Case Title: H & R BLOCK, INC. v. Lovelace

Citation: 208 Kan. 538, 493 P.2d 205

Docket Number: 46,182

State: kansas

Court: Kansas Supreme Court

Date: 1972-01-22T00:00:00Z

Document:
208 Kan. 538 (1972)
493 P.2d 205
H & R BLOCK, INC., Appellant,
v.
EARL LOVELACE, Appellee.
No. 46,182

Supreme Court of Kansas.
Opinion filed January 22, 1972.
James M. Immel, of Immel and Immel of Iola, argued the cause and was on the briefs for the appellant.
J.D. Conderman, of Conderman and Talkington, of Iola, argued the cause and was on the brief for the appellee.
The opinion of the court was delivered by
*539 HARMAN, C.:
This is an appeal by a plaintiff franchisor in an action brought by it to restrain an individual franchise from violating a covenant not to compete in the business of preparation of tax returns upon termination of the franchise. The issue here is the validity of the restrictive covenant.
The action was submitted to the trial court for determination upon undisputed facts which may be summarized as follows:
Plaintiff H & R Block, Inc. is a corporation engaged in franchising individuals and other concerns to operate a business solely for the preparation of income tax returns and services incident thereto under the name of H & R Block.
On or before January 1, 1961, plaintiff and defendant Earl Lovelace entered into the following written agreement:
"Now, THEREFORE, BE IT AGREED:
"1. First Party agrees:
"2. Second Party agrees:
Pursuant to this agreement, on January 1, 1961, defendant commenced the operation of a tax return business in Yates Center under the name H & R BLOCK, which he continued to operate during the income tax seasons of 1961 through 1968.
On October 29, 1968, defendant gave plaintiff notice of his intent to terminate the contract and on January 1, 1969, he commenced an income tax preparation business under his own name at the same location in Yates Center at which he had conducted business under the Block name and he has continued to operate an office at that location in competition with plaintiff since that time.
On March 17, 1969, plaintiff commenced this action by the filing of its petition in which it sought damages for breach of contract and an order restraining defendant "from competing with the plaintiff for a period of five (5) years from the termination of said contract as provided by the aforesaid agreement."
Thereafter defendant answered, alleging among other defenses that the purported restriction of competition contained in paragraph 4 of the franchise agreement was an unreasonable restraint of trade and contrary to public policy. At a pretrial conference issues were defined and the trial court made the following ruling:
On February 27, 1970, the case having been submitted for determination upon the pleadings and certain stipulations made at pretrial conference, the court rendered its final decision as follows:
Judgment was entered in accord with the foregoing memorandum. Plaintiff has now appealed from that part of the judgment which denied its request for injunctive relief restraining defendant from competing with plaintiff in the business of income tax return preparation.
Plaintiff contends the trial court erred in finding that the covenant against competition extended to the world and precluded defendant from carrying on an income tax business anywhere and in holding accordingly that it was unenforceable, and further that the court erred in finding the covenant unreasonable as to time and unenforceable for that reason.
This court has dealt many times with the law governing noncompetition clauses in agreements of various types (see 2 Hatcher's Kansas Digest, rev. ed., Contracts, §§ 52, 58; 3A West's Kansas Digest, Contracts, §§ 115-117). Most often the agreements have been incident to the sale or transfer of a business; however, the rule is well established that such a clause is good if it is ancillary *544 to any lawful contract (John Lucas & Co. v. Evans, 141 Kan. 57, 40 P.2d 359), subject, of course, to the test of reasonableness of the covenant and whether it is inimical to the public welfare (Mills v. Cleveland, 87 Kan. 549, 125 Pac. 58).
Although there is no rigid, absolute norm by which the reasonableness of a covenant against competition may be determined, rules evolving generally from this line of decisions are to the effect that the rights of the promisee, the promisor and the general public are to be taken into account; area and time limitations must be reasonable under the facts and circumstances of the particular case (Heckard v. Park, 164 Kan. 216, 188 P.2d 926, 175 A.L.R. 605). It is readily apparent the governing rules are equitable in nature as they must be where courts are called upon to resolve conflicts between basic principles of law, the conflicting rules here being (1) under the common law agreements in restraint of a person's right to exercise his trade or calling were void as against public policy (54 Am.Jur.2d, Monopolies, etc., § 511) and (2) contracts of persons sui generis are to be enforced.
