Court Watch

OLC began operating the Westlake Center as a Sylvan franchise, but shortly thereafter it became apparent that the Westlake Center was operating at a loss. The franchisees were able to make the required royalty payments; however, they were unable to meet their obligations under the two promissory notes. The franchisees ceased making the required payments on the promissory notes about two years after executing the license agreement. Several months later, the franchisor delivered two notices of default, advising the franchisees that their failure to make payments under the terms of the promissory notes was a breach of the agreement and that the franchisor had the right to terminate the agreement, effective April 17, 2010.

One day before the identified termination date, the franchisees filed a lawsuit in Ohio state court. The case was removed to the Northern District of Ohio and then transferred to the District of Maryland. The franchisor ultimately terminated the license agreement on Dec. 28, 2010, but the franchisees continued to operate the Westlake Center using the franchisor's trademarks and marketing materials. After termination of the agreement, the franchisor asserted amended counterclaims for trademark infringement, unfair competition, breach of the noncompete, breach of contract, and a claim for attorneys' fees. The franchisor moved for summary judgment on all of its amended counterclaims.

In defending the franchisor's motion for summary judgment related to breach of contract and breach of the covenant not to compete, the franchisees challenged the validity and enforceability of the license agreement and the promissory notes. The franchisees alleged that the franchisor was the first to breach the license agreement because it failed to provide certain documents related to the operations of the Westlake Center and because it allowed competing Sylvan franchises to operate in the exclusive territory of the Westlake Center. Therefore, the franchisees affirmatively alleged, they should not be liable for the payments due and owing under the license agreement and promissory notes, even though they reaped the benefits of operating as a Sylvan franchise while not making the required payments under the promissory notes.

The federal court rejected this “you breached first” defense by stating “[a] franchisee cannot simply respond to a franchisor's alleged initial breach by breaching the agreement herself and continuing to operate the franchise without the payment of any fees.” The court cited to its holding in 7-Eleven, Inc. v. McEvoy, indicating that if the franchisor had breached the franchise agreement first, then the franchisee should have either: 1) treated the franchisor's material breach as a repudiation of the franchise agreement and discontinued his performance and acceptance of benefits under the agreement; or 2) treated the breach as a partial breach and sued for damages. 300 F. Supp. 2d 353, 358 (D. Md. 2004). The federal court held that even assuming the franchisor did materially breach the license agreement, the franchisees “were nevertheless prohibited from taking the action they did ' namely, responding to [the franchisor's] breach by reaping the agreement's benefits while discontinuing their performance under the agreement.”

This case serves as a reminder that the often-raised “you breached first” defense is likely to fail if the party defending a breach of contract claim ceases to satisfy its obligations under a contract but continues to reap the benefits after the other party's alleged “first” breach. Franchisors and franchisees are advised to treat any material breach of a franchise or license agreement as a repudiation, and cease performance and the acceptance of benefits under that agreement. In the event of a partial breach, the non-breaching party should seek damages for the partial breach as soon as possible.

Franchisor Could Consider Franchise Agreement Expired After Franchisee Failed to Follow Renewal Provisions

The Eastern District of New York recently denied a motion for preliminary injunctive relief to prevent termination of a franchise agreement where the franchisee intended to renew the agreement but did not deliver notice of its intent to renew within a specified time frame. Bayit Care Corp. v. Tender Loving Health Care Services of Nassau Suffolk, LLC, No. 11-cv-3929, 2012 WL 1079042 (E.D. N.Y. March 30, 2012).

