Business Law 13th Edition by Frank Cross, Kenneth Clarkson, Roger LeRoy Miller

Exercise 14

BACKGROUND AND FACTS?Improv West Associates is the founder of the Improv Comedy Club and owner of the "Improv" trademark. Comedy Club, Inc. (CCI), owns and operates restaurants and comedy clubs. Improv West granted CCI an exclusive license to open four Improv clubs per year in 2001, 2002, and 2003. Their agreement prohibited CCI from opening any non-Improv comedy clubs "in the contiguous United States" until 2019. When CCI failed to open eight clubs by the end of 2002, Improv West commenced arbitration. In 2005, the arbitrator found that CCI had forfeited its right to open Improv clubs but that the parties' agreement had not terminated and the covenant not to compete was enforceable. Therefore, CCI could not open any new comedy clubs for the agreement's duration. A federal district court confirmed the award, and CCI appealed.
IN THE LANGUAGE OF THE COURT
GOULD, Circuit Judge:
* * * * The basic outline of what the arbitrator did, terminating an exclusive right to open Improv clubs nationwide, because of contractually inadequate performance contrary to the agreed schedule, while keeping in force the restrictive covenant makes sense in so far as CCI should not have an exclusive license on Improv clubs absent complying with designated performance. And so long as CCI was running some Improv clubs, a restrictive covenant to some degree could protect Improv West from damage caused by improper competition. Because we cannot say that there is no basis in the record for the arbitrator's decision, we hold that the arbitrator's award is not completely irrational.
CCI's "business" is operating full-service comedy clubs. CCI currently operates at least seven Improv clubs. As interpreted by the arbitrator, the * * * covenant not to compete applies geographically to the contiguous United States, and does not end until 2019. Thus, the covenant not to compete has dramatic geographic and temporal [time-related] scope. Combined with the arbitrator's ruling that CCI forfeited its rights to use the Improv marks license in any new location, the practical effect of the arbitrator's award * * * is that for more than fourteen years the entire contiguous United States comedy club market, except for CCI's current Improv clubs, is off limits to CCI. This forecloses competition in a substantial share of the comedy club business.
* * * * * * * The economic restraint of [this covenant] on competition is too broad to be countenanced [tolerated] * * *. The covenant not to compete must be more narrowly tailored to relate to the areas in which CCI is operating Improv clubs under the license agreement. [Emphasis added.]
However, we do not void the entire * * * covenant not to compete. * * * We weigh CCI's right to operate its business against Improv West's interest to protect and maintain its trademark, trade name and goodwill. This balance tilts in favor of Improv West with regard to counties where CCI is operating an Improv club.
Therefore, we hold that the district court should vacate [set aside] the arbitrator's [award] as to any county where CCI does not currently operate an Improv club, but uphold [the covenant] in those counties where CCI currently operates Improv clubs. Nationwide CCI may open and operate non-Improv comedy clubs in all those counties where it does not currently operate an Improv club. However, CCI may not open or operate any non-Improv clubs in those counties where it currently owns or operates Improv clubs.
DECISION AND REMEDY The federal appellate court reversed part of the lower court's confirmation of the award and remanded the case. A covenant not to compete in the comedy club business for fourteen years in forty-eight states is too broad to be enforced.
The Ethical Dimension Should any companies or subsidiaries affiliated with CCI be subject to the covenant not to compete? Would it be unethical to impose such a requirement? Discuss.
THE LEGAL ENVIRONMENT DIMENSION?Why would a business such as Improv West include a covenant not to compete in an agreement such as the contract at issue in this case? Explain.