Damages from Defaulting Franchisees: More Options Than You Think

The court noted, however, that the profits of the infringer are not intended to be an accurate or complete measure of the plaintiff's damages. The court said that using the infringer's profits as a measure of damages was particularly inadequate when, as is typical in most franchise cases, the defendant and plaintiff do not directly compete. Thus, the court in Hair Associates found that the best measure of the franchisor's actual losses was the franchise fees it lost when the defendant essentially operated a franchise without paying. The court also entered a permanent injunction against future use of the marks.

Trade Dress

A franchisor can also protect its trade dress. Trade dress is 'the total image of a product, and may include features such as size, shape, color or color combinations, texture, graphics, or even particular sales techniques.' John H. Harland Co. v. Clarke Checks, Inc., 711 F.2d 966, 980 (11th Cir. 1983). In the case of a restaurant, trade dress can include the shape and general appearance of the exterior, the identifying sign, the interior floor plan, the appointments and d'cor items, the equipment used to serve the food, and the servers' uniforms. To be capable of protection, the trade dress must be nonfunctional and have acquired a secondary meaning. If the former franchisee's use of the trade dress causes a likelihood of confusion, then the franchisor can recover damages similar to those allowed for trademarks. See The Warehouse Restaurant, Inc. v. The Customs House Restaurant, Inc., 217 U.S.P.Q. 411, 418 (N.D. Cal. 1982), appeal dismissed, 726 F.2d 480 (9th Cir. 1984).

The concept of nonfunctionality is key; a franchisor cannot protect its mere method and style of doing business. Bonanza International, Inc. v. Double 'B', 331 F. Supp. 694, 695-97 (D. Minn. 1971). In the case of a restaurant, any element of its trade dress that 'advances the concept [or theme] cannot be protected because those elements are related to the consumer demand for the concept.' Prufrock LTD., Inc. v. Lasater, 781 F.2d 129, 134 (8th Cir. 1986).

Copyright Infringement

A franchisor often will have a copyright on its written materials. Unauthorized use of such materials can give rise to federal or state copyright claims. On federal claims, the Copyright Act, 17 U.S.C. ' 504, provides that the franchisor can recover actual damages caused by the infringement, as well as any profits of the infringer that are attributable to the infringement and not taken into account in computing the actual damages. If the court cannot determine lost profits or statutory damages, or determines they are insufficient to compensate for the infringement, then the court must award statutory damages. The actual damages are measured by the diminution in market value of the copyright. See, e.g., Frank Music Corp. v. Metro-Goldwyn-Mayer, Inc., 772 F.2d 505 (9th Cir. 1985).

The problem in copyright infringement sometimes lies in determining the measure of the diminution in market value. Two cases outside of the franchise area best illustrate the difficulty in this determination.

In Frank Music, the defendant staged approximately 1700 performances of a tribute to Hollywood. Included in the show was approximately 6 minutes of music taken from plaintiff's play. The court found infringement, but awarded very little damages for diminution of market value.

By contrast, in Cream Records, Inc. v. Jos. Schlitz Brewing Company, 754 F.2d 826 (9th Cir. 1985), the defendant used in an advertisement ten notes from a popular theme. The court was convinced by plaintiff's evidence that once a musical composition is used in an advertisement, it has no further market value to other advertisers. The court awarded the entire market value of a license to use the theme in an advertisement.

Market Value

That leads us into the most interesting recent case regarding a franchisor's recoverable damages. In Flying J, Inc. v. Central CA Kenworth, et al., 45 Fed.Appx. 763, 2002 WL 2022061 (9th Cir. (Cal.), the defendants were alleged to have wrongfully acquired the plaintiff's copyrighted architectural plans. The defendant allegedly used those plans to build a truck stop. Flying J sued for infringement, and the trial court awarded both lost franchise fees, as a measure of the diminution in market value, and the defendant's profits. The court later struck the award of profits, to avoid a double recovery.

The defendant's first challenge on appeal was that use of the lost franchise fees to determine damages was too speculative to stand. The court, focusing on the same market value theories discussed above, said that market value meant what a willing buyer would have been reasonably required to pay a willing seller for the plans. Flying J argued that the plans were only available by becoming a franchisee. The court agreed. It appears from the opinion that the court would have accepted testimony that a franchisee would receive more benefits than just the plans, but since the defendant did not value the various elements of a franchise, the court did not allow such testimony at trial. Moreover, since there had been no evidence offered that there was any other way to get the plans, the court awarded the entire franchise fee, including both the up-front cost and a per-gallon charge, that would have been payable through the time of trial. The defendant next argued that since damages did have to be measured by market value, the franchise fee inappropriate because they were really a measure of value of the use of the plans. The court again disagreed, finding that the value of the plans was not based on the value of their use, but the cost of acquisition, and that the latter was clearly market value. Lastly, the defendant argued that there was no causal connection between the alleged infringement and the franchise fees. Three swings; three strikes ' the court found that the facility built by the defendant according to the plans was essentially a Flying J facility, and that Flying J would have received franchise fees if the plans had been lawfully acquired.