Tender Loving Health Care Services of Nassau Suffolk, LLC (“Tender Loving”) is a franchisor of home health and hospice services in Nassau and Suffolk County, NY. Bayit Care Corp. (“Bayit”) first entered into a 10-year franchise agreement with Tender Loving's predecessor in interest in 1992. In the 1992 franchise agreement (“1992 Agreement”), Bayit was given the option of extending the initial term of the franchise agreement for five additional years. To exercise the renewal option, the 1992 Agreement required that Bayit must have performed all of its contractual obligations and must sign the then-current form of the franchise agreement. The 1992 Agreement also specified the manner in which Bayit could exercise its renewal right: “Not less than one hundred eighty (180) days but not more than two hundred forty (240) days prior to the expiration of the Initial Term (or the Renewal Term), Franchisee shall, by written notice, inform Franchisor of his intention to exercise its renewal right.”

Before expiration of the original 10-year term, the parties entered into a Renewal Franchise Agreement, effective April 1, 2002 (the “2002 Agreement”). Instead of the five-year renewal contemplated by the 1992 Agreement, the 2002 Agreement had a 10-year term. The 2002 Agreement included the following renewal provision: “Franchisor hereby grants to Franchisee a Renewal Franchise Agreement for additional consecutive terms of ten (10) years, commencing April 1, 2002, and at the election of Franchisee, an option to renew for an additional consecutive term of five (5) years.” It also stated that “except as provided herein, the [1992] Franchise Agreement and all provisions contained therein shall remain in full force and effect.”

On Jan. 10, 2012, Bayit notified Tender Loving that it intended to renew the 2002 Franchise Agreement for an additional five-year term. It was undisputed by the parties that this notice was delivered three months after the 180-day exercise deadline in the 1992 Agreement. Therefore, Tender Loving considered the renewal notice to be ineffective.

Prior to expiration of the 2002 Agreement as of April 1, 2012, Bayit filed suit and sought injunctive relief to prevent termination. The court first found Bayit would be irreparably harmed by the termination because its business would cease to exist. The court then turned to the likelihood of success factor, noting that because it had found irreparable harm, the standard was whether there was a “sufficiently serious question going to the merits to make the issue a fair ground for trial.”

Bayit argued that because the 2002 Agreement discussed renewal, the renewal terms in the 1992 Agreement did not apply. With no agreed-upon method for indicating an intention to renew, Bayit argued that it was required only to provide reasonable notice. As a fallback, Bayit argued that the 2002 Franchise Agreement was ambiguous. The court disagreed with Bayit and found that under a literal reading, the 2002 Agreement needed to be read in conjunction with the specific renewal provisions of the 1992 Agreement. Therefore, it denied injunctive relief despite the fact that the balance of hardships tipped “decidedly” in favor of the requested relief.

Court Grants Sanctions After Former Franchisee Fails to Transfer Telephone Number

After franchisees leave a system, franchisors often face frustration in attempting to transfer franchisees' telephone numbers to the franchisor. Even where the post-termination obligations in the franchise agreement specifically provide for the transfer of telephone numbers, former franchisees may be unwilling or unable to comply with the provision. In Allegra Network LLC v. Bagnall, No. 11-11131, 2012 WL 1150988 (E.D. Mich. April 6, 2012), a frustrated franchisor moved for an order to show cause after the former franchisee failed to comply with a stipulated order to transfer the telephone number used in connection with its former franchised business.

The franchisor, Allegra Network LLC (“Allegra”) terminated the franchise agreement with Debra Bagnall because of her failure to pay royalties. Allegra then commenced a lawsuit, alleging a violation of the parties' noncompete agreement, and Bagnall's failure to transfer her telephone number. After several months of litigation, the case was settled, and the court entered a stipulated injunction, requiring, in part, transfer of the telephone number used in Bagnall's business. At the time of the stipulated order, the parties were aware that Bagnall's husband held the telephone number.

The parties learned the procedure for transfer of the number was for the holder to contact the telephone company and provide the contact information for the transferee. The transferee would then have 10 days to contact the phone company and claim the number. The parties agreed to keep in touch so that Allegra would know when it should call and claim the number.

Over the next several weeks, Allegra's counsel attempted to contact Bagnall's counsel on nine separate occasions, with no luck. After they finally spoke, there was confusion about who currently held the phone number and whether Bagnall's husband had attempted to transfer it. It was undisputed, however, that the number had not been transferred to Allegra. As a result, Allegra sought intervention from the court.

