Quarterly Journal of the forum on franchising Volume 30, number 1 • summer 2010
In This IssueThe Forum Provides Tools to Support Our Sophisticated Specialty .........................................2Christopher P. BussertInexperience and franchise law make a particularly bad combination, as evidenced by Nebraska v. Orr, a case in which an attorney found out the hard way that drafting franchise documents is not the same as drafting standard contracts. With the help of Forum resources, however, the type of nightmare arising from Orr can be put to rest.
How Waiver, Modification, and Estoppel May Alter Franchise Relationships ......................3Kerry L. Bundy and Scott H. IkedaFranchise agreements are not always as good as their word. As franchise relationships develop, the franchisor sometimes institutes temporary plans or relaxes certain requirements. Waiver, modification, and estoppel then act on those agreements in ways not intended when the agreements were executed. What’s a franchisor to do?
Puerto Rico’s Dealer and Franchise Statute Adapts to the Latest Developments in Law, Commerce, and Technology ............................... 10Manuel A. Pietrantoni and Ricardo F. CasellasPuerto Rico is a business haven for franchisees and deal-ers. Or is it? Law 75 mandates just cause for termination of a franchise or distribution agreement, so many view it as a protectionist law for franchisees and dealers. But the Puerto Rico Civil Code, federal copyright and trademark laws, and judicial interpretations of just cause could be at odds with the still-evolving Law 75.
Survey of Daubert Challenges in the Context of Franchise Liability Experts ............................ 17Christina L. Fugate, Brian J. Paul, and James L. PetersenExpert testimony has been expertly challenged under Daubert. Proposed expert testimony can be excluded for multiple reasons. However, courts will admit franchise liability expert testimony if it adheres to Rule 702 guide-lines. Overcoming a Daubert challenge is not impossible if you know the type of testimony allowed and the attri-butes that qualify an expert in the eyes of the court.
Microfranchising: A Business Approach to Fighting Poverty ..............................................24Deborah Burand and David W. KochPoverty afflicts a large number of people worldwide, but franchising on a small level can help alleviate the prob-lem. Whereas commercial franchising primarily benefits franchisors, microfranchising benefits those at the base of the economic pyramid—by creating job opportuni-ties. Although such scalable business opportunities have inherent challenges, the rewards can be great.
Franchisor Direct Liability .................................35Jay HewittVicarious liability only goes so far in litigation against a franchisor. Recognizing this, plaintiffs favor direct liabil-ity claims, in which the franchisor is alleged to be neg-ligent independent of negligence by the franchisee. The amount of control a franchisor exerts over its franchisee is a critical factor in judicial decisions involving direct liability claims. The author addresses ways franchisors can prevent and, if necessary, address such litigation.
Franchise (& Distribution) Currents .................43Jason J. Stover, C. Griffith Towle, and David M. ByersA detailed review of recent franchise and distribution law.
Franchise Law Journal (ISSN: 8756-7962) is published quarter-ly, by season, by the American Bar Association Forum on Fran-chising, 321 North Clark Street, Chicago, Illinois 60654-7598. Franchise Law Journal seeks to inform and educate members of the bar by publishing articles, columns, and reviews concern-ing legal developments relevant to franchising as a method of distributing products and services. Franchise Law Journal is in-dexed in the Current Law Index under the citation Franchising.
Requests for permission to reproduce or republish any material from the Franchise Law Journal should be sent to copyright@ abanet.org. Address corrections should be sent to [email protected].
The opinions expressed in the articles presented in Franchise Law Journal are those of the authors and shall not be construed to represent the policies of the American Bar Association and the Forum on Franchising.
R ecently one of my colleagues brought Nebraska v. Orr, 759 N.W.2d 702 (Neb. 2009), to my attention. The case details a nightmarish situation in which
a successful local coffee shop business sought the advice of an attorney, Jeffrey Orr, with more than forty years of experience to assist it in franchising. Unfortunately for all involved, Orr’s forty years of experience included almost no background in franchising other than on occasion review-ing franchise agreements on behalf of clients who were, or intended to become, franchisees. Based on that experience, Orr told the coffee shop business that he could handle its franchise needs. Although he had never prepared a franchise agreement, Orr reasoned that drafting one, as well as any necessary disclosure documents, was “simply a matter of contract drafting.”
Well, most of you have probably guessed where this is going. After twenty-one coffee shop franchises were sold, problems began to occur. For example, the franchisor received an inquiry from a representative of a potential fran-chisee asking for a copy of the Uniform Franchise Offering Circular (UFOC). The franchisor, unsure of what a UFOC was, referred the representative to Orr, who advised that the then current disclosure statement was “compliant and valid” and could be used anywhere. Despite providing these assur-ances, Orr subsequently prepared a second and then a third revision of the disclosure documents.
Eventually litigation ensued between the franchisor and several franchisees that went very badly for the franchisor. Moreover, the Federal Trade Commission instituted an investigation of the franchisor. An attorney specializing in franchise law was retained by the franchisor to give a second opinion as to the franchise documents and concluded that there were “major” legal deficiencies. Worse yet for Orr, a disciplinary proceeding was instituted as a result of his vio-lation of the Nebraska Rules of Professional Conduct. Orr was ultimately found to have violated these rules as a result of attempting a “legal procedure without ascertaining the law governing that procedure.”
Franchising is indeed a sophisticated specialty of the law involving more than standard contract drafting and a
The Forum Provides Tools to Support Our Sophisticated Specialty
Christopher P. Bussert
Christopher P. Bussert
Christopher P. Bussert is a partner in the Atlanta office of Kilpatrick Stockton LLP in Atlanta. He welcomes comments from readers at [email protected].
general knowledge of commer-cial litigation. Although numer-ous pitfalls await the unwary, the ABA Forum on Franchising pro-vides many tools to help its mem-bers avoid Orr’s fate. The Forum sponsors two scholarly publica-tions, the Franchise Law Journal and the Franchise Lawyer, each of which contains articles on a wide variety of scholarly sub-jects. With the added bonus of the Cumulative Index, which I
described in the Winter 2010 issue, locating potentially help-ful articles in the Franchise Law Journal has become even easier. In addition, each issue of the Franchise Law Jour-nal includes a section entitled “Franchise (& Distribution) Currents,” which includes summaries of recent cases orga-nized under topic headings. Perhaps the greatest opportu-nity to immerse oneself in the field of franchising, though, is to attend the Annual Forum on Franchising program; this year’s program will be held at the magnificent Hotel del Coronado resort in San Diego. The Annual Forum’s raison d’être is to provide “the preeminent forum to study and discuss the legal aspects of franchising,” and this year will certainly be no exception with two plenary sessions and twenty-four workshops. See pages 62 and 63.
This issue of the Journal contains several diverse and interesting articles. Leading off is Kerry L. Bundy and Scott H. Ikeda’s analysis of how waiver, modification, and estoppel may alter a franchise relationship. Next, Manuel A. Pietrantoni and Ricardo F. Casellas take a look at recent developments with respect to Puerto Rico’s dealer and franchise statute. Christina L. Fugate, Brian J. Paul, and James L. Petersen survey Daubert challenges in the context of franchise liability experts. Deborah Burand and David W. Koch present a very thoughtful article on the chal-lenges of microfranchising. Jay Hewitt examines the subject of franchisor direct liability. And finally, editorial board members Jason J. Stover, C. Griffith Towle, and David M. Byers cover recent relevant cases in Currents.
Take advantage of everything the Forum offers in terms of education. There is no better way to get (and remain) up to speed in the field.
E very franchise relationship is governed by the terms of the franchise agreement.
But after execution, the fran-chise agreement is often put in a drawer, only to be taken out and dusted off after a dispute arises. What occurs when the conduct or oral communication of one or both of the parties is inconsis-tent with the terms of the fran-chise agreement? When disputes arise, franchisees sometimes allege that because of the parties’ established course of dealing, the franchisor waived its rights, modified the fran-chise agreement’s terms based on its conduct, or is estopped from enforcing disputed provisions as written. Franchisors respond by arguing that it is not fair to penalize them for past leniency, that their actions were not intended to alter any terms in the franchise agreement, that the alleged prom-ise was not detrimentally relied upon, or that the franchise agreement’s standard no-oral-modification or no-waiver clause bars any claim of modification or waiver.
Who prevails in these disputes is far from uniform across all jurisdictions. This article will explore the legal doctrines of waiver, modification, and estoppel. It also will exam-ine to what lengths courts will go to enforce no-waiver or no-modification provisions in the face of the parties’ post-execution course of performance or one party’s subsequent actions or promises.
Litigators regularly use the terms waiver, modification, and estoppel in their pleadings, and courts regularly include them in their rulings. Oftentimes, however, the concepts go undefined, creating ambiguity about their elements and the pressure points necessary for a party to take advantage of these principles.
WAIvER
Waiver occurs when a party knowingly fails to enforce provi-sions of its agreement or performs its obligations under the agreement knowing that the other party has failed to per-form.1 Waiver is generally regarded as the intentional relin-quishment or the abandonment of a known right.2 Unless the parties do not dispute that one of the parties waived the right at issue, waiver can be tricky because it will involve
proving, to some extent, the state of mind of the party alleged to have waived its rights.
Many courts impose a tough standard for proving waiver. For instance, in Massachusetts, waiver is determined by an objective assessment of conduct, as opposed to the subjective expectations of the party claim-ing waiver, that requires “clear, decisive, and unequivocal con-duct.”3 As the general definition
suggests, waiver requires the existence of a right, knowl-edge of the existence of the right, and the waiving party’s actual intention to relinquish that right. The waiver inquiry is focused on the conduct of the waiving party. In Dunkin’ Donuts Inc. v. Gav-Stra Donuts, Inc.,4 a federal court in Mas-sachusetts held that, as a matter of law, the franchisor did not waive its right to terminate the franchise agreement for criminal conduct even if it waited six years after learning of the conduct. The court held that, at most, there was “mere silence” by the franchisor; and absent evidence that it took affirmative steps to waive its contractual right to terminate, there was no waiver.5
On the other hand, in some jurisdictions, waiver may be found where the party does not object to the violation or does not act on its rights for a substantial (or unreasonable) peri-od of time, and treats the postbreach situation as the norm.6 For instance, in Terry International v. Dairy Queen, Inc., a federal district court in Indiana found that Dairy Queen waived its right under Indiana law to object to nonfranchisor food products being sold where it knew about and had not objected to the franchisee’s sale of nonfranchisor products.7 According to the court, the franchisee’s sale of nonconform-ing food products for twenty-five years “surely constitute[d] a waiver of the requirement of written approval.”8
Temporary forbearance likely will not rise to the level of waiver.9 This concept is particularly important in today’s economy, where franchisors may want to delay sending default notices or invoking acceleration clauses while com-municating with their franchisees about how best to weather the financial storm. But if a party sat on its rights, it may only be able to retract the waiver by giving sufficient notice that it intends specifically to enforce its rights going for-ward.10 Not all waivers are retractable. If retraction would be unjust because the other party has materially changed its position in reliance on the waiver, courts generally will not allow the party to retract it.11
How Waiver, Modification, and Estoppel May Alter Franchise Relationships
Kerry L. Bundy and Scott H. Ikeda
Kerry L. Bundy is a partner and Scott H. Ikeda is an associate in the Minneapolis office of Faegre & Benson LLP.
In LaGuardia Associates v. Holiday Hospitality Franchis-ing,12 the U.S. District Court for the Eastern District of New York held that a franchisor waived its right to terminate a fran-chise agreement under New York law where it did not attempt to terminate until ten months after the franchisees’ default on payment. In part, the court opined that because Holiday repeatedly waived its right to payment and because the fran-chisees came to rely upon the additional sixty-day grace peri-od, Holiday could not require strict compliance “without first providing sufficient notice of the withdrawal and a reasonable time for [the franchisees] to alter their conduct.”13
MODIFICATIOn
Although waiver and modification both relate to an intent to depart from the terms of the original franchise agreement, they differ in that waiver “is the result of the intention of the one party who would otherwise have a right to insist on adherence to contract terms or claim damage for departure therefrom, whereas modification is the result of the bilateral action of both parties to the sales transaction.”14 As a result, waiver generally relates to the surrender of claims as to past performance, whereas modification alters the entire contract, embracing both performed acts as well as unperformed acts.
The parties may modify their agreement by introduc-ing new terms or canceling or amending existing elements by their conduct.15 In order to effectively modify an agree-ment, there must be evidence of an actual intent to modify.16 Courts will generally look to the parties’ mutual assent when analyzing modification by conduct; in other words, conduct that is based upon unilateral statements will likely not sup-port modification.17
Whether a modification is found may turn on whether the acts of the contracting parties are unequivocally incon-sistent with the contract right in dispute.18 The U.S. Court of Appeals for the Tenth Circuit in Haynes Trane Service Agency, Inc. v. American Standard, Inc.19 illustrates the fine distinction that courts may draw among conduct that is sufficiently unequivocal. Haynes Trane Service brought an action against American Standard for unlawfully termi-nating a distribution agreement without cause. After two jury trials and appeals, the Tenth Circuit held that, under Wisconsin law, American Standard’s pattern of terminat-ing other dealers with cause was insufficient to find that the contractual right to terminate the plaintiff without cause had been modified. The Tenth Circuit noted that evidence that American Standard always “emphasized a cause” for termination and only knew of terminations with cause did not rise to the requisite level of inconsistency. On the other hand, the court noted that had there been evidence of an American Standard policy to terminate only with cause, such as testimony that American Standard thought that it was contractually required to terminate only with cause, this evidence would have risen to the requisite level of inconsis-tency for a modification claim to prevail.20
Depending on the circumstances, a party may avoid a claim that the franchise agreement was orally modified by arguing
that the alleged oral modification is not enforceable because it violates the statute of frauds.21 Franchise agreements that are otherwise subject to the statute of frauds generally must be modified in writing.22 Nevertheless, a court may bar a party from raising the statute of frauds defense if it finds estoppel or waiver or that the parties partially or fully performed under the purported modification.23 The requirements to establish estoppel under these circumstances are similar to the cus-tomary estoppel standard discussed below. Where there is a representation or conduct that induces detrimental reliance, a party may argue that the party asserting the statute of frauds as a defense is barred from raising such a defense.24
ESTOPPEL
Estoppel generally requires (1) action or inaction, (2) on the part of one against whom estoppel is asserted, (3) which induces reasonable reliance thereon by the other, either in action or inaction, and (4) which is to his or her detriment.25 The party asserting estoppel must show that it detrimentally relied on the action or inaction made and that such reliance was reasonable.26
In Glenn Stetzer, Inc. v. Dunkin’ Donuts, Inc.,27 a federal district court in Connecticut refused to grant summary judg-ment to the franchisor on the franchisee’s estoppel claim where the parties agreed that the franchisee would develop a piece of property for one of the franchisor’s units. The fran-chisee took a longer time to develop the store than allowed by the parties’ development agreement and did not pay its fran-chise fees when due (believing they were due when the fran-chisor signed the agreement). When the franchisor sought to terminate on the basis that the development was not com-pleted by the date set forth in the development agreement, the franchisee claimed that it relied upon the franchisor’s “prom-ise of additional time to open the . . . store.” The franchisor countered that it did not give the franchisee any additional time and that the development agreement was unambigu-ous as to its expiration. Despite the development agreement’s expiration date, the court held that the franchisee was
entitled to show that [the franchisee] relied on [the franchisor]’s promise even if [the franchisor] prevails on the breach of contract claim. Because the parties dispute whether [the franchisor] promised to extend the time limit for opening the new store, a genuine issue of material fact exists which must be submitted to the trier of fact.28
In Cin-Doo, Inc. v. 7-Eleven, Inc., a federal district court in New Hampshire observed that Cin-Doo’s waiver claim “might prove enforceable under the theory of promissory estoppel.”29 Cin-Doo involved a franchisee lawsuit against the franchisor because the franchisor never rebuilt the fran-chisee’s store as was orally promised. Because of evidence demonstrating that Cin-Doo acted to its detriment in reli-ance on that oral promise, the court held that Cin-Doo may in fact state an estoppel claim based on this action and for-bearance in reliance on 7-Eleven’s promise.30
Although these franchisors did not necessarily lose31—Cin-Doo was before the court on a motion to dismiss, and Glenn Stetzer was a ruling on a summary judgment motion—both cases illustrate what a franchisor should not do. Simply put, it is not a good idea for a franchisor to tell a franchisee one thing and then change its mind without first thinking about what occurred or may have occurred during the interim. Regardless of changes in ownership or business plan, changing course when the franchisor knows that the other party has taken steps based on the franchisor’s statement or conduct cre-ates litigation risk.
nO-WAIvER CLAuSES
Many franchisors believe that by inserting clauses that pro-hibit modifications except by certain prescribed methods, they will avoid the problems identified in the preceding sec-tion. These franchisors are right in many instances.32 Most franchise agreements include some iteration of the following no-modification and no-waiver clause:
This Agreement supersedes all prior agreements and discus-sions between the parties regarding the subject matter and may be modified only by a writing signed by both parties. No waiver, amendment, release, or modification of this Agreement shall be established by conduct, custom, or course of dealing, but solely by a written document executed by both parties.
But how bulletproof are these provisions? Although some courts routinely enforce them, others routinely strike them down. Others take a middle road and examine each set of facts on a case-by-case basis according to an identified legal standard, i.e., courts will not always enforce these no-waiver or no-modification provisions but do not always invalidate them. The enforcement of these contractual provisions will be dependent on the applicable state law as well as the equi-ties surrounding their application.
DECISIOnS AT THE ExTREMES
Some courts routinely and as a matter of course enforce no-waiver and no-oral-modification clauses, and some say that conduct may never modify the express terms of the parties’ agreement. One court under Massachusetts law observed “that the Franchise Agreements are integrated contracts which require written consent to modification. The parties’ subsequent course of conduct is not sufficient to modify the terms of the Franchise Agreements.”33 A New York court has also broadly stated that a party was “precluded by the express terms of the agreement” from seeking to enforce an oral mod-ification of the parties’ franchise agreement.34 For example, in Days Inn Worldwide, Inc. v. Adrian Motel Co., LLC, the court
refused to find that the franchisor waived the franchisee’s obligations on the alternate grounds that the communication between the franchisor and franchisee on this issue was not in writing as required by the franchise agreement.35
In Dunkin’ Donuts Franchised Restaurants, LLC v. Kev Enterprises, Inc.,36 the franchisee unsuccessfully argued that
the franchisor waived its right to terminate the fran-chise agreement for late payment because of the franchisor’s prior accep-tance of late payments. Interestingly, in enforcing the no-waiver provision in the parties’ agreement, the court observed that the
notice letters asking the franchisee to cure its defaults “spe-cifically state[d] that [the franchisor] d[id] not waive [the franchisor’s] right relating to any prior Notice of Default.”37 Although it is not clear that the court explicitly relied upon the inclusion of these terms in the notices, the court’s men-tion of them implies that it at least considered them in reach-ing its decision.
On the other end of the spectrum, some courts have held that such boilerplate clauses are insufficient to prevent waiver or modification in certain circumstances. Canada Dry Corp. v. Nehi Beverage Co.38 is one example of how these clauses are not always fail-safe. In Canada Dry, the franchisor sought to terminate a franchise agreement based on the franchisee’s failure to renew its franchise in writing. The parties’ agree-ment required the franchisee to exercise an option in writ-ing to make its acquisition of two territories permanent, but the franchisee failed to do so. Despite the presence of a no-waiver clause in their agreement, the court, applying Indiana law, found that the franchisor waived its right to terminate based on the franchisee’s failure to renew in writing where the franchisor allowed the franchisee to continue to operate in the two territories and even retroactively granted a lim-ited extension of these territorial rights. The court let a jury verdict in the franchisee’s favor stand, noting that the fran-chisor should not “be permitted to interpose ‘boilerplate’ contract language in an attempt to obtain a result which the jury could, on the basis of the evidence presented, reasonably have found to be unduly harsh to [the franchisee].”39
In Cin-Doo,40 in which the court applied New Hamp-shire law, the parties’ franchise agreement specifically stated that no agent of the franchisor “is authorized to make any modification, addition, or amendment to or waiver of this Agreement unless in writing and executed by an Assistant Secretary of” the franchisor. During the course of the fran-chisee’s operation of the store, the franchisor discussed the possibility of updating the store and constructing an addi-tion with the franchisee and then, despite the franchisee’s initial disagreement, decided it would rather reconstruct the entire store. When nearby construction of an unrelated retail store took place that affected the franchisee’s traf-fic, the franchisor assured the franchisee that its problems
Some courts have held that boilerplate clauses are insufficient to prevent waiver or modification
would be resolved by the reconstruction of the store. Senior management of the franchisor even told the franchisee that its store would be reconstructed the following year, but none of these promises were ever reduced to writing. The franchi-see subsequently sold its other store for less than its market value because of the expected revenues from the soon-to-be reconstructed store, but the franchisor never reconstructed the franchisee’s remaining store and actually gave part of the real estate where the franchisee’s store was locat-ed to the other unrelated retail store that caused the franchisee’s traffic prob-lems. The court refused to grant summary judgment in the franchisor’s favor, reasoning that the franchi-see might be able to prove that the franchisor’s promise to reconstruct the store was enforceable on the grounds of estoppel or waiver despite the presence of no-waiver and no-modification clauses. In doing so, the court added that “[a]n express provision in a written contract that no rescission or variation shall be valid unless it too is in writing is ineffective to invalidate a subsequent oral agreement to the contrary.”41
A MORE nuAnCED APPROACH
With respect to no-waiver and no-modification clauses, most jurisdictions take a nuanced approach. For example, in In re Doctors Hospital of Hyde Park, Inc.,42 the court noted that under New York law, “[g]enerally a written agreement expressly stating that it can be modified only in writing can-not be modified orally.” But, continued the court, “[t]here are two exceptions to this general principle”: (1) where there has been partial performance “so long as the partial performance is ‘unequivocally referable’ to the oral modification” and (2) where equitable estoppel is appropriate.43 Other states require mutual assent,44 “such specificity” that there is “no doubt of the intention of the parties to change what they previously sol-emnized by formal document,”45 or acquiescence to a course of conduct consistent with acceptance of the modification.46 In New York,47 courts will “give effect to oral modifications to a written contract (even where that contract prohibits such modification), if the parties’ partial performance of the con-tract is ‘unequivocally referable’ to the oral modification,” notwithstanding a New York statute that expressly enforces contractual prohibitions against oral modification.48
Specifically, “[i]f the performance can be viewed as con-sistent with the terms of the agreement as written, then that performance is not unequivocally referable to the oral modi-fication, and will not be treated as a contract modification.”49 Delaware law, too, requires specificity such that the subse-quent “course of conduct must explicitly address the contract provision in order to modify the parties’ agreement.”50 This is a “difficult standard,” which requires a party to present proof that “leaves no doubt” the parties intended to change their
previously executed formal agreement.51 Because the inquiry centers on intent and mutual assent, courts are unlikely to find modification by conduct where one party has simply failed to exercise its rights under that term.52
In one case involving the issue of mutual assent, Southern States Cooperative, Inc. v. Global AG Associates, Inc.,53 a fed-eral district court in Pennsylvania applying Virginia law (but noting that the New Jersey statutory claim was viable under
New Jersey law) refused to grant summary judgment to a franchisor on the issue of contractual modifica-tion despite an unambigu-ous contract provision that prohibited modification by “conduct, custom, or course of dealing” and that required all modifications be in writ-
ing and executed by both parties. The court held that summa-ry judgment was inappropriate because there were fact issues regarding damages in light of evidence that the franchisor and franchisee routinely negotiated payment terms on a monthly basis. The dispute between the franchisor and franchisee in that case involved a disagreement over whether the franchi-sor could collect 18 percent interest on delinquent payments, as allowed under the parties’ agreement. The court refused to grant summary judgment to the franchisor because the parties negotiated payment terms on an ongoing basis, so the court was unable to determine damages as a matter of law.54
In Honeywell International, Inc. v. Air Products & Chemi-cals, Inc., a case under New York law, plaintiff and defendant were parties to an agreement whereby plaintiff manufactur-er agreed to sell its products to defendant, which would then market and sell the plaintiff ’s product.55 The case turned on the definition of two terms, product and customers, in their agreement. There appeared to be little doubt that the par-ties modified the agreement’s definition of these terms as they related to their profit-sharing agreement because the parties actually shared the profits based on definitions of those terms that were different from those in the franchise agreement, despite the agreement requiring “all modifica-tions to be in writing.”56 Interestingly, the trial court held that the modification of those terms was for that one pur-pose only; according to the trial court, the parties did not also modify those terms for purposes of contract termina-tion.57 The reviewing court found this to be error and held that the trial court’s conclusion of a limited modification was “legally erroneous” because it failed to interpret the agreement consistently.58 Thus, notwithstanding the parties’ express requirement that all modifications be in writing, the trial court and appellate court both held, albeit to different extents, that the agreement may have been modified.
In KBQ, Inc. v. E.I. DuPont de Nemours & Co.,59 the par-ties disputed whether the franchisor’s subsequent conduct modified the termination provision from at-will to one that required cause and an opportunity to cure. In applying Del-aware law, the court held that “modification by subsequent
The franchisor must balance the need to adjust and respond to system changes and franchisees’ needs while
conduct required such specificity as to leave no doubt of the intention of the parties to change what they previously sol-emnized by formal document.”60 The court refused to find modification even though (1) the franchisor gave the fran-chisee an “opportunity to cure perceived shortcomings in staffing”; (2) the franchisor approved the franchisee’s busi-ness plans and hiring of additional staff; and (3) the franchi-sor made “statements of congratulations” and “repeated use of terms such as ‘partnership’ and ‘long term relationship,’” holding that this conduct was not “sufficiently specific” to modify the terms of the agreement.61
A party may sometimes use one doctrine in an effort to defeat the other. In Davidson v. Conocophillips Co.,62 the fran-chisee sought rent reimbursement for the construction of a car wash that it had constructed without prior approval of the franchisor. The franchisee argued, among other things, that the franchisor had orally agreed to rent reimbursement and had already received governmental approval and pur-chased equipment by the time the franchisor decided that it would not assist the franchisee. The franchisee sued under California law and argued that the franchisor waived the no-modification term in their agreement because in its earlier snack shop remodeling, the franchisee made improvements without prior approval and the franchisee received reim-bursement. The franchisor argued that the previous remod-eling job was an anomaly, and the prior reimbursement explicitly stated that no additional remodeling would occur without prior written consent of the franchisor. The court held that this express agreement was enough to defeat the franchisee’s claim that the franchisor’s prior conduct waived the no-modification clause and granted summary judgment to the franchisor.63
COnCLuSIOn
A franchise relationship is fluid, not stagnant. It is natural for that relationship to grow and change during the term of the franchise agreement. It is also natural for a franchisor to want to relax contractual requirements when economic cir-cumstances necessitate it. What the franchisor must balance, however, is the need to adjust and respond to system changes and franchisees’ needs while preserving its contractual rights set forth in the franchise agreement. Franchisors have a good start when they include a no-waiver or no-modification clause in their franchise agreements; but because some juris-dictions will not find their inclusion determinative, franchi-sors will need to take other active steps to ensure that their management, sales, and operations teams know the terms of the agreement and communicate effectively when providing temporary relief from obligations under the franchise agree-ment or when making changes to the parties’ obligations.
An obvious starting point for ensuring predictability is that if the franchise system makes modifications to its agree-ments, it should put them in writing, either as an amend-ment or addendum to the franchise agreement, or as another document that requires the signatures of the franchisees. At a minimum, such modifications should be in a system-wide
memorandum. Creating an environment where a franchisor can show that when it intended to modify the terms, it did so in writing will help a franchisor defend against an oral modification claim by showing that oral modifications are contrary to its practice.
If the franchisor wants to make temporary changes to the system (such as allowing a temporary forbearance plan), franchisors may also want to consider expressly stating that the plan is temporary, that the franchisor reserves the right to require strict compliance with the original terms in the future, and that none of the franchisor’s actions constitute a waiver or modification of any kind.
Additionally, communicating to the franchisor team the risk of inaction in the face of noncompliance is critical. The longer a franchisor knows about a franchisee’s noncompli-ance and does not address it, the greater the risk that the franchisor will not be able to enforce its rights, particularly if the franchisee can show that it has detrimentally relied on the franchisor’s inaction. If a franchisor finds itself in a situ-ation where there may be doubt about the applicable rights given either past lack of enforcement or mixed messages, a franchisor may consider sending a “last chance” letter to the franchisee, communicating specifically with the franchisee about the franchisor’s expectations and providing express notice of what needs to happen moving forward.
Like several other aspects of franchise law, active inter-action and direct and unequivocal communication between the franchisor and franchisee should lessen the risk of ambi-guities arising over the obligations and rights of each party throughout the franchise relationship, including allowing the franchise agreement to be the last (and only) word.
EnDnOTES
1. CMS Enter. Group v. Ben & Jerry’s Homemade, Inc., No. 1991-C-7849, 1995 WL 500847, at *4 (Pa. Ct. Com. Pl. Aug. 3, 1995).
2. See, e.g., Burger King Corp. v. E-Z Eating 41 Corp., 572 F.3d 1306, 1315 (11th Cir. 2009) (under Florida law); Barrand, Inc. v. Whataburger, Inc., 214 S.W.3d 122, 144 (Tex. App. 2006); Dunkin’ Donuts, Inc. v. Panagakos, Civ. Action No. 96-11040-RGS, Bus. Franchise Guide (CCH) ¶ 11,474 (D. Mass. May 8, 1998).
3. Dunkin’ Donuts, Bus. Franchise Guide (CCH) ¶ 11,474. 4. 139 F. Supp. 2d 147, 157 (D. Mass. 2001). 5. Waiver is even more disfavored in Louisiana, where conduct
indicating waiver must be “so inconsistent with the intent to enforce the right as to induce a reasonable belief that it has been relin-quished.” Tate v. Charles Aguillard Ins. & Real Estate, Inc., 508 So. 2d 1371, 1374 (La. 1987).
6. Ramada Franchise Sys., Inc. v. Capitol View II Ltd. P’ship Venture, 132 F. Supp. 2d 358, 363–64 (D. Md. 2001).
7. Terry Int’l v. Dairy Queen, Inc., 554 F. Supp. 1088, 1095 (N.D. Ind. 1983).
8. Id.9. 31 C.J.S. Estoppel and Waiver § 89 (2008); see also Sacred Heart
Health Sys., Inc. v. Humana Military Healthcare Servs., Inc., 601 F.3d 1159, 1181 (11th Cir. 2010) (applying Florida law and holding that forbearance for reasonable time will not be waiver).
10. See U.C.C. 2-209(5).11. Id.; see also PC COM, Inc. v. Proteon, Inc., 946 F. Supp. 1125,
1133 (S.D.N.Y. 1996) (finding fact issues as to whether defendant’s communications were “reasonable notification” and whether with-drawal of waiver worked an injustice).
12. 92 F. Supp. 2d 119, 130 (E.D.N.Y. 2000).13. See also Am. Suzuki Motor Corp. v. Bill Kummer, Inc., 65
F.3d 1381, 1388 (7th Cir. 1995).14. See 2 R. Anderson, Uniform Commercial Code § 2-209:7,
at 319 (3d ed.1982). 15. Elliot & Frantz, Inc. v. Ingersoll-Rand Co., 457 F.3d 312, 322
(3d Cir. 2006).16. W. Michael Garner, 2 Franchise & Distribution Law &
Practice § 8.19 (Sept. 2009) (“In order to modify an agreement, there must be intent to modify.”).
17. See New Eng. Surfaces, Inc. v. E.I. DuPont de Nemours & Co., No. 06-cv-89-P-S, Bus. Franchise Guide (CCH) ¶ 13,713 (D. Me. Sept. 14, 2007).
18. Haynes Trane Serv. Agency, Inc. v. Am. Standard, Inc., 573 F.3d 947 (10th Cir. 2009) (manufacturer’s pattern of terminating with cause was insufficient to find that the contractual right to terminate without cause had been modified).
19. Id.20. Id. at 956–57.21. See Garner, supra note 16, § 8.22 (noting that if the statute of
frauds applies, “it will bar oral modification of such an agreement”).22. Wixon Jewelers, Inc. v. Di-Star, Ltd., Case No. 99-3401,
Bus. Franchise Guide (CCH) ¶ 11,909 (8th Cir. July 27, 2000) (“A modification to a contract must, itself, satisfy the statute of frauds if it would be subject to the statute of frauds were it a separate con-tract.”) (citation omitted); Allied Sales & Serv. Co. v. Global Indus. Tech., Inc., Case No. 97-0017-CB-M, Bus. Franchise Guide (CCH) ¶ 11,873 (S.D. Ala. May 1, 2000) (“The statute of frauds must also be satisfied ‘if the contract as modified is within its provisions.’”) (citation omitted); Koehler Enter., Inc. v. Shell Oil Co., Civ. Action No. WN-92-727, Bus. Franchise Guide (CCH) ¶ 13,724 (N.D. Ohio Sept. 25, 2007); see also Cin-Doo, Inc. v. 7-Eleven, Inc., Civ. 04-cv-50, ¶ 10,253 (D. Md. Feb. 22, 1993) (“Maryland law also provides, however, that changes to a contract subject to the statute of frauds in its modified form must be in writing.”).
23. Nicole S. Zellweger, Enforceability of Oral Franchise Agree-ments, 28 Franchise L.J. 3 (Winter 2009) (discussing estoppel and part performance in context of oral agreements in general); see also Koehler Enter., Bus. Franchise Guide (CCH) ¶ 13,724; see also Cin-Doo, Civ. 04-cv-50, ¶ 10,253 (examination of estoppel even though oral modification subject to statute of frauds); Stelwagon Mfg. Co. v. Tarmac Roofing Sys., Inc., 862 F. Supp. 1361, 1366 (E.D. Pa. 1994), affirmed in part, vacated in part on other grounds by 63 F.3d 1267 (3d Cir. 1995) (finding waiver due to industry course of dealing).
24. Koehler Enter., Bus. Franchise Guide (CCH) ¶ 13,724; see also Cin-Doo, Civ. 04-cv-50, ¶ 10,253 (holding under Maryland law that “[a]n equitable estoppel may arise where there is voluntary conduct or a voluntary representation by the party to be estopped which induces detrimental reliance on the part of the party asserting the estoppel”).
25. Am. Standard, Inc. v. Meehan, Case No. 3:07CV02377, Bus. Franchise Guide (CCH) ¶ 13,724 (N.D. Ohio Sept. 25, 2007); see also Cin-Doo, Inc. v. 7-Eleven, Inc., Civ. 04-cv-50-SM, 2005 WL
768592, at *4 (D.N.H. Apr. 6, 2005) (unpublished) (citing Restate-ment (Second) of Contracts § 90 and observing that promissory estoppel involves a statement that the maker reasonably expects will induce action or forbearance on the part of the other party, which does produce such action).
¶ 11,840 (D. Conn. Feb. 16, 2000).28. Id.29. Cin-Doo, 2005 WL 768592, at *3.30. Id.; see also Luther v. Kia Motors Am., Inc., No. 08-386, 2008
WL 2397331, at *3 (W.D. Pa. June 12, 2008) (holding that although it was not technically considering plaintiff’s estoppel claim because it was raised in briefing and not in the complaint, plaintiff still sur-vived a motion to dismiss on its negligent misrepresentation claim, which was similar to plaintiff’s estoppel claim).
31. Many times franchisors win on these claims. See, e.g., Dunkin’ Donuts, Inc. v. Panagakos, Civ. Action No. 96-11040-RGS, Bus. Fran-chise Guide (CCH) ¶ 11,474 (D. Mass. May 8, 1998) (refusing to find estoppel where franchisee had unclean hands); Haynes Trane Serv. Agency, Inc. v. Am. Standard, Inc., 573 F.3d 947, 958 (10th Cir. 2009) (same); Am. Standard, Bus. Franchise Guide (CCH) ¶ 13,724 (hold-ing that statements that it would not terminate without cause were not made with intent or knowledge that they would be relied upon and that franchisee could have made effort to confirm discussions in writing).
32. Garner, supra note 16, § 8.19 (“Where a written agreement provides that it can only be modified by a signed writing, an oral modification ordinarily is not enforceable.”); see also LaGuardia Assocs. v. Holiday Hospitality Franchising, 92 F. Supp. 2d 119, 128 (E.D.N.Y. 2000).
33. Dunkin’ Donuts Franchised Rests. LLC v. KEV Enters., Inc., 634 F. Supp. 2d 1324, 1334 (M.D. Fla. 2009).
34. Cohen Fashion Optical, Inc. v. V&M Optical, Inc., 858 N.Y.S.2d 260, 261 (N.Y. App. Div. 2008) (“The defendants’ claim that the parties entered into an enforceable oral modification of the subject franchise agreement is precluded by the express terms of the agreement. . . .”).
