Timothy A. Barnes, United States Bankruptcy Judge.
This matter comes before the court on the Amended Adversary Complaint Seeking Injunctive Relief [Adv. Dkt. No. 3] (the "
For the reasons set forth more fully below, upon review of the respective filings, the court concludes that Aire Serv's rights under the covenant not to compete in the Franchise Agreement (as defined below), including to injunctive relief, constitute a "claim" within the meaning of 11 U.S.C. § 101(5), which claim will be treated in accordance with bankruptcy law. The court further concludes that Aire Serv has no cause or right of action against Joseph under the covenant not to compete in the
The federal district courts have "original and exclusive jurisdiction" of all cases under title 11 of the United States Code, 11 U.S.C. § 101, et seq. (the "
A bankruptcy judge to whom a case has been referred may enter final judgment on any core proceeding arising under the Bankruptcy Code or arising in a case under the Bankruptcy Code. 28 U.S.C. § 157(b)(1). Bankruptcy judges must therefore determine, on motion or sua sponte, whether a proceeding is a core proceeding or is otherwise related to a case under the Bankruptcy Code. 28 U.S.C. § 157(b)(3). As to the former, the bankruptcy judge may hear and determine such matters. 28 U.S.C. § 157(b)(1). As to the latter, the bankruptcy judge may hear the matters, but may not decide them without the consent of the parties. 28 U.S.C. §§ 157(b)(1), (c). Instead, the bankruptcy court must "submit proposed findings of fact and conclusions of law to the district court, and any final order or judgment shall be entered by the district judge after considering the bankruptcy judge's proposed findings and conclusions and after reviewing de novo those matters to which any party has timely and specifically objected." 28 U.S.C. § 157(c)(1).
In addition to the foregoing considerations, the bankruptcy court must also have constitutional authority to hear and determine a matter. See Stern v. Marshall, 564 U.S. 462, 131 S.Ct. 2594, 180 L.Ed.2d 475 (2011). Constitutional authority exists when a matter originates under the Bankruptcy Code or, in noncore matters, where the matter is either one that falls within the public rights exception, id., or where the parties have consented, either expressly or impliedly, to the bankruptcy court hearing and determining the matter. See Wellness Int'l Network, Ltd. v. Sharif, ___ U.S. ___, 135 S.Ct. 1932, 1947, 191 L.Ed.2d 911 (2015) (parties may consent expressly or impliedly to a bankruptcy court's jurisdiction); Richer v. Morehead, 798 F.3d 487, 490 (7th Cir. 2015) (noting that "implied consent is good enough").
In the Response to Plaintiff's Motion for a Preliminary Injunction [Adv. Dkt. No. 13] (the "
As noted by this court in Wisenbaker shortly after the Stern decision was issued, Stern objections have become a form over substantive devise used by "strategic-minded defendants who have sought to use Stern to prolong and/or obfuscate litigation." Id. (full internal citation omitted). Like most Stern challenges of this nature, Joseph cites no statute, case or rule that supports his position, nor does he clarify whether his is a challenge to this court's jurisdiction, statutory authority or constitutional authority.
The court finds Joseph's Stern challenge to be disingenuous at best and legally deficient at worst. Joseph commenced this bankruptcy case, putting all of his affairs—including contractual disputes—before the court. Joseph scheduled Aire Serv as a creditor and noted the nature of the debt as a lawsuit. Official Form 106E/F, Creditors Who Have Unsecured Claims at 4.1 (contained in Official Form 101, Voluntary Petition for Individuals Filing for Bankruptcy [Case No. 19bk06272, Dkt. No. 1] (the "
It is also legally deficient. Recent amendments to the Federal Rules of Bankruptcy Procedure (the "
Joseph's Response is neither a responsive pleading nor a motion under Civil Rule 12(b). As such, his defense is waived, Fed. R. Civ. P. 12(h); Trs. of Cent. Laborers' Welfare Fund v. Lowery, 924 F.2d 731, 732 (7th Cir. 1991), and he has impliedly consented to the entry of final orders by the court in this adversary proceeding. Wellness, 135 S. Ct. at 1944-47 (2015) (implied consent constitutionally sufficient for entry of final orders by bankruptcy court), remanded to 617 F. App'x 589, 590 (7th Cir. 2015) (failure by a party to properly raise its lack of consent according to applicable rules forfeited the point); Richer, 798 F.3d at 490. Aire Serv has, of course, by invoking this court's jurisdiction by filing the Amended Complaint, also consented to the entry of final orders.
The court has original but not exclusive jurisdiction over this matter under 28 U.S.C. § 1334(b) as a matter arising in or related to a case under the Bankruptcy Code. Further, the court has statutory authority to hear the matter under 28 U.S.C. § 157(b)(1) as a matter that affects the administration of Joseph's bankruptcy estate and claim against the bankruptcy estate. 28 U.S.C. §§ 157(b)(2)(A), (B). Finally, as noted above, the parties have waived objections to or impliedly or explicitly consented to this court's constitutional authority over the matter.
The court therefore concludes that resolution of the matters presented herein is
In addition to reviewing the Amended Complaint, the Motion and the Response, and any and all exhibits submitted in conjunction therewith, the court has considered the arguments of the parties at the hearing held on July 18, 2019 (the "
The court has taken into consideration any and all exhibits submitted in conjunction with the foregoing. Though these items do not constitute an exhaustive list of the filings in this adversary proceeding, the court has taken judicial notice of the contents of the docket in this case. See Levine v. Egidi, Case No. 93C188, 1993 WL 69146, at *2 (N.D. Ill. Mar. 8, 1993) (authorizing a bankruptcy court to take judicial notice of its own docket); In re Brent, 458 B.R. 444, 455 n.5 (Bankr. N.D. Ill. 1989) (Goldgar, J.) (recognizing same).
