Court Watch

Contract Validity to Be Determined By Arbitration Unless the Arbitration Clause Itself Is Alleged to Be Invalid

The U.S. District Court for the Northern District of Illinois has ruled that a franchisor's arbitration clause can be used to require arbitration about contract terms unless the arbitration clause itself is alleged to be invalid. The Quizno's Master, Master, LLC and The Quizno's Franchise Company, LCC v. Shahe Kadriu, CCH Business Franchise Guide, ' 13,051 (N.D. Ill. April 11, 2005).

Shahe Kadriu was a Quizno's franchisee in Chicago. Her franchise agreement provided that if her store was closed for 5 consecutive days, it would be considered abandoned, and the franchise agreement would be terminated. Kadriu told Quizno's she was closing her store. After the store had been closed for 5 straight days, Quizno's declared the store abandoned and terminated the franchise agreement.

The franchise agreement required that all claims, including disputes over the validity of the agreement itself, be handled in arbitration. Not atypically, the franchise agreement excepted from arbitration claims related to Quizno's trademarks. Quizno's brought a lawsuit to enjoin Kadriu from using its trademarks, and sought specific performance of post-termination contract provisions. Kadriu responded with a counterclaim, claiming that the franchise agreement was invalid due to Quizno's alleged fraudulent inducement. Kadriu asked for rescission, a finding of fraud in the inducement, and punitive damages.

Quizno's presented two motions to the court. First, Quizno's requested a preliminary injunction on all of its causes of action. Quizno's also moved to stay the counterclaims, arguing that they involved the validity of the franchise agreement, which by its own terms was subject to arbitration.

The court first noted the federal presumption in favor of arbitration, and found that where a contract requires arbitration of challenges to its validity, the matter must go to arbitration unless, as the U.S. Supreme Court noted in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 338 U.S. 395 (1967), “the claim is fraud in the inducement of the arbitration clause itself.” Under that narrow circumstance, the issue is within the purview of the Federal Court. Kadriu did not make an allegation that the arbitration clause itself was fraudulently induced. Instead, she argued that Quizno's claims for preliminary injunction were based on the validity of the franchise agreement. Thus, she argued judicial economy and collateral estoppel required the court hearing the preliminary injunction motion to also hear her counterclaims. The court disagreed, stating that arbitration, when agreed to by the parties, is mandatory, thus making irrelevant any arguments regarding judicial economy. More importantly, the court noted that Kadriu's argument was itself irrelevant to the outcome. Regardless of whether she prevailed on her counterclaim and successfully rescinded the franchise agreement, it was clear she would no longer be a Quizno's franchisee, and had no continuing right to use Quizno's trademarks.

Kadriu next argued that Quizno's decision to bring a lawsuit operated to waive its right to oppose her bringing counterclaims in the same court. That argument was defeated by the explicit language of the arbitration clause. That clause carved out an exception from arbitration for “claims related to or based upon Franchisee's use of the Marks.” The court easily found that Quizno's claims of trademark infringement and unfair competition under the Lanham Act were clearly related to franchisee's use of Quizno's trademarks. The court noted that by acting in accordance with the specific exemption to the arbitration clause, Quizno's could not have waived its rights to have remaining matters arbitrated.

The court considered the waiver argument separately for the claim for specific performance. The court noted that the only post-termination rights Quizno's was seeking to enforce arguably fell within the trademark exception to the arbitration clause. Although the court said it would find that the specific performance clause did need to be arbitrated, it was reasonable for Quizno's to think it was acting properly; thus, its decision to pursue post-termination claims in court would not be a waiver of its right to require arbitration.

Lastly, Kadriu argued that the arbitration clause was invalid because it would be prohibitively expensive for her to arbitrate. The court ruled that she bore the burden of showing the likelihood of incurring prohibitive costs. That required a showing both of individualized evidence that Kadriu would be likely to incur prohibitive costs, and that she could not financially meet those costs. Although Kadriu did not make the required showing, the court found that the argument would not prevail even if she had done so. The “prohibitively expensive” argument is based upon a party being precluded from effectively vindicating its federal statutory rights in the arbitration. Kadriu's counterclaims were not based on federal law, but instead state law. Having found against Kadriu on each of her arguments, the court stayed the counterclaims in favor of arbitration.