35. Days Inn Worldwide, Inc. v. Adrian Motel Co., LLC, No. 07-13523, 2009 WL 3199882, at *8 (E.D. Mich. Sept. 30, 2009); see also Super 8 Motels, Inc. v. Rahmatullah, Civ. No. 07-01358, 2009 WL 2905463, at *8 (S.D. Ind. Sept. 9, 2009) (franchisee’s claim of oral modification that contradicted franchise agreement denied where franchise agreement required any modifications to be in writ-ing and signed by franchisor).
36. Case No. 8:09-CV-131-T-17MAP, Bus. Franchise Guide (CCH) ¶ 14,151 (M.D. Fla. June 5, 2009).
Cir. 1983).39. Id. at 518–19.40. Cin-Doo, Inc. v. 7-Eleven, Inc., Civ. 04-cv-50-SM, 2005 WL
768592, at *1 (D.N.H. Apr. 6, 2005).41. Id.42. In re Doctors Hosp. of Hyde Park, Inc., 373 B.R. 53, 63
(Bankr. N.D. Ill. 2007); see also Davidson v. Conoco Phillips Co., No. C08-1756BZ, 2009 WL 2136535, at *3–5 (unpublished) (analyz-ing modification pursuant to California statutes).
Litigation and Dispute Resolution DivisionEarsa Jackson (2012)Strasburger & Price, LLP214/[email protected]
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44. S. States Coop., Inc. v. Global AG Assocs., Inc., Case No. 06-1494, Bus. Franchise Guide (CCH) ¶ 13,878 (E.D. Pa. Mar. 27, 2008).
45. KBQ, Inc. v. E.I. DuPont de Nemours & Co., Civ. Action No. 97-40114-PBS, Bus. Franchise Guide (CCH) ¶ 11,451 (D. Mass. May 21, 1998).
46. Cromeens, Holloman, Sibert, Inc. v. AB Volvo, 349 F.3d 376 (7th Cir. 2003) (no modification under Illinois law because the occur-rences were contemplated by the contract and the manufacturer never had a chance to acquiesce to different terms).
47. Contract law is state-specific, and many of the statements contained herein are general principles of contract law. Readers are encouraged to consult with their particular state’s law.
48. Honeywell Int’l, Inc. v. Air Prods. & Chems., Inc., 872 A.2d 944, 955 (Del. 2005); N.Y. Gen. Oblig. Law § 15-301; Rose v. Spa Realty Assocs., 366 N.E.2d 1279, 1283 (N.Y. 1977) (“On the other hand, when the oral agreement to modify has in fact been acted upon to completion, the same need to protect the integrity of the written agreement from false claims of modification does not arise. In such case, not only may past oral discussions be relied upon to test the alleged modification, but the actions taken may demonstrate, objec-tively, the nature and extent of the modification. Moreover, apart from statute, a contract once made can be unmade, and a contractu-al prohibition against oral modification may itself be waived.”) (cita-tion omitted); O’Reilly v. NYNEX Corp., 693 N.Y.S.2d 13,14 (N.Y. App. Div. 1999) (“Plaintiffs’ claims based on an alleged oral promise not to terminate the contracts between plaintiffs and the corporate defendants were properly dismissed since the written agreements prohibited oral modifications and plaintiffs alleged neither full performance of the alleged modification nor partial performance unequivocally referable to the oral promise.”) (citations omitted).
49. Honeywell Int’l, 872 A.2d at 955.50. KBQ, Inc. v. E.I. du Pont de Nemours & Co., 6 F. Supp. 2d
94, 99 (D. Mass. 1998).51. Id.; see also Eclipse Med., Inc. v. Am. Hydro-Surgical Instru-
ments, Inc., 262 F. Supp. 2d 1334, 1361 (S.D. Fla.1999) (holding that “modification by oral agreement or conduct must be based on ‘clear and unequivocal evidence of a mutual agreement’ to amend the writ-ten contract, such that failure to enforce the amendment would work fraud on either party to refuse to enforce it”).
52. That said, one should still be concerned that a court may find waiver in these instances.
Puerto Rico’s Dealer and Franchise Statute Adapts to the Latest Developments in Law,
Commerce, and TechnologyManuel A. Pietrantoni and Ricardo F. Casellas
P uerto Rico’s Dealer’s Contract Law, commonly known as Law 75,1 pro-
tects dealers and franchisees against the termination, nonre-newal, or impairment of their agreements without just cause. The statute defines just cause to include a dealer’s failure to per-form “any of the essential obliga-tions” of the agreement, as well as “any action or omission . . . that adversely and substantially affects the interests of the prin-cipal or grantor in the marketing or distribution of the merchan-dise or service.”2
Law 75 was enacted forty-six years ago after intense lobbying from Puerto Rican dealers who were frustrated with suppliers that unilaterally terminated distribu-tion agreements so that they could supply clients directly after deal-ers had developed local markets for their products.3 The statute has withstood constitutional attacks4; intense lobbying from manufacturers and suppliers that want it abolished; and several amendments attempting to conform it to federal laws, such as an amendment regard-ing the validity of arbitration clauses in distribution agree-ments.5 Still, the interpretation of Law 75 and the impact of the statute are constantly evolving in light of current develop-ments in law, commerce, and technology—from mergers and acquisitions to the integration of the global markets, from the nuances of constructive termination to the scope of protec-tion afforded by federal trademark and copyright law. This article focuses on how each of these commercial and legal issues affects or is affected by the protections that Law 75 pro-vides to dealers and franchisees in Puerto Rico.6
TRAnSFERS, ASSIgnMEnTS, OR ACquISITIOnS
Law 75 provides that a principal or franchisor does not have “just cause” for terminating a distribution or franchise
Manuel A. Pietrantoni and Ricardo F. Casellas are trial lawyers and shareholders in the firm of Casellas Alcover & Burgos PSC in San Juan.
agreement merely because a dealer or franchisee violates an agreement provision that restricts its rights to sell, trans-fer, or otherwise assign its license or distribution rights to another party or to change its capital structure, manage-ment, or financing. To avoid liability under the statute, a principal or franchisor must prove that any such change has or will substantially hurt the development of the market, the distribution of merchandise, or the rendering of services.7
No judicial opinions have addressed this provision of Law 75. Nevertheless, the broad discretion that Law 75 affords dealers to assign their distribution rights appears to conflict with Article 1065 of the Puerto Rico Civil Code, which provides that “[a]ll the rights acquired by virtue of an obligation are transmissible, subject to law, should there be no stipulation to the contrary.”8 Put differently, an agree-ment that carries a nontransferable clause is valid and bind-ing upon the parties under the Puerto Rico Civil Code.
In addition, even in cases where the franchise agreement does not contain a transfer clause, to the extent that the prin-cipal-dealer relationship can be classified as a creditor-debt-or relationship, Law 75 may be at odds with Article 1159 of the Puerto Rico Civil Code, which provides that “[n]ovation, consisting in the substitution of a debtor in the place of the original one, may be made without the knowledge of the lat-ter, but not without the consent of the creditor.”9
Thus, the Puerto Rico Civil Code may afford principals broader rights to terminate for just cause than does Law 75. But the apparent conflict between a dealer’s right to trans-fer a distribution agreement under Law 75 and a principal’s right to prohibit such a transfer under the Puerto Rico Civil Code probably would be decided in favor of the dealer under the settled principle that when the terms of a specific statute (Law 75) and the terms of a general law conflict, the specific statute controls.10 Still, the Puerto Rico Civil Code’s provi-sions can be influential in a situation in which a franchisee transfers its rights without notice and consent of the fran-chisor because Law 75 creates a sufficiently close relation-ship between the franchisor and franchisee such that there is a legitimate interest in approving the transfer and substitu-tion of a third party.
In other contexts, the U.S. Court of Appeals for the First Circuit and the U.S. District Court for the District of Puer-to Rico have upheld the terms of a distribution contract if those terms are clear and unambiguous, even if they are inimical to the letter of Law 75. For example, with respect to forum selection clauses, Law 75 provides that any contrac-tual requirement for dealers to litigate any contract-related
controversy that arises outside of Puerto Rico or under foreign law or rule of law shall be deemed to violate public policy and thus be null and void.11 Despite this provision, however, courts routinely have enforced forum selection clauses that mandate litigation outside Puerto Rico.12
As another example, the court in Nike International Ltd. v. Athletic Sales, Inc. gave full force and effect to the renewal clause of a distribution agreement stating that the agreement would be automatically canceled if the dealer did not provide express notice of renewal within a prescribed time. The court did so despite the provision in Law 75 that “[n]otwithstanding the existence in a dealer’s contract of a clause reserving to the parties the unilateral right to terminate the existing relation-ship, no principal or grantor may . . . refuse to renew said contract on its normal expiration, except for just cause.”13 In holding the clause enforceable, the court relied on an article of the Puerto Rico Civil Code providing, “If the terms of a contract are clear and leave no doubt as to the intentions of the contracting parties, the literal sense of its stipulations shall be observed.”14 The court reasoned that “the legislature did not intend that Law 75 be a safe-haven for dealers to avoid the express terms of the contracts to which they willingly sub-scribed.”15 Thus, although Law 75 prohibits a principal from acting unilaterally or subjectively to terminate its agreement with a dealer without just cause, the statute does not necessar-ily prohibit a principal from terminating an agreement when the dealer has breached the agreement’s literal terms.
The Puerto Rico Supreme Court also has made clear that Law 75 does not afford dealers the right to act arbi-trarily with respect to their sales policies or to transform dealerships into “interminable relationships.”16 In Medina & Medina v. Country Pride Foods, Ltd., the court, examining the “history, sources, and raison d’être” of the statute, con-cluded that there is no bond between dealers and principals created by agreement or by a relation of dependency that subordinates one to the other. The court added thus:
We cannot possibly construe the statute in such a way that the dealer would govern—by imposing his conditions—the principal’s sales policies, or vice versa, with the inevitable loss of the financial and legal autonomy of both. Such inter-pretation would be contrary to public order because it would place an unreasonable restriction on man’s free will.17
In sum, an argument can be made that, despite Law 75’s language, a principal can unilaterally terminate its relation-ship with a dealer if the dealer assigns its distribution rights to another contrary to the “literal terms” of their distribution agreement because prohibiting termination in that circum-stance would place an unreasonable restriction on the prin-cipal’s right to choose the dealer that will resell its products. Nevertheless, in light of the language of Law 75, principals often find themselves hard-pressed to refuse to consent to a transfer of their dealers’ distribution rights absent just cause.
On the other hand, Law 75 is silent as to whether a princi-pal may assign, transfer, or sell its brand to another supplier without a dealer’s consent. Yet the statute’s clause protecting
a dealer from direct or indirect termination, impairment, or nonrenewal of its distribution agreement upon its express expiration date without just cause certainly has a bearing on this issue.18 In Goya de Puerto Rico, Inc. v. Rowland Cof-fee,19 the Puerto Rico district court concluded that the for-mer owner of a brand name of coffee distributed in Puerto Rico by an exclusive dealer was not liable under § 278a for an improper termination of the dealership agreement that allegedly occurred after the former owner assigned or transferred its rights and obligations under the dealer-ship agreement to a third-party principal. For many years, Goya de Puerto Rico, Inc. was the exclusive distributor in Puerto Rico for Café Bustelo coffee, a brand that had been owned by Tetley USA, Inc. Eventually, however, Tetley sold its Café Bustelo brand to Rowland Coffee Roasters, Inc., which “‘assumed Tetley’s obligations to [Goya] as exclusive distributor for Café Bustelo brand coffee’” in Puerto Rico as well as certain Caribbean countries. After Goya’s and Rowland’s relationship soured and Rowland began to sell coffee directly to customers in Puerto Rico, Goya sued both Rowland and Tetley for unjust impairment and termination under Law 75. Among other things, Goya alleged that Tet-ley breached its exclusive distribution rights by selling them to Rowland without compensating Goya.20 Relying on civil law, the court held that Tetley was not liable because Goya consented to the assignment to Rowland, which assumed all of the obligations under the distribution agreement, and therefore released Tetley from any liability stemming from the agreement for acts occurring after the assignment.21
One year later, in V. Suárez & Co., Inc. v. Dow Brands, Inc.,22 the First Circuit addressed the question of whether assignments without dealer consent constitute improper ter-minations under Law 75. In that case, manufacturer Dow terminated its distributor of household cleaning supplies in Puerto Rico after selling its product line to another compa-ny. The dealer sued Dow for termination without just cause under Law 75 after it was informed that Dow would no lon-ger be able to provide it products for distribution because of the sale. Analyzing Law 75’s definition of just cause, the court stated thus:
From a plain reading of the statute, it may appear that only action or inaction on the part of the dealer would provide just cause to allow a principal to terminate the relationship. But a plain reading of Act 75 would produce, in some situa-tions, absurd and constitutionally suspect results. As a con-sequence, the courts have filled in other readings.23
The First Circuit upheld Dow’s right to terminate, relying on two decisions by the Puerto Rico Supreme Court, Medina24 and Borg Warner International Corp. v. Quasar Co.25
In Medina, the court concluded that market withdrawal may constitute just cause, reasoning that Law 75 does not bar a principal from withdrawing from the Puerto Rican market when its action is not aimed at usurping the good-will or clientele established by the dealer and when the withdrawal, which constitutes just cause for terminating the
relationship, occurs because the parties have bargained in good faith but have not been able to agree on price, credit, or some other essential element of the dealership. In any case, the court held that the withdrawal must be preceded by a previous notice term, depending on the nature of the fran-chise, the characteristics of the dealer, and the nature of the pretermination negotiations.26
In Borg Warner, the court went a step further. There, the court “found just cause even when the product line continued to be distributed in Puerto Rico” and “dispensed” with the requirement for “prior notice in circumstances where the prin-cipal’s legitimate business reasons, totally independent of the . . . dealer, made giving notice to the dealer unreasonable.”27
The court in Dow concluded that not all situations war-rant negotiations prior to market withdrawals, especially where, as in that case, the dealer’s performance had declined steadily over time, the dealer had considered divesting itself of its distribution responsibilities, and the dealer had already stopped reselling several products in the line. The court reasoned that requiring the principal to negotiate with the dealer in these circumstances would not serve the pri-mary interest of Law 75, i.e., preventing the principal from unfairly usurping the distributor’s hard-won clientele and goodwill, and, indeed, would undermine the statute’s stated goal of encouraging a level playing field. The court stated,
Here, either negotiation would be meaningless or the plain-tiff dealer would acquire leverage it would not otherwise possess. This latter effect would create a new imbalance of power, making the entirely legitimate and unrelated corpo-rate interests of the principal in divesting itself of a product line subject to the interests of dealers. To read the Act to require such a result could discourage national and multina-tional companies from entering into distributorship agree-ments subject to Act 75 in Puerto Rico.28
The Dow court also determined that because there was “little reliance by [the dealer] on [the principal’s] line of busi-ness, and there was little [the dealer] could have done to pre-pare for [the] termination,” even with advance notice, it was reasonable to dispense with the prior notice requirement.29
The First Circuit’s opinion in Dow, together with the Puerto Rico Supreme Court’s opinions in Medina and Borg Warner, support the proposition that a manufacturer or supplier can sell or transfer its product lines without a deal-er’s consent and, in some circumstances, even without prior notice. It remains to be seen, however, whether the Puerto Rico Supreme Court will dispense with the negotiation and notice requirements altogether.
PRODuCT SALES DIvERSIOn
Law 75 does not operate to grant exclusivity,30 but it does protect dealers that have been granted exclusivity from the impairment of that right absent just cause. Specifically, the statute states that “no principal or grantor may directly or indirectly perform any act detrimental to the established
relationship . . . except for just cause.”31 Thus, if a princi-pal grants a dealer exclusivity and then, without just cause, sells directly to the trade or through another Puerto Rican dealer, the principal’s actions constitute an “impairment” under Law 75.32 That determination is straightforward. Oth-ers, however, are more complex.
In today’s global economy, market integrations and tech-nological advances threaten the grant of exclusivity that principals may have given to dealers for a determined geo-graphic area. For example, a distributor’s rights to exclusiv-ity in a specific market may be impaired when consumers in that market purchase products over the Internet, either from the principal or another distributor. Such exclusive rights also may be impaired when consumers purchase from an out-of-state national wholesaler or from another distribu-tor that can sell at a lower price than a Puerto Rican dealer presumably could. Several cases have addressed these more complicated scenarios.
In General Office Products Corp. v. Gussco Manufacturing, Inc.,33 the court considered whether a principal that granted exclusivity to its Puerto Rican dealer impaired that right of exclusivity under Law 75 by failing to take action against a third-party reseller interfering with the dealer’s market in Puerto Rico. The court concluded that once the exclusive dealer alerted the principal to the third party’s interference, the principal impaired the dealer’s right to exclusivity by failing to take action to prevent that interference. Although the principal was not required to act as a watchdog, once the dealer informed the principal of the problem, the court reasoned, the principal had a duty to act to prevent further interference.34 The court, however, gave no indication of the nature and extent of measures that the principal would have had to take to avoid liability under Law 75.
In Irvine v. Murad Skin Research Laboratories, Inc.,35 the First Circuit applied the rationale of Gussco in holding that a principal impaired a dealer’s right to exclusivity when it failed to stop an infomercial from being aired in Puerto Rico, causing the dealer’s clients to purchase the products adver-tised in the infomercial directly from the principal instead of from the dealer. In that case, the dealer was a corpora-tion that sold skin care products to the trade and salons. The principal was a stateside manufacturer of those products. The principal “broadcast an infomercial on various stateside cable television stations as part of its advertising campaign.” Without the principal’s knowledge, a New York broadcaster relayed the infomercial to Puerto Rico, making the princi-pal’s products available locally through telemarketing. The court concluded that a reasonable fact finder could have determined that the principal failed to take timely action to correct this interference once the dealer put it on notice and thus could have determined that the principal impaired the dealer’s exclusive distribution rights.36
Finally, in Twin County Grocers, Inc. v. Méndez & Co., Inc.,37 a cooperative-based warehouse distributor from New Jersey sought a declaratory judgment that Law 75 did not require it to prevent a third-party reseller from selling its products in Puerto Rico to Puerto Rican retailers, even though a local
dealer had been granted exclusive distribution rights, as long as the third-party reseller’s sales were conducted outside of Puerto Rico. The court disagreed, concluding that Law 75’s protection is not limited to situations in which a grantor or third party establishes a line of distribution within Puerto Rico but also covers situations in which Puerto Rican retail-ers bypass local distributors purchasing goods on the main-land from stateside wholesalers. The fact that the retailers purchase the goods outside of Puerto Rico does not less-en the impairment of the dealer’s exclusive agree-ment, the court concluded. “Whether such impairment results from a grantor or third party establishing a parallel line of distribution within the Commonwealth or from selling to Puerto Rico retailers outside of the island is not determinative,” the court stated.38 Although the court ultimately found that material issues of fact as to the existence of exclusive distribution agreements preclud-ed summary judgment, its decision is significant because it expands the protection that Law 75 affords to dealers against purchases made from national wholesalers or dis-tributors that conduct sales stateside for eventual resale to consumers in Puerto Rico.
COnSTRuCTIvE TERMInATIOn
Even though the remedies provision of Law 75 applies to both termination and impairment causes of action, courts in impairment cases usually allow only recovery of net profits from actual lost sales rather than the more severe remedies applied in termination cases.39 The remedies for termination may include the following:
(a) The actual value of the amount expended by the dealer in the acquisition and fitting of premises, equipment, installations, furniture and utensils, to the extent that these are not easily and reasonably useful to any other activity in which the dealer is normally engaged;
(b) The cost of the goods, parts, pieces, accessories and utensils that the dealer may have in stock, and from whose sale or exploitation he is unable to benefit;
(c) The goodwill of the business, or such part thereof attributable to the distribution of the merchandise or to the rendering of the pertinent services;
(d) The amount of the profit obtained in the distribution of the merchandise or in the rendering of the services, as the case may be, during the last five years, or if less than five, five times the average of the annual profit obtained during the last years, whatever they may be.40
In an effort to recover the full benefits of termination damages, however, dealers may argue that some acts of
principals that generally would constitute impairment, such as violating a dealer’s exclusive distribution rights, actually constitute constructive or de facto terminations instead. A dealer deprived of its right to exclusivity would argue that the exclusivity clause is the essence of the distribution agree-ment and that the loss of exclusivity results in a material reduction in the value of the agreement.
This argument has not been tested in Puerto Rico, how-ever, since the U.S. Supreme Court issued its opinion earlier
this year in Mac’s Shell Ser-vice, Inc. v. Shell Oil Prod-ucts Co. LLC.41 The Court held that substantial chang-es in rental terms imposed by a franchisor did not con-stitute constructive termi-nation under the Petroleum Marketing Practices Act (PMPA) because the fran-chisees were not compelled to abandon their franchises
but instead continued to occupy the same premises, receive the same fuel, and use the same trademarks. The Court was careful to limit its holding to constructive termination claims under the PMPA, stressing that “franchisees can still rely on state-law remedies to address wrongful franchisor con-duct that does not have the effect of ending the franchise.”42 Yet principals undoubtedly will argue that where the dealer continues reselling the principal’s product, the same reason-ing should apply to constructive termination claims under Law 75; that is, any constructive termination claim under state law should require an actual abrogation of the fran-chise, especially in light of the fact that the statute provides relief for impairment claims.
Dealers, on the other hand, may argue that even if an agreement is not literally terminated, actions by a principal that affect the essence of the agreement or are materially adverse to the operations, distribution value, or financial well-being of a Puerto Rican dealer can constitute construc-tive termination. Such actions may include, among others, realigning a dealer’s sales territory43 or divesting a dealer of the exclusivity that it enjoyed under its agreement with the principal.44 The only Puerto Rico decision touching on this issue, Eliane Exportadora, Ltda. v. Maderas Alfa, Inc., is unreported and contains no discussion of constructive ter-mination.45 The appellate court did conclude, however, that the principal’s impairment of the dealer’s exclusive distribu-tion rights constituted a de facto termination. In doing so, the appellate court provided no analysis or reasoning for its conclusion, but it is worth noting nonetheless given that no other Puerto Rican case has addressed the issue.
PREEMPTIOn unDER FEDERAL COPyRIgHT AnD TRADEMARK LAWS
The Puerto Rico courts have not yet had occasion to ana-lyze whether Law 75 is preempted by federal copyright
Courts in impairment cases usually allow recovery of net profits
from actual lost sales rather than the more severe remedies applied
or trademark laws. Arguments can be made both for and against preemption.
With respect to copyright, the question is whether Law 75 governs an exclusive distributorship relationship between a Puerto Rico dealer and a manufacturer that holds copy-rights in a work, or whether § 301 of the Copyright Act pre-empts the application of Law 75 in that case.
Law 75 affords dealers and franchisees the right to dis-tribute or sell the product of a principal without impair-ment or termination of their rights under their distribution or franchise agreements, absent just cause. Thus, the right of distribution that Law 75 protects belongs to the reseller, not to the copyright holder.
By contrast, the U.S. Copyright Act in § 106 affords copy-right owners exclusive rights to distribute copies of their own copyrighted works to the public by sale or other trans-fer of ownership.46 Sec-tion 301 of the Copyright Act, in turn, provides that “all legal or equitable rights equivalent to any of the exclusive rights within the general scope of copyright as specified by section 106” are governed exclusively by the Copyright Act; and, thus, “no person is entitled to any such right or equivalent right in any such work under the common law or statutes of any State.”47
Thus, a dealer or franchisee may argue that Law 75 is not statutorily or expressly preempted by the federal Copyright Act because the rights that each law protects are not equiva-lent. Section 106 of the Copyright Act protects the right of distribution of the copyright holder. The right of distribu-tion that Law 75 protects, on the other hand, belongs to the dealer as a reseller and not as a copyright holder.
Whether the Copyright Act preempts Law 75 under a con-flict preemption theory in the context of a dispute involving intellectual property rights is a different matter. Under con-flict preemption, “state law is ‘preempted to the extent it actu-ally conflicts with federal law, that is, when compliance with both state and federal law is impossible, or when the state law stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.’”48 This analysis depends on the purposes and objectives of Congress in grant-ing the copyright holder exclusive rights to distribute and authorize others to distribute copies of copyrighted works to the public by sale or other transfer of ownership.49
Arguably, Law 75 may be preempted by the Copyright Act in the context of a dispute involving intellectual proper-ty rights. If, for example, the Copyright Act permits a prin-cipal to enter into an exclusive distribution contract with a dealer of its choice but Law 75 subsequently subjects the principal to liability if it refuses to renew its contract with that dealer upon expiration absent just cause, then Law 75 may be preempted on the theory that it imposes obligations contrary to federal law.50
On the other hand, it may be argued that Law 75 does not
divest copyright holders of their ownership rights because they maintain control over the decision of whether to enter into distribution contracts in Puerto Rico. In other words, Law 75 does not obligate a copyright holder wishing to license its product in Puerto Rico to do so through a dealer or to grant exclusivity. Instead, Law 75 merely protects deal-ers from termination without just cause once the copyright holder has decided to sell its products through the dealer rather than directly to the trade.51 Dealers arguing against preemption might rely on this reasoning given that Law 75 is essentially regulating market distribution practices by imposing a just cause requirement on principals.
In that same vein, dealers may argue that the underlying purpose of Law 75, i.e., to protect dealers from termination by principals after the dealers have created a favorable market and goodwill for the principal’s product or services, does not
conflict with the underly-ing purpose of § 106 of the Copyright Act. This objec-tive presupposes that the principal will have volun-tarily chosen to enter into a distribution agreement with the dealer instead of, or in addition to, selling directly
to the trade. On the other hand, the main purpose of § 106, as it pertains to distribution, is to protect the copyright holder’s right to control the first public distribution of an authorized copy of its work, with the understanding that the copyright holder’s rights in the copy may cease once it sells the copy.
These two purposes seem to be in harmony. The Copy-right Act protects copyright holders’ rights of distribution before they transfer ownership of their products, and Law 75 protects dealers after they enter into distribution agreements with principals. Moreover, one of the chief prerequisites for a dealer to qualify for protection under Law 75 is to acquire title of the product it distributes.52 Thus, because copyright owners’ distribution rights cease with respect to a particu-lar copy once they no longer own it, it may be argued that there is no conflict between the distribution rights afforded to Puerto Rico dealers under Law 75 and the distribution rights afforded to copyright holders under the federal Copy-right Act, at least as it relates to Puerto Rico dealers that acquire title to the product,53 because the copyright holder is free to distribute its product in Puerto Rico directly to the trade without dealer intervention.
Similar arguments may be made regarding preemption under the Lanham Act,54 focusing on the respective purpos-es of the federal trademark law and the state dealer statute. A principal or franchisor may argue that Law 75 curtails the freedom of trademark holders to dictate the terms of their licensing arrangements by restricting their ability to termi-nate their agreements without cause. On the other hand, a dealer or franchisee may argue that Law 75 merely carries out Puerto Rico’s legitimate objective of protecting dealers and franchisees and does not undermine the Lanham Act’s goals of protecting trademark holders against infringement and
The right of distribution that Law 75 protects belongs to the reseller, not
ensuring that consumers will not be confused or deceived as to the source or sponsorship of products.55
COnCLuSIOn
Law 75 has evolved significantly over the past forty-five years, through the case law and through amendments to the statute. Some see Law 75 as a protectionist statute that hampers free commerce and Puerto Rico’s complete integra-tion into global markets. Others see it as a necessary source of security and stability for local dealers and franchisees, ensuring the support that they, in turn, provide to the local economy. Present-day commercial realities undoubtedly will continue to affect the ways in which Law 75 is amended by the legislature and interpreted by the courts. It remains to be seen whether those realities will weaken the protection enjoyed by Puerto Rico dealers or strengthen it.
EnDnOTES
1. P.R. Laws Ann. tit. 10, §§ 278 et seq.2. Id. tit. 10, § 278.3. Id. tit. 10, §§ 278 et seq. The Industry and Commerce Com-
mission of the Puerto Rico Senate, in a May 14, 1964, report issued while the bill was pending, noted “the unseasonable act of domestic and foreign manufacturers that, without justified cause, unilaterally terminate their relations with their distributors and agents in Puerto Rico, as soon as the latter have created a favorable market for their products, thereby frustrating the legitimate expectations and inter-ests of those who so efficiently have complied with their responsibili-ties.” Puerto Rico Senate Industry and Commerce Commission (4th Sess. 1964).
4. See, e.g., Pan Am. Computer Corp. v. Data Gen. Corp., 562 F. Supp. 693 (D.P.R. 1983) (holding that Law 75 does not violate the Due Process, Equal Protection, or Commerce Clauses of the U.S. Constitution).
5. P.R. Laws Ann. tit. 10, § 278b-3.6. As a commonwealth of the United States, Puerto Rico has
essentially the same legal landscape as any of the fifty states. Puer-to Rico is a civil law jurisdiction. Its state judiciary is directed by a supreme court with seven judges nominated by the governor of Puerto Rico and confirmed by the senate. The state judiciary also includes a court of appeals, a superior court, and a municipal court. State court proceedings are conducted in Spanish, and state court opinions are published in Spanish. The federal judiciary in Puerto Rico consists of the U.S. District Court for the District of Puerto Rico, which is part of the U.S. Court of Appeals for the First Circuit.
7. P.R. Laws Ann. tit. 10, § 278a-1.8. Id. tit. 31, § 3029; see Consejo de Titulares v. C.R.U.V., 1993
JTS 25, at *8 (P.R. 1993) (official translation has not been pub-lished) (recognizing that a contract that stipulates that it is non-transferable is one of the instances of nontransferability that the statute contemplates).
9. P.R. Laws Ann. tit. 31, § 3243.10. Inst. of Innovative Med., Inc. v. Laboratorio Unidos de Bio-
quimica Funcional, Inc., 613 F. Supp. 2d 181, 190 (D.P.R. 2009).11. P.R. Laws Ann. tit. 10, § 278b-2.
12. See, e.g., Royal Bed & Spring Co., Inc. v. Famossul Industria e Comercio de Moveis Ltd., 906 F.2d 45 (1st Cir. 1990); Antilles Cement Corp. v. Aalborg Portland A/S, 526 F. Supp. 2d 205 (D.P.R. 2007); D.I.P.R. Mfg., Inc. v. Perry Ellis Int’l, Inc., 472 F. Supp. 2d 151 (D.P.R. 2007); Caravi Distribs., Inc. v. Hitachi Home Prods., 842 F. Supp. 1492 (D.P.R. 1994).
13. Nike Int’l Ltd. v. Athletic Sales, Inc., 689 F. Supp. 1235 (D.P.R. 1988); P.R. Laws Ann. tit. 10, § 278a.
14. P.R. Laws Ann. tit. 31, § 3471.15. Nike Int’l, 689 F. Supp. at 1238.16. See Medina & Medina v. Country Pride Foods, Ltd., 858 F.2d
817, 823 (1st Cir. 1988).17. Id.18. See P.R. Laws Ann. tit. 10, § 278a.19. 206 F. Supp. 2d 211 (D.P.R. 2002).20. Id. at 215 n.6 (internal citation omitted).21. Id. at 219.22. 337 F.3d 1 (1st Cir. 2003).23. Id. at 4.24. 22 P.R. Offic. Trans. 172 (P.R. 1988).25. 138 P.R. Dec. 60 (P.R. 1995).26. Dow, 337 F.3d at 5 (citing Medina & Medina v. Country Pride
Foods, Ltd., 858 F.2d 817, 823 (1st Cir. 1988)).27. Id. at 6.28. Id. at 7–8.29. Id. at 9.30. Vulcan Tools of P.R. v. Makita U.S.A., Inc., 23 F.3d 564, 569
(1st Cir. 1994).31. P.R. Laws Ann. tit. 10, § 278a.32. See Casas Office Machines, Inc. v. Mita Copystar Am., Inc.,
33. 666 F. Supp. 328 (D.P.R. 1987).34. Id. at 332–33.35. 194 F.3d 313, 315 (1st Cir. 1999).36. Id. at 319.37. 81 F. Supp. 2d 276, 284 (D.P.R. 1999).38. Id. at 284–85.39. Goya de P.R., Inc. v. Rowland Coffee Roasters, 2004 WL
5459246, at *4 (D.P.R. 2004) (unreported) (“The standard to recu-perate impairment and termination damages is not necessarily iden-tical.”) (citations omitted).
40. P.R. Laws Ann. tit. 10, § 278.41. 130 S. Ct. 1251 (2010).42. Id. at 1260.43. See Petereit v. S.B. Thomas, Inc., 63 F.3d 1169 (2d Cir. 1995)
(finding it reasonable to believe that the Connecticut Franchise Act was intended to cover constructive as well as formal termination, and that “something greater than a de minimis loss of revenue” and less than “driving a franchisee out of business . . . must be shown . . . to justify a finding of constructive termination”).
44. See Maintainco, Inc. v. Mitsubishi Caterpillar Forklift Am., Inc., 975 A.2d 510 (N.J. Super. Ct. App. Div. 2009) (holding that dealership was not required to withdraw from its agreement with a manufacturer and allow itself to be “terminated” in order to bring a constructive termination claim under the New Jersey Franchise Practices Act); see also Carlos v. Philips Bus. Sys., Inc., 556 F. Supp.
769, 775–77 (E.D.N.Y. 1983) (concluding that a principal’s act of divesting a franchisee from the exclusivity it enjoyed under their agreement constituted termination under the New Jersey Franchise Practices Act and the Connecticut Franchise Act, two statutes with “good cause” requirements similar to those of Law 75).
49. 17 U.S.C. § 106(3).50. See, e.g., Orson, Inc. v. Miramax Film Corp., 189 F.3d 377,
386 (3d Cir. 1999) (holding that “the state may not mandate distri-bution and reproduction of a copyrighted work in the face of the exclusive rights to distribution granted under § 106 [of the Copy-right Act]”).
51. See Allied Artists Pictures Corp. v. Rhodes, 496 F. Supp. 408, 446–47 (S.D. Ohio 1980) (holding that an Ohio statute impos-ing various restrictions on licensing of motion pictures in Ohio was not preempted by the Copyright Act, after concluding that Ohio did not interfere “with the legitimate rights of owners of copyrighted motion pictures by regulating the ways in which . . . producer-distrib-utors license their product in order to achieve fair and open bargain-ing” (citing Watson v. Buck, 313 U.S. 387 (1941))).
52. Roberco, Inc. v. Oxford Indus., Inc., 22 P.R. Offic. Trans. 111 (P.R. 1988).
53. But see Re-Ace, Inc. v. Wheeled Coach Indus., Inc., 363 F.3d 51, 56 (1st Cir. 2004) (finding that a party qualified as a dealer under Law 75 even though it did not acquire title, in light of the fact that it met almost all other requirements set forth in Roberco, 22 P.R. Offic. Trans. at 111).
54. 15 U.S.C. §§ 1051 et seq.55. See Mariniello v. Shell Oil Co., 511 F.2d 853 (3d Cir. 1975)
(holding that New Jersey common law protecting franchisees from termination of their franchise agreements without cause was not preempted by the Lanham Act because operation of the state law would not erode the purpose of the federal law); Ispahani v. Allied Domecq Retailing USA, 727 A.2d 1023, 1026 (N.J. Super. Ct. App. Div. 1999) (holding that the New Jersey Franchise Practices Act was not preempted by the Lanham Act and emphasizing that “states may require more stringent standards than those designed by Congress, and may otherwise adopt law affecting the subject of a federal stat-ute, so long as the federal purpose is not undermined”); FMS, Inc. v. Volvo Constr. Equip. N. Am., Inc., 2007 WL 844899, at *6 (N.D. Ill. 2007) (not reported) (rejecting the argument that the Lanham Act preempted the Maine Franchise Law, which required a showing of good cause to terminate a franchise relationship).
Fundamentals of Franchising Third Edition
Rupert M. Barkoff and Andrew C. Selden, Editors
T he new edition of Fundamentals of Franchising is charged with useful definitions, practical tips, and
expert advice from experienced practitioners. Written specifically to help lawyers and nonlawyers brush up on franchise law, this practical guide examines fran-chise law from a wide range of experiences and view-points. Each chapter is written by two experienced practitioners and provides a well-rounded overview of franchise law and spotlights issues that may require further research or expertise. It will strengthen your understanding of key issues in franchise law, including trademark law, structuring of the franchise relation-ship, franchise disclosure issues, franchise registra-tion, franchise relationship laws, antitrust law, and counseling of franchisees.
