Court Watch

Franchisor Did Not Breach Contract and Franchisees Had Duty to Pay Fees

The U.S. District Court for the Western District of Kentucky has ruled that restaurant franchisor KFC Corporation did not breach its franchise agreement with franchisees as claimed, and that the franchisees were liable for their unpaid royalties and advertising fees. KFC Corporation v. Robert H. Mott, __ F.Supp.2d __, 2003 WL 22709071 (W.D.Ky. 2003).

In an action against a number of its franchisees, KFC moved for partial judgment on the pleadings. KFC sought judgment on its claims of: 1) breach of franchise and advertising agreements by two of the franchisees; 2) breach of a promissory note by another franchisee; and 3) breach of personal guarantee agreements by Robert and Phyllis Sherita Mott, the owners of the franchisee entities. KFC contended that the defendants admitted liability with respect to these claims and admitted that KFC suffered damages in the approximate amount claimed by KFC.

The franchisees admitted that they did not pay the royalties or advertising fees. However, they claimed that they were not liable for the claimed amounts due to certain breaches of contract allegedly committed by KFC. The court rejected all the franchisees' claims.

First, they claimed that KFC breached a prior agreement by inducing them to purchase or open 18 additional stores. The opinion does not explain how such an action, even if true, could have constituted a breach of contract. But an explanation was unnecessary because the court summarily rejected the notion that a claimed breach of a previous contract could affect the present contracts.

Second, the defendants contended that they “were held to standards, requirements, and instructions and procedures in excess of those enforced by KFC and its affiliates for the nearest other franchisees or KFC owned and operated outlets.” The court noted that their brief did not explain this contention, nor did their counterclaim allege that the imposition of any such standards or requirements occurred prior to the defendants' default. The court thus considered this a merely conclusory statement, and ruled that neither the statement nor the facts alleged evidenced a material issue of fact as to whether KFC committed a material breach of contract before the defendants ceased paying their fees.

Third, the defendants argued that “impossibility of performance” caused by the acts or omissions of KFC excused their nonperformance under the agreements. The defendants alleged that they offered to close the stores that were losing money, but they were instructed by KFC to apply for reinstatement and continue to operate. They contended that this scenario made it impossible for them to perform, and thus KFC was responsible for the losses.

The court held that this was “simply not a case of impossibility of performance.” It observed that under Kentucky law, “[t]he general rule is that a party to a contract will not be relieved of the obligations undertaken by him merely because supervening events have rendered the contract unprofitable.” (Kentucky law applied under the governing law clause of the franchise agreements.) The court concluded that the counterclaim set out claims for breach of contract and breach of the covenant of good faith and fair dealing which, as framed, did not suggest a genuine issue of material fact to preclude judgment in favor of KFC on its contract claims.

Having rejected the Motts' argument that their performance under their franchise agreements was excused, the court also concluded that no genuine issue of material fact existed as to the Motts' personal liability under the guarantees of the franchise agreements.

However, the court refused to grant KFC's claim for judgment on the pleadings on its contract damages. The court agreed with KFC that the defendants admitted to failing to pay the approximated royalties and advertising fees in KFC's complaint, and also agreed that the precise amount of damages need not be proven to state a claim for breach of contract. But the court did not agree that KFC was entitled to judgment in these amounts because KFC acknowledged that they were nothing more than estimates of the royalties and fees due. Based on the principle that “KFC is entitled to no more and no less than the sums due under the contract,” the court concluded that the pleadings did not entitle KFC as a matter of law to damages of the amounts claimed.

There was no reference in the opinion to a basic legal principle that KFC could have raised: A party to a contract that has been breached by the other party must choose whether to continue enjoying the benefits of the contract and performing its obligations under it (such as paying royalties), and sue for the breach, or to terminate the contract, stop performing its obligations and sue for breach. Thus even if KFC had breached the franchise agreement, this would not entitle the franchisees to stop paying royalties and other fees while continuing to operate under the KFC marks and system. If they wanted to remain KFC franchisees, they should have kept paying their royalties and fees and sued KFC for its alleged breach. Otherwise, they should have terminated the franchise agreement, shut their doors and sued KFC for damages. The franchisees in this case seem to have been trying to have their cake and eat it too, in a manner that the law does not typically allow.

