Court Watch

When a Business Agreement Is Not a Franchise Relationship

When are franchisors not required to provide prospective franchisees disclosures under franchise laws and regulations? The easy answer: when the 'franchisor' isn't really a franchisor. A Pennsylvania trial court granted a motion for summary judgment filed by the developer of a new concept who failed to comply with the franchise disclosure regulations because the relationship between the concept developer and a health care provider was not a 'franchise' under the FTC Franchise Rule. Mercy Health Sys. v. Metropolitan Partners Realty LLC, Business Franchise Guide '13,522 (filed Jan. 19, 2007).

Mercy Health System entered into two 15-year agreements with Metro-politan Partners Realty to operate two new ambulatory care facilities in Pennsylvania. After Mercy's efforts failed to renegotiate the agreements to address certain perceived inequities, Mercy filed a lawsuit alleging causes of action for rescission of the lease agreements, among other things, based on Metropolitan's failure to provide certain required disclosures prescribed by the federal franchise regulations.

Mercy alleged that the leases created 'accidental franchise arrangements' requiring various advance disclosures under the FTC Franchise Rule. Specifically, Mercy asserted that the parties' relationship qualified as a package franchise. The court explained that such a relationship exists where the franchisee adopts the business format established by the franchisor and identified by the franchisor's trademark, and the franchisee's 'method of operation in producing the goods or services sold by him are subject to significant controls instituted by the franchisor or alternatively the franchisor promises to render significant assistance to the franchisee in the operation of the business.'

One of the elements necessary to establish a franchise relationship is a trademark or service mark. The court determined that the record failed to show any standard services established by Metropolitan to be offered by Mercy and that, in any event, the services provided by Mercy were not offered under Metropolitan's THE WELLNESS PLACE service mark.

The court also considered the second element of the 'package franchise' definition ' that the franchisor assert substantial control over the franchisee's method of operation or provide substantial assistance to the franchisee in the operation of the business. The court concluded that Metropolitan had not exercised the requisite significant control or provided the substantial assistance necessary to classify the relationship between the parties as that of franchisor and franchisee. Metropolitan did not advise Mercy on which health plans to accept, how to advertise the facilities, which medical equipment to buy and use, or where to locate the projects.

Although the leases contained certain restrictions relating to signage at the facilities, hours of operation, food service, and subtenant restrictions, the court noted that the restrictions were of a nature customarily found in lease agreements where the landlord retains some level of management responsibilities under the lease, and that such restrictions do not rise to the level of substantial control or assistance required to establish a package franchise.

Accordingly, the court granted Metropolitan's motion for summary judgment because no franchise relationship existed between the parties.

Franchisee's Refusal to Accept Release Is Not Reason for Termination in NJ

It may seem elementary that franchisees have an obligation to perform under the terms of their agreements with franchisors, but don't be fooled. When it comes to renewing a franchise agreement, not every provision may be fair. Should franchisees be forced to go along with those that aren't? In many states, terminating or failing to renew a franchise requires 'good cause.' As the U.S. District Court for the District of New Jersey found, a franchisee's refusal to cave in to the unfair requirement that it execute a unilateral release did not constitute good cause under New Jersey law. Huntington Learning Centers, Inc. v. Futuredge, LLC, Business Franchise Guide '13,542 (filed July 28, 2005). Thus the court denied a learning center franchisor's motion for preliminary injunction against a holdover franchisee.

Huntington Learning Centers, Inc., a franchisor of learning centers throughout the United States, entered into a franchise agreement with Futuredge, LLC for operation of a franchise in California. As a condition for renewal contained in the original agreement, Huntington required Futuredge to execute a general release. When Futuredge refused, Huntington terminated the agreement and later filed a motion for preliminary injunction to prohibit Futuredge from operating the learning center in violation of in-term and post-term covenants against competition and covenants prohibiting use of Huntington's confidential information.

Under New Jersey common law, a franchisor cannot refuse to renew a franchise agreement without good cause. The court noted that 'good cause means a failure by the franchisee 'to substantially perform his obligations' under the franchise agreement.' Although Futuredge failed to comply with the provision in the agreement requiring the franchisee to execute a release as a condition to renewal, Futuredge nevertheless continued to fulfill its obligations under the terms of the agreement.

Huntington claimed the requirement of good cause did not apply because Huntington did not terminate or refuse to renew the agreement. Rather, Huntington claimed that Futuredge voluntarily allowed the agreement to expire. The court noted, however, that Futuredge believed it had valid legal claims against Huntington based on Huntington's alleged failure to make contributions to an advertising fund for its franchisees. The court determined that Huntington's insistence on the release coerced Futuredge into allowing the agreement to expire. Thus, the court determined that Huntington had caused the termination of the agreement, not Futuredge.

Moreover, the release was unilateral, requiring Futuredge to release its claims, but not requiring the same of Huntington. The court, therefore, found the agreement fundamentally unfair, and Futuredge's refusal to consent to such a release did not constitute good cause. Accordingly, the court found that Futuredge was operating as a holdover franchisee.

The court further found that as a holdover franchisee, Futuredge was not operating a competing business and was not misappropriating confidential information. Thus, Huntington could not demonstrate a likelihood of success on the merits to support the injunction.

Christopher M. Hanes is an associate in Kilpatrick Stockton LLP's Atlanta office, where he practices in the areas of trademark, unfair competition, copyright, and franchise law. He can be contacted at [email protected].

