between the parties was commercial, and these kinds of contracts are a collection of various promises and exchanges that are not neatly divisible into directly corresponding benefits and detriments.” In so noting, the Court cited other case law that described “mutual promises as consideration, even if the promises apply to different contract terms or are conditioned upon performance by the other party.” Accordingly, under this theory, “even if a Retail Dealer was not given exclusive territory under ¶ 2 … the omission of that specific benefit does not automatically void ¶ 11 for lack of consideration.” In so ruling, the Court also pointed out that CMI provided the Retail Dealers other benefits under the Distributorship Agreement.

            Next the Court examined whether the restrictive covenants should be voided and stricken because they omitted material facts, even though, as noted previously, they were supported by consideration. Initially, on this point, the Court stated that: “Restrictive covenants, like any contract, “must be sufficiently definite to enable a court to give it an exact meaning, and must obligate the contracting parties to matters definitely ascertained or ascertainable.” In turn, the Court identified three different perspectives of restrictive covenants that must pass a reasonableness test to be deemed valid, including: (1) the employer’s, (2) the employee’s, (3) and “sound public policy.” In addition, the clauses must be evaluated for their “function, geographic scope, and duration.” Last, the Court emphasized that that Virginia law requires that restrictive covenants be “narrowly drawn … and any ambiguities in the contract will be construed in favor of the employee.”

Applying these principles to the instant case, the Court held that the “Territory” that Retail Dealers are prohibited from competing in after their CMI employment ends is defined by ¶ 2 of the Distributorship Agreement; as such, the definition of “Territory” is a material term necessary for evaluating the geographic scope of the non-compete clause and the larger question of its enforceability. Seemingly exasperated with the lack of specificity in the agreements, the Court concluded that: “The problem with each of the Distributorship Agreements cited and attached by plaintiffs, however, is that ¶ 2 is blank-no county and state is listed.”  Facially, therefore, there was no non-compete clause to enforce because “Territory” as it is used in ¶ 11 is meaningless. In other words, CMI’s decision to omit a geographic scope rendered the restrictive clause overbroad and unreasonably “harsh and oppressive” to the Retail Dealers.

In ruling against the franchisor, the Court thought it important to signal that this was a result that the franchisor had brought on itself. In this regard, the Court lamented that “Some courts have upheld a non-compete clause despite the omission of a geographic scope, but [these kinds of cases] are distinguishable from the contract between CMI and the Retail Dealers because ¶ 11 explicitly limits the geographic scope of the restrictive covenant to a defined “Territory.” Instead of evaluating a complete restrictive covenant with no explicit geographic scope, CMI is asking me to enforce an incomplete covenant with a required but omitted geographic scope.”

CMI attempted to sidestep the legal gauntlet by arguing that, even though ¶ 2 was left blank (such that no Retail Dealers were granted exclusive territory), there nevertheless was an ascertainable geographic scope that was identifiable and that could be used by the Court: the territory “which [the Retail Dealers] serviced while working for CMI.” The Court stated that this argument, even assuming it were written in the agreement, which it was not, failed to cure the defect because Virginia law provides “no authority for courts to ‘blue pencil’ or otherwise rewrite the contract to eliminate any illegal overbreadth.” Such textual surgery as requested by CMI (to cross out “County, State of” and instead write something to the effect of “wherever the Retail Dealer sold CMI products during the duration of his or her employment”) is, according to the Court, expressly prohibited under Virginia’s rule of strict construction. Very simply, the Court pointed out that it was helpless to evaluate the non-compete clause in ¶ 11 “because I cannot properly evaluate its reasonableness without a geographic scope.”

            In addition, the Court evaluated the similar, but distinct, clause regarding non-solicitation. Again, however, the Court found the clause to be unenforceable because it lacked specific duration. CMI argued that the two-year period in the non-compete clause also applied to the non-solicitation clause, but the Court refused to “read it into” the second sentence regarding solicitation. As before, the Court cautioned that “Non-solicitation clauses, like non-compete clauses, are construed against the [drafter].” The Court, for the sake of argument, stated that “CMI could have added the same two-year term to the second sentence, and therefore its omission could reflect CMI’s intention for the duration to be indefinite. Regardless, I decline to inquire into CMI’s motivation or “blue pencil” in that limitation.”