Motorola Distributor Was Not a Franchisee Under State Franchise Law

The Wisconsin Court of Appeals has affirmed a trial court's decision to grant summary judgment in favor of a telecommunications manufacturer and against its distributor, dismissing all claims for wrongful termination of the relationship and violation of the Wisconsin Fair Dealership Act (WFDA), because the parties' relationship was not a franchise as defined under the WFDA. Satellite Communications Company v. Motorola, Inc., 2004 WL 57390 (Wis. App. 2004).

In 1989, Satellite Communications Company (“Satellite”) entered into an agreement with Motorola whereby it agreed to sell certain Motorola products. The relationship continued until 2002 when Motorola terminated its agreement with Satellite because Satellite failed to meet its sales quota even after it was given 60 days to cure the breach.

Following its termination, Satellite brought an action under the WFDA, asserting that Motorola could not terminate its agreement without “good cause.” Motorola moved for summary judgment on the grounds that Satellite was not a dealer within the meaning of the WFDA. Therefore, according to Motorola, it could not be liable under the WFDA because it did not govern its relationship with Satellite.

The circuit court granted summary judgment finding that the relationship between Motorola and Satellite was not of a dealer-grantor. Satellite filed an appeal in which it claimed that that the circuit court erred when it determined that Satellite was not a dealer within the meaning of the WFDA and consequently, improperly granted summary judgment against it.

The appellate court observed that in order to have a dealership under the WFDA, there must be a community of interest between the two parties. A community of interest means a continuing financial interest between the parties in either the operation of the dealership or the marketing of such goods and services. The court noted that there are two factors courts consider when determining whether there is a community of interest: 1) a continuing financial interest – that is, a shared financial interest in the operation of the dealership, and 2) interdependence, which is the degree to which the dealer and grantor cooperate, coordinate their activities, and share common goals in their business relationship.

Applying the test set forth above, the court concluded that the relationship between Satellite and Motorola was not a franchise under the WFDA. According to the appellate court, the record demonstrated that Satellite did not receive the largest source of its income from selling the Motorola products. In fact, observed the court, Satellite's main source of income was from leasing space on antenna towers and from repair and service work unrelated to its agreement with Motorola. Additionally, Satellite was not required to pay Motorola a franchise fee or make expenditures for facilities, equipment, or training that would have been lost as a result of the termination of the agreement. Thus, the appellate court concluded that Satellite failed to establish that it had a “continuing financial interest” as required by the WFDA.

In addition, the appellate court also concluded that Satellite could not establish the second prong of the “community of interest” test ' the interdependence prong. The court observed that Satellite was unable to establish any of the following traditional elements of interdependence: 1) it did not have an exclusive dealership; 2) there was no agreement requiring it to use its best efforts to sell the grantor's products; 3) the parties were not required to cooperate in setting sales targets; 4) the grantee was not required to pay start-up, or other services for the grantor's products; 5) the grantee was not required to maintain a parts inventory; 6) there was no agreement requiring the grantee to provide a certain amount of personnel to sell or service the grantor's products; 7) the grantee was not required to provide reports to the grantor; 8) the grantee was not required to have periodic reviews of its performance by the grantor; and 9) the grantee did not make extensive use of the grantor's trademarks and logos.

As a result, the appellate court affirmed the trial court's decision granting summary judgment in favor of Motorola and dismissed all claims for wrongful termination and violation of the WFDA.

Franchisor Not Liable for Fraud or Breach of Contract When Contractual Obligations Are Unambiguous

The U.S. Court of Appeals for the Third Circuit has affirmed a district court's decision granting summary judgment and dismissing a franchisee's claim against its franchisor for breach of contract and fraud. Associated/ACC International, LTD v. DuPont Flooring Systems Franchise Company, Inc., 2004 WL 75381 (3d Cir. 2004).