In determining the question of reasonableness a distinction has sometimes been made between covenants incident to an employment contract and those ancillary to a sale or other transfer of a business, practice or property. Where distinctions have been made courts of equity have been less prone to enforce restrictive covenants between employer and employee than where the restriction is part of a contract for sale of a business in which good will may be a part of the property sold, and such courts have construed the former more strictly against the employer-promisee in determining their reasonableness (for comprehensive analysis and summary on this aspect and on the subject of covenants against competition generally, see 41 A.L.R.2d 15, 20-33; 43 A.L.R.2d 94, 109-115; 45 A.L.R.2d 77, 96-98; 46 A.L.R.2d 119, 142-146).
Reasons given for distinctions made between employer-employee and sale covenants are trenchantly stated in Arthur Murray Dance Studios of Cleveland v. Witter, 105 N.E.2d 685, (CP, Ohio, 1952) as follows:
We think the sounder line of reasoning, as well as the weight of authority elsewhere, supports the view such distinction should be made.
The agreement before us is neither a contract of employment nor one for sale of a business, but rather that which in the modern business world has now come to be known as a franchise. In its simplest terms a franchise is a license from the owner of a trademark or trade name permitting another to sell a product or service under that name or mark. More broadly stated, the franchise has evolved into an elaborate agreement under which the franchise undertakes to conduct a business or sell a product or service in accordance with methods and procedures prescribed by the franchisor and the franchisor undertakes to assist the franchise through advertising, promotion and other advisory services. The franchise may encompass an exclusive right to sell the product in a specified territory (see 15 Business Organizations, Glickman, Franchising, § 2.01).
For our purpose here it is not necessary to categorize the franchise nor to distinguish it from other relationships, such as employee vis-a-vis independent contractor or the like, and we *546 would not be heard to do so. Suffice it to say under the contract here defendant operated under plaintiff's name in providing a service in which enterprise plaintiff retained a considerable amount of operational control including the prescribing of office hours, fees to be charged, methods and forms to be used, accounting periods, advertising and promotion and training of personnel, and upon breach of the contract by defendant, title to and possession of books, records, files and client lists vested in plaintiff.
Under these narrow facts we are inclined to the view the contract is more akin to one of employment than to a contract for sale or disposition of a business and sufficiently of that character to make strict construction against the promisee appropriate.
In the light of the foregoing principle we turn to the question of the territorial extent of the restriction contained in the contract. The trial court determined it to be without limitation. Plaintiff urges that, construing the entire agreement from its four corners, the covenant contained in paragraph 4 was intended only to prohibit competition by defendant within five miles of Yates Center  a reasonable limitation which should now be imposed on defendant. The difficulty is, paragraph 4 does not so state  rather it contains no limitation of any kind. That the parties knew how to fix specifically a territorial limitation is demonstrated by the fact subparagraphs a and b of paragraph 1 of the agreement do exactly that in prescribing a location for the franchised operation and in specifying an area in which plaintiff would not compete. Had it been the intention of the parties, and particularly the plaintiff (presumably the draftsman for the agreement), to limit the extent of the restrictive covenant as to defendant's competition it would have been simple so to state as was done in paragraph 1.
Plaintiff calls attention to the case of Foltz v. Struxness, 168 Kan. 714, 215 P.2d 133, in which a territorial limitation of one hundred miles from the city of Hutchinson, contained in a covenant not to compete, was reduced by the trial court to a radius of five miles from the city and enforced, which action was upheld by this court. Reliance upon this decision is misplaced in that the facts as well as the posture of the ruling upon appeal are distinguishable from those at bar. There the contract was between an older doctor with an established medical practice in the city of Hutchinson and a young doctor seeking a location. The contract of employment was for a period of one year, at the end of which *547 a partnership was to be negotiated to carry on the practice, the terms of which were left subject to further mutual agreement. Both parties were found by the trial court to have acted in good faith in attempting, albeit unsuccessfully, to negotiate that partnership agreement. Clearly the contract contemplated a transfer of a proprietary interest in an established practice. Moreover, the trial court there, applying equitable doctrine, reduced the territorial limitation under the particular facts of the case. The trial court here did not do so and we are not under the circumstances inclined to write a new contract for the parties.