The court then proceeded to examine Quizno's motion for preliminary injunction. The court applied the Seventh Circuit's tests for a preliminary injunction: 1) a likelihood of success on the merits; 2) no adequate remedy at law; and 3) irreparable harm if the injunction is not granted. Ty, Inc. v. Jones Group, Inc. 237 F.3d 891 (7th Cir. 2001). The court noted that if all three conditions were met, the court would balance the irreparable harm to the non-moving party if the preliminary relief were granted against the irreparable harm to the moving party if injunctive relief were denied. Lastly, the court would consider the impact on the public interest of denying or granting injunctive relief.

The court noted that Quizno's would likely prevail on both Lanham Act claims regardless of whether Kadriu prevailed on her counterclaims. The franchise was at an end, and thus Kadriu's continued use of the Quizno's trademarks would violate the Lanham Act. The court did find, however, that Quizno's third cause of action, for specific performance, depended on the validity of the franchise agreement. Given that the franchise agreement was under attack due to the claim for fraudulent inducement, that claim would be left for arbitration.

The court noted Seventh Circuit law that if there is no adequate remedy for the asserted harm, then the harm is irreparable. Citing Abbott Labs v. Mead Johnson & Co., 971 F.2d 6, 16 (7th Cir. 1992), the court noted a “well-established presumption that injuries arising from Lanham Act violations are irreparable, even absent a showing of business loss.” The court found that the association of an abandoned franchise with the Quizno's name could hurt the company's reputation in ways that could not be ascertained.

In balancing the harms, the court noted that the harm to Quizno's, both its reputation and the business of the other franchisees, outweighed the cost of compliance for Kadriu. In examining the public interest, the court noted that both the consuming public and other franchisees would benefit from stopping Kadriu's use of Quizno's trademarks.

Choice of Law Provision Void As to Iowa Franchisee, but Franchisor Entitled to Preliminary Injunction

The U.S. District Court for the Northern District of Iowa has ruled that a choice of law provision in a franchise agreement of American Express Financial Advisors, Inc. (“AEFA”) was void as against an Iowa franchisee, but that AEFA nonetheless was entitled to a preliminary injunction against the franchisee to enforce the post-termination obligations under the franchise agreement. American Express Financial Advisors, Inc. v. Yantis, ___ F.Supp.2d ___, 2005 WL 469362 (N.D. Iowa).

The dispute arose after Richard Yantis, an AEFA franchisee in Cedar Falls, IA, notified AEFA that he was terminating his affiliation with it as of the following day. Yantis associated with another broker-dealer 2 days later. AEFA then filed suit against Yantis, alleging claims for breach of contract, misappropriation of confidential information, conversion, unfair competition and injunctive relief. At the same time, AEFA also filed a Motion for Preliminary Injunctive Relief.

In support of its claims, AEFA asserted that for 2 months prior to terminating his affiliation with AEFA, and continuing thereafter, Yantis contacted clients whom he had serviced with AEFA, informed them of his intent to leave AEFA, and solicited them to move their accounts to his new broker-dealer. AEFA also asserted that Yantis had successfully solicited other AEFA employees to terminate their employment with AEFA and follow him to the new broker-dealer and that he had retained numerous client files, all in violation of his franchise agreement. In its motion for preliminary injunctive relief, AEFA sought to enjoin Yantis to comply with his post-termination obligations under the franchise agreement, including, without limitation, to return all client records and other documents; to cease using AEFA's confidential information, methods, procedures, and techniques; and to prevent him from soliciting any further business from AEFA clients, soliciting or hiring any AEFA employees, and revealing or disclosing information contained in AEFA records, for a period of 1 year or until otherwise vacated by the NASD. In defense, Yantis argued that he was an “independent businessman” who competes with other AEFA financial advisors, that he owns his own client list, and that he would suffer irreparable harm if the court enjoins him from contacting his own clients while allowing AEFA to establish contacts with them.

In arriving at its decision, the U.S. District Court first determined that the choice-of-law provision in the franchise agreement, which required application of Minnesota law, was void. The court noted, “Iowa public policy appears to prohibit the application of Minnesota law to the Franchise Agreement” because the Iowa Franchise Act “voids any choice-of-law provision in a franchise agreement regardless of whether the Act provides a cause of action for the injuries alleged by a plaintiff.” The court therefore applied Iowa law to the dispute.