In 1998, Associated/ACC International, LTD (“Associated”) entered into a franchise agreement with Dupont Flooring Systems Franchise Company, Inc., (“DuPont”). One of the exhibits to the franchise agreement, titled “Special Stipulations,” provided that the parties would share business leads in their particular market segments. Specifically, DuPont agreed that it would “encourage” all of its company-owned locations to inform Associated of potential leads that they uncovered in Associated's marketing segments.

In November 1999, the relationship between Associated and DuPont deteriorated, and Associated filed claims against DuPont alleging breach of contract by failing to adequately “encourage” DuPont-owned stores to share leads with Associated and fraudulent and/or negligent misrepresentations during and prior to the contract negotiations regarding DuPont's obligation to provide leads to Associated. Associated also asserted claims against DuPont's affiliates that operated the company-owned stores for alleged tortious interference.

In its motion for summary judgment, DuPont submitted evidence that it did encourage DuPont-owned operations to share leads with Associated. In response, Associated asserted that the fact that it received no viable leads from the company-owned locations was proof that DuPont breached its contractual obligation. In addition, Associated claimed that representatives of DuPont falsely and fraudulently misrepresented the meaning of the term “encourage” by promising that Associated would actually receive leads from company-owned locations.

The trial court granted summary judgment in favor of DuPont. It held that the term “encourage” was unambiguous. According to the court, the contract did not require DuPont to do anything more than it had done. Because DuPont presented conclusive evidence that it made an effort to “encourage” its managers in its company-owned locations to share leads with Associated, it had satisfied its contractual obligations. Moreover, with respect to the fraud claim, the court opined that even if DuPont's employees did fraudulently misrepresent the meaning of “encourage,” any reliance on the fraudulent misrepresentation was unreasonable because the term was unambiguous and not susceptible to a different interpretation.

On appeal, the appellate court adopted the trial court's decision and reasoning. Accordingly, the decision dismissing all claims against the franchisor was affirmed.

Franchisor Did Not Breach Contract and Franchisees Had Duty to Pay Fees

The U.S. District Court for the Western District of Kentucky has ruled that restaurant franchisor KFC Corporation did not breach its franchise agreement with franchisees as claimed, and that the franchisees were liable for their unpaid royalties and advertising fees. KFC Corporation v. Robert H. Mott, __ F.Supp.2d __, 2003 WL 22709071 (W.D.Ky. 2003).

In an action against a number of its franchisees, KFC moved for partial judgment on the pleadings. KFC sought judgment on its claims of: 1) breach of franchise and advertising agreements by two of the franchisees; 2) breach of a promissory note by another franchisee; and 3) breach of personal guarantee agreements by Robert and Phyllis Sherita Mott, the owners of the franchisee entities. KFC contended that the defendants admitted liability with respect to these claims and admitted that KFC suffered damages in the approximate amount claimed by KFC.

The franchisees admitted that they did not pay the royalties or advertising fees. However, they claimed that they were not liable for the claimed amounts due to certain breaches of contract allegedly committed by KFC. The court rejected all the franchisees' claims.

First, they claimed that KFC breached a prior agreement by inducing them to purchase or open 18 additional stores. The opinion does not explain how such an action, even if true, could have constituted a breach of contract. But an explanation was unnecessary because the court summarily rejected the notion that a claimed breach of a previous contract could affect the present contracts.

Second, the defendants contended that they “were held to standards, requirements, and instructions and procedures in excess of those enforced by KFC and its affiliates for the nearest other franchisees or KFC owned and operated outlets.” The court noted that their brief did not explain this contention, nor did their counterclaim allege that the imposition of any such standards or requirements occurred prior to the defendants' default. The court thus considered this a merely conclusory statement, and ruled that neither the statement nor the facts alleged evidenced a material issue of fact as to whether KFC committed a material breach of contract before the defendants ceased paying their fees.