Having conducted such review, this Memorandum Decision constitutes the court's determination of the Motion.
The matter before the court arises from a failed franchise relationship, the resulting litigation and certain related prepetition and postpetition events described in Parts A and B below. Certain relevant terms of the agreement governing the franchise arrangement are reproduced and discussed in Part C below. Unless noted otherwise, neither party appears to dispute the following factual underpinnings of the Amended Complaint and the Motion.
From 2002 to 2017, Joseph and his business associate Earl D. Stoxstell ("
The Franchise Agreement, among other things, allowed JSR to use Aire Serv's systems, marks and other business assets to operate an HVAC-repair business in a territory covering portions of Cook, Will and Kankakee Counties in exchange for certain fees and various nonmonetary obligations. See generally Franchise Agreement, at pp. 1-16; id., Exh. 1C (defining the franchise territory). The Franchise Agreement contains a guaranty promise whereby Joseph and Earl agreed to be bound by the same terms as JSR under the Franchise Agreement. Franchise
On August 29, 2017, Aire Serv terminated the franchise relationship, stating that JSR had failed to timely comply with certain audit obligations and had defaulted on royalty payments under the Franchise Agreement. Mot., Exhs. B-G [Adv. Dkt. Nos. 6-2 to 6-7] (correspondence from the initiation of the audit to the termination of the franchise); Am. Compl., at pp. 7-9; Mot., at pp. 4-5. After the termination of the franchise relationship, JSR, and later Joseph individually, have allegedly continued to operate an HVAC-repair business within the former franchise territory in violation of certain covenants not to compete in the Franchise Agreement and the Confidentiality Agreements. Am. Compl., at pp. 9-10; Mot., at pp. 5-7.
On September 28, 2018, over a year after the termination of the franchise arrangement, Aire Serv filed a suit
After the resolution of the Prepetition Suit and the dismissal of the Prior Case, Aire Serv conducted a "sting" operation to determine whether Joseph was operating a competing business within the former franchise territory in violation of the covenants not to compete. See Am. Compl., at pp. 9-10; Mot., at pp. 6-7. According to Aire Serv, that investigation, conducted on February 21, 2019, revealed that Joseph was apparently still operating a competing HVAC-repair business within the former franchise territory. Dotson Aff., at ¶¶ 2-13; see also Am. Compl., at pp. 9-10; Mot., at
On March 8, 2019 (the "
Thereafter, on March 28, 2019, Aire Serv commenced this adversary proceeding against the Debtors by filing a complaint adapted from the complaint from the Prepetition Suit for use in this adversary proceeding. Compare Compl. and Am. Compl. with Complaint [Prepetition Suit, Dkt. No. 1].
A few weeks after filing the Amended Complaint, Aire Serv brought the Motion now before the court. The Motion seeks a preliminary injunction, without having first sought a temporary restraining order, against Joseph alone, to restrain him from operating his HVAC-repair business while this adversary proceeding is pending. Mot., at pp. 1, 8-9. The Motion generally contains the same factual allegations as the Amended Complaint and relies on the prepetition, February 21, 2019 sting operation as evidence that Joseph is continuing to operate his HVAC-repair business within the former franchise territory postpetition. Compare Mot., at pp. 2-7 with Am. Compl., at pp. 4-10. Aire Serv asserts that a preliminary injunction is warranted because: Aire Serv will likely succeed on the merits, i.e., will likely obtain the permanent injunction sought in the Amended
For evidentiary support, the Motion relies mainly on a missing affidavit abbreviated as the "Truett Aff." in citations thereto in the Motion. See, e.g., Mot., at p. 2. No such affidavit was attached to the Motion or otherwise filed in this adversary proceeding, though Aire Serv did later file a different affidavit, the Dotson Affidavit, with the Reply.
In the Response, Joseph has conceded generally that he is continuing to operate an HVAC-repair business postpetition, that the covenant not to compete in the Franchise Agreement is valid and enforceable against Joseph and that Joseph is likely in violation of such covenant. Resp., at p. 5. Joseph contends, however, that Aire Serv cannot show the requisite likelihood of success on the merits of its claims because Aire Serv's alleged right to equitable relief of any kind under the Agreements against Joseph is a claim against Joseph's bankruptcy estate pursuant to 11 U.S.C. § 101(5)(B), as governed by In re Udell, 18 F.3d 403 (7th Cir. 1994). Resp., at pp. 3-4. According to Joseph, that means that Aire Serv must now assert any right to equitable relief against Joseph (or Dorothy) not in an adversary proceeding or other plenary suit, which Joseph appears to contend would violate the automatic stay, but instead via a proof of claim and the claims allowance process in the Main Case, i.e., in the same manner Aire Serv may seek to collect postpetition on any damages claim it may have against the Debtors. See id. In particular, Joseph points to a liquidated damages provision in the Franchise Agreement's covenant not to compete that allegedly provides an alternate damages remedy to the injunctive relief sought by Aire Serv. Id. Joseph also argues that applicable nonbankruptcy law would allow for an award of money damages as alternative to an injunction on the facts of the Amended Complaint. Id.
