The Role of Motive in Franchise Termination Cases

Should the franchisor's motive in a franchise termination case ever become the central issue? Some courts answer that seeking the true reason for termination is the target inquiry, as if a franchisor could not have a mixed motive for termination. The question turns the trial into a search as to whether the franchisor has breached an implied covenant of good faith and fair dealing which augments the terms of a written franchise agreement. Often the outcome depends on where in the life of the franchise relationship the dispute arises. At the end of the relationship, courts considering the propriety of termination and nonrenewal often treat the role of good faith and fair dealing differently than when, for example, reviewing whether the franchisor imposed unreasonable standards of performance.

In the recent series of cases, Dunkin' Donuts, Inc. v. Liu, Bus. Franchise Guide (CCH) ' '  12,392, 12,393 (ED Pa., 2000-2002), the franchisee was unsuccessful in asserting that the franchisor had an improper motive in terminating the franchises. Dunkin' as franchisor had filed a complaint alleging termination was warranted based on its franchisees' failure to obey all laws, particularly by committing willful tax offenses and/or by knowingly making false statements on tax returns and credit statements. Franchisees claimed they relied on the erroneous advice of their accountants and that Dunkin' had an improper motive for terminating the franchise. Based upon a Magistrate's Report and Recommendation, the District Court denied Dunkin's motion for summary judgment on its claims, finding that franchisees may not have knowingly violated the “obey all laws” clauses. The District Court granted Dunkin's motion for summary judgment dismissing the franchisees' counterclaims for breach of contract and fraud because the evidence did not support the counterclaims that the franchisees failed to receive the contractually mandated operations manual and training.

In later dispositions of Dunkin' Donuts, Inc. v. Liu reported at Bus. Franchise Guide (CCH) ' ' 12,394, 12,395, based again on the Report and Recommendation of the Magistrate, the District Court granted summary judgment in favor of Dunkin' on its termination based on failure of the franchise to timely pay the sublease and franchise agreement, and an injunction was granted to prevent post-termination use of trademarks. The court rejected the unclean hands defense of the franchisees, especially since they were given the opportunity to sell their franchise and refused. The court held that the right of a franchisor to terminate was independent of any claims the franchisee might have against the franchisor, including any improper motive. The court also determined that the franchisees failed to establish that Dunkin' had an improper motive. The case is currently on appeal to the Third Circuit Court of Appeals.

Recent cases have adopted and applied many different “rules of law” in dismissing good faith and fair dealing claims. Some of those rules are that the implied covenant of good faith and fair dealing “cannot override express terms” of a contract between the parties; the covenant cannot “modify” terms of a contract; courts cannot “make a new contract” through application of the covenant; and that there cannot be a contract breach and a good faith and fair dealing violation based on the same conduct.

For example, the court in King of Prussia Equipment Corp. v. Power Curbers, Inc., 158 F. Supp. 2d 463 (E.D. Pa. 2001), held in a distribution case that causes of action for breach of an express contract provision and breach of the implied covenant could not coexist where each involved the same facts. In this dealership case, the dealer alleged an oral agreement with the manufacturer to serve as a dealer indefinitely. The court rejected the claim for breach of the covenant of good faith and fair dealing, holding that under Pennsylvania law a party may not claim both breach of contract and breach of the implied covenant where the basis of the claims is essentially the same. Because the plaintiff had alleged breach of an express contractual provision, it was precluded from asserting that the contract was not terminable at will because of the implied covenant.

Similarly, in Lee v. General Nutrition Companies, Inc., Bus. Franch. Guide (CCH) Para. 12,411 (C.D. Cal. 2002), franchisees of two GNC outlets claimed that GNC acted in bad faith by placing competitive locations geographically proximate to the plaintiffs' locations, further cannibalized plaintiffs' business through Internet sales, and sold products at lower prices to a national retail chain than to the plaintiffs. The court dismissed the claims on the basis that the franchise agreement gave GNC a license to engage in the precise conduct which plaintiff's claimed was actionable, suggesting again that an implied covenant will not be interpreted so as to eradicate the express language of the franchise agreement.

While a predominance of recent decisions have been decided in the franchisor's favor and against a finding of breach of the good faith covenant, franchisees have had some success in other jurisdictions. For example, in Alban Wilson, et al. v. Amerada Hess Corp. et al., Bus. Franchise Guide (CCH) Para. 12,115 (N.J. Law Div. 2001) three independent franchise dealers of Hess gasoline alleged that Hess violated the good faith covenant regarding the setting of gasoline charges, notwithstanding a provision in the contract giving Hess unilateral authority to set dealer tank wagon prices. Essentially, plaintiff contended that Hess set prices in bad faith with the intent to ruin the plaintiff and ultimately acquire its business. The trial court granted Hess summary judgment and the Appellate Division affirmed. The N.J. Supreme Court, after citing and discussing Emerson Radio Corporation v. Orion Sales, Inc., 80 F.Supp. 2d 307 (D.N.J. 2000), concluded that the proper test for determining whether the good faith covenant has been breached is whether “that party exercises its discretionary authority arbitrarily, unreasonably, or capriciously, with the objective of preventing the other party from receiving its reasonably expected fruits under the contract.”

