Court Watch

Franchisee's Owners Have Standing to Sue Under New Jersey Franchise Practices Act

The U.S. District Court for the Eastern District of Pennsylvania has ruled that the shareholders of a franchisee have standing to sue a franchisor under the New Jersey Franchise Practices Act (NJFPA), but that the franchisor's denial of approval of the transfer of the franchise to a third party was not a violation of the NJFPA. Crawford v. SAP America, Inc., et al., __ F.Supp.2d __, 2004 WL 764393 (E.D.Pa. 2004).

Titan Technologies Group, LLC (Titan), a limited liability company owned by the plaintiffs, was the assignee of the rights to a “Provider Agreement” with SAP America, Inc. (SAP), which granted Titan the right to act as the exclusive sales agent for SAP computer software in New Jersey. By all accounts, Titan was extremely successful in marketing SAP's program. Approximately 1 year after entering into the initial Provider Agreement, Titan advised SAP that it intended to transfer its rights under the Agreement to Modis, a third party unrelated to Titan. SAP did not approve of the transfer. It informed Titan that it would not renew the franchise if it proceeded with the proposed sale. A few months later, Titan sold its business to another party ' Condor ' presumably on less favorable economic terms.

Following the transfer of the business to Condor, the owners of Titan brought suit against the franchisor, asserting a number of claims, including negligent misrepresentation, breach of contract, and violation of the NJFPA. SAP moved for summary judgment on all counts.

The court ruled that since the individual plaintiffs were not parties to the franchise agreement, they had no standing to sue SAP for breach of contract or fraudulent or negligent misrepresentation. However, the court was willing to entertain their claims under the NJFPA and for tortious interference based on SAP's refusal to approve Titan's transfer to Modis. The court ruled that as members in the franchisee entity, they had standing to pursue claims that their individual rights were infringed by a refusal to permit a transfer in violation of the NJFPA.

Even though the plaintiffs had standing to pursue their NJFPA claims, however, the court ruled that the NJFPA does not preclude a franchisor from objecting to a sale of the entire interest in the franchise, but merely precludes such interference if the proposed sale is to “employees, personnel of the franchisee, or spouse, child or heir of an owner.”

The court observed that while the NJFPA severely restricts a franchisor's freedom of action vis-'-vis the transfer of a franchise to “insiders,” it still permits the franchisor to have some voice in choosing the person or entities with whom it wishes to deal. The court therefore found no violation of the NJFPA.

The court also found that the plaintiffs could not prevail on their claim for tortious interference for the same reasons. According to the court, SAP's denial of approval of the transfer was not tortious, but merely a legitimate attempt to protect its own valid interests.

Arbitration Clause Enforced by Appeals Court

The U.S. Court of Appeals for the Fourth Circuit has ruled against a terminated Quality Inn franchisee that appealed a district court ruling, refusing to vacate an arbitration award against it and in favor of Choice Hotels. The court rejected the argument that the arbitration agreement was a contract of adhesion. Choice Hotels International, Inc. v. Chewl's Hospitality, Inc., not published in F.3d., 2003 W 22961190, CCH Bus. Fran. Guide Par. 12,721 (4th Cir. 2003).

The franchisee argued that the arbitration clause was unconscionable and that the arbitration agreement was a contract of adhesion. Under Maryland law, which applied under the franchise agreement, a contract of adhesion is one that is “drafted unilaterally by the dominant party and then presented on a take-it-or-leave-it basis to the weaker party who has no real opportunity to bargain about its terms,” the court noted. The district court had found that the franchisee was an experienced hotel franchise owner who decided to contract with Choice Hotels and change its affiliation from the Holiday Inn mark because it believed that the Quality Inn mark would increase profitability. Further, the court noted, the evidence showed that there were some negotiations before the agreement was finalized. The court concluded that the district court correctly ruled that the arbitration provision in the agreement was valid and enforceable.