Joseph asserts in the alternative that even if Aire Serv does not have a claim against Joseph on account of its alleged right to equitable relief, and even though Joseph agrees he is currently violating the Franchise Agreement's covenant not to compete, Aire Serv has failed to show irreparable harm pendente lite and the lack of an adequate legal remedy. See id. at pp. 5-6. Specifically, Joseph argues that Aire
After an initial round of briefing, which included the grant of an extension of time requested by Aire Serv, the court held the Hearing, at which counsel for the parties appeared and presented oral argument. See Order [Adv. Dkt. No. 11] (order entered May 2, 2019 after first hearing on the Motion setting a briefing scheduling with oral argument on June 13, 2019); Plaintiff's Motion to Extend Time [Adv. Dkt. No. 15]; Order Granting Plaintiff's Motion for Extension of Time [Adv. Dkt. No. 21]. The Hearing focused on whether Aire Serv must pursue its claims for equitable relief against Joseph in the Main Case. The court also questioned counsel for Aire Serv regarding, inter alia, the timing of the two-year term of the covenants not to compete and whether that term would run on August 29, 2019, two years from the date of the termination of the franchise relationship under the Franchise Agreement. In response, the parties sought and the court allowed a supplemental round of briefing on tolling the term of the covenants not to compete. Order [Adv. Dkt. No. 25].
In the Supplemental Reply, Aire Serv argues that the language of the covenants not to compete in the Franchise Agreement and the Confidentiality Agreement, or in the alternative applicable nonbankruptcy law, enables the tolling of extension of the term of the such covenants. See Supp. Reply, at pp. 1-4. Joseph asserts in response that the language in the Franchise Agreement's covenant not to compete is ambiguous at best on tolling, that the Confidentiality Agreement applies only to Dorothy and not Joseph and that tolling would not be equitable here as Aire Serv waited over a year to bring suit and was the cause of much of the delay in this adversary proceeding. See Supp. Resp., at pp. 1-3.
Following the Hearing, the court took the matter under advisement, pending receipt of the supplement briefs, with a status on August 22, 2019 and a written opinion to follow. With the timely submission of the supplemental briefing and the oral argument held at the Hearing, the matter is now fully briefed and argued.
The Franchise Agreement's covenant not to compete, contained in section 9 of the Franchise Agreement, provides in pertinent part as follows:
Franchise Agreement, at pp. 18-20.
The Guaranty in the Franchise Agreement provides as follows:
Franchise Agreement, at p. 36.
The Confidentiality Agreement contains the following covenant not to compete, in pertinent part:
Confidentiality Agreement, at p. 2.
Below, in Part A, the court first discusses the standards on a preliminary injunction and the law applicable to the interpretation and application of the Agreements. After having done so, the court then considers whether such standards are met with respect to the covenant not to compete
As to the Franchise Agreement's covenant not to compete, the court in Part B examines whether Aire Serv is likely to succeed on the merits to obtain specific performance of such covenant. The court first takes up the gating question of whether the term of such covenant, which has already expired, can be extended. Aire Serv would face considerable difficulty at trial in extending such covenant's term, but given the complexities involved in the extension analysis, the court examines whether Aire Serv has otherwise established that it is likely to succeed on the merits under such covenant. Aire Serv has not so established, as its claims under such covenant constitute a claim under 11 U.S.C. § 101(5) that must be asserted in the Main Case and not by way of an adversary proceeding.
With respect to the Confidentiality Agreement's covenant not to compete, as set forth in Part C, Aire Serv has also failed to establish a likelihood of success on the merits, but for a different reason than the covenant not to compete in the Franchise Agreement. The Confidentiality Agreement's covenant not to compete does not apply to Joseph, but rather only to Dorothy. Only Joseph is a defendant in this adversary proceeding. Aire Serv therefore has no claim under the Confidentially Agreement's covenant not to compete against the only defendant named in the Amended Complaint.
Finally, Aire Serv also has not met its burden to show irreparable harm pendente lite in the absence of a preliminary injunction and the inadequacy of its legal remedies, for the reasons set forth below, in Part D. Accordingly, the Motion is not well taken with respect to the Franchise Agreement's covenant not to compete and the Confidentiality Agreement's covenant not to compete.
"A preliminary injunction is an extraordinary remedy that is only granted where there is a clear showing of need." Cooper v. Salazar, 196 F.3d 809, 813 (7th Cir. 1999) (citing Mazurek v. Armstrong, 520 U.S. 968, 972, 117 S.Ct. 1865, 138 L.Ed.2d 162 (1997)).
To determine whether a preliminary injunction should be granted, courts consider five factors. Roland Mach. Co. v. Dresser Indus., Inc., 749 F.2d 380, 385-88 (7th Cir. 1984). A plaintiff bears the initial burden on the first three factors, which include: the likelihood of success on the merits of the plaintiff's claims; irreparable harm to the plaintiff if the preliminary injunction is denied; and the lack of any adequate remedy at law. Id. If the threshold showing is made by the plaintiff on the first three factors, the burden then shifts to the defendant on the last two: balance of the harm to plaintiffs if the preliminary injunction were wrongfully denied as against the harm to the defendant if the injunction were wrongfully granted; and the impact on persons not directly concerned in the dispute, or the public interest. Id.; see also Platinum Home Mortg. Corp. v. Platinum Fin. Grp., Inc., 149 F.3d 722, 726 (7th Cir. 1998).