In interpreting this standard further under the Seventh Circuit's case law, the court determined that in order for the plaintiff to properly assert a claim for breach of the good faith covenant, the party alleging the breach must allege that the party exercising discretion acted with an improper motive. The court noted that “without bad motive or intention, discretionary decisions that happen to result in economic disadvantage to the other party are of no legal significance.” Further, the court quoted the U.S. Court of Appeals for the Seventh Circuit, stating that “contract law does not require parties to behave altruistically toward each other; it does not proceed on the philosophy that I am my brother's keeper.” (quoting Original Great American Chocolate Chip Cookie Co. v. River Valley Cookies, Ltd. 970 F.2d 273, 280 (7th Cir. 1992) (holding that franchisee repeatedly violated franchise agreement and failed to present evidence that franchisor engaged in opportunistic behavior in terminating franchise).

In Cherick Distributors, Inc. v. Polar Corp., Bus. Franch. Guide (CCH) Para. 10,997 (Mass. App. 1996), the court had the opportunity to review a jury verdict that held that a supplier breached an at will, unwritten distributorship agreement by giving the distributor only 4 days notice. Under Massachusetts law, a contract terminable at will requires “reasonable notice.” In order to aid the jury in its deliberation of reasonableness, evidence was introduced that the plaintiff had urged other distributors to form an association to negotiate with the supplier, and the first meeting of this association was to occur on the evening of the effective date of the termination. The court upheld the jury verdict, concluding that “the jury could have found that the abrupt termination of Cherick's distributorship agreement, coinciding as it did with the planned meeting of Polar distributors, was calculated to put Cherick out of business and thereby discourage other distributors from the meeting.”

As the Cherick case demonstrates, the franchisor's motive may be essential to determine whether a proper termination has occurred, but perhaps only in the most difficult cases. Termination cases are generally controlled by the express language of the contract. The cases suggest that once the franchisor establishes grounds under the franchise agreement to terminate the relationship, the burden then should shift to the franchisee to prove that the franchisee is without blame and the franchisor is responsible for the franchisee's default. As long as one good reason for terminating the franchise exists which cannot be legitimately blamed on the franchisor, then the motive of the franchisor in terminating the franchise may well be irrelevant and may simplify trying franchise termination cases.

Should the franchisor's motive in a franchise termination case ever become the central issue? Some courts answer that seeking the true reason for termination is the target inquiry, as if a franchisor could not have a mixed motive for termination. The question turns the trial into a search as to whether the franchisor has breached an implied covenant of good faith and fair dealing which augments the terms of a written franchise agreement. Often the outcome depends on where in the life of the franchise relationship the dispute arises. At the end of the relationship, courts considering the propriety of termination and nonrenewal often treat the role of good faith and fair dealing differently than when, for example, reviewing whether the franchisor imposed unreasonable standards of performance.

In the recent series of cases, Dunkin' Donuts, Inc. v. Liu, Bus. Franchise Guide (CCH) ' '  12,392, 12,393 (ED Pa., 2000-2002), the franchisee was unsuccessful in asserting that the franchisor had an improper motive in terminating the franchises. Dunkin' as franchisor had filed a complaint alleging termination was warranted based on its franchisees' failure to obey all laws, particularly by committing willful tax offenses and/or by knowingly making false statements on tax returns and credit statements. Franchisees claimed they relied on the erroneous advice of their accountants and that Dunkin' had an improper motive for terminating the franchise. Based upon a Magistrate's Report and Recommendation, the District Court denied Dunkin's motion for summary judgment on its claims, finding that franchisees may not have knowingly violated the “obey all laws” clauses. The District Court granted Dunkin's motion for summary judgment dismissing the franchisees' counterclaims for breach of contract and fraud because the evidence did not support the counterclaims that the franchisees failed to receive the contractually mandated operations manual and training.

In later dispositions of Dunkin' Donuts, Inc. v. Liu reported at Bus. Franchise Guide (CCH) ' ' 12,394, 12,395, based again on the Report and Recommendation of the Magistrate, the District Court granted summary judgment in favor of Dunkin' on its termination based on failure of the franchise to timely pay the sublease and franchise agreement, and an injunction was granted to prevent post-termination use of trademarks. The court rejected the unclean hands defense of the franchisees, especially since they were given the opportunity to sell their franchise and refused. The court held that the right of a franchisor to terminate was independent of any claims the franchisee might have against the franchisor, including any improper motive. The court also determined that the franchisees failed to establish that Dunkin' had an improper motive. The case is currently on appeal to the Third Circuit Court of Appeals.

