Franchise 101: Pieces of the Trademark Pie; and Frozen Out of Court

Franchisor 101: Pieces of the Trademark Pie

An Illinois federal district court granted partial summary judgment in a trademark dispute against Ledo Pizza System, Inc. (“System”) and Ledo Pizza Carryouts, Ltd. (“Carryouts”), a franchisor of pizza restaurants (collectively, “Franchisor”), and in favor of an unrelated family-owned pizza restaurant, also called Ledo’s.

In 1955, the trademark “LEDO PIZZA” was first used by “Ledo Restaurant” in Maryland, an establishment founded by two families. In 1986, the families created Carryouts to expand operations, and executed an agreement transferring the “Ledo Pizza” trademark (“Trademark”) to Carryouts, but reserving to Ledo Restaurant the right to continue to use the Trademark.

In 1987, Carryouts applied to register the Trademark with the United States Patent and Trademark Office, claiming first use in 1955, and began granting licenses to third parties. The families later created System to create a Ledo Pizza franchise. Carryouts licensed System the right to use the Trademark and to grant sublicenses to franchisees in the Mid-Atlantic and Southeast regions. A dispute arose between the families leading to a buyout of System and Carryouts by one family, permitting the other family to continue operating Ledo Restaurant and use the Trademark.

In 1961, defendant, Ledo’s Inc., began using the Ledo Pizza mark for its pizza restaurant in Illinois without knowledge of Franchisor’s prior use. Ledo’s Inc. continuously operated the Illinois Ledo’s Pizza since its opening in 1961. Franchisor claimed to first discover the Illinois Ledo’s Pizza in 2020 and commenced litigation. Ledo’s Inc. countersued, seeking a declaration that it had the right to use the Trademark as an intermediate junior user.

The court analyzed whether there was a proper assignment of the Trademark and goodwill to Carryouts in 1986. The court concluded that both the right to use the Trademark and the goodwill were properly transferred to Carryouts. The court noted that the 1986 assignment to Carryouts included the rights to the recipe and pizza-making process, the key elements to create a Ledo pizza, which was evidence the assignment included goodwill.

Nevertheless, the court partially granted Ledo, Inc.’s motion for summary judgment with respect to its counterclaim as an intermediate junior user, holding that if a party can prove its continuous use of a trademark in an area that preempts the registrant’s constructive nationwide rights, that party may continue to use a registered mark in a limited geographic trade area, despite the existence of a senior user. Ledo’s Inc. showed its adoption and use of the Trademark in a remote area, without knowledge of Franchisor’s use, occurred prior to the date of the federal registration filing in 1987 and its use had been continuous since that time.

Failure to monitor activities of other trademark users, whether junior or senior, can hinder a franchisor’s ability to offer and sell franchises nationwide or in certain markets. Given that a common law trademark may have superior rights in a particular geographic region, franchisors should consult with counsel to determine whether there are prior users or superior rights holders in the trademarks licensed to franchisees.

Ledo Pizza System v. Ledo’s Inc., No. 20 CV 7350 (N.D. Ill. Mar. 7, 2024)

Franchisee 101: Frozen Out of Court

A Florida district court granted a motion to stay court proceedings pending arbitration between a franchisor and a third-party, non-signatory to a franchise agreement, containing an arbitration clause.

Rita’s Franchise Company (“Franchisor”) entered into a franchise agreement with two individuals for the operation of a Rita’s frozen dessert shop in Florida. The franchise agreement provided for arbitration in the event of a dispute. The individual franchisees were also managers of Ice Rak, LLC (“Ice Rak”), which entered into a lease for a premises the individuals personally guaranteed. Ice Rak and the landlord entered into a lease rider identifying Ice Rak as franchisee, that the premises could only be used for the operation of a Rita’s shop, and on termination of the franchise agreement, all rights to the premises would be transferred to Franchisor.

After the franchise agreement was terminated, Franchisor demanded liquidated damages, which the individuals refused to pay. As a result, Franchisor demanded arbitration pursuant to the franchise agreement. Subsequently, in a state lawsuit filed by Ice Rak to invalidate the lease rider, Ice Rak asserted it was a not a franchisee of Franchisor and not bound by the franchise agreement. Franchisor moved to compel arbitration. Ice Rak disputed that it agreed to arbitrate its claims, because the individuals agreed to arbitrate in the franchise agreement prior to Ice Rak’s incorporation. Franchisor contended that a non-signatory to a contract can be compelled to arbitrate under principles of equitable estoppel.

The court found the franchise agreement broadly defined “franchisee” to include shareholders, owners, guarantors, principals, members, or partners of franchisee and held that the franchise agreement’s definition includes Ice Rak as franchisee. Therefore, Ice Rak was required to arbitrate.

Additionally, the court found that the principles of equitable estoppel applied because Ice Rak represented to the public that it was “an independent franchisee” of Franchisor, sold Franchisor’s products, marketed and advertised itself on social media using Franchisor’s trademark, and held insurance in its name for the franchise. The court held that non-signatories may be estopped from disclaiming arbitration provisions where the non-signatory knowingly exploits the agreement containing the arbitration clause despite having never signed the agreement.

When signing a franchise agreement, franchisees should assess whether the identified franchisee is one or more individuals, an entity formed for the purpose of operating the franchised business, or both. Where an entity has consistently held itself out to be a franchisee regardless of who signed the franchise agreement, it may be estopped from claiming otherwise, even if the entity was not yet formed or otherwise in existence at the time of the franchise agreement’s execution.

Ice Rak, LLC v. Rita’s Franchise Co., LLC, No. 8:23-cv-2659-WFJ-TGW, 2024 U.S. Dist. LEXIS 44917 (M.D. Fla. Mar. 14, 2024)