Court Watch

In the Petition for Review, Got Junk argued that the literal terms of ' 20010 Bus. & Prof. Code precluded any waiver by any party of the CFRA. It further argued that the Court of Appeal ignored existing law that held that a choice-of-law provision embraced the prohibition against extra-territorial application. Lastly, it argued that there was indeed a split in the appellate courts as to whether the waiver of a statute embodying public policy could be effective.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.

Aggressive Pursuit of Unenforceable Provision in Franchise Agreement Equals Malicious Prosecution

A valuable lesson for franchisors can be learned from a recent not-for-publication case from California. In Robinson v. U-Haul Co. of California, et al., Bus. Franchise Guide (CCH) '14,481 (Cal. Ct. of Appeal, 1st Dist., Oct. 20, 2010), the appellate court considered various trial court rulings on defendant U-Haul's special motion to strike plaintiff Robinson's complaint for malicious prosecution and unfair business practices. The complaint was based on U-Haul's actions after Robinson terminated his dealership contract with U-Haul and had given U-Haul back all of its material and signs. In addition, U-Haul took over and assigned Robinson's telephone number to another U-Haul dealer.

After the agreement ended, Robinson opened a competing business, and U-Haul brought an action seeking an injunction against Robinson's new operation based on the post-term covenant against competition in Robinson's dealership agreement. The trial court denied U-Haul's motion for a preliminary injunction based on California Business and Professions Code ' 16600, which prohibits the enforcement of covenants against competition in most situations. After the denial of its motion for an injunction, U-Haul dismissed its complaint.

After U-Haul dismissed its complaint, Robinson filed a complaint against U-Haul asserting, among other things, that by filing a complaint based on a cause of action U-Haul knew was unenforceable, U-Haul's action amounted to malicious prosecution, and the mere inclusion of the unenforceable provision in its dealership agreements was an unfair business practice under California law. In response, U-Haul brought a special motion to strike under ' 425.16 of the California Code of Civil Procedure, allowing an expedited hearing on such a motion alleging that Robinson's suit was a strategic lawsuit against public participation or “SLAPP” suit.

Presumably, U-Haul alleged that bringing an action to enforce its contractual rights was a constitutionally protected activity ' and the court must have agreed. With that finding, Robinson had the burden to show that his claims were legally sufficient and that they were supported by a prima facie showing of facts sufficient to sustain a favorable judgment, rather than the burden being on the defendant to show that Robinson's causes of action were without merit.

To establish a cause of action for malicious prosecution, Robinson had to show: U-Haul's prior suit was concluded in his favor; lack of probable cause in bringing the action; and malice in forcing him to expend financial and emotional resources to defend the baseless claim. Malice is present when proceedings are instituted for an improper purpose, such as out of spite, ill will, or some other improper motive, such as where the person initiating the action does not believe that his claim is valid.

In opposition to the motion to strike, Robinson presented evidence showing that U-Haul had brought three prior actions against former dealers in California based on similar non-competition covenants, and that all of those actions failed because of California's strong public policy against the enforcement of such covenants based on the statute that had been in effect in one form or another since 1872. As such, there was no question that U-Haul was aware that the non-competition covenants in its dealership agreements were not valid in California, yet it brought its suit against Robinson anyway. Even though the existence of a trade secret exception is highly questionable in California, U-Haul countered that enforcement of the covenant was necessary to protect its trade secrets. However, since it produced no evidence that Robinson had access to any of its trade secrets, the court gave the argument little credence and affirmed the trial court's dismissal of U-Haul's motion to strike, which then allowed Robinson's malicious prosecution claim to go forward.

A more troubling aspect of the opinion is that the court, in upholding class action certification of Robinson's unfair business practices cause of action, concluded that the mere existence in the dealership agreement of the unenforceable covenant against competition constitutes an unfair business practice under California Business and Professions Code ' 17200. The court stated that since the dealership contract was a contract of adhesion, the uniformity in franchise agreements among U-Haul dealers made the case ideal for class adjudication on that point.

Many, probably most, franchise agreements contain non-competition covenants. In California, and wherever else enforcement is not possible or problematic, a well-informed franchisor understands that the provision may be useless. However, it is rare that the provision is removed in those states. If the holding in Robinson appears in a published opinion and spreads, franchisors could be subject to actions based on the mere existence of those provisions, even if they are not sought to be enforced.

Choice of Law: CA Defers to Washington

When a franchise agreement contains a choice-of-law provision, it is usually because the franchisor wishes to retain the ability to have a consistent state law not hostile to the franchisor govern the relationship. Franchisees, on the other hand, often prefer to have the law of the state where they operate apply. To complicate matters, many franchise protection and relationship laws have non-waiver provisions, which prohibit attempts to require a franchisee to waive any rights granted by the applicable franchise law. Choice-of-law provisions are often viewed as an attempt by the franchisor to apply a state law which by application waives certain protections granted to a franchisee under another state's law, usually the state where the franchisee operates. Choice-of-law issues often do not arise if the lawsuit is filed in the state whose law is selected to govern the relationship.

