Effecting Change in Franchise Networks

A constant source of tension between mature franchisors and their franchisees is the periodic need to modify the network's concept and system to keep up with (or ahead of) the competition; to incorporate new technologies; to respond to changed consumer demographics, ethnicities, preferences and trends; to introduce new products or services and delete from the system older products and services; to modify existing trademarks/service marks, or abandon them altogether in favor of new trademarks/service marks; to modify the exterior and interior design of the network's units and the equipment utilized on the premises; to establish new advertising platforms and campaigns; to require integration of new technologies; and, otherwise to keep the mature franchise network's image, products and/or services fresh, competitive and responsive.

Sometimes, modifying a mature franchisor's concept and system requires franchisees to make only slight changes. Other times, substantial unit renovations, franchisee retraining and new product/service offerings are involved. In other instances, a complete system overhaul is involved, requiring franchisees to retrofit their units completely to the new concept, operate under new trademarks/service marks and deal with entirely new product/service lines in lieu of existing product/service lines.

Frequently, the mature franchisor's attempt to overhaul its system encounters resistance from franchisees, which can range from slight to massive depending upon the degree of franchisee investment required; franchisee uncertainty about what the economic impact of the contemplated changes will be; the sometimes disparate burdens the overhaul will trigger among franchised units; the number of years remaining before franchise expiration; and franchisee inertia (“I've been doing this for so long, I don't want to change my ways now”). The ability of a mature franchisor to effect such system/concept changes largely derives from the reserved contractual right to do so. Franchise agreement language addressing this subject is critical.

But even when franchise agreement language specifically reserving to the franchisor the right to initiate systemwide changes is extant, franchisee lawsuits complaining of the franchisor's exercise of said right have been forthcoming. This article examines the law governing a franchisor's ability to effectuate broad-scale changes to its network.

Systemic Changes

It did not take long for a franchisee to sue its franchisor complaining of imposed system modifications. The franchisor in question ' Burger King ' was not so “mature” at the time. In 1966, a franchisee complained of Burger King changing certain standards and specifications ' including an increase in the quantity of meat to be used in making hamburgers. Trail Burger King, Inc. v. Burger King of Miami, Inc., 187 So. 2d 55 (Dist.Ct. of App. of Fla, 3d Dist. 1966). The franchisee refused to comply with Burger King's new standards. According to the Florida court, the franchisee deliberately sold hamburgers containing less meat than Burger King's new specifications required; refused to provide adequate condiments on tables; refused to provide background music; refused to paint his building; and utilized unauthorized drink dispensers. The franchisee filed suit over Burger King's threatened termination of its franchise.

Following a motion for a judgment on the pleadings, the court found that there was no question of fact to be determined and held that Burger King had the right “' to set and maintain standards and specifications for the operation of plaintiff(s)' restaurant and to make reasonable changes in such standards and specifications from time to time as circumstances may dictate ' .”

Affirming the lower court's decision in this 1966 case, the judiciary early on sounded a theme that has carried through to today, namely, that a franchisor's modification of its system is not equivalent to modification of the underlying franchise agreement but rather a mere effectuation of that agreement, as follows:

We have found that the [court below] was correct in determining that such changes are not modifications or amendments to the agreement, but were provided for in the agreement. It is clear from the language of the instrument that one of the objects is to provide uniformity among all franchised “Burger King” restaurants. Review of the clauses of the agreement ' reveals that this uniformity is accomplished by providing that the defendant set and maintain standards and specifications which the plaintiff must follow or suffer termination of the agreement. The [court below] has interpreted the agreement in accordance with the natural and ordinary meaning of the language employed. Id. at 58.

That franchisees complaining of proposed system modifications are actually the intended beneficiaries thereof was made clear in Principe v. McDonald's Corp., 631 F.2d 303 (4th Cir. 1980) cert. denied 451 U.S. 970 (1981), in which the Fourth U.S. Circuit Court of Appeals observed:

' (P)ervasive franchisor supervision and control benefits the franchisee ' His business is identified with a network of stores whose very uniformity and predictability attracts customers.

Litigation History

Over the years, virtually every court asked to rule on a mature franchisor's ability to modify its system and concept have sided with the franchisor. For example, the issue in Economou et al. v. Physicians Weight Loss Centers of America et al., 756 F.Supp. 1024, CCH Bus. Franchise Guide '9771 (N.D.Ohio 1991), was a franchisee's claim that its weight loss franchisor's change of program diet, consequent decrease in the franchise network's consumer weight loss guarantee and the franchisor's directive that the franchisee disseminate an information sheet warning about certain risks associated with its diet caused such grave economic harm to the franchisee that it was entitled to declare the contract terminated and to operate free of the subject franchise agreement's covenant not to compete.