This edition also covers disclosure requirements under the revised FTC Rule and reflects antitrust law changes concerning resale pricing practices under the Supreme Court’s decision in the Leegin case.
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2008, 410 pages, 7 x 10, paperISBN: 978-1-60442-053-1
F ranchise litigators routine-ly retain experts to pres-ent evidence in support of
damages claims. However, both franchisees and franchisors are increasingly offering expert testi-mony also to prove or defend lia-bility by offering an opinion on the ultimate issue to be decided by the trier of fact. As the case law shows, these liability experts are most often offered in fran-chise litigation to give an expert opinion on ultimate issues such as compliance with indus-try standards, the duties and obligations of franchisors and franchisees, and whether a contract constitutes the sale of a franchise. These proposed liability experts are and have been subject to Daubert challenges, but a properly selected and prepared liability expert can meet the challenge and be an effective addition to a party’s trial strategy.
This article will survey and analyze recent cases address-ing Daubert challenges to franchise liability experts. We will first provide a brief background on the Federal Rules governing the admission of expert testimony. Next, we will survey recent franchise cases addressing Daubert challenges to liability expert testimony in the context of industry stan-dards, the interpretation of the duties and obligations of a franchisor and/or franchisee, and whether or not a contract constitutes a franchise agreement. Finally, we will explore the trends that these cases reveal and suggest strategies for selecting a franchise liability expert.
RuLES gOvERnIng ExPERT TESTIMOny
Federal Rule of Evidence 702 governs the admission of expert testimony. It states:
If scientific, technical, or other specialized knowledge will assist the trier of fact to determine a fact at issue, a wit-ness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if (1) the testimony is based upon suf-ficient facts or data, (2) the testimony is the product of reli-able principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.1
As the U.S. Supreme Court declared in Daubert v. Mer-rell Dow Pharmaceuticals, Inc., Rule 702 requires trial judges to act as gatekeepers to ensure that any and all scientific testimony or evidence is not only relevant but also reliable.2 To help trial judges accomplish this task, the Court provided a list of nonexhaustive factors for trial courts to con-sider when evaluating proposed expert evidence: (1) whether the scientific theory has been tested, (2) whether the theory has been subject to peer review or publica-tion, (3) whether there is a known rate of error, and (4) whether the scientific theory has been gener-ally accepted.3
The Court further proclaimed in Kumho Tire Co., Ltd. v. Carmi-chael that the gatekeeper respon-sibility applies to all expert testimony, not just testimony
based in science.4 Thus, there is no question that the Daubert standard and the requirements set forth in Rule 702 apply to experts proposing to testify regarding liability issues in franchise litigation.
Expert testimony may include opinions on the ultimate issue to be decided by the trier of fact. Federal Rule of Evi-dence 704(a) states that “[e]xcept as provided in subdivision (b), testimony in the form of an opinion or inference other-wise admissible is not objectionable because it embraces an ultimate issue to be decided by the trier of fact.”
However, the determination of purely legal issues is the exclusive purview of the court. Therefore, expert testimony that merely states a legal conclusion will be excluded.5 In addition, experts proposing to testify regarding an ultimate issue must be qualified by “knowledge, skill, experience, train-ing, or education” to render an opinion. The proposed opin-ion evidence must also be deemed reliable and helpful to the trier of fact.6
A party seeking to exclude expert testimony will often assert a Daubert challenge seeking to exclude the testimony on one or more of three bases: (1) the expert is not suffi-ciently qualified, (2) the proposed testimony is not reliable, and/or (3) the proposed testimony will not assist the trier of fact.
Survey of Daubert Challenges in the Context of Franchise Liability Experts
Christina L. Fugate, Brian J. Paul, and James L. Petersen
Christina L. Fugate is an associate and Brian J. Paul and James L. Petersen are partners in the Indianapolis office of Ice Miller LLP.
Under Rule 702, a proposed expert will be able to offer expert testimony or evidence only if the moving party estab-lishes that the expert is “sufficiently qualified.”7 Therefore, a court’s first step in its gatekeeping duties is to determine whether a proposed expert is qualified in the subject matters about which the expert will testify.8 The Federal Rules do not require an expert to have any particular credentials to qualify as an expert witness.9 A witness may qualify as an expert based on his or her (1) knowledge, (2) skill, (3) expe-rience, (4) training, or (5) education.10 Thus, a background in just one of these five categories is sufficient.11 Neither Daubert nor the Federal Rules define these categories; there-fore, courts have applied “common sense interpretations.”12
RELIABILITy OF An ExPERT’S TESTIMOny
Although franchise liability experts are typically not clas-sified as scientific experts, they are still subject to Daubert challenges based on the reliability of the proposed expert testimony. Rule 702 unequivocally applies to “technical or other specialized knowledge.”13 When faced with a Daubert reliability challenge to exclude a nonscientific expert, includ-ing a franchise liability expert, courts tend to ignore the Daubert factors because they are often of “limited utility in the context of nonscientific expert testimony.”14 As the U.S. Court of Appeals for the Sixth Circuit remarked, “If [the Daubert] framework were to be extended to outside the scientific realm, many types of relevant and reliable expert testimony—that derived substantially from practical experi-ence—would be excluded.”15 This trend is consistent with the Kumho decision in which the Supreme Court noted that “Daubert’s list of specific factors neither necessarily nor exclusively applies to all experts in every case. . . . [W]hether Daubert’s specific factors are, or are not, reasonable mea-sures of reliability in a particular case is a matter that the law grants the trial judge broad latitude to determine.”16
RELEvAnCy OF An ExPERT’S TESTIMOny
In addition to requiring expert testimony and evidence to be reliable, Rule 702 allows testimony and evidence to be admitted only if it “will assist the trier of fact to understand the evidence or determine a fact in issue.”17 This requirement is primarily directed to relevance.18 Expert testimony will be excluded where
all the primary facts can be accurately and intelligibly described to the jury, and if they, as [persons] of common understanding, are as capable of comprehending the primary facts and of drawing correct conclusions from them as are witnesses possessed of special or peculiar training, experience, or observation in respect to the subject under investigation.19
In recent franchise cases, courts have excluded expert tes-timony on the ground that it does not assist the trier of fact and therefore is not relevant.20
SuRvEy OF FRAnCHISE CASES
Industry StandardsThe majority of cases addressing the admission of liability experts involve witnesses who propose to offer an opinion on industry standards and whether or not the opposing party conforms to such standards. Generally, industry stan-dards are an appropriate topic for a liability expert as long as the expert’s qualifications and proposed evidence satisfy Rule 702.21 As the case law below illustrates, this general proposition is also true for franchise liability experts.
In Mathis v. Exxon Corp., the U.S. Court of Appeals for the Fifth Circuit applied the Daubert factors and held that the trial court did not abuse its discretion by admitting the franchisee’s expert’s testimony.22 Mathis involved a breach of contract action filed by a franchisee against the franchi-sor, Exxon, based on a contract that required the franchi-sees to purchase gasoline from Exxon at a specified quantity and price.23 In support of its claims, the franchisee proposed to offer the opinions of an expert in the economics and industry standards of the gasoline market in the relevant geographic area.24 The expert opined that Exxon’s price of gasoline “was not commercially reasonable from an eco-nomic perspective because it was a price that, over time, put the purchaser at a competitive disadvantage.”25 This opinion was based on the expert’s calculation that “75 percent of the franchisee’s competitors were able to purchase gasoline at a lower price” and his calculation of what he determined to be a reasonable price.26
On appeal, Exxon argued that the trial court erred by per-mitting the expert to testify.27 The Fifth Circuit disagreed. The Fifth Circuit determined that the expert’s “testimony primarily drew on general business and economic principles that satisfy the Daubert factors.”28 In making this determina-tion, the court focused on the main purpose of the expert’s testimony, i.e., that the price Exxon charged its franchisees exceeded the reasonable price, and determined that any objec-tions to the expert’s methods or his definition of the relevant markets could be addressed through cross-examination.29
In AAMCO Transmissions, Inc. v. Baker, the U.S. District Court for the Eastern District of Pennsylvania determined that the proposed testimony of a franchisee’s liability expert was admissible.30 Baker involved a trademark infringement, unfair competition, and breach of contract action filed by a franchisor against a franchisee arising out of the franchi-sor’s termination of a franchise agreement.31 The franchisor alleged that the franchisee failed to deal fairly and honestly with the public.32 In support of its defense, the franchisee proposed to offer testimony from a liability expert.33 The franchisor filed a motion in limine to exclude the liability expert’s testimony, arguing that his opinion regarding liabil-ity was “unreliable because he failed to identify any meth-odology and he asserted facts he identified for the reader’s consideration instead of drawing any conclusions within reasonable scientific certainty.”34
The court disagreed. The court first noted that the expert’s opinion was reliable because he relied on
“automotive industry standards,” which the court deter-mined were “good grounds” for reliability.35 Second, the court reviewed the expert’s curriculum vitae. The expert’s vast “professional experience, training, and certifications regarding automobile repair and inspections” enhanced the reliability of his testimony.36 Finally, the expert explained in detail the specific process he used in formulating and applying his opinion in his expert report.37 Taken together, the court held that the expert’s opinions were admissible; any weaknesses or inadequacies in his opinions could be addressed through cross-examination.38
In Thomas J. Kline, Inc. v. Lorillard, Inc., the U.S. Court of Appeals for the Fourth Circuit affirmed the trial court’s decision to exclude the testimony of an expert witness who proposed to testify regarding the legitimacy and justifica-tions for certain credit decisions made by defendant in an anti–price discrimination action.39 The proposed expert was
not an economist; she held only a master’s degree in business administration.40 The expert had previously published only one article that had nothing to do with price discrimination, credit decisions, or antitrust issues.41 Finally, the proposed expert admitted that she did not have any personal experi-ence making credit decisions and “that her present employer devoted most of its efforts to providing expert testimony” in complex business litigation.42 Although no single fac-tor alone disqualified the proposed expert, taken together, the expert’s qualifications could not satisfy the minimum requirements set forth in Federal Rule of Evidence 702 as “it would be absurd to conclude that one can become an expert simply by accumulating experience in testifying.”43
In Lone Star Steakhouse & Saloon, Inc. v. Liberty Mutual
Savings Group, the U.S. District Court for the District of Kansas held in part that the franchisor’s expert was quali-fied to offer expert opinions on insurance industry standards and practices.44 Lone Star sued Liberty Mutual Savings Group for breach of contract of a commercial general liabil-ity insurance policy and breach of the implied covenant of good faith and fair dealing because Liberty Mutual refused to contribute any payment to a settlement agreement that Lone Star reached in an underlying lawsuit.45 Liberty Mutual moved to strike Lone Star’s expert, who proposed to testify, among other things, that the claims alleged in the underly-ing litigation fell within the insurance policy coverage.46 The court examined the expert’s experience and training, which included over twenty years of “experience handling and supervising insurance claims,” and concluded that he was more than sufficiently “qualified to express opinions relating to insurance industry standards and whether Liberty Mutu-
al’s conduct conformed to such standards.”47 The court further noted that such opinions were “relevant to Lone Star’s claim that Lib-erty Mutual breached its implied obligation of good faith and fair dealing.”48
Duties and Obligations of Franchisors and FranchiseesExpert testimony on the duties and obligations of franchisors and franchisees many times depends on an interpretation of certain pro-visions contained in the franchise agreement. Courts have typically allowed expert witnesses to testify about the proper interpretation of contract terms when the meaning depends on industry standards or trade practice.49 Howev-er, “such expert testimony is admissible only if the contract language at issue is ambiguous or involves a specialized term of art, science or trade.”50 As the following case law illustrates, if the franchise agreement is not ambiguous, liability expert evidence is not proper.
In TCBY Systems, Inc. v. RSP Co., the court admitted testimony of a franchise liabil-ity expert as to the custom and practice in the fast-food industry to assist the trier of fact
in interpreting a franchisor’s duty to assist a franchisee in the site selection of the franchise store.51 TCBY involved a lawsuit arising out the premature termination of a fran-chise agreement by the franchisee.52 The franchisor sued the franchisee, and the franchisee counterclaimed against the franchisor alleging that the franchisor “breached the fran-chise agreement by failing to provide reasonable assistance in selecting and evaluating a location for [the franchisee’s] [TCBY] store.”53
The main issue was the interpretation of the franchise agreement. The relevant portion of the franchise agreement stated that the franchisor would provide reasonable assis-tance in selecting and evaluating proposed store locations, but its selection was not a warranty or representation of the
ConduCting due diligenCe on Your expert WitnessBecome aware of your expert’s qualifications before any surprises are revealed in court. This includes, among other things:
•Conducting independent research of the expert’s curriculum vitae to ensure that it is accurate
•Locating all articles, speeches, treatises, and other materials authored by the expert
•Researching the expert’s prior history of testifying
•Determining whether the expert has previously been subject to a Daubert challenge and whether his testimony was excluded
•Ensuring that the expert’s prior testimony is not inconsistent with his current testimony
•Ensuring that the expert has the proper background and can qualify to render an opinion based on his knowledge, skill, experi-ence, training, and education
•Reviewing the expert’s methodology or basis for his opinions and ensuring that he has a proper foundation for opinion
•Ensuring that the expert can explain opinions in a way that is understandable to the trier of fact and will be helpful to explain the issues involved in the litigation
Experts who only provide conclusory opinions do not assist the trier of
fact and, therefore, will not be permitted to testify.
suitability of the selection.54 Despite the fact that the franchi-see’s site selection did not meet the franchisor’s geographic specifications, the franchisor approved the selection.55 After the franchisor refused to allow the franchisee to serve cer-tain menu items, the franchisee unilaterally terminated the franchise agreement.56 Thereafter, the franchisor sued the franchisee to “recover the value of royalties and advertising funds it would have received over the remaining term of the . . . franchise agreement.”57 The franchisee counterclaimed for breach of contract.58
To support its breach of contract claim, the fran-chisee proposed to offer a franchise expert to give an opinion that the process the franchisor followed in approving a site for a TCBY store did not meet the cus-tom and industry practices in the fast-food industry.59 The trial court admitted this testi-mony.60 On appeal, the U.S. Court of Appeals for the Eighth Circuit affirmed, concluding that the franchise agreement at issue was ambiguous as to the franchisor’s duties in assisting the franchisee in a site selection for the TCBY store. There-fore expert testimony on the applicable industry standard was required to assist the trier of fact in resolving the ambiguity.61
In Braucher v. Swagat Group, L.L.C., the U.S. District Court for the Central District of Illinois determined that a proposed expert witness lacked the required expertise to ren-der an opinion as to a franchisor’s duty to maintain a hotel pool and spa in a negligence and wrongful death action.62 A guest visiting an independently operated Comfort Inn Hotel was diagnosed with Legionnaires’ Disease and died after staying at the Comfort Inn Hotel.63 Approximately one month later, the Illinois Department of Public Health inves-tigated a possible outbreak and found 160 cases of respirato-ry illnesses reported by guests, five of whom were diagnosed with Legionnaires’ Disease, including the decedent.64 The department determined that the level of Legionella bacteria found in the pool and spa was 2,000 times higher than the level typically found in tap water.65
Plaintiff proposed to offer the testimony of a retired U.S. Coast Guard commander who opined that the franchisee had failed to maintain the pool properly, the decedent’s death was caused by the improperly maintained pool, the franchisee’s pool attendant falsified pool records, and, most importantly, both the franchisee and franchisor had a duty to maintain the pool.66 The witness had significant experience in water safety and water rescue procedures, but plaintiff did not present any evidence of the witness’s experience or knowledge relating to the duties and obligations of franchisors and franchisees on the topic of pool maintenance. The franchisor filed a motion to bar the witness’s testimony on the grounds that the witness was not qualified to testify regarding the duty of the franchi-sor or franchisee to maintain the pool.67
The court agreed that although the witness had vast expe-rience maintaining pools and was qualified to testify to the
maintenance of the pool in general, he was not qualified to render an expert opinion as to whether the franchisee or fran-chisor had a legal obligation to maintain the pool.68 The court observed that the witness “does not have any experience in either franchise relationships or in hotel industry practices. He has no special knowledge, experience, or training to enable him to render an expert opinion about when a franchisor is obligated to maintain a pool at a hotel operated under a writ-ten franchise agreement.”69 His expert testimony was thus
excluded.The U.S. District Court
for the Middle District of Tennessee in Cowan v. Tree-top Enterprises, Inc. applied certain Daubert factors in excluding a proposed lia-bility expert’s opinion that the franchisee’s restaurant managers were considered
employees under the Fair Labor Standards Act (FLSA).70 Plaintiffs filed an action under the FLSA alleging that the franchisee improperly deemed them bona fide executive employees and therefore exempt from FLSA’s overtime pay requirements.71 Plaintiffs argued that even though they were classified as unit managers, they were regular employees entitled to overtime pay.72
Pursuant to a franchise agreement with Waffle House, Inc., defendant franchisee owned and operated several fran-chises, each of which was a separate facility.73 Under the franchisor’s organizational structure, the franchisee assigned a unit manager to each restaurant.74 In support of the fran-chisee’s defense, the franchisor offered the expert report of a professor of industrial engineering who proposed to opine that unit managers were responsible for the day-to-day oper-ations of the restaurant and for the profitable operation of the restaurant.75 The expert witness based his opinion on “a documentary review of job titles, the Dictionary of Occu-pational Titles, Treetop’s organizational charts, and inter-views.”76 The expert also interviewed four unit district relief managers.77 Based on this analysis, the expert concluded that plaintiffs performed management functions. Plaintiffs filed a motion to strike, arguing in part that the expert’s methods were unreliable.78
After consideration of the Daubert factors, the court agreed.79 The court compared the case Donovan v. Waffle House, Inc., where the U.S. District Court for the Northern District of Georgia determined that similar expert reports were admissible because they were supported by tests and analysis conducted by the expert.80 The expert’s report in Cowan, however, did not reflect any underlying analyses. Thus, the court concluded that the expert’s methodology was unreliable and not admissible.81
In Little Oil Co., Inc. v. Atlantic Richfield Co., franchise gasoline distributors filed a lawsuit against a franchisor alleging that the franchisor’s institution of new market-ing changes was prohibited by the terms of the franchise agreement and constituted constructive termination of the
franchise agreement in violation of the Petroleum Market-ing Practices Act.82 In support of their claims, the distribu-tors retained an expert who proposed to opine, among other things, that the franchisor’s marketing changes constituted termination of the franchise agreement.83
The court did not permit the witness to offer any opinions that were a determination solely of ultimate facts, including the opinion that the franchisor’s marketing changes con-stituted a termination of the franchise agreement, because those opinions would not have been helpful to the jury.84 The jury had enough information and facts to reach its own con-clusion; thus, expert testimony was not proper.85
Elements of a FranchiseIn our review of franchise cases addressing the admissibility of liability expert testimony, we came across one case, Palaz-zetti Import/Export, Inc. v. Morson, in which the court, the U.S. District Court for the Southern District of New York, excluded the expert testimony of a franchise attorney who proposed to testify that a contract constituted the sale of a franchise based in part on industry standards.86
Palazzetti involved a dispute over the sale of a furniture store.87 Defendant asserted as an affirmative defense that the contract at issue constituted a sale of a franchise and was subject to rescission because plaintiff did not follow the reg-istration requirements.88 Plaintiff moved for an order from the court authorizing the testimony of its expert, a fran-chise law attorney who proposed to testify that the contract at issue did not constitute a franchise agreement, and even if it did constitute a franchise, it was subject to the “single instance” exception.89 The witness also proposed to offer expert testimony that certain agreements involving plaintiff and other parties were not franchise agreements because plaintiff made capital contributions, which were not cus-tomary in the franchise industry.90
In response, defendant maintained that the elements of a franchise agreement are straightforward, and therefore expert testimony about them would not assist the trier of fact in understanding or determining an issue in dispute.91 The court agreed:
Here, it is clear that neither of the elements of a franchise agreement requires knowledge beyond the ken of the average juror. Under Section 681, a franchise is a contract in which a franchisor (i) for a fee (ii)(a) prescribes a marketing plan for the sale of goods or services or (ii)(b) grants a franchisee the right to sell goods or services associated with the franchisor’s trademark. There is nothing particularly esoteric about any of these elements and, therefore, nothing that leads me to believe that the jurors would be assisted (rather than improp-erly swayed) by the testimony of the expert. Accordingly, his proposed expert testimony regarding the elements of a fran-chise agreement and their alleged absence here does not meet the standard of Rule 702.92
The court also excluded the witness’s proposed testimony as to industry standards.93 Although the court acknowledged
that industry custom is generally an appropriate topic for expert testimony, the only issue before the court was whether the contract met the statutory definition.94 Therefore, indus-try standards were irrelevant.95
The decision in Palazzetti to exclude testimony on the elements of a franchise agreement is consistent with the recent trend of trial judges generally choosing to exclude expert opinions on the meaning and elements of statutes and regulations.96 Indeed, recent case law from the district courts of the U.S. Court of Appeals for the Seventh Circuit establishes that an expert may not properly offer opinion testimony as to the elements of a statute and whether or not a defendant violated such statute where the statute is an issue in dispute.97
Moreover, in Stone Creek Investments, LLC v. United States, the Federal Claims Court excluded plaintiffs’ pro-posed expert reports and testimony of a federal income tax law professor and a practicing tax attorney.98 The tax profes-sor sought to testify that the tax transactions at issue did not lack economic substance and that plaintiffs fulfilled the requirements to satisfy a reasonable cause defense.99 The tax attorney sought to testify that an opinion letter at issue was of a quality and character upon which plaintiffs could rea-sonably rely in preparing the tax returns at issue.100
The court excluded the experts’ evidence because the experts impermissibly proposed to apply the law to the facts rather than to explain the law in a manner that would assist the trier of fact in resolving the ultimate issues in dispute.101 The court noted that the admission of expert testimony on the application of the law depends on whether or not it will assist the trier of fact in understanding the evidence or the ultimate issue in dispute.102 “[E]xpert testimony that merely tells the trier of fact what result to reach or states a legal conclusion in a way that says nothing about the facts is still objectionable. . . . Such evidence does not ‘assist’ as required by Rule 702.”103
RECEnT TREnDS
The foregoing cases reveal a few key observations. First, courts are generally receptive to admitting franchise liability expert testimony and evidence as long as the issue is suitable for an expert opinion. Experts who only provide conclusory opinions, however, do not assist the trier of fact and, there-fore, will not be permitted to testify.
Second, the right liability expert must be selected. Fran-chise litigators should keep Rule 702 in mind when choosing an expert to testify on liability issues. In particular, litigators should gather Daubert-related material from a proposed lia-bility expert right away to ensure that the expert is qualified and will offer testimony and evidence that is both reliable and relevant (see sidebar on page 19). In tendering an expert to, in effect, opine that your client should win on a key issue of the case, you will invite a Daubert challenge. That chal-lenge can be overcome if you select a truly qualified expert and require a rigorous review to identify facts necessary to support the opinion offered.
1. Fed. R. Evid. 702; Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993).
2. Daubert, 509 U.S. 579.3. Id. at 592–94.4. 526 U.S. 137 (1995).5. Palazzetti Imp./Exp., Inc. v. Morson, 2001 U.S. Dist. LEXIS
9538, at *6 (S.D.N.Y July 9, 2001). 6. Fed. R. Evid. 702; Ralston v. Smith & Nephew Richards, Inc.,
275 F.3d 965, 969 (10th Cir. 2001).7. Whiting v. Boston Edison Co., 891 F. Supp. 12, 24 (D. Mass.
1995) (quoting Rule 702).8. Braucher v. Swagat Group, L.L.C., 2010 U.S. Dist. LEXIS
26294, at *24 (C.D. Ill. Mar. 19, 2010); Casey v. Ohio Med. Prods., 877 F. Supp. 1380, 1383 (N.D. Cal. 1995); Whiting, 891 F. Supp. at 24.
9. Turf Racing v. Am. Suzuki, 223 F.3d 585, 591 (7th Cir. 2000). 10. Wright & Gold, 29 Federal Practice and Procedure
§ 6265 (1997).11. Id.12. Id.13. Fed. R. Evid. 702.14. First Tenn. Bank Nat’l Ass’n v. Hector, 268 F.3d 319, 334 (6th
Cir. 2001) (citing United States v. Jones, 107 F.3d 1147, 1158 (6th Cir. 1997)).
15. Id. 16. Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137, 153 (1995).17. Fed. R. Evid. 702; Smith v. IMG Worldwide, Inc., 2006 U.S.
Dist. LEXIS 82566, at *16 (E.D. Pa. Nov. 9, 2006).18. Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579, 591
(1993).19. Palazzetti Imp./Exp., Inc. v. Morson, 2001 U.S. Dist. LEXIS
9538, at *7 (S.D.N.Y. July 9, 2001) (citing United States v. Castillo, 924 F.2d 1227 (2d Cir. 1991) (quoting Salem v. U.S. Lines Co., 370 U.S. 31, 35 (1962)).
20. See Howerton v. Red Ribbon, Inc., 715 N.E.2d 963, 965 (Ind. Ct. App. 1999).
21. Levin v. Dalva Bros., Inc., 459 F.3d 68, 79 (1st Cir. 2006) (cit-ing Ford v. Allied Mut. Ins. Co., 72 F.3d 836, 841 (10th Cir. 2006); Vann v. City of N.Y., 72 F.3d 1040, 1049 (2d Cir. 1995); TCBY Sys., Inc. v. RSP Co., Inc., 33 F.3d 925, 928 (8th Cir. 1994)).
22. 302 F.3d 448, 461 (5th Cir. 2002).23. Id. at 451–52.24. Id. at 452.25. Id. 26. Id. at 452–53.27. Id. at 459.28. Id. at 460.29. Id.30. 2008 WL 5245768, at *4 (E.D. Penn. 2008). 31. Id. at *1.32. Id.33. Id. 34. Id. at *4.35. Id.36. Id.
37. Id. at *5.38. Id.39. 878 F.2d 791, 800 (4th Cir. 1989).40. Id. at 799.41. Id.42. Id.43. Id.44. 343 F. Supp. 2d 989, 1015 (D. Kan. 2004).45. Id. at 992–93.46. Id. at 1015.47. Id. 48. Id. The court, however, excluded the expert’s opinion on other
issues having to do with the interpretation of the policy and Liberty Mutual’s handling of the underlying litigation. Id.
49. Kona Tech. Corp. v. S. Pac. Transp. Co., 225 F.3d 595, 611 (5th Cir. 2000) (holding that expert testimony is admissible to inter-pret a contract provision having a specialized meaning in the rail-road industry).
50. Suzlon Wind Energy Corp. v. Shippers Stevedoring Co., 662 F. Supp. 2d 623, 668 (S.D. Tex. 2009); see also WH Smith Hotel Servs., Inc. v. Wendy’s Int’l, Inc., 25 F.3d 422 (7th Cir. 1994) (admit-ting expert testimony on industry custom and usage to assist the trier of fact with interpreting ambiguous contract terms).
51. 33 F.3d 925 (8th Cir. 1994).52. Id. at 926. 53. Id.54. Id. at 927.55. Id.56. Id.57. Id.58. Id.59. Id. at 929.60. Id. 61. Id.62. 2010 U.S. Dist. LEXIS 26294, at *24 (C.D. Ill. 2010). 63. Id. at *17.64. Id. 65. Id.66. Id. at *18, 23.67. Id. at *23.68. Id.69. Id.70. 120 F. Supp. 2d 672, 683 (M.D. Tenn. 1999). 71. Id. at 674.72. Id. 73. Id.74. Id. at 675.75. Id. at 681. 76. Id. 77. Id.78. Id. 79. Id. at 683. The court also considered an additional factor, i.e.,
“whether the expert’s opinion is a product of independent research or whether the opinion was formulated for the litigation.” Id. (citing Daubert v. Merrell Dow Pharm., Inc., 43 F.3d 1311, 1317 (9th Cir. 1995)).
80. Id. (citing Donovan v. Waffle House, Inc., 1983 U.S. Dist.
LEXIS 13420 (N.D. Ga. Sept. 26, 1983)). 81. Id. at 683–84. The court also determined that Dr. Deivana-
yagam’s opinion constituted a legal conclusion as the term primary responsibility has a distinct legal meaning under FLSA regulations. Id. at 684.
82. 852 F.2d 441, 443 (9th Cir. 1988)..83. Id. at 445–46.84. Id. at 446.85. Id.86. 2001 U.S. Dist. LEXIS 9538, at *7–10 (S.D.N.Y. July 9, 2001).87. Id. at *1.88. Id. at *2.89. Id. at *2–3.90. Id. at *3.91. Id. at *3–4.92. Id. at *8.93. Id. at *9.94. Id.95. Id.
96. See Frank Fried, Recent Decisions Address the Use of Expert Testimony in Government Contract Cases (Mar. 31, 2003), www.ffhsj.com/printfriendly.com.cfm?pageID=25&itemID=1715.
97. See Klaczak v. Consol. Med. Transp. Inc., 2005 U.S. Dist. LEXIS 13607 (N.D. Ill. May 26, 2005) (citing McCabe v. Crawford & Co., 272 F. Supp. 2d 736, 740 (N.D. Ill. 2003) (holding that plain-tiff’s expert, a law professor who specialized in consumer law, “may not expound on what complies and does not comply with the [Fair Debt Collection Practices Act]; these are inappropriate legal conclu-sions”); Cent. Die Casting & Mfg. Co., Inc. v. Tokheim Corp., 1998 U.S. Dist. LEXIS 18472, at *9 (N.D. Ill. Nov 19, 1998) (“The Court agrees that an expert’s opinion concerning whether a statute or regu-lation was violated is likely an inadmissible legal conclusion. . . .”)).
98. 81 Fed. Cl. 358, 364 (2008). 99. Id. at 359.100. Id. at 360.101. Id. at 364.102. Id. at 363.103. Id. (internal citations omitted).
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I magine a franchise network that trains, guides, and sup-ports hundreds of poor
women with little or no business experience to become successful business owners. Such “micro-franchise” efforts, though rela-tively small in number, have been gathering steam in the develop-ment community and, recently, attracting the attention of the mainstream franchising indus-try. Advocates have seized on microfranchising as a natural complement or follow-on to the widely acclaimed successes of the “microfinance” sector, which provides small-scale finance services to over 150 mil-lion of the world’s poor.1
Microfranchising today is where microfinance was a decade or more ago. It is appropriate at this juncture, then, to ask: What guidance can microfranchising usefully draw from the microfinance experience? The first section of this article examines lessons learned from the microfinance sec-tor and then traces the origins of microfranchising. The second section explores whether mainstream commercial franchising practices are relevant for franchising that takes place with those living at the base of the economic pyramid. The final section recommends the legal and regulatory envi-ronment that can best facilitate microfranchising.
LESSOnS FROM MICROFInAnCE
Nearly half the world (approximately 3 billion people) lives at the base of the economic pyramid.2 Of those, around 1.4 billion people live in extreme poverty with incomes of less than $1.25 a day.3 As shocking as these numbers are, the good news is that, over the last three decades, poverty rates have been falling globally.4 The bad news, however, is that the recent financial crisis has slowed the pace of poverty reduction. Worse still, the continuing effects of the crisis are expected to push yet another 64 million people into extreme poverty by the end of 2010.5
There is no silver bullet for moving people out of pov-erty. There are tools, however, that show striking success in
spurring poverty reduction and improving the lives of those liv-ing at the base of the economic pyramid. One of these is microfi-nance, which has steadily gained worldwide recognition.6 Today, over 150 million poor people in the world enjoy access to micro-credit, that is, loans as small as $25.7 Microcredits typically are used as working capital by peo-ple, often poor women, with little or no credit history and limited,
if any, physical collateral that might be pledged to secure their debt obligations.
Champions of microfinance can be found around the world. Many would agree with former Secretary General Kofi Annan of the United Nations that “[m]icrofinance has proved its value, in many countries, as a weapon against pov-erty and hunger. It really can change peoples’ [sic] lives for the better—especially the lives of those who need it most.”8
But is microfinance living up to its promise? Do poor people who gain access to microcredit actually grow their microenterprises into successful businesses?
Data suggests that microenterprises rarely grow into small- or medium-size businesses, even where the owners of these microenterprises have access to microcredit.9 Critics of microfinance point to the lack of employment opportuni-ties stimulated by microfinance. Some even go so far as to suggest that the sizable financial resources now devoted to the microfinance sector might be better spent on other, more effective poverty-alleviation interventions.10
There may be sound reasons, however, why so many microentrepreneurs keep their enterprises “micro.” Microen-trepreneurs may prefer to diversify their income-producing activities among several microenterprises instead of growing a single business that would be more vulnerable to factors outside of the microentrepreneurs’ control (including cor-rupt local government officials). The microentrepreneur may fear that a larger enterprise, particularly one that employs paid labor, will demand more entrepreneurial expertise and skills than the microentrepreneur currently commands.11
Another important reason that so many of these enter-prises stay “micro” is that microentrepreneurs may have chosen to invest profits into feeding and educating their children rather than expanding their businesses; in short, these microentrepreneurs are betting on their children, rath-er than on their businesses, to improve their families’ social and economic condition.
Microfranchising: A Business Approach to Fighting PovertyDeborah Burand and David W. Koch
Deborah Burand was director of the International Transactions Clinic at University of Michigan Law School when writing this article. She now is general counsel at Overseas Private Investment Corporation. The opinions expressed herein are her own. David W. Koch is a partner in the Reston, Virginia, firm of Plave Koch PLC.
This is a strategy shared by parents the world over. Unfortunately, however, it appears that microentrepreneurs’ investments in the education of their children are not gener-ating the hoped-for returns because their working-age chil-dren often find it difficult to secure jobs in the formal sector. This was documented by FINCA International, a global net-work of twenty-one microfinance institutions serving over 700,000 clients.12 In 2004, FINCA International conducted a survey of 1,500 microfinance clients in Mexico, Guatemala, Honduras, El Salvador, and Haiti. Of the surveyed clients’ children who had completed all or part of their secondary education, only one in six was employed in the formal sector (defined by FINCA as commanding a salary of at least $8 a day). The other working-age children of FINCA clients were unemployed or employed in the informal sector where they were earning less than $3 a day.13 If the FINCA study is representative of the microfinance sector as a whole, then the investment that many microentrepreneurs worldwide are making in the education of their children is not paying off.
There is good reason to think that this is a pervasive issue that reaches far beyond FINCA’s network of microfinance providers. The world is facing a youth employment crisis. The International Labor Organization (ILO) reports that “of the 1.1 billion young people aged 15 to 24 worldwide, one out of three is either seeking but unable to find work, has given up the job search entirely or is working but living on less than $2 a day.”14 Moreover, ILO data indicates that youth unemployment is a growing problem. In the decade between 1995 and 2005, the number of unemployed youth aged 15 to 24 increased by approximately 15 percent, from 74 million to 85 million.15
FROM MICROFInAnCE TO MICROFRAnCHISE
What can be done to bring scalable business opportunities to the base of the economic pyramid, in particular to micro-entrepreneurs and their working-age children? One possible answer is to look to commercial franchising models and practices. After all, a franchise network trains, guides, and supports individuals with little or no business experience to become successful business owners.
Is it a pipe dream to think that a franchise network could do the same for hundreds of poor women? Not if you were to step back in time to the 1890s to talk with former domes-tic servant Martha Matilda Harper. Harper established the first Harper Hairdressing Parlor in Rochester, New York, in 1891 and then extended her hair parlor into a business format franchise that trained and employed thousands of poor women. By 1928, there were 500 Harper Hairdressing Parlors around the world.16
If Martha Matilda Harper could build scalable business opportunities for poor women at the turn of the nineteenth century through the use of one of the earliest business for-mat franchises, how might franchise practices and business models be enlisted to build scalable business opportunities at the base of the economic pyramid in today’s world? Stan-dardized business systems; strong brand identity; valuable
know-how and experience; financing assistance; training and start-up support; establishment of supply channels; marketing services; research and development; and con-tinuing franchisee support, including peer learning oppor-tunities for franchisees, are but some of the hallmarks of commercial franchising that might be enlisted and adapted to grow scalable business opportunities so that more micro-entrepreneurs can bridge the gap between microenterprises and small enterprises while also providing improved employ-ment opportunities for their working-age children.
