Court Watch

Quiznos' Termination Of Franchise Agreement Declared Unlawful

In December 2008, the District Court for the City and County of Denver, CO, found that a sandwich shop franchisor's actions were wrongful and therefore constituted a breach of the franchise agreement when the franchisor purportedly terminated the agreement of a franchisee who, according to the franchisor's test, had failed to use the required amount of meat to make a single sandwich ordered and inspected by the franchisor's “mystery shopper.” The court found that the franchisor's quality-control test was inherently unreliable for multiple reasons and that the franchisor had wrongfully treated this franchisee differently from other franchisees who had failed the same test; therefore, the franchisor's decision to terminate the franchise agreement on the basis of that test violated the franchisor's obligation to act reasonably when exercising its discretion in determining (as permitted by the terms of the franchise agreement) whether the franchisee's actions had materially impaired the goodwill associated with the franchisor's trademarks. Quiznos Franchising II, LLC v. Zig Zag Restaurant Group, LLC, Case No. 06CV10765 (Colo. Dist. Ct. Dec. 31, 2008).

The case involved a husband and wife (“Defendants”) who had decided to become franchisees in the Quiznos sandwich shop system. In December 2004, Defendants had signed a franchise agreement allowing them to open a Quiznos store, with the location to be determined. With the help of Quiznos' real estate personnel, Defendants agreed on a location in a planned mall in Oxford, PA, about 100 miles from their home in Bethlehem, PA. A lease was signed, but ultimately the mall was never built, and the landlord and Defendants signed a mutual release relating to the lease. While development on the Oxford store continued, Quiznos presented Defendants with an opportunity to manage another franchised Quiznos store in Coopersburg, PA, only 10 minutes from Bethlehem. Seeing the opportunity to gain experience operating a Quiznos store while their store was in development, and the additional benefit of being closer to home, Defendants agreed to manage the Coopersburg store, which they did for about eight months before buying the store outright from its previous owner and assuming the franchise agreement and lease in February 2006. No store was ever opened pursuant to Defendants' first franchise agreement, and although the franchise agreement required the store to be opened within 12 months of the execution of the agreement, both parties acknowledged the delay beyond 12 months but failed to extend the deadline or terminate the agreement before this litigation began.

In the summer of 2006, just a few months after Defendants had begun operating the Coopersburg store as franchisees, Quiznos began a new marketing campaign designed to challenge competitor Subway by offering and aggressively promoting a new Prime Rib Philly Cheesesteak sandwich with “more than twice the meat” of Subway's comparable sandwich. Quiznos specifications required the sandwich to be made with at least 5 oz. of meat, compared with 2 oz. on the Subway sandwich.

In connection with the new campaign, Quiznos developed and instituted a field-testing program to see whether its franchisees were complying with the specifications. The test involved a Quiznos field employee calling each store, ordering one of the new sandwiches “to go,” picking up the sandwich, and disassembling and weighing the meat contained in the sandwich (which involved separating the melted cheese in the sandwich from the meat). The testers did not identify themselves as Quiznos employees, and the franchisees had no knowledge that the tests were being done until Quiznos acted on the results of those tests by purportedly terminating about 7% of the franchisees in the system.

Any store whose test results showed less than 4.5 oz. of meat on the sandwich received a curable notice of default under their franchise agreement. Furthermore, stores with test results that showed less than 4 oz. of meat, as well as stores where the tester determined that the shortage was intentional, received notices that their franchise agreements were being terminated; for them, no indication was made for any opportunity for the franchisee to cure. All of the notices included a telephone number and e-mail address by which the franchisees could ask questions about the notice. A Quiznos employee testified that, despite the unconditional and non-curable nature of the language in the termination notices, Quiznos intended to rescind the terminations if the franchisees merely called or e-mailed the number or address listed in the notice and passed a future third-party inspection.

