Effecting Change in Franchise Networks

TCP Capital Partners acquired The Dwyer Group in December 2010, including the franchise networks of Rainbow International, Mr. Rooter and Mr. Appliance, with the stated goal of accelerating earnings growth through business model refinements. New York-based investment house Trian acquired Wendy's in 2007 ' and very recently announced its plans to sell the Arby's franchised network (which it acquired in 2000). The Blackstone Group acquired Hilton Worldwide Inc. in 2007 and swiftly implemented a series of changes within and among Hilton's 10 networks of branded hotels (including one of its newest brands, the “Waldorf Astoria Collection”)

Attendant to each of these franchise network acquisitions (and a plethora of others transpiring over the past decade) was substantial network modification of the acquired system. However, there are significant business and legal issues which may circumscribe an acquiror's ability to effectuate such network change.

Third Player at the Table

Outside of the franchise arena, it is typically the case that the cast of characters in a planned merger or acquisition is limited and their responses ascertainable beforehand. The management of both companies will be involved, as will a raft of attorneys, accountants, financial institutions, regulatory agencies, and the press and public at large. Forecasting the positive or negative responses of these populations to the proposed merger or acquisition activity ' or their ability to scuttle same ' is usually sufficiently within the ambit of management such that the risk/reward of proceeding with the transaction is readily measurable.

However, in franchise-related mergers and acquisitions, there is another set of players at the table ' figuratively, but not usually literally ' whose temperaments are frequently unknown and who possess a plethora of weapons capable of defeating the proposed combination, or at least making it far more painful, expensive and cumbersome than would otherwise pertain. Those players are the franchisees of either the acquiring and/or the target franchise system. Due to the breadth of legal weapons they possess to challenge or even defeat proposed merger or acquisition activity ' ranging from royalty strikes to lawsuits and/or public announcements meant to instill fear in any participating bank or other financial institution ' these franchisees' proclivities, contracts and legal rights must carefully be taken into consideration and measured against the forces motivating the proposed transaction for a rational “risk/reward” analysis to transpire.

Though they have not been reported, there are several situations where franchisees were instrumental either in advancing or defeating proposed merger or acquisition activity. Whether it was a franchisee's procurement of a preliminary injunction blocking the acquisition of one franchised video rental chain by another, or the franchisee population of a fast food chain being pitched by both participants in a hostile takeover (and allying with the ultimate victor, which was not a coincidence), franchisees have ' in a non-public fashion ' frequently advanced or defeated planned merger or acquisition activity, and will continue to do so. (See, e.g., Garner, “A Franchise Lawyer's Perspective on the Duties of a Merging Franchisor,” Joining Forces: Successful Strategies for Making Purchases and Sales of Franchise Companies Work for Everyone.)

Accordingly, the solution is simple: To perform any rational risk/reward analysis of proposed franchise-related merger or acquisition activity, the legal rights, temperaments and predilections of the franchisees of the affected franchising entities must be taken into account.

Judicial Decisions

It is frequently the case that the majority of franchise agreements of mature franchisors are silent on the franchisor's ability to merge, acquire or be acquired. Frequently, vast numbers of these contracts (with the chains' largest franchisees) date back to the 1960s and 1970s, and for political purposes have changed only slightly since then.

Many of these contracts explicitly allot “exclusive territories” to franchisees; do not presage wholesale modifications to the franchisor's system (including change of name, concept and interior/exterior fixturization and/or co-branding); and, otherwise delineate franchisee rights and franchisor obligations that may make “conversion” of the acquired or merged chain impossible.

Given the clear and unequivocal language of such franchise agreements, measures must frequently be taken to mollify, compensate and/or release affected franchisees if conversion of the acquired/merged chain is to be realized. Of course, if sufficiently express franchise agreement language is extant that preordains franchisor merger, acquisition and resulting conversion activity, then many of the problems alluded to herein can be overcome.

