In the Spotlight: Franchise Law

Many commercial leases involve franchises. Consequently, a dispute between a franchisor and franchisee can result in problems for a landlord. Recent case law in New York addresses franchisor/franchisee disputes, but does not settle all of the issues satisfactorily.

Anti-Waiver Provision

New York's judiciary has only infrequently been called upon to rule whether franchisee disclaimers of franchisor misconduct ' either set forth within the subject franchise agreement itself or in a separate document subscribed contemporaneously therewith ' are somehow violative of the New York Franchise Act's “anti-waiver” provisions (at ' 687[5] thereof).

An appellate ruling addressing the issue two years ago was somewhat confusing. The decision held that a franchisor's use of such franchisee disclaimers did not violate the New York Franchise Act's anti-waiver provisions. The court nevertheless proceeded to hold that the subject franchisor could not use that franchisee's disclaimers to defend itself when the franchisee commenced an action against the franchisor asserting statutory fraud under the act.

Perhaps this confusing judicial decision was indirectly clarified in 2009 by a federal district court, in Dunkin' Donuts Franchised Restaurants LLC, et al. v. Tim & Tab Donuts Inc., Not Reported in F.Supp.2d, 2009 WL 2997382 (E.D.N.Y. 2009). In this case, a terminated Dunkin' Donuts franchisee continued to use Dunkin' Donuts' name and marks, and the franchisor commenced an action seeking, inter alia, summary judgment on its action for breach of contract, trademark infringement and unfair competition, and an injunction enjoining the franchisee from continuing to use Dunkin' Donuts' name and marks. In response, the franchisee claimed that Dunkin' Donuts fraudulently induced it to acquire the subject franchise.

Responding to the franchisee's fraud defense, Dunkin' Donuts relied on disclaimers in its franchise agreement by which the franchisee certified that no promises or representations were made by the franchisor that were not expressly contained in the subject franchise agreement or the franchise disclosure document furnished to the franchisee. Citing to these disclaimers, the court held:

' (A)lthough general merger clauses are ineffective to preclude parol evidence that a party was induced to enter a contract by means of fraud, when the contract states that a contracting party disclaims the existence of or reliance upon specified representations, that party will not be allowed to claim that he was defrauded into entering the contract in reliance on those representations (citation omitted). When a fraud defense is inconsistent with specific recitals in a contract, defendants are foreclosed from a claim of fraudulent inducement (citations omitted). Here, defendant ' was represented by counsel throughout the contract negotiations. The contract contains several disclaimers, one specifically addressing any representation made regarding profits and expenses. Furthermore, if (the franchisee) relied on any representations, the contract required him to state as much. He stated the opposite, in direct contradiction to his current position. In light of these specific disclaimers, and (the franchisee's) representation by counsel during the contract negotiations, he is foreclosed from claiming a defense of fraud, even if there were evidence of such.

Thus, while not referring to the New York Franchise Act's anti-waiver provision specifically, the court in Dunkin' Donuts at least indirectly held that a franchisor commits no wrongdoing by requiring a franchisee to disclaim fraudulent representations or activities in the subject franchise agreement and thereafter relying on that disclaimer as an affirmative defense. Accordingly, the court proceeded to grant Dunkin' Donuts' motion for summary judgment for breach of contract, trademark infringement and unfair competition, with the franchisee enjoined from continuing to use Dunkin' Donuts' trademarks, trade names and service marks.

Impact of Failure to Register

The subject of what impact, if any, a franchisor's failure to register with the New York Attorney General under the New York Franchise Act has on the enforceability of the subject franchise agreement is one that has generated much attention by New York's judiciary over the years.

Recently, the trial court held in Burgers Bar Five Towns, LLC v. Burger Holdings Corp. et al., 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010), citing unreported trial order at 2008 WL 5270297 (N.Y. Sup. Ct. 2008), that a franchisee of a kosher hamburger restaurant was entitled to recover damages from its franchisor based on the franchisor's failure to register with the New York Attorney General under the New York Franchise Act. The court awarded the plaintiff-franchisee summary judgment on its cause of action alleging a violation of the act, directed the return of all fees paid to the franchisor and awarded attorneys' fees to the plaintiff.