The sandwich tested from Defendants' store was determined to have 4.5 oz. of meat, but the tester also determined that the shortage was intentional. However, Quiznos was unable to explain why that determination had been made, and the individual who conducted the test did not testify in court. When Defendants received the notice of termination, they tried at least 20 times the same morning to reach someone at the telephone number listed in the notice, and they also sent an e-mail to the Quiznos “Help Desk” for franchisees, although that was a different e-mail address than the one indicated in the notice. The messages began as calm requests for someone at Quiznos to contact them about the notice, but as time passed without any response from Quiznos, one of Defendants' later messages suggested that Defendants planned to hold a press conference to complain about Quiznos' treatment of them. That message was returned. But instead of sending just the planned stock response indicating that the termination would be rescinded, Quiznos' general counsel informed Defendants that Quiznos would not tolerate any defamation and informed Defendants of the stock e-mail they would have received had they e-mailed to the listed address, but without also extending that opportunity to Defendants. The court noted that, out of about 300 franchisees that received notices of termination based on the field test, Defendants were the only ones who responded to the notice but were not given the opportunity to have the termination rescinded if they passed a future test. Bizarrely, as the court also notes, Quiznos' response also invited Defendants to continue to operate their store, but only “to mitigate damages.” Quiznos brought this lawsuit two days later.

That exchange led to what the court described as a “14-month period of operating [the] store in a Kakfaesque kind of shadow land between approved Quiznos franchisee and terminated franchisee/civil defendant.” Defendants continued to operate the store as a Quiznos, but received severely limited support from the franchisor due to the unusual and seemingly uncertain status, even within Quiznos' legal department, of Defendants' franchise agreement. Quiznos supplied Defendants with food for the store, but only limited other supplies, and essentially ceased all communications with Defendants. Ultimately, Defendants decided to cease operating as a Quiznos, and testified that the decision was made at least partially because they were concerned that Quiznos would not notify them if the food they were serving had been recalled.

In this lawsuit, Quiznos sought, inter alia, a declaratory judgment that they had lawfully terminated the Coopersburg franchise agreement based on the test result and liquidated damages for Defendants' breach. Defendants counterclaimed, seeking damages for Quiznos' wrongful termination. In its order, the court painstakingly recounted the facts of the case and the timeline of events, but went beyond the surface of the facts and explained its findings as to the true but unstated motivations for the events. In a clear example of the skepticism with which the court viewed Quiznos' claims, the judge stated, “It is clear to me, and I find, that this whole charade of 'terminating' and 'defaulting' franchisees who failed the field test was just that ' a charade ' driven not by Quiznos' genuine concern about whether its franchisees were making sandwiches to spec, but rather by its overriding public relations desire to be able to proceed with its national advertising campaign targeting Subway.”

On these primary issues, the court found for Defendants. The court found that the field test was fatally unreliable, due to both its flawed design (single small-size sandwich, weighing the deconstructed sandwich after cooking, etc.) and inconsistent and arbitrary application to franchisees (effectively punishing Defendants for choosing to call rather than e-mail in response to the termination notice, when the letter itself makes no distinction between the two methods of contact). Although the franchise agreement gave Quiznos the right to terminate the agreement if Defendants engaged “in conduct that, in the sole judgment of [Quiznos], materially impairs the goodwill associated with [Quiznos' trademarks and service marks],” the court found that Quiznos had a duty under Colorado law to exercise that judgment reasonably, and held that Quiznos' claim that the failure of a single sandwich to meet Quiznos' standards was not a reasonable basis to find a material impairment of goodwill.

Moreover, the court found that by permitting Defendants to continue operating their store after sending the termination notice, Quiznos had waived its right to terminate the Defendants' agreement, and was also estopped from asserting that right due to Defendants' reliance on that permission.

Interestingly, instead of granting Defendants typical contract damages for Quiznos' breach, the court found that rescission-type damages that attempted to put the parties into their respective positions from before entering into the agreement were more appropriate, due to the brief time between when Defendants assumed the agreement and when Quiznos attempted to terminate the agreement, and due to the unusual nature of the “shadow” period during which Defendants operated the store but with little or no support from Quiznos. Ultimately, by attempting to use the field test “charade” to justify the purported termination of Defendants franchise agreement, the court found that Quiznos had itself violated the agreement and exposed itself to liability to its franchisee.