A word of caution, however. Even when the subject franchise agreement explicitly sets forth a franchisor's right to sell out to a third party, the courts may still intervene. For example, in A.J. Temple Marble & Tile Inc. v. Union Carbide Marble Care Inc., 618 N.Y.S.2d 155, 162 Misc.2d 941, CCH Bus. Fran. Guide '10,523 (S.Ct., N.Y.Cty. 1994), the subject franchise agreement and franchise disclosure document repeatedly and explicitly authorized the franchisor to sell out to another entity freely so long as only two conditions were met: 1) that the assignee agreed to assume all contractual obligations to franchiseesl and) that the assignee was financially capable of doing so. (The author's firm represented the Union Carbide defendants in this action.) Even in such a circumstance, the New York Supreme Court permitted a franchisee to proceed with two causes of action (common law fraud and violation of the New York Franchise Act) alleging that there was some specific, secret, pre-existing plan to have the franchisor sell out that was concealed from plaintiff-franchisee. Accordingly, Union Carbide Marble Care's motion to dismiss these causes of action was denied.

Naturally, if the acquired or merged franchise network is not to be “converted” to the franchisor's name and concept, or if the acquisition is consummated by a franchisor holding company that is merely acquiring another chain, then many of these problems will frequently disappear ' but not always.

For example, in First and First Inc. et al. v. Dunkin' Donuts Inc., Unreported: 990 WL 36139, CCH Bus. Fran. Guide '9595 (E.D.Pa. 1990), in which Dunkin' Donuts was set to acquire the Mister Donut chain, 102 Mister Donut franchisees sought to enjoin the proposed acquisition claiming that the merger violated the Sherman Act, was the product of tortious interference with contract and would result in breach of contract. Rejecting plaintiffs' motion for a preliminary injunction, the court in the Eastern District of Pennsylvania held that the Mister Donut franchisees had not proven a probability of success on their antitrust action. The court held:

Plaintiffs, for various reasons, do not want the proposed merger to take place and they have tried to define a relevant product market in which Mister Donut and Dunkin' Donuts were the principal participants and in which the proposed merger would seem, therefore, to eliminate substantial competition. We are not unsympathetic to their concerns, but a federal antitrust action is not the appropriate vehicle in which to air them. The federal courts have on many occasions rejected self-serving efforts to define away competition under proffered market definitions that resemble the proverbial “strange red-haired, bearded, one-eyed man-with-a-limp” (citation omitted).

Further, the court denied the franchisee-plaintiffs' motion for a preliminary injunction on their claims of breach of contract and tortious interference with business relations. The court observed:

We can find nothing in plaintiffs' franchise agreements which prevents Mister Donut from selling its stock. Moreover, the facts give us a clear picture of defendants, who have said over and over again, that they will honor all contractual commitments of Mister Donut. Beyond speculation, we have seen no proof that they will not and believe that if any violations ever do actually occur, they could adequately be handled in an action at law. In short, we find no breach, anticipatory or otherwise, or evidence of a lack of good faith or fair dealing.

The court denied Dunkin' Donuts' motion to dismiss the underlying action, but reluctantly:

' [W]e ' decline to dismiss plaintiffs' complaint at this point in time, although, as we have noted, we have serious doubts about plaintiffs' ability to prevail.

Moreover, breach of contract actions within the framework of a franchise-related merger or acquisition can arise if the seller terminates franchise agreements deemed undesirable by the acquiror prior to the acquisition and/or the acquiror converts some, but not other, franchisees to its system. See, i.e., three related cases: Groseth International v. Tenneco Inc., 440 N.W.2d 276 (S.D. 1989); Karl Wendt Farm Equipment Co. v. International Harvestor Co., 931 F.2d 1112 (6th Cir. 1991); and Delta Truck and Tractor Inc. v. J.I. Case Co., CCH Bus. Fran. Guide '10,121 (5th Cir. 1992). These three related cases arose from International Harvester's sale of its farm equipment business to J.I. Case Co., a competitor owned by Tenneco Inc., which netted International Harvester approximately $500 million.

Because numerous territorial overlap situations among the two networks' dealers would be triggered by the transaction, Case and International Harvester agreed in their contract that Case would determine which of the two networks' dealers would remain and which would be terminated. In fact, approximately two-thirds of the dealers ultimately terminated were Case dealers, not International Harvester. But some International Harvester dealers that were terminated sued International Harvester, Case and Tenneco, variously alleging breach of contract, violation of state law and breach of fiduciary duty.

In all three cases, the defendants pointed to International Harvester's dire financial condition and cited the contract law doctrines of “frustration of purpose” and “commercial impracticability” as justifications for terminating the subject International Harvester dealer agreements. All three courts rejected this approach and held that the subject franchise agreements had been breached when the dealer was terminated other than in strict accordance with the terms of those contracts.