            Next, the Court ruled that CMI’s count alleging a violation of the Maryland Uniform Trade Secret Act (“MUTSA”), prohibiting the misappropriation of trade secrets, would not be dismissed. The defendants moved to dismiss the MUTSA claim on two grounds, including: (1) the CMI database and the CMI Call Center Website are not “trade secrets” under the MUTSA, and (2) CMI has not alleged that any defendant in fact “misappropriated” that information. The Court explained why it rejected both arguments.

In finding that the database and website were “trade secrets,” the Court initially examined the definition of “trade secrets” in MUTSA as:

information, including a formula, pattern, compilation, program, device, method, technique, or process, that:

(1) Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

The Court also found relevant the six-part test in the Restatement of Torts used by Maryland courts “as helpful guidance to determine whether the information in a given case constitutes ‘trade secrets’ within the definition of the statute.” 

First, according to the Court, the two services were highly valued by CMI, as measured in several ways, including the amount spent by CMI to create the Database and Call Center Website—allegedly over $260,000 and $500,000, respectively, and the fact that CMI invested that money with the intent of deriving a greater economic benefit over time (in the form of more efficient door-to-door sales and correspondingly higher revenues). In further explaining the Court’s view that the services had value, it stated that “CMI and the Retail Dealers utilized the information in regard to customers, their payment information, and what products they bought to better target regions and customers to increase sales. Moreover, the value of the Database and Call Center Website continued to increase as more sales were made and additional information was gathered and entered.”

The defendants attempted to rebut this conclusion by arguing that these types of lists are commonly created by companies like CMI and, therefore, are not sufficiently unique to have any actual economic value. The Court quickly pointed out that this argument “misses the mark … because the trade secret is the information itself – the customers and products they bought – not the type of software or whether other companies compile similar lists.” The Court also relied upon a prior recent Maryland court case in which a federal court stated that “Plaintiffs’ customer list has economic value because, according to Plaintiffs, it is, among other things, a compilation of customer preferences, it was not generally available to the public, and it was kept secret.” Further, on the value issue, the Court pointed out that the defendants had also failed to adequately contest the fact that the information contained within the Database and Call Center Website was not public knowledge outside of CMI and the individual Retail Dealers. From the Court’s perspective this failure was fatal since such exclusivity and confidentiality “is another marker of economic value.”

Second, according to the Court, CMI had sufficiently alleged that it carried out reasonable efforts to maintain the secrecy of the information. Regarding the Database, CMI alleged that it had limited access to only certain “authorized users,” including Meghan Tunney who was a “trusted member of CMI’s management team” at the time. Specifically, CMI alleged that the database itself was secured on CMI’s server or CMI-owned computers, requiring authorization credentials for access. As for the Call Center Website, CMI also alleged that it restricted access by requiring “office log-ons and passwords” which were only given to Meghan Tunney, Jones, Fincham, Combass, DeFries, and Omodho. Tunney had access because of her management role, while the other five defendants required access for their management of regional offices. CMI, regarding secrecy maintenance, also contended that after the mass resignation on January 5, 2015, it cancelled and removed access to the Database and Call Center Website for the employees who had left, including Meghan Tunney.

When the Court combined its supposition that CMI had taken “reasonable efforts” to maintain secrecy of the database and call center website, with its view that the trade secrets had “value”, it concluded that CMI’s allegations sufficiently alleged that the information constituted “trade secrets.”

            The Court in turn ruled that CMI had sufficiently alleged that defendants misappropriated CMI’s trade secrets to establish and operate The Meat Shoppe under the MUTSA. In so concluding, the Court highlighted one of the several misappropriation definitions in § 11–1201(c):

(2) Disclosure or use of a trade secret of another without express or implied consent by a person who:

(i) Used improper means to acquire knowledge of the trade secret; or

(ii) At the time of disclosure or use, knew or had reason to know that the person’s knowledge of the trade secret was:

The Court also examined whether the trade secret was derived from or through a person who had utilized improper means to acquire it. CMI, according to the Court, alleged that certain defendants (chiefly Meghan Tunney) directly obtained the information contained in the Database and Call Center Website through “improper means” and then distributed that information to former Retail Dealers who joined The Meat Shoppe. Then, allegedly, “All defendants then used that information to their competitive advantage.” Under relevant law regarding trade secrets, so held the Court, any use of the information regarding customers and their purchases for purposes unrelated to conducting CMI business required its “express or implied consent.” The Court relied for this principle upon a prior court’s ruling that “a former employee is obligated not to disclose or use the confidential information acquired during his employment.” In turn, concluded the Court, “That is precisely the kind of misappropriation alleged by CMI here-Meghan Tunney and the other defendants with access to the Database and Call Center Website downloaded or otherwise stored that information while employed by CMI with the intent to use it later to help The Meat Shoppe.”