The franchisee also argued that the arbitration award should be set aside on the grounds that the choice of Maryland law under the franchise agreement and the arbitration provision was invalid. In rejecting the franchisee's argument, the court ruled that Maryland had a substantial relationship to the parties because Choice Hotels was headquartered there and the parties agreed to conduct arbitration there. Moreover, the court ruled, application of Maryland contract law to the arbitration agreement would not be contrary to any fundamental policy of Virginia.

In addition, the franchisee argued that the arbitration award in favor of Choice Hotels should be set aside on the grounds that a liquidated damages clause in the franchise agreement was an unenforceable penalty. Under Maryland law, the court held, a liquidated damages clause is enforceable and not a penalty if it is a reasonable estimate of just compensation at the time the agreement was made. The court ruled that precise damages could not be determined at the time of contracting because there was no way to measure the royalties that Choice Hotels would receive from the franchisee. The court also found that the liquidated damages clause provided a reasonable method for calculating just compensation, taking into account the profits earned in the months before the termination and the time remaining before the franchisee would be able to terminate the franchise on its own.

In addition, the franchisee argued that Choice Hotels could not recover both liquidated damages and damages for trademark infringement. The court rejected this argument on the grounds that liquidated damages were a remedy for the termination due to the franchisee's default, while the damages for trademark infringement were compensation for the franchisee's continued use of the Quality Inn mark after termination.

Car Rental Agents Deemed Not to Be Franchisees

U.S. District Courts sitting in California and Washington issued similar opinions on the same day in cases brought by car rental agents against Avis under the California and Washington franchise registration/disclosure laws, respectively. Jon K. Morrison, Inc., et al. v. Avis Rent-A-Car Systems, Inc., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12.701 (W.D.Wa. 2003) and Adees Corp. v. Avis-Rent-A-Car System, Inc., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12.702 (C.D.Cal. 2003).

The Morrison opinion interpreted the definition of a franchise fee under the Washington Franchise Investment Protection Act (WFIPA). According to the Morrison court, Avis car rental agents remit the money they receive from customers to Avis, which then pays the agents a commission, less a “fleet surcharge.” The court ruled that neither the revenue Avis retained out of customers' payments to the agent nor the fleet surcharge constituted “franchise fees” under WFIPA, and therefore granted summary judgment to Avis against the agent's claims that Avis had violated WFIPA by terminating or refusing to renew the franchise without compensation.

The Morrison court first rejected the agent's argument that it paid a franchise fee in the form of the revenues retained by Avis as without merit, noting that this interpretation would convert every commissioned sales person into a franchise even though “none of the concerns WFIPA was intended to address” were involved. The court also held that the fleet surcharge did not constitute a franchise fee because the fleet surcharge was not an amount “paid to” Avis in order to continue to do business. In reaching this decision, the court observed that while the primary purpose of WFIPA is to protect agents from losing money invested in the franchise, the record showed that the plaintiff made no capital investment in Avis. The court concluded that plaintiff was not a “franchisee” entitled to the protections of the WFIPA.

The Adees court reached a similar conclusion in a case brought by an Avis car rental agent in California under the California Franchise Relations Act (CFRA). Like the court in Morrison, the court in Adees ruled that the fleet surcharge was not a franchise fee. The court observed that Avis paid for the fleet and had costs associated with this investment far in excess of the reimbursement represented by the fleet surcharge. Analyzing the surcharge, the court found that the agent received something of value ' the availability of Avis' fleet of cars ' in exchange for the payment; that the surcharge was an ordinary business expense for the agent, rather than an unrecoverable investment; and that the agent placed none of its own money at risk in the payment of the fleet surcharge to Avis. Unlike a royalty fee, the court held, the fleet surcharge was not imposed for the right to do business under the Avis name, but in return for Avis providing the agent with a fleet of vehicles to give it the ability to conduct the rental business.