In September 2008, the U.S. District Court for the Eastern District of New York found that two competing restaurants with similar names should be ordered to use names sufficiently different to allow consumers to distinguish between the two. The court also found that, because one of the restaurants had failed to adequately enforce the terms of the license agreements by which it had licensed third parties to use its marks, that restaurant had abandoned those licensing marks, which in the case of such “naked” licensing, results in the trademark owner forfeiting the abandoned portion of the uncontrolled marks. Patsy's Italian Restaurant, Inc. v. Banas d/b/a Patsy's, 575 F. Supp. 2d 427 (E.D.N.Y. 2008).

Plaintiff Patsy's Italian Restaurant (“Plaintiff”) brought actions against Defendant Patsy's Pizzeria (“Defendant”) for federal service mark and trademark infringement, and for trademark infringement and unfair competition under New York law. For over 60 years, the parties had been sharing the mark Patsy's for nearly identical restaurant-related services within the New York City market, with Plaintiff having registered a mark including the Patsy's name for restaurant services, and Defendant later having registered a similar mark, but in connection with its operation of a pizzeria. The parties had been vigorously litigating this and related lawsuits for many years, and this decision followed a jury trial.

The court's opinion primarily focused on complicated issues of trademark law, in which matters are interesting in their own right and certainly relevant to franchisors and franchisees, but the decision also contained an interesting discussion regarding a trademark licensors' obligation to enforce the terms of its licenses so as to ensure that its licensees do not exceed the authorized scope of use of the license marks. On this issue, the court found that, by allowing two licensed restaurants to provide services beyond those for which it claimed trademark protection, Defendant had failed to exercise sufficient quality control over those two franchised locations, and therefore the law supported Defendant losing a portion of its rights in the licensed marks, as opposed to losing all such rights, as would be the case in other types of trademark abandonment.

Also of note is the truly unusual nature of the relief granted by the court, which invalidated federally registered trademarks held by both Plaintiff and Defendant, enjoined both parties from using the mark Patsy's alone, and ordered Plaintiff to refer to its restaurant services using the mark Patsy's Italian Restaurant, and Defendant to refer to its pizzeria services using the mark Patsy's Pizzeria.

Quiznos' Termination Of Franchise Agreement Declared Unlawful

In December 2008, the District Court for the City and County of Denver, CO, found that a sandwich shop franchisor's actions were wrongful and therefore constituted a breach of the franchise agreement when the franchisor purportedly terminated the agreement of a franchisee who, according to the franchisor's test, had failed to use the required amount of meat to make a single sandwich ordered and inspected by the franchisor's “mystery shopper.” The court found that the franchisor's quality-control test was inherently unreliable for multiple reasons and that the franchisor had wrongfully treated this franchisee differently from other franchisees who had failed the same test; therefore, the franchisor's decision to terminate the franchise agreement on the basis of that test violated the franchisor's obligation to act reasonably when exercising its discretion in determining (as permitted by the terms of the franchise agreement) whether the franchisee's actions had materially impaired the goodwill associated with the franchisor's trademarks. Quiznos Franchising II, LLC v. Zig Zag Restaurant Group, LLC, Case No. 06CV10765 (Colo. Dist. Ct. Dec. 31, 2008).

The case involved a husband and wife (“Defendants”) who had decided to become franchisees in the Quiznos sandwich shop system. In December 2004, Defendants had signed a franchise agreement allowing them to open a Quiznos store, with the location to be determined. With the help of Quiznos' real estate personnel, Defendants agreed on a location in a planned mall in Oxford, PA, about 100 miles from their home in Bethlehem, PA. A lease was signed, but ultimately the mall was never built, and the landlord and Defendants signed a mutual release relating to the lease. While development on the Oxford store continued, Quiznos presented Defendants with an opportunity to manage another franchised Quiznos store in Coopersburg, PA, only 10 minutes from Bethlehem. Seeing the opportunity to gain experience operating a Quiznos store while their store was in development, and the additional benefit of being closer to home, Defendants agreed to manage the Coopersburg store, which they did for about eight months before buying the store outright from its previous owner and assuming the franchise agreement and lease in February 2006. No store was ever opened pursuant to Defendants' first franchise agreement, and although the franchise agreement required the store to be opened within 12 months of the execution of the agreement, both parties acknowledged the delay beyond 12 months but failed to extend the deadline or terminate the agreement before this litigation began.

