Ninth Circuit restricts scope of non-compete obligations under trademark agreement

In Comedy Club Inc v Improv West Associates (2007 WL 2556702, September 7 2007), the Ninth Circuit has vacated in part a district court order confirming an arbitration award which enforced a non-compete clause under a trademark licensing agreement. Although US law strongly favours the enforceability of arbitration awards, this decision is a useful reminder that arbitrators' actions can be challenged successfully under certain circumstances.

In the case at hand, Comedy Club entered into an agreement with Improv West Associates that granted it the exclusive nationwide right to use Improv's trademarks and service marks in connection with comedy clubs. The agreement contained an arbitration clause requiring the parties to refer any disputes over the agreement's terms.

Several years later, Comedy Club defaulted on certain of its obligations under the agreement. Improv sent a letter to Comedy Club terminating the licence and advising it that Improv intended to open its own clubs under its mark. Rather than invoking the arbitration clause, Comedy Club filed a declaratory judgment action in federal district court seeking to block the termination. The district court, however, dismissed the action and held that the parties were required to arbitrate their dispute. Following the parties' presentations of their cases, the arbitrator entered two orders which, among other things, purported to enforce a non-compete clause in the agreement by barring Comedy Club and its 'affiliates' from:

• operating any comedy clubs other than those extant as of the date of termination for the duration of the parties' original agreement; and
  
  
• changing the name of any of its current clubs.
  

In making this award, the arbitrator accepted and enforced the original agreement's definition of 'affiliates' as "family members, family members of shareholders, [and] all collateral relatives".

Following a district court order affirming the arbitrator's award, Comedy Club appealed to the Ninth Circuit. The appellate court first concluded that, as a matter of California state law, the arbitrator's order binding such affiliates as non-party relatives and ex-spouses was overbroad. Quoting Federal Rule of Civil Procedure 65(d), it held as follows:

"[W]e conclude that the district court should vacate the arbitration award insofar as it enjoins any of [Comedy Club's] affiliates who are not connected to the principals of [Comedy Club]... their officers, agents and servants, employees and attorneys, and [upon] those persons in active concert or participation with them."

Comedy Club fared marginally less well in its challenge to the other aspect of the arbitrator's order on the non-compete clause of the original agreement. According to Comedy Club, the arbitrator had acted irrationally because he had simultaneously revoked Comedy Club's licence to open clubs under Improv's marks other than those in place at the agreement's termination, and had prevented it from operating any other clubs. The Ninth Circuit remarked:

"The basic outline of what the arbitrator did, terminating an exclusive right to open... clubs [under Improv's marks] nationwide, because of contractually inadequate performance..., while keeping in force the restrictive covenant, to some degree could protect [Improv] 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."

Nevertheless, the appellate court concluded that the effective nationwide scope of the injunction awarded by the arbitrator could not be reconciled with California law. It explained that:

"[c]ombined with the arbitrator's ruling that [Comedy Club] forfeited [its] rights to use the... licence in any location, the practical effect of the arbitrator's award... is that the entire contiguous US comedy club market, except for [Comedy Club's] current [licensed] clubs, is off limits to [Comedy Club]."

The court therefore restricted the scope of Comedy Club's non-compete obligations to those counties in which Comedy Club operated clubs under what remained of the licence.

Theodore H Davis Jr, Kilpatrick Stockton LLP, Atlanta