The plaintiff in Adees also argued that a refueling charge imposed by Avis constituted a royalty and hence a franchise fee because it received nothing extra of value for this charge, and the plaintiff, not Avis, actually purchased the gasoline. The court held, however, that the refueling charge was “part and parcel of the rental transaction.” The fact that the agent purchased the gas did not, the court ruled, change the business reality that the car rental and the gas sale could not occur without Avis' assets. Therefore, the court concluded, the fact that Avis took a percentage of both did not transform a valid commission structure into a hidden franchise fee in the form of a royalty.

Franchisor Not Entitled to Lost Future Royalties

The U.S. District Court for the Western District of Michigan has refused to grant lost future royalties to a restaurant franchisor that terminated a franchise because of the franchisee's failure to pay royalties. Kissinger, Inc. v. Jaspal Singh, 304 F.Supp.2d 944 (W.D.Mich. 2003).

The franchisor terminated Singh's Baguette de France Restaurant franchise because, among other things, he allegedly failed to pay royalties. The franchisor sued Singh and moved for summary judgment, claiming past due royalties, future royalties, attorneys' fees, and expenses.

The court granted the motion as to the past due royalties, but refused to award the franchisor future royalties for the duration of the term of the franchise agreement. The court could find no Michigan case on the subject, but followed the well-known California appellate court opinion in Postal Instant Press, Inc. v. Sealy, 43 Cal. App. 4th 1701, 51 Cal. Rptr. 2d 365 (1996). The court in Sealy ruled that a franchisee's failure to make past royalty payments was not a “natural and direct” cause of the franchisor's failure to receive future royalty payments. It reasoned that the franchisor could have remained entitled to the future royalties for the full term of the franchise contract even if it sued to collect the past payments. According to the court's reasoning, it was the franchisor's own decision to terminate the franchise agreement that deprived it of its entitlement to those future royalty payments.

The court agreed with the Sealy court's analysis that when a franchisor terminates a franchise agreement based upon the franchisee's failure to make royalty payments, the franchisor's decision to terminate the franchise agreement is the proximate cause of the franchisor's lost future royalty payments, and the franchisor is therefore not entitled to collect future royalties as damages.

Franchisee's Owners Have Standing to Sue Under New Jersey Franchise Practices Act

The U.S. District Court for the Eastern District of Pennsylvania has ruled that the shareholders of a franchisee have standing to sue a franchisor under the New Jersey Franchise Practices Act (NJFPA), but that the franchisor's denial of approval of the transfer of the franchise to a third party was not a violation of the NJFPA. Crawford v. SAP America, Inc., et al., __ F.Supp.2d __, 2004 WL 764393 (E.D.Pa. 2004).

Titan Technologies Group, LLC (Titan), a limited liability company owned by the plaintiffs, was the assignee of the rights to a “Provider Agreement” with SAP America, Inc. (SAP), which granted Titan the right to act as the exclusive sales agent for SAP computer software in New Jersey. By all accounts, Titan was extremely successful in marketing SAP's program. Approximately 1 year after entering into the initial Provider Agreement, Titan advised SAP that it intended to transfer its rights under the Agreement to Modis, a third party unrelated to Titan. SAP did not approve of the transfer. It informed Titan that it would not renew the franchise if it proceeded with the proposed sale. A few months later, Titan sold its business to another party ' Condor ' presumably on less favorable economic terms.

Following the transfer of the business to Condor, the owners of Titan brought suit against the franchisor, asserting a number of claims, including negligent misrepresentation, breach of contract, and violation of the NJFPA. SAP moved for summary judgment on all counts.

The court ruled that since the individual plaintiffs were not parties to the franchise agreement, they had no standing to sue SAP for breach of contract or fraudulent or negligent misrepresentation. However, the court was willing to entertain their claims under the NJFPA and for tortious interference based on SAP's refusal to approve Titan's transfer to Modis. The court ruled that as members in the franchisee entity, they had standing to pursue claims that their individual rights were infringed by a refusal to permit a transfer in violation of the NJFPA.