Third, the defendants argued that “impossibility of performance” caused by the acts or omissions of KFC excused their nonperformance under the agreements. The defendants alleged that they offered to close the stores that were losing money, but they were instructed by KFC to apply for reinstatement and continue to operate. They contended that this scenario made it impossible for them to perform, and thus KFC was responsible for the losses.

The court held that this was “simply not a case of impossibility of performance.” It observed that under Kentucky law, “[t]he general rule is that a party to a contract will not be relieved of the obligations undertaken by him merely because supervening events have rendered the contract unprofitable.” (Kentucky law applied under the governing law clause of the franchise agreements.) The court concluded that the counterclaim set out claims for breach of contract and breach of the covenant of good faith and fair dealing which, as framed, did not suggest a genuine issue of material fact to preclude judgment in favor of KFC on its contract claims.

Having rejected the Motts' argument that their performance under their franchise agreements was excused, the court also concluded that no genuine issue of material fact existed as to the Motts' personal liability under the guarantees of the franchise agreements.

However, the court refused to grant KFC's claim for judgment on the pleadings on its contract damages. The court agreed with KFC that the defendants admitted to failing to pay the approximated royalties and advertising fees in KFC's complaint, and also agreed that the precise amount of damages need not be proven to state a claim for breach of contract. But the court did not agree that KFC was entitled to judgment in these amounts because KFC acknowledged that they were nothing more than estimates of the royalties and fees due. Based on the principle that “KFC is entitled to no more and no less than the sums due under the contract,” the court concluded that the pleadings did not entitle KFC as a matter of law to damages of the amounts claimed.

There was no reference in the opinion to a basic legal principle that KFC could have raised: A party to a contract that has been breached by the other party must choose whether to continue enjoying the benefits of the contract and performing its obligations under it (such as paying royalties), and sue for the breach, or to terminate the contract, stop performing its obligations and sue for breach. Thus even if KFC had breached the franchise agreement, this would not entitle the franchisees to stop paying royalties and other fees while continuing to operate under the KFC marks and system. If they wanted to remain KFC franchisees, they should have kept paying their royalties and fees and sued KFC for its alleged breach. Otherwise, they should have terminated the franchise agreement, shut their doors and sued KFC for damages. The franchisees in this case seem to have been trying to have their cake and eat it too, in a manner that the law does not typically allow.

Motorola Distributor Was Not a Franchisee Under State Franchise Law

The Wisconsin Court of Appeals has affirmed a trial court's decision to grant summary judgment in favor of a telecommunications manufacturer and against its distributor, dismissing all claims for wrongful termination of the relationship and violation of the Wisconsin Fair Dealership Act (WFDA), because the parties' relationship was not a franchise as defined under the WFDA. Satellite Communications Company v. Motorola, Inc., 2004 WL 57390 (Wis. App. 2004).

In 1989, Satellite Communications Company (“Satellite”) entered into an agreement with Motorola whereby it agreed to sell certain Motorola products. The relationship continued until 2002 when Motorola terminated its agreement with Satellite because Satellite failed to meet its sales quota even after it was given 60 days to cure the breach.

Following its termination, Satellite brought an action under the WFDA, asserting that Motorola could not terminate its agreement without “good cause.” Motorola moved for summary judgment on the grounds that Satellite was not a dealer within the meaning of the WFDA. Therefore, according to Motorola, it could not be liable under the WFDA because it did not govern its relationship with Satellite.

The circuit court granted summary judgment finding that the relationship between Motorola and Satellite was not of a dealer-grantor. Satellite filed an appeal in which it claimed that that the circuit court erred when it determined that Satellite was not a dealer within the meaning of the WFDA and consequently, improperly granted summary judgment against it.

The appellate court observed that in order to have a dealership under the WFDA, there must be a community of interest between the two parties. A community of interest means a continuing financial interest between the parties in either the operation of the dealership or the marketing of such goods and services. The court noted that there are two factors courts consider when determining whether there is a community of interest: 1) a continuing financial interest – that is, a shared financial interest in the operation of the dealership, and 2) interdependence, which is the degree to which the dealer and grantor cooperate, coordinate their activities, and share common goals in their business relationship.