The court decided entirely in favor of Allegra. It first decided that Bagnall did not take reasonable steps to comply with the order. She did not personally contact the phone company to request transfer, did not present the order to the phone company, did not ensure her husband complied with the order, and did not request the assistance of her attorney. The court had no sympathy for Bagnall's argument that she did not hold the telephone number and could not force her husband to transfer it: The stipulation between the parties imposed a duty on her to ensure that her husband complied with the order and presupposed that she had the ability to do so. Therefore, the court found clear and convincing evidence that she violated a “definite and specific” order of the court. In addition, Bagnall did not offer sufficient evidence to show that she could not comply with the order.

As a result of her contempt of the stipulated order, the court directed Bagnall to take all necessary actions to immediately transfer the telephone number, directed her to pay a civil penalty of $100 per day until the number was transferred, awarded attorneys' fees to Allegra, and scheduled another hearing to confirm compliance with the contempt order.

Cynthia M. Klaus is a shareholder and Susan E. Tegt is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] and [email protected], respectively.

'You Breached First' Is Not a Defense to Non-Performance

A recent case out of the District of Maryland serves as a reminder to franchisors and franchisees that a “you breached first” defense to a breach of contract claim will not likely absolve a breaching party from liability. The Maryland federal district court held in Ohio Learning Centers, LLC v. Sylvan Learning, Inc. that parties to a franchise agreement are not permitted to reap the benefits of that agreement, while ignoring their obligations, only to later assert that their behavior was permissible because the other party was the first to breach the franchise agreement. No. RDB-10-1932, 2012 WL 1067668 (D. Md. March 27, 2012).

In Ohio Learning Centers, the franchisees, Ohio Learning Centers, LLC (“OLC”) and Janet Tomaskovich (“Tomaskovich”), purchased the assets of a poor-performing, corporate-owned Sylvan learning center in Westlake, OH (the “Westlake Center”). Concurrent with the asset purchase, the franchisees entered into a license agreement with the franchisor, Sylvan Learning, Inc. (“Sylvan”), for the operation of the Westlake Center as a Sylvan franchise. The agreement granted the franchisees the authority to operate a Sylvan franchise using Sylvan's trademarks within an exclusive territory in exchange for the payment of royalties and fees. The agreement contained a noncompete clause prohibiting the franchisees from operating a competing learning center for two years after termination of the agreement within five miles of the Westlake Center. At the closing, OLC executed two promissory notes, guaranteed by Tomaskovich, for most of the asset purchase price and franchise fees due under the license agreement.

OLC began operating the Westlake Center as a Sylvan franchise, but shortly thereafter it became apparent that the Westlake Center was operating at a loss. The franchisees were able to make the required royalty payments; however, they were unable to meet their obligations under the two promissory notes. The franchisees ceased making the required payments on the promissory notes about two years after executing the license agreement. Several months later, the franchisor delivered two notices of default, advising the franchisees that their failure to make payments under the terms of the promissory notes was a breach of the agreement and that the franchisor had the right to terminate the agreement, effective April 17, 2010.

One day before the identified termination date, the franchisees filed a lawsuit in Ohio state court. The case was removed to the Northern District of Ohio and then transferred to the District of Maryland. The franchisor ultimately terminated the license agreement on Dec. 28, 2010, but the franchisees continued to operate the Westlake Center using the franchisor's trademarks and marketing materials. After termination of the agreement, the franchisor asserted amended counterclaims for trademark infringement, unfair competition, breach of the noncompete, breach of contract, and a claim for attorneys' fees. The franchisor moved for summary judgment on all of its amended counterclaims.

