Franchise Litigation: 10 Cases That Changed the Landscape in the Past Decade

Part One of a Two-Part Series

1) Armstrong Business Services, Inc., et al., Appellants v. H & R Block, et al., Bus. Franchise Guide (CCH) '12,485, 96 S.W.3d 867 (Mo. App. 2002).

The Armstrong case involved H&R Block franchisees who sued their franchisor for, among other things, encroaching upon the franchisees' territories through the franchisor's Internet business. H&R Block then filed a counterclaim, alleging that all of the franchisees' franchise agreements were terminable at will by Block.

To prove its claim, Block had to overcome two large obstacles: 1) the franchise agreements had unlimited 5-year renewal periods and said that they were terminable only if both sides agreed to terminate; and 2) many of the franchisees had statutory protections against termination.

Despite this uphill battle, the franchisor prevailed. The Missouri Court of Appeals found that Missouri disfavored contractual provisions granting perpetual rights and that under Missouri precedent, contracts with unlimited perpetual renewals were deemed terminable at will by either party at the end of any 5-year term.

The court also concluded that the franchisee-protection statutes of Illinois, Iowa, Michigan, Oregon, Virginia, and Washington did not apply because the parties' franchise agreements chose Missouri law. Since Missouri courts considered a Missouri choice of law as proper in such a situation, that choice-of-law provision trumped the statutory protections, and the franchisees could make no claims under their home-state statutes.

While it is easy to dismiss Armstrong as a Missouri intermediate court ruling, its choice-of-law analysis is based upon the Restatement (Second) of Conflicts of Law and may be very persuasive authority to other courts. In addition, the fact that a court may find a franchise agreement to mean, as a matter of law, something altogether different than what it says makes the case very interesting from a drafter's standpoint, as well as a litigator's point of view.

2) Bolter v. Superior Court, Bus. Franchise Guide (CCH) '12,035, 104 Cal.Rptr.2d 888 (Cal. Ct. App. 2001).

The petitioner franchisees, including Florence Bolter, were franchisees of respondent Harris Research (“Harris”). In the early 1980s, all three petitioners entered into franchise agreements with Harris to purchase “Chem-Dry” carpet cleaning businesses in Orange County, CA. Ultimately the California Court of Appeals was asked to determine whether the arbitration clauses found in the franchisees' renewal agreements were enforceable. The court was faced with the franchisees' petitioners' claim that the mandatory arbitration provision in the agreement entered into between the petitioners and Harris was unconscionable, as it required arbitration in Utah rather than California.

The Court of Appeals, in a very unusual ruling, determined that the arbitration clause was not enforceable as written. The majority explained that the rule governing unconscionability had two elements: procedural and substantive. The court found procedural unconscionability, which exists when the parties maintain unequal bargaining power, to be present within Harris' franchise agreements. Because Harris made no effort to dispute the fact that most of the petitioners were “one man operated franchises” of limited financial means contracting with a “large wealthy international franchiser,” the court found that the franchise agreements were contracts of adhesion between parties of unequal bargaining power. Also of great significance was the revelation that the franchisees were told that they must agree to Harris' terms to continue existing operations. Unlike traditionally valid contract terms offered to new parties to an agreement with the option to “take it or leave it,” small-business owners with existing operations had less freedom to reject the terms of the renewal agreements and forfeit their franchises.

The court also found substantive unconscionability to exist in the agreements, which traditionally involves contract terms one-sided enough to “shock the conscience.” Specifically, the holding focused on the “place and manner” circumstances of the arbitration agreements. Because arbitration was limited to Salt Lake City, this effectively left franchisees no option but to shut down their operations and incur significant expenses to arbitrate an agreement in another state. Furthermore, the franchise agreements prohibited franchisees from consolidating disputes with other claimants, further adding to the cost of arbitration.

As a result of finding both procedural and substantive unconscionability, the court severed the disputed provisions from the agreements, but kept the remaining elements of the agreement intact. Therefore, the franchisees were still bound to submit to arbitration, only in a more convenient forum, California.

