Court Watch

Samica Enterprises LLC v. Mail Boxes Etc., Inc., Bus. Franchise Guide (CCH) ' 14,731 (9th Cir., Dec. 1, 2011), is the most recent judicial pronouncement ' one that is labeled “Not for Publication” ' in the long-running feud between The UPS Store and some of its franchisees resulting from the system name change from “Mail Boxes Etc.” to “The UPS Store.” In this case, some 200 or so franchisees brought a variety of claims against their franchisor alleging, among other things, statutory fraud under the California Franchise Investment Law and common law fraud.

Fraud claims, though frequently alleged, are difficult to prosecute because they present so many hurdles that need to be jumped, including proving: 1) that a certain statement has been made, as well as when and by whom; 2) that the statement was false or incomplete or, in some jurisdictions, made without regard to its truth or falsity; 3) that the statement was relied upon and that such reliance was reasonable; 4) that the reliance was the cause of the plaintiff's damages; and 5) the amount of damages with reasonable certainty (except where rescission is the desired remedy).

As is the case in so many franchisee fraud claims, in Samica, the “reasonable reliance” requirement proved to be the Achilles heel for the franchisees. According to the Ninth Circuit, there was no evidence showing that the franchisees had relied upon any false or misleading statement made by the defendant. The court, apparently with no hesitation, affirmed the trial court's grant of summary judgment in favor of the defendant franchisor. All of the other claims brought by the franchisees were also resolved in favor of the franchisor by the trial court, and that court's grant of summary judgment on all these other claims also was affirmed on appeal.

Hardee's Food Systems, Inc. v. Hallbeck

One of the most interesting questions that members of the franchise community must frequently address is whether lost future profits are recoverable when a franchise agreement is terminated prior to its expiration. Had you asked me that question in 1990, my answer would have been “yes” if the contract expressly so provided, “yes” if the contract did not provide for their award, and “no” if the franchise agreement expressly stated that lost future profits were not included. In 2000, I would have said “no” if the contract stated that they weren't recoverable, and my answer in other circumstances would have been unpredictable. It would have been dependent on looking at the state whose law governed the contract, where the franchisee was resident, where the franchised business was located, and whether the franchisor or the franchisee terminated the agreement, as well as the reasons for the termination.

After the California Court of Appeals decided Postal Instant Press, Inc. v. Sealy, 51 Cal. Rptr. 2d 365 (1996), the judicial resolution of this issue by almost any court became unpredictable. The Sealy court concluded that an award of lost future profits generally would not be made if the franchisor had terminated the franchisee because: 1) the proximate cause of the damages was the franchisor's act of termination, not the franchisee's failure to pay royalties, and 2) such a damage award would be unconscionable. This decision was the first step in a march to confusion.

I have written on several occasions that one novel new precedent may be an aberrant result, but two such decisions become a trend. After Sealy was decided, several other courts adopted the Sealy line of reasoning, but others still followed the traditional rule that lost future profits were awardable damages. As recently reported in this column, the North Carolina Court of Appeals, reversing a lower court decision, made the law much clearer in North Carolina when it decided Meineke Car Care Centers, Inc. v. RLB Holdings, LLC, 423 F. App'x 274 (4th Cir. 2011). In Meineke, the court concluded that if a franchisor followed the right steps in pleading and prosecuting its case, the franchisor can recover lost future profits from a terminated franchisee even if the contract does not so provide.