In a proceeding for preliminary relief, such as a temporary restraining order or preliminary injunction, the court has discretion to consider hearsay and various other normally-inadmissible materials, documents and statements because the Federal Rules of Evidence apply differently in a proceeding on a motion for a preliminary relief. Univ. of Tex. v. Camenisch, 451 U.S. 390, 395, 101 S.Ct. 1830,
Texas law governs the interpretation and construction of the Franchise Agreement and the Confidentiality Agreement in this adversary proceeding, because the Agreements contain choice of law clauses in favor of Texas. Franchise Agreement, at p. 29; Confidentiality Agreement, at p. 2. These choice of law clauses are enforceable under both Illinois and federal choice of law rules and the parties do not appear to dispute that Texas law is the applicable nonbankruptcy law herein; accordingly, there is no actual conflict of law on the question of whether to enforce the choice of law clauses in the Agreements. Texas law applies to the construction and application of the Agreements in accordance with such choice of law clauses. See Jafari v. Wynn Las Vegas, LLC (In re Jafari), 569 F.3d 644, 649-52 (7th Cir. 2009); Jones v. Bailey (In re Morris), 30 F.3d 1578, 1581-82 (7th Cir. 1994).
Of course, federal law continues to govern questions of bankruptcy law and the standard for granting a preliminary injunction under Civil Rule 65, as made applicable by Bankruptcy Rule 7065.
To decide whether preliminary injunctive relief is warranted with respect to the Franchise Agreement's covenant not to compete, the court must first determine whether Aire Serv is likely to succeed on the merits of its claim for specific performance of such covenant.
As discussed above, following the Hearing on the Motion, the court ordered supplemental briefing, as the express term of such covenant appeared on its face to expire in short order. The Franchise Agreement provides that the term of its covenant not to compete will be: "for a period of two (2) years immediately following the later of the expiration, termination or non-renewal of this Agreement for any reason whatsoever or the date on which Franchisee actually ceases operation of the business[.]" Franchise Agreement, at p. 19 (emphasis added). Aire Serv terminated the franchise relationship on August 29, 2017. Mot., Exh. G [Adv. Dkt. No. 6-7]. As such, but for the italicized language, it appears that the term of the Franchise Agreement's covenant not to compete has now expired. Such term expired on August 29, 2019, two years from the date of the termination of the franchise relationship, unless the italicized portion of the quoted language applies to the facts in the
The italicized portion of the quoted language appears to effect some sort of tolling, but is ambiguous. Does the italicized language mean (a) the date on which JSR (and Joseph, the only defendant in the Amended Complaint) actually stop operating a business as Aire Serv's franchisee, which date as a practical matter may not correspond precisely with the date of the termination of the franchise relationship under and according to the Franchise Agreement, or (b) the date on which JSR (and Joseph) actually stop operating a competing business in violation of the covenant not to compete? The ambiguity can be understood by substituting two defined terms used in the Franchise Agreement for the word "business" in the italicized language above. The term "Franchised Business" is defined to mean a business operating as a franchisee under the Franchise Agreement, while the term "Competitive Business" is defined as a business in competition with Aire Serv or its franchisees, including a former franchisee violating the covenant not to compete. See Franchise Agreement, Exh. 1A, at pp. 1, 5; see also id. at p. 19 (provisions in the covenant not to compete prohibiting participation in or deriving benefit from a "Competitive Business").
The former reading, in which "business" is replaced by the "Franchised Business" or has a similar meaning, would prevent the term of the covenant not to compete from beginning to run earlier than termination if, for example, the termination is due to the improper cessation of operations as a franchisee under the Franchise Agreement (as termination is not made automatic in such cases). See id. at pp. 24-25 (non-exhaustive list of grounds for termination upon notice); see also id. at pp. 23-24 (automatic termination without notice). Such a reading would also arguably toll the covenant not to compete until after a (former) franchisee has finished complying with its short-term post-termination obligations under the Franchise Agreement. See id. at pp. 26-27. Under this reading, however, the tolling language, though likely reasonable, would offer Aire Serv no aid on the present facts.
By contrast, the second option is preferred by Aire Serv because it would effectively extend the term of the covenant not to compete for however long violations thereof continue, including up to such time as Aire Serv may actually obtain a final injunction against further violations, plus two years thereafter. See Supp. Reply, at pp. 1-4. Under this reading, as long as the violations are continuous and ongoing, Aire Serv could wait years to bring suit on the covenant not to compete and at the end of such a lawsuit, obtain a two-year injunction against further violations of such covenant. See id.
While Aire Serv is correct as a general matter that tolling agreements respecting the duration of covenants not to compete can be enforced under Texas law, to be enforceable such a tolling agreement must be reasonable, just as the overall duration of the covenant not to compete must be reasonable. Cent. States Logistics, Inc. v. BOC Trucking, LLC, 573 S.W.3d 269, 276-77 (Tex. Ct. App. 2018); Cardinal Personnel, Inc. v. Schneider, 544 S.W.2d 845, 847-48 (Tex. Civ. App. 1976). "A covenant not to compete that extends for an indeterminable amount of time is not reasonable and, as a result, is not enforceable." Cent. States, 573 S.W.3d at 277 (citing Cardinal Personnel, 544 S.W.2d at 847). In Cardinal Personnel, the covenant not to compete was to last six months after the later of the time employment ended or such time as the former employee stopped violating such covenant. Cardinal Personnel,
Aire Serv reads the language "the date on which Franchisee actually ceases operation of the business" as, in effect, indefinitely tolling the two-year term of the covenant not to compete until such time as Joseph stops violating such covenant, whether on his own or under judicial compulsion. Aire Serv's reading falls squarely within the reasoning of the above cases underlying the rule under Texas law that covenants not to compete whose duration cannot be objectively determined ex ante are unreasonable and therefore unenforceable as written. See Cent. States, 573 S.W.3d at 276-77; Cardinal Personnel, 544 S.W.2d at 847-48.