On appeal, the Appellate Division, Second Department, reversed. 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010). First, the court held that an issue of fact precluding the lower court's grant of summary judgment existed ' whether the franchisor qualified for the “isolated sales transaction” afforded by ' 684(3)(c) of the act (which relieves a franchisor offering a single franchise to no more than two persons from having to register under the act). But more pertinent to the discussion herein regarding the impact of a franchisor's non-registration upon the legality of the franchise sales transaction and the subject franchisee's ability to recover damages therefor, the court held:

It is ' undisputed that the defendants did not register an offering prospectus prior to entering into the subject agreement with the plaintiff ' (E)ven if the defendants violated the Franchise Sales Act by failing to register an offering prospectus, the plaintiff must still prove that it sustained damages as a result of the violation, and must further prove that the violation was “willful and material” in order to be entitled to an award of an attorney's fee (citations omitted). Here, the plaintiff failed to submit evidentiary proof that it sustained damages as a result of the defendants' alleged violation of the Franchise Sales Act, or that the alleged violation was “willful and material” (citation omitted). The plaintiff's failure to make a prima facie showing of its entitlement either to damages or an award of an attorney's fee provides an additional basis for denial of his motion for summary judgment.

Accordingly, the Appellate Division reversed the judgment of the court below.

Implied Covenant

The U.S. District Court in Massachusetts had occasion recently to interpret and apply New York law governing application of the implied covenant of good faith and fair dealing in the franchise context in Coriatt-Gaubil et al. v. Roche-Bobois International, S.A. et al., 'F.Supp.2d', 2010 WL 1994777 (D.Mass. 2010). (The author's firm represented defendants Roche-Bobois et al. in this action.)

In Coriatt-Gaubil, a franchisee commenced an action against its franchisor alleging, inter alia, that Roche-Bobois breached the implied covenant of good faith and fair dealing by terminating the plaintiff's franchise agreements. Rejecting the plaintiffs' assertion, the court held:

New York law governs the franchise agreements. There, the implied covenant of good faith and fair dealing prohibits a party from intentionally and purposely doing anything to prevent another party from carrying out the agreement on his part (citation omitted) ' Plaintiffs contend that (Roche-Bobois) breached the implied covenant of good faith and fair dealing by noticing the termination of the franchise agreements ' (P)laintiffs have not established a likelihood of success on the merits. It is not surprising that they cite no authority for the untenable proposition that a party can breach a contract's implied covenant of good faith and fair dealing by seeking to enforce the plain terms of that contract (citation omitted) (the court citing “the well-established principle that the implied covenant of good faith and fair dealing will be enforced only to the extent it is inconsistent with the provisions of the contract”).

Accordingly, the plaintiff's motion for a preliminary injunction enjoining franchise termination was denied.

The implied covenant also came into play in Yonaty v. Amerada Hess Corp., Not Reported in F.Supp.2d, 2009 WL 2824733 (N.D.N.Y. 2009), in which a gasoline station franchisee claimed that its franchisor breached the implied covenant of good faith and fair dealing by failing to make certain capital improvements to the dealer's station. Granting summary judgment to defendant Amerada Hess, and holding that it did not breach the duty of good faith it owed to plaintiff-franchisee, the court held:

To show a breach of the covenant of good faith and fair dealing, a plaintiff must show (1) fraud, (2) malice, (3) bad faith, (4) other intentional wrongdoing, or (5) reckless indifference to the rights of others such as gross negligence (citation omitted).

' Plaintiff has failed to come forward with any evidence that raises a genuine issue of material fact that would preclude the entry of summary judgment in favor of Defendant with respect to (gas station) maintenance issues; ' Defendant's extension of credit to Plaintiff; ' or raised any genuine issues to show that Defendant's failure to upgrade the (gasoline station) pump “brains” constitutes a breach of the duty of good faith.

In sum, for all of the above-stated reasons, the Court finds that Defendant is entitled to summary judgment with respect to Plaintiff's breach of the duty of good faith claim because, as a matter of law, Defendant has not breached that duty and Plaintiff has not raised any genuine issues of fact requiring a trial.

