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The courts will permit the equitable enforcement of a covenant not to compete included in a franchise agreement where the restrictions are reasonably necessary for the protection of the franchisor without imposing undue hardship on the franchisee, and the restrictions are reasonably limited as to the duration of time and geographical extent.
Appellee Piercing Pagoda, Inc., was a corporation engaged in the selling of earrings and provides an ear-piercing service for its customers. Appellee originally started through the efforts of Bernard Cohen, appellee’s sole stockholder. Prior to his dealings with the appellants’ Paul J. Hoffner Jr. and Kay Hoffner, he owned and operated a Piercing Pagoda. Sometime in 1970, appellants contacted the sole stockholder and expressed their interest in operating a Piercing Pagoda. The appellants then procured a location for the store and took a lease in their names. Thereafter, a letter of intent creating franchise rights in the appellants was signed by the parties. Appellant entered into a franchise agreement with appellee to open several of appellee's earrings and ear-piercing stores. The agreement required appellants to purchase all their earring requirements from the appellee. Appellants also agreed to a covenant not to compete, that restricted them from owning or operating an ear-piercing business for three years within thirty miles of any existing franchise of appellee or for one year where appellants' business had been operated and terminated. When the appellants terminated the agreement, the appellee brought an equitable action seeking enforcement of the covenant. The chancellor found that although the business had a legitimate interest to protect, the enforcement of the covenant was not proper since the appellee did not bargain for a share of the profits but for the requirement that the appellants purchase all earring inventory from them. In the chancellor's opinion, the appropriate relief was found in requiring the appellants to purchase all their earring requirements from the appellee for five years. The chancellor found that the appellee did not breach the agreement by engaging in over-pricing. Both sides challenged the chancellor's conclusions of law and the decree nisi. The court en banc made no change in the original findings of fact but found that the restrictive covenant was ancillary to a lawful business arrangement between the parties, and therefore enforceable. On appeal, the appellants contended that the restrictive covenant was invalid and unenforceable. They also claim that even if it is valid, they had a right to terminate their dealings with the appellee because of an alleged breach of the letter of intent on the part of the appellee.
Was the restrictive covenant valid and enforceable?
The court held that the restrictive covenant was enforceable, as the court found that the requirements clause in the contract did not invalidate the restrictive covenant. Thus, the appellants violated the terms of the covenant. However, the court modified the order to provide that the appellants' five franchise operations not within thirty miles of any existing franchise of appellee were subject to the covenant not to compete for a period of one year, rather than three years, and affirmed the decree as modified.