Even though the plaintiffs had standing to pursue their NJFPA claims, however, the court ruled that the NJFPA does not preclude a franchisor from objecting to a sale of the entire interest in the franchise, but merely precludes such interference if the proposed sale is to “employees, personnel of the franchisee, or spouse, child or heir of an owner.”

The court observed that while the NJFPA severely restricts a franchisor's freedom of action vis-'-vis the transfer of a franchise to “insiders,” it still permits the franchisor to have some voice in choosing the person or entities with whom it wishes to deal. The court therefore found no violation of the NJFPA.

The court also found that the plaintiffs could not prevail on their claim for tortious interference for the same reasons. According to the court, SAP's denial of approval of the transfer was not tortious, but merely a legitimate attempt to protect its own valid interests.

Arbitration Clause Enforced by Appeals Court

The U.S. Court of Appeals for the Fourth Circuit has ruled against a terminated Quality Inn franchisee that appealed a district court ruling, refusing to vacate an arbitration award against it and in favor of Choice Hotels. The court rejected the argument that the arbitration agreement was a contract of adhesion. Choice Hotels International, Inc. v. Chewl's Hospitality, Inc., not published in F.3d., 2003 W 22961190, CCH Bus. Fran. Guide Par. 12,721 (4th Cir. 2003).

The franchisee argued that the arbitration clause was unconscionable and that the arbitration agreement was a contract of adhesion. Under Maryland law, which applied under the franchise agreement, a contract of adhesion is one that is “drafted unilaterally by the dominant party and then presented on a take-it-or-leave-it basis to the weaker party who has no real opportunity to bargain about its terms,” the court noted. The district court had found that the franchisee was an experienced hotel franchise owner who decided to contract with Choice Hotels and change its affiliation from the Holiday Inn mark because it believed that the Quality Inn mark would increase profitability. Further, the court noted, the evidence showed that there were some negotiations before the agreement was finalized. The court concluded that the district court correctly ruled that the arbitration provision in the agreement was valid and enforceable.

The franchisee also argued that the arbitration award should be set aside on the grounds that the choice of Maryland law under the franchise agreement and the arbitration provision was invalid. In rejecting the franchisee's argument, the court ruled that Maryland had a substantial relationship to the parties because Choice Hotels was headquartered there and the parties agreed to conduct arbitration there. Moreover, the court ruled, application of Maryland contract law to the arbitration agreement would not be contrary to any fundamental policy of Virginia.

In addition, the franchisee argued that the arbitration award in favor of Choice Hotels should be set aside on the grounds that a liquidated damages clause in the franchise agreement was an unenforceable penalty. Under Maryland law, the court held, a liquidated damages clause is enforceable and not a penalty if it is a reasonable estimate of just compensation at the time the agreement was made. The court ruled that precise damages could not be determined at the time of contracting because there was no way to measure the royalties that Choice Hotels would receive from the franchisee. The court also found that the liquidated damages clause provided a reasonable method for calculating just compensation, taking into account the profits earned in the months before the termination and the time remaining before the franchisee would be able to terminate the franchise on its own.

In addition, the franchisee argued that Choice Hotels could not recover both liquidated damages and damages for trademark infringement. The court rejected this argument on the grounds that liquidated damages were a remedy for the termination due to the franchisee's default, while the damages for trademark infringement were compensation for the franchisee's continued use of the Quality Inn mark after termination.

Car Rental Agents Deemed Not to Be Franchisees

U.S. District Courts sitting in California and Washington issued similar opinions on the same day in cases brought by car rental agents against Avis under the California and Washington franchise registration/disclosure laws, respectively. Jon K. Morrison, Inc., et al. v. Avis Rent-A-Car Systems, Inc., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12.701 (W.D.Wa. 2003) and Adees Corp. v. Avis-Rent-A-Car System, Inc., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12.702 (C.D.Cal. 2003).