Interestingly, Flying J was not able to stop future infringement. The court denied a permanent injunction, just as it had earlier prohibited Flying J from seeking future damages, as a sanction for inadequacies in Flying J's own expert's opinion. Thus, the fees that would have been due through trial were the sole damages recoverable.

One last possibility is third-party liability. When an outsider interferes with the franchise relationship, they can be liable for damages based on a theory of civil conspiracy. In Meineke Discount Muffler v. Wesley Jaynes, 999 F.2d 120 (5th Cir. 1993), a competing business entered into a distribution agreement while the Jayneses were still under contract with Meineke. Due to the short amount of time remaining on the Meineke contract, the court awarded only a modest amount of damages, but it did award them against the third-party as well as the Jayneses.

The sheer variety of legal theories available makes it clear that franchise relationships, both real and prospective, can provide a franchisor with an equal variety of damages.

Jon S. Swierzewski is a member of the Larkin, Hoffman, Daly & Lindgren, Ltd., franchise group in Bloomington, MN, He chairs the firm's business litigation department.

When the relationship between a franchisor and a franchisee breaks down, one might think the standard measure of damages is just the lost franchise fees. However, just as a simple failure to perform is not the only type of wrong suffered by franchisors, unpaid fees are not the only types of damages available. This article examines a number of cases in which the franchisor's claims ' and claimed damages ' were outside the ordinary.

A franchisor invests blood, sweat, and tears ' and usually a lot of money ' in creating, developing, and marketing its business. Portions of that business are expressed in one or more forms of protectable intellectual property, such as patented products, machinery or processes, trademarks or trade names, copyrights, or trade dress. Most times, when a dispute arises between a franchisor and a franchisee, the franchisor has claims under the statutes or case law protecting such intellectual property.

For example, when a franchisee wrongfully uses the franchisor's trademarks, often after the end of the franchise relationship, it can be liable for damages measured in several different ways. In Hair Associates v. National Hair Replacement Services, Inc. et al., 987 F.Supp. 569, (W. D. Mich. 1997), the franchisor asserted such a claim against a terminated franchisee. The court cited the relevant provisions of the Lanham Act, 15 U.S.C. ' 1125(a), that entitle the registrant of a mark to recover: 1) defendant's profits; 2) damages sustained by the plaintiff; and 3) the costs of the action. The court also has discretion to enter judgment for any sum above the amount found as actual damages, not exceeding three times that amount. The court wrestled with alternative methods of computing the defendant's profits, but ultimately settled on a sum.

The court noted, however, that the profits of the infringer are not intended to be an accurate or complete measure of the plaintiff's damages. The court said that using the infringer's profits as a measure of damages was particularly inadequate when, as is typical in most franchise cases, the defendant and plaintiff do not directly compete. Thus, the court in Hair Associates found that the best measure of the franchisor's actual losses was the franchise fees it lost when the defendant essentially operated a franchise without paying. The court also entered a permanent injunction against future use of the marks.

Trade Dress

A franchisor can also protect its trade dress. Trade dress is 'the total image of a product, and may include features such as size, shape, color or color combinations, texture, graphics, or even particular sales techniques.' John H. Harland Co. v. Clarke Checks, Inc. , 711 F.2d 966, 980 (11th Cir. 1983). In the case of a restaurant, trade dress can include the shape and general appearance of the exterior, the identifying sign, the interior floor plan, the appointments and d'cor items, the equipment used to serve the food, and the servers' uniforms. To be capable of protection, the trade dress must be nonfunctional and have acquired a secondary meaning. If the former franchisee's use of the trade dress causes a likelihood of confusion, then the franchisor can recover damages similar to those allowed for trademarks. See The Warehouse Restaurant, Inc. v. The Customs House Restaurant, Inc., 217 U.S.P.Q. 411, 418 (N.D. Cal. 1982), appeal dismissed, 726 F.2d 480 (9th Cir. 1984).