Denying the franchisee's motion for a preliminary injunction, the Ohio district court observed that:

In any event, the fact remains that the franchise agreements specifically allow [the franchisor] to make such changes 'These contractual clauses serve to defeat plaintiffs' breach of contract claim ' In sum, this court finds that defendants have shown a substantial likelihood of success on the merits. Id. at CCH page 22,001.

In turn, the court granted the franchisor's cross-motion for a preliminary injunction enforcing its covenant not to compete.

Similarly, in Great Clips, Inc. v. Levine et al., Not reported in F.Supp., 1991 WL 322974 and 1991 WL 322975, CCH Bus. Franchise Guide '9933 (D. Minn. 1991), the Minnesota district court had before it a franchisee complaining that its franchisor's policy manual amendments incorporating new retail price restrictions amounted to a breach of contract, violation of the Sherman Act and violation of the implied covenant of good faith and fair dealing. The court disagreed, granting to franchisor Great Clips its requested declaratory judgment that no Sherman Act violation was extant and that no violation of the implied covenant had transpired.

For a case holding that a franchisor's modification of its system in fact breached the implied covenant of good faith and fair dealing and gave rise to tortious bad faith, unfair dealing and fraudulent misrepresentation, see Amos v. Union Oil Company of California, dba Unocal., 663 F.Supp. 1027, CCH Bus. Franchise Guide '8891 (D.Ore. 1987). In this case, Unocal dealers complained of their franchisor's sudden shift in strategy from serving the “upper end” of the market (high octane) to substituting a commonplace gasoline product without a competitive price that, it was alleged, made it impossible for the dealers to compete. Following a jury trial, it was found that Unocal breached the implied covenant of good faith and fair dealing, engaged in fraud, tortious bad faith and unfair dealing. The court denied Unocal's motion for a directed verdict before the case went to the jury, and felt compelled to issue an opinion explaining why:

Plaintiffs presented evidence that the discontinuance of the special grade [of gasoline] and substitution of a commonplace product without a competitive price made it impossible for plaintiffs to compete. The dealers suffered complaints from customers whose cars did not perform well with the lower octane product and confusion as to why they should pay a higher price for a product available everywhere for substantially less. Unocal conducted no prior studies of the effect of the change on the dealers. There was evidence that Unocal recognized and ignored the risk of a dramatic shift in customer base and volume loss with the change to 87 octane without becoming competitive on the price ' Id. at CCH pages 17,828-17,829.

However, the norm remains that absent such allegedly predatory conduct, franchisees challenging their franchisors' system wide modifications will usually fail.

'Constructive Termination'

Sage counsel should be aware of yet another legal issue prompted by franchisor systemic changes, namely, whether such changes amount to “constructive termination” of the subject franchise agreement in violation of state “relationship” laws. One case from Connecticut and a plethora of cases from Wisconsin address this issue. See, e.g., Petereit et al. v. S.B. Thomas, Inc., 63 F.3d 1169 (2d Cir. 1995); Wisconsin Music Network, Inc. v. Muzak Limited Partnership, 5 F.3d 218, CCH Bus. Franchise Guide '10,283 (7th Cir. 1993); Ziegler Co., Inc. v. Rexnord Inc., 147 Wis.2d 308, 433 N.W.2d 8, CCH Bus. Franchise Guide '9317 (Wisc.Sup.Ct. 1988); and the recent Wisconsin Supreme Court decision in Jungbluth v. Hometown, Inc., 201 Wis.2d 320, 548 N.W. 2d 519, CCH Bus. Franchise Guide '10,936 (Wisc.Sup.Ct. 1996). The majority opinion in Jungbluth found that franchisor-imposed system modifications are not to be confused with “constructive termination” of the subject franchise agreements, and no violation of state franchise relationship law provisions forbidding franchise termination in the absence of good cause will be found to have transpired.

