Court Watch

A recent case decided by the Minnesota District Court has added some clarity about which violations of the Minnesota Franchise Act can actually lead to a rescission claim by a franchisee. The court in Bonus of America, Inc. v. Angel Falls Services, L.L.C., Bus. Franchise Guide (CCH) '14, 415, emphasized that franchisees do not have an absolute right to rescission based on violations of the Minnesota Franchise Act. Instead, “to avoid unjust outcomes based on technical violations, absent actual fraud, franchisees do not have an absolute right to rescind a franchise agreement which violates the [Minnesota Franchise Act].” The question then becomes: Which types of violations constitute “technical violations” of the statute?

In this case, the franchisor sold a master franchise to a franchisee in Minnesota on June 4, 2007. The franchisor had submitted its franchise registration to the state on April 19, 2007, but, unfortunately for the franchisor, the state did not approve the registration until July 26, 2007. Therefore, the franchisor sold the franchise to the Minnesota franchisee well over a month before it was actually registered with the state of Minnesota. The franchisee later brought a claim against the franchisor seeking, among other relief, rescission of the master franchise agreement.

The court found that the franchisor's lack of a valid registration in the state at the time of the sale was a “technical violation,” and, as such, the franchisee did not have an absolute right to rescind. The franchisor was therefore entitled to make equitable defenses against rescission, such as the defense of unclean hands on the part of the franchisee. Interestingly, the franchisee also alleged that the franchisor had provided it with revenue information for two other franchisees that was not included in the franchise disclosure document. The court failed to make a clear decision as to whether the franchisee was entitled to rescission based on this allegation, but it did state that in any case, the franchisor would also be entitled to assert equitable defenses against rescission based on these alleged improper pre-sale disclosures.

District Court Can Grant Interim Injunctive Relief to Preserve Status Quo Despite Arbitration Agreement

The Ninth Circuit Court of Appeals recently held that even where parties to a contract agree to arbitrate disputes, and where the arbitration association's rule specifically provides for the issuance of interim injunctive relief, a district court can grant preliminary injunctive relief to preserve the status quo pending the arbitration proceedings. Toyo Tire Holdings of Americas Inc. v. Continental Tire North America, Inc., 609 F.3d. 975 (9th Cir. 2010). Through this holding, the Ninth Circuit noted that it joins the First, Second, Third, Fourth, Sixth, Seventh, Eighth, and Tenth Circuits, which have reached similar conclusions.

In 1988, plaintiff Toyo Tire Holdings of Americas Inc. (“Toyo”) formed a general partnership with the defendants in this case (“Defendants”), and the parties entered into a partnership agreement (the “Partnership Agreement”). The partnership manufactured tires for distribution. On Dec. 22, 2009, Defendants sent Toyo a letter announcing that they were dissolving the partnership, that, pursuant to the Partnership Agreement, they could acquire Toyo's share of tires manufactured by the partnership in 2010, and that they intended to enforce the non-competition clause that prohibited Toyo from selling any other tires in North America for five years.

The Partnership Agreement contained an arbitration clause requiring arbitration in accordance with the rules of the International Chamber of Commerce. Therefore, on Jan. 11, 2010, Toyo requested arbitration, including a request for interim injunctive relief, with the International Chamber of Commerce, International Court of Arbitration.

On the same day, Toyo also commenced a lawsuit in California state court, which Defendants promptly removed to federal district court in California. On Jan. 14, 2010, Toyo moved the court for a preliminary injunction to prevent Defendants from terminating it as a partner in the partnership, from withholding its tire supply, and from making defamatory statements about it.

Without specifically considering each of the factors for preliminary injunctive relief, the district court indicated that it believed injunctive relief was warranted. It concluded, however, that under a prior case, Simula, Inc. v. Autoliv, Inc., 175 F.3d 716 (9th Cir. 1999), a district court may not grant a preliminary injunction when the parties have agreed to arbitrate and the arbitrator has the power to grant injunctive relief.

International Chamber of Commerce rules do give arbitrators the power to order interim injunctive relief, but also state that “any competent judicial authority” may order interim injunctive relief before the file is transmitted to the panel and “in appropriate circumstances even thereafter.”