Of course, even when the subject franchise agreement(s) appears explicitly to authorize the merger or acquisition activity in question, franchisees still can invoke the amorphous “implied covenant of good faith and fair dealing” in an effort to have the judiciary substitute notions of “fairness” for what the contract actually says.

For example, in Clark v. America's Favorite Chicken Co. (AFC), 110 F.3d 295, CCH Bus. Fran. Guide '11,147 (5th Cir. 1997), owners of several Popeye's Fried Chicken franchises appealed from the U.S. District Court's summary judgment order dismissing their claims complaining of their franchisor's acquisition and operation of a competing franchise system, Church's Fried Chicken. Key among plaintiffs' contentions was that defendant Popeye's (the corporate predecessor to appellant AFC) violated the implied covenant of good faith and fair dealing by consummating the acquisition.

In affirming dismissal of the franchisees' claims, the court noted that the franchise agreement at issue explicitly authorized the franchisor to “' develop and establish other franchise systems for the same, similar, or different product or services” ' a contractual provision that the franchisees sought to negotiate out but, when this attempt failed, was left intact in the subject contract. Citing its decision in Domed Stadium Hotel Inc. v. Holiday Inns Inc., 732 F.2d 480 (5th Cir. 1984), the court held:

This [franchise agreement] language unambiguously reserves to AFC the right to enter into [the franchisees' trade] area and compete against them under a different set of proprietary marks. Moreover, the record establishes that appellants were aware of the significance of this provision' They cannot now be heard to argue that actions expressly authorized by this provision constitute a breach of the implied covenant of good faith and fair dealing ' In sum, the franchise agreement expressly reserves to AFC the right to do precisely what appellants now charge it with: to compete against its franchisees under a different set of proprietary marks.

In contrast, in A.J. Temple Marble & Tile Inc. v. Union Carbide Marble Care Inc., supra., a franchisee “implied covenant” claim complaining of the sale of its franchisor to a third party was permitted to survive a motion to dismiss even in the face of clear franchise agreement language specifically authorizing such a sale. While the franchisor had the right to sell out, observed the court, an “implied covenant” inquiry could be had regarding the franchisee's contention that “[Union Carbide Marble Care] sold the system to an entity with no experience as a franchisor, with no reputation, recognition or renown in the marble or stone care business ' .”

Further, a motion for summary judgment to dismiss an “implied covenant” claim complaining of the acquisition of franchisor Hot 'N Now by PepsiCo Inc. was denied. In Loehr v. Hot 'N Now Inc., 'F.Supp.'B, CCH Bus. Fran. Guide '11,352 (S.D.Fla., 1998), the franchisee alleged that the defendants destroyed his business by materially altering Hot 'N Now's fast food concept, and asserted causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing. In denying defendants' motion for summary judgment, the court held:

[T]he core of plaintiffs' Complaint is that Hot 'N Now underhandedly destroyed plaintiffs' business by materially changing the Hot 'N Now fast food concept ' Defendant responds by arguing that the “express” language of the contract gave defendant discretion to make decisions regarding the franchise. As a result, defendant argues that it did not breach its implied duty of good faith and fair dealing because defendant followed the “express” terms of the contract. However, plaintiffs argue that the duty of good faith and fair dealing was created to protect parties from abuses of discretion (citation omitted). In other words, the good faith and fair dealing standard requires parties to utilize their discretion in light of the “spirit” of the contract (citation omitted).

' [T]he implied covenant of good faith limits the controlling party's discretion and the controlling party must exercise that discretion reasonably and with proper motive and may not do so arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties (citation omitted). Therefore, the issue of whether [defendants breached their] implied duty of good faith and fair dealing is a question of fact most properly resolved by the jury.

The most recent body of case law addressing an acquiror's ability to effect broad and systemic change in an acquired franchise network relates to the acquisition of franchisor Mail Boxes Etc. (MBE) by shipper United Parcel Service and UPS's subsequent determination to rebrand all Mail Boxes Etc. stores as UPS stores. Mail Boxes Etc. franchisees, through their independent association, commenced an action against Mail Boxes Etc., claiming that compulsory re-identification coupled with UPS's new business model caused irreparable harm. In December 2007, the Superior Court of California granted summary judgment to Mail Boxes Etc., ruling that the franchisor had the contractual right to compel franchisee re-identification. Independent Association of Mailbox Center Owners Inc. v. Mail Boxes Etc. USA Inc., 2007 WL 5635421 (Cal. Superior 2007).

