United States: Update: Section 1 Challenge To Jimmy John's No-Poach Agreement Survives Motion To Dismiss

We recently wrote that the Department of Justice's and the Federal Trade Commission's announcements condemning no-poaching agreements already have sparked civil class actions, including a putative class action against Jimmy John's. Butler v. Jimmy John's Franchise, LLP, No. 18-cv-0133, 2018 WL 3631577 (S.D. Ill. July 31, 2018). Since then, the district court denied a motion by Jimmy John's to dismiss the plaintiff's Section 1 claim.

According to the allegations, the plaintiff in Jimmy John's, Sylas Butler, worked as a delivery driver and in-store employee for a Jimmy John's franchise, but his supervisor cut his hours to approximately four hours per week. Butler wanted to transfer to a different Jimmy John's franchise, but the Jimmy John's franchise agreement prohibits any franchisee from soliciting or hiring any employee who has worked at another Jimmy John's franchise within the previous 12 months. The franchise agreement imposes strict penalties for violating that clause, including termination of the franchise agreement. The franchise agreement also provides that all current and future franchisees are third-party beneficiaries of the agreement, meaning that other Jimmy John's franchisees can enforce the no-hire provision. Finally, Jimmy John's franchisees require their employees to sign a noncompete agreement, based on a form agreement provided by Jimmy John's, that forbids their employees from working for any other area business that sells subs or sandwiches for two years after leaving the franchisee's employment. Thus, the Jimmy John's franchise agreement and the noncompete agreement allegedly precluded Butler from transferring to a different Jimmy John's or a similar business.

Butler filed a complaint alleging that Jimmy John's and its franchisees' no-poach agreements violated Section 1 of the Sherman Act. Jimmy John's moved to dismiss the complaint on the grounds, inter alia, that the complaint failed to allege a plausible claim. Specifically, Jimmy John's argued that the no-hire provisions are, as a matter of law, purely vertical restrictions on intrabrand competition, which are permitted under the antitrust law.

The court agreed that vertical conspiracies are generally analyzed under the rule of reason, but it did not accept that the alleged conspiracy was strictly vertical as a matter of law. "This first puzzle is how to define the agreements in question: Are they vertical, horizontal, or a combination of the two?" 2018 WL 3631577, at *6. If the district court found the no-hire provision to be a horizontal agreement among Jimmy John's franchisees, the no-hire provision could be deemed a per se violation of the Sherman Act. Alternatively, the no-hire provision could be subject to the rarely used quick-look approach, which applies where per se analysis is not applicable but "an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anticompetitive effect on customers and markets." Id. at *4. Under the quick-look approach, if the plaintiff can show that there are no legitimate justifications for the alleged behavior, then the plaintiff need not prove the relevant markets or provide evidence of market power.

Butler's complaint alleged several facts supporting the contention that Jimmy John's franchisees were independent, competing businesses rather than parts of a single enterprise. The Jimmy John's franchise agreement provides that each franchisee is responsible for developing its own restaurants, including all obligations and liabilities of the business. Id. at *1. The franchise agreement does not guarantee an exclusive territory; Jimmy John's franchisees may be forced to compete with other franchisees that open or are already operating in the area. Id. The franchise agreement also disclaims that the franchisees are agents, joint venture partners or employers for any purpose. Id. Also, the president and CEO of Jimmy John's testified in a related case that its franchisees "independently own[ ] and operate[ ] a franchise business that stands in an arm's length contractual relationship with Jimmy John's." Id.

Accepting these facts as true for the motion to dismiss, the court found that Butler sufficiently alleged a horizontal agreement among the franchisees that was orchestrated by Jimmy John's corporate headquarters – a "hub and spoke" conspiracy. The court analogized the no-hire agreements among the franchisees to the agreements at issue in Toys "R" Us, Inc. v. F.T.C., 221 F.3d 928 (7th Cir. 2000). In that case, Toys "R" Us, which at the time wielded market power, coerced 10 toy manufacturers to enter into vertical agreements with Toys "R" Us that restricted the manufacturers' ability to sell products to discount clubs such as Costco. Toys "R" Us coordinated the series of agreements and assured each manufacturer that the manufacturer's competitors were entering into similar agreements with Toys "R" Us. On appeal, the Seventh Circuit reversed the district court's finding that the agreements were a series of vertical agreements. Rather, the Seventh Circuit held that Toys "R" Us participated in a horizontal boycott of the discount clubs and thus committed a per se violation of the Sherman Act.

The district court in Jimmy John's found that "[t]he franchisees are independently-owned horizontal competitors, just like the toy manufacturers" in Toys "R" Us. 2018 WL 3631577 at * 7. The court also found that the no-poach agreement more resembled a horizontal agreement among the franchisees than a vertical agreement with Jimmy John's. "The franchisees tacitly agree amongst each other to enforce the no-hire provision through austere enforcement of the employee non-compete contracts." Id. The district court heavily relied on the fact that "the franchise agreements give the franchisees a contractual right to enforce the no-hire agreements directly against each other through the third-party beneficiary provision." Id. "That is a horizontal agreement." Id.

But the district court acknowledged "one massive elephant in the room that distinguishes this case from Toys "R" Us." Id. Unlike the toy manufacturers in Toys "R" Us, "[a]ll of the firms in this case deal in the same brand: Jimmy John's sandwiches." Id. And, as the defendants argued in their motion to dismiss, "antitrust law is more concerned with interbrand restraints, not intrabrand restraints." Id. That difference "puts these proceedings in murky waters: Should the per se rule apply to a horizontal price fixing and group boycott scheme, even though the horizontal agreement is amongst firms dealing in the same brand?" Id. The court reasoned that "[i]f the evidence in this case shows that the franchisees are truly as independent as Butler pleads, this case will likely result in a quick look analysis." Id. The district court, however, found it "cannot decide at this early stage in the proceedings which rule will apply." Id. at 8.

A takeaway from Jimmy John's is that a franchisor and its franchisees should consider whether the franchisees are competitors or a part of an intrabrand supply chain. There may be business reasons for a franchisor to treat its franchisees as separate, competing entities, but in balance that structure may have meaningful negative implications under the antitrust laws. While antitrust laws generally permit agreements restricting intrabrand competition, such as exclusive market areas or minimum resale prices, these agreements could be per se violations if reached by competitors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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