In Simula, the plaintiff argued that preliminary injunctive relief should be granted by the court because the arbitrators did not have the power to grant such relief. The court in that case denied the motion because the arbitrators did have the power to grant interim injunctive relief, and there was no evidence of any imminent need for such relief to maintain the status quo until the question could be addressed by the arbitrators. The Ninth Circuit distinguished the case because, unlike the plaintiff in Simula, Toyo had showed the need for imminent relief. It sought an injunction to preserve the status quo until the arbitral panel could decide the issue. As such, allowing a court to grant this relief did not frustrate the federal policy in favor of arbitral dispute resolution, but was actually necessary to preserve the meaningfulness of the arbitral process. The court recognized that although speed and efficiency are goals of arbitration, they do not always materialize, and the selection of an arbitral panel can take considerable time. If courts were not permitted to step in and grant injunctive relief to preserve the status quo pending constitution of the panel, parties may be without a remedy. In this case, if Toyo lost its customers before the arbitral panel could rule on the issue, any relief would then be useless.

Therefore, the Ninth Circuit held that the district court abused its discretion in incorrectly applying Simula and remanded the case for expedited consideration of the preliminary injunction factors.

Termination Allowed Even When Franchisee Disputed Amounts Owed

Krispy Kreme Doughnut Corporation (“Krispy Kreme”) recently succeeded in obtaining an injunction against a previously terminated franchisee, prohibiting the former franchisee from operating in New York's Penn Station and at one other location. The court found the franchisee was properly terminated, even in light of the former franchisee's allegations that the franchisor provided improper notices of default and termination.

In Krispy Kreme Doughnut Corporation et al.. v. Satellite Donuts, LLC et al., 10 Civ. 4272, the franchisee fell behind on royalty fees, advertising fund fees, and other fees due under its franchise agreements. Although the franchisee alleged that Krispy Kreme orally promised to defer collection of these fees, Krispy Kreme provided the franchisee with a “Notice of Default and Demand For Payment” setting forth a particular amount due. The notice provided that Krispy Kreme would have the right to terminate the franchise agreement if the franchisee failed to pay the total amount due by a date certain.

The franchisee approached the franchisor and indicated that a third party was considering investing in the business, which would allow the franchisee to pay its debts to the franchisor. The franchisor refused to extend the cure period for the default in order to allow time for the franchisee to make arrangements for the third-party investment.

Subsequently, the franchisor issued a “Notice to Cease and Desist” stating that the default remained uncured and, consequently, the franchise agreements were thereby terminated. The Notice to Cease and Desist also provided that the franchisee no longer had authorization to use the marks. After receiving this notice, the franchisee continued to operate, and Krispy Kreme subsequently brought an action for a preliminary injunction enjoining the franchisee from continuing to operate the business and using the Krispy Kreme marks.

The franchisee argued that the notices of default and termination were inadequate to properly terminate the agreements. First, the franchisee alleged that the franchisor overstated the amount due in the first notice of default and thus violated the principle of good faith and fair dealing. The court rejected this argument. It stated that, although there may be a dispute as to amounts owed to the franchisor, the franchisee should have undertaken some action in order to cure the default. Among the options available were for the franchisee to: 1) pay the undisputed amounts; 2) bring an action for declaratory judgment on the amount owed; or 3) move for a Yellowstone injunction tolling the cure period pending resolution of the dispute. But by refusing to tender any payment whatsoever, the franchisee did not move toward curing the default, and thus the franchisor was entitled to terminate the franchise agreements.

Importantly, the court also provided that there was “no obligation on the part of Krispy Kreme to indicate with precision the amount of defendants' default under the Agreements.” Also, the court rejected the franchisee's contention that the covenant of good faith and fair dealing was violated by the franchisor's refusal to extend the cure period to allow time for a third-party investment. Finally, the court rejected any evidence of oral promises by the franchisor that it would defer royalty payments, as the franchise agreements contained a “no-oral-modification clause.”

The franchisee further argued that the notice of termination was inadequate because it was titled “Notice to Cease and Desist,” and was not specifically called a “Notice of Termination.” The court found that the letter itself specifically referred to termination of the franchise agreements, and therefore the agreements were properly terminated despite the fact that the name of the notice did not include the word “termination.”

The court also found that irreparable harm was easily shown in this case, and because the franchisee had been properly terminated, the franchisor was entitled to an injunction prohibiting the franchisee from operating at the franchised locations.

Cynthia M. Klaus is a shareholder and Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] or 952-896-3392, and [email protected] or 952-896-3263, respectively.

No Absolute Right to Rescind Based on Franchisor's Violation of State Law

One of the consequences feared most by franchisors relating to a violation of state franchise laws is the potential that a franchisee may be able to rescind the purchase of its franchise. A violation of state franchise laws during the sales process can result in the franchisee being able to terminate the franchise agreement and receive reimbursement from the franchisor of all sums paid to it during the franchise relationship (after giving back all tangible materials supplied to the franchisee by the franchisor).

