In Comedy Club v. Improv West Associates the Ninth Circuit held that an in-term covenant not to compete (a covenant that continues during the term of a contract or relationship) in a Trademark License agreement was overbroad, but enforced a more limited version of the covenant. The Court held that while there is no exception in California’s law against non-competition agreements for in-term covenants not to compete, they may be valid, at least in the context of a "franchise like" agreement.
Defendant Improv West ("Improv") is the founder and owner of the Improv Comedy Club trademark. It entered into an agreement with Comedy Club International ("CCI") providing that: 1) CCI had an exclusive right to use the "Improv" name to open comedy clubs in the United States, 2) CCI had to open four clubs a year for the first three years, and 3) CCI was prohibited from opening comedy clubs under any other name until the agreement expired in 2019.
CCI failed to open the requisite number of clubs. Improv immediately cancelled CCI’s right to use the Improv name, began opening its own clubs, and sought to enforce the non-compete for the term of the agreement because CCI continued to run established Improv clubs. The arbitrator upheld the agreement in full, issuing an injunction preventing CCI from opening any comedy club, under any name, anywhere in the United States until 2019.
The Ninth Circuit held that the in-term covenant not to compete violated California Business and Professions Code section 16600. The Court noted that there is no exception to 16600 for in-term covenants, but the Court held that an in-term covenant not to compete could be valid under certain circumstances. Although the Court did not analyze or offer any particular circumstance, it did discuss several older cases dealing with franchise arrangements and "exclusive dealing" contracts. The Court neither limited the validity of in-term covenants to those situations, nor indicated when in-term non-competes in other contracts might also be valid.
The Court analogized CCI’s contract to a franchise agreement and held that it would be enforceable if properly limited. However, the covenant, as written, effectively operated to put CCI out of the comedy club business until 2019. The breadth of the prohibition was illegal because, the court held, "in-term covenants not to compete cannot prevent a party from engaging in its business or trade in a substantial section of the market." Rather than strike the agreement outright, the Court modified the non-compete and ruled that CCI should be prohibited from opening a new comedy club only in any county where it already operates an Improv club.
The Court also took issue with the agreement’s definition of "affiliate." The covenant prohibited CCI’s "affiliates" from competing. However, the definition of "affiliate" was so broadly written that, as the Court put it, it included a CCI owner’s "ex-wife and his ex-wife’s cousins, nephews, uncles, and aunts." The Court limited the definition to officers, agents, servants, employees, attorneys, and "those persons in active concert or participation" with the enterprise.
There are several lessons to be drawn from Comedy Club. Any in-term covenant should be carefully limited to a reasonable territory. Generally, the geographic scope should be the territory where the company or companies are doing business during the agreement. The closer the relationship between the parties resembles a "franchise" or "exclusive dealing" contract, the more likely it is to be upheld. When drafting an in-term covenant, businesses should be cautious about using broad and sweeping language. Finally, the Courts analysis, as well as some language in a footnote, suggests that any post-term covenant not to compete will be invalid and unenforceable in California.
For further information, please contact Adam Tullman at (415) 774-2976.