Plain language provides that a “distribution contract” includes the relationship established to distribute merchandise or provide a service by means of a “concession” or a “franchise” in the Puerto Rico market. 10 L.P.R.A. Sec. 278(b). It is plain that Law 75 applies to a franchise agreement.
But does Law 75 regulate the enforceability of contractual provisions in a franchise agreement without the triggering event of a termination or impairment or where Law 75 is silent on the issue?
At least with respect to a non-compete obligation in a franchise agreement, the answer is No. In Franquicias Martin’s BBQ v. Garcia de Gracia, 2010 TSPR 71 (P.R. May 10, 2010), the Supreme Court of Puerto Rico invalidated a non-compete provision in a franchise agreement, not under Law 75, but applying the Civil Code. The Civil Code provides that agreements are enforceable on their terms unless contrary to good faith, "morals" or public policy. Finding no provision in Law 75 that regulates the validity of a non-compete agreement, and suggesting that Law 75’s public policy is not implicated without an unjustified termination of the agreement, the court turned to the Civil Code, which is the primary source of law.
In the opinion, the court relegated Law 75 to a footnote (n. 10): “Law 75 of June 24, 1964, as amended, 10 L.P.R.A. Sec. 278, is limited to regulating the termination or non-renewal of a distribution contract without just cause, and is applicable to those persons that fit within the imprecise definition of a distributor.” (translation ours).
The court could not have meant that Law 75 does not apply to franchise agreements because the statutory definition of distributor is “imprecise”. After all, plain language in Law 75 includes a franchise relationship within the definition of a distribution contract.
What the court does suggest is that Law 75 does not come into play merely because a distribution or franchise agreement is at issue in the case. The court’s opinion suggests that Law 75 would not apply where: 1) the agreement has not been impaired or terminated without just cause, or 2) there is no provision in Law 75 specifically governing the legality of the contested provision at issue (in that case, the non-compete obligation).
Thus, for example and consistent with existing case law, a provision in a distribution agreement allowing the unilateral or automatic termination, non-renewal, or expiration of the agreement clashes with the specific provision in Law 75 expressly requiring just cause. Law 75 would apply in that situation as the contractual provision violates the statute and public policy requiring just cause.
On the other hand, the court’s opinion leaves room for argument that, where Law 75 does not specifically “preempt” or “regulate” the provision at issue in a franchise or distribution agreement, Law 75’s public policy is not at stake simply because there has been an unjustified termination, impairment or non-renewal of the agreement. Thus, in that scenario, the Civil Code remains the primary legal source to determine the enforceability of a contractual provision that is not specifically governed by Law 75. A narrow exception may be an arbitration provision which is governed solely and preempted by the Federal Arbitration Act and the Supremacy Clause although Law 75 regulates the enforcement of arbitration clauses in distribution contracts.
Applying the Civil Code may have important repercussions on the outcome of a franchise or distribution dispute. The Civil Code presumes both the existence of good faith and the validity of contractual obligations. The burden of proof is on the party challenging the enforcement of a contract.
It remains to be seen how far the court's footnote goes in determining the rule of decision in franchising and distribution issues under Law 75.
Showing posts with label non-compete; Law 75 contracts. Show all posts
Showing posts with label non-compete; Law 75 contracts. Show all posts
Thursday, July 1, 2010
Friday, June 25, 2010
Whether a non-compete obligation in a franchise agreement is enforceable under Puerto Rico law depends on the reasonableness of the restriction as applied to the facts of each case.
In Franquicias Martin’s BBQ Inc. v. Luis Garcia de Gracia, No. 2009-0410 (P.R. May 10, 2010), the Supreme Court of Puerto Rico considered the validity of a non-compete provision in the context of a franchise agreement.
The court determined that Puerto Rico Law 75, which regulates distribution and franchise relationships from unjustified terminations, did not specify the norms by which to determine the validity of a non-compete obligation. Nor does Law 75 invalidate per se a non-compete obligation. For guidance, the court turned to the Civil Code’s general precept that contractual obligations are enforceable unless contrary to public policy. Finding no statutory prohibition against the enforcement of non-compete obligations, the court adopted the criteria to validate a non-compete in employment relationships.