Resale Price Maintenance

Over the past decade, it has become increasingly clear to many franchisors that engaging in true “price point advertising” ' that is, advertising a product or service for sale at a unitary price good at every outlet nationwide (and not just “at participating locations only”) ' is of critical import. Simply stated, their non-franchised competitors engage in “price point” advertising all the time, while until only recently ' as elucidated below ' franchisors were absolutely forbidden by federal antitrust law from compelling their franchisees to offer products or services at a predetermined retail price. But all that changed over the past 15 years.

Franchisors historically were legally precluded from dictating the prices that their franchisees could charge for goods and services by virtue of a nearly century-old U.S. Supreme Court decision, holding that such activity was a per se violation of Section 1 of the Sherman Act ' a “red light” infraction, if you will, which could result in an award of treble damages and attorneys' fees. Doctor Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1914).

Since that 1914 U.S. Supreme Court decision, the Court has from time to time provided exceptions from this absolute ban on resale price maintenance. The first exception came in 1919, when the Supreme Court decided that, while a manufacturer and retailer could not agree to a minimum resale price program, the manufacturer could nevertheless unilaterally refuse to sell to a retailer that did not adhere to the manufacturer's minimum resale price ' even though the economic effects of both categories of activity are generally the same. United States v. Colgate & Co., 250 U.S. 300 (1919).

But 15 years ago, in State Oil Co. v. Khan, 522 U.S.3 (1997), the Supreme Court eliminated the per se rule against maximum resale price maintenance programs, instead subjecting such programs to the more liberal “rule of reason” analysis. (Importantly for franchisors, the U.S. Supreme Court earlier rejected what had been the per se prohibition on certain non-price vertical restraints ' such as “exclusive territories”' instead holding that these, too, should fall under the “rule of reason” analytical prism. Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S.36 (1977).

And in 2007, in a further reversal of its own nearly century-old doctrine, the U.S. Supreme Court abandoned its absolute prohibition on minimum resale price maintenance agreements, holding that such agreements must be analyzed under the more liberal “rule of reason” standard (and not automatically declared illegal under the per se standard) when challenged as a violation of Section 1 of the Sherman Act. The Supreme Court's decision was rendered in Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877 (2007).

Over the past two years, the Eleventh U.S. Circuit Court of Appeals and the U.S. District Court for the Southern District of Florida have ruled three times that franchisor Burger King Corporation (BKC) had the right to impose on franchisees maximum prices for its “Value Menu” items by virtue of the Burger King franchise agreement provision which states that the franchisor could make changes and additions to its operating system ” ' which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary' .”

In the Eleventh Circuit case, the court affirmed the lower court's determination that: “BKC has the right, under the parties' franchise agreements, to require compliance with the Value Menu. The franchise agreements specifically require Defendants to adhere to BKC's comprehensive restaurant format and operating system.” Burger King v. E-Z Eating 41 Corp., 572 F.3d 1306 (11th Cir. 2009).

In a subsequent, but entirely parallel case ' whose impact would be felt system-wide within the Burger King network (since plaintiff was Burger King's National Franchisee Association (NFA)) ' the U.S. District Court for the Southern District of Florida issued two opinions. In the first, rendered in May 2010, the court held that under the language of the Burger King franchise agreement, ” ' [plaintiff's] claim that [the Burger King franchise agreement] does not grant BKC the authority to impose maximum prices ' fails as a matter of law.” National Franchisee Association v. Burger King Corporation, 715 F.Supp.2d 1232 (S.D.Fla. May 20, 2010)

However, since the subject Burger King franchise agreement language permitted Burger King to compel modifications of its system “which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary ' “, the court in its first decision granted Burger King's motion to dismiss its franchisees' claim that it did not have the authority under said franchise agreement to set maximum prices but let proceed the franchisees' claim that Burger King's imposition of the $1 double cheeseburger violated its contractual duty of good faith. However, on that issue, too, Burger King prevailed. National Franchisee Association v. Burger King Corporation, Slip Copy, 2010 WL 4811912 (S.D. Fla, Nov. 19, 2010).

The ability of franchisors to dictate precisely the minimum and maximum retail prices which their franchisees may charge the public for products and services can dramatically heighten those franchisors' competitive positions versus other brands.

“Price-point” advertising no longer has to be followed by the usual “at participating locations only” disclaimer (with customer dissatisfaction naturally resulting upon a customer's visiting and being charged more at a non-participating franchised location). Instead, the ability to engage in price-point campaigns aggressively on a system-wide basis is facilitated. Further, a uniform retail pricing paradigm will preclude one franchisee from seeking to underprice, and draw market share from, its competitive franchisees ' especially important if the first, underpricing franchisee has large economies of scale enabling it aggressively to underprice its franchisee competitors. In addition, not to miss the obvious, franchisors' revenues ' based as they are as a percentage of franchisee gross sales ' may more easily be ascertained and predicted, even optimized, as opposed to the generally prevailing situation where a franchisee can lower or raise its retail prices to any point it desires.

