COURT WATCH

Procedural Matters Rule in Several Recent Franchisor-Franchisee Disputes

Bring back the days when the reported decisions were filled with cases concerning disputes over the quality of the franchise system and whether the parties had complied with their respective obligations to make the franchise relationship work. A seagull's view of the recent decisions involving franchise relationships suggests that even though most of the text of a franchise agreement is devoted to describing the parties' rights and obligations relating to the granting, construction, and operation of the franchise, when the franchise relationship becomes fractured, the field of battle more often than not moves not to the substantive relationship of the parties, but to what might be termed the legalese portions of the franchise agreement and procedural matters ' arbitration, jurisdiction, statutes of limitations, whether preliminary injunctions should be granted, choice of forum, and choice of state law ' to name only a few of these non-substantive issues. The meat of the franchise relationship becomes secondary. The cynic in our audience might say that the sideshows at the circus have moved to center ring.

Arbitrator Bias at Issue for Subway Dispute

Arbitration issues continue as a major showstopper. The most recent addition to the list is found in Doctor's Associates, Inc. v. Dhaliwal, 2 Bus. Franchise Guide (CCH) ' 13,179, at 39,762, (D. Conn. Sept. 30, 2005), involving the credentials of the selected arbitrator. The facts in Dhaliwal showed that the arbitrator had previously handled several arbitrations involving the plaintiff, the franchisor of the Subway system, but had not revealed this information to the defendant franchisee or to the supervisory body for the arbitration, the American Arbitration Association, prior to the arbitration hearing. Rather, the arbitrator had indicated that there was only one instance where he had served as an arbitrator in a Doctor's Associates case. Demonstrating that courts do not like to second-guess the results in arbitration proceedings, the U.S. District Court for the Northern District of Connecticut concluded that the franchisee had failed to meet the burden of showing how such additional involvements had affected the arbitrator's impartiality. Of importance were the facts that the franchisee had waited until after the arbitration award against him was rendered before raising the issue, and even then only made conclusory statements about the grounds for disqualification, rather than cutting to the chase and demonstrating more specifically how the multiple involvements between the franchisor and the arbitrator were prejudicial to the franchisee's interests.

Statute of Limitations in Indiana

Statutes of limitations, another issue not really addressing the substance of a franchise relationship, have also returned to center stage in recent days, as demonstrated in a recent decision from the Indiana Court of Appeals. The Indiana Deceptive Franchise Practices Act (“IDFPA”) provides that a franchisor cannot unilaterally and substantially modify a franchise agreement without the franchisee's consent. In Kahlo Jeep Chrysler Dodge of Knightstown, Inc., v. DaimlerChrysler Motors Company LLC, 835 N.E.2d 526, 2 Bus. Franchise Guide (CCH) ' 13,178, at 39,757 (Ind. Ct. App. Oct. 12, 2005), the plaintiffs, a group of motor vehicle dealers, alleged, among other things, that the manufacturer violated this provision of the IDFPA.

The automobile dealers' contract granted the manufacturer the right to unilaterally change the provisions of its agreements as long as the changes were system-wide. In this case, the manufacturer changed the sales performance requirements under the contract shortly before this proceeding was filed, but more than 2 years after the contracts had been signed. The court ruled that the 2-year statute of limitations set forth in the Act expired prior to the date this suit was filed because the violation of the statute occurred not when the actual modification was announced or implemented, but when the contract was signed. Interestingly, this means that the franchisee must challenge a right-to-modify provision at a time when there may be no beef with the franchisor, and once a 2-year period running from the signing date has expired, the franchisor can act with impunity vis-'-vis this statutory prescription. Given that most franchisees will be unfamiliar with this statutory right, the protection afforded by the Indiana legislature has thus become in practice hollow as a result of the Kahlo decision.

Balancing Interests When Preliminary Injunction Sought

Preliminary injunctions also have become a continuing fad. In KJ Loughery, Inc. v. KRK, Inc., 2 Bus. Franchise Guide (CCH) ' 13,170, at 39,708 (E.D. Pa. June 6, 2005) a post-term non-competition provision was enforced by means of a preliminary injunction, pending final outcome of the litigation. The case appears to be plain vanilla, in that the court enjoined a home inspection franchisee from continuing his trade in substantially the same trade area after the franchise agreement was terminated. The critical issue in most of these cases is often how the interests of the parties are balanced, and, here, the court concluded that there were both business and public interests that would be protected by the issuance of the preliminary injunction. While often lawyers for franchisors in these kinds of cases fear that it will be difficult to convince a court as to what the irreparable harm may be, the Loughery court had little trouble finding there was irreparable harm because the franchisee's experience and continued presence could harm the franchisor's ability to re-enter the marketplace, as would the former franchisee's established relationships with local realtors, who were a major source of customers.

