Seventh Circuit Revives Franchise No-Poach Case, Holds Per Se Treatment Possible

A recent opinion by the U.S. Court of Appeals for the Seventh Circuit reinstates allegations against McDonald’s that no-poach provisions in the company’s franchise agreements violate the antitrust laws, holding that such provisions may be per se illegal.

Until 2017, McDonald’s franchise agreements included so-called no-poach provisions barring franchisees from hiring or soliciting another franchise’s employee until six months after the employee left the other franchise. Two former employees sued, alleging that these agreements violated § 1 of the Sherman Act by restricting their ability to obtain higher-paying work at other McDonald’s locations.  As reported here, late last year the district court dismissed the employees’ claims, finding that the no-poach agreements were not per se unlawful because they were “ancillary” to franchise agreements that served a procompetitive purpose – i.e., “increased output of burgers and fries.”  Instead, the district court applied the more exacting rule of reason and, finding plaintiffs failed to plausibly allege a relevant market and McDonald’s market power within it, dismissed plaintiffs’ complaint.

In a unanimous opinion by Judge Frank Easterbrook, the Seventh Circuit vacated the district court’s opinion, holding that although the district court correctly concluded plaintiffs’ claims failed under the rule of reason, it had “jettisoned the per se rule too early.” In particular, the Seventh Circuit found that the complaint alleged a horizontal restraint in so far as McDonald’s operates several of the restaurants itself or through a subsidiary and that it enforced the no-poach restriction at those restaurants, making this arrangement horizonal in nature.  The Seventh Circuit went on to say that the district court too hastily concluded that the no-poach provision was “ancillary” merely because it appeared in a franchise agreement that expanded the output of fast food.  The Seventh Circuit found this approach wrongly “treats benefits to consumers (increased output) as justifying detriments to workers.”  It also questioned whether the no-poach clause itself increases output. Although the court recognized that restraints on poaching can sometimes be output enhancing, if, for example, they protect a franchise’s investment in training workers, whether any given no-poach clause does so presents “potentially complex questions, which cannot be answered by looking at the language of the complaint.”

Of particular note to franchisors, the appeals court proposed various questions courts might consider in determining if a no-poach clause promotes output, including whether its geographic scope and length are tailored to the franchise’s goal of protecting its investment in employee training. The court suggested that if a no-poach clause covers too broad an area or lasts longer than necessary for the franchise to recoup its investment in the employee, that might be evidence that the clause is not an “ancillary” restraint and, thus, may be per se unlawful. The court remanded the case to the district court to consider these questions with the benefit of discovery, noting that the classification of a restraint as ancillary is an affirmative defense, not something plaintiffs must anticipate in their complaint.

In light of this opinion, companies should take a fresh look at any no-poach provisions in their franchise agreements.  A few relevant considerations include:

• Are these restrictions necessary? While the Seventh Circuit stopped short of holding that no-poach provisions in franchise agreements are categorically subject to the per se rule, this decision means that challenges to such provisions may be less likely to be dismissed on a motion to dismiss and could thus become more expensive to defend.
• Are these restrictions justifiable? The Seventh Circuit suggested that courts must evaluate the geographic scope, length, and purpose of no-poach restrictions.
• Are there less-restrictive alternatives? If the scope and length of the relevant restrictions are not justified given their purpose, are there ways the restrictions can be more narrowly tailored to meet the desired goal?

Answers to these types of questions can help companies evaluate the validity of any no-poach restrictions that may exist in their franchise agreements.  These can be complex issues to analyze so companies are encouraged to seek the advice of experienced distribution & franchise and antitrust counsel in making these determinations.