In defending the franchisor's motion for summary judgment related to breach of contract and breach of the covenant not to compete, the franchisees challenged the validity and enforceability of the license agreement and the promissory notes. The franchisees alleged that the franchisor was the first to breach the license agreement because it failed to provide certain documents related to the operations of the Westlake Center and because it allowed competing Sylvan franchises to operate in the exclusive territory of the Westlake Center. Therefore, the franchisees affirmatively alleged, they should not be liable for the payments due and owing under the license agreement and promissory notes, even though they reaped the benefits of operating as a Sylvan franchise while not making the required payments under the promissory notes.

The federal court rejected this “you breached first” defense by stating “[a] franchisee cannot simply respond to a franchisor's alleged initial breach by breaching the agreement herself and continuing to operate the franchise without the payment of any fees.” The court cited to its holding in 7-Eleven, Inc. v. McEvoy, indicating that if the franchisor had breached the franchise agreement first, then the franchisee should have either: 1) treated the franchisor's material breach as a repudiation of the franchise agreement and discontinued his performance and acceptance of benefits under the agreement; or 2) treated the breach as a partial breach and sued for damages. 300 F. Supp. 2d 353, 358 (D. Md. 2004). The federal court held that even assuming the franchisor did materially breach the license agreement, the franchisees “were nevertheless prohibited from taking the action they did ' namely, responding to [the franchisor's] breach by reaping the agreement's benefits while discontinuing their performance under the agreement.”

This case serves as a reminder that the often-raised “you breached first” defense is likely to fail if the party defending a breach of contract claim ceases to satisfy its obligations under a contract but continues to reap the benefits after the other party's alleged “first” breach. Franchisors and franchisees are advised to treat any material breach of a franchise or license agreement as a repudiation, and cease performance and the acceptance of benefits under that agreement. In the event of a partial breach, the non-breaching party should seek damages for the partial breach as soon as possible.

Franchisor Could Consider Franchise Agreement Expired After Franchisee Failed to Follow Renewal Provisions

The Eastern District of New York recently denied a motion for preliminary injunctive relief to prevent termination of a franchise agreement where the franchisee intended to renew the agreement but did not deliver notice of its intent to renew within a specified time frame. Bayit Care Corp. v. Tender Loving Health Care Services of Nassau Suffolk, LLC, No. 11-cv-3929, 2012 WL 1079042 (E.D. N.Y. March 30, 2012).

Tender Loving Health Care Services of Nassau Suffolk, LLC (“Tender Loving”) is a franchisor of home health and hospice services in Nassau and Suffolk County, NY. Bayit Care Corp. (“Bayit”) first entered into a 10-year franchise agreement with Tender Loving's predecessor in interest in 1992. In the 1992 franchise agreement (“1992 Agreement”), Bayit was given the option of extending the initial term of the franchise agreement for five additional years. To exercise the renewal option, the 1992 Agreement required that Bayit must have performed all of its contractual obligations and must sign the then-current form of the franchise agreement. The 1992 Agreement also specified the manner in which Bayit could exercise its renewal right: “Not less than one hundred eighty (180) days but not more than two hundred forty (240) days prior to the expiration of the Initial Term (or the Renewal Term), Franchisee shall, by written notice, inform Franchisor of his intention to exercise its renewal right.”

Before expiration of the original 10-year term, the parties entered into a Renewal Franchise Agreement, effective April 1, 2002 (the “2002 Agreement”). Instead of the five-year renewal contemplated by the 1992 Agreement, the 2002 Agreement had a 10-year term. The 2002 Agreement included the following renewal provision: “Franchisor hereby grants to Franchisee a Renewal Franchise Agreement for additional consecutive terms of ten (10) years, commencing April 1, 2002, and at the election of Franchisee, an option to renew for an additional consecutive term of five (5) years.” It also stated that “except as provided herein, the [1992] Franchise Agreement and all provisions contained therein shall remain in full force and effect.”