An interesting side note about this case is the reported open-court discussion concerning the appropriate amount of bond that the franchisor would be required to post to protect the franchisee in the event the injunction was subsequently ruled to have been incorrectly granted. The court quickly fixed upon a $10,000 figure, but the franchisee's lawyer protested the amount, claiming that his client might lose a substantial amount of sales (more than $300,000) because of the injunction. The inability of the franchisee to demonstrate his past profits and prospective lost profits at the time of the hearing persuaded the judge not to grant a significant increase in the amount of the bond, although the court did up the ante to $35,000. Often in these cases, by requiring significant amounts for bonds, a court may give a pyrrhic victory to the party asking for the injunction by making the amount of the bond so prohibitive that the party seeking the injunction cannot or decides not to post the bond. Such was not the result here, however.

Substance Returns: What Constitutes a Franchise Relationship?

Substance has not been fully pushed into the corner by procedure. In Ayers v. Marathon Ashland Petroleum LLC. No. 103CV1780RLYTAB, 2005 WL 2428205, 2 Bus. Franchise Guide (CCH) ' 13,181, at 39,765 (S.D. Ind. Sept. 30, 2005), the court addressed the more traditional problem of what constitutes a franchise relationship and what are the consequences of being classified as a franchisor. In layman's terms, under the Federal Trade Commission's disclosure rule and the various state franchise sales/disclosure and franchise relationships laws, generally a franchise relationship will exist only if there is a trademark association between the franchisor and franchisee (the “Trademark Test”), the franchisor provides substantial assistance to or exerts substantial control over the franchisee (the “Control Test”), and there is a fee charged for the right to engage in the business (the “Franchise Fee Test”).

The IDFPA, however, which was the center of attention in Ayers, has a slight twist to what constitutes a franchise in that the definition of a franchise is met if either: (i) all three of these tests are met; or (ii) only the Trademark Test and Control Test are met and the business in question involves selling cars and/or trucks and selling gasoline and/or oil primarily for use in vehicles with or without the sale of accessory items.

In Ayers, the putative franchisor argued that it charged no franchise fee; it also contended that it did not fall within the confines of the second definition of a franchise because that provision required a franchisor to be engaged in the sale of both certain motor vehicles and gasoline, whereas the supplier-defendant only sold gasoline. The court, however, applying the rule of common sense, concluded that there was an ambiguity in the statute's language, and that while the Indiana legislature may have used the word “and” ' so that both motor vehicle and gasoline sales would appear to be prerequisites to being subject to the provisions of the IDFPA's prescriptions, the legislature really meant “or” because very few businesses sell both product lines, and the legislature certainly could not have intended to adopt a rule that covered such a small number of businesses.

The putative franchisor also argued that the Control Test had not been met and thus no franchise relationship existed between the parties for that reason. The Control Test under the Indiana statute is worded differently and is somewhat narrower than the test described above and which is found in the FTC's Disclosure Rule, in that it requires there be a “marketing plan or system prescribed in substantial part by a franchisor.” What constitutes a marketing plan is not statutorily defined, and has been the subject of a notable volume of litigation over the years after the various state disclosure and relationship laws were enacted.

Thus the Ayers court, not surprisingly, decided this was an issue for a jury to decide. The court noted that: Marathon's program contained training requirements; the defendant conducted a mystery shop program to evaluate franchisee performance; exterior and interior appearance of the plaintiffs' facilities were reviewed by the supplier-defendant; and there were mandatory store hours. The court also noted that rent on the facilities was tied to sales volume, which suggested that there was a de facto sales quota. The court compared these factors to the situation in an Indiana Court of Appeal decision, Master Abrasives Corp. v. Williams, 469 N.E.2d 1196 (Ind. Ct. App. 1984), rev'd on other grounds, Enservco, Inc., v. Indiana Securities Division, 623 N.E.2d 416 (Ind. 1993), where that court found a marketing plan to be present because of five factors which included: 1) a division of the state into prescribed marketing areas; 2) sales quotas; 3) approval rights on sales personnel; 4) mandatory training; and 5) a requirement that franchisees solicit sales information from customers. While the Ayers court did not suggest that the Williams decision prescribed the precise and complete elements of a marketing plan, it did find substantial similarity between the distribution systems in the two cases and ruled that that the plaintiffs' evidence could lead a jury to conclude that the plaintiffs operated their businesses under a marketing plan or system prescribed by the defendant. Accordingly, the court denied the defendant's motion for summary judgment.