Recent cases have adopted and applied many different “rules of law” in dismissing good faith and fair dealing claims. Some of those rules are that the implied covenant of good faith and fair dealing “cannot override express terms” of a contract between the parties; the covenant cannot “modify” terms of a contract; courts cannot “make a new contract” through application of the covenant; and that there cannot be a contract breach and a good faith and fair dealing violation based on the same conduct.

For example, the court in King of Prussia Equipment Corp. v. Power Curbers, Inc ., 158 F. Supp. 2d 463 (E.D. Pa. 2001), held in a distribution case that causes of action for breach of an express contract provision and breach of the implied covenant could not coexist where each involved the same facts. In this dealership case, the dealer alleged an oral agreement with the manufacturer to serve as a dealer indefinitely. The court rejected the claim for breach of the covenant of good faith and fair dealing, holding that under Pennsylvania law a party may not claim both breach of contract and breach of the implied covenant where the basis of the claims is essentially the same. Because the plaintiff had alleged breach of an express contractual provision, it was precluded from asserting that the contract was not terminable at will because of the implied covenant.

Similarly, in Lee v. General Nutrition Companies, Inc., Bus. Franch. Guide (CCH) Para. 12,411 (C.D. Cal. 2002), franchisees of two GNC outlets claimed that GNC acted in bad faith by placing competitive locations geographically proximate to the plaintiffs' locations, further cannibalized plaintiffs' business through Internet sales, and sold products at lower prices to a national retail chain than to the plaintiffs. The court dismissed the claims on the basis that the franchise agreement gave GNC a license to engage in the precise conduct which plaintiff's claimed was actionable, suggesting again that an implied covenant will not be interpreted so as to eradicate the express language of the franchise agreement.

While a predominance of recent decisions have been decided in the franchisor's favor and against a finding of breach of the good faith covenant, franchisees have had some success in other jurisdictions. For example, in Alban Wilson, et al. v. Amerada Hess Corp. et al., Bus. Franchise Guide (CCH) Para. 12,115 (N.J. Law Div. 2001) three independent franchise dealers of Hess gasoline alleged that Hess violated the good faith covenant regarding the setting of gasoline charges, notwithstanding a provision in the contract giving Hess unilateral authority to set dealer tank wagon prices. Essentially, plaintiff contended that Hess set prices in bad faith with the intent to ruin the plaintiff and ultimately acquire its business. The trial court granted Hess summary judgment and the Appellate Division affirmed. The N.J. Supreme Court, after citing and discussing Emerson Radio Corporation v. Orion Sales, Inc., 80 F.Supp. 2d 307 (D.N.J. 2000), concluded that the proper test for determining whether the good faith covenant has been breached is whether “that party exercises its discretionary authority arbitrarily, unreasonably, or capriciously, with the objective of preventing the other party from receiving its reasonably expected fruits under the contract.”

In interpreting this standard further under the Seventh Circuit's case law, the court determined that in order for the plaintiff to properly assert a claim for breach of the good faith covenant, the party alleging the breach must allege that the party exercising discretion acted with an improper motive. The court noted that “without bad motive or intention, discretionary decisions that happen to result in economic disadvantage to the other party are of no legal significance.” Further, the court quoted the U.S. Court of Appeals for the Seventh Circuit, stating that “contract law does not require parties to behave altruistically toward each other; it does not proceed on the philosophy that I am my brother's keeper.” (quoting Original Great American Chocolate Chip Cookie Co. v. River Valley Cookies, Ltd. 970 F.2d 273, 280 (7th Cir. 1992) (holding that franchisee repeatedly violated franchise agreement and failed to present evidence that franchisor engaged in opportunistic behavior in terminating franchise).

In Cherick Distributors, Inc. v. Polar Corp., Bus. Franch. Guide (CCH) Para. 10,997 (Mass. App. 1996), the court had the opportunity to review a jury verdict that held that a supplier breached an at will, unwritten distributorship agreement by giving the distributor only 4 days notice. Under Massachusetts law, a contract terminable at will requires “reasonable notice.” In order to aid the jury in its deliberation of reasonableness, evidence was introduced that the plaintiff had urged other distributors to form an association to negotiate with the supplier, and the first meeting of this association was to occur on the evening of the effective date of the termination. The court upheld the jury verdict, concluding that “the jury could have found that the abrupt termination of Cherick's distributorship agreement, coinciding as it did with the planned meeting of Polar distributors, was calculated to put Cherick out of business and thereby discourage other distributors from the meeting.”

As the Cherick case demonstrates, the franchisor's motive may be essential to determine whether a proper termination has occurred, but perhaps only in the most difficult cases. Termination cases are generally controlled by the express language of the contract. The cases suggest that once the franchisor establishes grounds under the franchise agreement to terminate the relationship, the burden then should shift to the franchisee to prove that the franchisee is without blame and the franchisor is responsible for the franchisee's default. As long as one good reason for terminating the franchise exists which cannot be legitimately blamed on the franchisor, then the motive of the franchisor in terminating the franchise may well be irrelevant and may simplify trying franchise termination cases.