Vicarious Liability

Two recent cases involving convenience store franchisers appear to buck the 15-year-old judicial trend that a franchisor that does not control the day-to-day operations of its franchisee or the “instrumentality of harm” causing damage to a third party will generally be granted summary judgment in vicarious liability actions brought against it.

In Barker v. 7-Eleven Inc. et al., Not Reported in F.Supp.2d, 2010 WL 2267841 (Sup. Ct., Qns. Cty. 2010), a plaintiff who slipped and fell inside a franchised 7-Eleven convenience store sued both 7-Eleven and its franchisee. Rejecting 7-Eleven's motion for summary judgment, the trial court held that 7-Eleven had ” ' failed to demonstrate that the plaintiff did not raise a triable issue of fact which would preclude summary judgment (citations omitted). Whether 7-Eleven maintained the right to direct and control the manner and degree to which the franchisee could respond to the (dangerous condition) are issues which the trier of fact must resolve (citations omitted).”

In a similar vein, the appellate court in Walsh v. Super Value Inc. et al., Not Reported in F.Supp.2d, 2010 WL 2510183 (App. Div., 2d Dept. 2010) reversed a lower court's grant of summary judgment to defendant Shell Oil Company in a case involving a customer's complaint that she suffered injury after falling on a painted curb outside a franchised convenience store. The patron claimed that the paint applied to the curb outside the store was inherently slippery and caused her accident. In reversing and remanding, the court held:

Here, each of the defendants (both franchisor Shell and its franchisee) was responsible, either directly or vicariously, for the application of (the subject paint) to the curb. There was evidence that Shell directed the use of that paint ' Shell failed to establish its prima facie entitlement to judgment as a matter of law. Although there was evidence that Shell required the use of (the subject paint) and Shell itself admitted that it specified that paint as one of three acceptable products, it offered no evidence regarding its own knowledge of the characteristics and properties of the paint, and ' made no showing of a lack of knowledge as to any other accidents involving the paint it designated for use.

David J. Kaufmann is a founding member and senior partner at Kaufmann Gildin Robbins & Oppenheim, and wrote the New York Franchise Act. This article also appeared in the New York Law Journal, an ALM sister publication of this newsletter.

Many commercial leases involve franchises. Consequently, a dispute between a franchisor and franchisee can result in problems for a landlord. Recent case law in New York addresses franchisor/franchisee disputes, but does not settle all of the issues satisfactorily.

Anti-Waiver Provision

New York's judiciary has only infrequently been called upon to rule whether franchisee disclaimers of franchisor misconduct ' either set forth within the subject franchise agreement itself or in a separate document subscribed contemporaneously therewith ' are somehow violative of the New York Franchise Act's “anti-waiver” provisions (at ' 687[5] thereof).

An appellate ruling addressing the issue two years ago was somewhat confusing. The decision held that a franchisor's use of such franchisee disclaimers did not violate the New York Franchise Act's anti-waiver provisions. The court nevertheless proceeded to hold that the subject franchisor could not use that franchisee's disclaimers to defend itself when the franchisee commenced an action against the franchisor asserting statutory fraud under the act.

Perhaps this confusing judicial decision was indirectly clarified in 2009 by a federal district court, in Dunkin' Donuts Franchised Restaurants LLC, et al. v. Tim & Tab Donuts Inc., Not Reported in F.Supp.2d, 2009 WL 2997382 (E.D.N.Y. 2009). In this case, a terminated Dunkin' Donuts franchisee continued to use Dunkin' Donuts' name and marks, and the franchisor commenced an action seeking, inter alia, summary judgment on its action for breach of contract, trademark infringement and unfair competition, and an injunction enjoining the franchisee from continuing to use Dunkin' Donuts' name and marks. In response, the franchisee claimed that Dunkin' Donuts fraudulently induced it to acquire the subject franchise.