The Texas case on which Aire Serv heavily relies, Arrow Chem. Corp. v. Pugh, 490 S.W.2d 628, 633 (Tex. Civ. App. 1972), is earlier than those cited above and is not to the contrary. There, an employer and employee had agreed to a covenant not to compete whose term would "be automatically extended for a period of eighteen (18) months from the date on which [the employee] permanently ceases such violation [of the covenant not to compete] or for a period of eighteen (18) months from the date of the entry by a court of competent jurisdiction of a final order . . . enforcing such covenant, whichever period is later." Id. at 630 (quoting the contract) (emphasis added). The court in Arrow Chemical read the quoted language as limiting the term of the covenant not to compete to the later of "eighteen months from the date of the termination of employment or eighteen months from the date of the entry . . . of a final judgment" and held such a term to be reasonable. Id. at 633. The court, however, did not specifically analyze or discuss the italicized portion of the quotation, as such analysis was unnecessary under the facts of that case. The timing of both the events giving rise to the lawsuit and the lawsuit itself apparently removed the need for the former employer to rely on such language to extend the term of the covenant not to compete. See id. at 630-31.
Thus, Aire Serv's reading of the alleged tolling language in the Franchise Agreement's covenant not to compete, which reading would render a portion of the covenant not to compete unenforceable under applicable nonbankruptcy law, would face significant challenges were the matter to proceed to trial.
Aire Serv's purely equitable arguments for extending the term of the covenant not to compete fare no better. Again, Aire Serv is correct as a general matter that at least some Texas courts recognize the possibility of an equitable extension of the term of a covenant not to compete without its own tolling language based on undue delay in litigating a covenant not to compete, ongoing violations of interim equitable relief pendente lite or other similar conduct. See, e.g., Farmer v. Holley, 237 S.W.3d 758, 761 (Tex. Ct. App. 2007) (recognizing the possibility of equitable extensions of covenants not to compete based on continuous and ongoing violations, but declining to grant such an extension after balancing the equities); RenewData Corp. v. Strickler, Case No. 03-95-00273-CV, 2006 WL 504998, at *5 (Tex. Ct. App. Mar. 3, 2006) (recognizing the possibility of equitable extensions of covenants not to compete based on the delay inherent in litigation, but declining to grant such an extension where the party seeking to enforce the covenant not to compete was the main source of the delay); see also Sadler Clinic Ass'n v. Hart, 403 S.W.3d 891, 898-99 (Tex. Ct. App. 2013) (discussing the origin of such equitable extensions in federal case law and noting a potential conflict with one Texas Supreme Court case, but declining to grant such an extension as the facts did not warrant one in any case).
Much of the delay after the Prepetition Suit was filed also appears to have been caused by Aire Serv and does not appear to be the sort of delay inherent to litigation. It is true that Joseph's filing of the Prior Case weeks after Aire Serv brought the Prepetition Suit forced Aire Serv to delay its efforts to enforce the covenants not to compete against Joseph. In the Prepetition Suit, however, as in this adversary proceeding, Aire Serv after commencing litigation did not immediately seek preliminary equitable relief, such as the entry of a temporary restraining order. Further, in the Prior Case, Aire Serv never brought an adversary proceeding or otherwise attempted to pursue Joseph. Aire Serv likewise apparently did not attempt to pursue its legal remedies against Joseph during the month-long gap between the dismissal of the Prior Case and the filing of the Main Case to which the Amended Complaint relates.
Once the Main Case had been filed, Aire Serv waited three weeks before filing the Complaint, even though the Complaint and the Amended Complaint herein are nearly identical to the complaint in the Prepetition Suit. Aire Serv then waited almost three weeks again before bringing the Motion, again without seeking more immediate, preliminary equitable relief. Despite having already filed a similar lawsuit once and having conducted an evidence-gathering investigation during the gap between the Prior Case and the Main Case, Aire Serv simply has not moved quickly in this adversary proceeding in seeking a preliminary injunction. Aire Serv also requested at least one extension of the briefing schedule on the Motion. Further, the Motion, once brought, was filed without the necessary supporting evidence, namely the missing affidavit noted above.
As the court in RenewData noted, where a party seeking to enforce a covenant not to compete waited months before bringing suit and was the source of much, but not all, of the delay in the suit it filed, such facts fit well within the old maxim that one who seeks equity must do equity. RenewData, 2006 WL 504998, at *5. Where a party seeking to enforce a contractual provision like a covenant not to compete does "not diligently pursue its remedies" thereunder, it would be inequitable for the court to extend the enforceability of the contract, at least to the extent the enforcement delays can be fairly attributed to the party seeking enforcement. Id.
Here, while there has been some delay of the sort inherent in litigation, for example, the time originally given for Joseph and Aire Serv to brief the Motion, and this Memorandum Decision has been delayed due to the court's overwhelming caseload, Aire Serv's conduct since the termination of the franchise relationship will make succeeding on this theory at trial very difficult. Given, however, the
In this adversary proceeding, with the exception of the tolling issue discussed above, the question of whether Aire Serv is likely to succeed on the merits under the Franchise Agreement's covenant not to compete does not turn on the usual sorts of nonbankruptcy law issues presented in a suit on such a covenant, such as the validity and enforceability of such a covenant under nonbankruptcy law. Here, Joseph has generally conceded that the Franchise Agreement's covenant not to compete is valid and enforceable under applicable nonbankruptcy law. Resp., at p. 5. Joseph has also conceded that the business he is currently operating "likely violates the [Franchise Agreement's] noncompete agreement and as such [Aire Serv] has a likelihood of success on the merits" of its claims under the Franchise Agreement and applicable nonbankruptcy law. Id. In other words, setting aside the gating question raised by the court regarding the term of the Franchise Agreement's covenant not to compete, Joseph agrees that Aire Serv will likely be able to show that Joseph is in violation of such covenant postpetition. See id.