However, we must stress that the benefits afforded by the recent U.S. Supreme Court decisions subjecting resale price maintenance agreements to the “rule of reason,” rather than the “per se” standard does not yet enable franchisors to engage in such activity nationwide. Most critically, relatively few franchise agreements reserve to the respective franchisors the right to impose minimum or maximum retail prices upon their franchisees. Absent such a contractual reservation of right, these franchisors ' notwithstanding the Burger King decisions discussed above ' may be held utterly without power to engage in such activity.

Moreover, and also of critical concern, while the U.S. Supreme Court has declared resale price maintenance as now subject only to a “rule of reason” analysis when legality is determined, it is critically important to understand that the states ' many of which feature their own non-preempted antitrust laws ' have not followed suit and may never do so. In this regard, it is vital to note that a number of states statutorily declare resale price maintenance agreements to be per se unlawful.

Furthermore, as noted above, while proving a “rule of reason” case is often difficult for antitrust plaintiffs, in its recent decision, the Supreme Court did outline circumstances under which resale price maintenance programs would be considered problematic and perhaps declared illegal.

Finally, it will now be up to lower courts to recraft resale price maintenance jurisprudence under the Supreme Court's “rule of reason” analysis ' and there is no way of knowing just how these lower courts will rule on the issue, what disparities among the circuits will evolve and how those disparities will in the future be reconciled by the U.S. Supreme Court.

Conclusion

We recommend that franchisors engage in the following course of conduct: 1) closely analyze state antitrust laws and edicts regarding resale price maintenance agreements and monitor how those may be impacted by, or changed, following the U.S. Supreme Court decisions referenced above; and 2) include in successor franchise agreements a reservation of right under which the franchisor may impose minimum/maximum retail prices upon its franchisees to the greatest extent permitted by law.

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

A constant source of tension between mature franchisors and their franchisees is the periodic need to modify the network's concept and system to keep up with (or ahead of) the competition; to incorporate new technologies; to respond to changed consumer demographics, ethnicities, preferences and trends; to introduce new products or services and delete from the system older products and services; to modify existing trademarks/service marks, or abandon them altogether in favor of new trademarks/service marks; to modify the exterior and interior design of the network's units and the equipment utilized on the premises; to establish new advertising platforms and campaigns; to require integration of new technologies; and, otherwise to keep the mature franchise network's image, products and/or services fresh, competitive and responsive.

Sometimes, modifying a mature franchisor's concept and system requires franchisees to make only slight changes. Other times, substantial unit renovations, franchisee retraining and new product/service offerings are involved. In other instances, a complete system overhaul is involved, requiring franchisees to retrofit their units completely to the new concept, operate under new trademarks/service marks and deal with entirely new product/service lines in lieu of existing product/service lines.

Frequently, the mature franchisor's attempt to overhaul its system encounters resistance from franchisees, which can range from slight to massive depending upon the degree of franchisee investment required; franchisee uncertainty about what the economic impact of the contemplated changes will be; the sometimes disparate burdens the overhaul will trigger among franchised units; the number of years remaining before franchise expiration; and franchisee inertia (“I've been doing this for so long, I don't want to change my ways now”). The ability of a mature franchisor to effect such system/concept changes largely derives from the reserved contractual right to do so. Franchise agreement language addressing this subject is critical.

But even when franchise agreement language specifically reserving to the franchisor the right to initiate systemwide changes is extant, franchisee lawsuits complaining of the franchisor's exercise of said right have been forthcoming. This article examines the law governing a franchisor's ability to effectuate broad-scale changes to its network.

Systemic Changes

It did not take long for a franchisee to sue its franchisor complaining of imposed system modifications. The franchisor in question ' Burger King ' was not so “mature” at the time. In 1966, a franchisee complained of Burger King changing certain standards and specifications ' including an increase in the quantity of meat to be used in making hamburgers. Trail Burger King, Inc. v. Burger King of Miami, Inc. , 187 So. 2d 55 (Dist.Ct. of App. of Fla, 3d Dist. 1966). The franchisee refused to comply with Burger King's new standards. According to the Florida court, the franchisee deliberately sold hamburgers containing less meat than Burger King's new specifications required; refused to provide adequate condiments on tables; refused to provide background music; refused to paint his building; and utilized unauthorized drink dispensers. The franchisee filed suit over Burger King's threatened termination of its franchise.