The Court also seemed perturbed about the potential assertion by the non-poachers of some type of immunity argument when it cautioned that:

[E]ven if only one or a few of the defendants directly misappropriated the information, the other defendants are not immunized from liability. The MUTSA clearly includes within the definition of misappropriation the use of information by a person who knew or had reason to know that it was obtained through improper means. Again, as currently pleaded, CMI alleges that every Retail Dealer who continued using CMI’s customer and product information while working for The Meat Shoppe knew or had reason to know that the information was obtained and continued to be utilized improperly. 

Next, the Court turned to the intentional interference with contract claim, in which CMI argued that defendants intentionally and tortiously interfered with the individual Distributorship Agreements between CMI and its former Retail Dealers. The Court was informed by Maryland law showing that CMI faced the burden to prove the following five elements: 1) the existence of a contract between plaintiff and a third party; 2) defendant’s knowledge of that contract; 3) defendant’s intentional interference with that contract; 4) breach of that contract by a third party; 5) resulting damages to the plaintiff.

More specifically, CMI accused defendants of tortiously causing CMI’s Retail Dealers to breach the restrictive covenants in their agreements and to also breach overall the contracts. The Court rejected both of these arguments. With regard to CMI’s first allegation in this count that the defendants “caused numerous Retail Dealers … to breach the restrictive covenant contained in each Retail Dealer’s Distributorship Agreement,” the Court referred back to its earlier decision that even though each Distributorship Agreement between CMI and the individual Retail Dealers was valid and enforceable, the non-compete covenants therein were not. As the Court stated: “Accordingly, the defendants cannot be liable for tortiously interfering with the non-compete clause when ‘no valid restrictive covenant existed.’”

The Court then turned to the business-related torts alleged by CMI. In this regard CMI alleged that defendants committed three business-related torts—tortious interference with prospective advantage, unfair competition, and injurious falsehood. The Court rightly pointed out that the three business torts “are related in that they deter and punish gaining an improper business advantage through intentional deceit and fraud instead of vigorous competition.”

The Court, before ruling on the claims, set out the relevant underlying facts common to the three torts, the scope of which the Court viewed to “overlap.” The first group of facts relates to the “coordinated raid … and ransacking of CMI’s offices and freezers” and the misappropriation of CMI’s trade secrets from its database and call center. These facts also regard various defendants allegedly having stolen documents and destroyed others, with the apparent intent to utilize them to establish The Meat Shoppe. Surveillance footage existed of these events. Moreover, CMI also alleged that that Meghan Tunney and a few other defendants logged into the Database and Call Center Website while working at CMI but without its permission; as alleged by CMI, after accessing the website and data, the defendants took the confidential information with the intent to help establish The Meat Shoppe. Because CMI had argued that the other defendants who were not directly implicated in these acts used the improperly obtained information as part of their job with the knowledge that it was unlawful to do so, they were also potentially liable for the three business-related torts.

            The second set of facts regarding the three business torts included allegations that the defendants knowingly (or with reckless disregard for the truth) made false and deceitful statements to non-defendant Retail Dealers and CMI customers regarding the business status of CMI and the origin of The Meat Shoppe. One of the allegations was that Liam Tunney told the non-defendant Retail Dealers on January 5, 2015 that he “was a co-owner of CMI and that he was taking his one-half of the company and renaming it, that CMI was going bankrupt, and that CMI’s owners were tax evaders.” CMI also accused all of the defendants of having “provided false and misleading information to CMI’s customers,” including the fact that CMI changed its name to The Meat Shoppe, “and that the Meat Shoppe is ‘the same company’ as CMI .”

In explaining in part why the Court was not persuaded by the defendant’s arguments on these points, it stated that “The fact that defendants used equipment, clothing, and documents with The Meat Shoppe logo does not disprove their alleged deceitful statements to CMI employees and customers. Indeed, CMI does not dispute the fact that defendants operated with a different logo, but instead alleges that defendants’ deceitful and unlawful statements occurred while explaining to the non-defendant Retail Dealers and CMI customers why they should now work for and purchase from The Meat Shoppe.” The Court continued its explanation by concluding that “It is those deceitful and false statements which are most damaging to CMI, because customers would be under the false impression that they were either still purchasing from CMI-albeit under a different corporate form-or that CMI was out of business and The Meat Shoppe was thus their next best option.”