In the even more recent Hardee's Food Systems, Inc. v. Hallbeck, Bus. Franchise Guide (CCH) ' 14,693 (E.D. Mo., Sept. 21, 2011) case, a federal district court in Missouri reached the same result as did the Meineke court, and in doing so relied heavily on Meineke. Speculating as to how the Missouri Supreme Court and the Illinois Supreme Court might rule, the U.S. District Court for the Eastern District of Missouri refused to grant the defendant franchisee's motion for a summary judgment. Even though the franchisee had closed its unit before suit was filed, the franchisee claimed that the franchisor terminated the agreement by a letter of termination issued after the store had closed. The court rejected this argument, as well as franchisee's argument that: 1) a ruling in favor of the franchisor would be like granting liquidated damages, and there was no liquidated damages provision in the franchise agreement; and 2) the calculation of damages would be speculative. The court dismissed both of these contentions, and others, and ultimately concluded that there was a genuine issue of fact as to whether the franchisor would have “realized lost future profits.” The other open issue left for trial was the amount of damages, as to which the franchisor had presented evidence from an expert witness, and the franchisee seemingly took exception as to the methodology used by the expert.

Accordingly, at the end of the day, while the issue of the recovery of lost future profits has not been fully resolved, and the likely result in any case is in large measure dependent upon the particular facts of the dispute, Meineke and Hardee's suggest that Las Vegas would now favor the franchisor in these disputes.

Southern Wine and Spirits of Nevada, Inc. v. Mountain Valley Spring Company, LLC

Bad contract drafting, coupled with use of vague words such as “exclusive,” which lend themselves to various interpretations, often lead to bad consequences for manufacturers and franchisors. The contract in the Southern Wine and Spirits of Nevada, Inc. v. Mountain Valley Spring Company, LLC, 646 F.3d 526 , Bus. Franchise Guide (CCH) ' 14,670 (8th Cir., July 19, 2011) dispute provided only for termination for breach or with mutual consent of the parties. While the court recognized the common law prejudice against perpetual agreements when the term of the contract is not expressly stated, the court also recognized that, if possible, each provision of a contract must be given meaning when trying to determine the intent of the parties. In Southern Wine, the court concluded that the provision containing the two grounds for termination cited above would become meaningless unless the parties intended that the term were perpetual. The court thus felt compelled to rule in favor of perpetuity rather than adopt the bottler's contention that the contract could be terminated by either party at will or upon the giving of reasonable notice. Several simple words, clearly indicating that the contract was, or was not, perpetual would have avoided the need for the litigation that ensued. But we all learn from our experiences.

A Love of Food I, LLC v. Maoz Vegetarian USA, Inc.

When do the long arms of franchise sales law extend beyond state borders? The various state statutes regulating franchise sales reflect what explicitly or implicitly are different philosophies. In most states, the legislature views its only interest as protecting franchisees within its border ' that is, the franchisee must be a resident of the state or operating a business in that state in order for the franchise sales law to apply.

People often say that New Yorkers can't see beyond the Hudson River. But when it comes to franchise sales regulation, the franchise sales statute goes to the other extreme. Not only does the statute protect New Yorkers, but it also protects franchisees in any other jurisdiction if the franchisor is domiciled or located in New York, or if the offer is made from or to New York.

On a motion for reconsideration in A Love of Food I, LLC v. Maoz Vegetarian USA, Inc., Bus. Franchise Guide (CCH) ' 14,684 (D. Md. Sept. 13, 2011), the court was presented with a fact pattern showing that the franchisor mailed out a franchise disclosure document from its office in New York to a prospective franchisee who purchased a franchise to operate a business in Washington, DC. The franchisor's principal place of business was in Maryland. The franchisee later brought suit alleging, among other claims, violations of the Maryland Franchise Registration and Disclosure Act and the New York Franchise Sales Act. The contract provided that New York law would apply.

The court clearly confirmed its earlier rejection of the franchisor's claims that it was not subject to jurisdiction in Maryland, noting that the degree of contacts between the transaction and Maryland was sufficient for personal jurisdiction. Under the legendary U.S. Supreme Court Rudzewicz decision (Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985)), the standard for personal jurisdiction is set quite low. Almost any contact will be sufficient for jurisdiction to exist. In the instant case, the contacts included mailing the disclosure documents to Maryland and the contemplation that various continuing obligations would be performed in Maryland by the franchisee. These contacts were sufficient to find that the defendant Maoz was subject to the Maryland federal district court's jurisdiction.

