Comedy Club, Inc. v. ImprovWest Associates: Who's Laughing Now?

February 2008

ECJ Convinces the Ninth Circuit to Limit the Enforceability of Overbroad Non-Compete Covenants in California

By Karina B. Sterman, Esq

In Comedy Club, Inc. v. Improv West Associates, 502 F. 3rd 1100 (9th Cir. 2007), the United States Court of Appeals for the Ninth Circuit concluded that a licensor's in-term covenant not to compete was too broad under California law, and in a rare occurrence, reversed an arbitrator's award enforcing it. This decision is important because it creates significant legal precedent for covenants not to compete and because it was brought before the Ninth Circuit and argued by our very own Karina B. Sterman and Kelly O. Scott.

When everyone was getting along, Comedy Club, Inc. (CCI) and Improv West Associates (Improv) entered into an agreement that granted CCI an exclusive nationwide right to use Improv's trademarks in connection with the opening and operation of Improv comedy clubs. The agreement contained a very broad in-term covenant not to compete, which prohibited CCI from opening and operating any non-Improv clubs during the term of the agreement. This non-competition restriction applied to the entire United States and lasted for twenty years, until 2019. The agreement also contained a development schedule for opening new clubs which provided that CCI's failing to comply with the development schedule would result in CCI losing the right to use Improv's trademarks or open any other comedy clubs whatsoever, but would not result in Improv losing any of its rights for the entire twenty year term of the agreement.

Less than a few years into the twenty year agreement, CCI did not meet one of the scheduled club opening dates and Improv proclaimed it to be in default of the agreement. Accordingly, Improv revoked CCI's right to open more Improv clubs and insisted that CCI was also prohibited from opening any non-Improv comedy clubs anywhere in the Unites States until 2019. Since this would have effectively put CCI out of business, CCI filed a lawsuit seeking a declaratory judgment that the covenant prohibiting CCI from opening any non-Improv clubs during the term of the agreement was invalid.

CCI and Improv went to arbitration on the issue and at the conclusion, the arbitrator found against CCI, stating in his award not only that the in-term covenant was valid and enforceable for the duration of the agreement, but that it also applied to all "affiliates" of CCI, which was so broadly defined in the agreement that it applied to unknowing third parties who were not parties to the agreement or the arbitration and knew nothing of either. CCI sought to overturn this draconian arbitration award at the district court level, but the district court confirmed it. So CCI appealed to the
Ninth Circuit.

On appeal, the Ninth Circuit found that the in-term covenant restricting CCI from opening any comedy clubs throughout the United States for twenty years violated Cal. Bus. and Prof. Code §16600 because it foreclosed competition in a substantial share of the comedy club business. Consequently, the Ninth Circuit concluded that the covenant could be enforced only in those areas where CCI was operating an Improv comedy club. In ordering the district court to partially vacate the arbitrator's award as being "in manifest disregard of the law", the Ninth Circuit observed that the covenant between CCI and Improv could not be enforced because it had "dramatic geographic and temporal scope." Accordingly, the appellate court limited the application of the restrictive covenant only to areas where CCI already operated comedy clubs and allowed CCI to open new clubs anywhere else it wished. In addition, the Ninth Circuit held that no part of the arbitration award could be binding against "affiliates" in such a broad sense.

Improv tried to get this decision reversed by seeking a rehearing in the Ninth Circuit, but this request was denied on January 23, 2008 and the decision stands.

Kelly Scott Named 2008 Super Lawyer

Congratulations to Kelly O. Scott, who has been named a California "Super Lawyer" for 2008 by Los Angeles magazine. Of course, our Employment Law Department attorneys have been recognized as "Super" before, with Kelly being named a "Super Lawyer" four times in the last five years, Karina Sterman being named a "Rising Star" three times in the last three years, and Lauren Katunich named a "Rising Star" in 2007. The "Rising Stars" for 2008 will be named in July, so good luck Karina and Lauren.

President Bush Signs FMLA 'Military Family'Amendments

The new provisions to FMLA, which have already gone into effect, provide as much as twenty-six weeks of leave for "family members" to care for veterans injured while on active duty in the U.S. Armed Forces, as well as up to 12 weeks of leave for family members of military personnel under a "qualifying exigency." Make sure you post the amended FMLA language and notify employees immediately!

If you have any questions regarding this bulletin, please contact Kelly O. Scott, Editor of this publication and Head of ECJ's Employment Law Department at (310) 281-6348 or kscott@ecjlaw.com; or Karina B. Sterman at (310) 281- 6395 or ksterman@ecjlaw.com. If one of your colleagues would like to be a part of the Employment Law Reporter mailing list, or if you would like to receive copies electronically, please contact Marlena Chumo at (310) 281-6328, or mchumo@ecjlaw.com.