Like Armstrong, Bolter is an example of a court not enforcing a contract term as written. The issue of whether renewal agreements are more “unconscionable” than initial franchise agreements has always been a matter of dispute within the franchise bar. Franchisee attorneys argue that while a new franchisee may choose to walk away from a franchise opportunity with no penalty, the same is not true of a franchisee who must sign a renewal agreement or lose his business. While this argument has found little other support in reported cases, Bolter certainly comes down squarely in favor of the “contract of adhesion” argument.

3) Camp Creek Hospitality Inns, Inc. v. Sheraton Franchise Corp., Bus. Franchise Guide (CCH) '11, 393, 139 F. 3d 1396 (11th Cir. 1998).

Camp Creek Hospitality Inns, Inc. (“Camp Creek”) was a franchisee of the Sheraton hotel chain. Ultimately, Camp Creek sued its franchisor for, among other things, opening a company-owned location near the franchisee's hotel, both of which were near the Atlanta airport.

At the time that the franchisee sued, it was becoming generally accepted by most franchise attorneys that it was futile to argue that encroachment on a franchisee's nonexclusive territory constituted a breach of an implied covenant of good faith and fair dealing. However, the Eleventh Circuit revived the doctrine, at least where there was no express reservation of rights by the franchisor to encroach upon the franchisee.

The court held that in applying the covenant of good faith and fair dealing to cases of encroachment, the implied covenant will not defeat any express contract language about competing franchises, but when there is no specific language permitting franchisor encroachment, the franchisor may not capitalize upon the franchisee's business in bad faith. Because in this case there was no express contractual language regarding competition by the franchisor with a company-owned hotel, the court held that there was sufficient evidence from which a reasonable person could differ over whether Sheraton's conduct violated the duty of good faith and fair dealing, given all of the facts and circumstances of this case.

The Court of Appeals noted that the original License Agreement had contained a reservation of rights allowing the franchisor to compete, but that the document that was ultimately signed did not. This silence ultimately provided the legal footing for the franchisee's claim. The Court of Appeals took this as evidence that the franchisee had never agreed to allow encroachment by the franchisor.

The lesson of Camp Creek is twofold. First, never assume that a legal doctrine is dead and buried. Second, silence does not always favor the franchisor. If the franchisee can establish that there is a reason for contractual silence regarding encroachment, the franchisee may have some legal rights under the covenant of good faith and fair dealing.

4) Emporium Drug Mart, Inc. v. Drug Emporium, Inc., summary reported at Bus. Franchise Guide (CCH) '11,966 (AAA Sept. 2, 2000).

Texas franchisees of drugstores brought arbitration demands against their franchisor Drug Emporium, Inc. when the franchisor began an online subsidiary that sold its products to customers located within the franchisee's territories. The franchise agreements gave franchisees the exclusive right to operate drugstores in designated territories using the franchisor's trade name and marks. The franchisor argued that the exclusivity provision only applied to “brick and mortar” franchises and did not extend to “virtual” drugstores.

The franchisor certified this subsidiary as a “drugstore” in SEC filings. The virtual stores used the same trade name and marks and advertised themselves as providing everything that the actual drugstores provided.

The franchisees claimed that the use of the franchisor's name and trademarks on the Web site and the marketing practices used created a likelihood of consumer confusion. The franchisees also submitted evidence that the franchisor attempted to build its market share at their expense by offering special sales at prices much lower than those available at the franchisee's stores.

The panel concluded that the Internet sales did violate the exclusivity provisions of the franchise agreements, and rejected a distinction between “virtual” stores and “brick and mortar” stores after examining marketing practices and public filings by the franchisor. The panel also found that the franchisees had a reasonable expectation that they would not be forced to compete with direct drugstore sales by the franchisor or its subsidiary; and also found that the franchisees demonstrated likelihood of consumer confusion.