The more interesting claim, however, related to the applicability of the New York franchise sales law. The franchisor contended that the New York statute would not be applicable because the franchisee was not located in New York, nor was the business to be operated in New York. As most franchise practitioners believe, unlike the statutes in other jurisdictions, if an offer has been made from or to New York or accepted in New York the statute will be applicable regardless of where the franchisee resides or where his or her business will be operated. The lesson learned from this decision is as follows: Besides the opportunity to pay high rents and deal with the New York crowds, franchisors who operate in New York must accept the risk that any franchisee, even those located in states that do not have laws governing franchise sales, may sue them for breach of the New York franchise sales law. This may keep bad franchisors from operating in this jurisdiction, but it also encourages good franchisors to locate their headquarters elsewhere.

As a side note, not only does New York reach beyond its borders to protect franchisees in other states, its definition of what constitutes a franchise is broader than the definition in other states. All other registration states have a three-prong definition of a franchise: In shorthand, 1) there must be a trademark involved in the business, 2) a fee must be paid by the franchisee to the franchisor, and 3) the franchisor must have a certain level of control over the franchisee. In New York, the fee and the trademark tests, or the fee and the control tests, are in each case sufficient for a franchise relationship to exist. Trademark licensors in New York: beware.

Rupert M. Barkoff is a partner in Kilpatrick Townsend & Stockton LLP, residing in its Atlanta office, where he chairs the firm's Franchise Practice. He is a former chair of the American Bar Association's Forum on Franchising, a member of this newsletter's Board of Editors, and co-editor-in-chief of the ABA's Fundamentals of Franchising, a primer on the law of franchising and certain related areas. He can be reached at 404-815-6366 or at [email protected].

Recent Franchise Decisions Show Same Old Songs, with a Few Different Beats

This month's column addresses four recent cases covering four old topics: the reasonable reliance requirement in fraud claims; the likelihood that a franchisor can recover lost future profits when it or its franchisee terminates a franchise arrangement prematurely; whether franchise agreements with unspecified terms can be perpetual agreements; and the scope of the Maryland and New York franchise laws. The topics are ones that we have seen discussed before, and the results in these decisions are substantially less than surprising, but nevertheless worth noting.

Samica Enterprises LLC v. Mail Boxes Etc., Inc.

Samica Enterprises LLC v. Mail Boxes Etc., Inc., Bus. Franchise Guide (CCH) ' 14,731 (9th Cir., Dec. 1, 2011), is the most recent judicial pronouncement ' one that is labeled “Not for Publication” ' in the long-running feud between The UPS Store and some of its franchisees resulting from the system name change from “Mail Boxes Etc.” to “The UPS Store.” In this case, some 200 or so franchisees brought a variety of claims against their franchisor alleging, among other things, statutory fraud under the California Franchise Investment Law and common law fraud.

Fraud claims, though frequently alleged, are difficult to prosecute because they present so many hurdles that need to be jumped, including proving: 1) that a certain statement has been made, as well as when and by whom; 2) that the statement was false or incomplete or, in some jurisdictions, made without regard to its truth or falsity; 3) that the statement was relied upon and that such reliance was reasonable; 4) that the reliance was the cause of the plaintiff's damages; and 5) the amount of damages with reasonable certainty (except where rescission is the desired remedy).

As is the case in so many franchisee fraud claims, in Samica, the “reasonable reliance” requirement proved to be the Achilles heel for the franchisees. According to the Ninth Circuit, there was no evidence showing that the franchisees had relied upon any false or misleading statement made by the defendant. The court, apparently with no hesitation, affirmed the trial court's grant of summary judgment in favor of the defendant franchisor. All of the other claims brought by the franchisees were also resolved in favor of the franchisor by the trial court, and that court's grant of summary judgment on all these other claims also was affirmed on appeal.