Nevertheless, despite the above concessions, Joseph contends that the claims asserted by Aire Serv in the Amended Complaint all constitute "claims" within the meaning of section 101(5)(B) of the Bankruptcy Code and that Aire Serv must raise such claims by filing a proof of claim in the underlying bankruptcy case, not via an adversary proceeding. See id. at pp. 2-4. For the reasons set forth more fully below, Aire Serv's claims under the Franchise Agreement's covenant not to compete do constitute claims within the meaning of section 101(5)(B) and Aire Serv is therefore not likely to succeed on the merits of the Amended Complaint.
Section 101(5)(B) of the Bankruptcy Code defines a claim to include a "right to an equitable remedy for breach of performance if such breach gives rise to a right to payment, whether or not such right to an equitable remedy is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or unsecured." 11 U.S.C. § 101(5)(B). The Supreme Court explained that Congress desired the definition of a claim under section 101(5) to apply broadly. Ohio v. Kovacs, 469 U.S. 274, 279, 105 S.Ct. 705, 83 L.Ed.2d 649 (1985); see also, e.g., In re Kimball Hill, Inc., 565 B.R. 878, 896 (Bankr. N.D. Ill. 2017) (Barnes, J.) (definition of claim under section 101(5) is "very broad"). At issue in Kovacs was whether the state of Ohio had a claim under the Bankruptcy Code based on an obligation owed to the state for the clean-up
The Seventh Circuit has specifically addressed whether a right to injunctive relief to enforce a covenant not to compete constitutes a claim in In re Udell, 18 F.3d 403 (7th Cir. 1994). See also Kennedy v. Medicap Pharmacies, Inc., 267 F.3d 493, 495-98 (6th Cir. 2001) (following Udell). There, guided by Kovacs, the Seventh Circuit held that the right to a prospective injunction to enforce a covenant not to compete was not a claim under section 101(5)(B) and could thus be enforced prospectively in a postpetition adversary proceeding against the debtor where the covenant not to compete at-issue provided for capped liquidated damages of $25,000 in addition to a right to seek equitable relief. Udell, 18 F.3d at 406-09.
The Udell decision turned on just that, that the covenant not to compete gave rise to a right to specific performance and damages. Id. The court reasoned that a right to an equitable remedy constitutes a claim under section 101(5)(B) where performance or payment could be sought based on the same breach that gives rise to the equitable right, but not both. Id. at 407.
Udell is based in large part on the Seventh Circuit's reading of the express language of section 101(5)(B) itself, which defines a claim in this instance as a "right to an equitable remedy for breach of performance if such breach gives rise to a right to payment." 11 U.S.C. § 101(5)(B). The Seventh Circuit's conceptualization of concordant versus mutually exclusive remedies is not, however, found anywhere in the statute and Udell has been criticized for just this reason. See, e.g., Daniel J. Bussel, Doing Equity in Bankruptcy, 34 Emory Bankr. Dev. J. 13, 42-44 (2017) (discussing the main criticism of Udell, outlining the competing view of section 101(5)(B) and collecting cases); see also Udell, 18 F.3d at 412 (the concurring opinion in Udell).
Udell involved the following remedial provision in a covenant not to compete: "In the event of [the debtor]'s actual or threatened breach of the provisions of this [covenant], [his employer] shall be entitled to an injunction restraining [him] as well as reimbursement for reasonably [sic] attorneys fees incurred in securing said judgment and stipulated damages in the sum of $25,000.00." Udell v. Standard Carpetland USA, Inc., 149 B.R. 908, 909 (N.D. Ind. 1993) (quoting the contract) (internal quotation marks omitted), rev'd sub nom. In re Udell, 18 F.3d 403 (7th Cir. 1994). The Seventh Circuit read the above provision as establishing a right to liquidated damages that was cumulative to and coexisted with the right to an injunction thereunder. Udell, 18 F.3d at 407-09. The injunction covered threatened future violations of the covenant not to compete, but separate from that right to equitable relief, the employer was also entitled to receive a predetermined amount of money damages. Id. Accordingly, the right to the injunction was not a claim under the Bankruptcy Code because the right to payment arising from the same breach was not an alternate remedy to the injunction, but independent from and cumulative with the right to equitable relief. Id.
Thus, under Udell the right to an equitable remedy to enforce a covenant not to compete constitutes a claim under section
Here, the covenant not to compete in the Franchise Agreement expressly provides for liquidated damages only as an alternative remedy to injunctive relief and thus Aire Serv's right to injunctive relief constitutes a claim under section 101(5)(B) and the reasoning in Udell. Specifically, the liquidated damages provision in the Franchise Agreement's covenant not to compete provides that "[i]f Franchisor establishes that Franchisee has violated the material terms of this Section 9 [the covenant not to compete] and such provisions are not enforceable by equitable relief for any reason, Franchisee agrees that Franchisor will incur certain damages. . . ." Franchise Agreement, at p. 20. This language makes monetary damages an alternative to equitable relief to enforce the covenant not to compete.