The panel awarded a preliminary injunction that prohibited Internet sales to customers located in the franchisees' territories and also required that the franchisor and its subsidiary place a clear notice on the Web site stating that the subsidiary is unable to process orders to the identified territories, and, instead, must direct those customers to the nearest franchised outlet.

Drug Emporium made a huge splash on the national legal scene. In 2000, it was widely assumed that brick-and-mortar stores were a thing of the past and that the Internet was the wave of the shopping future. The lesson of Drug Emporium is that there will always be new technologies and unexpected developments over the course of a franchise agreement. Courts and arbitrators may not be willing to provide the franchisor with legal rights that are not explicitly reserved in the franchise agreement.

5) Meineke v. Broussard, Bus. Franchise Guide (CCH) '11,459, 155 F.3d 331 (4th Cir. 1998).

Meineke is a case so big that it involved an enormous variety of substantive legal concepts (fraud, breach of contract, breach of fiduciary duty, state unfair trade practices claims, the interaction of punitive damages with statutory damages) and procedural issues (class action issues such as commonality and typicality, the enforceability of releases).

While perhaps an unfair summary, Meineke can be regarded as a case in which muffler franchisees sued their franchisor and every affiliate of their franchisor for mismanagement of the franchisees' advertising fund. After a trial, the franchisees were awarded approximately $590 million. The franchisor, of course, appealed.

The Court of Appeals overturned the district court's class certification and determined that the court's decision to certify the class fell “well short” of the requirement under Rule 23(a) of the Federal Rules of Civil Procedure that a class exhibit numerosity, commonality, typicality, and adequacy of representation. As a result of this improper classification, the Court of Appeals reversed the previous ruling for the plaintiffs.

In addition to ruling that the class had been improperly certified, the Court of Appeals ruled that a breach of fiduciary duty claim should not have been allowed because North Carolina law did not recognize such a relationship between franchisor and franchisee. Furthermore, the Court of Appeals ruled that the district court should not have pierced the corporate veil to allow judgment against Meineke's parent firm GKN. The Court of Appeals found no independent liability on GKN's part. The court basically found that the entirety of the fraud allegations made by the franchisees were just a “mere breach of contract.”

Meineke was a chilling lesson for all franchisors. From the sheer enormity of the damages award, to the finding of individual liability against officers and directors, to the trebling of damages, all franchisors immediately reviewed their advertising fund policies and their contractual language regarding how they would handle the advertising fund. While, ultimately, the franchisees obtained some money in settlement, the lesson for franchisees in the Court of Appeals decision is that it is sometimes best not to overplay your hand, particularly in a conservative jurisdiction. The damages sought by the franchisees were so large that they were almost certain to destroy the franchisor. Faced with a class action that grew to such proportions, the Fourth Circuit was far more likely to strike down the decision and to find fault with the certification of the class.

6) Miller v. McDonald's Corp., Bus. Franchise Guide (CCH) '11,248, 945 P.2d 1107 (Or. Ct. App. 1997).

Joni Miller, the plaintiff, suffered injuries after biting into a sapphire stone that was inside a Big Mac sandwich in a McDonald's restaurant in Tigard, OR. Rather than simply keeping the sapphire and quietly leaving the restaurant, she sued the franchisee 3K Restaurants (“3K”) and the franchisor McDonald's Corporation (“McDonald's”). At issue in the case was whether McDonald's could be held vicariously liable for the acts of 3K. The franchise agreement required 3K to operate in compliance with McDonald's standards or risk loss of the franchise. With regard to food preparation, 3K was required to use “only those methods of food handling and preparation that defendant may designate from time to time.” In addition, McDonald's sent field consultants to inspect franchise operations. However, the franchise agreement stipulated that 3K was not an agent of the defendant for any purpose, but was rather an independent contractor responsible for all liability claims for injury, illness or death caused by operation of the restaurant.