Procedural Matters Rule in Several Recent Franchisor-Franchisee Disputes

Bring back the days when the reported decisions were filled with cases concerning disputes over the quality of the franchise system and whether the parties had complied with their respective obligations to make the franchise relationship work. A seagull's view of the recent decisions involving franchise relationships suggests that even though most of the text of a franchise agreement is devoted to describing the parties' rights and obligations relating to the granting, construction, and operation of the franchise, when the franchise relationship becomes fractured, the field of battle more often than not moves not to the substantive relationship of the parties, but to what might be termed the legalese portions of the franchise agreement and procedural matters ' arbitration, jurisdiction, statutes of limitations, whether preliminary injunctions should be granted, choice of forum, and choice of state law ' to name only a few of these non-substantive issues. The meat of the franchise relationship becomes secondary. The cynic in our audience might say that the sideshows at the circus have moved to center ring.

Arbitrator Bias at Issue for Subway Dispute

Arbitration issues continue as a major showstopper. The most recent addition to the list is found in Doctor's Associates, Inc. v. Dhaliwal, 2 Bus. Franchise Guide (CCH) ' 13,179, at 39,762, (D. Conn. Sept. 30, 2005), involving the credentials of the selected arbitrator. The facts in Dhaliwal showed that the arbitrator had previously handled several arbitrations involving the plaintiff, the franchisor of the Subway system, but had not revealed this information to the defendant franchisee or to the supervisory body for the arbitration, the American Arbitration Association, prior to the arbitration hearing. Rather, the arbitrator had indicated that there was only one instance where he had served as an arbitrator in a Doctor's Associates case. Demonstrating that courts do not like to second-guess the results in arbitration proceedings, the U.S. District Court for the Northern District of Connecticut concluded that the franchisee had failed to meet the burden of showing how such additional involvements had affected the arbitrator's impartiality. Of importance were the facts that the franchisee had waited until after the arbitration award against him was rendered before raising the issue, and even then only made conclusory statements about the grounds for disqualification, rather than cutting to the chase and demonstrating more specifically how the multiple involvements between the franchisor and the arbitrator were prejudicial to the franchisee's interests.

Statute of Limitations in Indiana

Statutes of limitations, another issue not really addressing the substance of a franchise relationship, have also returned to center stage in recent days, as demonstrated in a recent decision from the Indiana Court of Appeals. The Indiana Deceptive Franchise Practices Act (“IDFPA”) provides that a franchisor cannot unilaterally and substantially modify a franchise agreement without the franchisee's consent. In Kahlo Jeep Chrysler Dodge of Knightstown, Inc., v. DaimlerChrysler Motors Company LLC , 835 N.E.2d 526, 2 Bus. Franchise Guide (CCH) ' 13,178, at 39,757 (Ind. Ct. App. Oct. 12, 2005), the plaintiffs, a group of motor vehicle dealers, alleged, among other things, that the manufacturer violated this provision of the IDFPA.

The automobile dealers' contract granted the manufacturer the right to unilaterally change the provisions of its agreements as long as the changes were system-wide. In this case, the manufacturer changed the sales performance requirements under the contract shortly before this proceeding was filed, but more than 2 years after the contracts had been signed. The court ruled that the 2-year statute of limitations set forth in the Act expired prior to the date this suit was filed because the violation of the statute occurred not when the actual modification was announced or implemented, but when the contract was signed. Interestingly, this means that the franchisee must challenge a right-to-modify provision at a time when there may be no beef with the franchisor, and once a 2-year period running from the signing date has expired, the franchisor can act with impunity vis-'-vis this statutory prescription. Given that most franchisees will be unfamiliar with this statutory right, the protection afforded by the Indiana legislature has thus become in practice hollow as a result of the Kahlo decision.

Balancing Interests When Preliminary Injunction Sought

Preliminary injunctions also have become a continuing fad. In KJ Loughery, Inc. v. KRK, Inc., 2 Bus. Franchise Guide (CCH) ' 13,170, at 39,708 (E.D. Pa. June 6, 2005) a post-term non-competition provision was enforced by means of a preliminary injunction, pending final outcome of the litigation. The case appears to be plain vanilla, in that the court enjoined a home inspection franchisee from continuing his trade in substantially the same trade area after the franchise agreement was terminated. The critical issue in most of these cases is often how the interests of the parties are balanced, and, here, the court concluded that there were both business and public interests that would be protected by the issuance of the preliminary injunction. While often lawyers for franchisors in these kinds of cases fear that it will be difficult to convince a court as to what the irreparable harm may be, the Loughery court had little trouble finding there was irreparable harm because the franchisee's experience and continued presence could harm the franchisor's ability to re-enter the marketplace, as would the former franchisee's established relationships with local realtors, who were a major source of customers.