In Minnesota, the Minnesota Franchise Act specifically provides that “a person who violates any provision ' thereunder shall be liable to the franchisee ' who may sue for damages caused thereby, for rescission, or other relief as the court may deem appropriate.” Minn. Stat. ' 80C.17. The statutory language appears to allow a court to grant rescission to a franchisee for any violation by the franchisor of the Minnesota Franchise Act, no matter how minor or technical. Courts in Minnesota have since limited the factual circumstances in which franchisees can be granted rescission, however.

A recent case decided by the Minnesota District Court has added some clarity about which violations of the Minnesota Franchise Act can actually lead to a rescission claim by a franchisee. The court in Bonus of America, Inc. v. Angel Falls Services, L.L.C., Bus. Franchise Guide (CCH) '14, 415, emphasized that franchisees do not have an absolute right to rescission based on violations of the Minnesota Franchise Act. Instead, “to avoid unjust outcomes based on technical violations, absent actual fraud, franchisees do not have an absolute right to rescind a franchise agreement which violates the [Minnesota Franchise Act].” The question then becomes: Which types of violations constitute “technical violations” of the statute?

In this case, the franchisor sold a master franchise to a franchisee in Minnesota on June 4, 2007. The franchisor had submitted its franchise registration to the state on April 19, 2007, but, unfortunately for the franchisor, the state did not approve the registration until July 26, 2007. Therefore, the franchisor sold the franchise to the Minnesota franchisee well over a month before it was actually registered with the state of Minnesota. The franchisee later brought a claim against the franchisor seeking, among other relief, rescission of the master franchise agreement.

The court found that the franchisor's lack of a valid registration in the state at the time of the sale was a “technical violation,” and, as such, the franchisee did not have an absolute right to rescind. The franchisor was therefore entitled to make equitable defenses against rescission, such as the defense of unclean hands on the part of the franchisee. Interestingly, the franchisee also alleged that the franchisor had provided it with revenue information for two other franchisees that was not included in the franchise disclosure document. The court failed to make a clear decision as to whether the franchisee was entitled to rescission based on this allegation, but it did state that in any case, the franchisor would also be entitled to assert equitable defenses against rescission based on these alleged improper pre-sale disclosures.

District Court Can Grant Interim Injunctive Relief to Preserve Status Quo Despite Arbitration Agreement

The Ninth Circuit Court of Appeals recently held that even where parties to a contract agree to arbitrate disputes, and where the arbitration association's rule specifically provides for the issuance of interim injunctive relief, a district court can grant preliminary injunctive relief to preserve the status quo pending the arbitration proceedings. Toyo Tire Holdings of Americas Inc. v. Continental Tire North America, Inc. , 609 F.3d. 975 (9th Cir. 2010). Through this holding, the Ninth Circuit noted that it joins the First, Second, Third, Fourth, Sixth, Seventh, Eighth, and Tenth Circuits, which have reached similar conclusions.

In 1988, plaintiff Toyo Tire Holdings of Americas Inc. (“Toyo”) formed a general partnership with the defendants in this case (“Defendants”), and the parties entered into a partnership agreement (the “Partnership Agreement”). The partnership manufactured tires for distribution. On Dec. 22, 2009, Defendants sent Toyo a letter announcing that they were dissolving the partnership, that, pursuant to the Partnership Agreement, they could acquire Toyo's share of tires manufactured by the partnership in 2010, and that they intended to enforce the non-competition clause that prohibited Toyo from selling any other tires in North America for five years.

The Partnership Agreement contained an arbitration clause requiring arbitration in accordance with the rules of the International Chamber of Commerce. Therefore, on Jan. 11, 2010, Toyo requested arbitration, including a request for interim injunctive relief, with the International Chamber of Commerce, International Court of Arbitration.

On the same day, Toyo also commenced a lawsuit in California state court, which Defendants promptly removed to federal district court in California. On Jan. 14, 2010, Toyo moved the court for a preliminary injunction to prevent Defendants from terminating it as a partner in the partnership, from withholding its tire supply, and from making defamatory statements about it.

Without specifically considering each of the factors for preliminary injunctive relief, the district court indicated that it believed injunctive relief was warranted. It concluded, however, that under a prior case, Simula, Inc. v. Autoliv, Inc., 175 F.3d 716 (9th Cir. 1999), a district court may not grant a preliminary injunction when the parties have agreed to arbitrate and the arbitrator has the power to grant injunctive relief.

International Chamber of Commerce rules do give arbitrators the power to order interim injunctive relief, but also state that “any competent judicial authority” may order interim injunctive relief before the file is transmitted to the panel and “in appropriate circumstances even thereafter.”