Miller testified that she assumed that the restaurant was under the control of McDonald's corporation. She explained that the restaurant was similar in appearance and operation to other McDonald's restaurants she had frequented. The only visible signs in the establishment read “McDonald's” and the employee uniforms and menu carried the McDonald's name. Therefore, Miller claimed that she had relied on the McDonald's reputation when deciding to frequent the establishment.

After the trial court dismissed the case, the Court of Appeal ruled that the case should have gone to the jury on the theories of actual authority and apparent liability. Regarding actual agency, the rule of vicarious liability required that the defendant have the right to control how 3K fulfilled its obligations under the franchise agreement. The court adopted the Delaware rule of Billops v. Magness, 391 A.2d 196 (Del. 1978), which stated that a franchisor could be liable if the franchise agreement “goes beyond the stage of setting standards, and allocates to the franchisor the right to exercise control over the daily operations of the franchise.” Id. at 197-198. Here, the Court of Appeals stated that the facts suggested that a jury could find that McDonald's might exercise such control because 3K was required to use precise operating methods in handling and preparing food and because McDonald's enforced methods through on-site inspections.

With regard to apparent agency, the court found that the plaintiff could prove that she justifiably relied upon the care and skill of the franchisor's agent. McDonald's claimed that Miller would have to prove that she frequented the restaurant because she believed McDonald's owned and operated it and others she had visited. However, the court refused to require this high burden of proof, and instead determined that it was enough that she relied on the general reputation of McDonald's. Because of the franchisor's efforts to create a public perception of a common McDonald's system, this issue was held to be significantly reasonable for submission to a jury. As a result of finding that actual and apparent agency was not absent as a matter of law, the case was reversed and remanded for trial.

The lesson of Miller is that franchisors should be aware of the common law in the jurisdictions in which they operate. If the law in a jurisdiction is favorable to a finding against the franchisor on an agency claim, the franchisor must require sufficient insurance from its franchisees to protect the franchisor adequately.

Next month's installment of this series will provide the final four cases.

The authors developed this article from a presentation that they made at the 2004 American Bar Association's Forum on Franchising Legal Symposium. To obtain the full presentation, contact ABA.

Part One of a Two-Part Series

1) Armstrong Business Services, Inc., et al., Appellants v. H & R Block, et al., Bus. Franchise Guide (CCH) '12,485, 96 S.W.3d 867 (Mo. App. 2002).

The Armstrong case involved H&R Block franchisees who sued their franchisor for, among other things, encroaching upon the franchisees' territories through the franchisor's Internet business. H&R Block then filed a counterclaim, alleging that all of the franchisees' franchise agreements were terminable at will by Block.

To prove its claim, Block had to overcome two large obstacles: 1) the franchise agreements had unlimited 5-year renewal periods and said that they were terminable only if both sides agreed to terminate; and 2) many of the franchisees had statutory protections against termination.

Despite this uphill battle, the franchisor prevailed. The Missouri Court of Appeals found that Missouri disfavored contractual provisions granting perpetual rights and that under Missouri precedent, contracts with unlimited perpetual renewals were deemed terminable at will by either party at the end of any 5-year term.

The court also concluded that the franchisee-protection statutes of Illinois, Iowa, Michigan, Oregon, Virginia, and Washington did not apply because the parties' franchise agreements chose Missouri law. Since Missouri courts considered a Missouri choice of law as proper in such a situation, that choice-of-law provision trumped the statutory protections, and the franchisees could make no claims under their home-state statutes.

While it is easy to dismiss Armstrong as a Missouri intermediate court ruling, its choice-of-law analysis is based upon the Restatement (Second) of Conflicts of Law and may be very persuasive authority to other courts. In addition, the fact that a court may find a franchise agreement to mean, as a matter of law, something altogether different than what it says makes the case very interesting from a drafter's standpoint, as well as a litigator's point of view.

2) Bolter v. Superior Court, Bus. Franchise Guide (CCH) '12,035, 104 Cal.Rptr.2d 888 (Cal. Ct. App. 2001).

