Court Watch

Since the delegation clause was the only improper provision in the franchise agreement, the appellate court held that the contract, although one of adhesion, was not “permeated with unconscionability.” Therefore, the motion to deny arbitration granted by the trial court was reversed.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. He can be reached at [email protected] or 415-956-1900.

Right to Condemnation Award for Loss of Goodwill May Be Assigned to Franchisor

Under California law, the owner of a business conducted on condemned property can claim compensation for the loss of goodwill. Cal. Code of Civ. Proc. ' 1263.510. A 1992 case held that a franchisor could not make a claim for loss of goodwill under that statute since it was not the owner of the concerned business, citing, among other things, the franchise agreement's disclaimer of any partnership, joint venture or agency relationship between the operator and the franchisor. Redevelopment Agency v. International House of Pancakes, Inc. , 12 Cal.Rptr. 2d 358 (1992).

The issue came up again in Galardi Group Franchise & Leasing, LLC v. City of El Cajon, 2011 WL 2184347 (Cal. Ct. of Appeal 4th Dist., June 7, 2011). When the city of El Cajon acquired the location in question under its power of eminent domain ' it was a long-standing Wienerschnitzel restaurant ' the city refused to pay either the franchisee or the franchisor for the loss of goodwill. The city maintained that Galardi, as a franchisor, had no right to claim goodwill damages under the IHOP precedent. Galardi claimed that its agreement with the Wienerschnitzel restaurant operator did not amount to a franchise agreement, a fact that the court did not find controlling as to whether Galardi was the “owner” of the business. In order to cover its bases and bring an action against the city, Galardi obtained an assignment of the restaurant operator's right to claim goodwill damages against the city and brought an action for its own loss of goodwill and, as its assignee, for that of the operator. The city maintained that a provision in the “Operator Agreement” in which the operator of the concerned facility “waives all right to or interest in any condemnation award or settlement” waived the operator's right to claim goodwill damages against the city and, as such, there were no rights to assign. The trial court found for the city on both counts.

In affirming the trial court finding that Galardi was not the owner of the business, the appellate court cited the IHOP-like disclaimers about partnership, agency, etc., in the Operator Agreement, as well as other provisions which sought, as do most franchise agreements, to immunize the franchisor against liability, operating expenses, etc. It then turned to the assignment to Galardi of the operator's right to goodwill damages.

Galardi argued that the waiver of condemnation damages provision in its Operator Agreement was intended to determine the right to such damages between itself and its operator, not to establish rights between it, its operator and a third-party public agency. The appellate court, reviewing the matter de novo, indicated that a party seeking the rights of a third-party beneficiary bears the burden of showing the provision was made for its benefit personally or as a member of a class of which it is a member. Here, there was no indication that was the case. The court held that the clear intent of the parties was to determine the right to goodwill damages among themselves and that they did not consider that right waived, citing, among other things, that the parties' execution of the assignment occurred after the property was acquired by the city, indicating that the parties considered the right to such damages to be in effect long after the Operator Agreement was signed.

In light of this case, those who write franchise agreements may want to craft their eminent domain provisions to be assignments of the appropriate rights, rather than merely having the franchisee disclaim its rights to the concerned compensation.

Exercising a Contract Right to Change Franchise Agreement Terms Is Not a 'Material Modification'

Unless an exemption is available under the statute, California Corporations Code ' 31125 requires a franchisor that wishes to solicit a franchisee to agree to a material modification of an existing franchise agreement to make a filing with the California Department of Corporations and allow the franchisee five days to review, or if the change is already signed to rescind, the proposed change. In re: ConocoPhillips Company Service Station Rent Contract Litigation, Bus. Franchise Guide (CCH) '14,598 (USDC, N.D. California April 13, 2011), multi-district litigation between ConocoPhillips Company and many of its gasoline stations franchisees, arose out of Conoco's motion to dismiss the plaintiffs' Second Amended Consolidated Master Complaint. The Complaint, among other things, claimed that Conoco's increase in the stations' rent without complying with ' 31125 violated the California Franchise Investment Law. The Dealer Station Lease at issue provided that the station operator would pay Conoco rent in accordance with Conoco's “Rent Policy” and that the Rent Policy could be amended by Conoco “at any time and from time to time.” The leases stated that the Rent Policy would be adopted by Conoco “in good faith and in the ordinary course of business” and that the dealers would be given at least 90 days notice of any change. The station operators did not allege that the changes were not in good faith, outside of the ordinary course of business, or that the required notice was not given.