In the summer of 2006, just a few months after Defendants had begun operating the Coopersburg store as franchisees, Quiznos began a new marketing campaign designed to challenge competitor Subway by offering and aggressively promoting a new Prime Rib Philly Cheesesteak sandwich with “more than twice the meat” of Subway's comparable sandwich. Quiznos specifications required the sandwich to be made with at least 5 oz. of meat, compared with 2 oz. on the Subway sandwich.

In connection with the new campaign, Quiznos developed and instituted a field-testing program to see whether its franchisees were complying with the specifications. The test involved a Quiznos field employee calling each store, ordering one of the new sandwiches “to go,” picking up the sandwich, and disassembling and weighing the meat contained in the sandwich (which involved separating the melted cheese in the sandwich from the meat). The testers did not identify themselves as Quiznos employees, and the franchisees had no knowledge that the tests were being done until Quiznos acted on the results of those tests by purportedly terminating about 7% of the franchisees in the system.

Any store whose test results showed less than 4.5 oz. of meat on the sandwich received a curable notice of default under their franchise agreement. Furthermore, stores with test results that showed less than 4 oz. of meat, as well as stores where the tester determined that the shortage was intentional, received notices that their franchise agreements were being terminated; for them, no indication was made for any opportunity for the franchisee to cure. All of the notices included a telephone number and e-mail address by which the franchisees could ask questions about the notice. A Quiznos employee testified that, despite the unconditional and non-curable nature of the language in the termination notices, Quiznos intended to rescind the terminations if the franchisees merely called or e-mailed the number or address listed in the notice and passed a future third-party inspection.

The sandwich tested from Defendants' store was determined to have 4.5 oz. of meat, but the tester also determined that the shortage was intentional. However, Quiznos was unable to explain why that determination had been made, and the individual who conducted the test did not testify in court. When Defendants received the notice of termination, they tried at least 20 times the same morning to reach someone at the telephone number listed in the notice, and they also sent an e-mail to the Quiznos “Help Desk” for franchisees, although that was a different e-mail address than the one indicated in the notice. The messages began as calm requests for someone at Quiznos to contact them about the notice, but as time passed without any response from Quiznos, one of Defendants' later messages suggested that Defendants planned to hold a press conference to complain about Quiznos' treatment of them. That message was returned. But instead of sending just the planned stock response indicating that the termination would be rescinded, Quiznos' general counsel informed Defendants that Quiznos would not tolerate any defamation and informed Defendants of the stock e-mail they would have received had they e-mailed to the listed address, but without also extending that opportunity to Defendants. The court noted that, out of about 300 franchisees that received notices of termination based on the field test, Defendants were the only ones who responded to the notice but were not given the opportunity to have the termination rescinded if they passed a future test. Bizarrely, as the court also notes, Quiznos' response also invited Defendants to continue to operate their store, but only “to mitigate damages.” Quiznos brought this lawsuit two days later.

That exchange led to what the court described as a “14-month period of operating [the] store in a Kakfaesque kind of shadow land between approved Quiznos franchisee and terminated franchisee/civil defendant.” Defendants continued to operate the store as a Quiznos, but received severely limited support from the franchisor due to the unusual and seemingly uncertain status, even within Quiznos' legal department, of Defendants' franchise agreement. Quiznos supplied Defendants with food for the store, but only limited other supplies, and essentially ceased all communications with Defendants. Ultimately, Defendants decided to cease operating as a Quiznos, and testified that the decision was made at least partially because they were concerned that Quiznos would not notify them if the food they were serving had been recalled.

In this lawsuit, Quiznos sought, inter alia, a declaratory judgment that they had lawfully terminated the Coopersburg franchise agreement based on the test result and liquidated damages for Defendants' breach. Defendants counterclaimed, seeking damages for Quiznos' wrongful termination. In its order, the court painstakingly recounted the facts of the case and the timeline of events, but went beyond the surface of the facts and explained its findings as to the true but unstated motivations for the events. In a clear example of the skepticism with which the court viewed Quiznos' claims, the judge stated, “It is clear to me, and I find, that this whole charade of 'terminating' and 'defaulting' franchisees who failed the field test was just that ' a charade ' driven not by Quiznos' genuine concern about whether its franchisees were making sandwiches to spec, but rather by its overriding public relations desire to be able to proceed with its national advertising campaign targeting Subway.”