There is no common definition of microfranchise.17 Some have called it “a scaled down franchise with a small enough price tag that low income people can afford it.”18 Others have described microfranchising as “a variety of franchise types . . . [that aim] to impact poverty by facilitating job creation, economic activity and distribution of goods and services to the base of the pyramid markets.”19 In this arti-cle, the term microfranchise means a business model that, although adopting many of the business practices employed in mainstream commercial franchising, involves businesses that are affordable enough to be owned and operated by people living at the base of the economic pyramid. Even this definition, however, leaves much room for interpretation, particularly as one tries to determine what an “affordable franchise” is from the point of view of the world’s poor. To this point, Jason Fairbourne, author of MicroFranchis-ing: Creating Wealth at the Bottom of the Pyramid, founder of the Fairbourne Consulting Group, and Peery Fellow at the Ballard Center for Economic Self-Reliance at Brigham Young University’s Marriott School of Management, has offered some loose boundaries, noting that although “. . . the average US franchise costs roughly $250,000 . . . micro-franchises range from $25 to $25,000.”20
Microfranchising, as used in this article, is distinct from the related concept of “social franchising.” Social (sector) franchising typically is aimed at bringing products and ser-vices, like education and health care, to people living at the base of the economic pyramid through the use of business format franchise practices. Some researchers have suggested that social franchising necessarily does not generate profit.21 This assertion has been contested vigorously by others, how-ever, who cite a network like The HealthStore Foundation’s CFWshops in Kenya as an example of a social sector fran-chise that aims to be profitable. This Kenyan chain of 80 microfranchised drug shops and clinics served over 540,000 patients and customers in 2009, according to its program sponsor, The HealthStore Foundation.22
Perhaps a more relevant differentiation between social franchising and microfranchising is not that of profitabil-ity but rather of who is the target franchisee. To put it dif-ferently, unlike social franchising, microfranchising may or may not deliver goods and services to the poor, but it will always aim to build franchisable business opportunities that are affordable for the poor. In contrast, social sector franchising may or may not draw its franchisees from the poor, but it will always aim to deliver needed products and services to the poor.
Microfranchise networks are still relatively few in num-ber. Although no single repository purports to have a com-plete list, one source recently listed over sixty microfranchise opportunities in twenty countries.23 Some of these opportu-nities are relatively large, such as SPOT City Taxis, which reportedly has grown into the largest taxi operator in Banga-lore, India, with more than 300 cars, each owned by a micro-franchisee;24 and Fan Milk, which is listed on the Ghana stock exchange and is reportedly the leading distributor of dairy products in Ghana with some 8,500 microfranchi-sees selling milk, ice cream, yogurt, and popsicles from carts and bicycles.25
As previously noted, microfranchising today is where microfinance was a decade or more ago. Many microfranchises have yet to demonstrate that they are financially sustainable at the network level and even, at times, at the unit level.26 Transparency in measuring the per-formance of microfranchise networks lags far behind that of its cousin, the microfinance sector.27 And like microfinance of ten or more years ago, microfranchising activity generally appears to be taking place off the radar screen of any regula-tory or legal authority.28
WHAT LESSOnS CAn MICROFRAnCHISIng LEARn FROM COMMERCIAL FRAnCHISIng?
All organizations that begin franchising face a steep learning curve; in fact, it is often said that franchising organizations are entering a whole new business because the business of franchising is so different from the business concept that is being franchised. Persuading a customer to part with money for a desired good or service is a very different exercise from persuading a prospective franchisee to invest money and time in building a franchise. It is hard and unfamiliar work to market a franchise opportunity, recruit prospective fran-chisees, screen applicants, train successful candidates, and complete all of the other steps necessary to help these fran-chisees open for business.
And the franchisor’s job does not end when the franchise opens. The new franchisor might not be prepared for the full weight of franchisees’ expectations, namely, the expectation that the franchisor has expertise in the business model that the franchisees are trying to execute; that the franchisor can teach that expertise and will be available to share it at all hours; that the franchisor will provide ongoing support in the form of product research, marketing research, sourcing of inputs, etc.; that the franchisor will enforce system stan-dards to promote uniformity of image and consistency of operations; and that the franchisor will demonstrate overall leadership of the brand.
So franchising is a leap for any organization, but micro-franchising by an organization with little or no experience in commercial franchising is likely a much longer leap. A variety
of microfranchise sponsors, ranging from nongovernmental organizations (NGOs) to foundations to for-profit entities, have launched microfranchise networks with varying levels of the skills needed for key franchisor functions such as creating a supply chain, assessing business talent, enforcing system stan-dards, and managing relationships for commercial success.
To what extent can sponsors of microfranchise networks look to commercial franchising for guidance? Microfranchis-ing and commercial franchising may have less in common than meets the eye. First, the objectives of microfranchisors
and mainstream commer-cial franchisors are likely to be very different. Some start microfranchise networks in order to bridge the gap between microbusinesses and small businesses, that is, to provide a financially sustainable model that will
permit microentrepreneurs to “graduate” into small-busi-ness owners. Others start microfranchise networks (or social sector franchise networks) as a distribution channel to sell products and/or services to the economically disadvantaged. In either case, the focus of the microfranchise network is likely to be on the financial performance of the microfran-chisee and the resulting economic impact of the microfran-chising operations at the local level, be it through increasing employment opportunities or increasing unit sales.29 Gen-erating financial returns for the microfranchisor appears to be a secondary consideration for many microfranchise net-works, although financial sustainability at the network level is a long-term goal of many microfranchise networks—even those initially funded by donor grants.30
Commercial franchisors, of course, similarly must be mindful of the financial performance of franchisees if the system is to succeed. But the emphasis is different; put simply, commercial franchisors launch franchise programs primarily to benefit themselves, with potential side benefits to franchisees, whereas many of today’s microfranchisors appear to be launching their microfranchise programs pri-marily to benefit the poor.
Microfranchising and commercial franchising also differ markedly in the nature and capabilities of the franchisees. Microfranchisees are drawn from poor populations. They are likely to have very little, if any, money to invest in a microfran-chise. They may have little or no education. They may live in remote areas and have no reliable means of transportation. They may not have access to technology or even to electricity. Moreover, they are unlikely to have significant business expe-rience other than on a subsistence level.31 For these reasons, traditional product distribution franchises, which require less capital and are far less complex than business format fran-chises, have dominated microfranchising thus far.32
Despite these significant differences, commercial franchis-ing can contribute much to microfranchising efforts. First, as unlikely as it may seem today, mainstream commercial franchisors might consider offering their own microfranchise
Despite significant differences, commercial franchising can contribute
brands. The development community and the mainstream franchising community are rapidly learning more about each other, and one result is a heightened focus on profit-ability of the microfranchise brand at the network level. This focus might eventually offer mainstream franchisors a profit opportunity that they instinctively dismiss today. Even if sig-nificant profit is not on the near horizon, a mainstream fran-chisor might be willing to offer a microfranchise opportunity in order to lay the groundwork for its brand in a developing country that shows promise or to gain a jump on its competi-tors or simply as a charitable endeavor to enhance its reputa-tion. The franchisor might wish to tout itself to its customers as a do-gooder in developing countries even if it means taking a small loss on microfranchising.33
A mainstream franchisor could contain its investment and risk by developing the microfranchise as a second brand, per-haps with little or no public association with its primary com-mercial brand but with the ability to leverage the back-end support of the principal brand. Under this approach, if the secondary microfranchise brand fails, its failure would not taint the primary brand in the market. The information box accompanying this article provides mainstream franchisors with some reference works and organizations to consult for more information on how to get started in microfranchising.
Second, and more likely, commercial franchising can contribute to microfranchising by providing ideas and refer-ence points for structuring and managing microfranchised brands. A microfranchisor can readily draw from the vast body of materials and resources developed in franchising over the last thirty or forty years. But the information shar-ing could also take place through direct mentoring relation-ships whereby established commercial franchisors actively mentor franchisors that are working with the economically disadvantaged. Just as the microfinance sector has benefited from mentor relationships with the commercial banking sector, so too could microfranchising benefit from similar arrangements with commercial franchisors.
Even if, in some ways, commercial franchising might instruct more effectively by contrast than by similarity, it can offer useful lessons. The following paragraphs provide a few examples.
Brand ManagementA threshold question is who should serve as the “brand manager” for a microfranchise brand in a particular mar-ket. In commercial franchising, foreign brands typically, though not always, enter a market through master franchis-ing, in which a local party is appointed to fulfill the role of the “franchisor.” The master franchisee, as brand manager, grants subfranchises, provides training and opening assis-tance, supervises marketing efforts, and supports ongoing operations of the subfranchisees. By contrast, if the brand is homegrown, master franchising typically is unnecessary (the brand owner knows its own market) and potentially even detrimental (because it inserts a middleman between the brand owner and the ultimate operator).
Microfranchisors can draw from these commercial
practices by performing a similar self-analysis of their inter-nal capabilities to grow and manage the microfranchise brand in a particular market. The microfranchisor might lack the business expertise to maximize its brand, particular-ly if the microfranchisor is an NGO or development agency. Or the microfranchisor might lack the organizational scale and resources to fulfill the franchisor support functions for an expanding network of small-scale, intensely local micro-franchised businesses. In either case, a master franchising model could offer a solution. It would permit the micro-franchisor to retain sponsorship of the program as well as an in-country connection to the ultimate operators.34 At the same time, the microfranchise brand owner could hand off day-to-day implementation to a better-qualified brand manager. Conceivably, that brand manager might even be a mainstream franchisor with a primary commercial brand that is looking to do some good in the world, gain a foothold in a new market, or both.
Of course, the microfranchisor has other alternatives; for example, it could simply hire employees or consultants with the necessary franchising expertise. However, this alterna-tive requires the microfranchisor to have sufficient funds to hire the required talent, whereas the appointment of a mas-ter franchisee assumes that the master franchisee will use its own resources to manage the brand in exchange for the lion’s share of the revenue stream from subfranchisees.
Experience has taught that the success of master franchis-ing in the commercial context depends greatly on choosing the right local partner. The challenge would be no less for a microfranchisor. For example, the brand owner might be reluctant to grant a master franchise to a commercial enter-prise that it suspects would not fully embrace its poverty-fighting mission or that has little experience in dealing with a subfranchisee pool comprising those living at the base of the economic pyramid. Nevertheless, the master franchise structure and the considerations that underlie its use could be instructive for microfranchising, particularly for those aiming to develop a global or regional footprint.
ContractsIn commercial franchising, the franchisor typically presents prospective franchisees with a long, detailed franchise agree-ment spelling out the respective rights and obligations of the parties. The goals of these franchise agreements have evolved over time. Although franchisee advocates believe that these agreements continue to be largely protective of the franchi-sor at the expense of the franchisee, there has been some movement toward more balanced terms governing the cre-ation, operation, and termination of franchise relationships.
Given the characteristics of prospective microfranchi-sees and the very different risks inherent in a microfranchise from those encountered in a mainstream commercial fran-chise, standard commercial contracting practices may not be appropriate for microfranchises. Microfranchisees may not have the ability to read, let alone understand the legal com-plexities of, a lengthy written agreement. In fact, in some circumstances one could argue that individualized contracts
should not be used at all.This is not to say that there should not be franchisee pro-
tections built into the microfranchisor-microfranchisee rela-tionship. Indeed, one might argue that the inherent power and information asymmetries between a microfranchisor and its microfranchisees make franchisee protections even more important than in the commercial context. Microfi-nance experts have noted, “Not only may low-income con-sumers be more vulnerable to misconduct by providers [of microfinance services and products] and less able to protect themselves, the consequences of their financial missteps may be more severe, resulting in lost income, assets, and con-sumption.”35 If this is true of microfinance borrowers, it is likely to be true of microfranchisees too.
On the other hand, at this early stage of development of the microfranchise sector, it may be more appropriate to advance microfranchisee protections outside of an indi-vidual contract, given the limitations of the microfranchisee to understand its terms and, ultimately, the challenges of enforcing such a contract in any meaningful manner.
Maturation of the NetworkThe current literature on microfranchising rarely provides more than a glimpse of the business terms between the microfranchisor and its microfranchisees. To some extent, this may be a function of the dominance in microfranchis-ing of simple product distribution business models. When
the microfranchisor-microfranchisee relationship involves only the purchase and resale of tangible products, along with instructions for the microfranchisee’s use of the brand in downstream sales to consumers, elaborate business terms are not necessary.
If microfranchising begins to reach meaningful scale, however, even relatively simple microfranchise networks are likely to encounter new challenges, such as (1) growing pains from expansion of their networks, (2) competition from rival brands for microfranchisees and end customers, and (3) migration into the more complex arrangements of busi-ness format franchising.
Commercial franchising offers some approaches to adjust-ing and expanding the business terms as challenges like these arise. For example, microfranchisors must be prepared to deal with intrabrand conflicts if and when the number of micro-franchises in operation approaches a saturation point in a particular geographic area. Commercial franchisors try to avoid such conflicts through market studies that estimate how many franchises a market will support and/or by assigning territories, locations, or customers in a way that will assure that each franchisee has a viable business opportunity.36
Listed below in summary form are further examples of problems that maturing microfranchise networks might encounter that may not be addressed in their original busi-ness terms, along with corresponding potential adjustments or expansions drawn from the commercial franchising world:
Copycat businesses, especially those started by former or breakaway franchisees
•Confidentiality clauses that prohibit franchisees from using proprietary information outside of the franchise
•Noncompete clauses•Ability to cut off inputs or repossess key equipment
dilution of management quality
•Owner/operator requirement•Restrictions on transfer of the franchise• If the business is large enough, right to approve manager(s) of the franchise
inconsistent marketing•Pooled contributions from franchisees to be used for brand advertising con-
trolled by the franchisor•Formation of franchisee advisory council to provide coordinated input
Failure to comply with operating requirements
•Reporting obligations, including direct electronic access by franchisor to franchi-see data, if feasible
• Inspection and audit rights•Franchisee peer pressure
Failure to pay amounts owed
•Requirement of payment by direct debit to account established by or for franchisee• Inspection and audit rights•Self-help remedies, such as ability to cut off supplies or require cash on delivery
implementing updates to the business model
•Unilateral right to update operations manual that franchisees must follow•Shorten term of franchise•Requirement of franchisee’s agreement to then-current terms at key milestones
This list is by no means exhaustive. Moreover, it begs the questions how effectively these adjustments can be made in the absence of written contracts between the microfranchi-sor and its microfranchisees and how effectively they can be enforced absent a stable and transparent legal system in the microfranchisee’s country.
Putting specific business terms aside, the single most impor-tant lesson of commercial franchising is that successful fran-chising always depends on good relationships. As franchise networks expand, however, it is increasingly difficult to man-age the brand by direct contact with individual franchisees. Distances grow, schedules conflict, personnel change, and voices multiply, all of which present obstacles to maintaining the quality of communication that the franchise system knew in its earlier life.37 Microfranchisors will need to construct channels of communication (from the outset, if possible) that ensure microfranchisees receive important microfranchisor communications in a consistent form at the same time and thereby avoid distortions that can undercut brand image. The reach of mobile technology into rural areas potentially makes this goal achievable where it would not have been a decade ago.
Microfranchisors also must embrace the notion that com-plaints from microfranchisees are not necessarily destructive. Just as microfinance providers have grown increasingly aware of the importance of developing effective grievance and redress mechanisms for consumers of microfinance prod-ucts and services, so too should microfranchisors develop effective channels for microfranchisees to lodge complaints and criticisms. In fact, complaints show that the complainer cares enough to bring the matter to the microfranchisor’s attention. What is more dangerous for any franchisor, com-mercial or micro, is silence, which could signify either a lack of complaints or, alternatively, that unexpressed complaints are festering into something even less healthy. Encouraging complaints, of course, is easier said than done when working with the poor. Microfinance providers have found that these populations, even when made aware of their right to com-plain, often fear expressing their views due to age, gender, societal position, language, or undue deference to authority figures, to name just a few factors.38
Accordingly, another useful technique that could be bor-rowed from commercial franchising is the formation of a franchisee advisory committee (FAC). The FAC gives the franchisee community a common outlet to express opinions, share ideas, and vent criticism about marketing, franchisor support, and other aspects of business operations. At the same time, the FAC gives the franchisor a venue to float trial balloons and adjust strategy with less risk of provoking anxi-ety in the franchisee community. For example, the franchisor might go to the FAC with a presentation on a new product or service before staking out a systemwide position from which it will be difficult to back away.39 An FAC might be even more important and useful in the microfranchise con-text as it offers a way to mitigate at least some of the power and information asymmetries that are likely to exist between microfranchisors and microfranchisees. Although a single microfranchisee may be reluctant to lodge a complaint or
raise a criticism directly with the microfranchisor, it may be less intimidating to speak up within the FAC, particularly if other microfranchisees share the concern being voiced.
There is another reason why the establishment of FACs may be wise for microfranchisors: the creation of social capital among participating microfranchisees. FACs could serve some of the functions that village banking groups have served in the microfinance context. Village banking groups, which can range in size from ten to thirty borrowers or even more, provide opportunities for village leadership and peer learning and support, among other things.40 A significant challenge in establishing such an FAC, however, will be over-coming the physical distance likely to exist between micro-franchisees, particularly those who live in rural areas.
Franchisor SupportAs noted previously, microfranchisors with limited commer-cial experience might not be prepared for the full weight of ongoing microfranchisee expectations. Perhaps it is true that microfranchisees at the base of the economic pyramid, also inexperienced with franchising, will have few expectations at the beginning and that they will be relatively easy to sat-isfy.41 Over time, however, microfranchisors should expect (and even hope) that their microfranchisees will evolve in the same way that they do in maturing commercial networks, namely, that microfranchisees will become empowered and likely more demanding of the microfranchisor.
In a maturing franchise system, it is not uncommon to hear two types of complaint. The first complaint is that the franchisor simply does not understand the franchisee’s prob-lems, especially if the franchisor operates no or only a few company-owned businesses of the type operated by the fran-chisee. The franchisor’s directives come across to the franchi-see much like the parent’s dreaded “do as I say, not as I do.”42
The second type of complaint is that the franchisor is no longer “earning” the royalty that the franchisee must pay to be in the system. To the franchisor, this comes across as a flippant “what have you done for me lately?”
From the viewpoint of an experienced practitioner, these tensions seem to be inherent in franchising. But when they arise, microfranchisors can reduce tensions by embracing two business principles borrowed from the commercial context:
1. Continuously strive to add value to the microfranchi-see’s operations
2. Make a sound business case for microfranchisor-imposed requirements
The microfranchisor can add value by, for example, offer-ing ongoing training and undertaking product develop-ment, marketing research, and operations analysis for which microfranchisees have neither the time nor the resources. The microfranchisor can make a sound business case by, among other things, using data collected from microfranchisees (preferably on an aggregate basis that protects individual results) to benchmark each microfranchisee’s performance against the network and derive best practices. In commercial
franchising, these activities typically are not obligations in the franchise agreement, but they are assumed in practice by a responsible franchisor. Responsible microfranchisors should consider doing the same.
HOW (OR WHETHER) TO REguLATE MICROFRAnCHISIng: ARE THERE LESSOnS TO BE LEARnED FROM REguLATIOn AnD SELF-REguLATIOn OF FRAnCHISIng?
For more than thirty years, commercial franchisors have been accustomed to operating under the franchise sales laws at the federal level and in fifteen of the United States. Twen-ty years ago, however, commercial franchisors faced consid-erable uncertainty in taking their franchise systems abroad. Absent express statutory or regulatory recognition of the franchise method of doing business, commercial franchisors could not be sure whether or how their franchise offerings would be regulated and in some cases whether franchising was permitted at all.
Today, almost two dozen countries have adopted statutes governing the offer and sale of franchises, including several countries with significant populations of the poor: Brazil, Indonesia, Malaysia, Mexico, and South Africa. In other countries, such as India, commercial franchising has thrived without the imprimatur of a franchise law.
Self-regulation also plays a role in commercial franchising, though some franchisee advocates question whether it is more than a public relations exercise. The International Franchise Association (IFA), for example, takes a four-step approach to self-regulation: (1) a code of conduct, (2) a streamlined code enforcement mechanism, (3) an ombudsman program, and (4) educational programs. This commitment to self-regulation is intended to provide an “effective alternative to litigation and legislation, both of which are costly, time con-suming, and potentially destructive to franchising.”43
One can imagine that self-regulation will be equally important, perhaps even more so, in building, structur-ing, and maintaining healthy microfranchise relationships. This is in part due to the disparity of negotiating power and the potential for misunderstandings between even well-intentioned, socially motivated microfranchisors and their respective microfranchisees. It also is due to the costs and time involved in pursuing court-led dispute resolution in markets where microfranchising is likely to take place. The lack of efficient and well-functioning court systems makes litigation an unlikely solution for either the microfranchisor or the microfranchisee.44
Microfranchising, as noted above, appears to be taking place beneath the radar of any regulatory authority. In fact, most microfranchise programs have appeared in countries that do not have franchise sales laws. This is not surprising: franchise laws generally have arisen in jurisdictions where they were preceded by a substantial amount of commercial franchising activity, and commercial franchisors generally have not entered developing countries marked by extreme poverty, at least not beyond the major metropolitan markets.
Yet one can legitimately ask: Would microfranchising be further along today if it had experienced explicit regulatory recognition in poverty-stricken countries? More pointedly, would express recognition stimulate or impede microfran-chising going forward?
The concept of regulation as promotion has precedent in both commercial franchising and microfinance. In com-mercial franchising, for example, the introduction of fran-chise regulation in China answered the question of whether franchising was legally permitted. In that sense, the Chinese regulation could be viewed as “enabling.” Similarly, in micro-finance, “providing an explicit regulatory space . . . may very well have the effect of increasing the volume of financial ser-vices delivered and the number of clients served.”45 In the last ten years, specialized laws and regulations have been adopted to promote microfinance, many of which are aimed at prudential regulation of deposit-taking microfinance pro-viders.46 However, as commentators in microfinance have noted over the years, any discussion of an explicit new regu-latory space must weigh potential unintended consequences, in particular, the risk that the political process of regulatory change might stymie innovation and competition.47
Franchising is well enough known worldwide that, as a general matter, it should not need enabling legislation beyond the general law of contracts in any jurisdiction. If enabling regulations were proposed, however, they would likely mimic existing franchise laws and regulations, which are built on an investor protection model that was borrowed originally from regulation of the sale of securities. In both franchising and securities, regulation was a response to fraudulent conduct by fly-by-night operators. So, one must ask: Do investors in microfranchises (that is, the microfran-chisees) need the protection of the type of franchise sales laws that regulate commercial franchising?
Nothing in the literature on microfranchising suggests that microfranchisees have been victimized by widespread fraud to date. It is certainly possible that unscrupulous par-ties could try to exploit potential microfranchisees with empty promises, and a pattern of such abuse might make it necessary to create a regulated channel as a marker of legitimacy. But the mere possibility of future fraud is not an adequate basis for regulation of microfranchising.
Moreover, the traditional approach to investor protection in commercial franchising is mandated disclosure of detailed information to the prospective franchisee, sometimes accom-panied by a requirement to register the franchise offering with government authorities. Consider, for example, the Franchise Act 1998 of Malaysia, which requires the fran-chisor, before making an offer or sale of a franchise, to reg-ister a disclosure document, a sample franchise agreement, the operations manual, the training manual, and audited accounts and financial statements with a Registrar of Fran-chises.48 Registered franchisors must file updated disclosures in an annual report. Violations of the law are punishable by fine, and a court can declare the agreement void and order a refund of all payments by the franchisee.
burdens of Franchise Act 1998, be inclined to launch a microfranchise program in Malaysia? The compliance costs seem likely to overwhelm the modest financial and social returns to be expected from microfranchising.
Worse, the Malaysia statute confirms the danger that creat-ing a regulatory space will invite interference in business terms. For example, the Malaysian law requires that franchise agree-ments have a term of at least five years and prohibits termi-nation except for good cause. Moreover, the franchisor must compensate the franchisee if it refuses to renew or extend the franchise at the end of its term. The law contains no exception that would apply to microfranchises, although it authorizes the supervising ministry by order to exempt any person or class of people from part or all of the act.49
On the microfranchisee side, it is questionable wheth-er the receipt of a detailed set of disclosures would be of real benefit to poor pop-ulations living in Malaysia or elsewhere. The recipients may not have the ability to read or the business sophistication to understand the information presented. On the other hand, the obligation to prepare (and possibly register) a disclosure document can have a disciplining effect on the franchisor regardless of whether franchisees actually read it.
Rather than a comprehensive registration-and-disclosure regime, microfranchising would be better served by a self-regulatory structure that is simpler for both the microfran-chisor and its microfranchisees. The basic elements would include the following:
• A registry in which microfranchisors would simply give notice of their intention to offer a microfranchise program (similar to the one-page “notice” registra-tion that franchisors make in the states of Indiana, Michigan, and Wisconsin). A registry could be vol-untary or mandatory, and it could be government-managed or privately run. The registry would help to distinguish legitimate microfranchise programs from any fraudsters that might seek to exploit poor people. To determine who may or must register, the registry would necessarily have to define microfranchise as appropriate for the jurisdiction.
• Annual reporting to provide very basic information on the performance of microfranchise networks, such as the number of microfranchises granted, microfranchisee turnover (i.e., numbers dropping out or terminated by the brand owner), and per-haps certain economic results such as impact on employment (if such data can be collected from microfranchisees).50 The transparency of this infor-mation would (1) foster competition between micro-franchise brands as potential microfranchisees learn to use the information to decide among particular systems; and (2) help identify the business sectors in
which microfranchising is successful or not success-ful, which would help microfranchise sponsors tar-get their efforts and perhaps help governments tailor incentives or policies.
• A basic code of practice to which members of the registry would subscribe. This would be similar to the codes that IFA and other commercial franchising trade groups have established for their members. The code of practice would informally govern relationships between microfranchisors and their microfranchisees by reference to a set of business norms. The code would not be regulatory or contractual in the sense
that it could be enforced by government authorities or privately, other than by affecting membership in the registry. However, to some extent, the code of practice would stand in for the pri-vate contract terms found in commercial franchise
agreements but sometimes lacking in microfranchis-ing. Moreover, if signatories of such a code of prac-tice were made public, then market forces (which are likely to include funders of microfranchise networks, namely, their donors and investors) could be brought to bear on the signatories.
This is akin to the approach that microfinance recently has taken with the adoption of the microfinance sector’s Client Protection Principles, which describe the minimum protection that microfinance clients should expect to receive from microfinance providers. These Client Protection Prin-ciples for microfinance are focused on the particular risks that low-income clients are likely to face when procur-ing financial services.51 A growing number of providers of financial services, microfinance networks, donors and inves-tors, and individuals working in microfinance have endorsed these principles since they were first announced in 2009.52
So what would a code of practice look like in the micro-franchise context? For starters, it likely would include all of the five basic value statements now found in the IFA Code of Ethics: (1) trust, truth, and honesty—foundations of franchising, (2) mutual respect and reward—winning together as a team, (3) open and frequent communica-tion—successful franchise systems thrive on it, (4) obey the law—a responsibility to preserve the promise of franchis-ing, and (5) conflict resolution.53
The challenge is that the expression of these values may need to shift significantly to accommodate the needs of a microfranchisee population comprising those living at the base of the economic pyramid. Take, for example, the absence of any ombudsman framework to facilitate dispute resolution between microfranchisors and microfranchisees. Or, even stickier, consider the challenges in determining the suitability of potential microfranchisees in a world where credit bureaus are largely absent and even national identity
Microfranchising appears to be taking place beneath the radar of
cards are sometimes nonexistent. Yet these challenges must be faced. And, importantly, transferable learnings should be shared amongst microfranchise networks.
The IFA Code of Ethics reminds us:
The public image and reputation of the franchise system is one of its most valuable and enduring assets. A positive image and reputation will create value for franchisors and fran-chisees, attract investment in existing and new outlets from franchisees and from new franchise operators, help capture additional market share, and enhance consumer loyalty and satisfaction. This can only be achieved with trust, truth, and honesty between franchisors and franchisees.54
For microfranchising to build on the success of microfi-nance and to grow to an equally meaningful scale, uphold-ing a similar positive reputation will be crucial.
COnCLuSIOn
Increasing the poor’s access to financial servic-es is a necessary, but not the only, ingredient in reducing poverty in the world. Increasing the poor’s access to scalable business opportunities is another critically important ingredient. For a man or woman living on one or two dollars a day, owning a microfranchise may prove to be a critical first step toward building a more sustainable livelihood. Both microfinance and mainstream franchising have much to teach those who are working to advance franchising at the base of the economic pyramid. Although the challenges of microfranchising are signifi-cant and the issues complex, the rewards could be extraordinary. At stake are the lives and live-lihoods of billions, including, it is important to note, the world’s next generation.
EnDnOTES
1. See Sam Daley-Harris, State of the Micro-credit Summit Campaign 2009, at 4 (2009), available at www.microcreditsummit.org (as of Dec. 31, 2007, the report reached 154 million clients).
2. The approximately three billion people who live at the base of the economic pyramid have daily incomes of less than $2 a day. See generally Daley-Harris, supra note 1, at 4.
3. See Press Release, The World Bank, New Data Shows 1.4 Billion Live on Less Than $1.25 a Day, but Progress Against Poverty Remains Strong (Aug. 26, 2008).
4. Id. The number of people living in poverty has fallen by 500 million since 1981.
5. World Bank, Global Economic Prospects: Crisis, Finance and Growth 2010 (released Jan. 21, 2010); see also Robert B. Zoellick, President, The
World Bank Group, Address at Thomson Reuters Building, Canary Wharf, London: Seizing Opportunity from Crisis: Making Multilat-eralism Work (Mar. 31, 2009).
6. The United Nations named 2005 “The International Year of Microcredit.” U.N. General Assembly A/RES/53/197 (International Year of Microcredit); see also U.N. General Assembly A/RES/58/221 (Resolution on the Programme of Action for the Year of Micro-credit) (adopted by the General Assembly). In 2006, the Nobel Peace Prize was awarded jointly to the founder of microfinance, Professor Muhammad Yunus, and the microfinance lender he created, the Gra-meen Bank. See Press Release, The Nobel Peace Prize for 2006 (Oct. 13, 2006), available at http:/nobelprize.org.
7. See Daley-Harris, supra note 1, at 3.8. Kofi Annan, Sec’y Gen., United Nations, Secretary-General
Message on the Launch of the International Year of Microcredit (Nov. 18, 2004).
9. FINCA International, a global microfinance network with
reFerenCe Box■ The Ayllu Initiative, http://aylluinitiative.wordpress.com.■ Steve Beck, Wouter Deelder & Robin Miller, Franchising
in Frontier Markets: What’s Working, What’s Not, and Why, MIT Innovations 153–62 (Winter 2010).
■ Laura Brix & Katharine McKee, Consumer Protection Regulation in Low-Access Environments: Opportunities to Promote Responsible Finance, 60 CGAP Focus Note, Feb. 2010.
■ Robert Peck Christen, Timothy R. Lyman & Richard Rosenberg, Microfinance Consensus Guidelines: Guiding Principles on Regulation and Supervision of Microfinance (CGAP/The World Bank Group 2003).
■ Lisa Jones Christensen, David Lehr & Jason Fairbourne, A Good Business for Poor People, Stan. Soc. Innovation Rev., Summer 2010.
■ Consultative Group to Assist the Poor, www.cgap.org.■ Jason S. Fairbourne & Stephen W. Gibson, The Microfranchise
Toolkit: How to Systematize and Replicate a Microfranchise (Econ. Self-Reliance Ctr., Brigham Young Univ. 2007).
■ Stephen W. Gibson & Jason Fairbourne, Where There Are No Jobs: The Microfranchise Handbook (Acad. for Creating Enter.).
■ David Lehr, Microfranchising at the Base of the Pyramid (Acumen Fund, 2008).
■ Kirk Magleby, Ending Global Poverty: The MicroFranchise Solution (PowerThink Publ’g 2007).
■ Marriott Sch. of Mgmt., Brigham Young Univ., Ballard Center for Economic Self-Reliance, http://marriottschool.byu.edu/selfreliance/.
operations in twenty-three countries, conducted research to map the growth of the self-employed businesses of its microentrepreneurs. According to FINCA’s research, nine of every ten clients stopped growing their businesses after three to four consecutive loans. See John Hatch, Microfranchise Theory—Opportunities for Partnership: How Microfinance and Microfranchising Complement Each Other, in Microfranchising: Creating Wealth at the Bottom of the Pyra-mid 102 (Jason S. Fairbourne, Stephen Gibson & W. Gibb Dyer, Jr. eds., BYU 2007).
10. See, e.g., A. Karnani, Microfinance Misses Its Mark, Stan. Soc. Innovation Rev. (Summer 2007).
11. Zoltan Acs, director of the Center for Entrepreneurship and Public Policy at George Mason University, coined the term neces-sity entrepreneurs to capture those people who are self-employed because they see no better employment option. This is in stark con-trast to opportunity entrepreneurs, or people who are eager to find and exploit opportunities in the market. See Lisa Jones Christensen, David Lehr & Jason Fairbourne, A Good Business for Poor People, Stan. Soc. Innovation Rev. 44, 46 (Summer 2010). The authors of “A Good Business for Poor People” go on to note that in developing countries “not only is it difficult to find a job, it is also difficult to envision a new business—especially one that employs other people or adds new products or services. Lacking both employment oppor-tunities and ideas for new businesses, necessity entrepreneurs often wind up copying other businesses.” Id.
12. See FINCA International’s website at www.finca.org.13. See Hatch, supra note 9, at 103.14. Press Release, ILO, New ILO Study Says Youth Unemploy-
ment Rising, with Hundreds of Millions More Working but Living in Poverty (Oct. 27, 2006) (announcing release of ILO Report, Glob-al Employment Trends for Youth 2006).
15. Id.16. See National Women’s Hall of Fame, www.greatwomen.org.17. Microfinance practitioners are likely to point out that defi-
nitional issues have also plagued the microfinance sector. There is still no widely accepted definition of microcredit, for example. Some have tried to define microcredit by describing attributes and features of the loan product, e.g., its maximum size, intended use (working capital, income generation, other), duration, and absence of physical collateral. Still others have tried to define microcredit by also describ-ing the intended target customer, e.g., gender, poverty level, etc. In sum, microcredit means many different things to many different peo-ple depending on the context. See generally What Is Microcredit? (Apr. 2010), www.grameen-info.org (suggesting that there is a need to develop classifications of microcredit).
18. See, e.g., What Is Microfranchising?, www.microfranchises.org.19. See Dalberg Global Dev. Advisors, Franchising in Fron-
tier Markets: What’s Working, What’s Not and Why 77, Annex 1 (Common Definitions—Microfranchising) (Dec. 2009).
20. Microfranchising: Creating Wealth at the Bottom of the Pyramid 8 (Jason S. Fairbourne, Stephen Gibson & W. Gibb Dyer, Jr. eds., BYU 2007).
21. See Dalberg, supra note 19, at 77, Annex 1 (Common Defini-tions—Social Franchising).
22. See www.cfwshops.org/statistics.html.23. See the Resources tab at www.microfranchises.org, the web-
site of Microfranchise Ventures, LLC. Even using an expansive
definition of microfranchise, there are relatively few (less than 100) microfranchise networks in the world as compared to the over 10,000 microfinance providers existing today. See Dalberg, supra note 19, Annex 5 (Sample Set of Micro-franchises) (lists sixty-eight micro-franchises drawn from Kirk Magleby, Microfranchise Opportu-nity Catalogue, referenced on www.microfranchises.org); see also Daley-Harris, supra note 1, at 3.
24. See Steve Beck, Woulter Deelder & Robin Miller, Franchising in Frontier Markets, 42:5 Franchising World 80 (IFA May 2010) (by the authors of the Dalberg report, supra note 19).
25. See Christensen et al., supra note 11, at 44.26. See generally Dalberg, supra note 19, at 25. This, too, echoes
the microfinance story as, a decade or so ago, debates raged not only on whether microfinance providers could reach financial sus-tainability but also on whether such sustainability should be a goal of microfinance providers. Today, fifteen years later, both of these debates have quieted as sustainable microfinance providers serve nearly 75 percent of the world’s microfinance clients (not counting those served by state banks). See Alexia Latortue, Microfinance in 2010 (May 17, 2010), www.cgap.org (Latortue is the acting CEO of the Consultative Group to Assist the Poor (CGAP)).
27. See Latortue, supra note 26. Like microfranchising, microfi-nance in its early days was marked by very little transparency, mak-ing it hard to measure or compare the performance of microfinance providers. In part, this was due to the lack of consensus on how to benchmark and evaluate performance. Today, by comparison, some 1,700 microfinance providers regularly report on their finan-cial performance to the Microfinance Information Exchange (MIX Market). Audited financial reports are common in the microfinance sector. Rating agencies have also become part of the microfinance landscape. MicroRate, Planet Rating, Microfinanza Rating, and M-Cril specialize in rating microfinance providers on their financial and, increasingly, on their social performance.