With respect to AEFA's motion for preliminary injunctive relief, the court concluded that AEFA was likely to succeed on the merits of its claims for breach of contract, misappropriation, and conversion. On the breach of contract claim, the court concluded that the restrictive covenants in the franchise agreement, which prevented Yantis from inducing AEFA's customers and employees from leaving AEFA and following him to a competing broker-dealer, were reasonably necessary to protect AEFA's good will and were not unreasonably restrictive of Yantis' rights because their duration was limited to only 1 year, and the geographic area of such restriction was limited to the area in which Yantis worked. The court also determined that the restrictive covenants were not prejudicial to the public, that AEFA had an interest in keeping the client and financial information confidential, and that the nature of the occupation being restrained, financial advisor, did not raise any particular problems.

On the misappropriation claim, the court concluded that AEFA likely would be able to establish that its “client names, addresses and data, including suitability information, investments and investment history, financial plans, and financial goal information, prospective client names, addresses, and data, and know-how concerning the methods of operations, client lists and other financial information” fell within the legal definition of a “trade secret” under the Iowa Uniform Trade Secrets Act. The court also concluded that AEFA likely would succeed in showing that the information derived independent economic value from not being generally known or readily ascertainable and that AEFA makes a significant effort to guard the secrecy of this information by requiring all of its financial advisors and their staff to sign confidentiality agreements. Finally, the court concluded that AEFA likely would show that “Yantis inevitably will use the information he acquired through improper means ' through a breach of his duties under his Franchise Agreement.”

On the conversion claim, the court determined that the franchise agreement made clear that the client files were the property of AEFA and that Yantis had wrongfully exercised control over AEFA's property by retaining such files after terminating his employment with AEFA. Finally, the court ruled that AEFA would suffer irreparable harm to its good will and client relationships if Yantis' actions were not enjoined, that the balance of harms weighed in favor of granting the injunction, and that the public interest is served by enforcing a valid restrictive covenant and preventing the unauthorized disclosure of trade secrets.

State Interests Is Not the Proper Test in Determining Governmental Taking

Few cases reach the U.S. Supreme Court, and even fewer are accepted for hearing and decision. When a case involving both franchising and the U.S. Constitution comes down, it is a rare day indeed. In Lingle v. Chevron U.S.A., Inc., CCH Business Franchise Guide, ' 13,069 (U.S. May 23, 2005), the Court examined a Hawaiian statute that limited the rent that oil companies could charge dealers leasing company-owned sites. The legislation was passed in response to fears that market concentration in the Hawaiian oil market could adversely affect retail gasoline prices.

Chevron brought suit seeking a declaration that the rent cap was an unconstitutional taking of its property, which in the absence of just compensation, was prohibited by the Fifth Amendment (applicable to the states through the Fourteenth Amendment). The parties stipulated to relevant facts, and both moved for summary judgment. The District Court granted summary judgment to Chevron, finding that a government regulation of private property that does not “substantially advance legitimate state interests” effects a Fifth Amendment taking. The District Court based its decision on the Supreme Court case of Agins v. City of Tiburon, 447 U.S. 255 (1980). The Ninth Circuit agreed that Agins provided the proper legal standard, but found the existence of material facts and reversed the summary judgment in favor of Chevron. After a 1-day bench trial, the District Court found in favor of Chevron. The Ninth Circuit affirmed.

The Supreme Court first examined its many taking precedents, starting with the gold standard of taking, direct government appropriation or government physical invasion of private property. The Court noted, however, that beginning with Pennsylvania Coal Co. v. Mahon, 260 U.S. 393 (1922), it had recognized that government regulation of private property could be so onerous that its effect amounted to a direct appropriation or ouster. Such so-called “regulatory takings” could be compensable under the Fifth Amendment. Beyond these two categories, the Court noted that regulatory taking challenges were to be examined under the standards set forth in Penn Central Transp. Co. v. New York City, 438 U.S. 104 (1978).

