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Franchising: Once You Start, Can You Stop?

By Eric H. Karp
September 16, 2003

If a company ceases to expand its brand and market penetration through the sale of franchises as part of a plan to convert to an employee-based operation, is it exposed to liability for breach of the implied covenant of good faith and fair dealing? The answer is yes, according to one California appellate court. In Sherman v. Master Protection Corp., 2002 WL 31854905 (Cal. App. 6 Dist. Dec. 18, 2002)(rev. den. April 9, 2003) [Business Franchise Guide (CCH) '12,503], a non-published decision, a unanimous three-judge panel of the California Court of Appeal for the Sixth District recently awarded damages and legal fees to a franchisee on that very basis.

In Sherman, the defendant, Master Protection Corporation (MPC), used the brand name 'FireMaster' to market and service fire protection equipment. The plaintiff, Michael Sherman, purchased franchises from MPC in 1987 and 1991 for the sums of $40,000 and $60,000, respectively. He paid nothing down; the purchase price for each franchise was set by the franchisor and based on the gross sales for the previous year; the entire price was paid for by promissory notes of Sherman to MPC.

Each franchise agreement recited that Sherman had the right to sell or assign it rights under the agreement subject to a right of first refusal in favor of MPC, and if not exercised, to a buyer approved by MPC. The franchisee was required to meet annual increasing sales targets. Because the purchase price of MPC franchises was tied to sales, their value thus increased as sales rose. When Sherman purchased his franchises, 100 percent of the sales of FireMaster were through MPC franchises.

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