28. Today, by contrast, specialized laws and regulations have been adopted around the world to promote microfinance, particu-larly deposit-taking microfinance providers. See, e.g., CGAP, Law Library, www.cgap.org, which aims to meet the needs of banking regulators and supervisors, microfinance providers, national micro-finance networks, and other stakeholders seeking to understand the optimal mix of regulation and supervision for microfinance. See also Basel Comm. on Banking Supervision, Microfinance Activi-ties and the Core Principles for Effective Banking Supervision (issued for public comment Feb. 9, 2010).
29. Indeed, microfranchising experts sometimes lapse into “employ-ment” language when describing the relationship with the micro-franchisor. See Christensen et al., supra note 11, at 46 (stating that a nineteen-year-old Fan Milk franchisee “likes his employers” and that Fan Milk “employs” 8,500 franchisees). In commercial franchising, the distinction between a franchisee and an employee is a sensitive legal issue, and commercial franchisors take pains not to mix the concepts.
30. Here, too, one can see a parallel with the evolution of the microfinance sector. In recent years, the microfinance sector has begun to attract new entrants whose primary aim is to return a profit to their investors. The deliberate commercialization of microfinance has been controversial, causing some, including the founder of microfinance, Dr. Yunus, to ask how much profit is appropriate for a microfinance provider to generate, particularly when those profits are not reinvested
in the microfinance provider or shared with microentrepreneur clients.31. Microfranchising experts observe that these factors make
microfranchising a better business model in poor communities than entrepreneurship-building efforts, which “assume that poor people would like to be entrepreneurs, if only their lack of education and capital were not standing in the way.” Christensen et al., supra note 11. In fact, “research has long indicated that many newly minted entrepreneurs turned to self-employment as a last resort, not because of their desire to be small business pioneers.” Id.
32. See Beck et al., supra note 24. The authors cite Fan Milk (Ghana), Kegg Farms (India), Natura (Brazil), and Coca-Cola’s Manual Distribution Centers (Africa) as examples of “traditional format” franchises. They also cite SPOT Taxi of Bangalore, India, although the SPOT Taxi program would more properly be charac-terized as a “business format” franchise.
33. Dalberg, supra note 19. The Dalberg report points out, however, that homegrown commercial franchise concepts are bet-ter positioned to succeed than Western concepts because of better alignment with local tastes, pricing, cost structure, and enabling or disabling environments.
34. In commercial franchising, the franchisor, whether a foreign or domestic company, tightly controls the intellectual property not-withstanding the appointment of a master franchisee. Among other things, the commercial franchisor typically becomes the registered owner of the relevant trademarks or service marks in each coun-try and retains contractual control of other brand elements, such as trade dress and recipes or other trade secret information.
35. Laura Brix & Katharine McKee, Consumer Protection Regulation in Low-Access Environments: Opportunities to Promote Responsible Finance, CGAP Focus Note No. 60, at 3 (Feb. 2010).
36. Some laws would limit the microfranchisor’s freedom to restrict intrabrand competition between microfranchisees. For example, the European Union Block Exemption on Vertical Restraints does not allow the franchisor to prohibit “passive” selling outside of the fran-chisee’s territory. See Commission Regulation 330/2010 of 20 Apr. 2010, art. 4(b), available at http://ec.europa.eu/competition/antitrust/legislation/vertical.html. It should also be noted that the data needed for reliable market studies and to map territories may not be available for communities at the base of the economic pyramid.
37. See Kay Marie Ainsley, Debra A. Harrison & David W. Koch, The Evolving Franchise System: How to Guide an Emerging System from “Baby Steps” to a “Grown-Up” System, 43d Annual Legal Symposium 15 (IFA 2010) (conference workshop paper).
38. See Brix & McKee, supra note 35, at 3.39. See generally Andrew C. Selden & Rupert M. Barkoff, Coun-
seling Franchisees, in Fundamentals of Franchising 303–05 (ABA Forum on Franchising, 3d ed. 2008).
40. To learn more about village banking, see What Is Village Banking?, www.finca.org.
41. For example, see the comments of the Fan Milk franchisee profiled in Christensen et al., supra note 11.
42. Ainsley, Harrison & Koch, supra note 37, at 18.43. See IFA Self-Regulation Program, www.franchise.org.44. For example, according to a recent newsletter from a law
firm in New Delhi, the time that the average case spends in Indian courts is fifteen years, and more than thirty million cases are pend-ing. Kundra & Bansal Indian Legal and Business Update (June
1–30, 2010), available at www.kundrabansal.com/database/IBU/ILBUJUNE2010.pdf.
45. Robert Peck Christen, Timothy R. Lyman & Richard Rosenberg, Microfinance Consensus Guidelines: Guiding Prin-ciples on Regulation and Supervision of Microfinance 4 (CGAP/The World Bank Group 2003), available at www.cgap.org.
46. See supra note 28.47. See generally Robert Peck Christen & Richard Rosenberg,
The Rush to Regulate (CGAP Occasional Paper No. 4, Apr. 2000); see also Christen et al., supra note 45.
48. See generally Franchise Act 1998, reprinted in Bus. Franchise Guide (CCH) ¶ 7185.
49. Id. art. 58. Several franchise laws in the United States con-tain de minimis exemptions for very-low-investment franchises. The theory behind these exemptions is that the investor does not need protection when the investor is not risking much money. That theory is inapposite to the poor who invest in microfranchises, however. The amount of money that they risk is small in an absolute sense but likely to be large relative to their net worth and income.
50. Arguably the most effective activity that IFA has undertaken to advance the interests of franchising in recent years is commission-ing professional studies on the economic impact of franchising. See, e.g., 2 The Economic Impact of Franchised Businesses (IFA Feb. 2008), available at www.franchise.org (study prepared for the IFA Educational Foundation by PricewaterhouseCoopers).
51. See The Client Protection Principles in Microfinance, available at www.cgap.org. The six areas addressed by the Client Protection Principles are (1) Avoidance of Over-Indebtedness, (2) Transparent and Responsible Pricing, (3) Appropriate Collections Practices, (4) Ethical Staff Behavior, (5) Mechanisms for Redress of Grievances, and (6) Privacy of Client Data.
52. Endorsement of the Client Protection Principles brings vary-ing responsibilities, depending on the particular role of the endorser. These include the following:
For microfinance institutions: Endorsement begins with (1) a self assessment of each Institution’s own policies and practices to identify areas for improvement and (2) active promotion of Smart Microfinance and the core Client Protection Principles among staff.
For networks and associations: Endorsement is a commit-ment to engage with affiliated organizations to endorse, promote and support The Smart Campaign and the implementation of the six core principles of client protection.
For investors and donors: Endorsement is a commitment to support providers of financial services that adequately pro-tect their clients by incorporating Smart Microfinance into their screening, due diligence, audits, funding agreements, monitoring, reporting, and governance roles.
For supporting organizations and individuals: Endorsement is a commitment to personally practice Smart Microfinance and to work within their own organizations to implement the core Client Protection Principles throughout their operations when applicable.See What Does It Mean to Endorse the Smart Campaign?,
www.smartcampaign.org.53. See IFA Code of Ethics, available at www.franchise.org.54. Id.
M ost franchise counsel have been down the well-worn path of vicar-
ious liability. For decades it has been standard practice for guests injured at a franchisee’s premises to sling a vicarious liability rope past the franchisee to the fran-chisor, hoping to lasso it into the litigation. Vicarious liability is an indirect method to snag the innocent franchisor, and federal and state case law is full of fran-chise cases going both ways (confusingly, even involving the same franchisor) on vicarious liability theories of agency and apparent agency. Now, an increasingly popular strategy for ensnaring a franchisor is to fire a shot directly at the target by alleging direct negligence or direct liability by the franchisor.
There are several reasons counsel for an injured plaintiff may assert a direct negligence claim against a franchisor in addition to a vicarious liability claim: money, insurance cov-erage, and litigation strategy. This article will discuss fran-chisor direct liability, why plaintiffs allege it distinct from vicarious liability, and the legal issues relevant to analyzing these claims.
vICARIOuS LIABILITy: LOvE ME TEnDER
The starting point to an understanding of direct liability is an understanding of vicarious liability. Under a vicarious liability theory, the franchisor itself is not alleged to be neg-ligent. Rather, the plaintiff alleges that the negligent fran-chisee is the innocent franchisor’s agent. As the Wisconsin Supreme Court stated in Kerl v. Dennis Rasmussen, Inc., a very thorough opinion involving an Arby’s franchise,
[v]icarious liability is a form of strict liability without fault. A master [franchisor] may be held liable for a servant’s [franchi-see’s] torts regardless of whether the master’s own conduct is tortious. Although a plaintiff who suffers a single injury may plead both vicarious and direct liability claims against a [fran-chisor] . . . , vicarious liability is a separate and distinct theory of liability, and should not be confused with any direct liabil-ity that may flow from the [franchisor’s] own fault in bringing about plaintiff’s harm. Vicarious liability is imputed liability.
It is imposed upon an innocent party for the torts of another because the nature of agency relationship—specifically the element of control or right of control—justifies it.1
All franchise agreements have (or should have) indem-nification provisions that allow the franchisor to tender its defense to the franchisee on a vicarious liability claim. The franchisee is required to pay for the franchisor’s defense and indemnify the franchisor for any settlement or judgment lev-ied against the franchisor. In addition, the franchise agree-ment should require the franchisee to list the franchisor as an additional insured on the franchisee’s liability policy. Passing the responsibility down to the franchisee makes sense in a vicarious liability claim because it is the franchi-see’s negligence, not the franchisor’s, that brought the fran-chisor into the litigation (“you got me into this lawsuit, so it’s your responsibility to get me out”). A vicarious liabil-ity claim usually results in the franchisor kicking the claim down to the franchisee and the franchisee’s insurance carrier and lawyer, who will already be defending the same allega-tions of negligence against the franchisee. The allegation of an agency relationship can be challenged by the franchisor at summary judgment, but the risk is an adverse ruling find-ing an agency relationship that will be cited by the plaintiffs’ counsel against that franchisor in all future litigation. When damages are safely below the franchisee’s limit of insurance coverage, franchisors may simply let the franchisee handle the franchisor’s defense on the vicarious liability claim and resolve the entire litigation against both defendants by motion, settlement, or trial.
With vicarious liability, the plaintiff cannot settle with the allegedly negligent franchisee and still proceed against the franchisor because releasing the negligent franchisee agent automatically releases the innocent franchisor princi-pal.2 Agency law does not allow the franchisee to cut and run and let the plaintiff go solely after the franchisor’s deep-er pockets at trial because the claim against the principal is a derivative claim based entirely on the negligent conduct of the franchisee agent. If the damages are high and poten-tially exceed the limits of the franchisee’s insurance policy, the plaintiff can reach the franchisor’s much larger insur-ance policy only if it proceeds to trial and gets a verdict that exceeds the franchisee’s coverage.
The practical result is that the plaintiff must either jointly settle both its claim against the franchisee and its vicarious liability claim against the franchisor before trial by taking what it can get from the franchisee and its insurance policy, or roll the dice and proceed to trial against both defendants and hope it can get a verdict above the franchisee’s policy limits to reach the franchisor’s policy.
A franchisee has not only the contractual obligation but
Franchisor Direct LiabilityJay Hewitt
Jay Hewitt is a partner at Pfeiffer Gleaton Wyatt Hewitt, PA, in Greenville, South Carolina, practicing franchise law and litigation, business law, and complex litigation and appeals. He represented Choice Hotels in the case of Allen v. Choice Hotels at the trial court and on appeal to the the Fourth Circuit.
the financial incentive to get the franchisor out of the litiga-tion on a vicarious liability claim because under most fran-chise agreement indemnity provisions and state common law, the franchisor will sue the franchisee for any amount that the franchisor pays in a settlement or a verdict on a vicarious liability claim. In addition, subjecting the fran-chisor to vicarious liability for the franchisee’s negligent conduct is no way to curry favor with the franchisor for a pleasant future business relationship. Thus, on a vicarious liability claim, even though the franchisor remains a named defendant in the case, the plaintiff in most cases really is only proceeding against the small business franchisee and the franchisee’s insurance policy.
DIRECT LIABILITy: nOT SO TEnDER
A direct liability claim changes everything. The franchisor cannot tender its defense of that claim to the franchisee because the franchisor itself is alleged to be negligent inde-pendent of any negligence by the franchisee. The franchise agreement indemnity provision and the franchisee’s insur-ance policy will not obligate the franchisee to defend direct negligence allega-tions against the franchisor, and the franchisor will want to have its own counsel defending those allegations anyway. When both claims are alleged, the franchisor theoretically could still tender its defense of the vicarious liability claim to the franchisee, but it can be awkward and inefficient to let the franchisee’s counsel defend the franchi-sor on the vicarious liability claim while the separate fran-chisor’s counsel defends the direct negligence claim.
A direct negligence claim draws the franchisor’s insurance policy immediately into the litigation, which to the plaintiff means another (much deeper) pocket at the settlement table. Strategically, during the litigation, the plaintiff ’s lawyer will no doubt try to divide and conquer, hoping to drive a wedge between the franchisor and the franchisee by getting them to blame each other’s negligence as the cause of the plaintiff ’s injury. Nothing excites a plaintiff ’s lawyer more than two defendants with separate insurance policies who are not cooperating and are pointing fingers at each other. The plaintiff can also settle the negligence claims against the franchisee (and thereby the vicarious liability claims against the franchisor) yet still keep alive its direct negligence claims against the franchisor.
Plaintiffs often allege a vicarious liability claim without a direct liability claim simply because they do not have any evidence of direct negligence by the franchisor. Plaintiffs rarely allege a direct liability claim by itself.3 Plaintiffs who do allege a direct liability claim by itself are usually employ-ees of the franchisee because workers’ compensation laws prevent the employee from suing not only its employer fran-chisee but also the franchisor on a vicarious liability theory.
The franchisor’s vicarious liability is predicated upon the negligence of the franchisee, and the franchisee is protected from suit by the exclusivity provision of state workers’ com-pensation statutes. The franchisor is entitled to the same protection because its vicarious liability is derivative.4 While the franchisee employee is recovering those workers’ com-pensation benefits, the only claim available to it in a court of law may be a direct liability claim against the franchisor.
IS THERE A DuTy?
A franchisor should respond to direct negligence claims dif-ferently than vicarious liability claims. As discussed above, when a vicarious liability claim is alleged by itself, in most cases it is appropriate for the franchisor simply to tender it to the franchisee to defend. By contrast, a franchisor should always take the lead in defending a direct negligence claim, including specifically challenging at the summary judgment stage whether a duty exists.
In any negligence claim, the plaintiff must allege that the defendant owed a duty of care, the defendant breached its
duty by a negligent act or omission, the breach proxi-mately caused the injury, and the plaintiff suffered damages.5 Whether a duty exists is an issue of law to be determined by the court and not a jury;6 thus, a franchisor always has good
grounds to challenge a direct negligence claim at summary judgment on this duty issue.
Plaintiffs’ counsel will, of course, attempt to defeat sum-mary judgment on the direct negligence claim by dumping on the court all sorts of allegations and disputed facts about the franchisor’s negligent act or omission; but, even if they were true, such facts are irrelevant and premature. Disputed facts about what, how, when, or where the accident happened or expert testimony on how the franchisor was negligent are not relevant to the legal issue of whether a duty exists at sum-mary judgment. A plaintiff will have its opportunity to argue facts as to the particulars of the accident to a jury later, but only after the court has ruled that a duty exists.
At summary judgment, a careful franchisor lawyer should rely only on undisputed facts in the record about the relationship between the franchisor and the franchisee and which controls what in the franchise relationship—the only facts relevant to the issue of duty. Those facts should be based on the written franchise agreement and the franchi-sor’s written rules and regulations and thus should be undis-puted, and the testimony of the franchisee and franchisor should be consistent on these issues.
Who Has the “Con”?In the great dramatic movie Crimson Tide, actors Gene Hack-man and Denzel Washington play the captain and lieutenant of a nuclear-powered submarine with confusing orders to
A franchisor should respond to direct negligence claims differently
launch its nuclear ballistic missiles. They battle for control of the sub and its crew in the midst of a mutiny, each announc-ing over the ship’s radio that they “have the con” (i.e., the control) whenever they take and retake control.
The issue of whether a duty exists depends on who has the con, i.e., the franchisor or the franchisee. There is little debate that as the owner/operator, the franchisee owes a duty of care to guests, invitees, customers, and members of the public on its premises, utilizing its products or services, or encounter-ing its vehicles on the roadways. Direct liability cases look at the franchisor’s control over the franchisee to determine if the franchisor also owes a duty to the same individuals.
These direct liability cases look to the franchisor’s actual control or retained right of control to determine the pres-ence of a duty for purposes of evaluating whether the fran-chisor was itself negligent. This is distinct from a claim of vicarious liability under respondeat superior, which imputes the servant’s negligence against the master without any requirement of fault on the part of the master.7
If the franchisor does not owe a duty to the plaintiff, franchisee guests, employees, or members of the public encountering the franchisee, the franchisor cannot be liable for negligence and should be entitled to summary judgment.
What Line?Although vicarious and direct liability are distinct claims, the same facts, i.e., the level of franchisor control, unfortunately determine both the existence of a duty for direct liability and the existence of an agency relationship for vicarious liability. As one commentator observed, “the line separating claims involving an undertaking of responsibilities by the franchisor sufficient to create a duty for the purposes of direct liability from claims based on franchisor control sufficient to support vicarious liability under an actual agency theory may be indis-cernible, if a line exists at all.”8 If both direct and vicarious liability turn on the same issue, the level of franchisor con-trol, trying to keep them as “separate and distinct theories of liability”9 can create an intellectual migraine. Logically, in every case, both claims should either succeed or fail together.
Even more confusing, some courts have been predisposed to hold that whether an agency relationship exists is almost always an issue of fact for the jury.10 Yet the same facts, i.e., franchisor control, determine whether a duty exists for direct liability, an issue of law that the court should decide at summary judgment.11
For this reason, franchisor counsel must make a judg-ment call about whether to move for summary judgment solely on the direct liability claim, which may have a better chance of being granted as a clear issue of law, rather than muddy the motion with an agency label. This would leave the vicarious liability claim to be defended by the franchisee and its insurance carrier after the direct liability claim has been dismissed. However, franchisor counsel will no doubt be forced to spend many months in discovery prior to fil-ing a summary judgment motion on direct liability while
the plaintiff ’s lawyer is simultaneously building its case of franchisee negligence against the franchisee and vicarious liability against the franchisor. Thus, as a practical matter, franchisor counsel may want to defend the vicarious liability and agency allegations at the same time and build toward a summary judgment motion on both claims.
A franchisor may be able to ensure a win on a summary judgment motion on direct liability long before litigation arises. During the franchise relationship, the franchisor should train the franchisee and reinforce the franchise agree-ment and the rules and regulations, making it clear that the franchisee, not the franchisor, controls the day-to-day opera-tions of the franchise. When litigation arises, the deposition testimony from the franchisee that it, not the franchisor, con-trols the day-to-day operations and the particular instrumen-tality causing the plaintiff’s injury should be very persuasive on the franchisor’s motion for summary judgment.
COnTROL OF DAy-TO-DAy OPERATIOnS vERSuS InJuRy-CAuSIng ACTIvITy
While franchise law was developing in the 1980s and early 1990s, courts applied the traditional test for agency and looked at whether the franchisor exercised general control of the day-to-day operations of the franchisee to determine the existence of an agency relationship for vicarious liability.12 Fortunately, most courts now recognize that franchising is a unique business relationship and that the traditional agency test is a bit outdated and unfair to franchisors given the devel-opment of the modern franchise industry. The very nature of the franchise business model requires that the franchisor exercise some general control over its franchisees using its intellectual property, brand identity, marketing experience, and business methods.13 In addition, the federal Lanham Act requires a franchisor to exercise control over its franchi-see and police the use of its registered trademark or service mark,14 thus it would be unfair if complying with this federal law subjects the franchisor to agency liability. “The purpose of the Lanham Act . . . is to ensure the integrity of registered trademarks, not to create a federal law of agency . . . [or to] automatically saddle the licensor with the responsibilities under state law of a principal for his agent.”15 Courts recog-nize that “imposing liability on a franchisor for control over day-to-day operations of a franchise could unfairly penalize the franchisor, which must exercise a high degree of control to protect its trade or service mark under the Lanham Act.”16
Courts now look to the franchisor’s level of control over the specific injury-causing activity.
Courts have adapted the traditional master/servant “control or right to control” test to the franchise context by narrow-ing its focus: the franchisor must control or have the right to control the daily conduct or operation of the particular “instrumentality” or aspect of the franchisee’s business that is alleged to have caused the harm before vicarious liability may be imposed on the franchisor for the franchisee’s tor-tious conduct.17
For direct liability, courts conduct the same examination of franchisor control of the specific injury-causing activity to determine whether the franchisor had its own indepen-dent duty to guests of the franchisee regarding that activity.
Fires and Criminal AssaultsMany plaintiffs allege injury occurring at the franchisee premises caused by alleged lapses in safety and security resulting in fires and criminal assaults, and allege that the franchisor controlled that aspect of the franchisee’s opera-tion and thereby owed a duty to the plaintiff.
A case involving fire was recently decided by the U.S. District Court for the District of South Carolina in Allen v. Greenville Hotel Partners, Inc.18 and affirmed by the U.S. Court of Appeals for the Fourth Circuit in Allen v. Choice Hotels International, Inc., in an unpublished, but no less valuable, per curiam written opinion.19 At approximately 3:00 a.m. on a cold January night in 2004, an arsonist started a fire at a Comfort Inn hotel, causing six deaths and dozens of injuries. The arsonist was in a love triangle dispute with a female guest staying with another male in one of the rooms and allegedly entered the hotel undetected through a rear exit door with a malfunctioning lock. Plaintiffs alleged that the franchisee was aware of this malfunctioning exit door lock.
Plaintiffs alleged negligence by the franchisee, and vicari-ous and direct liability by the franchisor, Choice Hotels International, Inc. Although the district court denied sum-mary judgment to the franchisee that owned and oper-ated the hotel,20 it granted Choice summary judgment on the issue of vicarious liability, finding that “Choice did not control the hotel’s daily operations or hotel security and life safety systems” and thus could not be liable on an actual agency theory.21 The court also granted Choice summary judgment on apparent agency, finding that Choice did not hold the franchisee out in such a way that induced reliance on the appearance of an agency relationship.22 In the same decision, the court granted Choice summary judgment on all theories of direct liability.23 The case proceeded to appeal at the Fourth Circuit only on direct liability because plain-tiffs settled all negligence claims with the franchisee and, as discussed above, thereby had to release Choice on all vicari-ous liability claims.
Plaintiffs alleged direct negligence by the franchisor on three theories. First, they alleged that Choice had a duty to require the franchisee to install fire sprinklers in the hotel, even though local codes did not require the hotel to have fire sprinklers installed and the hotel did not have them. The district court24 and the Fourth Circuit25 held that Choice did not owe such a duty.
The second argument for finding a duty was that Choice controlled the hotel’s daily operations and specifically the security and life safety systems by issuing rules and regula-tions, essentially the same argument for alleging an agency relationship for vicarious liability. Choice’s rules and regu-lations required the franchisee to have life safety systems, which included smoke and fire detection, fire extinguishing equipment, emergency exits, and lighting that complied with
local codes, and even recommended fire sprinklers. Plaintiffs argued that these detailed requirements showed that Choice controlled the hotel’s life safety systems and therefore owed a duty to plaintiffs.
The franchisee testified, however, that Choice did not par-ticipate in the selection of fire or safety equipment installed at the hotel, that the franchisee did not need Choice’s approval to make changes to safety and security systems, that Choice did not have any role in the decision regarding whether to install fire sprinklers, and that Choice did not inspect those safety and security aspects of the hotel. The district court and the Fourth Circuit found it significant that the fran-chisee “(1) owned the building, land, and hotel equipment; (2) held the operating licenses and permits; (3) hired, fired, supervised, and disciplined the franchisee’s employees; (4) determined wages and room rates; (5) provided daily training for employees, and (6) provided insurance for the hotel.”26 The district court and the Fourth Circuit held that quality and operational standards in a franchise agreement and Choice’s rules and regulations merely ensure uniformity at all franchise locations to foster consistency through the franchise system, and did not establish that Choice owed a duty to guests at the franchisee’s hotel.27
Plaintiffs’ third duty argument was based on the allega-tions that Choice promulgated extensive rules and regula-tions regarding life safety, required renovations, and also voluntarily undertook to address a specific complaint about the malfunctioning exit door lock that plaintiffs contend was made prior to the fire. Plaintiffs alleged that a guest had called Choice’s toll-free number complaining about the malfunctioning exit door and that the Choice telephone representative had stated that the complaint would be addressed.28 Choice had no record of such a call; but even if it had occurred, Choice’s rules and regulations provided that the complaint would be forwarded to the franchisee. The district court rejected this voluntary undertaking argument on a motion for reconsideration,29 and the Fourth Circuit30 agreed. The Fourth Circuit held that “requiring renova-tions to the hotel and accepting and forwarding hotel-guest complaints to the franchisee does not indicate that Choice voluntarily undertook to regulate safety systems or make repairs to the hotel.”31
In Wu v. Dunkin’ Donuts, Inc.,32 the U.S. District Court for the Eastern District of New York considered a similar issue regarding franchisor control of security. Plaintiff was an employee of a Dunkin’ Donuts franchise. During a shift at approximately 1:00 a.m., she was brutally attacked and raped by two males in the store. Plaintiff sued the franchisor for vicarious and direct liability for alleged negligent provi-sion of security at the franchised location. Plaintiff alleged that the franchisor had sufficient control to create an agency relationship for vicarious liability33 and a duty for direct liability. Plaintiff alleged that this franchisor control arose from retaining the right to enforce franchise standards, inspect the franchisee’s premises, and terminate the franchi-see for violation of the standards.
The district court disagreed. “Most courts have found
that retaining a right to enforce standards or to terminate an agreement for failure to meet standards is not sufficient control. A right to enter premises and inspect also generally does not give rise to a legal duty.”34 The court found it signif-icant that the franchisor merely offered recommendations, rather than requirements, to the franchisee regarding secu-rity.35 The Wu court also recognized the public policy danger that imposing liability on a franchisor on the grounds that it controlled safety and security by making safety recommendations and sug-gestions would discourage franchisors from promoting awareness of security issues at franchised locations.36
The court also rejected plaintiff’s argument that the franchisor voluntari-ly assumed a duty to provide and maintain security at the franchisee’s location. Plaintiff alleged that Dunkin’ Donuts “voluntarily instituted a company-wide program designed to increase security at [franchised locations] and then negligent-ly failed to follow through on this commitment.” The court held that plaintiff failed to show that she relied on Dunkin’ Donuts’ assumption of the duty to provide security or that Dunkin’ Donuts’ actions increased the risk of harm to her.37
Swimming Pools, Parking Lots, etc.In Triplett v. Soleil Group, Inc.,38 plaintiff alleged that she was exposed to bacteria in a Sheraton hotel whirlpool and contracted Legionnaires’ disease. The federal court in South Carolina granted summary judgment to franchisor Starwood Hotels on plaintiff ’s vicarious and direct liability claims. On direct liability, plaintiff alleged that Starwood created a duty to guests at the hotel by controlling the franchisee through a license agreement and rules and regulations, including regu-lations regarding “the specific water depth, temperature, step heights and tread of the whirlpool.” Starwood also per-formed “periodic quality assurance inspections . . . to ensure compliance with these standards.”39
The court found it persuasive that the franchisee’s gen-eral manager testified that Starwood had no control over the day-to-day operations of the hotel. Although the brand standards did have specific guidelines for depth, tempera-ture, and step heights of the whirlpool, they did not deal with maintaining the water quality of the pool. The dis-trict court relied on the Fourth Circuit’s opinion in Allen v. Choice Hotels40 to hold that a license agreement and rules and regulations merely ensure that the franchisee operate the hotel consistent with brand standards and do not con-stitute sufficient control to create a legal duty to plaintiff.41
In Hunter v. Ramada Worldwide, Inc.,42 plaintiff alleged that she tripped over a garden hose in a common area of the hotel. The court found no evidence that Ramada controlled daily maintenance at the hotel or had the power to hire or fire employees or to determine wages, working conditions,
or standards of productivity or to supervise or discipline employees. The court held that “a franchisor does not have a general duty to either its franchisee or the guests or cus-tomers of its franchisee” and that there was no dispute that Ramada lacked control over the day-to-day operations of the hotel sufficient to create a duty for direct liability.43
In Anderson v. Turton Development, Inc.,44 plaintiff was injured when she tripped over a handicapped park-ing ramp in a franchise hotel parking lot. Plaintiff alleged negligence against the franchisee and alleged that the franchisor was vicariously liable under actual and apparent agency theories as well as directly liable. The court denied summary judgment to the
franchisee but granted summary judgment to the franchi-sor on all theories. On direct liability, the court held that although the franchise regulations “required the construc-tion of handicap parking ramps and provided a suggested design,” the evidence showed that the franchisee designed the ramp causing the injury.45
In Little v. Howard Johnson Co.,46 plaintiff was injured “when she slipped on a walkway [that] allegedly had not been . . . cleared of ice and snow.” The court held that the franchi-sor was not directly liable because under Michigan law it was not deemed a “possessor” of the land by virtue of the control granted in the franchise agreement, nor did the agreement set snow removal standards or give the franchisor the right to enter the property to perform or direct snow removal.
DAMnED IF yOu DO, DAMnED IF yOu DOn’T
With direct liability claims, plaintiffs often attempt to impose a higher duty on franchisors than is required by the law, arguing that franchisors have a duty to act and exert more control over the franchisee by implementing policies to protect franchisee guests or employees. Essentially plain-tiffs argue that the franchisor did not exert enough control. While making this argument, plaintiffs often simultaneously make the contradictory argument in the same case that the franchisor exerted too much control over the franchisee, creating an agency relationship subjecting it to vicarious liability and creating a duty for direct liability. With these inconsistent arguments, plaintiffs’ counsel attempt to create a “damned if you do, damned if you don’t” perfect liability trap for franchisors.
Implementing too many policies and becoming too involved in franchisee activities such as safety and security make a franchisor liable for controlling the franchisee. For example, in Martin v. McDonald’s Corp.,47 the franchisor was found vicariously liable because it controlled security issues by creating a branch to deal with franchisee security problems and designating a regional security manager.
Implementing too many policies and becoming too involved in
franchisee activities such as safety and security make a franchisor liable
Yet, switching to the direct liability claim plaintiffs will argue in the same case that the franchisor failed to imple-ment enough policies or take extra measures to protect fran-chisee employees and guests, subjecting it to direct liability. Many courts have rejected these extra-duty arguments, but the danger still exists for franchisors. For example, as dis-cussed above in Greenville Hotel Partners, the district court and Fourth Circuit rejected plaintiffs’ argument that the franchisor had an addi-tional duty to require the installation of fire sprin-klers when they were not required by local fire codes. Similarly, in Chelkova v. Southland Corp.,48 plaintiff, an employee of the franchi-see, was injured by a criminal assault occurring on the fran-chised premises. Plaintiff alleged a direct negligence theory that the franchisor had a duty to require various safety and security measures to be installed at the franchise location that were not required by law. The Illinois Appellate Court held that plaintiff sought to impose an additional duty on the franchisor that did not exist under Illinois law or the franchise agreement. The franchisor was held not to be directly liable because even though the franchisor distrib-uted a robbery prevention kit and paid for a security system, implementing security measures was not mandatory and was left to the franchisee’s discretion.49
Franchisors have to strike a balance between exercising enough control to protect their brand and reputation while not exercising so much control that they create an agency relationship for vicarious liability or a duty for direct liabil-ity.50 As one commentator noted,
[F]ranchisors are often confronted with a perplexing dilem-ma. They are practically compelled by federal law to closely control and supervise local operations in order to protect their trademark and to assure customers of consistent, high quality products or services. Yet, when franchisors exert the control necessary to be in accordance with federal law, their legitimate intentions may in essence backfire and leave them legally liable for the actions of the local franchisee.51
vOLunTARILy unDERTAKIng A DuTy
If plaintiffs cannot establish that a franchisor owed a duty, they often argue that the franchisor “voluntarily undertook” a duty that the franchisee had by involving itself in (i.e., controlling) that aspect of the franchisee’s operation. This argument usually amounts to nothing more than the same control-of-the-franchisee argument under a different name. The argument comes from the general rule of law that when one assumes to act, even voluntarily, he becomes subject to the duty to act carefully.52
A number of such plaintiff allegations have made their way to the courts, but the courts have generally found for
the franchisor, especially in recent years. In Allen v. Choice Hotels, the Fourth Circuit held that Choice did not volun-tarily undertake a duty to address a complaint allegedly made about security at the franchisee’s hotel by having a policy to forward complaints received to the franchisee.53 In Wu, the court held that simply providing a list of suggested and recommended security items does not establish that
the franchisor voluntarily assumed control of security at a franchisee location.54
In Hyde v. Schlotzsky’s, Inc.,55 customers of the franchisee alleged that they contracted hepatitis A from eating tainted food at a Schlotzsky’s deli franchise. The customers brought a
direct liability claim against the franchisor on the grounds that the franchisor had a cleanliness and inspection policy concerning franchisee employee hygiene and therefore vol-untarily assumed the duty to follow up when a franchisee received unsatisfactory inspection results. The Georgia Court of Appeals held that Schlotzsky’s had the right to evaluate the franchisee’s compliance with standards but that this did not amount to undertaking a duty to involve itself in the day-to-day operations of the restaurant or assuming control of the manner of executing work at the restaurant.56 In Castro v. Brown’s Chicken & Pasta, Inc.,57 the Illinois Appellate Court held that a franchisor did not voluntarily undertake a duty to provide security to customers who were tragically murdered at the franchisee premises because all security measures were left up to the franchisee’s discretion, and the franchisee was free to implement any security mea-sure it deemed necessary.
CASES FInDIng DIRECT LIABILITy
Most reported opinions discussed in this article find no duty and no franchisor direct liability. This may be due to franchisors settling cases that have the risk of finding a duty and direct liability to avoid an adverse written opin-ion. Most of the cases finding that a franchisor duty exists and subjecting franchisors to direct negligence liability are from the 1980s and early 1990s. The clear trend in recent case law from around the country is to find that franchisor control does not create a duty to customers or employees of the franchisee subjecting the franchisor to a direct neg-ligence claim, even though some courts are still holding franchisors liable to customers on agency and vicarious liability theories.
A case from the early 1990s, Decker v. Domino’s Pizza, Inc.,58 demonstrates the danger when courts do not grant summary judgment to the franchisor and a direct liabil-ity claim is allowed to go to trial. In Decker, plaintiff, an employee of the franchisee, was assaulted during a rob-bery at the franchised premises. The jury awarded plaintiff $400,000 on a direct liability theory. The Illinois Appellate
The trend in case law is that franchisor control does not create a duty to
customers or employees of the fran-chisee for a direct negligence claim.
Court held that Domino’s could be liable on a direct neg-ligence “voluntary undertaking” theory because it “under-took to establish a security program to deter robber[ies]” at franchisee locations, established a division of the franchi-sor to handle security matters, generated literature for fran-chisees to follow, created a standards committee to review crime prevention measures for the franchisee, and evaluated franchisees on compliance with safety and security aspects. The court held that Domino’s voluntarily undertook a duty to provide a security program for franchisees to deter rob-bery and protect franchisee employees and could be held liable for negligent performance of that duty.59
Decker is an example of a franchisor being penalized for attempting the commendable goal of preventing crime at franchised premises. The unfortunate message to franchisors from this case was that Domino’s would have been better off not to make any effort to assist franchisees with safety and security—a counterproductive result that courts in Wu v. Dunkin’ Donuts and Allen v. Choice Hotels have recently begun to recognize the public policy need to correct.
In another early 1990s case, Whitten v. Kentucky Fried Chicken Corp.,60 the Indiana Court of Appeals held that a franchisor could be directly liable to a franchisee employ-ee injured by a fryer. The court found it significant that the specific instrumentality causing the injury, a fryer, was purchased by the franchisee with the approval, if not at the direction, of the franchisor. The court noted that the fran-chise agreement had “a sophisticated system for selecting, approving, testing, recommending, and maintaining qual-ity control over certain equipment.”61 The court relied on a similar result reached in a case from the early 1980s, Wise v. Kentucky Fried Chicken Corp.,62 where the franchisor select-ed, recommended, inspected, and/or supplied the specific equipment causing injury to plaintiff, subjecting the fran-chisor to direct liability. The court also relied on Papastathis v. Beall,63 where plaintiff “was struck on the head by a soft drink can [that] fell from an allegedly defective soft drink dispenser rack” selected, recommended, and inspected by the franchisor, subjecting it to direct liability.