Although the Court in Penn Central had acknowledged it had been unable to articulate a clear formula for evaluating such claims, it had identified several key factors. Those included the economic impact of the regulation on the claimant, and the extent to which the regulation has interfered with distinct investment-based expectations. The Court then noted that the three principal tests of taking ' direct physical taking, onerous regulation amounting to a taking, and the Penn Central factors ' all shared one commonality ' they focused on the harm to the claimant, not the purpose for the regulation. The Court distinguished the Agins case by noting that it mentioned two factors, the substantial advancement of legitimate state interests, and whether the regulation denied an owner economically valuable use of the property. The Court acknowledged the Agins court had presented those factors in the alternative, but said the case now before it presented the first opportunity to decide if “substantial advancement” could stand alone as a test of taking. The Court concluded it could not.

The Court noted that focusing on the public purpose of the taking could result in anomalous results when two property owners were similarly burdened, but the public purpose in one case was compelling while in the other it was not. By focusing on the effect on the property owner, equivalent taking would be equally compensated, regardless of the public purpose. The Court also recognized a practical difficulty in applying the “substantially advances” test. In the Court's view, this would require a means versus ends test of every challenged regulation: a burden beyond the capability, and perhaps mandate, of the courts.

An interesting sidelight to this decision is that 1 month later the Supreme Court handed down its decision in Kelo, et al. v. City of New London, Connecticut, ___ U.S. ___ (No. 04-108 June 23, 2005), in which it held that a government authority could take private properties to further an integrated redevelopment plan. The Court in Kelo relied on Chevron to support its rejection of the landowners' argument that the court should require a “reasonable certainty” that the public benefits would actually accrue from the redevelopment. The Court said the wisdom of the taking, just as the substantial advancement of the government's interest, was not an argument to be carried on in the federal courts.

UPDATE: Petition Granted to Rehear Nagrampa

On June 28, 2005, the Ninth Circuit Court of Appeals granted the petition of the franchisee for rehearing en banc in Nagrampa v. Mailcoups, Inc., 401 F.3d 1024, discussed in the June 2005 issue of FBLA. The case had held that the arbitrator decides issues of unconscionability directed to the franchise agreement as a whole, and the court is limited to deciding unconscionability issues directed to the arbitration clause only. The case can no longer be cited. An en banc panel consists of the Chief Judge and 10 other circuit judges chosen at random.

---

Genevieve Beck Jon Swierzewski [email protected] [email protected]

Contract Validity to Be Determined By Arbitration Unless the Arbitration Clause Itself Is Alleged to Be Invalid

The U.S. District Court for the Northern District of Illinois has ruled that a franchisor's arbitration clause can be used to require arbitration about contract terms unless the arbitration clause itself is alleged to be invalid. The Quizno's Master, Master, LLC and The Quizno's Franchise Company, LCC v. Shahe Kadriu, CCH Business Franchise Guide, ' 13,051 (N.D. Ill. April 11, 2005).

Shahe Kadriu was a Quizno's franchisee in Chicago. Her franchise agreement provided that if her store was closed for 5 consecutive days, it would be considered abandoned, and the franchise agreement would be terminated. Kadriu told Quizno's she was closing her store. After the store had been closed for 5 straight days, Quizno's declared the store abandoned and terminated the franchise agreement.

The franchise agreement required that all claims, including disputes over the validity of the agreement itself, be handled in arbitration. Not atypically, the franchise agreement excepted from arbitration claims related to Quizno's trademarks. Quizno's brought a lawsuit to enjoin Kadriu from using its trademarks, and sought specific performance of post-termination contract provisions. Kadriu responded with a counterclaim, claiming that the franchise agreement was invalid due to Quizno's alleged fraudulent inducement. Kadriu asked for rescission, a finding of fraud in the inducement, and punitive damages.

Quizno's presented two motions to the court. First, Quizno's requested a preliminary injunction on all of its causes of action. Quizno's also moved to stay the counterclaims, arguing that they involved the validity of the franchise agreement, which by its own terms was subject to arbitration.

The court first noted the federal presumption in favor of arbitration, and found that where a contract requires arbitration of challenges to its validity, the matter must go to arbitration unless, as the U.S. Supreme Court noted in Prima Paint Corp. v. Flood & Conklin Mfg. Co. , 338 U.S. 395 (1967), “the claim is fraud in the inducement of the arbitration clause itself.” Under that narrow circumstance, the issue is within the purview of the Federal Court. Kadriu did not make an allegation that the arbitration clause itself was fraudulently induced. Instead, she argued that Quizno's claims for preliminary injunction were based on the validity of the franchise agreement. Thus, she argued judicial economy and collateral estoppel required the court hearing the preliminary injunction motion to also hear her counterclaims. The court disagreed, stating that arbitration, when agreed to by the parties, is mandatory, thus making irrelevant any arguments regarding judicial economy. More importantly, the court noted that Kadriu's argument was itself irrelevant to the outcome. Regardless of whether she prevailed on her counterclaim and successfully rescinded the franchise agreement, it was clear she would no longer be a Quizno's franchisee, and had no continuing right to use Quizno's trademarks.