When a Business Agreement Is Not a Franchise Relationship

When are franchisors not required to provide prospective franchisees disclosures under franchise laws and regulations? The easy answer: when the 'franchisor' isn't really a franchisor. A Pennsylvania trial court granted a motion for summary judgment filed by the developer of a new concept who failed to comply with the franchise disclosure regulations because the relationship between the concept developer and a health care provider was not a 'franchise' under the FTC Franchise Rule. Mercy Health Sys. v. Metropolitan Partners Realty LLC, Business Franchise Guide '13,522 (filed Jan. 19, 2007).

Mercy Health System entered into two 15-year agreements with Metro-politan Partners Realty to operate two new ambulatory care facilities in Pennsylvania. After Mercy's efforts failed to renegotiate the agreements to address certain perceived inequities, Mercy filed a lawsuit alleging causes of action for rescission of the lease agreements, among other things, based on Metropolitan's failure to provide certain required disclosures prescribed by the federal franchise regulations.

Mercy alleged that the leases created 'accidental franchise arrangements' requiring various advance disclosures under the FTC Franchise Rule. Specifically, Mercy asserted that the parties' relationship qualified as a package franchise. The court explained that such a relationship exists where the franchisee adopts the business format established by the franchisor and identified by the franchisor's trademark, and the franchisee's 'method of operation in producing the goods or services sold by him are subject to significant controls instituted by the franchisor or alternatively the franchisor promises to render significant assistance to the franchisee in the operation of the business.'

One of the elements necessary to establish a franchise relationship is a trademark or service mark. The court determined that the record failed to show any standard services established by Metropolitan to be offered by Mercy and that, in any event, the services provided by Mercy were not offered under Metropolitan's THE WELLNESS PLACE service mark.

The court also considered the second element of the 'package franchise' definition ' that the franchisor assert substantial control over the franchisee's method of operation or provide substantial assistance to the franchisee in the operation of the business. The court concluded that Metropolitan had not exercised the requisite significant control or provided the substantial assistance necessary to classify the relationship between the parties as that of franchisor and franchisee. Metropolitan did not advise Mercy on which health plans to accept, how to advertise the facilities, which medical equipment to buy and use, or where to locate the projects.

Although the leases contained certain restrictions relating to signage at the facilities, hours of operation, food service, and subtenant restrictions, the court noted that the restrictions were of a nature customarily found in lease agreements where the landlord retains some level of management responsibilities under the lease, and that such restrictions do not rise to the level of substantial control or assistance required to establish a package franchise.

Accordingly, the court granted Metropolitan's motion for summary judgment because no franchise relationship existed between the parties.

Franchisee's Refusal to Accept Release Is Not Reason for Termination in NJ

It may seem elementary that franchisees have an obligation to perform under the terms of their agreements with franchisors, but don't be fooled. When it comes to renewing a franchise agreement, not every provision may be fair. Should franchisees be forced to go along with those that aren't? In many states, terminating or failing to renew a franchise requires 'good cause.' As the U.S. District Court for the District of New Jersey found, a franchisee's refusal to cave in to the unfair requirement that it execute a unilateral release did not constitute good cause under New Jersey law. Huntington Learning Centers, Inc. v. Futuredge, LLC, Business Franchise Guide '13,542 (filed July 28, 2005). Thus the court denied a learning center franchisor's motion for preliminary injunction against a holdover franchisee.

Huntington Learning Centers, Inc., a franchisor of learning centers throughout the United States, entered into a franchise agreement with Futuredge, LLC for operation of a franchise in California. As a condition for renewal contained in the original agreement, Huntington required Futuredge to execute a general release. When Futuredge refused, Huntington terminated the agreement and later filed a motion for preliminary injunction to prohibit Futuredge from operating the learning center in violation of in-term and post-term covenants against competition and covenants prohibiting use of Huntington's confidential information.

Under New Jersey common law, a franchisor cannot refuse to renew a franchise agreement without good cause. The court noted that 'good cause means a failure by the franchisee 'to substantially perform his obligations' under the franchise agreement.' Although Futuredge failed to comply with the provision in the agreement requiring the franchisee to execute a release as a condition to renewal, Futuredge nevertheless continued to fulfill its obligations under the terms of the agreement.

Huntington claimed the requirement of good cause did not apply because Huntington did not terminate or refuse to renew the agreement. Rather, Huntington claimed that Futuredge voluntarily allowed the agreement to expire. The court noted, however, that Futuredge believed it had valid legal claims against Huntington based on Huntington's alleged failure to make contributions to an advertising fund for its franchisees. The court determined that Huntington's insistence on the release coerced Futuredge into allowing the agreement to expire. Thus, the court determined that Huntington had caused the termination of the agreement, not Futuredge.

Moreover, the release was unilateral, requiring Futuredge to release its claims, but not requiring the same of Huntington. The court, therefore, found the agreement fundamentally unfair, and Futuredge's refusal to consent to such a release did not constitute good cause. Accordingly, the court found that Futuredge was operating as a holdover franchisee.

The court further found that as a holdover franchisee, Futuredge was not operating a competing business and was not misappropriating confidential information. Thus, Huntington could not demonstrate a likelihood of success on the merits to support the injunction.

Christopher M. Hanes is an associate in Kilpatrick Stockton LLP's Atlanta office, where he practices in the areas of trademark, unfair competition, copyright, and franchise law. He can be contacted at [email protected].