Concurrently, another MBE franchisee ' which did not convert its store to the “UPS” name ' commenced a separate action asserting, inter alia, that UPS committed various violations of law by presenting an MBE renewal franchise agreement which would have obligated plaintiff to convert to the UPS name, cease offering competitive shipping services and comply with franchisor UPS's designated retail prices. In essence, plaintiff-franchisee asserted that its contractual right to renew had been thus abrogated by UPS in violation of law. Given the urgency of the franchise renewal issue, the trial court bifurcated the trial, with the first phase to interpret the meaning of the original MBE franchise agreement's renewal provision.

Following a bench trial in August 2009, the court ruled against plaintiff-franchisee, holding that UPS had unfettered discretion to eliminate any economic rights or alter any aspect of the Mail Boxes Etc. franchise upon renewal so long as the same terms were then being offered to newcomers to the franchise system.

A similar result was obtained following phase two of trial, with the trial court entering judgment against plaintiff-franchisee based on its prior finding that it was not entitled to renew its MBE franchise agreement and must accept whatever franchise agreement UPS offered. G.I. McDougal Inc. et al. v. Mail Boxes Etc. Inc., 2008 WL 2152911 (Cal. App. 2 Dist. 2008) (nonpublished/noncitable). Plaintiff-franchisee filed an appeal of this decision to the California Court of Appeal on Jan. 12, 2011, which appeal remained pending at press time.

Catherine L. Burns is a partner in the Boston office of Seyfarth Shaw LLP. She can be reached at [email protected] or 617-946-4972.

This two-part series looks at the law governing a franchisor's ability to effectuate broadscale changes to its network. Part one reviewed systemic changes ' new products, new services and new uniform pricing protocols among them. Part Two herein examines franchise network change triggered by an acquisition of the franchisor.

The acquisition of a franchised network ' whether by a competitor (a “strategic” buyer) or a private equity concern (a “financial” buyer) ' is often followed by significant modifications to that network.

Dunkin' Donuts was acquired by Bain Capital in 2006, with the company shortly thereafter announcing a dramatic nationwide expansion plan and the introduction of a plethora of new food and beverage items. Roark Capital Group over the past decade acquired (among others) the Carvel, Auntie Anne's, Seattle's Best, Money Mailer, Cinnabon and McAlister's Deli networks with the goal of introducing new sales and marketing initiatives; upgrading and enhancing technology; acquiring complementary product lines; and, otherwise effecting significant changes to the acquired networks.

TCP Capital Partners acquired The Dwyer Group in December 2010, including the franchise networks of Rainbow International, Mr. Rooter and Mr. Appliance, with the stated goal of accelerating earnings growth through business model refinements. New York-based investment house Trian acquired Wendy's in 2007 ' and very recently announced its plans to sell the Arby's franchised network (which it acquired in 2000). The Blackstone Group acquired Hilton Worldwide Inc. in 2007 and swiftly implemented a series of changes within and among Hilton's 10 networks of branded hotels (including one of its newest brands, the “Waldorf Astoria Collection”)

Attendant to each of these franchise network acquisitions (and a plethora of others transpiring over the past decade) was substantial network modification of the acquired system. However, there are significant business and legal issues which may circumscribe an acquiror's ability to effectuate such network change.

Third Player at the Table

Outside of the franchise arena, it is typically the case that the cast of characters in a planned merger or acquisition is limited and their responses ascertainable beforehand. The management of both companies will be involved, as will a raft of attorneys, accountants, financial institutions, regulatory agencies, and the press and public at large. Forecasting the positive or negative responses of these populations to the proposed merger or acquisition activity ' or their ability to scuttle same ' is usually sufficiently within the ambit of management such that the risk/reward of proceeding with the transaction is readily measurable.

However, in franchise-related mergers and acquisitions, there is another set of players at the table ' figuratively, but not usually literally ' whose temperaments are frequently unknown and who possess a plethora of weapons capable of defeating the proposed combination, or at least making it far more painful, expensive and cumbersome than would otherwise pertain. Those players are the franchisees of either the acquiring and/or the target franchise system. Due to the breadth of legal weapons they possess to challenge or even defeat proposed merger or acquisition activity ' ranging from royalty strikes to lawsuits and/or public announcements meant to instill fear in any participating bank or other financial institution ' these franchisees' proclivities, contracts and legal rights must carefully be taken into consideration and measured against the forces motivating the proposed transaction for a rational “risk/reward” analysis to transpire.