Applying the test set forth above, the court concluded that the relationship between Satellite and Motorola was not a franchise under the WFDA. According to the appellate court, the record demonstrated that Satellite did not receive the largest source of its income from selling the Motorola products. In fact, observed the court, Satellite's main source of income was from leasing space on antenna towers and from repair and service work unrelated to its agreement with Motorola. Additionally, Satellite was not required to pay Motorola a franchise fee or make expenditures for facilities, equipment, or training that would have been lost as a result of the termination of the agreement. Thus, the appellate court concluded that Satellite failed to establish that it had a “continuing financial interest” as required by the WFDA.

In addition, the appellate court also concluded that Satellite could not establish the second prong of the “community of interest” test ' the interdependence prong. The court observed that Satellite was unable to establish any of the following traditional elements of interdependence: 1) it did not have an exclusive dealership; 2) there was no agreement requiring it to use its best efforts to sell the grantor's products; 3) the parties were not required to cooperate in setting sales targets; 4) the grantee was not required to pay start-up, or other services for the grantor's products; 5) the grantee was not required to maintain a parts inventory; 6) there was no agreement requiring the grantee to provide a certain amount of personnel to sell or service the grantor's products; 7) the grantee was not required to provide reports to the grantor; 8) the grantee was not required to have periodic reviews of its performance by the grantor; and 9) the grantee did not make extensive use of the grantor's trademarks and logos.

As a result, the appellate court affirmed the trial court's decision granting summary judgment in favor of Motorola and dismissed all claims for wrongful termination and violation of the WFDA.

Franchisor Not Liable for Fraud or Breach of Contract When Contractual Obligations Are Unambiguous

The U.S. Court of Appeals for the Third Circuit has affirmed a district court's decision granting summary judgment and dismissing a franchisee's claim against its franchisor for breach of contract and fraud. Associated/ACC International, LTD v. DuPont Flooring Systems Franchise Company, Inc., 2004 WL 75381 (3d Cir. 2004).

In 1998, Associated/ACC International, LTD (“Associated”) entered into a franchise agreement with Dupont Flooring Systems Franchise Company, Inc., (“DuPont”). One of the exhibits to the franchise agreement, titled “Special Stipulations,” provided that the parties would share business leads in their particular market segments. Specifically, DuPont agreed that it would “encourage” all of its company-owned locations to inform Associated of potential leads that they uncovered in Associated's marketing segments.

In November 1999, the relationship between Associated and DuPont deteriorated, and Associated filed claims against DuPont alleging breach of contract by failing to adequately “encourage” DuPont-owned stores to share leads with Associated and fraudulent and/or negligent misrepresentations during and prior to the contract negotiations regarding DuPont's obligation to provide leads to Associated. Associated also asserted claims against DuPont's affiliates that operated the company-owned stores for alleged tortious interference.

In its motion for summary judgment, DuPont submitted evidence that it did encourage DuPont-owned operations to share leads with Associated. In response, Associated asserted that the fact that it received no viable leads from the company-owned locations was proof that DuPont breached its contractual obligation. In addition, Associated claimed that representatives of DuPont falsely and fraudulently misrepresented the meaning of the term “encourage” by promising that Associated would actually receive leads from company-owned locations.

The trial court granted summary judgment in favor of DuPont. It held that the term “encourage” was unambiguous. According to the court, the contract did not require DuPont to do anything more than it had done. Because DuPont presented conclusive evidence that it made an effort to “encourage” its managers in its company-owned locations to share leads with Associated, it had satisfied its contractual obligations. Moreover, with respect to the fraud claim, the court opined that even if DuPont's employees did fraudulently misrepresent the meaning of “encourage,” any reliance on the fraudulent misrepresentation was unreasonable because the term was unambiguous and not susceptible to a different interpretation.

On appeal, the appellate court adopted the trial court's decision and reasoning. Accordingly, the decision dismissing all claims against the franchisor was affirmed.