Following a motion for a judgment on the pleadings, the court found that there was no question of fact to be determined and held that Burger King had the right “' to set and maintain standards and specifications for the operation of plaintiff(s)' restaurant and to make reasonable changes in such standards and specifications from time to time as circumstances may dictate ' .”

Affirming the lower court's decision in this 1966 case, the judiciary early on sounded a theme that has carried through to today, namely, that a franchisor's modification of its system is not equivalent to modification of the underlying franchise agreement but rather a mere effectuation of that agreement, as follows:

We have found that the [court below] was correct in determining that such changes are not modifications or amendments to the agreement, but were provided for in the agreement. It is clear from the language of the instrument that one of the objects is to provide uniformity among all franchised “Burger King” restaurants. Review of the clauses of the agreement ' reveals that this uniformity is accomplished by providing that the defendant set and maintain standards and specifications which the plaintiff must follow or suffer termination of the agreement. The [court below] has interpreted the agreement in accordance with the natural and ordinary meaning of the language employed. Id. at 58.

That franchisees complaining of proposed system modifications are actually the intended beneficiaries thereof was made clear in Principe v. McDonald's Corp. , 631 F.2d 303 (4th Cir. 1980) cert. denied 451 U.S. 970 (1981), in which the Fourth U.S. Circuit Court of Appeals observed:

' (P)ervasive franchisor supervision and control benefits the franchisee ' His business is identified with a network of stores whose very uniformity and predictability attracts customers.

Litigation History

Over the years, virtually every court asked to rule on a mature franchisor's ability to modify its system and concept have sided with the franchisor. For example, the issue in Economou et al. v. Physicians Weight Loss Centers of America et al., 756 F.Supp. 1024, CCH Bus. Franchise Guide '9771 (N.D.Ohio 1991), was a franchisee's claim that its weight loss franchisor's change of program diet, consequent decrease in the franchise network's consumer weight loss guarantee and the franchisor's directive that the franchisee disseminate an information sheet warning about certain risks associated with its diet caused such grave economic harm to the franchisee that it was entitled to declare the contract terminated and to operate free of the subject franchise agreement's covenant not to compete.

Denying the franchisee's motion for a preliminary injunction, the Ohio district court observed that:

In any event, the fact remains that the franchise agreements specifically allow [the franchisor] to make such changes 'These contractual clauses serve to defeat plaintiffs' breach of contract claim ' In sum, this court finds that defendants have shown a substantial likelihood of success on the merits. Id. at CCH page 22,001.

In turn, the court granted the franchisor's cross-motion for a preliminary injunction enforcing its covenant not to compete.

Similarly, in Great Clips, Inc. v. Levine et al., Not reported in F.Supp., 1991 WL 322974 and 1991 WL 322975, CCH Bus. Franchise Guide '9933 (D. Minn. 1991), the Minnesota district court had before it a franchisee complaining that its franchisor's policy manual amendments incorporating new retail price restrictions amounted to a breach of contract, violation of the Sherman Act and violation of the implied covenant of good faith and fair dealing. The court disagreed, granting to franchisor Great Clips its requested declaratory judgment that no Sherman Act violation was extant and that no violation of the implied covenant had transpired.

For a case holding that a franchisor's modification of its system in fact breached the implied covenant of good faith and fair dealing and gave rise to tortious bad faith, unfair dealing and fraudulent misrepresentation, see Amos v. Union Oil Company of California, dba Unocal., 663 F.Supp. 1027, CCH Bus. Franchise Guide '8891 (D.Ore. 1987). In this case, Unocal dealers complained of their franchisor's sudden shift in strategy from serving the “upper end” of the market (high octane) to substituting a commonplace gasoline product without a competitive price that, it was alleged, made it impossible for the dealers to compete. Following a jury trial, it was found that Unocal breached the implied covenant of good faith and fair dealing, engaged in fraud, tortious bad faith and unfair dealing. The court denied Unocal's motion for a directed verdict before the case went to the jury, and felt compelled to issue an opinion explaining why:

Plaintiffs presented evidence that the discontinuance of the special grade [of gasoline] and substitution of a commonplace product without a competitive price made it impossible for plaintiffs to compete. The dealers suffered complaints from customers whose cars did not perform well with the lower octane product and confusion as to why they should pay a higher price for a product available everywhere for substantially less. Unocal conducted no prior studies of the effect of the change on the dealers. There was evidence that Unocal recognized and ignored the risk of a dramatic shift in customer base and volume loss with the change to 87 octane without becoming competitive on the price ' Id. at CCH pages 17,828-17,829.