In 1-800-Got Junk? v. Superior Court , 116 Cal.Rptr.3d 923 (Ca. Ct. App. Oct. 21, 2010), the franchise agreement contained a Washington choice-of-law provision, presumably because Washington was close to the franchisor's headquarters in Vancouver, Canada. California franchisee Millennium Asset Recovery, Inc. filed suit in California for wrongful termination of the franchise agreement. The franchisor had terminated the franchise by virtue of a non-curable termination notice based upon false revenue reporting.

The California Franchise Relations Act (“CFRA”) permits non-curable termination notices based on a number of situations, including “engag[ing] in conduct which reflects materially and unfavorably upon the operation and reputation of the franchise business or system.” See ' 20021(c) Cal. Bus. & Prof. Code. On the other hand, the Washington Franchise Investment Protection Act (“WFIPA”) limits non-curable notices to four situations, none of which encompassed the franchisee's conduct. It is thus understandable why the franchisee wanted Washington law to apply, as provided in the franchise agreement. The franchisee could have increased its odds by suing in Washington, and in fact the franchise agreement provided that Washington would be the exclusive forum for dispute resolution. (Even if the franchisor did no business in Washington, the forum selection clause could be read as a consent to in personam jurisdiction.) Nonetheless, the franchisee sued in California, in reliance on the CFRA provision, which made forum selection clauses for any non-California venue void. Cal. Bus. & Prof. Code ' 20040.5.

The franchisee sought a ruling that Washington law should apply, and the trial court ruled in its favor on this issue. As the court observed, it was “an anomalous case ' the franchisee is seeking enforcement of the franchise agreement's choice of law provision and the franchisor is seeking its invalidation.” 116 Cal.Rptr.3d at 925 (note 2). The franchisor took a writ petition, and the court of appeal, in a published opinion, ruled that Washington law applied. The court came to its conclusion by applying traditional choice-of-law principles set forth in ' 187 of the Restatement [Second of Conflict of Laws] coupled with an analysis of whether the “anti-waiver” provision in the CFRA (' 20010 Bus. & Prof. Code), which makes void a contractual stipulation that purports to waive any provision of the CFRA, precluded application of Washington law.

The court's ' 187 Restatement analysis was simple. Even though it was admitted by the franchisee that Washington bore no “substantial relationship” between the franchisee or the transaction, it applied the alternative test, finding that a “reasonable basis” existed for the choice of Washington law because Washington was the U.S. state law closest to the headquarters of the franchisor in Vancouver, and ample authority supported the selection of one state law to govern the relationship of a franchisor and its multi-state franchisees.

The last prong of the ' 187 test ' whether a fundamental public policy of California precluded enforcement of Washington law ' posed somewhat of a challenge because of the CFRA which, in its non-waiver provision, evinced California's policy that the CFRA could not be waived. While that could be interpreted as precluding any choice-of-law provision (' 20010, Bus. & Prof. Code, provides: “Any condition, stipulation or provision purporting to bind any person to waive compliance with any provision of this law is contrary to public policy and void.”), the court held that it only precluded choice of a law that would “diminish” the rights granted by the CFRA. It reached this result by looking to cases interpreting a similar anti-waiver provision contained in the California Franchise Investment Law (“CFIL”). (See Wimsatt v. Beverly Hills Weight etc. International, Inc. (1995) 38 Cal.Rptr.2d 612, where the court held that enforcement of a forum selection clause to a state other than California would only violate a similar anti-waiver provision if it operated to impair the franchisee's rights under the CFIL.)

Because the Washington Franchise Investment Protection Act had more favorable protections regarding termination than the CFRA, application of Washington law did not operate as a waiver of the CFRA protections. The franchisor in this case found itself in the unenviable position of trying to escape a provision that it presumably drafted ' never a good position to be in. Whether its predicament could have been avoided by clever drafting is doubtful. For instance, ask yourself if the following would be upheld: “The laws of the State of Washington shall apply to this agreement unless there is a more favorable law to the franchisor.”

On Dec. 1, 2010, the franchisor filed a Petition for Review to the California Supreme Court, which had not yet been ruled upon at press time.

In the Petition for Review, Got Junk argued that the literal terms of ' 20010 Bus. & Prof. Code precluded any waiver by any party of the CFRA. It further argued that the Court of Appeal ignored existing law that held that a choice-of-law provision embraced the prohibition against extra-territorial application. Lastly, it argued that there was indeed a split in the appellate courts as to whether the waiver of a statute embodying public policy could be effective.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.