The structure of the liquidated damages provision in Udell, as compared to the one here, further illustrates the difference. In Udell, the applicable liquidated damages were clearly not calculated as recompense for the breach as a whole. Udell, 18 F.3d at 409. In contrast, the covenant not to compete in the Franchise Agreement here is just as clearly structured with liquidated damages designed to compensate for the entire breach. The Franchise Agreement states that "in such event, Franchisee shall pay to Franchisor, as liquidated damages and not as a penalty, a sum of money equal to 104 times the largest weekly License Fee paid . . . during the term of th[e Franchise] Agreement." Franchise Agreement, at p. 20.
The amount of liquidated damages under the Franchise Agreement is calculated as the product of two factors: first, 104—the number of weeks in two years which is the term of the covenant not to compete; and second, the largest weekly fee actually paid by JSR to Aire Serv during the term of the franchise, which fee is calculated as a percentage of gross receipts. See id., Exh. 1A, at p. 3 (defining license fee). The formula, based on the length of the covenant not to compete and historical data regarding licensing fees paid to Aire Serv during the franchise term, appears intended to provide a reasonable forecast of damages to compensate Aire Serv for losses incurred over the term of the covenant not to compete if Aire Serv cannot obtain equitable relief. Such differences in the calculation and amount of liquidated damages further confirm what the contractual language expressly states—that Aire Serv's right to monetary relief under the Franchise Agreement—the liquidated damages—is not cumulative with, but rather is an alternative to, the right to equitable relief thereunder.
The Udell standard remains, to this day, the standard for considering whether a covenant not to compete is a claim in bankruptcy—both inside and outside of this Circuit. See, e.g., In re Gacharna, 480 B.R. 909, 911-13 (Bankr. N.D. Ill. 2012) (Cox, J.) (applying Udell and holding that the right to specific performance of a covenant not to compete was not a claim where the agreement did not provide for an alternate damages remedy for the breach of such covenant); Outdoor Media Grp., Inc. v. Love (In re Love), Case No. 00-83615, 2001 WL 34076354, at *4-5 (Bankr. C.D. Ill. Mar. 9, 2001) (similar); see also, e.g., MCS Acquisition Corp. v. Gilpin (In re Gilpin), Case No. 07-8031, 2008 WL 2787520, at *4-5 (6th Cir. B.A.P. July 17, 2008) (collecting cases); Kennedy, 267 F.3d at 495-98. That is the case despite the considerable criticism of Udell noted above. Bussel, supra, at 42-44; see also,
That being stated, the court notes that more recent decisions from the Seventh Circuit, in accord with some cases from outside this Circuit, seemed to adopt just such a more expansive view. See, e.g., In re LaMont, 740 F.3d 397, 408 n.15, 409 (7th Cir. 2014) (citing Udell but holding that the right to equitable relief held by a tax purchaser under the Illinois tax sale scheme was a claim because such tax purchaser also had right to payment that was cumulative with, not an alternative to, its right to equitable relief). Under the reasoning set forth in LaMont as extrapolated to the question presented here, covenants not to compete would be considered claims if there existed also a right to liquidated damages, whether or not the rights were concordant or mutually exclusive.
Whether it be on under the narrower conceptualization of claims in Udell or the broader one in Kovacs, LaMont, Rederford and Continental Airlines, what is clear is that in bankruptcy, the Franchise Agreement's covenant not to compete gives rise to a claim, not a right of specific enforcement. As Aire Serv has an alternate right to money damages to enforce the covenant not to compete in the Franchise Agreement, the injunctive relief Aire Serv seeks for Joseph's alleged violation of such covenant is a claim under the Udell and Aire Serv must pursue such equitable relief as a claim in the Main Case, not in this adversary proceeding.
As Aire Serv has an alternate right to money damages to enforce the covenant not to compete in the Franchise Agreement, the injunctive relief Aire Serv seeks for Joseph's alleged violation of such covenant not to compete is a claim under the Bankruptcy Code and Aire Serv must pursue such claim for equitable relief in the Main Case, not through the Amended Complaint in an adversary proceeding.
Aire Serv has also brought suit against Joseph on the covenant not to compete in the Confidentiality Agreement, see Am. Compl., at pp. 10-13, but that covenant not to compete differs in material respects from the covenant not to compete in the Franchise Agreement. Compare Franchise Agreement, at p. 20 with Confidentiality Agreement, at p. 2. For example, the covenant not to compete in the Confidentiality Agreement does not contain any liquidated damages provision and does not expressly incorporate the liquidated damages provision in the Franchise Agreement's covenant not to compete. See Confidentiality Agreement, at p. 2.
Aire Serv also cannot succeed on this theory, however, for an entirely different reason.
In construing a written contract, the court must ascertain the intentions
The language used by the parties in the Confidentiality Agreement provides in pertinent part that "for a period of two (2) years . . . Associate shall not . . . own, maintain, operate, or engage or participate in, or have any financial interest . . . in any. . . entity which engages in any business which is the same or similar to the Franchise[] or is otherwise in competition with the business of Franchisor or Franchisor's geographical area. . . ." Confidentiality Agreement, at p. 2 (emphasis added). The Confidentiality Agreement defines "Associate" to mean Dorothy and uses "Franchisee" as the defined term for Joseph. Id. at p. 1. Thus, the operative language of the Confidentiality Agreement's covenant not to compete applies only to Dorothy (Associate) and does not impose any duties or obligations on Joseph (Franchisee). The triggering language in the Confidentiality Agreement's covenant not to compete further reinforces this reading by providing that the covenant not to compete will come into effect on "the earlier of the termination of the Franchise Agreement or the date on which Associate [Dorothy] ceases to be associated with Franchisee [Joseph]. . ., whether because of the later to occur of a termination of an employment arrangement or marriage. . . ." Id. at p. 2.
