Schlotzsky's, Ltd. v. Sterling Purchasing

• Decision Date: 05 March 2008
• Docket Number: No. 06-50720.,06-50720.
• Citation: 520 F.3d 393
• Parties: SCHLOTZSKY'S, LTD., Plaintiff-Appellee, v. STERLING PURCHASING AND NATIONAL DISTRIBUTION CO., INC., Defendant-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

520 F.3d 393

SCHLOTZSKY'S, LTD., Plaintiff-Appellee, v. STERLING PURCHASING AND NATIONAL DISTRIBUTION CO., INC., Defendant-Appellant.

No. 06-50720.

United States Court of Appeals, Fifth Circuit.

March 5, 2008.

Edward Wood Dunham (argued), Erika Lynn Amarante, Wiggin & Dana, New Haven, CT, Shannon H. Ratliff, Lisa A. Paulson, Richard A. Fordyce, Ratliff Law Firm, Austin, TX, for Plaintiff-Appellee.

Anthony Stanley DiVincenzo (argued), DiVincenzo, Schoenfield & Swartzman, Chicago, IL, for Defendant-Appellant.

Appeals from the United States District Court for the Western District of Texas.

Before BARKSDALE, DENNIS and SOUTHWICK, Circuit Judges.

SOUTHWICK, Circuit Judge:

After a jury trial, the district court ruled in favor of a restaurant franchisor on claims brought against a food distributor under the Lanham Act. On appeal, the distributor alleges the Lanham Act was inapplicable, that an award of attorney fees and an injunction should be overturned, and that its counterclaims should be reinstated. We disagree and affirm.

FACTS

Schlotzsky's, Inc., the franchisor for a quick-serve restaurant system, filed for bankruptcy in 2004. Estate assets were sold at bankruptcy court auction. In January 2005, Schlotzsky's, Ltd. became the owner of the Schlotzsky's Deli restaurant system, trademarks, and associated rights. That company, which we refer to as Schlotzsky's, is the plaintiff. When the predecessor and bankrupt company is referenced, we will call it "Schlotzsky's, Inc."

Some of the Schlotzsky's restaurant locations are company-owned while others are owned by franchisees. A franchise agreement governs the relationship between Schlotzsky's and each franchisee. Each agreement is not identical. However, all agreements give Schlotzsky's the right to establish quality standards, specify approved products, and designate manufacturers and distributors for products in which Schlotzsky's has a proprietary interest. Franchisees pay Schlotzsky's a percentage of restaurant sales as a royalty. Manufacturers pay license fees to Schlotzsky's for the right to use its trademark.

Some franchisees formed the Schlotzsky's Independent Franchisee Association (SIFA). SIFA advocated members' interests but did not own or operate any Schlotzsky's restaurants. SIFA did not have the power to bind any franchisee, contract on behalf of any franchisee, or act as the agent for any franchisee. The association is now inactive, as we will discuss.

In 2003 and 2004, Schlotzsky's, Inc. faced financial difficulties and a possible shortage of products. In March 2004, SIFA and Defendant Sterling Purchasing & National Distribution Co., Inc., agreed that Sterling would assess its ability to act as a supply chain manager for the Schlotzsky's system. In that role, Sterling would be the interface between the various franchise stores and suppliers to ensure that franchise locations received all necessary products. SIFA designated Sterling as an exclusive purchase and distribution representative, but had no authority to do so. In response to SIFA's request, Schlotzsky's, Inc. began unsuccessful negotiations with Sterling.

In June 2004, Schlotzsky's, Inc. replaced its senior management. In August 2004, the company filed for Chapter 11 bankruptcy. SIFA then introduced Sterling to the company's new management team. In a letter dated September 7, 2004, the bankrupt Schlotzsky's, Inc. approved Sterling as a non-exclusive supply chain manager for its restaurant system, retaining the right to revoke this designation upon written notice to Sterling. Sterling continued to negotiate regarding its authority, but the non-exclusive nature of the relationship was not modified.

Franchisees began making alternative supply arrangements as the system's difficulties made some distributors reluctant to continue to supply financially strapped franchisees. SIFA thought Sterling could increase consistency in the product supply chain and that franchisees could avoid the indirect payment of license fees passed on to them from approved distributors. In October 2004, the bankrupt Schlotzsky's, Inc. and Sterling reached an impasse as to the non-exclusive nature of their relationship and negotiations were terminated. Despite the unsatisfactory terms of the agreement, Sterling continued to act as a non-exclusive distribution manager, and Schlotzsky's, Inc. continued to build relationships with other manufacturers and distributors.