Though they have not been reported, there are several situations where franchisees were instrumental either in advancing or defeating proposed merger or acquisition activity. Whether it was a franchisee's procurement of a preliminary injunction blocking the acquisition of one franchised video rental chain by another, or the franchisee population of a fast food chain being pitched by both participants in a hostile takeover (and allying with the ultimate victor, which was not a coincidence), franchisees have ' in a non-public fashion ' frequently advanced or defeated planned merger or acquisition activity, and will continue to do so. (See, e.g., Garner, “A Franchise Lawyer's Perspective on the Duties of a Merging Franchisor,” Joining Forces: Successful Strategies for Making Purchases and Sales of Franchise Companies Work for Everyone.)

Accordingly, the solution is simple: To perform any rational risk/reward analysis of proposed franchise-related merger or acquisition activity, the legal rights, temperaments and predilections of the franchisees of the affected franchising entities must be taken into account.

Judicial Decisions

It is frequently the case that the majority of franchise agreements of mature franchisors are silent on the franchisor's ability to merge, acquire or be acquired. Frequently, vast numbers of these contracts (with the chains' largest franchisees) date back to the 1960s and 1970s, and for political purposes have changed only slightly since then.

Many of these contracts explicitly allot “exclusive territories” to franchisees; do not presage wholesale modifications to the franchisor's system (including change of name, concept and interior/exterior fixturization and/or co-branding); and, otherwise delineate franchisee rights and franchisor obligations that may make “conversion” of the acquired or merged chain impossible.

Given the clear and unequivocal language of such franchise agreements, measures must frequently be taken to mollify, compensate and/or release affected franchisees if conversion of the acquired/merged chain is to be realized. Of course, if sufficiently express franchise agreement language is extant that preordains franchisor merger, acquisition and resulting conversion activity, then many of the problems alluded to herein can be overcome.

A word of caution, however. Even when the subject franchise agreement explicitly sets forth a franchisor's right to sell out to a third party, the courts may still intervene. For example, in A.J. Temple Marble & Tile Inc. v. Union Carbide Marble Care Inc. , 618 N.Y.S.2d 155, 162 Misc.2d 941, CCH Bus. Fran. Guide '10,523 (S.Ct., N.Y.Cty. 1994), the subject franchise agreement and franchise disclosure document repeatedly and explicitly authorized the franchisor to sell out to another entity freely so long as only two conditions were met: 1) that the assignee agreed to assume all contractual obligations to franchiseesl and) that the assignee was financially capable of doing so. (The author's firm represented the Union Carbide defendants in this action.) Even in such a circumstance, the New York Supreme Court permitted a franchisee to proceed with two causes of action (common law fraud and violation of the New York Franchise Act) alleging that there was some specific, secret, pre-existing plan to have the franchisor sell out that was concealed from plaintiff-franchisee. Accordingly, Union Carbide Marble Care's motion to dismiss these causes of action was denied.

Naturally, if the acquired or merged franchise network is not to be “converted” to the franchisor's name and concept, or if the acquisition is consummated by a franchisor holding company that is merely acquiring another chain, then many of these problems will frequently disappear ' but not always.

For example, in First and First Inc. et al. v. Dunkin' Donuts Inc., Unreported: 990 WL 36139, CCH Bus. Fran. Guide '9595 (E.D.Pa. 1990), in which Dunkin' Donuts was set to acquire the Mister Donut chain, 102 Mister Donut franchisees sought to enjoin the proposed acquisition claiming that the merger violated the Sherman Act, was the product of tortious interference with contract and would result in breach of contract. Rejecting plaintiffs' motion for a preliminary injunction, the court in the Eastern District of Pennsylvania held that the Mister Donut franchisees had not proven a probability of success on their antitrust action. The court held:

Plaintiffs, for various reasons, do not want the proposed merger to take place and they have tried to define a relevant product market in which Mister Donut and Dunkin' Donuts were the principal participants and in which the proposed merger would seem, therefore, to eliminate substantial competition. We are not unsympathetic to their concerns, but a federal antitrust action is not the appropriate vehicle in which to air them. The federal courts have on many occasions rejected self-serving efforts to define away competition under proffered market definitions that resemble the proverbial “strange red-haired, bearded, one-eyed man-with-a-limp” (citation omitted).