However, the norm remains that absent such allegedly predatory conduct, franchisees challenging their franchisors' system wide modifications will usually fail.

'Constructive Termination'

Sage counsel should be aware of yet another legal issue prompted by franchisor systemic changes, namely, whether such changes amount to “constructive termination” of the subject franchise agreement in violation of state “relationship” laws. One case from Connecticut and a plethora of cases from Wisconsin address this issue. See, e.g., Petereit et al. v. S.B. Thomas, Inc., 63 F.3d 1169 (2d Cir. 1995); Wisconsin Music Network, Inc. v. Muzak Limited Partnership , 5 F.3d 218, CCH Bus. Franchise Guide '10,283 (7th Cir. 1993); Ziegler Co., Inc. v. Rexnord Inc. , 147 Wis.2d 308, 433 N.W.2d 8, CCH Bus. Franchise Guide '9317 (Wisc.Sup.Ct. 1988); and the recent Wisconsin Supreme Court decision in Jungbluth v. Hometown, Inc. , 201 Wis.2d 320, 548 N.W. 2d 519, CCH Bus. Franchise Guide '10,936 (Wisc.Sup.Ct. 1996). The majority opinion in Jungbluth found that franchisor-imposed system modifications are not to be confused with “constructive termination” of the subject franchise agreements, and no violation of state franchise relationship law provisions forbidding franchise termination in the absence of good cause will be found to have transpired.

Resale Price Maintenance

Over the past decade, it has become increasingly clear to many franchisors that engaging in true “price point advertising” ' that is, advertising a product or service for sale at a unitary price good at every outlet nationwide (and not just “at participating locations only”) ' is of critical import. Simply stated, their non-franchised competitors engage in “price point” advertising all the time, while until only recently ' as elucidated below ' franchisors were absolutely forbidden by federal antitrust law from compelling their franchisees to offer products or services at a predetermined retail price. But all that changed over the past 15 years.

Franchisors historically were legally precluded from dictating the prices that their franchisees could charge for goods and services by virtue of a nearly century-old U.S. Supreme Court decision, holding that such activity was a per se violation of Section 1 of the Sherman Act ' a “red light” infraction, if you will, which could result in an award of treble damages and attorneys' fees. Doctor Miles Medical Co. v. John D. Park & Sons Co. , 220 U.S. 373 (1914).

Since that 1914 U.S. Supreme Court decision, the Court has from time to time provided exceptions from this absolute ban on resale price maintenance. The first exception came in 1919, when the Supreme Court decided that, while a manufacturer and retailer could not agree to a minimum resale price program, the manufacturer could nevertheless unilaterally refuse to sell to a retailer that did not adhere to the manufacturer's minimum resale price ' even though the economic effects of both categories of activity are generally the same. United States v. Colgate & Co. , 250 U.S. 300 (1919).

But 15 years ago, in State Oil Co. v. Khan, 522 U.S.3 (1997), the Supreme Court eliminated the per se rule against maximum resale price maintenance programs, instead subjecting such programs to the more liberal “rule of reason” analysis. (Importantly for franchisors, the U.S. Supreme Court earlier rejected what had been the per se prohibition on certain non-price vertical restraints ' such as “exclusive territories”' instead holding that these, too, should fall under the “rule of reason” analytical prism. Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S.36 (1977).

And in 2007, in a further reversal of its own nearly century-old doctrine, the U.S. Supreme Court abandoned its absolute prohibition on minimum resale price maintenance agreements, holding that such agreements must be analyzed under the more liberal “rule of reason” standard (and not automatically declared illegal under the per se standard) when challenged as a violation of Section 1 of the Sherman Act. The Supreme Court's decision was rendered in Leegin Creative Leather Products, Inc. v. PSKS , Inc. , 551 U.S. 877 (2007).