The petitioner franchisees, including Florence Bolter, were franchisees of respondent Harris Research (“Harris”). In the early 1980s, all three petitioners entered into franchise agreements with Harris to purchase “Chem-Dry” carpet cleaning businesses in Orange County, CA. Ultimately the California Court of Appeals was asked to determine whether the arbitration clauses found in the franchisees' renewal agreements were enforceable. The court was faced with the franchisees' petitioners' claim that the mandatory arbitration provision in the agreement entered into between the petitioners and Harris was unconscionable, as it required arbitration in Utah rather than California.

The Court of Appeals, in a very unusual ruling, determined that the arbitration clause was not enforceable as written. The majority explained that the rule governing unconscionability had two elements: procedural and substantive. The court found procedural unconscionability, which exists when the parties maintain unequal bargaining power, to be present within Harris' franchise agreements. Because Harris made no effort to dispute the fact that most of the petitioners were “one man operated franchises” of limited financial means contracting with a “large wealthy international franchiser,” the court found that the franchise agreements were contracts of adhesion between parties of unequal bargaining power. Also of great significance was the revelation that the franchisees were told that they must agree to Harris' terms to continue existing operations. Unlike traditionally valid contract terms offered to new parties to an agreement with the option to “take it or leave it,” small-business owners with existing operations had less freedom to reject the terms of the renewal agreements and forfeit their franchises.

The court also found substantive unconscionability to exist in the agreements, which traditionally involves contract terms one-sided enough to “shock the conscience.” Specifically, the holding focused on the “place and manner” circumstances of the arbitration agreements. Because arbitration was limited to Salt Lake City, this effectively left franchisees no option but to shut down their operations and incur significant expenses to arbitrate an agreement in another state. Furthermore, the franchise agreements prohibited franchisees from consolidating disputes with other claimants, further adding to the cost of arbitration.

As a result of finding both procedural and substantive unconscionability, the court severed the disputed provisions from the agreements, but kept the remaining elements of the agreement intact. Therefore, the franchisees were still bound to submit to arbitration, only in a more convenient forum, California.

Like Armstrong, Bolter is an example of a court not enforcing a contract term as written. The issue of whether renewal agreements are more “unconscionable” than initial franchise agreements has always been a matter of dispute within the franchise bar. Franchisee attorneys argue that while a new franchisee may choose to walk away from a franchise opportunity with no penalty, the same is not true of a franchisee who must sign a renewal agreement or lose his business. While this argument has found little other support in reported cases, Bolter certainly comes down squarely in favor of the “contract of adhesion” argument.

3) Camp Creek Hospitality Inns, Inc. v. Sheraton Franchise Corp., Bus. Franchise Guide (CCH) '11, 393, 139 F. 3d 1396 (11th Cir. 1998).

Camp Creek Hospitality Inns, Inc. (“Camp Creek”) was a franchisee of the Sheraton hotel chain. Ultimately, Camp Creek sued its franchisor for, among other things, opening a company-owned location near the franchisee's hotel, both of which were near the Atlanta airport.

At the time that the franchisee sued, it was becoming generally accepted by most franchise attorneys that it was futile to argue that encroachment on a franchisee's nonexclusive territory constituted a breach of an implied covenant of good faith and fair dealing. However, the Eleventh Circuit revived the doctrine, at least where there was no express reservation of rights by the franchisor to encroach upon the franchisee.

The court held that in applying the covenant of good faith and fair dealing to cases of encroachment, the implied covenant will not defeat any express contract language about competing franchises, but when there is no specific language permitting franchisor encroachment, the franchisor may not capitalize upon the franchisee's business in bad faith. Because in this case there was no express contractual language regarding competition by the franchisor with a company-owned hotel, the court held that there was sufficient evidence from which a reasonable person could differ over whether Sheraton's conduct violated the duty of good faith and fair dealing, given all of the facts and circumstances of this case.