The court held that rent changes were contemplated and allowed by the lease agreement. As such, it ruled that the disputed rent increases were not “material modifications” of the contract requiring compliance with ' 31125.

While certainty is a favorable attribute in a franchise agreement, it is wise to allow flexibility when it can be foreseen that key provisions may change over time. However, placing reasonable restrictions on the nature, timing and amount of such changes, or other applicable parameters, may give franchisees and prospective franchisees who may be considering the advisability of purchasing the franchise some comfort when being asked to agree to provisions that may be modified in the future.

Single Unconscionable Provision in Franchise Agreement Will Not Defeat Arbitration Clause

In Htay Htay Chin v. Advanced Fresh Concepts Franchise Corp., Bus. Franchise Guide (CCH) '14,602 (Cal. Ct. of Appeal 2nd Dist., April 20, 2011), the concerned franchise agreement contained an arbitration clause that delegated the issue of the validity of the arbitration provision to the arbitrator. The contract also contained provisions that required a waiver of punitive damages and specified that “[a]ny award shall be based on established law and shall not be made on broad principles of justice and equity.”

The plaintiff maintained that the franchise agreement was a contract of adhesion, offered to her on a take-it-or-leave-it basis by a party with superior bargaining power ' which she claimed satisfied the requirement for procedural unconscionability. In order to satisfy the requirement that there also be substantive unconscionability (inequitable provisions), the plaintiff pointed, among other things, to the delegation clause and the other cited provisions to show that the agreement was unfair.

Because neither party claimed that the Federal Arbitration Act, (9 U.S.C. ' 1 et seq.) pre-empted the California law that had been selected in the franchise agreement, the case was resolved under California contract law. Under that law, the court held that precedent required that the provision that specified that the arbitrator decide arbitrability would not be enforced in an adhesion contract interpreted under California law, distinguishing Rent-A-Center, West, Inc. v. Jackson , 130 S.Ct. 2772 (2010). That unenforceability does not condemn the entire arbitration provision, however, unless it contains additional unconscionable terms, as claimed by the plaintiff.

The trial court found that the provisions requiring that the award of the arbitrator be based on “established law and ' not on broad principles of justice and equity” was unconscionable because it would prevent equitable claims and defenses from being raised. The appellate court pointed out that “[w]hen an arbitrator's powers are unrestricted by agreement, judicial review must be narrow and differential.” The cited language, however, would not prevent equitable relief but would, rather, merely limit the arbitrator's broad powers and allow judicial review on the merits of the arbitration award to see that they complied with the restrictions of the contract.

The plaintiff maintained, and the trial court agreed, that the provision limiting recovery to actual damages and waiving punitive damages was also unconscionable since it waived punitive damages that were available under a statute, the section of the California Franchise Investment Law (“CFIL”) that allows damages for selling an unregistered franchise, citing a 1979 California appellate case, Spahn v. Guild Industries Corp. , 94 Cal.App.3d 143 (1979), that upheld a punitive damage award for the fraudulent sale of an unregistered franchise. Although the appellate court did not point out that the punitive damage award in Spahn was for fraud in the sale of the franchise, not the California Franchise Investment Law violation, the court stated that since the franchise at issue was registered and the complaint did not allege a violation of the registration provisions, that argument was inapposite in any event.

Since the delegation clause was the only improper provision in the franchise agreement, the appellate court held that the contract, although one of adhesion, was not “permeated with unconscionability.” Therefore, the motion to deny arbitration granted by the trial court was reversed.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. He can be reached at [email protected] or 415-956-1900.