Honesty Is Fundamentally the Best Policy

In response, Pilot argued that the nature of the breach 'destroyed' the trust that it, as franchisor, needed to continue to do business with the franchisee. Pilot described the franchisee's scheme as having improperly run the business of Pilot's customers through the franchisee's own affiliated company and not through Pilot. Though not mentioned in the LJL Transp. opinion, this latter argument is consistent with franchisor trademark infringement claims and consumer confusion arguments that are often asserted in franchise termination cases. Pilot also made the added futility argument that trust was vital and that its loss was impossible to cure, as Pilot depended on the franchisee's honest daily reporting to know how much in royalties the franchisee was responsible to pay. This latter argument is often asserted by franchisors of franchise concepts that are cash businesses.

Agreeing with the trial court, the Superior Court adopted the reasoning from three cases in other jurisdictions 'which hold that some types of dishonest conduct are so egregious and of such a nature that the aggrieved party may terminate the contract immediately even where a cure provision is specifically provided in the contract.' (Citing Southland Corp. v. Froelich, 41 F.Supp.2d 277 (E.D.N.Y. 1999); Larken, Inc. v. Larken Iowa City Partnership, Ltd. 589 N.W.2d 700 (Iowa 1999); and Leghorn v. Wieland, 289 So. 2d 745, 748 (Fla. Dist. Ct. App. 1974.)) The Superior Court expressly confirmed that every other state that has considered the issue as to whether there is an absolute right to cure any default has rejected that concept, and that it joined those jurisdictions in rejecting it as well.

In a second argument asserted by the franchisee that was rejected as waived, the franchisee argued that the breach was not significant enough to justify its termination, as the $35,000 worth of business wrongfully diverted represented only one half of one percent (0.5%) of its total billings and only about $5500 of lost revenue to Pilot. The superior court rejected the argument because the franchisee failed to raise it in the trial court, thereby depriving the franchisor of notice to defend against it and the opportunity to conduct discovery as to whether there were more diversions in addition to the $35,000 that the franchisee admitted. In rejecting the argument, however, the court left the door open to the possibility that 'a trier of fact could find that the breach was not sufficiently egregious to warrant termination,' assuming that the franchisee paid the withheld royalties.

The LJL Transp. decision confirms that Pennsylvania franchisees possess no absolute right to cure breaches of franchise agreements where they commit egregious acts of dishonesty. This is a good result because the honesty of the parties is implicit in contract law. The loss of honesty be-tween parties to a contract, like that of a couple contemplating a divorce, is often irreconcilable. In stating its egregiously dishonest conduct standard, however, the superior court appears to have opened the door to further litigation in contract termination cases for acts of dishonest conduct. In the wake of LJL Transp., parties to contracts, where the issue of honest performance is questioned, are left to wonder: 1) whether there is a threshold of factual sufficiency needed to support a termination on dishonesty grounds; and 2) if so, what is the measurable quantum of evidence needed under the circumstances to surmount such threshold?

John J. Jacko III is a franchise, commercial, and business litigator and a member of the Government Contracts Section of Buchanan Ingersoll & Rooney PC(www.bipc.com) in its Philadelphia and Princeton, NJ, offices. He can be reached at [email protected] or 215-665-3923.

The Superior Court of Pennsylvania recently delivered good news for franchisors and their counsel, as it expressly held 'that there are circumstances where the nature of the breach permits the aggrieved party to immediately terminate the contract despite a 'cure' provision where a franchisee commits grievous acts of dishonest conduct.' In LJL Transp., Inc . v. Pilot Air Freight Corp. , __ A2.d __, 2006 PA Super 176, 2006 WL 1977508 (Pa. Super, Pa. July 17, 2006) (No. 2068 EDA 2005), Judge Richard B. Klein, with Judge Maureen Lally-Green concurring, authored the opinion affirming a Northampton County trial court's order denying the franchisee's motion for summary judgment and granting the franchisor's cross-motion for summary judgment.