In another early 1980s case, Clem v. Steveco, Inc.,64 the Indiana Court of Appeals denied summary judgment to a 7-Eleven franchisor on a direct liability theory where a fran-chisee employee was kidnapped and murdered. The court acknowledged that the franchisor’s liability for injuries suf-fered by employees of the franchisee was a “developing area of the law” in 1983 but relied on Wise to hold that whether the franchisor retained sufficient control over the franchisee to create a duty to the employee raised material issues of fact regarding the degree of control.65
Fortunately, recent case law such as Wu has recognized that public policy should encourage franchisors to make security suggestions and recommendations and not hold them liable for doing so. Indeed, it is interesting that in 2002, eight years after Decker was decided, the same Illinois court held in Chelkova, discussed above, that a franchisor had not voluntarily undertaken a duty regarding security on similar facts where a franchisee employee was injured in a robbery.
SuggESTIOnS FOR FRAnCHISORS
Preventing franchisor direct liability begins before litigation begins. Franchisees should be trained and reminded consis-tently throughout the franchise relationship that they are in control of the day-to-day operation of their businesses. Specific attention should be paid to hotly litigated issues to clarify that the franchisee, not the franchisor, controls such aspects of the franchise as safety and security, sanitation and cleanliness, parking lots, etc. Franchisors should inspect for items of brand identity and quality of service only, not issues such as safety and security. A franchisor can subject itself to direct liability where it specifically involves itself in selecting, recommending, and inspecting particular equip-ment or safety procedures of the franchisee.
When litigation begins, franchisor counsel should build discovery on the direct liability claim toward a summary judgment motion based on the argument that the franchisor does not owe a duty to the plaintiff. This motion requires evidence that the franchisee, not the franchisor, controlled the specific aspect of the business or instrumentality at the franchise causing the injury. Such evidence will come from the franchise agreement, the franchisor’s rules and regula-tions, and testimony from franchisor home office personnel and the franchisee, all of which should be undisputed and consistent. Franchisor counsel should consult with franchi-see counsel to find out what the franchisee’s testimony will be on that control issue to avoid being surprised by the fran-chisee’s testimony when the plaintiff ’s lawyer takes the fran-chisee’s deposition. Then franchisor counsel should consider noticing the deposition of the franchisee to ask these ques-tions on control first rather than waiting for the plaintiff ’s counsel to take the franchisee’s deposition and muddy the record with testimony that is difficult to clean up.
2001), rev’d on other grounds, 356 S.C. 238, 588 S.E.2d 588 (2003).3. Unfortunately some plaintiffs sue only the franchisor, without
naming the franchisee, as if the franchisor owns and operates the busi-ness itself. Often these plaintiff’s counsel either do not understand the franchise relationship and do not even look for the name of the franchi-see owner, or simply choose to ignore it thinking it can go for the “big company defendant” and deep pocket. In most cases franchisor counsel can convince reasonable plaintiff counsel to correct this pleading error by providing the name of the franchisee owner and proof of its adequate insurance, allowing the plaintiff to amend its complaint to substitute the franchisee for the franchisor before the franchisor counsel files a motion to dismiss and promises to make litigation expensive for the plaintiff.
4. Clem v. Steveco, Inc., 450 N.E.2d 550 (Ind. Ct. App. 1983) (“It would be an anomalous result to deny the protection of the Act to an employer’s franchisor, whose liability is only derivative, when pro-tection is given to an employer.”).
5. Prosser on Torts § 30; Restatement of Torts § 281.6. Triplett v. Soleil Group, Inc., 664 F. Supp. 2d 645, 648 (D.S.C. 2009).
7. Kerl, 682 N.W.2d at 335.8. Joseph H. King, Limiting Vicarious Liability of Franchisors for
the Torts of Their Franchisees, 62 Wash & Lee L. Rev. 417, 427 n.36 (2005).
9. Kerl, 682 N.W.2d at 335.10. Fernander v. Thigpen, A & H Foods, Inc., & Burger Chef
Sys., Inc., 278 S.C. 140, 142, 293 S.E.2d 424 (S.C. 1982) (“Generally, questions of agency ordinarily should not be resolved by summary judgment where there are any facts giving rise to an inference of an agency relationship.” (citation omitted)).
11. Triplett, 664 F. Supp. 2d at 648.12. Fernander, 278 S.C. 140, 293 S.E.2d 424; Hayman v. Ramada
1979); Hunter v. Ramada Worldwide, Inc., 2005 U.S. Dist. LEXIS 39822, 2005 WL 1490053 (E.D. Mo. 2005) (noting that “courts are gen-erally mindful that a franchisor does have a legitimate interest in retain-ing some degree of control in order to protect integrity of its marks”).
16. Allen v. Choice Hotels Int’l, Inc., 942 So. 2d 817, 826 (Miss. Ct. App. 2006); Raines v. Shoney’s, Inc., 909 F. Supp. 1070, 1078 (E.D. Tenn. 1995) (protection of trademark and service mark is nec-essary duty of franchisor).
17. Kerl, 682 N.W.2d at 340.18. 409 F. Supp. 2d 672 (D.S.C. 2006). The author of this article,
Jay Hewitt, was counsel for franchisor Choice Hotels in this litigation.19. 276 F. App’x 339, 2008 WL 1925110 (4th Cir. 2008).20. Greenville Hotel Partners, 405 F. Supp. 2d 653 (D.S.C. 2005).21. Id. at 679.22. Id. at 680, 682; see also J. Schultz, You Can’t Have Your Cake and
Eat It Too: The Standards for Establishing Apparent Agency, 60 S.C. L. Rev. 999 (2009) (discussing the Greenville Hotel Partners decision).
23. Greenville Hotel Partners, 409 F. Supp. 2d at 676–78.24. Id.25. Choice Hotels, 276 F. App’x at 342–43.26. Greenville Hotel Partners, 409 F. Supp. 2d at 677.27. Choice Hotels, 276 F. App’x at 343.28. Greenville Hotel Partners, 2006 U.S. Dist. LEXIS 33771
(D.S.C. 2006)29. Id.30. Choice Hotels, 276 F. App’x at 343–44.31. Id.32. 105 F. Supp. 2d 83, 88 (E.D.N.Y. 2000).
33. The opinion does not address the issue whether an exclusivity provision exists under the New York workers’ compensation law to bar the employee’s vicarious liability claim against the franchisor.
34. Wu, 105 F. Supp. 2d at 88.35. Id.36. Id. at 93–94.37. Id. at 94–95.38. 664 F. Supp. 2d 645 (D.S.C. 2009).39. Id.40. 276 F. App’x 339, 2008 WL 1925110 (4th Cir. 2008).41. Triplett, 664 F. Supp. 2d at 650.42. 2005 WL 1490053 (E.D. Mo 2005).43. Id. at *6, n.5.44. 483 S.E.2d 597 (Ga. Ct. App. 1997).45. Id. at 601.46. 455 N.W.2d 390 (Mich. Ct. App. 1990).47. 572 N.E.2d 1073 (Ill. App. Ct. 1991), appeal denied, 580
N.E.2d 117 (Ill. 1991).48. 771 N.E.2d 1100 (Ill. App. Ct. 2002).49. Id. at 1110.50. See Anderson v. Turton Dev., Inc., 483 S.E.2d 597, 601 (Ga.
Ct. App. 1997) (“[A] franchisor is faced with the problem of exer-cising sufficient control over a franchisee to protect the franchisor’s national identity and professional reputation, while at the same time foregoing such a degree of control that would make it vicariously liable for the acts of the franchisee and its employees.”).
51. Randall K. Hanson, The Franchising Dilemma Continues: Update on Franchisor Liability for Wrongful Acts by Local Franchi-sees, 20 Campbell L. Rev. 91, 92 (1997).
Jason J. Stover, C. Griffith Towle, and David M. Byers
AnTITRuST
Toledo Mack Sales & Serv., Inc. v. Mack Trucks, Inc., 2010 WL 819059, Bus. Franchise Guide (CCH) ¶ 14,329 (N.D. Ohio Mar. 9, 2010)Plaintiff Toledo Mack Sales & Services, Inc. (Toledo) was a longtime distributor of Mack Trucks, Inc. (Mack). The par-ties’ relationship ultimately unraveled, resulting in the termi-nation of the distributorship and multiple lawsuits.
In 2002, Toledo filed an antitrust action against Mack in the U.S. District Court for the Eastern District of Penn-sylvania. Mack asserted counterclaims for misappropria-tion of trade secrets. The matter was tried to a jury, and judgment was entered in favor of Mack and against Toledo in the amount of $1.6 million. Allegedly on the basis of evidence discovered during this lawsuit, Mack believed that Toledo had improperly disclosed trade secrets to one of Mack’s competitors (PAI). As a result, Mack served a notice of termination of the distributor agreement. In response, Toledo filed a protest with the Ohio Motor Vehicle Dealers Board (Board). The Board found that Mack did not have “good cause” to terminate Toledo, and the Franklin Coun-ty Court of Common Pleas agreed. Mack appealed to the Ohio Court of Appeals.
While the matter was pending before the appellate court, Toledo discovered evidence suggesting that PAI was not a competitor of Mack. Toledo brought this evidence to the attention of the Board, the court of commons pleas, and the appellate court in an unsuccessful effort to derail the pending termination. The appellate court ultimately found that there was good cause for termination. The Ohio Supreme Court declined review, and Mack terminated Toledo’s franchise.
The parties’ agreement required that upon termination, Mack purchase Toledo’s inventory and vehicles. Mack paid cash for the vehicles but offset the price of the parts against the $1.6 million Toledo owed Mack from the earlier anti-trust lawsuit. As a result of Mack’s decision not to pay cash for the parts, Toledo defaulted on a loan, and more than $1 million in personal assets pledged as collateral for the loan was liquidated. Toledo subsequently filed a new lawsuit in the U.S. District Court for the Northern District of Ohio.
Toledo asserted claims for, among other things, con-version, breach of contract, and abuse of process. Mack responded by filing a Rule 12(b)(6) motion to dismiss, which the court granted.
Toledo’s conversion claim was based on Mack’s allegedly
Jason J. Stover is a principal in the Minneapolis office of Gray Plant Mooty. C. Griffith Towle is a shareholder at BartkoZankel in San Francisco. David M. Byers is in-house counsel at Starbucks Coffee Company.
wrongful refusal to pay cash for the parts it was required to repur-chase pursuant to the parties’ agreement. The court dismissed the conversion claim because under Ohio law, a tort exists only if a party breaches a duty that he owes to another independent of the contract.
Mack sought to dismiss Tole-do’s breach of contract claim on the ground that there was nothing in the distributor agree-ment that precluded Mack from offsetting the amounts owed to Toledo by the judgment that it had obtained. The court agreed. In so holding, the court found that the provisions in the agree-ment prohibiting Toledo from offsetting amounts owed to Mack gave rise to an inference that payment in cash would not be required and the credit offsets would otherwise be appropriate under the principal of expressio unius est exclusio alterius (the listing of certain items implies the exclusion of those not listed). The court was persuaded by the fact that the lack of reciprocity with respect to the provisions in the agreement evidenced a gen-eral concern on the part of Mack regarding the creditworthiness of Toledo and protecting Mack from “having to bear the risk of a distributor’s insolvency.”
The court also dismissed Toledo’s abuse of process claim because Toledo was unable to establish any “ulterior pur-pose” on the part of Mack “for which the proceedings were not designed.” Under Ohio law, the improper purpose is typically some form of coercion intended to obtain a col-lateral advantage by the use of process as a “threat or a club.” As alleged by Toledo, the “improper purpose” was simply that Mack wanted to terminate Toledo’s distributor-ship. Thus, the court found that Mack’s termination of the distributorship could not be improper for purposes of an abuse of process claim because it was the very matter at issue before the lower courts.
Gruma Corp. v. Morrison, 2010 WL 1253093, Bus. Franchise Guide (CCH) ¶ 14,346 (Ark. Apr. 1, 2010)In this action by a distributor against its supplier, the court held that the arbitration clause in their agreement was enforceable under federal law and that the applicable state franchise statute could still provide enforceable remedies within the arbitration forum.
After the supplier terminated the parties’ food products distribution agreement, the distributor sued in Arkansas state court, alleging violations of the Arkansas Franchise Practices Act (AFPA). The supplier moved to dismiss based on the arbitration provision in the agreement, but the trial court denied the motion, holding that compelling arbitra-tion would conflict with the AFPA (the appellate opinion does not make clear the specific basis for the trial court’s holding). On appeal, the Arkansas Supreme Court reversed, holding that the Federal Arbitration Act (FAA) compelled enforcement of contractual arbitration provisions. The court also found no fundamental incompatibility between the AFPA and enforcing the FAA because the substantive rights granted under the franchise statute could be enforced within the arbitration provision, thereby allowing the dis-tributor any statutory protection to which it was entitled.
Mussetter Distrib., Inc. v. DBI Beverage Inc., 2010 WL 395638, Bus. Franchise Guide (CCH) ¶ 14,322 (N.D. Cal. Feb. 3, 2010)This case is discussed under the topic heading “Termination and Nonrenewal.”
BAnKRuPTCy
In re All Am. Props., Inc., 2010 WL 891685, Bus. Franchise Guide (CCH) ¶ 14,330 (Bankr. M.D. Pa. Mar. 10, 2010)The U.S. Bankruptcy Court for the Middle District of Penn-sylvania denied Petro Franchise Systems’ (Petro) motion to “annul” an automatic stay to enforce an order entered by a U.S. district court in Texas awarding both damages and injunctive relief against Petro’s former franchisee and debt-or, All American Properties, Inc. (All American). Petro and All American entered into a franchise agreement pursuant to which All American operated a Petro-branded travel cen-ter in Pennsylvania. All American failed to pay royalties, and Petro terminated the franchise agreement. Notwithstanding, All American refused to de-identify its Petro travel center. As a result, Petro filed a lawsuit in the U.S. District Court for the Western District of Texas and obtained an injunction requiring All American to cease utilizing the Petro trade-marks. Thereafter, All American rebranded the travel center under a new name. In response, Petro filed an amended com-plaint seeking, among other things, an injunction prohibit-ing All American from violating the post-term covenant not to compete in the franchise agreement.
During the pendency of the litigation, Petro filed a motion to compel further discovery, which the district court
granted. All American failed to comply, and the court held a hearing on an order to show cause why sanctions should not be imposed against All American for failing to comply with the court’s discovery order. The court imposed sanc-tions against All American and further required it to comply with the court’s order by January 14, 2010. On that date, the court held another hearing as a result of All American’s continuing failure to comply with the court’s order. At the hearing, the court awarded damages to Petro of approxi-mately $500,000 and enjoined All American from violating the covenant not to compete. “Mere minutes” after the hear-ing, but prior to the formal docketing of the district court’s order, All American filed a Chapter 11 petition.
In considering Petro’s request to lift the automatic stay, the bankruptcy court weighed All American’s conduct with the adverse impact that enforcing the district court’s order would have on All American’s creditors. Although the bank-ruptcy court was troubled by All American’s conduct, which it characterized as “reprehensible,” and viewed the timing of the bankruptcy petition as “suspect,” it denied Petro’s request to lift the automatic stay on the ground that if the district court’s order were to be enforced, it would preju-dice All American’s other creditors because the order pro-vided for significant damages that would be liquidated and enforced against the estate.
CHOICE OF FORuM
Candela Mgmt. Group, Inc. v. Taco Maker, Inc., 2010 WL 1253552, Bus. Franchise Guide (CCH) ¶ 14,351 (S.D. Ohio Mar. 31, 2010)Candela Management Group (Candela) entered into several development and franchise agreements with Taco Maker, Inc. (Taco Maker) pursuant to which Candela was granted the right to operate Taco Maker locations in Ohio and other states. Each of the agreements included forum selection clauses requiring that any dispute between the parties be brought in Puerto Rico. Notwithstanding, Candela and two individuals (all residents of Ohio) filed a lawsuit in the U.S. District Court of the Southern District of Ohio against Taco Maker and others, asserting claims for statutory franchise fraud, common law fraud, and breach of contract. Taco Maker filed a motion to transfer the action to Puerto Rico pursuant to 28 U.S.C. § 1406(a) and 28 U.S.C. § 1404(a).
Taco Maker’s motion was initially heard by a magistrate judge who issued a report and recommendation denying the motion. The magistrate judge found that the action should not be transferred pursuant to § 1406(a), which authorizes the dismissal or transfer of an action if it was filed in the “wrong” district, because a substantial part of the events or omissions giving rise to Candela’s claims occurred in Ohio. In reaching this decision, the magistrate judge rejected Taco Maker’s argument that the forum selection clauses in the agreements rendered all venues other than the District of Puerto Rico improper. The magistrate judge also denied Taco Maker’s motion to transfer pursuant to § 1404(a). As a threshold matter, the magistrate judge first determined that
Taco Maker had the burden of proving that transferring the action would facilitate the convenience of the parties and witnesses and be in the interest of justice. This decision turned out to be outcome-determinative because the mag-istrate judge concluded that the convenience of the parties and witnesses did not weigh in favor of or against transfer, that the relevant documents were located in both Ohio and Puerto Rico, and that “the locus of operative facts [did] not favor one venue over the other.” Because the magistrate judge believed that the burden of proof was on Taco Maker, he concluded that “this state of equipoise” militated against transferring the action and denied the motion. Taco Maker filed objections to the magistrate judge’s recommendations.
The district court agreed with the magistrate judge’s fac-tual determinations (i.e., that the factors neither supported nor weighed against a transfer) but granted Taco Maker’s motion to transfer pursuant to § 1404(a). The difference was the district court’s conclusion that the burden of proof was on Candela because the parties’ agreement contained an enforceable forum selection clause. As a result, because the factors were “neutral,” the district court found that Can-dela had failed to meet its burden of demonstrating why the action should not be transferred.
Hardee’s Food Sys., Inc. v. Hallbeck, 2010 WL 1141343, Bus. Franchise Guide (CCH) ¶ 14,344 (E.D. Mo. Mar. 22, 2010)The court denied these franchisees’ motion to dismiss for improper venue and alternative motion to transfer, based on the franchisees’ failure to demonstrate that the forum court lacked a connection to the claims and failure to demonstrate that the alternative venue was the better forum.
This case involved claims by a St. Louis–based franchisor against a group of franchisees that had operated an Illinois franchise but that were personally based in Wisconsin. The franchisor brought the suit in its home district in Missouri. The franchisees moved to dismiss for improper venue and alternatively moved to transfer the lawsuit to the Illinois dis-trict in which the franchised business was located.
The court denied the motion to dismiss because the fran-chisees failed to establish that the court lacked a substan-tial connection to the claims. The court found that the two subject agreements were signed and accepted by the fran-chisor in Missouri and that extensive correspondence and communication between the parties originated from or were directed to the franchisor’s office in Missouri. Also, the counterclaims that the franchisees stated they intended to assert had to do with the franchisor’s decisions and actions taken at its Missouri office. Holding that a motion to dismiss based on improper venue did not pose the question of the best venue but only whether the venue in which the litigation was taking place had a substantial connection to the claims, the court denied the motion to dismiss.
The court also denied the franchisees’ motion to trans-fer. The franchisees claimed that a Missouri court would be inconvenient for the ninety-four customer witnesses the franchisees intended to call; and though the court found that those witnesses’ testimony was largely cumulative, it
held that the convenience of the witnesses factor favored the franchisees. The court held that the convenience of the parties favored the franchisor, particularly because the franchisees’ proposed forum (Illinois) was not their home state (Wisconsin), so the forum state was not significantly less convenient than the forum that the franchisees were proposing. The court also held that the interests of justice favored the franchisor, based largely on the same analysis as the other factors. Combining its analysis on those three factors, the court held that Missouri was the proper venue for the action.
Toyz, Inc. v. Wireless Toyz, Inc., Case No. C 09-05091, Bus. Franchise Guide (CCH) ¶ 14,313 (N.D. Cal. Jan. 25, 2010)This case is discussed under the topic heading “Jurisdiction.”
CLASS ACTIOn
Green v. SuperShuttle Int’l, Inc., Case No. 09-2129, Bus. Franchise Guide (CCH) ¶ 14,315 (D. Minn. Jan. 29, 2010)Plaintiffs claimed that defendants had wrongfully character-ized them as franchisees rather than employees, thus depriv-ing plaintiffs of wages that they were allegedly due. Plaintiffs commenced a class action against defendants in state court, alleging that plaintiffs had violated the Minnesota Fair Labor Standards Act. Defendants removed the case to the U.S. District Court for the District of Minnesota pursuant to the Class Action Fairness Act (CAFA), and plaintiffs moved to remand.
Plaintiffs argued that the amount in controversy in their case was less than the $5 million required by the CAFA and that there were fewer than the required 100 class members. The court found that defendants had received in excess of $5 million in franchise fees since January 1, 2006, thus meeting the amount in controversy requirement. With respect to the class size, plaintiffs argued that the applicable statute of lim-itations was only three years for an action to recover unpaid wages. Plaintiffs argued that defendants had employed fewer than 100 drivers during the most recent three-year period, thus depriving the federal court of jurisdiction. The court found, however, that plaintiffs sought to recover fees that they had affirmatively paid to defendants, not amounts that defendants had failed to pay to plaintiffs. That distinction caused plaintiffs’ claims to be subject to a six-year statute of limitations. Applying that longer limitations period, the court found that more than 100 drivers had been employed by defendants.
The court also rejected plaintiffs’ argument that an excep-tion to the CAFA applied. Plaintiffs argued that the court lacked jurisdiction because SuperShuttle Minnesota, one of named defendants, was an entity from which significant relief was sought. Because that entity was a citizen of the same state as plaintiffs, plaintiffs argued that federal juris-diction was inappropriate. The court disagreed, finding that Minnesota defendant could not be considered a significant one. That entity did not have any assets of its own and was dependent on SuperShuttle International, a Delaware
company, for its survival. Because any judgment would have to be paid by another entity, SuperShuttle Minnesota could not be considered a significant defendant and did not inter-fere with federal jurisdiction under the CAFA.
Moua v. Jani‑King of Minn., Inc., 2010 WL 935758, Bus. Fran-chise Guide (CCH) ¶ 14,335 (D. Minn. Mar. 12, 2010)In this case, the U.S. District Court for the District of Minne-sota denied a motion for class certification filed by current and former Jani-King franchisees on the ground that plaintiffs had failed to prove that common questions of fact predominated. The franchisees asserted claims against Jani-King Interna-tional and its regional business division (Jani-King of Min-nesota) for breach of the franchise agreement, breach of the implied covenant of good faith and fair dealing, violations of the Minnesota Franchise Act, and fraud. In particular, plain-tiffs alleged that (i) they had been told that they would be pro-vided with a certain amount of monthly business, (ii) many of the accounts offered to them were underbid such that they were not profitable, (iii) the offered accounts were geographi-cally inconvenient, (iv) the same accounts were offered to multiple franchisees, (v) they were required immediately to accept an account when it was offered, and (vi) accounts were unilaterally taken away from plaintiffs under the pretense that the franchisees’ services were substandard.
Plaintiffs sought class certification pursuant to Federal Rule of Civil Procedure 23(b)(3), which requires that com-mon questions of law or fact predominate over any ques-tions affecting individual members and that a class action must be “superior to other available methods for fairly and efficiently adjudicating the controversy.” Jani-King’s princi-pal argument in opposition to the motion was that plaintiffs could not satisfy the predominance and superiority require-ments of Rule 23(b)(3). Because plaintiffs did not meet their burden of showing that common questions predominate, the court did not address the threshold requirements of Rule 23(a) or the requirement that class resolution be “supe-rior” pursuant to Rule 23(b)(3).
In support of class certification for their beach of con-tract claim, plaintiffs alleged that the conduct that constitut-ed the breach was “employed consistently across the class.” Notwithstanding, the court found that individual testimony would be required from each class member to prove that Jani-King employed the “tactics” against it and that indi-vidualized proof would be necessary to establish that such tactics prevented each class member from achieving the mini-mum amount of monthly business that had allegedly been promised to it. The court further noted that Jani-King would likely present contrary evidence and challenge the credibility of the evidence offered by the class members in support of the claims, which would require numerous minitrials.
Plaintiffs’ claim for breach of the implied covenant of good faith and fair dealing was for the most part based on the same conduct that gave rise to the breach of contract claim. Jani-King argued that individualized proof would again be necessary to determine whether and to what extent the alleged conduct was used against each class member.
The district court agreed.The court then considered plaintiffs’ fraud-based claims
under the Minnesota Franchise Act, the Minnesota False Statement in Advertising Act, and common law. The court noted that each of these claims required that plaintiffs prove that they had relied on the alleged misrepresentations, omis-sions, and deceptive conduct. Although some of the mis-representations were contained in the Uniform Franchise Offering Circular (UFOC), the court found that individual-ized inquiries would still be required of all class members to establish that they both received and relied on the alleged misrepresentations, omissions, and deceptive conduct. The court distinguished other cases that had permitted class treatment of fraud-based claims based on brochures and the like on the basis that in those cases it was undisputed that class members had been shown identical documents and/or received uniform oral statements. The court further noted that although courts had relaxed the reliance requirements for fraud claims under the Minnesota consumer protection laws, it had not eliminated defendants’ right to present con-trary evidence, and that Jani-King had submitted evidence establishing that there were variations in what had allegedly been told to the class members. Accordingly, the court found that plaintiffs had also failed to sustain their burden of prov-ing that common issues would predominate over individual-ized ones with respect to the fraud-based claims.
COnTRACT ISSuES
Ammirato v. Duraclean Int’l, Inc., 2010 WL 475303, Bus. Franchise Guide (CCH) ¶ 14,320 (E.D.N.Y. Feb. 8, 2010)Fact issues precluded a franchisor’s effort to defeat by sum-mary judgment claims that third-party loans to a franchisee were effectively made to the franchisor or to the franchisee as agent for the franchisor.
A Duraclean franchisee obtained a series of loans from acquaintances (plaintiffs) to finance cleaning projects by the Duraclean “National Team.” The National Team was mar-keted in varying ways, sometimes appearing to be a franchi-see or group of franchisees and other times appearing to be a division or agent of the franchisor. To make matters more confusing, the owner of the primary franchisee involved eventually purchased a one-half ownership interest in the Duraclean franchisor. When the franchisee failed to repay the loans, plaintiff lenders sued the franchisor, alleging that they believed that the franchisor was the recipient or ulti-mate beneficiary of the funds.
The franchisor moved for summary judgment, but the court held that fact issues precluded summary judgment on the contract claims. Despite the fact that the franchisee was the only person from the Duraclean system in contact with plaintiffs and that he told most of plaintiffs he needed the money for his “Duraclean franchise,” the court held that the ambiguous marketing of the Duraclean National Team raised an unresolved question about whether the franchi-sor or franchisee was the intended recipient of the funds. The court rejected the franchisor’s argument that the loans
would be void because of their usurious interest rate, based on the factual question about whether the franchisee and the lenders had a “special relationship” that the franchisee used to induce the lenders to presume the legality of the loans.
The court granted summary judgment to the franchisor on plaintiffs’ deceptive trade practices and Racketeer Influ-enced and Corrupt Organizations Act (RICO) claims, find-ing that the allegations involved solely private transactions, that New York’s deceptive trade practices statute does not govern, and that the complaint failed to allege sufficient facts to support a RICO claim.
B.A. Constr. & Mgmt., Inc. v. Knight Enters., Inc., 2010 WL 545504, Bus. Franchise Guide (CCH) ¶ 14,324 (6th Cir. Feb. 17, 2010)This case is discussed under the topic heading “Statutory Claims.”
Bird Hotel Corp. v. Super 8 Motels, Inc., Case No. 06-4073, Bus. Franchise Guide (CCH) ¶ 14,337 (D.S.D. Feb. 16, 2010)Plaintiffs were a class of franchisees in the Super 8 Motels franchise system. Plaintiffs’ franchise agreements required plaintiffs to pay a 2 percent fee on their gross sales to fund a customer loyalty program. Super 8 later attempted to impose a separate 5 percent fee to fund a new “TripRewards” pro-gram. Plaintiffs objected to that additional fee, claiming that it was not authorized by their franchise agreements.
The court agreed with plaintiffs and granted plain-tiffs’ motion for summary judgment. Super 8 argued that it retained the ability to implement its new TripRewards program because plaintiffs had agreed that Super 8 could change its system standards and that the new program fell within that language. The court disagreed, finding that the franchise agreements did not give Super 8 the right to impose a new fee even if the program itself were permissible under the franchise agreements.
The court denied, however, plaintiffs’ motion for sum-mary judgment as to their damages claims. Plaintiffs sought to recover damages in the full amount of the 5 percent fee that franchisee class members had paid to Super 8. Super 8 argued that the class members had not suffered any dam-ages at all because the TripRewards program had resulted in increased sales for plaintiffs and saved them the expenses associated with the old customer loyalty program. Because material issues of fact existed as to the amount of plaintiffs’ damages, the court held that the grant of summary judg-ment was inappropriate.
Boon Rawd Trading Int’l Co. v. Paleewong Trading Co., 2010 WL 668063, Bus. Franchise Guide (CCH) ¶ 14,354 (N.D. Cal. Feb. 19, 2010)This case is discussed under the topic heading “Statute of Limitations.”
Cal. Sun Tanning USA, Inc. v. Elec. Beach, Inc., 2010 WL 827725, Bus. Franchise Guide (CCH) ¶ 14,332 (3d Cir. Mar. 11, 2010)
In this case, the U.S. Court of Appeals for the Third Cir-cuit upheld the U.S. District Court for the Eastern District of Pennsylvania’s decision enforcing a putative settlement agreement between California Sun Tanning (California Sun) and its former franchisee, Electric Beach, Inc. (Elec-tric Beach). California Sun terminated the parties’ franchise agreement after learning that Electric Beach had system-atically underreported revenues and failed to pay royalties estimated to be in excess of $50,000. California Sun subse-quently filed a complaint seeking, among other things, to preclude Electric Beach from continuing to use the Califor-nia Sun trademarks. In addition, California Sun filed a sepa-rate arbitration action for damages in accordance with the terms of the franchise agreement.
Shortly after the lawsuit was filed, the parties entered into settlement discussions, which culminated in a series of e-mails setting forth the principal terms of a settlement. As set forth in the e-mails, the parties agreed that California Sun would buy Electric Beach’s franchise and related assets for $85,000 (less certain expenses) and exchange mutual general releases. Thereafter, counsel for California Sun advised the district court that the parties had “agreed in principal [sic] to amicably resolve their differences” and requested thirty days in which to document the agreement and “consummate all aspects of that agreement.” Before the agreement could be documented, disputes arose regarding the condition of the facility; Electric Beach’s failure to have paid rent, taxes, and other items; and Electric Beach’s removal of merchan-dise and other items that were to be covered by the parties’ settlement. Electric Beach ultimately agreed to “modify” the parties’ purported settlement by deducting the unpaid rent and other items from the purchase price but refused to make additional deductions from the settlement proceeds as insisted by California Sun. The parties were unable to bridge their differences, and Electric Beach filed a motion to enforce the settlement agreement in the district court.
The district court found that the parties had reached an enforceable settlement agreement and that the various e-mails evidenced that agreement. The court found that Electric Beach’s assets were to have been purchased free of all liens and encumbrances and confirmed the deduction in the purchase price for the back rent and other items and further ordered Electric Beach to return the items that had been removed from the location. Finally, the court ordered California Sun to pay Electric Beach the amount due after accounting for the deductions. California Sun appealed to the Third Circuit.
California Sun initially raised procedural arguments claiming that the district court did not have jurisdiction because California Sun had obtained the relief it had sought in the complaint (i.e., Electric Beach was no longer using its trademarks) and that the amount in controversy no lon-ger supported subject matter jurisdiction. The Third Circuit promptly rejected these arguments and observed that they “test the boundaries of good faith.”
The Third Circuit then addressed the substance of California Sun’s claims as to why the alleged settlement
agreement should not be enforced: (i) the e-mails did not constitute an enforceable agreement because the parties contemplated a written document evidencing the terms of the settlement; (ii) the doctrines of mutual and/or unilat-eral mistake precluded the enforcement of the agreement; and (iii) even if there was an enforceable agreement, the agreement should not be enforced because Electric Beach breached the agreement and had unclean hands. The court analyzed the parties’ exchange of e-mails and concurred with the lower court’s finding that because the parties had agreed to the essential terms of the contract, the fact that they had intended to formalize the agreement in writing did not prevent the enforcement of the agreement. The court also rejected California Sun’s claim that the doctrine of mutual mistake or unilateral mistake was applicable because California Sun actually received exactly what it wanted; and, thus, there could be no mutual or unilateral mistake. Finally, the court rejected California Sun’s argu-ment that Electric Beach was not entitled to specific perfor-mance because Electric Beach had breached the agreement and had unclean hands, holding that if any party had breached the agreement, it was California Sun in that it was seeking to retain the benefit of the bargain (i.e., possession and ownership of the location) without satisfying its obliga-tion to pay the amounts owed.
Constr. Crane & Tractor, Inc. v. Wirtgen Am., Inc., 2010 WL 1172224, Bus. Franchise Guide (CCH) ¶ 14,345 (Tenn. Ct. App. Mar. 24, 2010)In this action by a terminated equipment distributor, the court held that the parties’ discussions about new contract terms and their changes to their course of dealing did not constitute a new agreement, and therefore the parties’ rela-tionship was not governed by a relationship statute that went into effect after their written agreement was executed.
The manufacturer and distributor in this action first entered into an agreement in 1988 and entered into addi-tional agreements in 1990 and 1992. Those agreements governed the distributor’s purchase and resale of the manu-facturer’s milling equipment and parts in areas of Delaware, Pennsylvania, and New Jersey. In 1999, the manufacturer’s home state of Tennessee enacted a relationship law prohibit-ing suppliers of construction equipment from terminating or not renewing a supply agreement without good cause; prior to its enactment, Tennessee had no statutory restric-tions on such agreements, and the agreement of these parties allowed termination on ninety days’ notice for any reason.
In 2000, the distributor proposed that the manufacturer grant it additional territory, but those discussions did not generate a concrete contract amendment. In 2001, the dis-tributor asked for the right to sell additional product lines that the manufacturer had acquired. The manufacturer allowed it, but the parties did not rewrite their contract or enter into a new written agreement. In 2002, the manufac-turer sent the distributor a draft of a new sales and service agreement, but the parties never signed it and discussed it only briefly. Over the next five years, the parties’ relationship
continued to have broad gray areas, with no clear delineation of the breadth of the distribution rights granted, and seem-ingly inconsistent rights were granted to other distributors in the system. In June 2007, the manufacturer eliminated the distributor’s New Jersey territory; and after the distributor sought injunctive relief to prevent that, the manufacturer terminated the distribution agreement altogether. The trial court held that the 1992 agreement was controlling and did not restrict termination and that the 1999 statute did not apply to the preexisting contractual relationship.
The appeals court affirmed, finding no evidence that the parties’ post-1999 discussions were sufficiently definite to form an enforceable contract. The distributor was allowed to expand its product lines, but only “at its own risk” and without any assurance of continued rights as it had been granted for the initial product line in the 1992 agreement. Also, the addition of those product lines was consistent with the basic framework of the 1992 agreement, so the addition alone was insufficient to establish a mutual intent to funda-mentally change the relationship. The court also observed that the 2002 agreement had never been signed and, more importantly, that both parties continued to cite and rely on the earlier agreements as establishing the definitive terms of their relationship.
JOC, Inc. v. Exxon Mobil Oil Corp., 2010 WL 1380750, Bus. Franchise Guide (CCH) ¶ 14,352 (D.N.J. Apr. 1, 2010)This case is discussed under the topic heading “Good Faith and Fair Dealing.”
Kellogg USA, Inc. v. B. Fernandez Hermanos, Inc., Case No. 07-1213, Bus. Franchise Guide (CCH) ¶ 14,319 (D.P.R. Jan. 27, 2010)BFH was a party to a distribution agreement with Kellogg. Since approximately 1910, BFH was responsible for the sale and distribution of Kellogg cereal products in Puerto Rico. The parties’ first written distributorship agreement was signed in 1961. In 1966, the parties entered into a new agree-ment that added terms to the 1961 agreement. Between 1967 and 1992, the parties entered agreements that contained the same terms as the 1966 agreement.
One of Kellogg’s subsidiaries began selling and market-ing Kellogg’s products in Puerto Rico. In response, BFH filed suit alleging that Kellogg had breached Puerto Rico’s Law 75, which prohibits the termination of distributors such as BFH. The court granted BFH’s motion for preliminary injunction, requiring Kellogg to continue distributing its products in Puerto Rico solely through BFH. The appellate court later reversed that decision, finding that the district court should have joined Kellogg’s Puerto Rican subsidiary as an indispensable party. Joining that party as a defendant would have deprived the court of diversity jurisdiction. Accordingly, on remand the district court dismissed BFH’s complaint for lack of jurisdiction.