Last, although CMI did not identify specific customers that it lost to defendants by name, the Court nevertheless determined that CMI had sufficiently alleged damages because “defendants do not seem to dispute the fact that CMI has suffered a significant decline in revenue since the mass resignations that occurred on January 5, 2015–over seventy percent.” According to the Court, if it drew all reasonable inferences in CMI’s favor, its allegations would entitle it to establish proximate damages resulting from defendants’ conduct. In conclusion, the Court felt that CMI’s allegations had established the inference that defendants were “trading … upon the good name and reputation built by another.” Accordingly, the Court denied the defendants’ motion to dismiss these related claims.

CMI also alleged a claim that defendants engaged in a civil conspiracy to commit the acts alleged above “and to use such information to operate” The Meat Shoppe and its related entities. The Court correctly pointed out that a civil conspiracy “standing alone, is not actionable” under Maryland law; to be actionable, such a claim requires proof of a distinct “tortious injury to the plaintiff.” As such, according to relevant law, a plaintiff must allege: (1) an agreement by two or more persons; (2) to commit an unlawful act in furtherance of the agreement; (3) that damages plaintiff. In turn, the Court reasoned that “Because I have held above that several of CMI’s claims withstand defendants’ … motion to dismiss, there are a serious of wrongful acts which CMI claims defendants conspired to perpetrate. Moreover, it is plausible that a civil conspiracy existed among the defendants which was designed to injure CMI.”

CMI’s count for unjust enrichment alleged that all of the defendants had accepted the benefit of the information contained in the CMI Database but failed to pay CMI for its value. As the Court noted, this restitutionary remedy “is established when: (1) the plaintiff confers a benefit upon the defendant; (2) the defendant knows or appreciates the benefit; and (3) the defendant’s acceptance or retention of the benefit under the circumstances is … inequitable.” Without missing a beat, the Court dismissed this claim because “CMI did not confer the benefit of the database to defendants as is required under the first element — defendants allegedly stole it.” In this regard, “The problem … is that an unjust enrichment theory is inapplicable to these facts. All of CMI’s allegations regarding the Database (and Call Center Website) are that defendants covertly misappropriated the information prior to and on January 5, 2015 when they left CMI to join The Meat Shoppe. Certainly when defendants worked at CMI they knowingly obtained the benefit of the Database to more efficiently sell CMI’s products and in return they provided CMI with its contractually mandated share of the revenue, but that time period is not at issue in this dispute. Instead, CMI focuses on what happened immediately before and after defendants left CMI. CMI did not intend to confer the benefit of the Database on defendants for use at The Meat Shoppe, which is why defendants face potential liability under the MUTSA and common law business torts. Those causes of action encompass the same conduct alleged here, and are the appropriate vehicles to obtain CMI’s desired remedies (including compensatory damages).” Accordingly, the Court dismissed the unjust enrichment claim of CMI.

Finally, CMI alleged that Liam Tunney and the Retail Dealer Defendants breached their respective Distributorship Agreements by terminating the contracts without paying their existing unpaid balances that were owed to CMI. Under the Distribution Agreements, upon termination “All amounts owing by Retail Dealer to [CMI] shall … become immediately due and payable.” The Court in this regard reasoned that “A Retail Dealer could owe a balance because CMI provided its products to them on credit, requiring its share of the revenue and the return of unsold products to the warehouse each day. If a Retail Dealer had not yet paid CMI its share of the revenue prior to terminating the Distributorship Agreement, that failure would constitute a breach of ¶ 10(a).” No more than this was required under applicable pleading rules in order to sidestep the defendants’ motion to dismiss the breach of contract claim.

Interestingly, in rejecting the defendants’ motion to dismiss CMI’s claim that the defendants had violated the post-termination restrictive covenant, the Court, in a related hidden footnote, showed again its overarching conservative jurisprudential view towards the issues raised by the case when it rejected CMI’s alternative argument that Maryland contract law allowed the Court to “blue pencil” the restrictive covenant. In essence, the Court found that Maryland law makes a clear distinction between “removing the offending language” on the one hand and “supplementing or rearranging the remaining language” on the other.  As the Court explained, “Here, CMI is not simply asking me to excise terms but instead to add and rearrange contract language. This kind of “flexible blue penciling” was endorsed by the Maryland Court of Special Appeals in the Holloway case, but as I noted in a previous case, “[n]o Maryland case since Holloway has applied the flexible approach” and it was a departure from “the traditional use of the strict divisibility rule by Maryland courts.” 

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