Kadriu next argued that Quizno's decision to bring a lawsuit operated to waive its right to oppose her bringing counterclaims in the same court. That argument was defeated by the explicit language of the arbitration clause. That clause carved out an exception from arbitration for “claims related to or based upon Franchisee's use of the Marks.” The court easily found that Quizno's claims of trademark infringement and unfair competition under the Lanham Act were clearly related to franchisee's use of Quizno's trademarks. The court noted that by acting in accordance with the specific exemption to the arbitration clause, Quizno's could not have waived its rights to have remaining matters arbitrated.

The court considered the waiver argument separately for the claim for specific performance. The court noted that the only post-termination rights Quizno's was seeking to enforce arguably fell within the trademark exception to the arbitration clause. Although the court said it would find that the specific performance clause did need to be arbitrated, it was reasonable for Quizno's to think it was acting properly; thus, its decision to pursue post-termination claims in court would not be a waiver of its right to require arbitration.

Lastly, Kadriu argued that the arbitration clause was invalid because it would be prohibitively expensive for her to arbitrate. The court ruled that she bore the burden of showing the likelihood of incurring prohibitive costs. That required a showing both of individualized evidence that Kadriu would be likely to incur prohibitive costs, and that she could not financially meet those costs. Although Kadriu did not make the required showing, the court found that the argument would not prevail even if she had done so. The “prohibitively expensive” argument is based upon a party being precluded from effectively vindicating its federal statutory rights in the arbitration. Kadriu's counterclaims were not based on federal law, but instead state law. Having found against Kadriu on each of her arguments, the court stayed the counterclaims in favor of arbitration.

The court then proceeded to examine Quizno's motion for preliminary injunction. The court applied the Seventh Circuit's tests for a preliminary injunction: 1) a likelihood of success on the merits; 2) no adequate remedy at law; and 3) irreparable harm if the injunction is not granted. Ty, Inc. v. Jones Group, Inc. 237 F.3d 891 (7th Cir. 2001). The court noted that if all three conditions were met, the court would balance the irreparable harm to the non-moving party if the preliminary relief were granted against the irreparable harm to the moving party if injunctive relief were denied. Lastly, the court would consider the impact on the public interest of denying or granting injunctive relief.

The court noted that Quizno's would likely prevail on both Lanham Act claims regardless of whether Kadriu prevailed on her counterclaims. The franchise was at an end, and thus Kadriu's continued use of the Quizno's trademarks would violate the Lanham Act. The court did find, however, that Quizno's third cause of action, for specific performance, depended on the validity of the franchise agreement. Given that the franchise agreement was under attack due to the claim for fraudulent inducement, that claim would be left for arbitration.

The court noted Seventh Circuit law that if there is no adequate remedy for the asserted harm, then the harm is irreparable. Citing Abbott Labs v. Mead Johnson & Co. , 971 F.2d 6, 16 (7th Cir. 1992), the court noted a “well-established presumption that injuries arising from Lanham Act violations are irreparable, even absent a showing of business loss.” The court found that the association of an abandoned franchise with the Quizno's name could hurt the company's reputation in ways that could not be ascertained.

In balancing the harms, the court noted that the harm to Quizno's, both its reputation and the business of the other franchisees, outweighed the cost of compliance for Kadriu. In examining the public interest, the court noted that both the consuming public and other franchisees would benefit from stopping Kadriu's use of Quizno's trademarks.

Choice of Law Provision Void As to Iowa Franchisee, but Franchisor Entitled to Preliminary Injunction

The U.S. District Court for the Northern District of Iowa has ruled that a choice of law provision in a franchise agreement of American Express Financial Advisors, Inc. (“AEFA”) was void as against an Iowa franchisee, but that AEFA nonetheless was entitled to a preliminary injunction against the franchisee to enforce the post-termination obligations under the franchise agreement. American Express Financial Advisors, Inc. v. Yantis , ___ F.Supp.2d ___, 2005 WL 469362 (N.D. Iowa).