The court set forth a four-part test to determine the validity of a non-compete obligation in a franchise agreement. First, does the franchisor have a legitimate interest in the non-compete obligation, so that its business would be substantially affected without the restriction? A relevant factor is the employee’s position and his or her ability to be able to compete against the employer in the future. Second, the scope of the restriction must be reasonable in terms of the employer’s interests, the object, place, time and clients affected. The object must be limited to activities “similar” to those carried out by the employer. Third, the term of the restriction should not exceed 12 months. When the restriction applies to a geographic area, it must be limited to that strictly necessary to prevent “real competition” with the employer. When the restriction limits the scope of clients, it must be to those that the employee serviced personally and were clients of the employer before the employee’s resignation or termination. Finally, the employer must offer some consideration as a quid pro quo for the non-compete.
On the facts of the case, the franchisor, a rotisserie-style fast food restaurant chain, established a reasonable restriction of two years (it was not per se illegal to exceed the 12 month limitation) and limited the sale of products to those “similar” to the rotisserie chicken sold by the employer. It was unreasonable, however, as the non-compete prohibited the operation of a similar business within ten miles of any restaurant of the franchisor when the employee’s competing restaurant, established in the same location previously operated by the franchisor, had only a two mile radius of operations. The court did not explain the basis supporting the conclusion that the former employee's restaurant had a two mile radius of operations. In any event, the court determined that the prohibition in the contract was on its face broader than reasonably necessary for its admittedly legitimate purpose, could not be saved, and invalidated the entire non-compete agreement as contrary to good faith and public policy.
It is debatable whether the court's decision provides certainty and uniformity by which to guide contracting parties in the future or whether it is likely to cause confusion and litigation. Given the factually intensive and variable nature of the inquiry, it is probable that litigation will be both inevitable and costly to enforce a non-compete in a franchise or distribution agreement.
The court determined that Puerto Rico Law 75, which regulates distribution and franchise relationships from unjustified terminations, did not specify the norms by which to determine the validity of a non-compete obligation. Nor does Law 75 invalidate per se a non-compete obligation. For guidance, the court turned to the Civil Code’s general precept that contractual obligations are enforceable unless contrary to public policy. Finding no statutory prohibition against the enforcement of non-compete obligations, the court adopted the criteria to validate a non-compete in employment relationships.
The court set forth a four-part test to determine the validity of a non-compete obligation in a franchise agreement. First, does the franchisor have a legitimate interest in the non-compete obligation, so that its business would be substantially affected without the restriction? A relevant factor is the employee’s position and his or her ability to be able to compete against the employer in the future. Second, the scope of the restriction must be reasonable in terms of the employer’s interests, the object, place, time and clients affected. The object must be limited to activities “similar” to those carried out by the employer. Third, the term of the restriction should not exceed 12 months. When the restriction applies to a geographic area, it must be limited to that strictly necessary to prevent “real competition” with the employer. When the restriction limits the scope of clients, it must be to those that the employee serviced personally and were clients of the employer before the employee’s resignation or termination. Finally, the employer must offer some consideration as a quid pro quo for the non-compete.
On the facts of the case, the franchisor, a rotisserie-style fast food restaurant chain, established a reasonable restriction of two years (it was not per se illegal to exceed the 12 month limitation) and limited the sale of products to those “similar” to the rotisserie chicken sold by the employer. It was unreasonable, however, as the non-compete prohibited the operation of a similar business within ten miles of any restaurant of the franchisor when the employee’s competing restaurant, established in the same location previously operated by the franchisor, had only a two mile radius of operations. The court did not explain the basis supporting the conclusion that the former employee's restaurant had a two mile radius of operations. In any event, the court determined that the prohibition in the contract was on its face broader than reasonably necessary for its admittedly legitimate purpose, could not be saved, and invalidated the entire non-compete agreement as contrary to good faith and public policy.
It is debatable whether the court's decision provides certainty and uniformity by which to guide contracting parties in the future or whether it is likely to cause confusion and litigation. Given the factually intensive and variable nature of the inquiry, it is probable that litigation will be both inevitable and costly to enforce a non-compete in a franchise or distribution agreement.
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