An interesting side note about this case is the reported open-court discussion concerning the appropriate amount of bond that the franchisor would be required to post to protect the franchisee in the event the injunction was subsequently ruled to have been incorrectly granted. The court quickly fixed upon a $10,000 figure, but the franchisee's lawyer protested the amount, claiming that his client might lose a substantial amount of sales (more than $300,000) because of the injunction. The inability of the franchisee to demonstrate his past profits and prospective lost profits at the time of the hearing persuaded the judge not to grant a significant increase in the amount of the bond, although the court did up the ante to $35,000. Often in these cases, by requiring significant amounts for bonds, a court may give a pyrrhic victory to the party asking for the injunction by making the amount of the bond so prohibitive that the party seeking the injunction cannot or decides not to post the bond. Such was not the result here, however.

Substance Returns: What Constitutes a Franchise Relationship?

Substance has not been fully pushed into the corner by procedure. In Ayers v. Marathon Ashland Petroleum LLC. No. 103CV1780RLYTAB, 2005 WL 2428205, 2 Bus. Franchise Guide (CCH) ' 13,181, at 39,765 (S.D. Ind. Sept. 30, 2005), the court addressed the more traditional problem of what constitutes a franchise relationship and what are the consequences of being classified as a franchisor. In layman's terms, under the Federal Trade Commission's disclosure rule and the various state franchise sales/disclosure and franchise relationships laws, generally a franchise relationship will exist only if there is a trademark association between the franchisor and franchisee (the “Trademark Test”), the franchisor provides substantial assistance to or exerts substantial control over the franchisee (the “Control Test”), and there is a fee charged for the right to engage in the business (the “Franchise Fee Test”).

The IDFPA, however, which was the center of attention in Ayers, has a slight twist to what constitutes a franchise in that the definition of a franchise is met if either: (i) all three of these tests are met; or (ii) only the Trademark Test and Control Test are met and the business in question involves selling cars and/or trucks and selling gasoline and/or oil primarily for use in vehicles with or without the sale of accessory items.

In Ayers, the putative franchisor argued that it charged no franchise fee; it also contended that it did not fall within the confines of the second definition of a franchise because that provision required a franchisor to be engaged in the sale of both certain motor vehicles and gasoline, whereas the supplier-defendant only sold gasoline. The court, however, applying the rule of common sense, concluded that there was an ambiguity in the statute's language, and that while the Indiana legislature may have used the word “and” ' so that both motor vehicle and gasoline sales would appear to be prerequisites to being subject to the provisions of the IDFPA's prescriptions, the legislature really meant “or” because very few businesses sell both product lines, and the legislature certainly could not have intended to adopt a rule that covered such a small number of businesses.

The putative franchisor also argued that the Control Test had not been met and thus no franchise relationship existed between the parties for that reason. The Control Test under the Indiana statute is worded differently and is somewhat narrower than the test described above and which is found in the FTC's Disclosure Rule, in that it requires there be a “marketing plan or system prescribed in substantial part by a franchisor.” What constitutes a marketing plan is not statutorily defined, and has been the subject of a notable volume of litigation over the years after the various state disclosure and relationship laws were enacted.

Thus the Ayers court, not surprisingly, decided this was an issue for a jury to decide. The court noted that: Marathon's program contained training requirements; the defendant conducted a mystery shop program to evaluate franchisee performance; exterior and interior appearance of the plaintiffs' facilities were reviewed by the supplier-defendant; and there were mandatory store hours. The court also noted that rent on the facilities was tied to sales volume, which suggested that there was a de facto sales quota. The court compared these factors to the situation in an Indiana Court of Appeal decision, Master Abrasives Corp. v. Williams , 469 N.E.2d 1196 (Ind. Ct. App. 1984), rev'd on other grounds, Enservco, Inc., v. Indiana Securities Division , 623 N.E.2d 416 (Ind. 1993), where that court found a marketing plan to be present because of five factors which included: 1) a division of the state into prescribed marketing areas; 2) sales quotas; 3) approval rights on sales personnel; 4) mandatory training; and 5) a requirement that franchisees solicit sales information from customers. While the Ayers court did not suggest that the Williams decision prescribed the precise and complete elements of a marketing plan, it did find substantial similarity between the distribution systems in the two cases and ruled that that the plaintiffs' evidence could lead a jury to conclude that the plaintiffs operated their businesses under a marketing plan or system prescribed by the defendant. Accordingly, the court denied the defendant's motion for summary judgment.