Franchisors frequently face this common scenario: upon termination or expiration of a franchise agreement, the franchisee leaves the system with the franchisor's confidential information and trade secrets and – worse – attempts to use that information in a competing business. Confidential information – including secret recipes, proprietary processes and customer lists – is the lifeline of every franchise system. Franchisors build their confidential materials over years or decades by expending valuable resources on conducting research and initiating development.
For example, a franchisor's manual may set out the formula for its secret recipes or the procedures for successfully running the day-to-day operations of the business. Gaining access to a franchisor's confidential information is what motivates franchisees to buy into the franchisor's system. Without becoming a franchisee, interested persons cannot tap into the franchisor's valuable sources of information. Therefore, when a franchisor's confidential information is stolen, the value of the brand is put at risk. To protect their trade secrets and confidential information, franchisors in Texas should be familiar with the Texas Uniform Trade Secrets Act.
In September 2013 Texas became the 48th state to adopt the Uniform Trade Secrets Act, a uniform law prohibiting the theft of trade secrets. Before the enactment of the Texas Uniform Trade Secrets Act,(1) franchisors – and any owners of confidential information – could pursue various common law tort, restitutionary, or contract theories under Texas law to recover for a misappropriation of trade secrets or confidential information.
In 360 Mortgage Group, LLC v Homebridge Financial Services, Inc,(2) the US District Court for the Western District of Texas held that the Texas Uniform Trade Secrets Act pre-empts many such theories. Under Texas law, franchisors must generally bring claims relating to misappropriation of a trade secret under the Texas Uniform Trade Secrets Act. The act expressly "displaces conflicting tort, restitutionary, and other laws of [Texas] providing civil remedies for misappropriation of trade secret".(3) Accordingly, the court held that the act pre-empts claims – except for contract claims – that seek civil remedies for misappropriation of trade secrets. By contrast, a claim is not pre-empted if the plaintiff can show that the claim is based on facts that are unrelated to the misappropriation of the trade secret.
It is common for a franchisor to initiate litigation when a former franchisee uses the franchisor's confidential information or trade secrets in connection with a competing business or otherwise fails to return such information following the expiration or earlier termination of the franchise agreement. As 360 Mortgage makes clear, franchisors in Texas must pursue any tort claims relating to a franchisee's improper use of the franchisor's trade secrets or confidential information under the Texas Uniform Trade Secrets Act.
Furthermore, franchisors should continue to rely on their franchise agreements to protect trade secrets and confidential information. The act does not affect contractual remedies.(4) As long as the franchise agreement obligates the franchisee to protect the confidential information and return the confidential information when the relationship ends, a franchisor can sue a franchisee for breach of contract if the franchisee fails to return or otherwise misuses the franchisor's trade secrets or confidential information.
Below is a list of recommendations for how franchisors can use the franchise agreement to further protect their trade secrets and confidential information:
- Incorporate confidentiality obligations into the franchise agreement for the franchisee and its employees, including a process for returning all confidential information upon expiration or earlier termination of the agreement.
- Describe and define all confidential information as property of the franchisor (eg, operations manuals, trade secrets, customer information, business policies and procedures, financial information, sales information and marketing plans).
- Use expressed acknowledgements in the franchise agreement, whereby the franchisee acknowledges the value of the confidential information, acknowledges that such information constitutes trade secrets and agrees to maintain it as confidential both during and after the franchise relationship.
- Provide contractual remedies for breaches of the confidentiality agreement.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.