Kellogg then sued BFH, seeking to execute on the bond that BFH had posted to secure its injunction. BFH brought a counterclaim alleging the same wrongful termination claims
it had asserted in its original action. Both parties moved for summary judgment. Kellogg argued that it was entitled to summary judgment on BFH’s Law 75 claim as that law was not passed until 1964. Kellogg argued that the parties’ relationship predated 1964 and that Law 75 could not be applied retroactively to it. The court found that although Law 75 could not be applied retroactively, it would apply to the extent the parties had extinctively novated their original contract sometime after the law took effect. The court added that the novation issue was one of fact that the court could not resolve on summary judgment as a reasonable jury could find that the parties’ contracts entered after 1964 constituted novations of the original 1961 agreement. Accordingly, the court denied Kellogg’s motion for summary judgment.
The court also rejected BFH’s motion for summary judg-ment on its claim that Kellogg had committed fraud by misrepresenting the terms of a later agreement between the parties. The court found that BFH could not have reason-ably relied on any misrepresentations by Kellogg as a matter of law. The court reasoned that BFH was a sophisticated party whose counsel had reviewed the agreement at issue, thus preventing BFH from arguing that it was fraudulently induced to enter the agreement.
Because fact issues remained to be resolved as to whether Kellogg had breached the underlying distribution agreement, the court denied Kellogg’s motion to execute on the bond BFH had posted to secure its injunction. Such execution was appropriate only if Kellogg demonstrated it had been wrong-fully enjoined, a decision that could not be made via sum-mary judgment given the presence of disputed fact issues.
Toledo Mack Sales & Serv., Inc. v. Mack Trucks, Inc., 2010 WL 819059, Bus. Franchise Guide (CCH) ¶ 14,329 (N.D. Ohio Mar. 9, 2010)This case is discussed under the topic heading “Antitrust.”
DAMAgES
Century 21 Real Estate LLC v. Perfect Gulf Props., Inc., Case No. 6:08-cv-1890-Orl-28KRS, Bus. Franchise Guide (CCH) ¶ 14,336 (M.D. Fla. Feb. 17, 2010)Plaintiff entered into numerous franchise agreements with defendant as well as a Development Advance Promissory Note. That note was in the form of a forgivable loan, such that plaintiff would forgive the entire amount of the note if defendant met certain performance criteria. When defen-dant failed to pay amounts due under the franchise agree-ments, plaintiff terminated those agreements and sought to collect past due fees along with the full balance of the note.
Plaintiff sought summary judgment, and defendant argued that plaintiff ’s claims were barred by various affir-mative defenses. Defendant argued that the personal guar-antors of the note could not be held liable because plaintiff had misled them as to the purpose of the loan. Defendant claimed that plaintiff had represented that the loan would be used for the expansion of defendant’s business, but in reality a large percentage of the loan amount was withheld
by plaintiff to pay past due franchise fees owed by defen-dant. The court found that plaintiff itself had not made the representations complained of by the guarantors. Instead, those representations had been made by defendant’s princi-pal. The court also rejected defendant’s argument that plain-tiff failed to mitigate its damages because plaintiff should have known that defendant did not qualify for a loan before it made that loan. The court found, however, that the doc-trine of mitigation of damages applies only after a contract is breached, not before.
Defendant also argued that plaintiff waived its right to collect amounts owed by permitting defendant to extend its agreements and acquire new franchises even as defendant was in default under its existing agreements and the note. The court rejected that argument, finding that plaintiff had the right, but not the obligation, to pursue defendant’s breach of contract. The court also rejected defendant’s related defense of laches, finding that plaintiff had not waited an unreason-ably long amount of time in enforcing its contract rights.
Kiddie Acad. Domestic Franchising LLC v. Faith Enters. DC, LLC, 2010 WL 673112, Bus. Franchise Guide (CCH) ¶ 14,326 (D. Md. Feb. 22, 2010)The court limited the award of future damages against a ter-minated franchisee and the amount awarded to the franchi-sor in attorney fees.
After terminating its franchisees for failure to pay royal-ties, the franchisor sued for breach of contract and prevailed on summary judgment on its claims. The franchisor claimed over $600,000 in lost future royalties, based on the remain-ing thirteen years in the term of the franchise agreement. Although the franchisor had not yet located a replacement franchisee in the three years following termination of one of defendant franchisees, the court found that the franchisor “may well secure a replacement franchisee” and that award-ing lost royalties going forward may allow a double recovery of contract damages. As a result, the court limited the future royalties award to the latter of the period from termination through the earlier of the date of judgment or the date on which a replacement franchisee is secured. Also, because the franchisor had not shown the costs that it avoided in terminating the franchise, which must be deducted from the anticipated future royalties, the court denied summary judg-ment on the future royalties claim. With respect to a sec-ond terminated franchisee, the court denied the franchisor its claimed expenses for securing a new franchisee because the franchisor had failed to show that those expenses were costs of enforcing the prior franchisee’s agreement. The court similarly denied the franchisor’s claim for employee pay based on time spent enforcing the franchise agreements because the franchisor had presented those expenses as a lump sum and had not established the reasonableness of those expenses.
Finally, the court reduced the attorney fees award sought by the franchisor. The reduction was partly based on the imprecision of the time entries but was also based on a finding of excessive hourly rates, holding that the “upward departure
[from rates suggested by Local Rules] is not justified by the novelty or difficulty of this case—a relatively routine contract dispute—and no special legal skill was required to litigate it.” Although the court acknowledged “the superior experience” of the franchisor’s counsel, it nonetheless held that such expe-rience did not justify their higher hourly rates.
DEFInITIOn OF FRAnCHISE
BJB Elec., L.P. v. N. Cont’l Enters., Inc., Case No. 09 C 3022, Bus. Franchise Guide (CCH) ¶ 14,317 (N.D. Ill. Feb. 9, 2010)BJB Electric brought suit against North Continental Enter-prises (NCE) claiming that NCE had failed to pay for goods delivered by BJB Electric. BJB Electric sold electrical com-ponent parts manufactured in Germany. BJB Electric and NCE were parties to a distribution agreement whereby NCE would purchase products from BJB Electric and resell them to customers in North America. The parties agreed that NCE would have the exclusive right to sell those compo-nents to customers in North America. The parties operated under that agreement for twenty-five years until BJB Elec-tric terminated it.
When BJB Electric brought suit, NCE filed a counter-claim alleging that BJB Electric terminated the parties’ dis-tribution agreement in violation of the Illinois Franchise Disclosure Act. BJB Electric moved to dismiss that coun-terclaim, arguing that its relationship with NCE was not a franchise and that NCE had failed to plead the elements necessary to find a franchise relationship under Illinois law. The court agreed and granted BJB Electric’s motion. The court found that NCE had failed to allege that it received the right to use BJB Electric’s name or trademark in marketing the products it purchased from BJB Electric. The court also observed that NCE had not alleged that it paid any type of franchise fee to BJB Electric. Because those two allegations were necessary to find the existence of a franchise relation-ship, the court dismissed NCE’s counterclaim.
S&S Sales, Inc. v. Pancho’s Mexican Foods, Inc., 2010 WL 749562, Bus. Franchise Guide (CCH) ¶ 14,328 (E.D. Ark. Mar. 3, 2010)This case is discussed under the topic heading “Statutory Claims.”
FRAuD
Jones v. Petland, Inc., 2010 WL 597503, Bus. Franchise Guide (CCH) ¶ 14,323 (S.D. Ohio Feb. 12, 2010)The court dismissed franchisees’ fraud claim against a third-party vendor for lack of particularity in the complaint.
The franchisees owned a Petland franchise in Tennes-see. Defendant Loveland Pet Products, Inc. is an approved supplier of merchandise to Petland franchisees. The fran-chisees sued Petland and a series of suppliers, claiming that merchandise was overpriced and that Petland received kick-backs from its approved vendors. The franchisees brought a claim of aiding and abetting fraud against Loveland, on the
basis that Loveland sold overpriced merchandise to franchi-sees and paid kickbacks to Petland in exchange for being approved by Petland as a system vendor.
On Loveland’s motion to dismiss, the court held that the franchisees’ complaint failed to plead the underlying fraud of Petland with sufficient particularity, which was therefore fatal to the aiding and abetting claim against Loveland. The court held that the franchisees had failed to allege facts that would establish Loveland had knowledge of any Petland fraud and also held that there was a “complete disconnect” between any fraud of Petland, which induced the franchise purchase, and the purported fraud of Loveland, which related to merchandise sold to the franchisees after they had executed the franchise agreement.
Colo. Coffee Bean, LLC v. Peaberry Coffee, Inc., 2010 WL 547633, Bus. Franchise Guide (CCH) ¶ 14,325 (Colo. Ct. App. Feb. 18, 2010)The court held that the poor financial performance of a franchisor’s parent company could give rise to a franchisee’s claim for fraudulent nondisclosure against the parent.
This action was brought by a group of franchisees in the Peaberry Coffee system. Peaberry franchises are sold by Pea-berry Coffee Franchise, Inc., which is a wholly owned sub-sidiary of Peaberry Coffee, Inc. Each of plaintiff franchisees was provided with a UFOC, which included an earnings claim disclosing gross sales figures of Peaberry’s company-owned stores. The UFOC and franchise agreement also contained common provisions disclaiming any contrary or other information, effectively notifying the franchisees not to rely on any other representations, although the franchi-sor also sent them an information packet that included a local newspaper article in which the president of the parent company was quoted as saying that “Peaberry is profitable now.” The franchisees alleged that the company stores were, in fact, unprofitable and that the parent company had suf-fered significant financial losses annually. The franchisees sued the franchisor and its parent company, with claims of fraudulent nondisclosure, negligent misrepresentation, alter ego, and violation of Colorado’s Consumer Protection Act. They also sued the franchisor’s law firm on similar claims. After trial of the claims against Peaberry, the court found in favor of defendants and also dismissed the claims against the law firm. The franchisees appealed.
On the franchisees’ fraudulent nondisclosure claim, the trial court had found that Peaberry did conceal material financial facts from the franchisees but that the franchisees could not reasonably rely on that nondisclosure because the nonreliance provisions in the UFOC precluded reli-ance on information outside the transactional documents. The appellate court concurred that the UFOC language precluded reliance on the company stores’ net losses. How-ever, the appellate court held that the UFOC and the fran-chise agreement did not preclude reasonable reliance on the nondisclosure of the parent company’s losses. Despite the breadth of the UFOC and contractual disclaimers of reli-ance, the court held (with somewhat tortured logic) that the
purpose of the disclaimers was to put franchisees on notice that their success is not assured; but the potential insolvency of the franchisor’s parent company could destroy the value of a franchise regardless of the franchisee’s efforts, and the franchisees may have reasonably relied on the nondisclosure of those facts, giving rise to a claim. The court also rejected the franchisor’s argument that the FTC Franchise Rule pro-hibited disclosure of parent financials absent a parent guar-anty of the franchisor’s performance. Despite the explicit prohibition on disclosing parent financials in the Franchise Rule, the court distinguished full financial statements from “merely informing prospective franchisees that the franchi-sor’s parent has been—or is—unprofitable.” Finding the former different from the latter, the court held that a state common law requirement to disclose “financial informa-tion at issue” was permitted, based on the FTC’s statement that the Franchise Rule did not preempt state laws unless inconsistent (and these were not inconsistent). The court remanded on the fraudulent nondisclosure claim because of inconsistencies in the court’s factual findings.
The appellate court also upheld the pretrial dismissal of the Colorado Consumer Protection Act claim, holding that Peaberry’s marketing practices did not significantly impact the public, based on the small volume of people who responded to solicitations and the lack of any affirmative misstatement in the materials.
The appellate court upheld the trial court’s enforce-ment of the contractual jury waiver, where plaintiffs had not argued that the provision was unfair, unreasonable, or beyond their ability to understand. The appellate court fur-ther upheld the dismissal of the negligent misrepresentation claim against the company’s law firm because plaintiffs had failed to identify any specific language in the UFOC that constituted an affirmative misrepresentation and because Colorado law did not support the notion that general por-trayals of financial viability could be the basis for a negli-gent misrepresentation claim.
S&S Sales, Inc. v. Pancho’s Mexican Foods, Inc., 2010 WL 749562, Bus. Franchise Guide (CCH) ¶ 14,328 (E.D. Ark. Mar. 3, 2010)This case is discussed under the topic heading “Statutory Claims.”
gOOD FAITH AnD FAIR DEALIng
JOC, Inc. v. Exxon Mobil Oil Corp., 2010 WL 1380750, Bus. Franchise Guide (CCH) ¶ 14,352 (D.N.J. Apr. 1, 2010)JOC, Inc. and Sung Eel Chang Auto, Inc. (collectively, plain-tiffs) operate a number of Exxon Mobil (Exxon) gas stations in New Jersey pursuant to Petroleum Marketing Practices Act (PMPA) agreements. Among other things, Exxon has the exclusive right to determine and change the wholesale gasoline price (known as the dealer tank wagon, or DTW, price), determine the quantities of gasoline that the franchi-sees are expected to purchase each year, establish the terms and conditions pursuant to which the gasoline is delivered,
and exercise a certain degree of control over the stations that plaintiffs lease from Exxon.
Plaintiffs alleged that they were unable to operate at a profit or even remain economically viable under their cur-rent PMPA agreements with Exxon for various reasons, including that Exxon’s pricing practices were preventing them from being able to charge competitive prices. Plaintiffs also contended that Exxon had engaged in various actions that demonstrated bad faith in response to their financial difficulties. Specifically, plaintiffs alleged that Exxon denied their requests for permission either to convert their service bays into convenience stores or purchase their stations and become independent operators, and to waive the rent.
Plaintiffs filed suit in the U.S. District Court for the District of New Jersey asserting claims for (1) breach of contract under New Jersey’s equivalent of § 2-305 of the Uniform Commercial Code, (2) breach of the implied cov-enant of good faith and fair dealing, (3) breach of the New Jersey Unfair Motor Fuels Practices Act (UMFPA), and (4) conspiracy to discriminate against plaintiffs in the prices charged for gasoline. Exxon filed a motion to dismiss pursu-ant to Federal Rule of Civil Procedure 12(b)(6).
Plaintiffs alleged that Exxon breached its contractual obligations because the DTW pricing charged to plaintiffs was discriminatory and set in bad faith with the intention to prevent plaintiffs from competing. Exxon moved to dismiss on the ground that plaintiffs had not provided the required notice of the alleged breach. In response, plaintiffs argued that Exxon knew that plaintiffs were struggling and, thus, had been given sufficient notice to comply with the notice provision of the New Jersey Commercial Code. The court disagreed. Plaintiffs did not allege in the complaint that they had specifically notified Exxon that the PMPA agreements had been breached as a result of high prices or their finan-cial difficulties. As a result, the ourt dismissed the breach of contract claim without prejudice and with leave to amend to allege that the required notice of breach of contract had been given to Exxon.
In their claim for breach of the implied covenant of good faith and fair dealing, plaintiffs alleged that Exxon exercised its discretionary authority regarding DTW pricing, rental rates, and other decisions in an arbitrary, unreasonable, or capricious manner. Additionally, they alleged that Exxon knew that its prices and other decisions prevented plain-tiffs from receiving the contractual rewards or benefits they reasonably expected. The court found that these allegations were sufficient to state a claim for a breach of the implied covenant of good faith and fair dealing. Moreover, the court held that although a claim for breach of the implied cov-enant of good faith and fair dealing is a contract claim, it can give rise to an independent cause of action under New Jersey law. In this case, the independent cause of action arose under Article 1 of the New Jersey Commercial Code (and not Article 2), and therefore the notice requirement in Article 2 was not applicable. As a result, the motion to dis-miss the claim for breach of the implied covenant of good faith and fair dealing was denied.
In their cause of action for breach of the UMFPA, plain-tiffs claimed that Exxon “acted with the intent to destroy or substantially lessen competition.” Plaintiffs alleged that Exxon offered different prices to different sellers and con-trolled plaintiffs’ operating costs and was thereby respon-sible for their financial problems. The court held that these allegations were insufficient to support an inference that Exxon was implementing its policies in a discriminatory manner in violation of the UMFPA. Accordingly, plaintiffs’ UMFPA claim was dismissed without prejudice and with leave to amend to plead with greater clarity that Exxon’s pricing and other policies were implemented to discriminate and with intent to restrain competition.
The fourth claim for conspiracy to discriminate against plaintiffs in the prices charged for gasoline was not addressed by the court.
InJunCTIvE RELIEF
LaBelle Chevrolet, LLC v. Gen. Motors, LLC, 2010 WL 1325445, Bus. Franchise Guide (CCH) ¶ 14,353 (D. Mass. Apr. 2, 2010)LaBelle Chevrolet, LLC (LaBelle) is a so-called wind-down Chevrolet motor vehicle dealer of General Motors, LLC (GM). LaBelle filed suit against GM and sought to enjoin GM from relocating a competing dealership into LaBelle’s Area of Primary Responsibility.
LaBelle was one of the approximately 1,000 GM deal-ers that were terminated in connection with the “old” GM’s bankruptcy. As a wind-down dealer, LaBelle was permitted to continue selling Chevrolet cars until October 31, 2010, at which time it would receive a termination payment. LaBelle sought to continue as a Chevrolet dealer pursuant to the Federal Consolidated Appropriations Act (Act), pursu-ant to which terminated dealers could seek to be reinstat-ed through an arbitration process. LaBelle filed a demand for arbitration seeking to be reinstated. Shortly thereafter, LaBelle learned that Chevrolet had authorized a competi-tive dealer to relocate its business into LaBelle’s Area of Pri-mary Responsibility. In response, LaBelle sought to enjoin GM from relocating the competitive dealer into LaBelle’s Area of Primary Responsibility pending the outcome of the arbitration regarding whether LaBelle would be reinstated as a regular dealer.
The district court undertook the traditional analysis of whether an injunction was appropriate pursuant to Feder-al Rule of Civil Procedure 65. LaBelle argued that it was likely to succeed on the merits because it had met or exceed-ed the criteria for reinstatement. In response, GM argued that it had issued a letter of intent reinstating LaBelle as an authorized Chevrolet dealership, thus rendering the arbi-tration moot. LaBelle claimed that the terms of the letter of intent were somewhat different from the parties’ origi-nal dealer agreement. The court found this argument to be “underwhelming” because whether LaBelle had been rein-stated or not had no bearing on whether the court should grant the requested injunctive relief. The court concluded
that there was nothing in the dealer agreement that pre-cluded Chevrolet from relocating an existing dealer into LaBelle’s Area of Primary Responsibility. Thus, the court reasoned that LaBelle was unlikely to succeed on the mer-its. Although this determination was essentially dispositive of LaBelle’s request for a preliminary injunction, the court considered the other relevant injunction factors.
The court noted that LaBelle’s claim of irreparable harm was “overstated” because GM had agreed to reinstate LaBelle’s dealership, and the dealer agreement precluded LaBelle from challenging the relocation of an existing com-petitor into its territory. The court also ruled that the balance of the hardships weighed against entering an injunction. In particular, the court found that the risk of harm to LaBelle was minimal given that it essentially had no basis to contest the relocation of an existing dealer into its Area of Primary Responsibility, whereas the risk of harm to GM and the third-party dealer was substantial. The court was particu-larly concerned about the potential harm to the competi-tive dealer who claimed to have already invested significant time and resources into the relocation and had apparently already obtained a number of customers at its new location. The court also felt that there would be at least some tangen-tial harm to GM’s reputation and customer goodwill in the event an injunction was issued. Finally, the court found that it did not appear the public interest would be impacted one way or another upon either entering or denying the request-ed injunctive relief.
JuRISDICTIOn
Domino’s Pizza Franchising, LLC v. Yeager, Case No. 09-14704, Bus. Franchise Guide (CCH) ¶ 14,312 (E.D. Mich. Jan. 25, 2010)Domino’s Pizza terminated defendants’ franchise agree-ments and brought suit to enforce defendants’ post-termi-nation obligations, including the obligation to remove the franchisor’s trademarks from the premises of defendants’ stores and abide by the terms of a post-termination cove-nant against competition. Although defendants’ stores were located in Nevada and California, Domino’s brought suit in Michigan (Domino’s home state), arguing that defendants were subject to personal jurisdiction in that state.
The court agreed that it could exercise personal jurisdic-tion over defendants and ultimately entered the injunctive relief Domino’s requested. The court found that personal jurisdiction was appropriate because defendants had entered their franchise agreements in Michigan; submitted month-ly payments to Domino’s in Michigan; used the Domino’s computer system that was located in Michigan; and received benefits “such as advertising, products, and system develop-ment, all emanating from Michigan.” Turning to the request for injunctive relief, the court found that Domino’s had established a strong likelihood of succeeding on its trade-mark infringement and restrictive covenant claims. Although defendants argued the covenant against competition was unconscionable because they were not aware of that clause
when they entered the franchise agreements, the court none-theless found the scope of the restriction reasonable.
Green v. SuperShuttle Int’l, Inc., Case No. 09-2129, Bus. Franchise Guide (CCH) ¶ 14,315 (D. Minn. Jan. 29, 2010)This case is discussed under the topic heading “Class Action.”
Toyz, Inc. v. Wireless Toyz, Inc., Case No. C 09-05091, Bus. Franchise Guide (CCH) ¶ 14,313 (N.D. Cal. Jan. 25, 2010)Plaintiff franchisees brought suit against their franchisor and some of its past and present officers, alleging that the franchisor and its officers had misrepresented the franchise opportunity. The franchisor’s principal place of business was located in Michigan, and individual defendants also resided in Michigan. Plaintiffs commenced their action in the state courts of California, their home state. Defendants removed the case to federal court and brought a motion to dismiss individual defendants for lack of personal jurisdiction. The franchisor also sought transfer of the action to a fed-eral court in Michigan. Simultaneously, plaintiffs moved to remand the case to the state court in which it had originated.
The court first denied plaintiffs’ motion to remand. Plaintiffs argued that defendants filed their notice of remov-al more than thirty days after the first defendant had been served with the complaint, though the notice of removal had been filed within thirty days of the date the last defen-dant was served with process. Plaintiffs asked the court to adopt the so-called first-served rule to hold that a notice of removal must be filed within thirty days of the date on which the first defendant is served. The court rejected plaintiffs’ argument, endorsing instead the last-served rule, which provides that a notice of removal is timely if filed within thirty days of the date on which the last defendant is served with process.
Turning to individual defendants’ motion to dismiss, the court found that plaintiffs had failed to show that individual defendants had sufficient personal contacts with the state of California to justify the exercise of personal jurisdiction over them. Although plaintiffs alleged that individual defen-dants had personally made misrepresentations to them, they did not offer any evidence to show that the misrepresenta-tions had been made in California. Moreover, considering the factors articulated by the U.S. Court of Appeals for the Ninth Circuit, the court concluded that the exercise of per-sonal jurisdiction would be unreasonable due to the limited contacts between individual defendants and the state of California. The court thus granted individual defendants’ motion but elected to transfer plaintiffs’ claims rather than dismiss them outright.
Finally, the court granted the franchisor’s motion to transfer the case to a federal court in Michigan. The court found that it would be inconvenient for plaintiffs to litigate the same case twice, once against the franchisor in Califor-nia and again against the officers in Michigan. Instead, the court ordered that the entire matter be transferred to a fed-eral court in Michigan.
STATuTE OF LIMITATIOnS
Boon Rawd Trading Int’l Co. v. Paleewong Trading Co., 2010 WL 668063, Bus. Franchise Guide (CCH) ¶ 14,354 (N.D. Cal. Feb. 19, 2010)Plaintiff and counterdefendant Boon Rawd Trading Inter-national Co. (BRTI) is an exporter of Singha beer and other Boon Rawd products. Defendant and counterclaimant Paleewong Trading Co. (PTC) was a long-time U.S. import-er and distributor of Singha beer. BRTI terminated its rela-tionship with PTC, and litigation ensued.
The factual background regarding the parties’ dispute is convoluted. PTC alleged that it had been the de facto exclu-sive importer and distributor of Singha beer in numerous states for thirty-two years and that its territory had included portions of California and New York for twenty-six of those years. BRTI became the exporter of Singha beer in 2000. Prior to that date, a different entity was the exporter. It was undisputed that there was never any written contract evi-dencing the claimed exclusive agreement between PTC and the prior exporter. Rather, PTC alleged that a “course of conduct” with the prior exporter formed the basis for such agreement. PTC further claimed that there was a “mutual understanding” with BRTI that PTC would continue to be the exclusive importer and distributor of Boon Rawd prod-ucts (including Singha beer), that PTC’s rights could not be terminated without good cause, and that PTC was entitled to compensation in the event the agreement was terminated.
According to PTC, BRTI engaged in a scheme beginning in 2002 to “strip” PTC of its exclusive importation rights by, among other things, appointing a subsidiary as a “dual importer” of Boon Rawd products to compete with PTC; and the dual importer engaged in price discrimination, misappropriation of PTC’s confidential propriety informa-tion, and other alleged wrongdoing. Continuing through 2006, BRTI allegedly attempted either to terminate and/or acquire for a nominal amount PTC’s exclusive importation rights. In 2006, BRTI proposed that its subsidiary and PTC form a joint venture that would share importation rights to Boon Rawd products while leaving PTC with its exclusive distribution rights in the alleged exclusive territories. During negotiations regarding the proposed venture, BRTI began exporting its products to the subsidiary. The negotiations were ultimately unsuccessful. BRTI then allegedly offered to purchase PTC’s importation rights for $3 million, and the parties executed a memorandum of understanding to this effect. However, BRTI refused to go forward with this transaction and allegedly renewed its efforts to “force” PTC out of the import business by improper pricing, continuing to allow its subsidiary to import Boon Rawd products into California, fabricating complaints, and making unreason-able demands. Further negotiations occurred during 2008 but were unsuccessful. During that period of time, BRTI’s subsidiary also allegedly sold products to distributors in California below the cost that BRTI was selling those prod-ucts to PTC and engaged in other wrongdoing. In 2009, BRTI sent PTC notice that it intended to terminate PTC’s
importation rights effective December 31, 2009. Shortly after serving the notice of termination, BRTI
filed a declaratory relief action in the U.S. District Court for the Northern District of California. PTC responded by asserting counterclaims for, among others, breach of implied contract, intentional interference with prospective economic advantage, breach of the implied covenant of good faith and fair dealing, promissory estoppel, conversion, unjust enrich-ment, and violations of the California Franchise Relations Act (CFRA). BRTI filed a motion to dismiss.
BRTI argued that PTC’s breach of the implied contract claim based on the dual importation of Boon Rawd’s prod-ucts (which began in 2006) was barred by the applicable two-year statute of limitations. In response, PTC argued that BRTI had not actually breached the implied agreement until after 2006 (and, thus, the cause of action had accrued with-in the two-year period); that BRTI was equitably estopped from asserting a statute of limitations defense; and/or that BRTI’s conduct amounted to a series of successive breaches, and, as a result, there was a continuous accrual. In rejecting PTC’s arguments, the court concluded that PTC knew BRTI had actually breached the alleged implied contract regard-ing exclusive importation rights in 2006, and, thus, the cause of action had accrued at that time. The court further found that nothing BRTI had said or done amounted to a mis-representation regarding PTC not needing to file a suit in a timely manner, and, therefore, there could be no equitable estoppel claim. Finally, the court disposed of PTC’s argu-ment that BRTI’s conduct amounted to a series of separate breaches of the implied agreement because the agreement in question was not a severable contract like an installment agreement. Accordingly, there was no continuous accrual for the breaches.
PTC’s intentional interference with prospective economic advantage was based on BRTI’s alleged “scheme and pattern of tortious conduct” that began in 2002 when BRTI’s subsid-iary was appointed dual importer of Boon Rawd products. BRTI argued that the applicable two-year statute of limita-tions also barred this claim. In response, PTC argued that the “continuing tort” doctrine was applicable and that the statute of limitations did not begin to run until the date of its last injury or when the tortious conduct ceased. The court was unwilling to extend the continuing tort doctrine to the tort of intentional interference with prospective economic advan-tage but found that there were discrete wrongful acts that had occurred within the two-year limitations period. Thus, the court granted BRTI’s motion to dismiss with respect to acts that occurred prior to December 2007 but denied it for acts that occurred after December 2007. Similarly, the court permitted PTC to assert claims for breach of the implied cov-enant of good faith and fair dealing to the extent that the alleged breaching conduct occurred after December 2007.
BRTI sought to dismiss PTC’s promissory estoppel claim arising out of the alleged exclusive importation rights on the ground that it was not applicable. This doctrine is only applicable when the alleged promise lacks adequate consid-eration. Here, the court agreed with BRTI that the alleged
promises made by BRTI were bargained for and given in exchange for PTC’s future performance. Thus, because PTC’s performance was requested at the time the promises were made and such performance was bargained for, the doctrine of promissory estoppel was inapplicable.
The court granted BRTI’s motion to dismiss PTC’s claim that BRTI had converted PTC’s customer goodwill. The court found that although the trend in California is to per-mit a claim of conversion of intangible property rights, there was no law upholding a conversion of customer goodwill claim; and the court was unwilling to extend existing law.
The court also granted BRTI’s motion to dismiss the unjust enrichment claim on the ground that such a claim only exists when there is no enforceable agreement or when the agreement was “procured by fraud or is unenforceable or ineffective for some reason.” PTC had failed to allege either that there was no binding agreement or that the express con-tract was procured by fraud or was otherwise ineffective. Thus, the court found that PTC had not alleged the requisite facts to support such a claim.
Finally, the court granted BRTI’s motion to dismiss PTC’s claim for violations of the CFRA. The court concluded that PTC had failed to allege adequately the necessary factual predicate to establish that BRTI was a franchise within the meaning of the CFRA.
Guirguis v. Dunkin’ Donuts Inc., Case No. 09-5118, Bus. Franchise Guide (CCH) ¶ 14,338 (D.N.J. Mar. 1, 2010)Plaintiff alleged that Dunkin’ Donuts violated the parties’ Store Development Agreement (SDA) by denying him per-mission to open a Dunkin’ Donuts shop at a location where Dunkin’ Donuts later approved a different franchisee. Plain-tiff brought suit against Dunkin’ Donuts, claiming breach of contract. Dunkin’ Donuts moved to dismiss, arguing that plaintiff ’s claim was barred by the SDA’s statute of limita-tions and arbitration clause.
The court granted Dunkin’ Donuts’ motion. The court found that the parties had agreed to be bound by a two-year statute of limitations and that plaintiff discovered the facts underlying his breach of contract claim more than two years before filing suit. The court also found that the SDA required arbitration unless plaintiff agreed to waive any claims for puni-tive damages and his right to a jury trial. Looking to the face of plaintiff’s complaint, the court held that plaintiff had not waived those rights and was thus bound to arbitrate his claims.
Pinnacle Pizza Co., Inc. v. Little Caesar Enters., Inc., Case No. 08-3999, Bus. Franchise Guide (CCH) ¶ 14,341 (8th Cir. Mar. 22, 2010)This case is discussed under the topic heading “Trademarks.”
STATuTORy CLAIMS
Al’s Serv. Ctr. v. BP Prods. N. Am., Inc., 599 F.3d 720, Bus. Franchise Guide (CCH) ¶ 14,347 (7th Cir. Mar. 26, 2010)In this action by a dealer against its oil company supplier, the U.S. Court of Appeals for the Seventh Circuit held that
the termination of the franchise relationship was caused by the dealer’s abandonment of its business, not by any actions of the supplier, and that the dealer therefore had no valid claim under the PMPA.
Plaintiff in this action was a BP dealer operating under BP’s Amoco brand. In 2003, after learning that the state would be condemning a small (but critical) portion of the gas station for a highway-widening project, BP notified the dealer that it would terminate their franchise agreement ten days before that condemnation took effect. Under the PMPA, partial condemnation of the marketing premises is a valid basis for termination of the franchise. But after the condemnation took place in 2005, and despite another notice from BP asserting that the franchise had been ter-minated, the dealer continued to operate and BP continued to supply gasoline. In 2006, following allegations that BP had ceased supplying fuel to the dealer, the dealer obtained a preliminary injunction prohibiting BP from terminating the franchise. Later that year, in connection with the high-way project, the state removed the dealer’s roadside sign. The dealer asked BP to replace the sign, but BP refused; the dealer did not invoke the injunction or seek any court relief at that time. In 2008, the dealer abandoned the business and pursued its suit against BP. The trial court ultimately grant-ed summary judgment in favor of BP.
On appeal, the court held that BP was entitled to termi-nate the franchise based on the condemnation. Even though the size of the condemned parcel was small, the state had condemned one of the two entrances on the highway side of the gas station, which “significantly degraded the marketing premises.” The court held that the alleged interruption in supply and BP’s refusal to replace the sign may have altered the parties’ relationship, but neither constituted a termina-tion of the franchise or failure to renew the franchise rela-tionship. Instead, it was the dealer’s own abandonment of its business that caused the termination of the franchise. The court noted that the dealer could still pursue its state law claims in state court.
Ammirato v. Duraclean Int’l, Inc., 2010 WL 475303, Bus. Franchise Guide (CCH) ¶ 14,320 (E.D.N.Y. Feb. 8, 2010)This case is discussed under the topic heading “Contract Issues.”
Awuah v. Coverall N. Am., Inc., 2010 WL 1257980, Bus. Franchise Guide (CCH) ¶ 14,349 (D. Mass. Mar. 23, 2010)The court held that, under Massachusetts law, cleaning ser-vice franchisee plaintiffs were employees of the franchisor because both franchisees and franchisor were fundamen-tally in the cleaning service industry.
Plaintiffs in this action were a group of franchisees in the Coverall cleaning service system. They brought this lawsuit claiming that the franchisor had misclassified them as inde-pendent contractors and had committed unfair or deceptive trade practices. The franchisees moved for summary judg-ment under Massachusetts’s Independent Contractor Stat-ute, asserting that they were in fact employees.
The trial court agreed. Under Massachusetts law, an indi-vidual performing a service is considered an employee unless the would-be employer can establish, among other things, that “the service is performed outside the usual course of the business of the employer.” The franchisor argued that it is not in the commercial cleaning business but in the franchis-ing business, contending that it neither performs any cleaning itself nor employs any cleaners. However, the court found that the franchisor trained its franchisees, provided them with uni-forms and badges, contracted with and billed virtually all cus-tomers, and received a percentage of the revenue from every cleaning service. Based on these facts, the court found that the franchisor “sells cleaning services, the same services pro-vided by these plaintiffs.” As a result, the franchisor could not establish that the franchisees were performing services outside the usual course of the franchisor’s business, so those franchi-sees qualified as employees under Massachusetts law.
Subsequent to this decision, at the beginning of trial, the court dismissed the franchisees’ employment claims based on their failure to establish that they had suffered any dam-ages as a result of the misclassification.
B.A. Constr. & Mgmt., Inc. v. Knight Enters., Inc., 2010 WL 545504, Bus. Franchise Guide (CCH) ¶ 14,324 (6th Cir. Feb. 17, 2010)The U.S. Court of Appeals for the Sixth Circuit remanded to the district court for further findings on whether a gaso-line distributor had violated the PMPA when it terminated its franchise agreement with a gas station dealer.
Under the parties’ agreement, the distributor was obligat-ed to provide the dealer with a $130,000 signing bonus to per-form improvements to the gas station (the distributor would be reimbursed over time by supplier Citgo if the dealer hit certain sales targets). The distributor’s obligation to make that payment was contingent on Citgo’s acceptance of the retail outlet and on the distributor’s approval of the dealer’s retail plans and designs. The distributor did not advance the $130,000, but the dealer began operating anyway. Within a few months, the dealer was giving the distributor bad checks to pay for fuel deliveries and then ceased purchasing fuel from the distributor altogether for several months. The dis-tributor terminated the franchise agreement and foreclosed on the leased property. The dealer sued, claiming that the distributor had breached the contract by not paying the $130,000 signing bonus and by refusing to sell fuel to the dealer. The district court granted the dealer summary judg-ment on liability, and the distributor appealed.
The Sixth Circuit held that the district court failed to make a factual determination on the distributor’s approval of the dealer’s retail plans and designs, which was the second precondition of the distributor’s obligation to pay the sign-ing bonus. The court reversed the district court’s summary judgment order and remanded for further factual findings. The distributor also argued that the franchise agreement was voidable because the dealer had fraudulently represent-ed its historical fuel sales to secure the distributor’s agree-ment to pay the signing bonus. The appeals court found that
the distributor had failed to present any evidence that the dealer’s representations about historical fuel sales were inac-curate and held that the district court properly granted the dealer summary judgment on the distributor’s fraud claim.
