Franchisors license out their intellectual property, including business-critical trade secrets like price lists, protocols, procedures, developed systems of management, and compensation structures.  What if an ex-franchisee (or even a current franchisee!) uses those secrets to compete against the franchisor?  Recent federal appellate case law sets the stage for a franchisor to successfully enjoin a franchisee from operating a competing business based on misappropriation of the franchisor’s trade secrets.  The decision illustrates why it is important for franchisors to have a clear understanding of what they consider to be trade secret and to include express trade secret clauses in their franchise agreements.

The Handel’s Case

In Handel’s Enterprises v. Schulenburg, No. 18-3596, 2019 U.S. App. LEXIS 9483 (6th Cir. Apr. 1, 2019) an existing franchisee of Handel’s ice cream shop wanted to open a second franchise location, but it did not want to pay a separate franchise fee.  The franchisor didn’t approve the second location based on the franchisee’s refusal to pay the separate fee, so the franchisee started its own competing ice cream shop at the location instead.  Because the franchisee was still operating its original franchise location, it still had access to the franchisor's trade secrets, including specifications, standards, procedures, recipes, and unique ingredients.  Although the franchise agreement did not specifically identify the franchisor's trade secrets, it did include a clause entitled "TRADE SECRETS OF THE FRANCHISOR," which required the franchisee to acknowledge that the business information it received was the franchisor's trade secrets.

Against this backdrop, the franchisor sought an injunction to prevent the franchisee from operating the competing ice cream shop based on trade secret misappropriation under the Ohio Uniform Trade Secrets Act.  Even though there was no proof that any trade secret was actually being used at the competing shop, the district court granted the injunction.  On appeal, the Sixth Circuit agreed with the district court’s finding that there was actual or threatened misappropriation of the franchisor’s trade secrets and upheld the injunction.  This was because the franchisee still had access to the franchisor’s trade secrets, and there was evidence that the franchisee was stocking up on ice cream flavors at its existing franchise location for use at the new store.

Takeaways

As this case shows, trade secrets are a protectable, enforceable intellectual property right under a franchise agreement.  The court recognized several broad categories of trade secrets that the franchisor shared in franchise training sessions: the operations manual, including specifications, standards, and procedures, as well as ice cream flavors and the methods for creating them.  Moreover, a claim of trade secret misappropriation can be a relatively quick and effective way to stop a franchisee from taking the franchisor’s intellectual property and using it to operate a competing business.  (Within three months of filing suit, the franchisor secured a court order that prevented the franchisee from competing in any way whatsoever with the franchisor.  That order took effect while the decision was on appeal—meaning that the franchisee had to shutter its already-open and operating competing ice cream shop.)  But such a claim can only be made if the franchisor knows precisely what its trade secrets are, takes measures to maintain them as secret, and positions itself to act quickly upon learning of misuse or theft.  The case also shows that having contractual language specifically directed to trade secrets is helpful.  That said, an even better practice would be to reference and incorporate an addendum that calls out the specific information that the franchisor will claim is a protectable trade secret.  This will put the franchisor in a more favorable position to defend against a potential argument that the trade secrets were "never clearly defined," which did not pose a problem in this case, but often does.

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