The Court of Appeals noted that the original License Agreement had contained a reservation of rights allowing the franchisor to compete, but that the document that was ultimately signed did not. This silence ultimately provided the legal footing for the franchisee's claim. The Court of Appeals took this as evidence that the franchisee had never agreed to allow encroachment by the franchisor.

The lesson of Camp Creek is twofold. First, never assume that a legal doctrine is dead and buried. Second, silence does not always favor the franchisor. If the franchisee can establish that there is a reason for contractual silence regarding encroachment, the franchisee may have some legal rights under the covenant of good faith and fair dealing.

4) Emporium Drug Mart, Inc. v. Drug Emporium, Inc., summary reported at Bus. Franchise Guide (CCH) '11,966 (AAA Sept. 2, 2000).

Texas franchisees of drugstores brought arbitration demands against their franchisor Drug Emporium, Inc. when the franchisor began an online subsidiary that sold its products to customers located within the franchisee's territories. The franchise agreements gave franchisees the exclusive right to operate drugstores in designated territories using the franchisor's trade name and marks. The franchisor argued that the exclusivity provision only applied to “brick and mortar” franchises and did not extend to “virtual” drugstores.

The franchisor certified this subsidiary as a “drugstore” in SEC filings. The virtual stores used the same trade name and marks and advertised themselves as providing everything that the actual drugstores provided.

The franchisees claimed that the use of the franchisor's name and trademarks on the Web site and the marketing practices used created a likelihood of consumer confusion. The franchisees also submitted evidence that the franchisor attempted to build its market share at their expense by offering special sales at prices much lower than those available at the franchisee's stores.

The panel concluded that the Internet sales did violate the exclusivity provisions of the franchise agreements, and rejected a distinction between “virtual” stores and “brick and mortar” stores after examining marketing practices and public filings by the franchisor. The panel also found that the franchisees had a reasonable expectation that they would not be forced to compete with direct drugstore sales by the franchisor or its subsidiary; and also found that the franchisees demonstrated likelihood of consumer confusion.

The panel awarded a preliminary injunction that prohibited Internet sales to customers located in the franchisees' territories and also required that the franchisor and its subsidiary place a clear notice on the Web site stating that the subsidiary is unable to process orders to the identified territories, and, instead, must direct those customers to the nearest franchised outlet.

Drug Emporium made a huge splash on the national legal scene. In 2000, it was widely assumed that brick-and-mortar stores were a thing of the past and that the Internet was the wave of the shopping future. The lesson of Drug Emporium is that there will always be new technologies and unexpected developments over the course of a franchise agreement. Courts and arbitrators may not be willing to provide the franchisor with legal rights that are not explicitly reserved in the franchise agreement.

5) Meineke v. Broussard, Bus. Franchise Guide (CCH) '11,459, 155 F.3d 331 (4th Cir. 1998).

Meineke is a case so big that it involved an enormous variety of substantive legal concepts (fraud, breach of contract, breach of fiduciary duty, state unfair trade practices claims, the interaction of punitive damages with statutory damages) and procedural issues (class action issues such as commonality and typicality, the enforceability of releases).

While perhaps an unfair summary, Meineke can be regarded as a case in which muffler franchisees sued their franchisor and every affiliate of their franchisor for mismanagement of the franchisees' advertising fund. After a trial, the franchisees were awarded approximately $590 million. The franchisor, of course, appealed.

The Court of Appeals overturned the district court's class certification and determined that the court's decision to certify the class fell “well short” of the requirement under Rule 23(a) of the Federal Rules of Civil Procedure that a class exhibit numerosity, commonality, typicality, and adequacy of representation. As a result of this improper classification, the Court of Appeals reversed the previous ruling for the plaintiffs.

In addition to ruling that the class had been improperly certified, the Court of Appeals ruled that a breach of fiduciary duty claim should not have been allowed because North Carolina law did not recognize such a relationship between franchisor and franchisee. Furthermore, the Court of Appeals ruled that the district court should not have pierced the corporate veil to allow judgment against Meineke's parent firm GKN. The Court of Appeals found no independent liability on GKN's part. The court basically found that the entirety of the fraud allegations made by the franchisees were just a “mere breach of contract.”