On Jan. 10, 2012, Bayit notified Tender Loving that it intended to renew the 2002 Franchise Agreement for an additional five-year term. It was undisputed by the parties that this notice was delivered three months after the 180-day exercise deadline in the 1992 Agreement. Therefore, Tender Loving considered the renewal notice to be ineffective.

Prior to expiration of the 2002 Agreement as of April 1, 2012, Bayit filed suit and sought injunctive relief to prevent termination. The court first found Bayit would be irreparably harmed by the termination because its business would cease to exist. The court then turned to the likelihood of success factor, noting that because it had found irreparable harm, the standard was whether there was a “sufficiently serious question going to the merits to make the issue a fair ground for trial.”

Bayit argued that because the 2002 Agreement discussed renewal, the renewal terms in the 1992 Agreement did not apply. With no agreed-upon method for indicating an intention to renew, Bayit argued that it was required only to provide reasonable notice. As a fallback, Bayit argued that the 2002 Franchise Agreement was ambiguous. The court disagreed with Bayit and found that under a literal reading, the 2002 Agreement needed to be read in conjunction with the specific renewal provisions of the 1992 Agreement. Therefore, it denied injunctive relief despite the fact that the balance of hardships tipped “decidedly” in favor of the requested relief.

Court Grants Sanctions After Former Franchisee Fails to Transfer Telephone Number

After franchisees leave a system, franchisors often face frustration in attempting to transfer franchisees' telephone numbers to the franchisor. Even where the post-termination obligations in the franchise agreement specifically provide for the transfer of telephone numbers, former franchisees may be unwilling or unable to comply with the provision. In Allegra Network LLC v. Bagnall, No. 11-11131, 2012 WL 1150988 (E.D. Mich. April 6, 2012), a frustrated franchisor moved for an order to show cause after the former franchisee failed to comply with a stipulated order to transfer the telephone number used in connection with its former franchised business.

The franchisor, Allegra Network LLC (“Allegra”) terminated the franchise agreement with Debra Bagnall because of her failure to pay royalties. Allegra then commenced a lawsuit, alleging a violation of the parties' noncompete agreement, and Bagnall's failure to transfer her telephone number. After several months of litigation, the case was settled, and the court entered a stipulated injunction, requiring, in part, transfer of the telephone number used in Bagnall's business. At the time of the stipulated order, the parties were aware that Bagnall's husband held the telephone number.

The parties learned the procedure for transfer of the number was for the holder to contact the telephone company and provide the contact information for the transferee. The transferee would then have 10 days to contact the phone company and claim the number. The parties agreed to keep in touch so that Allegra would know when it should call and claim the number.

Over the next several weeks, Allegra's counsel attempted to contact Bagnall's counsel on nine separate occasions, with no luck. After they finally spoke, there was confusion about who currently held the phone number and whether Bagnall's husband had attempted to transfer it. It was undisputed, however, that the number had not been transferred to Allegra. As a result, Allegra sought intervention from the court.

The court decided entirely in favor of Allegra. It first decided that Bagnall did not take reasonable steps to comply with the order. She did not personally contact the phone company to request transfer, did not present the order to the phone company, did not ensure her husband complied with the order, and did not request the assistance of her attorney. The court had no sympathy for Bagnall's argument that she did not hold the telephone number and could not force her husband to transfer it: The stipulation between the parties imposed a duty on her to ensure that her husband complied with the order and presupposed that she had the ability to do so. Therefore, the court found clear and convincing evidence that she violated a “definite and specific” order of the court. In addition, Bagnall did not offer sufficient evidence to show that she could not comply with the order.

As a result of her contempt of the stipulated order, the court directed Bagnall to take all necessary actions to immediately transfer the telephone number, directed her to pay a civil penalty of $100 per day until the number was transferred, awarded attorneys' fees to Allegra, and scheduled another hearing to confirm compliance with the contempt order.

Cynthia M. Klaus is a shareholder and Susan E. Tegt is an associate at Larkin Hoffman in Minneapolis. They can be contacted at [email protected] and [email protected], respectively.