Responding to the franchisee's fraud defense, Dunkin' Donuts relied on disclaimers in its franchise agreement by which the franchisee certified that no promises or representations were made by the franchisor that were not expressly contained in the subject franchise agreement or the franchise disclosure document furnished to the franchisee. Citing to these disclaimers, the court held:

' (A)lthough general merger clauses are ineffective to preclude parol evidence that a party was induced to enter a contract by means of fraud, when the contract states that a contracting party disclaims the existence of or reliance upon specified representations, that party will not be allowed to claim that he was defrauded into entering the contract in reliance on those representations (citation omitted). When a fraud defense is inconsistent with specific recitals in a contract, defendants are foreclosed from a claim of fraudulent inducement (citations omitted). Here, defendant ' was represented by counsel throughout the contract negotiations. The contract contains several disclaimers, one specifically addressing any representation made regarding profits and expenses. Furthermore, if (the franchisee) relied on any representations, the contract required him to state as much. He stated the opposite, in direct contradiction to his current position. In light of these specific disclaimers, and (the franchisee's) representation by counsel during the contract negotiations, he is foreclosed from claiming a defense of fraud, even if there were evidence of such.

Thus, while not referring to the New York Franchise Act's anti-waiver provision specifically, the court in Dunkin' Donuts at least indirectly held that a franchisor commits no wrongdoing by requiring a franchisee to disclaim fraudulent representations or activities in the subject franchise agreement and thereafter relying on that disclaimer as an affirmative defense. Accordingly, the court proceeded to grant Dunkin' Donuts' motion for summary judgment for breach of contract, trademark infringement and unfair competition, with the franchisee enjoined from continuing to use Dunkin' Donuts' trademarks, trade names and service marks.

Impact of Failure to Register

The subject of what impact, if any, a franchisor's failure to register with the New York Attorney General under the New York Franchise Act has on the enforceability of the subject franchise agreement is one that has generated much attention by New York's judiciary over the years.

Recently, the trial court held in Burgers Bar Five Towns, LLC v. Burger Holdings Corp. et al., 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010), citing unreported trial order at 2008 WL 5270297 (N.Y. Sup. Ct. 2008), that a franchisee of a kosher hamburger restaurant was entitled to recover damages from its franchisor based on the franchisor's failure to register with the New York Attorney General under the New York Franchise Act. The court awarded the plaintiff-franchisee summary judgment on its cause of action alleging a violation of the act, directed the return of all fees paid to the franchisor and awarded attorneys' fees to the plaintiff.

On appeal, the Appellate Division, Second Department, reversed. 71 A.D.3d 939, 897 N.Y.S.2d 502 (2d Dept. 2010). First, the court held that an issue of fact precluding the lower court's grant of summary judgment existed ' whether the franchisor qualified for the “isolated sales transaction” afforded by ' 684(3)(c) of the act (which relieves a franchisor offering a single franchise to no more than two persons from having to register under the act). But more pertinent to the discussion herein regarding the impact of a franchisor's non-registration upon the legality of the franchise sales transaction and the subject franchisee's ability to recover damages therefor, the court held:

It is ' undisputed that the defendants did not register an offering prospectus prior to entering into the subject agreement with the plaintiff ' (E)ven if the defendants violated the Franchise Sales Act by failing to register an offering prospectus, the plaintiff must still prove that it sustained damages as a result of the violation, and must further prove that the violation was “willful and material” in order to be entitled to an award of an attorney's fee (citations omitted). Here, the plaintiff failed to submit evidentiary proof that it sustained damages as a result of the defendants' alleged violation of the Franchise Sales Act, or that the alleged violation was “willful and material” (citation omitted). The plaintiff's failure to make a prima facie showing of its entitlement either to damages or an award of an attorney's fee provides an additional basis for denial of his motion for summary judgment.

Accordingly, the Appellate Division reversed the judgment of the court below.

Implied Covenant

The U.S. District Court in Massachusetts had occasion recently to interpret and apply New York law governing application of the implied covenant of good faith and fair dealing in the franchise context in Coriatt-Gaubil et al. v. Roche-Bobois International, S.A. et al., 'F.Supp.2d', 2010 WL 1994777 (D.Mass. 2010). (The author's firm represented defendants Roche-Bobois et al. in this action.)