On these primary issues, the court found for Defendants. The court found that the field test was fatally unreliable, due to both its flawed design (single small-size sandwich, weighing the deconstructed sandwich after cooking, etc.) and inconsistent and arbitrary application to franchisees (effectively punishing Defendants for choosing to call rather than e-mail in response to the termination notice, when the letter itself makes no distinction between the two methods of contact). Although the franchise agreement gave Quiznos the right to terminate the agreement if Defendants engaged “in conduct that, in the sole judgment of [Quiznos], materially impairs the goodwill associated with [Quiznos' trademarks and service marks],” the court found that Quiznos had a duty under Colorado law to exercise that judgment reasonably, and held that Quiznos' claim that the failure of a single sandwich to meet Quiznos' standards was not a reasonable basis to find a material impairment of goodwill.

Moreover, the court found that by permitting Defendants to continue operating their store after sending the termination notice, Quiznos had waived its right to terminate the Defendants' agreement, and was also estopped from asserting that right due to Defendants' reliance on that permission.

Interestingly, instead of granting Defendants typical contract damages for Quiznos' breach, the court found that rescission-type damages that attempted to put the parties into their respective positions from before entering into the agreement were more appropriate, due to the brief time between when Defendants assumed the agreement and when Quiznos attempted to terminate the agreement, and due to the unusual nature of the “shadow” period during which Defendants operated the store but with little or no support from Quiznos. Ultimately, by attempting to use the field test “charade” to justify the purported termination of Defendants franchise agreement, the court found that Quiznos had itself violated the agreement and exposed itself to liability to its franchisee.

In September 2008, the U.S. District Court for the Eastern District of New York found that two competing restaurants with similar names should be ordered to use names sufficiently different to allow consumers to distinguish between the two. The court also found that, because one of the restaurants had failed to adequately enforce the terms of the license agreements by which it had licensed third parties to use its marks, that restaurant had abandoned those licensing marks, which in the case of such “naked” licensing, results in the trademark owner forfeiting the abandoned portion of the uncontrolled marks. Patsy's Italian Restaurant, Inc. v. Banas d/b/a Patsy's, 575 F. Supp. 2d 427 (E.D.N.Y. 2008).

Plaintiff Patsy's Italian Restaurant (“Plaintiff”) brought actions against Defendant Patsy's Pizzeria (“Defendant”) for federal service mark and trademark infringement, and for trademark infringement and unfair competition under New York law. For over 60 years, the parties had been sharing the mark Patsy's for nearly identical restaurant-related services within the New York City market, with Plaintiff having registered a mark including the Patsy's name for restaurant services, and Defendant later having registered a similar mark, but in connection with its operation of a pizzeria. The parties had been vigorously litigating this and related lawsuits for many years, and this decision followed a jury trial.

The court's opinion primarily focused on complicated issues of trademark law, in which matters are interesting in their own right and certainly relevant to franchisors and franchisees, but the decision also contained an interesting discussion regarding a trademark licensors' obligation to enforce the terms of its licenses so as to ensure that its licensees do not exceed the authorized scope of use of the license marks. On this issue, the court found that, by allowing two licensed restaurants to provide services beyond those for which it claimed trademark protection, Defendant had failed to exercise sufficient quality control over those two franchised locations, and therefore the law supported Defendant losing a portion of its rights in the licensed marks, as opposed to losing all such rights, as would be the case in other types of trademark abandonment.

Also of note is the truly unusual nature of the relief granted by the court, which invalidated federally registered trademarks held by both Plaintiff and Defendant, enjoined both parties from using the mark Patsy's alone, and ordered Plaintiff to refer to its restaurant services using the mark Patsy's Italian Restaurant, and Defendant to refer to its pizzeria services using the mark Patsy's Pizzeria.