Sterling began to hold itself out to manufacturers and distributors as the exclusive representative for purchasing and distribution of all goods and services within the Schlotzsky's system. Some specific evidence of this is discussed below. Sterling received rebates from manufacturers and distributors of Schlotzsky's branded and proprietary products. These rebates were passed on to the franchisees in the cost of supplies.

By January 2005, Schlotzsky's, Ltd. (the plaintiff in this case) was the franchisor and the owner of the trademarks and other rights following the bankruptcy court sale. The new company's management began negotiating with potential new distributors. In March 2005, Schlotzsky's contracted with two primary distributors for their branded and proprietary products. Beginning June 30, 2005, SYGMA Network, Inc. would act as the primary distributor for states west of the Mississippi River and Commissary Operations, Inc. ("COI") would act as the primary distributor for states east of the Mississippi River. With the new distributors in place, Schlotzsky's terminated Sterling as the non-exclusive supply chain manager, with June 30, 2005, being the effective date of termination. Franchisees were required to purchase at least ninety-five percent of products through either SYGMA or COI. These steps apparently convinced SIFA leaders that they no longer needed their association; SIFA voluntarily placed itself on inactive status. However, Schlotzsky's became increasingly troubled with Sterling's actions.

In March 2005, Schlotzsky's filed suit against Sterling in federal court in the Western District of Texas. In March 2006, a jury found that Sterling willfully committed false designation of affiliation, sponsorship, or approval with respect to Schlotzsky's commercial activities. The jury also found that Sterling wrongfully obtained $350,000 in profits. Sterling's antitrust and tortious interference counterclaims were dismissed under Federal Rule of Civil Procedure 50. The district court set aside the jury's damage award, finding it to be inequitable to award damages for loss of profits to Schlotzsky's because damages were not proved with the required specificity. Instead, the district court awarded extensive injunctive relief. Seventy-five percent of the requested attorney fees were awarded.

Sterling timely appealed the decisions of the district court. Schlotzsky's cross-appealed the district court's refusal to award disgorgement of profits and the district court's reduction of attorney fees. In a subsequent motion to dismiss its cross-appeal, Schlotzsky's maintained these issues were wrongly decided but concluded that it was unlikely under the applicable standard of review that this Court would disturb the district court's rulings. We granted the motion to dismiss the cross-appeal, leaving only Sterling's issues to be resolved.

DISCUSSION

Schlotzsky's brought suit against Sterling under the Lanham Act. 15 U.S.C. §§ 1051-1141. We find it useful to make a brief introduction to the Act before analyzing the specific issues before us:

The present Trademark Act, the Lanham Act of 1946, took effect on July 5, 1947 and was intended to combine the previous Trademark Act and its numerous amendments scattered throughout the United States statutes, to eliminate confusion created by conflicting interpretations, to simplify and liberalize registration and make it more meaningful, to dispense with overly technical prohibitions, and to provide prompt and effective relief against infringement. In addition to the usual objectives of the protection of trademarks, i.e., securing to the owner the goodwill of his business and protecting the public against false and deceptively marked goods, the Act is aimed at broadening the trademark owner's rights.

4A CALLMANN ON UNFAIR COMP., TR. & MONO. § 26:1 (4th ed.). The Lanham Act codified and unified the common law on unfair competition and trademark protection, and through several amendments since its adoption in 1946, remains the principal statutory protection of trademarks. Inwood Lab., Inc. v. Ives Lab., Inc., 456 U.S. 844, 861 n. 2, 102 S.Ct. 2182, 72 L.Ed.2d 606 (1982) (White, J., concurring).

Sterling divides its Lanham Act challenges into three parts: (1) the Act is inapplicable; (2) even if the Act is applicable, there is no evidentiary support for either an injunction or attorney fees; and (3) issuing the injunction was error as a matter of law. Sterling also alleges that it was error to dismiss its claims under (4) state tort law, and (5) federal antitrust law. We will discuss the issues in that order.

I. Applicability of the Lanham Act

Sterling argues that the Lanham Act relates only to trademarks, not to all commercial activities. It alleges that its actions did not involve a misuse of Schlotzsky's trademark and therefore did not violate the Lanham Act.

We first look at Sterling's actions, then decide whether those actions ran afoul of the Lanham Act. There is ample evidence that Sterling mischaracterized its relation with Schlotzsky's. For example, on September 14, 2004, shortly after Sterling became a non-exclusive supply chain manager, Sterling and Van Eerden Food Service signed an agreement wherein Sterling stated that it was a "purchasing agent appointed by both Schlotzsky's, Inc." and SIFA and was "appointed by Schlotzsky's, Inc. and [SIFA] to be their exclusive representative in the purchasing of products . . . ." There was evidence of seven contracts between Sterling and distributors...