Further, the court denied the franchisee-plaintiffs' motion for a preliminary injunction on their claims of breach of contract and tortious interference with business relations. The court observed:

We can find nothing in plaintiffs' franchise agreements which prevents Mister Donut from selling its stock. Moreover, the facts give us a clear picture of defendants, who have said over and over again, that they will honor all contractual commitments of Mister Donut. Beyond speculation, we have seen no proof that they will not and believe that if any violations ever do actually occur, they could adequately be handled in an action at law. In short, we find no breach, anticipatory or otherwise, or evidence of a lack of good faith or fair dealing.

The court denied Dunkin' Donuts' motion to dismiss the underlying action, but reluctantly:

' [W]e ' decline to dismiss plaintiffs' complaint at this point in time, although, as we have noted, we have serious doubts about plaintiffs' ability to prevail.

Moreover, breach of contract actions within the framework of a franchise-related merger or acquisition can arise if the seller terminates franchise agreements deemed undesirable by the acquiror prior to the acquisition and/or the acquiror converts some, but not other, franchisees to its system. See, i.e. , three related cases: Groseth International v. Tenneco Inc. , 440 N.W.2d 276 (S.D. 1989); Karl Wendt Farm Equipment Co. v. International Harvestor Co. , 931 F.2d 1112 (6th Cir. 1991); and Delta Truck and Tractor Inc. v. J.I. Case Co., CCH Bus. Fran. Guide '10,121 (5th Cir. 1992). These three related cases arose from International Harvester's sale of its farm equipment business to J.I. Case Co., a competitor owned by Tenneco Inc., which netted International Harvester approximately $500 million.

Because numerous territorial overlap situations among the two networks' dealers would be triggered by the transaction, Case and International Harvester agreed in their contract that Case would determine which of the two networks' dealers would remain and which would be terminated. In fact, approximately two-thirds of the dealers ultimately terminated were Case dealers, not International Harvester. But some International Harvester dealers that were terminated sued International Harvester, Case and Tenneco, variously alleging breach of contract, violation of state law and breach of fiduciary duty.

In all three cases, the defendants pointed to International Harvester's dire financial condition and cited the contract law doctrines of “frustration of purpose” and “commercial impracticability” as justifications for terminating the subject International Harvester dealer agreements. All three courts rejected this approach and held that the subject franchise agreements had been breached when the dealer was terminated other than in strict accordance with the terms of those contracts.

Of course, even when the subject franchise agreement(s) appears explicitly to authorize the merger or acquisition activity in question, franchisees still can invoke the amorphous “implied covenant of good faith and fair dealing” in an effort to have the judiciary substitute notions of “fairness” for what the contract actually says.

For example, in Clark v. America's Favorite Chicken Co. (AFC) , 110 F.3d 295, CCH Bus. Fran. Guide '11,147 (5th Cir. 1997), owners of several Popeye's Fried Chicken franchises appealed from the U.S. District Court's summary judgment order dismissing their claims complaining of their franchisor's acquisition and operation of a competing franchise system, Church's Fried Chicken. Key among plaintiffs' contentions was that defendant Popeye's (the corporate predecessor to appellant AFC) violated the implied covenant of good faith and fair dealing by consummating the acquisition.

In affirming dismissal of the franchisees' claims, the court noted that the franchise agreement at issue explicitly authorized the franchisor to “' develop and establish other franchise systems for the same, similar, or different product or services” ' a contractual provision that the franchisees sought to negotiate out but, when this attempt failed, was left intact in the subject contract. Citing its decision in Domed Stadium Hotel Inc. v. Holiday Inns Inc. , 732 F.2d 480 (5th Cir. 1984), the court held:

This [franchise agreement] language unambiguously reserves to AFC the right to enter into [the franchisees' trade] area and compete against them under a different set of proprietary marks. Moreover, the record establishes that appellants were aware of the significance of this provision' They cannot now be heard to argue that actions expressly authorized by this provision constitute a breach of the implied covenant of good faith and fair dealing ' In sum, the franchise agreement expressly reserves to AFC the right to do precisely what appellants now charge it with: to compete against its franchisees under a different set of proprietary marks.