We think the trial court correctly construed the contract as one intended to prohibit competition by defendant anywhere, and, accordingly, properly declined to enforce it because of unreasonableness as to territorial extent.
The enterprise was for a service activity of a local nature, that is, one generally sought and obtained by the customer locally. Unlimited territorial restriction was unnecessary and unjustifiable for plaintiff's protection and therefore unreasonable.
Once it is determined the covenant was unenforceable because of the extent of the territorial restriction, consideration of other matters raised becomes unnecessary.
The judgment is affirmed.
APPROVED BY THE COURT.
FONTRON, J., dissenting:
I cannot agree with the action of my colleagues in striking down, as unenforceable, the covenant not to compete which was a component part of the agreement under which the parties lived for some eight years, presumably to their mutual benefit and profit. The court's opinion is premised on the proposition that the covenant not to compete is unrestricted as to area and that it was intended to prevent competition anywhere  or in the words of the trial court, whose decision is being upheld, "the territorial restraint ... actually extends to the world."
Such an interpretation strikes me as unreasonable and even a bit absurd, considering all the contract provisions. I understand the rule of construction to be, as often declared by this court, that a contract must be interpreted in a reasonable manner in the light of all its terms, its intended purpose and the circumstances attendant upon its making. This principle is well expressed in Weiner v. Wilshire Oil Co., 192 Kan. 490, 496, 389 P.2d 803:
(See, also, 2 Hatcher's Kansas Digest [Rev. Ed.] Contracts, § 52, 58 and 3A West's Kansas Digest, Contracts, § 115, 117.)
The general rules of interpretation outlined in Weiner have been applied by this court in the construction of contracts involving restrictive covenants. In Heckard v. Park, 164 Kan. 216, 188 P.2d 926, the plaintiff, who had been employed to teach and train a young musician, sued for specific enforcement of a written agreement containing certain restrictive covenants breached by the youthful artist. In an opinion upholding the contract as valid, this court said:
In Foltz v. Struxness, 168 Kan. 714, 215 P.2d 133, a case arising over a restrictive covenant in a contract between two doctors, the following pronouncement of the law is found.
Applying the basic tests of construction to the instant contract, I find myself baffled by the interpretation given it by a majority of the members of this court. It seems perfectly clear to me that the purpose of the restriction is to protect the plaintiff franchisor from competition by the defendant franchise for a period of 5 years. A covenant against competition is, in my view, a legitimate subject for contract in a situation of this kind. Such was the decision in Shakey's Incorporated v. Martin, 91 Idaho 758, 430 P.2d 504, where the Idaho court held in effect that a franchisor, in selling its franchises, has a legitimate business interest which is protectable by a covenant not to compete.
In all frankness, what would be the area in which plaintiff's interest might require protection in this case? I can only conclude that the area of protection was intended by the parties to be that area in which the defendant was franchised to operate an income tax service under the plaintiff's name and according to its system. By the express terms of the franchise the tax return business was to be conducted by defendant within a distance of 5 miles from Yates Center, not at some distant spot of this teeming world. Added weight is given this view by the provisions of paragraph 1b wherein the franchisor agrees to refrain from competing with the franchise "within said 5 mile area" during the term covered by the agreement.
To repeat  I believe that a fair and reasonable construction of the restriction set forth in the contract between these parties is that Mr. Lovelace, the defendant, is not to compete with H & R Block, Inc. within a five-mile area radiating from Yates Center. Any other construction would, to me, appear irrational.