Over the past two years, the Eleventh U.S. Circuit Court of Appeals and the U.S. District Court for the Southern District of Florida have ruled three times that franchisor Burger King Corporation (BKC) had the right to impose on franchisees maximum prices for its “Value Menu” items by virtue of the Burger King franchise agreement provision which states that the franchisor could make changes and additions to its operating system ” ' which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary' .”

In the Eleventh Circuit case, the court affirmed the lower court's determination that: “BKC has the right, under the parties' franchise agreements, to require compliance with the Value Menu. The franchise agreements specifically require Defendants to adhere to BKC's comprehensive restaurant format and operating system.” Burger King v. E-Z Eating 41 Corp. , 572 F.3d 1306 (11th Cir. 2009).

In a subsequent, but entirely parallel case ' whose impact would be felt system-wide within the Burger King network (since plaintiff was Burger King's National Franchisee Association (NFA)) ' the U.S. District Court for the Southern District of Florida issued two opinions. In the first, rendered in May 2010, the court held that under the language of the Burger King franchise agreement, ” ' [plaintiff's] claim that [the Burger King franchise agreement] does not grant BKC the authority to impose maximum prices ' fails as a matter of law.” National Franchisee Association v. Burger King Corporation , 715 F.Supp.2d 1232 (S.D.Fla. May 20, 2010)

However, since the subject Burger King franchise agreement language permitted Burger King to compel modifications of its system “which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary ' “, the court in its first decision granted Burger King's motion to dismiss its franchisees' claim that it did not have the authority under said franchise agreement to set maximum prices but let proceed the franchisees' claim that Burger King's imposition of the $1 double cheeseburger violated its contractual duty of good faith. However, on that issue, too, Burger King prevailed. National Franchisee Association v. Burger King Corporation, Slip Copy, 2010 WL 4811912 (S.D. Fla, Nov. 19, 2010).

The ability of franchisors to dictate precisely the minimum and maximum retail prices which their franchisees may charge the public for products and services can dramatically heighten those franchisors' competitive positions versus other brands.

“Price-point” advertising no longer has to be followed by the usual “at participating locations only” disclaimer (with customer dissatisfaction naturally resulting upon a customer's visiting and being charged more at a non-participating franchised location). Instead, the ability to engage in price-point campaigns aggressively on a system-wide basis is facilitated. Further, a uniform retail pricing paradigm will preclude one franchisee from seeking to underprice, and draw market share from, its competitive franchisees ' especially important if the first, underpricing franchisee has large economies of scale enabling it aggressively to underprice its franchisee competitors. In addition, not to miss the obvious, franchisors' revenues ' based as they are as a percentage of franchisee gross sales ' may more easily be ascertained and predicted, even optimized, as opposed to the generally prevailing situation where a franchisee can lower or raise its retail prices to any point it desires.

However, we must stress that the benefits afforded by the recent U.S. Supreme Court decisions subjecting resale price maintenance agreements to the “rule of reason,” rather than the “per se” standard does not yet enable franchisors to engage in such activity nationwide. Most critically, relatively few franchise agreements reserve to the respective franchisors the right to impose minimum or maximum retail prices upon their franchisees. Absent such a contractual reservation of right, these franchisors ' notwithstanding the Burger King decisions discussed above ' may be held utterly without power to engage in such activity.

Moreover, and also of critical concern, while the U.S. Supreme Court has declared resale price maintenance as now subject only to a “rule of reason” analysis when legality is determined, it is critically important to understand that the states ' many of which feature their own non-preempted antitrust laws ' have not followed suit and may never do so. In this regard, it is vital to note that a number of states statutorily declare resale price maintenance agreements to be per se unlawful.

Furthermore, as noted above, while proving a “rule of reason” case is often difficult for antitrust plaintiffs, in its recent decision, the Supreme Court did outline circumstances under which resale price maintenance programs would be considered problematic and perhaps declared illegal.

Finally, it will now be up to lower courts to recraft resale price maintenance jurisprudence under the Supreme Court's “rule of reason” analysis ' and there is no way of knowing just how these lower courts will rule on the issue, what disparities among the circuits will evolve and how those disparities will in the future be reconciled by the U.S. Supreme Court.

Conclusion

We recommend that franchisors engage in the following course of conduct: 1) closely analyze state antitrust laws and edicts regarding resale price maintenance agreements and monitor how those may be impacted by, or changed, following the U.S. Supreme Court decisions referenced above; and 2) include in successor franchise agreements a reservation of right under which the franchisor may impose minimum/maximum retail prices upon its franchisees to the greatest extent permitted by law.

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