In Simula, the plaintiff argued that preliminary injunctive relief should be granted by the court because the arbitrators did not have the power to grant such relief. The court in that case denied the motion because the arbitrators did have the power to grant interim injunctive relief, and there was no evidence of any imminent need for such relief to maintain the status quo until the question could be addressed by the arbitrators. The Ninth Circuit distinguished the case because, unlike the plaintiff in Simula, Toyo had showed the need for imminent relief. It sought an injunction to preserve the status quo until the arbitral panel could decide the issue. As such, allowing a court to grant this relief did not frustrate the federal policy in favor of arbitral dispute resolution, but was actually necessary to preserve the meaningfulness of the arbitral process. The court recognized that although speed and efficiency are goals of arbitration, they do not always materialize, and the selection of an arbitral panel can take considerable time. If courts were not permitted to step in and grant injunctive relief to preserve the status quo pending constitution of the panel, parties may be without a remedy. In this case, if Toyo lost its customers before the arbitral panel could rule on the issue, any relief would then be useless.

Therefore, the Ninth Circuit held that the district court abused its discretion in incorrectly applying Simula and remanded the case for expedited consideration of the preliminary injunction factors.

Termination Allowed Even When Franchisee Disputed Amounts Owed

Krispy Kreme Doughnut Corporation (“Krispy Kreme”) recently succeeded in obtaining an injunction against a previously terminated franchisee, prohibiting the former franchisee from operating in New York's Penn Station and at one other location. The court found the franchisee was properly terminated, even in light of the former franchisee's allegations that the franchisor provided improper notices of default and termination.

In Krispy Kreme Doughnut Corporation et al.. v. Satellite Donuts, LLC et al., 10 Civ. 4272, the franchisee fell behind on royalty fees, advertising fund fees, and other fees due under its franchise agreements. Although the franchisee alleged that Krispy Kreme orally promised to defer collection of these fees, Krispy Kreme provided the franchisee with a “Notice of Default and Demand For Payment” setting forth a particular amount due. The notice provided that Krispy Kreme would have the right to terminate the franchise agreement if the franchisee failed to pay the total amount due by a date certain.

The franchisee approached the franchisor and indicated that a third party was considering investing in the business, which would allow the franchisee to pay its debts to the franchisor. The franchisor refused to extend the cure period for the default in order to allow time for the franchisee to make arrangements for the third-party investment.

Subsequently, the franchisor issued a “Notice to Cease and Desist” stating that the default remained uncured and, consequently, the franchise agreements were thereby terminated. The Notice to Cease and Desist also provided that the franchisee no longer had authorization to use the marks. After receiving this notice, the franchisee continued to operate, and Krispy Kreme subsequently brought an action for a preliminary injunction enjoining the franchisee from continuing to operate the business and using the Krispy Kreme marks.

The franchisee argued that the notices of default and termination were inadequate to properly terminate the agreements. First, the franchisee alleged that the franchisor overstated the amount due in the first notice of default and thus violated the principle of good faith and fair dealing. The court rejected this argument. It stated that, although there may be a dispute as to amounts owed to the franchisor, the franchisee should have undertaken some action in order to cure the default. Among the options available were for the franchisee to: 1) pay the undisputed amounts; 2) bring an action for declaratory judgment on the amount owed; or 3) move for a Yellowstone injunction tolling the cure period pending resolution of the dispute. But by refusing to tender any payment whatsoever, the franchisee did not move toward curing the default, and thus the franchisor was entitled to terminate the franchise agreements.

Importantly, the court also provided that there was “no obligation on the part of Krispy Kreme to indicate with precision the amount of defendants' default under the Agreements.” Also, the court rejected the franchisee's contention that the covenant of good faith and fair dealing was violated by the franchisor's refusal to extend the cure period to allow time for a third-party investment. Finally, the court rejected any evidence of oral promises by the franchisor that it would defer royalty payments, as the franchise agreements contained a “no-oral-modification clause.”

The franchisee further argued that the notice of termination was inadequate because it was titled “Notice to Cease and Desist,” and was not specifically called a “Notice of Termination.” The court found that the letter itself specifically referred to termination of the franchise agreements, and therefore the agreements were properly terminated despite the fact that the name of the notice did not include the word “termination.”

The court also found that irreparable harm was easily shown in this case, and because the franchisee had been properly terminated, the franchisor was entitled to an injunction prohibiting the franchisee from operating at the franchised locations.

Cynthia M. Klaus is a shareholder and Meredith A. Bauer is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] or 952-896-3392, and [email protected] or 952-896-3263, respectively.