The Morrison opinion interpreted the definition of a franchise fee under the Washington Franchise Investment Protection Act (WFIPA). According to the Morrison court, Avis car rental agents remit the money they receive from customers to Avis, which then pays the agents a commission, less a “fleet surcharge.” The court ruled that neither the revenue Avis retained out of customers' payments to the agent nor the fleet surcharge constituted “franchise fees” under WFIPA, and therefore granted summary judgment to Avis against the agent's claims that Avis had violated WFIPA by terminating or refusing to renew the franchise without compensation.

The Morrison court first rejected the agent's argument that it paid a franchise fee in the form of the revenues retained by Avis as without merit, noting that this interpretation would convert every commissioned sales person into a franchise even though “none of the concerns WFIPA was intended to address” were involved. The court also held that the fleet surcharge did not constitute a franchise fee because the fleet surcharge was not an amount “paid to” Avis in order to continue to do business. In reaching this decision, the court observed that while the primary purpose of WFIPA is to protect agents from losing money invested in the franchise, the record showed that the plaintiff made no capital investment in Avis. The court concluded that plaintiff was not a “franchisee” entitled to the protections of the WFIPA.

The Adees court reached a similar conclusion in a case brought by an Avis car rental agent in California under the California Franchise Relations Act (CFRA). Like the court in Morrison, the court in Adees ruled that the fleet surcharge was not a franchise fee. The court observed that Avis paid for the fleet and had costs associated with this investment far in excess of the reimbursement represented by the fleet surcharge. Analyzing the surcharge, the court found that the agent received something of value ' the availability of Avis' fleet of cars ' in exchange for the payment; that the surcharge was an ordinary business expense for the agent, rather than an unrecoverable investment; and that the agent placed none of its own money at risk in the payment of the fleet surcharge to Avis. Unlike a royalty fee, the court held, the fleet surcharge was not imposed for the right to do business under the Avis name, but in return for Avis providing the agent with a fleet of vehicles to give it the ability to conduct the rental business.

The plaintiff in Adees also argued that a refueling charge imposed by Avis constituted a royalty and hence a franchise fee because it received nothing extra of value for this charge, and the plaintiff, not Avis, actually purchased the gasoline. The court held, however, that the refueling charge was “part and parcel of the rental transaction.” The fact that the agent purchased the gas did not, the court ruled, change the business reality that the car rental and the gas sale could not occur without Avis' assets. Therefore, the court concluded, the fact that Avis took a percentage of both did not transform a valid commission structure into a hidden franchise fee in the form of a royalty.

Franchisor Not Entitled to Lost Future Royalties

The U.S. District Court for the Western District of Michigan has refused to grant lost future royalties to a restaurant franchisor that terminated a franchise because of the franchisee's failure to pay royalties. Kissinger, Inc. v. Jaspal Singh , 304 F.Supp.2d 944 (W.D.Mich. 2003).

The franchisor terminated Singh's Baguette de France Restaurant franchise because, among other things, he allegedly failed to pay royalties. The franchisor sued Singh and moved for summary judgment, claiming past due royalties, future royalties, attorneys' fees, and expenses.

The court granted the motion as to the past due royalties, but refused to award the franchisor future royalties for the duration of the term of the franchise agreement. The court could find no Michigan case on the subject, but followed the well-known California appellate court opinion in Postal Instant Press, Inc. v. Sealy , 43 Cal. App. 4th 1701, 51 Cal. Rptr. 2d 365 (1996). The court in Sealy ruled that a franchisee's failure to make past royalty payments was not a “natural and direct” cause of the franchisor's failure to receive future royalty payments. It reasoned that the franchisor could have remained entitled to the future royalties for the full term of the franchise contract even if it sued to collect the past payments. According to the court's reasoning, it was the franchisor's own decision to terminate the franchise agreement that deprived it of its entitlement to those future royalty payments.

The court agreed with the Sealy court's analysis that when a franchisor terminates a franchise agreement based upon the franchisee's failure to make royalty payments, the franchisor's decision to terminate the franchise agreement is the proximate cause of the franchisor's lost future royalty payments, and the franchisor is therefore not entitled to collect future royalties as damages.