There is no claim by defendant that he was forced into making the agreement, nor is there any indication of coercion on the part of plaintiff. The defendant appears to be possessed of normal, if not superior, intelligence (being an accountant and tax consultant) and fully capable of entering into his own contracts with understanding and comprehension. He should be required to respect and to carry out a voluntary agreement.
In its opinion, this court seems to emphasize the similarity between contracts of franchise and contracts of employment. The resemblance seems somewhat exaggerated. Although in some respects *550 the two may be comparable, a contract granting a franchise is much more analogous to a contract for sale of a business than it is to an employment contract. The analogy between contracts of sale and contracts of franchise is implicit in the Idaho court's decision in Shakey's Incorporated v. Martin, supra.
However, the resemblance between contracts for the sale of a business and contracts which grant a franchise is not basic to the views expressed in this dissent, for the Kansas court has upheld restrictive covenants in contracts of employment (Heckard v. Park, supra; Foltz v. Struxness, supra) as well as contracts of sale. (Mills v. Cleveland, 87 Kan. 549, 125 Pac. 58; Pohlman v. Dawson, 63 Kan. 471, 65 Pac. 689.) So long as the restraint is reasonable and not offensive to the public interest, the same tests are to be applied in either case. In the Heckard case we held:
This rule was reiterated in the Struxness decision.
The trial court found that the territorial limitation, which it construed as being world-wide, was unreasonably broad and this court has concurred in that view. I would concede that a restriction against competition anywhere in the world might well be unreasonable under the facts of this case. But a 5-mile limitation is an entirely different matter. In Struxness the trial court reduced the area limitation from a distance of 100 miles from the city of Hutchinson to a distance of 5 miles therefrom, and the court was upheld. In Wilson v. Gamble, et al., 180 Miss. 499, 177 So. 363, cited in the Struxness opinion, the contract of an assistant physician not to engage in practice within 5 miles of a city was held to be valid. Cases relating to the reasonableness of area limitation in covenants not to compete are collated in 46 A.L.R.2d Anno: Sale  Covenant As To Competition  Area, pp. 119-396. A good many authorities holding a 5-mile restraint to be reasonable are listed in § 179 at pp. 361, 362, while none of a contrary view appear. A 5-mile limitation appears entirely reasonable in this case and since no claim is made that public policy is violated, the rule expressed in Foltz v. Struxness, supra, is particularly apt:
It should further be pointed out that Foltz v. Struxness, supra, stands for the proposition that where a territorial restriction is more extensive than required to provide reasonable protection against encroachment, a court of equity is empowered to reduce the territory to the extent reasonably necessary to insure the contemplated protection and to enforce the contract to such extent. This ruling finds substantial support among the authorities and in my judgment should have been followed by the trial court in this case.
The majority opinion does not note the trial court's conclusion that the time limitation of 5 years was also unreasonable. This finding was arrived at, by the court's own statement, "Without any evidence whatever." I believe the court was mistaken in finding as a matter of law that the time limit was unreasonable. The law in this regard is seen reflected by the statement found in 45 A.L.R.2d Anno: Sale  Covenant As To Competition  Time, § 11, p. 115:
See, also, Heckard v. Park, supra, where the contract in issue covered a period of seven years.
For reasons disclosed above I must, with due respect, dissent. I would reverse the judgment of the court below.
KAUL, J., joins in the foregoing dissenting opinion.
OWSLEY, J., dissenting:
In my opinion, the construction of the contract in the majority opinion is erroneous. It appears clear to me that the restrictive covenant prohibiting competition is limited to an area within five miles of Yates Center, Kansas, and for a period of five years.
I dissent on the ground the restriction against competing with plaintiff for a period of five years is unreasonable. The purpose of the restriction is to prevent defendant from acquiring the customers served by H & R Block, Inc. This could be done effectively by preventing the defendant from competing with plaintiff in the preparation of income tax returns for a period of one year. A prohibition *552 beyond one year would result in a hardship on defendant not justified by the advantage to plaintiff.
Exercising our equitable powers, I would modify this contract to limit the time of restraint to one year and then enforce the contract as written.