In Coriatt-Gaubil, a franchisee commenced an action against its franchisor alleging, inter alia, that Roche-Bobois breached the implied covenant of good faith and fair dealing by terminating the plaintiff's franchise agreements. Rejecting the plaintiffs' assertion, the court held:

New York law governs the franchise agreements. There, the implied covenant of good faith and fair dealing prohibits a party from intentionally and purposely doing anything to prevent another party from carrying out the agreement on his part (citation omitted) ' Plaintiffs contend that (Roche-Bobois) breached the implied covenant of good faith and fair dealing by noticing the termination of the franchise agreements ' (P)laintiffs have not established a likelihood of success on the merits. It is not surprising that they cite no authority for the untenable proposition that a party can breach a contract's implied covenant of good faith and fair dealing by seeking to enforce the plain terms of that contract (citation omitted) (the court citing “the well-established principle that the implied covenant of good faith and fair dealing will be enforced only to the extent it is inconsistent with the provisions of the contract”).

Accordingly, the plaintiff's motion for a preliminary injunction enjoining franchise termination was denied.

The implied covenant also came into play in Yonaty v. Amerada Hess Corp., Not Reported in F.Supp.2d, 2009 WL 2824733 (N.D.N.Y. 2009), in which a gasoline station franchisee claimed that its franchisor breached the implied covenant of good faith and fair dealing by failing to make certain capital improvements to the dealer's station. Granting summary judgment to defendant Amerada Hess, and holding that it did not breach the duty of good faith it owed to plaintiff-franchisee, the court held:

To show a breach of the covenant of good faith and fair dealing, a plaintiff must show (1) fraud, (2) malice, (3) bad faith, (4) other intentional wrongdoing, or (5) reckless indifference to the rights of others such as gross negligence (citation omitted).

' Plaintiff has failed to come forward with any evidence that raises a genuine issue of material fact that would preclude the entry of summary judgment in favor of Defendant with respect to (gas station) maintenance issues; ' Defendant's extension of credit to Plaintiff; ' or raised any genuine issues to show that Defendant's failure to upgrade the (gasoline station) pump “brains” constitutes a breach of the duty of good faith.

In sum, for all of the above-stated reasons, the Court finds that Defendant is entitled to summary judgment with respect to Plaintiff's breach of the duty of good faith claim because, as a matter of law, Defendant has not breached that duty and Plaintiff has not raised any genuine issues of fact requiring a trial.

Vicarious Liability

Two recent cases involving convenience store franchisers appear to buck the 15-year-old judicial trend that a franchisor that does not control the day-to-day operations of its franchisee or the “instrumentality of harm” causing damage to a third party will generally be granted summary judgment in vicarious liability actions brought against it.

In Barker v. 7-Eleven Inc. et al., Not Reported in F.Supp.2d, 2010 WL 2267841 (Sup. Ct., Qns. Cty. 2010), a plaintiff who slipped and fell inside a franchised 7-Eleven convenience store sued both 7-Eleven and its franchisee. Rejecting 7-Eleven's motion for summary judgment, the trial court held that 7-Eleven had ” ' failed to demonstrate that the plaintiff did not raise a triable issue of fact which would preclude summary judgment (citations omitted). Whether 7-Eleven maintained the right to direct and control the manner and degree to which the franchisee could respond to the (dangerous condition) are issues which the trier of fact must resolve (citations omitted).”

In a similar vein, the appellate court in Walsh v. Super Value Inc. et al., Not Reported in F.Supp.2d, 2010 WL 2510183 (App. Div., 2d Dept. 2010) reversed a lower court's grant of summary judgment to defendant Shell Oil Company in a case involving a customer's complaint that she suffered injury after falling on a painted curb outside a franchised convenience store. The patron claimed that the paint applied to the curb outside the store was inherently slippery and caused her accident. In reversing and remanding, the court held:

Here, each of the defendants (both franchisor Shell and its franchisee) was responsible, either directly or vicariously, for the application of (the subject paint) to the curb. There was evidence that Shell directed the use of that paint ' Shell failed to establish its prima facie entitlement to judgment as a matter of law. Although there was evidence that Shell required the use of (the subject paint) and Shell itself admitted that it specified that paint as one of three acceptable products, it offered no evidence regarding its own knowledge of the characteristics and properties of the paint, and ' made no showing of a lack of knowledge as to any other accidents involving the paint it designated for use.

David J. Kaufmann is a founding member and senior partner at Kaufmann Gildin Robbins & Oppenheim, and wrote the New York Franchise Act. This article also appeared in the New York Law Journal, an ALM sister publication of this newsletter.