Looking at these provisions in the context of the entire Confidentiality Agreement, these provisions fair no better. The other operative provisions therein besides the covenant not to compete all appear to impose duties on Dorothy individually and give rights to Aire Serv with respect to Dorothy alone. See, e.g., id. at p. 1 (providing that "Associate hereby agrees to be bound by [certain] provisions of the Franchise Agreement[,]" "Associate agrees not to use Confidential Information[,]" and "Associate agrees not to disclose, communicate or divulge any Confidential Information for Associate's benefit or for the benefit of any other third party. . . .").
Finally, the Confidentiality Agreement was but one contract in a group of many executed together as part of the renewal of the franchise relationship underlying the Amended Complaint and the Confidentiality Agreement therefore must be read and understood in the context of all the documents governing the transaction. In addition to the Confidentiality Agreement under which Aire Serv has sued Joseph, there was a second, extremely similar confidentiality agreement executed by Mary, the wife of Joseph's business associate Earl, governing her relationship with Aire Serv, but not imposing new or different duties or obligations on Earl himself. See Franchise Agreement, Exh. 7B. The second confidentiality agreement contains the same operative language discussed above and appears to apply to Mary in the same manner the Confidentiality Agreement applies to Dorothy. See id. at pp. 1-2. Moreover, the terms of the Franchise Agreement itself, including the arguably-broader covenant not to compete therein, apply fully both to Joseph and Earl by virtue of the Guaranty. See Franchise Agreement, at p. 36. Reading the Confidentiality Agreement's covenant not to compete to impose a second set of obligations not to compete on Joseph not only would be contrary
Aire Serv has not brought suit against Dorothy and has presented no evidence and made no allegations that Dorothy is violating or has violated the covenant not to compete in the Confidentiality Agreement. As Aire Serv likely does not have a claim or cause of action against Joseph under the Confidentiality Agreement's covenant not to compete, because such covenant by its terms does not apply to Joseph or impose any obligation not to compete on Joseph, Aire Serv is unlikely to succeed on the merits of its claim for a permanent injunction against Joseph to enforce the covenant not to compete in the Confidentiality Agreement.
Aire Serv has, therefore, failed to establish a likelihood of success on the merits of the Amended Complaint under the Confidentiality Agreement's covenant not to compete.
Aire Serv has also failed to submit sufficient evidence to succeed on the remaining two elements on which Aire Serv has the initial burden.
It is true that courts often appear to assume the irreparability of injuries such as the loss of goodwill and other harms typically occasioned by violations of a covenant not to compete, usually based on the difficulty of calculating damages therefor. Nevertheless, for the court to grant a preliminary injunction, the court still needs at least some proof that such harm will occur or continue to occur while the lawsuit pending if no preliminary injunction issues. See, e.g., Mazurek, 520 U.S. at 972, 117 S.Ct. 1865; Camenisch, 451 U.S. at 395, 101 S.Ct. 1830. Mere allegations that a defendant is continuing to engage in particular activity that harms a plaintiff-franchisor, such as the ongoing use of proprietary assets, will not suffice without at least some proof of such harms themselves in addition to evidence of the conduct violating the covenant not to compete. See, e.g., Baskin-Robbins Inc. v. Patel, 264 F.Supp.2d 607, 612 (N.D. Ill. 2003).
Here, Aire Serv's submissions on the elements of irreparable harm and inadequate remedy at law consisted entirely of argument and allegations without any independent evidence that the ongoing violation of the covenants not to compete by Joseph would result in the sorts of harms alleged while this adversary proceeding remains pending. See Mot., at pp. 11-13. In particular, Aire Serv failed to submit the missing Truett affidavit upon which the Motion relied as evidence of the harms alleged. That failure left Aire Serv with essentially no meaningful evidentiary submissions as to irreparable harm and the inadequacy of legal remedies. The Dotson Affidavit and the remaining documentary evidence related to proving up Joseph's violation of the covenants not to compete or to the breakdown of the franchise relationship before Aire Serv terminated such relationship. Without at least something
Accordingly, Aire Serv has failed to establish that it will suffer irreparable harm pendente lite or that it lacks an adequate remedy at law, in addition to having failed to establish a likelihood of success on the merits under the covenants not to compete in the Franchise Agreement and the Confidentiality Agreement. The Motion is therefore not well taken and the court declines to issue a preliminary injunction in favor of Aire Serv.
Aire Serv has not shown that it is likely to succeed on the merits of the Amended Complaint under either the covenant not to compete in the Franchise Agreement or the covenant not to compete in the Confidentiality Agreement, that it will, without a preliminary injunction, suffer irreparable harm while the Amended Complaint remains is pending or that its legal remedies are inadequate. Accordingly, Aire Serv has not satisfied its initial burden its request for a preliminary injunction.
For all of the foregoing reasons and by separate order entered concurrently herewith, the Motion will be denied and no preliminary injunction will issue.
This matter coming to be heard on the Motion for Preliminary Injunction [Dkt. No. 6] (the "
NOW, THEREFORE, IT IS HEREBY ORDERED THAT:
The Motion is DENIED.