Hardee's Food Systems, Inc. v. Hallbeck

One of the most interesting questions that members of the franchise community must frequently address is whether lost future profits are recoverable when a franchise agreement is terminated prior to its expiration. Had you asked me that question in 1990, my answer would have been “yes” if the contract expressly so provided, “yes” if the contract did not provide for their award, and “no” if the franchise agreement expressly stated that lost future profits were not included. In 2000, I would have said “no” if the contract stated that they weren't recoverable, and my answer in other circumstances would have been unpredictable. It would have been dependent on looking at the state whose law governed the contract, where the franchisee was resident, where the franchised business was located, and whether the franchisor or the franchisee terminated the agreement, as well as the reasons for the termination.

After the California Court of Appeals decided Postal Instant Press, Inc. v. Sealy , 51 Cal. Rptr. 2d 365 (1996), the judicial resolution of this issue by almost any court became unpredictable. The Sealy court concluded that an award of lost future profits generally would not be made if the franchisor had terminated the franchisee because: 1) the proximate cause of the damages was the franchisor's act of termination, not the franchisee's failure to pay royalties, and 2) such a damage award would be unconscionable. This decision was the first step in a march to confusion.

I have written on several occasions that one novel new precedent may be an aberrant result, but two such decisions become a trend. After Sealy was decided, several other courts adopted the Sealy line of reasoning, but others still followed the traditional rule that lost future profits were awardable damages. As recently reported in this column, the North Carolina Court of Appeals, reversing a lower court decision, made the law much clearer in North Carolina when it decided Meineke Car Care Centers, Inc. v. RLB Holdings, LLC , 423 F. App'x 274 (4th Cir. 2011). In Meineke, the court concluded that if a franchisor followed the right steps in pleading and prosecuting its case, the franchisor can recover lost future profits from a terminated franchisee even if the contract does not so provide.

In the even more recent Hardee's Food Systems, Inc. v. Hallbeck, Bus. Franchise Guide (CCH) ' 14,693 (E.D. Mo., Sept. 21, 2011) case, a federal district court in Missouri reached the same result as did the Meineke court, and in doing so relied heavily on Meineke. Speculating as to how the Missouri Supreme Court and the Illinois Supreme Court might rule, the U.S. District Court for the Eastern District of Missouri refused to grant the defendant franchisee's motion for a summary judgment. Even though the franchisee had closed its unit before suit was filed, the franchisee claimed that the franchisor terminated the agreement by a letter of termination issued after the store had closed. The court rejected this argument, as well as franchisee's argument that: 1) a ruling in favor of the franchisor would be like granting liquidated damages, and there was no liquidated damages provision in the franchise agreement; and 2) the calculation of damages would be speculative. The court dismissed both of these contentions, and others, and ultimately concluded that there was a genuine issue of fact as to whether the franchisor would have “realized lost future profits.” The other open issue left for trial was the amount of damages, as to which the franchisor had presented evidence from an expert witness, and the franchisee seemingly took exception as to the methodology used by the expert.

Accordingly, at the end of the day, while the issue of the recovery of lost future profits has not been fully resolved, and the likely result in any case is in large measure dependent upon the particular facts of the dispute, Meineke and Hardee's suggest that Las Vegas would now favor the franchisor in these disputes.

Southern Wine and Spirits of Nevada, Inc. v. Mountain Valley Spring Company, LLC

Bad contract drafting, coupled with use of vague words such as “exclusive,” which lend themselves to various interpretations, often lead to bad consequences for manufacturers and franchisors. The contract in the Southern Wine and Spirits of Nevada, Inc. v. Mountain Valley Spring Company, LLC , 646 F.3d 526 , Bus. Franchise Guide (CCH) ' 14,670 (8th Cir., July 19, 2011) dispute provided only for termination for breach or with mutual consent of the parties. While the court recognized the common law prejudice against perpetual agreements when the term of the contract is not expressly stated, the court also recognized that, if possible, each provision of a contract must be given meaning when trying to determine the intent of the parties. In Southern Wine, the court concluded that the provision containing the two grounds for termination cited above would become meaningless unless the parties intended that the term were perpetual. The court thus felt compelled to rule in favor of perpetuity rather than adopt the bottler's contention that the contract could be terminated by either party at will or upon the giving of reasonable notice. Several simple words, clearly indicating that the contract was, or was not, perpetual would have avoided the need for the litigation that ensued. But we all learn from our experiences.

