Seller's Flagrant Disregard of Non-compete Leads to Damage Award

Perhaps because they are more familiar with the law in other states or perhaps because they don't think that non-competes are "fair", many non-lawyers in Colorado believe that non-competes are rarely enforced. Or they think that they can take a risk and breach a non-compete because damages won't be awarded.  Those errors can lead to costly decisions as demonstrated by Judge Blackburn's decision on July 21, 2008 in Tax Services of America v. Mitchell.

In Tax Services, Judge Blackburn of the federal district court in Colorado found that one of the defendants had signed a non-compete when she sold a tax preparation business known as Qwik Tax. The other defendants signed non-competes when they were employed by the purchaser of the business. Despite these non-competes, the three defendants opened an office of "Kwik Tax Service" within 135 feet of the purchaser's business. Defendants then prepared many tax returns for the purchaser's customers, effectively stealing the purchaser's business. The purchaser's business dropped precipitously once "Kwik Tax" opened while Kwik Tax's revenue increased "exponentially during the same period". 

Judge Blackburn not only entered injunctive relief against the defendants precluding them from breaching the non-compete, he also awarded damages to the purchaser for lost profits. Judge Blackburn also awarded over $370,000 in attorneys fees and costs against the defendants. 

Judge Blackburn's decision should serve as a warning to anyone who considers breaching a non-compete, especially a non-compete which arises out of the sale of a business. Courts are favorably inclined to enforce non-competes arising out of purchase agreements for businesses and damages will be awarded if a purchaser can prove its damages were caused by the competing business. 

Colorado Court of Appeals Enforces Non-Compete Against Purchaser of Franchise

In the latest decision involving a non-compete in a franchise agreement, the Colorado Court of Appeals ruled on May 15, 2008 that a franchisor may enforce a non-compete when the non-compete arises from the purchase of an existing franchise.

In Keller Corp. v. Kelley, the defendant Kelley had purchased an existing franchise and entered into a new franchise agreement with the franchisor. The new franchise agreement included a covenant not to compete. When the franchise agreement terminated, Kelley began operating a competing business. In response, the franchisor filed an action seeking injunctive relief to enforce the non-compete. The trial court denied the motion for preliminary injunction and the franchisor appealed.

The court held that the non-compete fell within the ‘sale of business’ exception to the general rule that precludes the enforcement of non-competes. The court acknowledged that non-competes typically are included in contracts for the sale of a business in order to protect the buyer. Nonetheless, it concluded that there was nothing in the statute that limited its application to the protection of buyers.

Importantly, the court noted that it had not reached the issue of whether an agreement establishing a franchise in a territory for the first time would constitute the sale of a “business” within the meaning of the Colorado statute on non-competes. The court wasn’t required to reach that issue because the franchise agreement between Kelley and the franchisor was entered into as part of the transaction in which Kelley had acquired a “going business” from the previous franchisees.

The Court of Appeals also refrained from ruling on whether the geographic reach of the non-compete was reasonable. The trial court had noted that the restriction on competition was “enormous” because precluded competition within a fifty mile radius of any of franchisor’s existing territories, which included franchises in Colorado Springs, Vail, Aspen, Fort Collins, Grand Junction and Thornton. The Court of Appeals merely observed that the reach of the injunction could be limited by the trial court to an area considered by it to be reasonable.

The Court of Appeals previously has addressed non-competes in franchise agreements. In an earlier decision, the Court of Appeals had ruled that a non-compete arising from the sale of an existing franchise could be enforced by the purchaser of the franchise.

Non-compete in Franchise Agreement Enforced Against Franchisee

In a brief, direct decision, Judge Miller, a federal district judge in Colorado, recently granted a franchisor’s motion for preliminary injunction in Dry Cleaning To Your Door, Inc. v. Waltham Ltd. Defendants had signed a franchise license agreement with a non-compete which prohibited them from being engaged in a residential dry cleaning pick-up and delivery business for two years after the expiration of the franchise agreement. Defendants declined to renew the franchise but continued to operate a residential dry clearing pick-up and delivery business. Franchisor responded and sought an injunction precluding defendants from operating the business.

With little apparent hesitation, Judge Miller issued the injunction. He found that, in the franchise industry, non-competition provisions and “territorial integrity” are critical factors to protect the value of the “franchise systems”.

Importantly, Judge Miller elected to apply Florida law to evaluate the enforceability of the non-compete. He reasoned that Florida had ample contacts with the transaction and that applying Florida law is not contrary to the public policy of Colorado.

Applying Florida law, Judge Miller concluded that the geographic scope of the non-compete was unreasonably broad. The non-compete barred competition within the defendants’ territory or the territory of another franchise, together with a 25 mile radius around such territories. Judge Miller ruled that the non-compete should be to an area five miles around defendant’s territory.