As recognized by the trial court, the case was one of first impression in Pennsylvania. At issue was an examination of the propriety of a franchise termination arising out of a franchisee's demonstrated and admitted lack of honesty. The facts are simple. Franchisor, Pilot Air Freight Corporation ('Pilot'), terminated its Lehigh Valley and Harrisburg, PA, franchisee's franchise agreement without affording the franchisee an opportunity to cure pursuant to the agreement's 90-day cure provision. Pilot stated that its reasons for terminating the franchise were that the franchisee: 1) improperly shipped products through third-party affiliated entities of the franchisee, ie, other than Pilot, and 2) failed to disclose those shipments and payments to Pilot.

The franchisee countered that the termination was improper because it was deprived of an absolute right: the opportunity to cure pursuant to the franchise agreement's 90-day cure provision. Additionally, the franchisee argued that the absolute right to cure ' irrespective of the type of breach at issue ' meant that, under the circumstances of the case, the franchisee should have been given the opportunity to make payment of royalties on the shipments that were improperly diverted.

In response, Pilot argued that the nature of the breach 'destroyed' the trust that it, as franchisor, needed to continue to do business with the franchisee. Pilot described the franchisee's scheme as having improperly run the business of Pilot's customers through the franchisee's own affiliated company and not through Pilot. Though not mentioned in the LJL Transp. opinion, this latter argument is consistent with franchisor trademark infringement claims and consumer confusion arguments that are often asserted in franchise termination cases. Pilot also made the added futility argument that trust was vital and that its loss was impossible to cure, as Pilot depended on the franchisee's honest daily reporting to know how much in royalties the franchisee was responsible to pay. This latter argument is often asserted by franchisors of franchise concepts that are cash businesses.

Agreeing with the trial court, the Superior Court adopted the reasoning from three cases in other jurisdictions 'which hold that some types of dishonest conduct are so egregious and of such a nature that the aggrieved party may terminate the contract immediately even where a cure provision is specifically provided in the contract.' (Citing Southland Corp. v. Froelich, 41 F.Supp.2d 277 (E.D.N.Y. 1999 ); Larken, Inc. v. Larken Iowa City Partnership, Ltd. 589 N.W.2d 700 (Iowa 1999); and Leghorn v. Wieland, 289 So. 2d 745, 748 (Fla. Dist. Ct. App. 1974.)) The Superior Court expressly confirmed that every other state that has considered the issue as to whether there is an absolute right to cure any default has rejected that concept, and that it joined those jurisdictions in rejecting it as well.

In a second argument asserted by the franchisee that was rejected as waived, the franchisee argued that the breach was not significant enough to justify its termination, as the $35,000 worth of business wrongfully diverted represented only one half of one percent (0.5%) of its total billings and only about $5500 of lost revenue to Pilot. The superior court rejected the argument because the franchisee failed to raise it in the trial court, thereby depriving the franchisor of notice to defend against it and the opportunity to conduct discovery as to whether there were more diversions in addition to the $35,000 that the franchisee admitted. In rejecting the argument, however, the court left the door open to the possibility that 'a trier of fact could find that the breach was not sufficiently egregious to warrant termination,' assuming that the franchisee paid the withheld royalties.

The LJL Transp. decision confirms that Pennsylvania franchisees possess no absolute right to cure breaches of franchise agreements where they commit egregious acts of dishonesty. This is a good result because the honesty of the parties is implicit in contract law. The loss of honesty be-tween parties to a contract, like that of a couple contemplating a divorce, is often irreconcilable. In stating its egregiously dishonest conduct standard, however, the superior court appears to have opened the door to further litigation in contract termination cases for acts of dishonest conduct. In the wake of LJL Transp., parties to contracts, where the issue of honest performance is questioned, are left to wonder: 1) whether there is a threshold of factual sufficiency needed to support a termination on dishonesty grounds; and 2) if so, what is the measurable quantum of evidence needed under the circumstances to surmount such threshold?

John J. Jacko III is a franchise, commercial, and business litigator and a member of the Government Contracts Section of Buchanan Ingersoll & Rooney PC(www.bipc.com) in its Philadelphia and Princeton, NJ, offices. He can be reached at [email protected] or 215-665-3923.