The dispute arose after Richard Yantis, an AEFA franchisee in Cedar Falls, IA, notified AEFA that he was terminating his affiliation with it as of the following day. Yantis associated with another broker-dealer 2 days later. AEFA then filed suit against Yantis, alleging claims for breach of contract, misappropriation of confidential information, conversion, unfair competition and injunctive relief. At the same time, AEFA also filed a Motion for Preliminary Injunctive Relief.

In support of its claims, AEFA asserted that for 2 months prior to terminating his affiliation with AEFA, and continuing thereafter, Yantis contacted clients whom he had serviced with AEFA, informed them of his intent to leave AEFA, and solicited them to move their accounts to his new broker-dealer. AEFA also asserted that Yantis had successfully solicited other AEFA employees to terminate their employment with AEFA and follow him to the new broker-dealer and that he had retained numerous client files, all in violation of his franchise agreement. In its motion for preliminary injunctive relief, AEFA sought to enjoin Yantis to comply with his post-termination obligations under the franchise agreement, including, without limitation, to return all client records and other documents; to cease using AEFA's confidential information, methods, procedures, and techniques; and to prevent him from soliciting any further business from AEFA clients, soliciting or hiring any AEFA employees, and revealing or disclosing information contained in AEFA records, for a period of 1 year or until otherwise vacated by the NASD. In defense, Yantis argued that he was an “independent businessman” who competes with other AEFA financial advisors, that he owns his own client list, and that he would suffer irreparable harm if the court enjoins him from contacting his own clients while allowing AEFA to establish contacts with them.

In arriving at its decision, the U.S. District Court first determined that the choice-of-law provision in the franchise agreement, which required application of Minnesota law, was void. The court noted, “Iowa public policy appears to prohibit the application of Minnesota law to the Franchise Agreement” because the Iowa Franchise Act “voids any choice-of-law provision in a franchise agreement regardless of whether the Act provides a cause of action for the injuries alleged by a plaintiff.” The court therefore applied Iowa law to the dispute.

With respect to AEFA's motion for preliminary injunctive relief, the court concluded that AEFA was likely to succeed on the merits of its claims for breach of contract, misappropriation, and conversion. On the breach of contract claim, the court concluded that the restrictive covenants in the franchise agreement, which prevented Yantis from inducing AEFA's customers and employees from leaving AEFA and following him to a competing broker-dealer, were reasonably necessary to protect AEFA's good will and were not unreasonably restrictive of Yantis' rights because their duration was limited to only 1 year, and the geographic area of such restriction was limited to the area in which Yantis worked. The court also determined that the restrictive covenants were not prejudicial to the public, that AEFA had an interest in keeping the client and financial information confidential, and that the nature of the occupation being restrained, financial advisor, did not raise any particular problems.

On the misappropriation claim, the court concluded that AEFA likely would be able to establish that its “client names, addresses and data, including suitability information, investments and investment history, financial plans, and financial goal information, prospective client names, addresses, and data, and know-how concerning the methods of operations, client lists and other financial information” fell within the legal definition of a “trade secret” under the Iowa Uniform Trade Secrets Act. The court also concluded that AEFA likely would succeed in showing that the information derived independent economic value from not being generally known or readily ascertainable and that AEFA makes a significant effort to guard the secrecy of this information by requiring all of its financial advisors and their staff to sign confidentiality agreements. Finally, the court concluded that AEFA likely would show that “Yantis inevitably will use the information he acquired through improper means ' through a breach of his duties under his Franchise Agreement.”

On the conversion claim, the court determined that the franchise agreement made clear that the client files were the property of AEFA and that Yantis had wrongfully exercised control over AEFA's property by retaining such files after terminating his employment with AEFA. Finally, the court ruled that AEFA would suffer irreparable harm to its good will and client relationships if Yantis' actions were not enjoined, that the balance of harms weighed in favor of granting the injunction, and that the public interest is served by enforcing a valid restrictive covenant and preventing the unauthorized disclosure of trade secrets.