The concept of nonfunctionality is key; a franchisor cannot protect its mere method and style of doing business. Bonanza International, Inc. v. Double 'B', 331 F. Supp. 694, 695-97 (D. Minn. 1971). In the case of a restaurant, any element of its trade dress that 'advances the concept [or theme] cannot be protected because those elements are related to the consumer demand for the concept.' Prufrock LTD., Inc. v. Lasater , 781 F.2d 129, 134 (8th Cir. 1986).

Copyright Infringement

A franchisor often will have a copyright on its written materials. Unauthorized use of such materials can give rise to federal or state copyright claims. On federal claims, the Copyright Act, 17 U.S.C. ' 504, provides that the franchisor can recover actual damages caused by the infringement, as well as any profits of the infringer that are attributable to the infringement and not taken into account in computing the actual damages. If the court cannot determine lost profits or statutory damages, or determines they are insufficient to compensate for the infringement, then the court must award statutory damages. The actual damages are measured by the diminution in market value of the copyright. See, e.g., Frank Music Corp. v. Metro-Goldwyn-Mayer, Inc., 772 F.2d 505 (9th Cir. 1985).

The problem in copyright infringement sometimes lies in determining the measure of the diminution in market value. Two cases outside of the franchise area best illustrate the difficulty in this determination.

In Frank Music, the defendant staged approximately 1700 performances of a tribute to Hollywood. Included in the show was approximately 6 minutes of music taken from plaintiff's play. The court found infringement, but awarded very little damages for diminution of market value.

By contrast, in Cream Records, Inc. v. Jos. Schlitz Brewing Company , 754 F.2d 826 (9th Cir. 1985), the defendant used in an advertisement ten notes from a popular theme. The court was convinced by plaintiff's evidence that once a musical composition is used in an advertisement, it has no further market value to other advertisers. The court awarded the entire market value of a license to use the theme in an advertisement.

Market Value

That leads us into the most interesting recent case regarding a franchisor's recoverable damages. In Flying J, Inc. v. Central CA Kenworth, et al., 45 Fed.Appx. 763, 2002 WL 2022061 (9th Cir. (Cal.), the defendants were alleged to have wrongfully acquired the plaintiff's copyrighted architectural plans. The defendant allegedly used those plans to build a truck stop. Flying J sued for infringement, and the trial court awarded both lost franchise fees, as a measure of the diminution in market value, and the defendant's profits. The court later struck the award of profits, to avoid a double recovery.

The defendant's first challenge on appeal was that use of the lost franchise fees to determine damages was too speculative to stand. The court, focusing on the same market value theories discussed above, said that market value meant what a willing buyer would have been reasonably required to pay a willing seller for the plans. Flying J argued that the plans were only available by becoming a franchisee. The court agreed. It appears from the opinion that the court would have accepted testimony that a franchisee would receive more benefits than just the plans, but since the defendant did not value the various elements of a franchise, the court did not allow such testimony at trial. Moreover, since there had been no evidence offered that there was any other way to get the plans, the court awarded the entire franchise fee, including both the up-front cost and a per-gallon charge, that would have been payable through the time of trial. The defendant next argued that since damages did have to be measured by market value, the franchise fee inappropriate because they were really a measure of value of the use of the plans. The court again disagreed, finding that the value of the plans was not based on the value of their use, but the cost of acquisition, and that the latter was clearly market value. Lastly, the defendant argued that there was no causal connection between the alleged infringement and the franchise fees. Three swings; three strikes ' the court found that the facility built by the defendant according to the plans was essentially a Flying J facility, and that Flying J would have received franchise fees if the plans had been lawfully acquired.

Interestingly, Flying J was not able to stop future infringement. The court denied a permanent injunction, just as it had earlier prohibited Flying J from seeking future damages, as a sanction for inadequacies in Flying J's own expert's opinion. Thus, the fees that would have been due through trial were the sole damages recoverable.

One last possibility is third-party liability. When an outsider interferes with the franchise relationship, they can be liable for damages based on a theory of civil conspiracy. In Meineke Discount Muffler v. Wesley Jaynes , 999 F.2d 120 (5th Cir. 1993), a competing business entered into a distribution agreement while the Jayneses were still under contract with Meineke. Due to the short amount of time remaining on the Meineke contract, the court awarded only a modest amount of damages, but it did award them against the third-party as well as the Jayneses.

The sheer variety of legal theories available makes it clear that franchise relationships, both real and prospective, can provide a franchisor with an equal variety of damages.

Jon S. Swierzewski is a member of the Larkin, Hoffman, Daly & Lindgren, Ltd., franchise group in Bloomington, MN, He chairs the firm's business litigation department.