A Love of Food I, LLC v. Maoz Vegetarian USA, Inc.

When do the long arms of franchise sales law extend beyond state borders? The various state statutes regulating franchise sales reflect what explicitly or implicitly are different philosophies. In most states, the legislature views its only interest as protecting franchisees within its border ' that is, the franchisee must be a resident of the state or operating a business in that state in order for the franchise sales law to apply.

People often say that New Yorkers can't see beyond the Hudson River. But when it comes to franchise sales regulation, the franchise sales statute goes to the other extreme. Not only does the statute protect New Yorkers, but it also protects franchisees in any other jurisdiction if the franchisor is domiciled or located in New York, or if the offer is made from or to New York.

On a motion for reconsideration in A Love of Food I, LLC v. Maoz Vegetarian USA, Inc., Bus. Franchise Guide (CCH) ' 14,684 (D. Md. Sept. 13, 2011), the court was presented with a fact pattern showing that the franchisor mailed out a franchise disclosure document from its office in New York to a prospective franchisee who purchased a franchise to operate a business in Washington, DC. The franchisor's principal place of business was in Maryland. The franchisee later brought suit alleging, among other claims, violations of the Maryland Franchise Registration and Disclosure Act and the New York Franchise Sales Act. The contract provided that New York law would apply.

The court clearly confirmed its earlier rejection of the franchisor's claims that it was not subject to jurisdiction in Maryland, noting that the degree of contacts between the transaction and Maryland was sufficient for personal jurisdiction. Under the legendary U.S. Supreme Court Rudzewicz decision ( Burger King Corp. v. Rudzewicz , 471 U.S. 462 (1985)), the standard for personal jurisdiction is set quite low. Almost any contact will be sufficient for jurisdiction to exist. In the instant case, the contacts included mailing the disclosure documents to Maryland and the contemplation that various continuing obligations would be performed in Maryland by the franchisee. These contacts were sufficient to find that the defendant Maoz was subject to the Maryland federal district court's jurisdiction.

The more interesting claim, however, related to the applicability of the New York franchise sales law. The franchisor contended that the New York statute would not be applicable because the franchisee was not located in New York, nor was the business to be operated in New York. As most franchise practitioners believe, unlike the statutes in other jurisdictions, if an offer has been made from or to New York or accepted in New York the statute will be applicable regardless of where the franchisee resides or where his or her business will be operated. The lesson learned from this decision is as follows: Besides the opportunity to pay high rents and deal with the New York crowds, franchisors who operate in New York must accept the risk that any franchisee, even those located in states that do not have laws governing franchise sales, may sue them for breach of the New York franchise sales law. This may keep bad franchisors from operating in this jurisdiction, but it also encourages good franchisors to locate their headquarters elsewhere.

As a side note, not only does New York reach beyond its borders to protect franchisees in other states, its definition of what constitutes a franchise is broader than the definition in other states. All other registration states have a three-prong definition of a franchise: In shorthand, 1) there must be a trademark involved in the business, 2) a fee must be paid by the franchisee to the franchisor, and 3) the franchisor must have a certain level of control over the franchisee. In New York, the fee and the trademark tests, or the fee and the control tests, are in each case sufficient for a franchise relationship to exist. Trademark licensors in New York: beware.

Rupert M. Barkoff is a partner in Kilpatrick Townsend & Stockton LLP, residing in its Atlanta office, where he chairs the firm's Franchise Practice. He is a former chair of the American Bar Association's Forum on Franchising, a member of this newsletter's Board of Editors, and co-editor-in-chief of the ABA's Fundamentals of Franchising, a primer on the law of franchising and certain related areas. He can be reached at 404-815-6366 or at [email protected].