State Interests Is Not the Proper Test in Determining Governmental Taking

Few cases reach the U.S. Supreme Court, and even fewer are accepted for hearing and decision. When a case involving both franchising and the U.S. Constitution comes down, it is a rare day indeed. In Lingle v. Chevron U.S.A., Inc ., CCH Business Franchise Guide,  ' 13,069 (U.S. May 23, 2005), the Court examined a Hawaiian statute that limited the rent that oil companies could charge dealers leasing company-owned sites. The legislation was passed in response to fears that market concentration in the Hawaiian oil market could adversely affect retail gasoline prices.

Chevron brought suit seeking a declaration that the rent cap was an unconstitutional taking of its property, which in the absence of just compensation, was prohibited by the Fifth Amendment (applicable to the states through the Fourteenth Amendment). The parties stipulated to relevant facts, and both moved for summary judgment. The District Court granted summary judgment to Chevron, finding that a government regulation of private property that does not “substantially advance legitimate state interests” effects a Fifth Amendment taking. The District Court based its decision on the Supreme Court case of Agins v. City of Tiburon , 447 U.S. 255 (1980). The Ninth Circuit agreed that Agins provided the proper legal standard, but found the existence of material facts and reversed the summary judgment in favor of Chevron. After a 1-day bench trial, the District Court found in favor of Chevron. The Ninth Circuit affirmed.

The Supreme Court first examined its many taking precedents, starting with the gold standard of taking, direct government appropriation or government physical invasion of private property. The Court noted, however, that beginning with Pennsylvania Coal Co. v. Mahon , 260 U.S. 393 (1922), it had recognized that government regulation of private property could be so onerous that its effect amounted to a direct appropriation or ouster. Such so-called “regulatory takings” could be compensable under the Fifth Amendment. Beyond these two categories, the Court noted that regulatory taking challenges were to be examined under the standards set forth in Penn Central Transp. Co. v. New York City , 438 U.S. 104 (1978).

Although the Court in Penn Central had acknowledged it had been unable to articulate a clear formula for evaluating such claims, it had identified several key factors. Those included the economic impact of the regulation on the claimant, and the extent to which the regulation has interfered with distinct investment-based expectations. The Court then noted that the three principal tests of taking ' direct physical taking, onerous regulation amounting to a taking, and the Penn Central factors ' all shared one commonality ' they focused on the harm to the claimant, not the purpose for the regulation. The Court distinguished the Agins case by noting that it mentioned two factors, the substantial advancement of legitimate state interests, and whether the regulation denied an owner economically valuable use of the property. The Court acknowledged the Agins court had presented those factors in the alternative, but said the case now before it presented the first opportunity to decide if “substantial advancement” could stand alone as a test of taking. The Court concluded it could not.

The Court noted that focusing on the public purpose of the taking could result in anomalous results when two property owners were similarly burdened, but the public purpose in one case was compelling while in the other it was not. By focusing on the effect on the property owner, equivalent taking would be equally compensated, regardless of the public purpose. The Court also recognized a practical difficulty in applying the “substantially advances” test. In the Court's view, this would require a means versus ends test of every challenged regulation: a burden beyond the capability, and perhaps mandate, of the courts.

An interesting sidelight to this decision is that 1 month later the Supreme Court handed down its decision in Kelo, et al. v. City of New London, Connecticut, ___ U.S. ___ (No. 04-108 June 23, 2005), in which it held that a government authority could take private properties to further an integrated redevelopment plan. The Court in Kelo relied on Chevron to support its rejection of the landowners' argument that the court should require a “reasonable certainty” that the public benefits would actually accrue from the redevelopment. The Court said the wisdom of the taking, just as the substantial advancement of the government's interest, was not an argument to be carried on in the federal courts.

UPDATE: Petition Granted to Rehear Nagrampa

On June 28, 2005, the Ninth Circuit Court of Appeals granted the petition of the franchisee for rehearing en banc in Nagrampa v. Mailcoups, Inc., 401 F.3d 1024, discussed in the June 2005 issue of FBLA . The case had held that the arbitrator decides issues of unconscionability directed to the franchise agreement as a whole, and the court is limited to deciding unconscionability issues directed to the arbitration clause only. The case can no longer be cited. An en banc panel consists of the Chief Judge and 10 other circuit judges chosen at random.

---

Genevieve Beck Jon Swierzewski Larkin Hoffman Daly & Lindgren Ltd. [email protected] [email protected]