Meineke was a chilling lesson for all franchisors. From the sheer enormity of the damages award, to the finding of individual liability against officers and directors, to the trebling of damages, all franchisors immediately reviewed their advertising fund policies and their contractual language regarding how they would handle the advertising fund. While, ultimately, the franchisees obtained some money in settlement, the lesson for franchisees in the Court of Appeals decision is that it is sometimes best not to overplay your hand, particularly in a conservative jurisdiction. The damages sought by the franchisees were so large that they were almost certain to destroy the franchisor. Faced with a class action that grew to such proportions, the Fourth Circuit was far more likely to strike down the decision and to find fault with the certification of the class.

6) Miller v. McDonald's Corp., Bus. Franchise Guide (CCH) '11,248, 945 P.2d 1107 (Or. Ct. App. 1997).

Joni Miller, the plaintiff, suffered injuries after biting into a sapphire stone that was inside a Big Mac sandwich in a McDonald's restaurant in Tigard, OR. Rather than simply keeping the sapphire and quietly leaving the restaurant, she sued the franchisee 3K Restaurants (“3K”) and the franchisor McDonald's Corporation (“McDonald's”). At issue in the case was whether McDonald's could be held vicariously liable for the acts of 3K. The franchise agreement required 3K to operate in compliance with McDonald's standards or risk loss of the franchise. With regard to food preparation, 3K was required to use “only those methods of food handling and preparation that defendant may designate from time to time.” In addition, McDonald's sent field consultants to inspect franchise operations. However, the franchise agreement stipulated that 3K was not an agent of the defendant for any purpose, but was rather an independent contractor responsible for all liability claims for injury, illness or death caused by operation of the restaurant.

Miller testified that she assumed that the restaurant was under the control of McDonald's corporation. She explained that the restaurant was similar in appearance and operation to other McDonald's restaurants she had frequented. The only visible signs in the establishment read “McDonald's” and the employee uniforms and menu carried the McDonald's name. Therefore, Miller claimed that she had relied on the McDonald's reputation when deciding to frequent the establishment.

After the trial court dismissed the case, the Court of Appeal ruled that the case should have gone to the jury on the theories of actual authority and apparent liability. Regarding actual agency, the rule of vicarious liability required that the defendant have the right to control how 3K fulfilled its obligations under the franchise agreement. The court adopted the Delaware rule of Billops v. Magness , 391 A.2d 196 (Del. 1978), which stated that a franchisor could be liable if the franchise agreement “goes beyond the stage of setting standards, and allocates to the franchisor the right to exercise control over the daily operations of the franchise.” Id. at 197-198. Here, the Court of Appeals stated that the facts suggested that a jury could find that McDonald's might exercise such control because 3K was required to use precise operating methods in handling and preparing food and because McDonald's enforced methods through on-site inspections.

With regard to apparent agency, the court found that the plaintiff could prove that she justifiably relied upon the care and skill of the franchisor's agent. McDonald's claimed that Miller would have to prove that she frequented the restaurant because she believed McDonald's owned and operated it and others she had visited. However, the court refused to require this high burden of proof, and instead determined that it was enough that she relied on the general reputation of McDonald's. Because of the franchisor's efforts to create a public perception of a common McDonald's system, this issue was held to be significantly reasonable for submission to a jury. As a result of finding that actual and apparent agency was not absent as a matter of law, the case was reversed and remanded for trial.

The lesson of Miller is that franchisors should be aware of the common law in the jurisdictions in which they operate. If the law in a jurisdiction is favorable to a finding against the franchisor on an agency claim, the franchisor must require sufficient insurance from its franchisees to protect the franchisor adequately.

Next month's installment of this series will provide the final four cases.

The authors developed this article from a presentation that they made at the 2004 American Bar Association's Forum on Franchising Legal Symposium. To obtain the full presentation, contact ABA.