The U.S. Court of Appeals for the Ninth Circuit recently vacated in part an arbitrator’s award in a dispute over a breached trademark licensing agreement, holding the arbitrator acted with manifest disregard of the law by upholding an overly restrictive covenant not to compete and acted beyond his scope of authority in issuing a permanent injunction against non-parties to the license agreement.   Comedy Club, Inc. v. Improv West Assoc., Case Nos. 05-55739, -56100 (9th Cir., Jan. 29, 2009) (Gould, R.).

Comedy Club, Inc. (CCI) owns and operates comedy clubs throughout the United States.   On June 13, 1999, CCI entered into a trademark licensing agreement with Improv West whereby CCI was granted the exclusive right to use Improv West’s trademarks (Improv and Improvisation) in opening comedy clubs around the country.  The agreement contained an in-term covenant not to compete, prohibiting CCI and its affiliates from owning or operating any non-Improv comedy venues until the agreement expired in 2019.  CCI breached the agreement by failing to adhere to a development schedule set forth in the contract.

When Improv West attempted to withdraw CCI’s license due to breach, CCI filed an action in district court seeking declaratory relief that it still retained rights to the trademarks and the covenant not to compete was void under California law.   The district court granted Improv West’s request for arbitration.  The arbitrator held that CCI’s breach forfeited its rights to the trademarks, the covenant not to compete was valid until 2019 and CCI and its affiliates were enjoined from owning or operating any non-Improv comedy clubs pursuant to the covenant not to compete for the duration of the agreement.  While the district court upheld the arbitration award in its entirety, the Ninth Circuit held that the arbitrator exhibited manifest disregard of the law by upholding the covenant not to compete and exceeded his authority in binding CCI’s affiliates to the arbitration award.  The Supreme Court, on a petition for a writ of certiorari, vacated the Ninth Circuit opinion and remanded the case for reconsideration in light of the Supreme Court’s holding in Hall Street Associates v. Mattel. 

In Hall Street, the Supreme Court offered several possible readings of the manifest disregard doctrine as grounds to modify or vacate an arbitration award, including the reasoning utilized by the Ninth Circuit.  As Hall Street did not directly conflict with the Ninth Circuit’s prior analysis, the Court re-affirmed its conclusion that manifest disregard of the law is appropriate grounds to vacate an arbitration award.

Utilizing the manifest disregard standard, the Ninth Circuit reiterated that the license agreement’s broad covenant not to compete violated California law because prohibiting CCI from operating comedy venues in the United States for 14 years stifled competition in a “substantial share of the affected line of commerce.”   In addition, the Court re-affirmed that in binding CCI’s affiliates (broadly defined to include non-party relatives and former spouses) to the license agreement and covenant not to compete, the arbitrator exceeded his authority under California law, which typically does not bind non-parties to arbitration agreements in the absence of an agency relationship.

The Ninth Circuit affirmed its prior holding in its entirety and adjusted the arbitration award to only prohibit CCI from opening non-Improv venues in counties where CCI currently operates Improv clubs and to limit the definition of affiliates to those persons with agency relationships to the signatories of the trademark agreement.