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SCOTT v. SNELLING & SNELLING

March 8, 1990

TERRY SCOTT, DAVID E. RAY, LEIGH GARDNER RAY, DAVID R. PRINSZE, SUSAN M. KENNEDY, and EMPLOYEE LEASING ASSOCIATES INC., a California corporation, Plaintiffs,
v.
SNELLING AND SNELLING, INC., a Pennsylvania corporation, Defendant


Eugene F. Lynch, United States District Judge.


The opinion of the court was delivered by: LYNCH

EUGENE F. LYNCH, UNITED STATES DISTRICT JUDGE

 This case involves a dispute arising from the termination of a number of virtually identical franchise agreements for the operation of temporary personnel service (TPS) agencies under the Snelling and Snelling name between the plaintiffs and defendant, *fn1" and the subsequent formation of competing businesses by the plaintiffs. Plaintiffs brought this action upon their termination of the agreements seeking damages for breach of contract, rescission and a declaratory judgment. Snelling counterclaimed, alleging breach of contract and unfair competition; it seeks damages and injunctive relief. The parties have made cross-motions for partial summary judgment on the single issue of whether the covenants restricting competition in the franchise agreements are enforceable against the plaintiffs.

 I. FACTUAL BACKGROUND

 The undisputed facts which gave rise to this case are as follows. In late 1985, plaintiffs David E. Ray, Leigh Gardner Ray and Terry Scott entered into a franchise agreement with Snelling to operate a TPS in Walnut Creek, California, under the Snelling name. The agreement provided, inter alia, for the support services such as training and operating procedure manuals to be provided by Snelling to the plaintiffs, for the terms by which Snelling licensed its proprietary marks to plaintiffs, and for the financial contributions which plaintiffs were required to make to Snelling in return for the license to operate the TPS franchise. The agreement also included the provisions for termination by plaintiffs *fn2" and the covenant by plaintiffs not to compete with another Snelling TPS franchisee in their former franchise area for two years after termination *fn3" which are the subjects of the cross-motions for summary judgment.

 Soon after the completion of the agreement for a Walnut Creek franchise, the same plaintiffs entered into a substantially similar agreement to operate a Snelling TPS franchise in Pleasanton, California. Plaintiff David R. Prinsze also entered into a substantially similar agreement to operate a Snelling TPS franchise in San Jose, California, on May 29, 1987. On July 28, 1988, plaintiff Susan Kennedy joined with Prinsze to form plaintiff Employee Leasing Associates, which took over operation of the San Jose franchise.

 Following some difficulties in the franchise relationship between the parties, plaintiffs sent a letter on July 28, 1989 informing Snelling of the filing of the original complaint in this action as well as their intention to terminate their franchise agreements immediately. The letter also informed Snelling of the plaintiffs' intention to form competing TPS businesses at the locations from which they formerly operated their Snelling TPS franchises.

 After plaintiffs filed an amended complaint, Snelling filed a motion seeking a preliminary injunction prohibiting the operation of the competing TPS agencies by the plaintiffs pursuant to the restrictive covenants in the franchise agreements. On October 5, 1990, the Court granted in part Snelling's motion for a preliminary injunction, requiring plaintiffs to cease use of the Snelling name in competing businesses, to provide Snelling with lists identifying customers and employees, to assign all telephone numbers previously identified as Snelling numbers to Snelling and to allow Snelling to inspect plaintiffs' financial records. The Court did not, however, enjoin the plaintiffs from continuing to operate their competing TPS agencies.

 The plaintiffs have substantially complied with the Court's preliminary injunction order. Now they have brought this partial summary judgment motion seeking a ruling that the restrictive covenant in the franchise agreements is not enforceable. Snelling seeks a contrary ruling that the covenants are enforceable by cross-motion for partial summary judgment.

 II. STANDARD FOR SUMMARY JUDGMENT

 Federal Rule of Civil Procedure 56(c) provides that a motion for summary judgment shall be granted if the moving party establishes the absence of any genuine issue of material fact which would preclude a ruling by the Court on the motion as a matter of law. Such a showing can be made by an affirmative demonstration in affidavits or declarations by a moving party who bears the burden of proof on the controverted issue at trial. However, in a circumstance where the nonmoving party with the burden of proof fails to come forward with any evidence which would create a genuine issue of material fact, summary judgment for the moving party is appropriate. Celotex Corp. v. Catrett, 477 U.S. 317, 323-24, 106 S. Ct. 2548, 91 L. Ed. 2d 265 (1986); Cal. Architectural Bldg. Prod., Inc. v. Franciscan Ceramics, 818 F.2d 1466, 1468 (9th Cir. 1987). In addition, a determination of the legal effect of the plain language of a contract where the intention of the parties is not in dispute is a question of law well suited to a grant of summary judgment. Edison v. Reliable Ins. Co., 664 F.2d 1130, 1131 (9th Cir. 1981).

 Here, the validity of the restrictive covenant in the franchise agreements is a question of law. Thus, the allocation of burdens of proof is irrelevant, for the most part, to the decision whether to grant summary judgment on the issue. This statement should be qualified by the recognition that, under California law, *fn4" a covenant restraining competition will be enforced when the subsequent competition constitutes unfair competition, such as the unauthorized use of trade secrets or confidential information. See, e.g., American Paper & Packaging Products, Inc. v. Kirgan, 183 Cal.App.3d 1318, 228 Cal. Rptr. 713 (1986); Moss, Adams & Co. v. Shilling, 179 Cal.App.3d 124, 224 Cal. Rptr. 456 (1986). The determination of whether a particular type of information is confidential or a trade secret would generally be a question of fact, with the party asserting the existence of a trade secret bearing the burden of proof. Tele-Count Engineers, Inc. v. Pacific Tel. & Tel. Co., 168 Cal.App. 3d 455, 463, 214 Cal. Rptr. 276 (1985). As such, as discussed below, Snelling would bear the burden of proof on this issue at trial as the party asserting the existence of a trade secret.

 III. DISCUSSION

 Plaintiffs make essentially two arguments in support of their position that the covenant restraining competition in the franchise agreements is unenforceable. First, they contend that Snelling is collaterally estopped from claiming that the covenant is valid after having lost on the issue in a previous arbitration based on a similar contract to which Snelling was a party. In the alternative, they assert that California law should govern the determination of the validity of the covenant not to compete and that under California law the covenant is invalid. Each of these contentions will be considered in turn.

 A. COLLATERAL ESTOPPEL

 On October 30, 1989, an arbitrator declared that a covenant restraining competition in a franchise agreement between Snelling and another party was unenforceable. *fn5" Plaintiff asserts that this arbitration result compels this Court similarly to declare the covenant between Snelling and the plaintiffs unenforceable. This is essentially an assertion of the doctrine of non-mutual defensive collateral estoppel, wherein a litigant not a party to a prior case seeks to preclude relitigation of an issue by its current opponent who was a party to the prior case and lost on the very issue which the opponent seeks to relitigate in the current action. Blonder-Tongue Laboratories v. Univ. of Illinois, 402 U.S. 313, 91 S. Ct. 1434, 28 L. Ed. 2d 788 (1971).

 In order to prevail on an assertion of non-mutual defensive collateral estoppel, plaintiffs must show that:

 
1) the issue decided in a prior adjudication is identical with that presented in the action in question; and 2) there was a final judgment on the merits; and 3) the party against whom the plea is asserted was a party or in privity with a party to the prior adjudication.

 Clemmer v. Hartford Ins. Co., 22 Cal.3d 865, 874, 587 P.2d 1098 (1978) (emphasis in original). *fn6" Under this standard, the plaintiffs' ...


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