In contrast, in A.J. Temple Marble & Tile Inc. v. Union Carbide Marble Care Inc., supra., a franchisee “implied covenant” claim complaining of the sale of its franchisor to a third party was permitted to survive a motion to dismiss even in the face of clear franchise agreement language specifically authorizing such a sale. While the franchisor had the right to sell out, observed the court, an “implied covenant” inquiry could be had regarding the franchisee's contention that “[Union Carbide Marble Care] sold the system to an entity with no experience as a franchisor, with no reputation, recognition or renown in the marble or stone care business ' .”

Further, a motion for summary judgment to dismiss an “implied covenant” claim complaining of the acquisition of franchisor Hot 'N Now by PepsiCo Inc. was denied. In Loehr v. Hot 'N Now Inc., 'F.Supp.'B, CCH Bus. Fran. Guide '11,352 (S.D.Fla., 1998), the franchisee alleged that the defendants destroyed his business by materially altering Hot 'N Now's fast food concept, and asserted causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing. In denying defendants' motion for summary judgment, the court held:

[T]he core of plaintiffs' Complaint is that Hot 'N Now underhandedly destroyed plaintiffs' business by materially changing the Hot 'N Now fast food concept ' Defendant responds by arguing that the “express” language of the contract gave defendant discretion to make decisions regarding the franchise. As a result, defendant argues that it did not breach its implied duty of good faith and fair dealing because defendant followed the “express” terms of the contract. However, plaintiffs argue that the duty of good faith and fair dealing was created to protect parties from abuses of discretion (citation omitted). In other words, the good faith and fair dealing standard requires parties to utilize their discretion in light of the “spirit” of the contract (citation omitted).

' [T]he implied covenant of good faith limits the controlling party's discretion and the controlling party must exercise that discretion reasonably and with proper motive and may not do so arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties (citation omitted). Therefore, the issue of whether [defendants breached their] implied duty of good faith and fair dealing is a question of fact most properly resolved by the jury.

The most recent body of case law addressing an acquiror's ability to effect broad and systemic change in an acquired franchise network relates to the acquisition of franchisor Mail Boxes Etc. (MBE) by shipper United Parcel Service and UPS's subsequent determination to rebrand all Mail Boxes Etc. stores as UPS stores. Mail Boxes Etc. franchisees, through their independent association, commenced an action against Mail Boxes Etc., claiming that compulsory re-identification coupled with UPS's new business model caused irreparable harm. In December 2007, the Superior Court of California granted summary judgment to Mail Boxes Etc., ruling that the franchisor had the contractual right to compel franchisee re-identification. Independent Association of Mailbox Center Owners Inc. v. Mail Boxes Etc. USA Inc., 2007 WL 5635421 (Cal. Superior 2007).

Concurrently, another MBE franchisee ' which did not convert its store to the “UPS” name ' commenced a separate action asserting, inter alia, that UPS committed various violations of law by presenting an MBE renewal franchise agreement which would have obligated plaintiff to convert to the UPS name, cease offering competitive shipping services and comply with franchisor UPS's designated retail prices. In essence, plaintiff-franchisee asserted that its contractual right to renew had been thus abrogated by UPS in violation of law. Given the urgency of the franchise renewal issue, the trial court bifurcated the trial, with the first phase to interpret the meaning of the original MBE franchise agreement's renewal provision.

Following a bench trial in August 2009, the court ruled against plaintiff-franchisee, holding that UPS had unfettered discretion to eliminate any economic rights or alter any aspect of the Mail Boxes Etc. franchise upon renewal so long as the same terms were then being offered to newcomers to the franchise system.

A similar result was obtained following phase two of trial, with the trial court entering judgment against plaintiff-franchisee based on its prior finding that it was not entitled to renew its MBE franchise agreement and must accept whatever franchise agreement UPS offered. G.I. McDougal Inc. et al. v. Mail Boxes Etc. Inc., 2008 WL 2152911 (Cal. App. 2 Dist. 2008) (nonpublished/noncitable). Plaintiff-franchisee filed an appeal of this decision to the California Court of Appeal on Jan. 12, 2011, which appeal remained pending at press time.

Catherine L. Burns is a partner in the Boston office of Seyfarth Shaw LLP. She can be reached at [email protected] or 617-946-4972.