Clark Invs., Inc. v. Airstream, Inc., 2010 WL 1222312, Bus. Fran-chise Guide (CCH) ¶ 14,250 (Ill. App. 3d Dist. Mar. 23, 2010)Clark Investments, Inc., doing business as R&R RV Sales (R&R), entered into a franchise agreement (first agreement) with Airstream, Inc. (Airstream) pursuant to which it was granted the right to sell one model of recreational vehicle (RV) made by Airstream. The agreement included inven-tory requirements and sales goals and gave R&R the state of Illinois as its exclusive sales territory. Shortly before the expiration of the first agreement, Airstream offered R&R a replacement contract. The replacement contract had no expiration date, no sales goals for R&R, and no exclusive territory for R&R. R&R refused to sign the replacement agreement because it did not include an exclusive territory. When the first agreement expired, the parties continued to do business without a written agreement until R&R eventu-ally signed another written agreement (second agreement), which had reduced inventory requirements, no sales goals, and no exclusive territory and granted R&R the right to sell additional Airstream products. Airstream then “entered into an agreement with another dealer to locate an Airstream franchise . . . about 90 miles from R&R’s franchise location” that would sell some of the same products as R&R.
R&R filed suit in Illinois state court asserting claims against Airstream for, among other things, violations of the Illinois Motor Vehicle Franchise Act (Franchise Act) based on Airstream’s decision to locate another dealer within ninety miles of R&R’s business. Airstream filed a motion for summary judgment, which was granted. R&R appealed the trial court’s grant of summary judgment.
The appellate court held that Airstream had not vio-lated the Franchise Act because the second franchise was not located within fifteen miles of R&R’s franchise and, thus, was not prohibited by the express terms of the Fran-chise Act (815 Ill. Comp. Stat. 710/2(q)). The court fur-ther found that even if the second agreement was void as R&R claimed, the first agreement had expired by its own terms, and the exclusive sales territory provision included in it would no longer be applicable. Finally, the appel-late court also concluded that Airstream had not violated the Franchise Act by failing to extend the first agreement because it had offered a replacement contract to R&R. The replacement contract itself did not violate the Franchise Act because it did not “substantially change or modify the sales and service obligations or capital requirements” of R&R. Accordingly, the trial court’s grant of summary judgment for Airstream was affirmed.
JOC, Inc. v. Exxon Mobil Oil Corp., 2010 WL 1380750, Bus. Franchise Guide (CCH) ¶ 14,352 (D.N.J. Apr. 1, 2010)This case is discussed under the topic heading “Good Faith and Fair Dealing.”
MacWilliams v. BP Prods. N. Am., Inc., Case No. 09-1844, Bus. Franchise Guide (CCH) ¶ 14,316 (D.N.J. Feb. 3, 2010)Plaintiff MacWilliams operated two gasoline service sta-tions pursuant to dealer supply agreements with BP’s pre-decessor in interest, Amoco. The dealer supply agreements provided that Amoco would supply gasoline to MacWil-liams at a specified price, subject to change at any time with notice. BP also agreed to provide MacWilliams with end-of-month volume allowances, consisting of payments made to MacWilliams based on the volume of gasoline sold at his stations. The agreements provided that those allowances were also subject to change.
BP later assigned its supply responsibilities to a third party, Ocean Petroleum. Ocean advised MacWilliams that Ocean intended to cancel the end-of-month volume allowance pro-gram. MacWilliams protested that decision, claiming that the termination of that program constituted a constructive termination of his dealer supply agreement. MacWilliams demanded return of the security deposit he had provided to BP in exchange for the end-of-month volume allowance program. When Ocean refused, MacWilliams brought suit against BP, claiming a constructive termination of his dealer agreement under the PMPA and seeking the return of his security deposit.
The court found that “[t]he PMPA does not expressly pro-vide a cause of action for constructive termination,” although it noted that some courts had implied such an action. Even assuming such a cause of action could be brought under the PMPA, the court reasoned that Ocean had the contractual right to discontinue the volume allowance program. In this case the court held that the dealer agreements could not be constructively terminated by conduct that was express-ly authorized by the parties’ agreements. Accordingly, the court concluded that plaintiff ’s complaint failed to state a claim for relief for breach of the PMPA. The court did find, however, that MacWilliams had properly stated a claim for relief regarding return of its security deposit and permitted that claim to proceed.
S&S Sales, Inc. v. Pancho’s Mexican Foods, Inc., 2010 WL 749562, Bus. Franchise Guide (CCH) ¶ 14,328 (E.D. Ark. Mar. 3, 2010)Plaintiff S&S Sales (S&S) is an Arkansas-based wholesale dis-tributor of snack foods, including products manufactured by Pancho’s Mexican Foods (Pancho’s). S&S alleged that it had an exclusive franchise agreement to sell Pancho’s products in parts of Arkansas and that Pancho’s breached this agreement when it entered into a separate agreement with Associate Wholesale Grocers (AWG) pursuant to which AWG began distributing Pancho’s products in S&S’s purported territory. S&S sued Pancho’s for violations of the Arkansas Franchise Practices Act (AFPA), the Arkansas Deceptive Trade Prac-tices Act (ADTPA), fraud, and civil conspiracy. Additionally, S&S sued AWG for intentional interference with contract, violations of the ADTPA, and other claims. Both Pancho’s and AWG filed motions for summary judgment.
that the AFPA did not apply because the parties did not “contemplate” that S&S maintain a “place of business” in Arkansas as required by the statute. Although there was no documentation or contract between the parties specifically requiring S&S to establish a place of business in Arkansas, S&S operated a warehouse in Arkansas. Pancho’s argued, however, that the warehouse did not constitute a place of business within the meaning of the AFPA because S&S did not display and sell Pancho’s products directly from the warehouse as also required by the statute. The court held that there was a triable issue of fact as to whether S&S’s warehouse operations constituted a place of business under the AFPA because it was undisputed that S&S sold at least some Pancho’s products directly from its warehouse, and there was some evidence that S&S actually “displayed” Pan-cho’s products at its warehouse.
Pancho’s also sought summary judgment on the grounds that S&S’s claims were barred by the applicable statutes of limitations and/or the doctrine of laches. Pancho’s argued that S&S had known for a number of years that Pan-cho’s directly sold its products to Walmart stores in S&S’s claimed territory. The court found, however, that there was a triable issue of fact as to whether direct sales by Pancho’s to Walmart were factually or contractually analogous to sales by Pancho’s to a “middleman” distributor like S&S (and AWG).
In addressing AWG’s motion for summary judgment, the court noted that the parties’ respective arguments relied on conflicting deposition testimony that effectively “under-cut” AWG’s arguments that there were no triable issues of material fact. S&S alleged that AWG violated Arkansas’s consumer protection statute, which makes illegal any trade practice that is unconscionable. Based on the conflicting deposition testimony, the court ruled that whether AWG’s conduct was unconscionable was a question for the jury to resolve. The court similarly found that the testimony of the witnesses established triable issues of material facts regard-ing each of the elements of S&S’s tortious interference with contract claim.
TERMInATIOn AnD nOnREnEWAL
Al’s Serv. Ctr. v. BP Prods. N. Am., Inc., 599 F.3d 720, Bus. Franchise Guide (CCH) ¶ 14,347 (7th Cir. Mar. 26, 2010)This case is discussed under the topic heading “Statutory Claims.”
Clark Invs., Inc. v. Airstream, Inc., 2010 WL 1222312, Bus. Fran-chise Guide (CCH) ¶ 14,250 (Ill. App. 3d Dist. Mar. 23, 2010)This case is discussed under the topic heading “Statutory Claims.”
Constr. Crane & Tractor, Inc. v. Wirtgen Am., Inc., 2010 WL 1172224, Bus. Franchise Guide (CCH) ¶ 14,345 (Tenn. Ct. App. Mar. 24, 2010)This case is discussed under the topic heading “Contract Issues.”
Ganley v. Mazda Motor of Am., Inc., 2010 WA 697360, Bus. Franchise Guide (CCH) ¶ 14,333 (6th Cir. Mar. 2, 2010)Ganley, Inc. (Ganley) owned and operated a number of automobile dealerships in Ohio, including a Mazda deal-ership. Thomas Ganley was its principal shareholder. The Ganley Mazda dealership was unprofitable and was the worst-performing dealership in Ohio based on Mazda’s sales and other criteria. Mazda served a notice of pending termination of the dealership pursuant to the procedures required by the Ohio Motor Vehicle Dealers Act (Dealers Act). Ganley filed a protest of the impending termination with the Ohio Motor Vehicle Dealers Board (Board). As a result, Mazda was prohibited from enforcing the termina-tion until the Board had determined whether there was good cause for the termination.
Shortly before the Board hearing, Ganley requested approval from Mazda to transfer the controlling interest in Ganley from Thomas Ganley to his son, Kenneth Ganley. After the Board hearing, but before any decision had been issued, Mazda denied the proposed transfer on the ground that Ganley had failed to submit information necessary to evaluate the proposal. Thereafter, Ganley submitted addi-tional supporting information, including Kenneth’s pro-posed business plan for making the dealership profitable. Mazda refused to consent to the proposed transfer on the basis that (i) the dealership had been terminated and, thus, there was nothing to transfer; (ii) even if the dealership could be transferred, Kenneth had failed to meet Mazda’s criteria; and (iii) in any event, Mazda intended to exercise its right of first refusal. In response, Kenneth filed a separate protest with the Board claiming that Mazda’s decision to deny the proposed transfer was without “good cause.”
The Board ultimately determined that Mazda had good cause to terminate the franchise. As a result, Mazda termi-nated the franchise, and Ganley ceased selling Mazda cars. Kenneth subsequently withdrew his transfer protest, which the Board then dismissed “with prejudice.”
Plaintiffs contested the termination principally on the ground that Mazda had failed to properly apply its own criteria in considering the proposed transfer of the control-ling interest in Ganley from Thomas to Kenneth. Plaintiffs claimed that if Mazda had properly applied its criteria, the transfer would have been approved. In response, Mazda argued that the criteria was simply a “threshold barrier” and “merely the first step in [the] approval process.” The parties filed cross-motions for summary judgment. The district court denied plaintiffs’ motion and entered sum-mary judgment in favor of Mazda, finding that (i) plain-tiffs’ Dealers Act claim was barred by res judicata because the Board had dismissed Kenneth’s transfer protest, and (ii) plaintiffs could not establish damages. Plaintiffs appealed to the Sixth Circuit.
The Sixth Circuit held that the lower court was incorrect in finding that the Dealers Act claim was barred by res judicata because the claim had not actually been litigated. However, the court went on to consider the merits of plaintiffs’ Deal-ers Act claim and concluded that the undisputed evidence
established that plaintiffs could not prevail on the merits of their claim. Although it was undisputed that Mazda had failed to strictly follow its own written criteria, the court found that this was simply “one factor to be considered” and that Maz-da’s deviation from the evaluation criteria was minor under the circumstances. The court further found that “nothing else in the record weigh[ed] against a finding of good cause” for the termination. On the other hand, the court held that there were two significant factors that weighed in favor of finding that the termination was with good cause. First, the court believed that Kenneth’s proposed business plan was inadequate under the circumstances in that it did not address potential relocation of the dealership, facility upgrades, or replacement of any of Ganley’s existing management. Given Ganley’s poor perfor-mance, the court felt that significant changes were necessary. Second, and most importantly, the court found that regardless of whether Thomas or Kenneth was the majority shareholder of Ganley, the termination of the franchise was imminent; and even if the proposed transfer “had been approved, the pre-existing termination proceeding would not have been mooted.” Thus, even if the transfer had been approved, all that Kenneth would have acquired was the “‘stock in a dealership . . . [that was] subject to . . . termination.’”
The court also considered plaintiffs’ claim that Mazda breached the parties’ agreement by unreasonably with-holding consent to the transfer. The district court did not reach the issue of whether Mazda had unreasonably with-held its consent, instead concluding that plaintiffs could not establish damages as a result of the alleged breach. The Sixth Circuit agreed, finding that Thomas could not have suffered damages as a result of Mazda’s denial of the pro-posed transfer because his intent was to gift his interest in Ganley to Kenneth for free. The court further found that Ganley suffered no damages because the franchise would have been terminated regardless of who was the controlling shareholder and that “[a]ny assertion that Ganley . . . would have become profitable under Kenneth’s majority owner-ship” was speculative.
Kellogg USA, Inc. v. B. Fernandez Hermanos, Inc., Case No. 07-1213, Bus. Franchise Guide (CCH) ¶ 14,319 (D.P.R. Jan. 27, 2010)This case is discussed under the topic heading “Contract Issues.”
Maita Distribs., Inc. of San Mateo v. DBI Beverage Inc., 667 F. Supp. 2d 1140, Bus. Franchise Guide (CCH) ¶ 14,321 (N.D. Cal. Nov. 3, 2009)The court held that California’s beer distribution statute nei-ther grants a termination right nor prohibits termination of beer supply agreements and is solely intended to provide a mechanism to value terminated distribution rights.
Plaintiff Maita Distributors was a distributor for both Miller and Coors. Those contracts were terminable only for cause and did not grant any right to terminate upon the manufacturer’s transfer of products or brands to anoth-er manufacturer. When Miller and Coors formed a joint
venture (MillerCoors) in 2008, they transferred their respec-tive brands to the joint venture. Shortly thereafter, the joint venture gave Maita notice that both distribution contracts would be terminated and that the distribution rights would be granted to defendant DBI Beverage. Maiti objected, and under California’s beer distribution statute (Cal. Bus. & Prof. Code § 25000.2), Maiti engaged in negotiations with DBI to resolve the dispute. When negotiations were unsuc-cessful, DBI attempted to invoke statutorily mandated arbi-tration, and Maita resisted. Maiti, DBI, and MillerCoors eventually ended up in federal court, where Maita argued that the beer distribution statute did not permit termination of the distribution agreement, and DBI and MillerCoors argued that the statute did grant that termination right.
The court held that the statute neither granted a termina-tion right nor prohibited termination, opining that
[t]his appears to be an unusual case in which the legislature focused on providing a solution to so narrow an issue—pro-viding a means to efficiently determine the fair market value of beer distribution rights to be paid to an existing distribu-tor—that it failed to address the problem in a sufficiently thorough context.
In other words, the statute did not speak to the parties’ termination rights (or protection from termination with-out cause); instead, it merely established what is, in effect, a mechanism for negotiating and measuring damages in the event of a wrongful termination. Having held that the stat-ute did not provide a termination right, the court did not address arguments that the statute was an unconstitutional impairment of contracts.
Mussetter Distrib., Inc. v. DBI Beverage Inc., 2010 WL 395638, Bus. Franchise Guide (CCH) ¶ 14,322 (N.D. Cal. Feb. 3, 2010)The court held that the arbitration requirement in Califor-nia’s beer distribution statute was not an unconstitutional impairment of contracts because it was not a substantial impairment of rights and was consistent with other long-standing regulations imposed on the beer industry.
The facts of this case closely followed that of Maita Dis-tributors, Inc. of San Mateo v. DBI Beverage Inc., also reported in this issue. After the consolidation of Miller and Coors into a joint venture, the newly combined manufacturer terminated existing contracts with Mussetter Distributing and replaced that distributor with DBI Beverage. Also, as in Maita, the parties contested whether California’s beer distribution stat-ute (Cal. Bus. & Prof. Code § 25000.2) permitted or pro-hibited termination without cause; and the court, which also presided over the Maita case, adopted its holding in that case that the statute neither permitted nor prohibited termination.
In this action, the terminated distributor also argued that the statute was an unconstitutional impairment of con-tracts, on the grounds that it required the parties to engage in arbitration to determine the fair market value of the terminated distribution rights. Mussetter contended that
the arbitration requirement deprived it of the benefit of its bargain and imposed significant costs, which amounted to a constitutional violation. The court disagreed, holding that the arbitration requirement “has not operated a substantial impairment” of the contractual relationship. The arbitration requirement only applied in a narrow set of circumstances, i.e., where a successor manufacturer acquires a brand and replaces a distributor and the successor and prior distribu-tors cannot agree on the value of the prior distributor’s involuntarily transferred rights. The court also held that the cost of arbitration was comparable to litigation and, at least to some degree, within the control of the parties. Finally, the court held that California had been regulating the beer industry for decades in comparable ways, including by restricting the effect of contractual provisions that required litigation outside the state or that allowed termination for failure to meet an unreasonable quota.
Prudence Corp. v. Shred‑It Am., Inc., 2010 WL 582597, Bus. Franchise Guide (CCH) ¶ 14,334 (9th Cir. Feb. 18, 2010)Franchisor Shred-it America, Inc. (SAI) appealed a judg-ment in favor of Prudence Corporation (Prudence) for breach of the franchise agreement between SAI and Pru-dence. The U.S. District Court for the Central District of California found that “SAI had breached the franchise agreement by failing to . . . submit proposed renewal terms” for the franchise agreement in a timely manner. As a result, the district court ordered that the franchise agreement be renewed at the original royalty rate and awarded attorney fees and costs to Prudence.
The Ninth Circuit upheld the judgment finding that the district court had discretion to order specific performance at the original royalty rate because the express terms of the franchise agreement provided that “where a party improp-erly withholds its approval of any action provided for in the [agreement], specific performance is the [appropriate] rem-edy.” Additionally, the Ninth Circuit found that by improp-erly delaying renewal of the agreement for “well over a year,” SAI had waived its right to negotiate different terms than those provided for in the original agreement.
Volvo Trucks N. Am. v. Wausau Truck Ctr., Inc., 779 N.W.2d 423 (2010), Bus. Franchise Guide (CCH) ¶ 14,331 (Wis. Ct. App. Mar. 11, 2010)Volvo Trucks North America (Volvo) terminated its dealer, Wausau Truck Center, Inc. (Wausau Truck) on the ground that it had breached the parties’ dealership agreement. Wausau Truck contested the termination, claiming that it had cured the breach.
Wausau Truck sold both Volvo and Peterbilt trucks but decided to sell its Volvo dealership and focus exclusively on its Peterbilt dealership. As part of that decision, Wausau Truck implemented a so-called Volvo Elimination Plan, pursuant to which, among other things, it promoted Peter-bilt trucks at the expense of Volvo trucks. After notice and an opportunity to cure, Volvo terminated Wausau Truck’s dealership agreement. Wausau Truck admitted that its
policy of favoring Peterbilt trucks constituted a breach of the parties’ agreement but argued that it subsequently changed its mind about selling its Volvo dealership and had “recommitted itself to promoting Volvo products” prior to the termination. After a hearing, the Wisconsin Division of Hearings and Appeals (Division), which is responsible for resolving wrongful termination disputes under the Wis-consin Motor Vehicle Dealer Law (Dealer Law), found that Wausau Truck had cured the breach and ordered Volvo to rescind the termination. Both the Wisconsin circuit court and appellate court agreed. Wausau Truck appealed to the state Supreme Court.
The issue on appeal was whether Wausau Truck had “cured” its breach within the required cure period. In addressing this issue, the court first considered the Division’s interpretation of the word cure as used within the Dealer Law. Volvo argued that to cure the breach, Wausau Truck was effectively required to undo the effects of its breach and restore matters to the way they were before the breach. The Division disagreed with Volvo’s interpretation and conclud-ed that in order to cure its breach, Wausau Truck had to both stop the offending conduct and to substantially per-form the contract. The court agreed.
The court then addressed the ultimate issue of wheth-er Wausau Truck had cured the breach. In essence, Volvo argued that Wausau Truck had not cured the breach because some parts of the Volvo Elimination Plan remained in place (e.g., the dealership no longer included Volvo in its name) and that the steps it had taken to cure the breach were taken merely to bolster Wausau Truck’s “litigation position.” The court carefully considered what steps Wausau Truck had undertaken to implement the Volvo Elimination Plan and what step it had taken to “recommit” to Volvo (i.e., cure the breach). The court found that there was substantial evidence supporting the Division’s finding that Wausau Truck had, in fact, cured its breach of the dealership agreement, and it upheld the rescission of the termination notice.
TRADEMARKS
Pinnacle Pizza Co., Inc. v. Little Caesar Enters., Inc., Case No. 08-3999, Bus. Franchise Guide (CCH) ¶ 14,341 (8th Cir. Mar. 22, 2010)Pinnacle Pizza filed suit against its franchisor Little Caesar Enterprises (LCE), claiming that LCE wrongfully appropri-ated the “Hot-N-Ready” concept that Pinnacle developed as a Little Caesar’s franchisee. Pinnacle began running a Hot-N-Ready advertising campaign in 1997. When that campaign proved successful, Pinnacle shared that idea with LCE and other franchisees, encouraging other franchisees to offer a similar promotion. LCE eventually incorporat-ed the Hot-N-Ready concept into its marketing materials and obtained a trademark for that phrase. Pinnacle then brought suit, claiming that LCE had breached the franchise agreement by wrongfully appropriating Pinnacle’s concept. The district court granted summary judgment to LCE, and Pinnacle appealed.
On appeal, the court found that Pinnacle’s claim for breach of the franchise agreement was barred by the appli-cable statute of limitations. The court held that Pinnacle’s claim accrued as of the first date that LCE had used the phrase Hot-N-Ready, which fell outside the applicable lim-itations period. For that reason, the court also found that plaintiff ’s claim under the South Dakota Franchise Act was barred.
The court further denied plaintiff ’s motion to cancel LCE’s trademark of the phrase Hot-N-Ready. Pinnacle argued that LCE had registered that trademark in bad faith in its application for registration by relying on the date Pin-nacle had first used that phrase. The court observed that evi-dence alone was insufficient proof of bad faith. The court added that even if LCE knew Pinnacle believed that Pin-nacle owned the rights to that phrase when LCE registered it, that fact alone would not justify cancellation.
vICARIOuS LIABILITy
Braucher v. Swagat Group, LLC, 2010 WL 1241825, Bus. Franchise Group (CCH) ¶ 14,355 (C.D. Ill. Mar. 18, 2010)Defendants Himanshu M. Desai; Vasant Patel; Vijay C. Patel; Swagat Group, LLC (LLC); and Vaidik Internation-al, Inc. (collectively, Swagat Defendants) and defendant Choice Hotels Int’l, Inc. (Choice Hotels) were sued in the U.S. District Court for the Central District of Illinois on behalf of two women who became ill (one of whom died) after staying at a Comfort Inn owned by defendant LLC and operated under a franchise agreement with Choice Hotels. The two women were diagnosed with Legionnaires’ disease, which is caused by bacteria that was found in the Comfort Inn’s pool and spa.
The franchise agreement required, among other things, that the Swagat Defendants comply with Choice Hotels’ Rules and Regulations for operating the hotel as a Comfort Inn and authorized Choice Hotels to periodically conduct Quality Assurance Reviews (QARs) of the hotel. The pur-pose of the QAR was to confirm that the Swagat Defendants were complying with the Rules and Regulations and identify areas where the Comfort Inn did not meet the minimum standards for the brand as set forth therein. The QAR was not intended to determine compliance with federal, state, and local laws and regulations, which was the sole responsi-bility of the Swagat Defendants.
With respect to the pool and spa, the QAR inspector con-ducted a visual inspection of the pool and checked to make sure that the water was being regularly tested by reviewing the pool records maintained by defendant LLC but did not conduct any tests of the water himself. The inspector had the authority to shut down the pool if the water was cloudy because of the safety hazard that cloudy water could pose. Defendant Vasant Patel maintained the Comfort Inn’s pool and spa on behalf of defendant LLC. Choice Hotels did not provide him with any training for his position. Periodic tests of the hotel’s pool and spa conducted by the Illinois Department of Health revealed inappropriate chlorine and
pH levels on a number of occasions, as a result of which the pool and spa were shut down each time until the problems were corrected. The water in the pool and spa was never tested by Choice Hotels.
The franchise agreement also included an indemnifica-tion clause requiring that the Swagat Defendants indemnify Choice Hotels in the event that Choice Hotels was subject to a claim for loss or damage but was not at fault. The business relationship provision in the franchise agreement stated that defendant LLC was an independent contractor. The Swagat Defendants placed a plaque in the Comfort Inn lobby stating that the hotel was independently owned and operated. Additionally, both Choice Hotels’ website and the 2006 Choice Hotels’ Worldwide Hotel Directory contained a statement that each hotel was independently owned and operated.
Plaintiffs filed suit against the Swagat Defendants and Choice Hotels, alleging negligence, wrongful death counts, survival act counts, and funeral expense counts (collectively, Duty Counts); res ipsa counts on behalf of each plaintiff (Res Ipsa Counts); and agency counts (Agency Counts) against Choice Hotels. Choice Hotels filed cross-claims against the Swagat Defendants for express indemnity under the indemnification clause in the franchise agreement, implied indemnity, and contribution.
Before the court were the following motions: (i) a motion to strike and bar opinions by plaintiffs’ expert (Expert Motion), (ii) Choice Hotels’ motions for summary judg-ment regarding plaintiffs’ claims (Choice Hotels Summary Judgment Motions), (iii) the Swagat Defendants’ motions for partial summary judgment regarding Choice Hotels’ cross-claims (Swagat Partial Summary Judgment Motions), and (iv) the Swagat Defendants’ motions for summary judg-ment regarding plaintiffs’ claims (Swagat Summary Judg-ment Motions).
The court granted the Expert Motion, finding that although plaintiffs’ expert was an expert in water safety and water rescue procedures with some experience in main-taining swimming pools, he was not qualified to render an opinion regarding who had a legal duty to maintain the pool and spa properly. He was permitted, however, to offer opinions about how the pool and spa should have been maintained.
With respect to the Choice Hotels Summary Judgment Motions, the court held that there was no evidence that Choice Hotels went beyond the limited activity necessary to maintain the required level of quality associated with the franchised brand. Choice Hotels did not impose additional requirements for controlling the bacteria levels in the pool and spa and never took any action to test the water for quality and, therefore, did not exercise sufficient control to be considered an operator of the Comfort Inn at issue. As a result, the court granted the Choice Hotels Summary Judgment Motions on the Duty Counts. Because Choice Hotels did not exercise exclusive control over the Comfort Inn, the court also granted summary judgment on the Res Ipsa Counts. The court further found that Choice Hotels
did not hold the Swagat Defendants out as its agents and, in fact, displayed disclaimers in relevant locations stating that the Comfort Inn was independently owned and oper-ated; it therefore also granted summary judgment on the Agency Counts.
With respect to the Swagat Partial Summary Judgment Motions, the court held that the Swagat Defendants were not entitled to summary judgment on the express indemni-ty cross-claim because an issue of fact remained regarding whether the Swagat Defendants were legally responsible for the bacteria in the pool and spa. The court also held that “Choice Hotels [was] not vicariously liable for the acts of the Swagat Defendants, so there [was] no implied indemnity.” As a result, the Swagat Defendants were granted summary judgment on the implied indemnity cross-claim.
Finally, with respect to the Swagat Summary Judgment Motions, the court held that defendants Vijay C. Patel, Desai, and Vaidik International were entitled to summary judgment because as members of a limited liability com-pany, they were not personally liable for the tortious acts of defendant LLC. Moreover, although the individuals had signed the franchise agreement in their personal capacities and were thus liable on the contract, this fact did not there-by make them liable for any other obligation of the LLC. The court held that “Vasant Patel [was] entitled to partial summary judgment to the extent that . . . [p]laintiffs [were] seek[ing] to hold him liable as a member of . . . [defendant] LLC,” but that did not protect him from personal liabil-ity for his own actions. The court denied the motion for summary judgment on the Res Ipsa Counts because the evidence presented in the form of expert opinions about the causation of plaintiffs’ illness was sufficient to establish that an issue of fact existed for summary judgment pur-poses. The court also held that defendants LLC and Vasant Patel had a duty to plaintiffs as guests of the Comfort Inn, and the expert opinion regarding causation was sufficient for the court to deny the motion for summary judgment as to the Duty Counts.
does the ABA Have Your e-mail Address?
You may be missing out on important e-mail from both the ABA and the Franchise Law Journal. A growing number of communications from the ABA, including the Franchise Lawyer, are being sent by e-mail because of the skyrocketing cost of paper, manufacturing, and postage. Paper consumes a tremendous amount of energy in its production and shipment. Effective May 12, 2008, the U.S. Postal Service started linking its postage rates to the consumer price index. Postage is expected to increase every May for the foreseeable future.
For the present, you will continue to receive a hard copy version of Franchise Law Journal. But you may not receive other information unless your e-mail address appears in your ABA membership record. Use one of the following convenient methods to add your e-mail address:
✆ By phone: ABA Member Services at 1.800.285.2221 between 7:30 a.m. and 5:30 p.m., CST
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By e-mail: [email protected]. Or go to www.abanet.org and click on Contact ABA at the bottom of the homepage.
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NomiNatiNg Committee issues RepoRt
I am pleased to let you know that Edward Wood Dunham, chair of the Nominating Committee, has reported the results of the committee’s deliberations.
The nominees are:
Chair Elect–(2-year term)*Joseph J. FittanteLarkin Hoffman Daly & Lindgren Ltd.
Governing Committee–(3-year terms)*Kerry L. BundyFaegre & Benson LLPKathryn M. KotelCarlson Restaurants WorldwideEric H. KarpWitmer, Karp, Warner & Ryan LLPJames A. GonieaAmerican Driveline Systems, Inc.
Governing Committee–(2-year terms)*Michael K. LindseyPaul, Hastings, Janofsky & Walker LLPDiane Green-KellyReed Smith
Forum members will vote on these nominations dur-ing our annual business meeting on Friday, October 15, 2010, in San Diego, California.
* All terms start in August 2011.
Ronald K. Gardner ChairForum on Franchising
FRANCHISING:Some lIke It HOT!
OcTOber 13–15, 2010tHe Hotel Del CoRoNADo
S a n D i e g O , c a
WeDneSDaY, OcTOber 1310:00AM–5:30pM Forum registration
11:30AM–12:30pM Box lunch pick-up
12:30pM–5:00pM Forum intensive programs i1 Fundamentals of Franchising® i2 The Impact of Social Media on Franchising and the Franchise Practitioner in 2010
THUrSDaY, OcTOber 147:00AM–5:30pM Forum registration
7:00AM–8:30AM Continental Breakfast
7:00AM–8:30AM Women’s Caucus Breakfast (ticketed)
9:00AM–11:30AM guest/spouse Breakfast and Coronado Walking tour (ticketed)
8:45AM–10:15AM plenary 1 strategic and tactical decision-Making: What do Your peers think of Your decisions?
9:00AM–11:30 a.m. spouse/guest Breakfast and Walking tour (ticketed)
10:15AM–10:30AM Break
10:30AM–11:45AM W1 The Most Frequently Litigated Substantive Provisions in Franchise and Dealership Agreements W2 Advanced Disclosure Issues: Pushing the Envelope
33rD annUal FOrUm On FrancHiSing
PrOgram ScHeDUle W3 The Annotated Franchise Agreement W4 The Impossible Dream: Controlling Your International Franchise System W5 Business Laws and Regulations That Affect Franchise Systems W6 Claims under the “Little FTC Acts” W7 Gift Cards and Loyalty Programs
11:45AM–12:45pM networking Buffet lunch
12:45pM–2:00pM W8 Litigating Unlawful FPR’s and Practical Tips for Doing So W9 Bet the System Litigation W10 Unique and Often Overlooked Provisions of State Franchise Registration and Disclosure Laws W11 Franchising in Latin America W12 Challenges to a Franchise System when a Third Party, e.g., Landlord or Supplier, Files for Bankruptcy W13 Ethical Issues for Attorneys and Other Professionals in Franchise Counselling W14 The Other IP: Hot Topics in Trade Secrets, Copyrights and Patents
2:00pM–2:15pM Break
2:15pM–3:30pM W15 Survey of State Dealer Law Topics W16 Protecting the Franchise Brand in the Age of Social Media W17 Litigating Incurable Defaults W18 The Fundamentals of an M&A Transaction in a Franchise System W19 Best Practices for Establishing a Franchise Compliance Program W20 Fundamentals 201: Stop That Right Now—Preparing for, and Winning, Injunctions W21 State Taxation of Franchisors
3:30pM–3:45pM Break
3:45pM–5:00pM W2 Advanced Disclosure Issues: Pushing the Envelope W6 Claims under the “Little FTC Acts” W11 Franchising in Latin America W14 The Other IP: Hot Topics in Trade Secrets, Copyrights and Patents W22 Antitrust Issues–Back in Vogue W23 Going Green–The Impact of Energy Efficient Schemes and Carbon Reduction Commitments on Franchising
WeDneSDaY, OcTOber 13
Welcome reception 5:00 p.m.–6:30 p.m. Hotel del sundeckgather with your colleagues and friends for cocktails and hors d’oeuvres as you watch the sunset and enjoy the warm embrace of one of America’s most cherished seaside resorts. Complimentary for all attendees and their guests.
newcomers’ networking night 6:45 p.m.–10:00 p.m. stingarees, downtown san diegoCome experience a night on the town in downtown san diego with other young lawyers (that is, those lawyers under the age of 36 or who have been admitted to practice for less than 5 years) and first and second time attendees to the Forum. transportation provided. Additional fee for attendees and guests.
THUrSDaY, OcTOber 14
annual reception/Dinner 6:30 p.m.–9:30 p.m. All American Beach party the Hotel del Beachthe magnificent pacific ocean provides the ultimate backdrop for an unforgettable evening on the beach. this party is all about relaxing and just having fun with friends. Come casual for a beach barbecue, volleyball, the limbo, bonfire with s’mores, and a live band playing your favorite Buffett songs. Additional fee for guests.
FriDaY, OcTOber 15
reception/Dinner 6:00 p.m.–9:30 p.m. the san diego Zooupon arriving at the world famous san diego Zoo, you will be transported via a double-decker bus to the zoo’s newest and most unique exhibit, elephant odyssey. enjoy a glass of jungle juice and local California cuisine at the outdoor sabertooth grill while taking in the views of the surrounding wildlife. Additional fee for attendees and guests.
SaTUrDaY, OcTOber 16
community Service event 8:00 a.m.–1:00 p.m. transportation providedthe Community service event this year will support the san diego river park Foundation and take place at the mouth of the san diego river in ocean Beach. We will work in the dune, marsh, and intertidal areas, which contain rare wetlands and nesting sites for endangered birds. transportation provided.
SPecial evenTSW24 Fundamentals 201: Starting a Franchise System: Practical Considerations, Planning and Development
6:30pM–9:30pM All American Beach party Hotel del Beach
FriDaY, OcTOber 157:00AM–4:30pM Forum registration
7:30AM–9:00AM Continental Breakfast iFdi Breakfast (ticketed) Franchise professors’ open House solo/small Firm Breakfast (ticketed) paralegal/Franchise Administrator open House
9:15AM–10:30AM W1 The Most Frequently Litigated Substantive Provisions in Franchise and Dealership Agreements W3 The Annotated Franchise Agreement W5 Business Laws and Regulations That Affect Franchise Systems W13 Ethical Issues for Attorneys and Other Professionals in Franchise Counselling W15 Survey of State Dealer Law Topics W20 Fundamentals 201: Stop That Right Now—Preparing for, and Winning, Injunctions W23 Going Green—The Impact of Energy Efficient Schemes and Carbon Reduction Commitments on Franchising
10:30AM–10:45AM Break
10:45AM–12:15pM Business Meeting plenary 2 Annual Franchise and distribution law developments
1:15pM–2:30pM W4 The Impossible Dream: Controlling Your International Franchise System W7 Gift Cards and Loyalty Programs W9 Bet the System Litigation W16 Protecting the Franchise Brand in the Age of Social Media W19 Best Practices for Establishing a Franchise Compliance Program W22 Antitrust Issues–Back in Vogue W24 Fundamentals 201: Starting a Franchise System: Practical Considerations, Planning and Development
2:30pM–2:45pM Break
2:45pM–4:00pM W8 Litigating Unlawful FPR’s and Practical Tips for Doing So W10 Unique and Often Overlooked Provisions of State Franchise Registration and Disclosure Laws W12 Challenges to a Franchise System when a Third Party, e.g., Landlord or Supplier, Files for Bankruptcy W17 Litigating Incurable Defaults W18 The Fundamentals of an M&A Transaction in a Franchise System W21 State Taxation of Franchisors
6:00pM–9:30pM reception/dinner (ticketed) the san diego Zoo
mOre inFOrmaTiOn & regiSTraTiOnplease visit the Forum on Franchising website: www.abanet.org/forums/franchising. For further information on san diego, travel, activities, and entertainment options, visit www.coronadovisitorcenter.com.
