Court Watch

Despite the letter, Pancake House continued operating the restaurant using IHOP's trademarks. Therefore, on June 1, 2012, IHOP commenced litigation, claiming trademark infringement and requesting injunctive relief. The New Jersey District Court issued a temporary restraining order, enjoining Pancake House from using the marks until a preliminary injunction hearing was held on June 18, 2012. In spite of the temporary restraining order, Pancake House was continuing to use IHOP's trademarks at the time of the June 18 hearing. IHOP also moved for contempt based on Pancake House's failure to comply with the temporary restraining order.

In considering the motion for preliminary injunction, the court decided that Pancake House could only be enjoined from use of the marks if the termination by IHOP was proper. In other words, if the method of immediate termination by IHOP was found to be improper, then Pancake House not only was not properly terminated as a franchisee, but it also was not terminated at all, in which case it had a continuing license to use IHOP's trademarks.

The court then turned to the issue of whether IHOP's purported immediate termination pursuant to Section 12.02 of the franchise agreement was proper, and thus effective to terminate the franchise agreement. Pancake House argued that regardless of Section 12.02, the termination also must comply with the New Jersey Franchise Practices Act (“NJFPA”), which allows for immediate termination based on a criminal conviction only where the offense is “directly related to the business conducted pursuant to the franchise.” The court found that the more restrictive statutory termination provision applied in this case because Section 12.04 of the franchise agreement, which had not been cited by either party, states that if any law limits the termination rights in the franchise agreement, then the franchise agreement should be interpreted in conformity with the minimum requirements of such law. Thus, the court concluded, the more restrictive requirements of the NJFPA were incorporated
into the franchise agreement.

Because the crime had not occurred at the Pancake House franchised restaurant, IHOP had not received adverse publicity, and neither party had become less profitable as a result of the conviction, the court declared that there was no direct factual nexus between the conviction and the business conducted under the franchise agreement. As a result, the court found that IHOP failed to present sufficient evidence that the conviction satisfied the immediate termination standard of the NJFPA, and therefore it was not likely to succeed on its claim that the franchise agreement had been terminated and the trademark license had expired.

This case reminds franchisors of the care that must be taken in terminating franchisees. In addition, it stands for the proposition that an improper termination may not be a termination at all.

'Franchisor's Actions Speak Louder Than Words' in CA Vicarious Liability Action

A California Court of Appeal recently reversed the dismissal of an employee's claims for harassment and assault under the California Fair Employment and Housing Act against franchisor Domino's Pizza, holding Domino's Pizza exercised sufficient control over its franchisee to subject Domino's Pizza to vicarious liability. Patterson v. Domino's Pizza, LLC, 143 Cal. Rptr. 3d 396 (Cal. Ct. App. 2012).

In Patterson, the plaintiff was a teenage employee of Domino's Pizza franchisee Sui Juris, LLC (“Sui Juris”). The plaintiff commenced legal action against Sui Juris and Domino's Pizza, alleging she was sexually harassed and assaulted at her job by an assistant manager. She claimed both Sui Juris and Domino's were the assistant manager's employers and were therefore vicariously liable for the assistant manager's actions. Domino's filed a motion for summary judgment, claiming that Sui Juris was an independent contractor of Domino's under the terms of a written franchise agreement and that there was no principal-agency relationship between the franchisee and the franchisor. The trial court granted summary judgment in favor of Domino's, holding that because the franchise agreement articulates that the franchisee is responsible for “supervising and paying the persons who work in the Store,” Domino's can have no role in Sui Juris' employment decisions and therefore does not exercise the requisite control for a finding of vicarious liability. The trial court held Sui Juris was an independent contractor and that the assistant manager was not an employee or agent
of Domino's. Patterson appealed.

In reversing the decision of the trial court, the California Court of Appeal looked more closely into the franchise relationship between Domino's and Sui Juris, reviewing not just the franchise agreement but also the course of dealings between the franchisor and the franchisee. The appellate court, relying upon California case law, found a franchisor may be subject to vicarious liability where it assumes substantial control over the franchisee's local operations, its management, employee relations or its employee discipline. Domino's claimed that the language in the franchise agreement stating that Sui Juris “shall be solely responsible for recruiting, hiring, training, scheduling for work, supervising and paying the persons who work in the Store and those persons shall be your employees, and not [Domino's] agents or employees,” as a matter of law, absolved Domino's from any finding of control over franchisee-employee matters. However, other language in the franchise agreement, as well as the conduct of the parties, showed substantial control over the franchisee's operations by Domino's.

For example, under the terms of the franchise agreement between Domino's and Sui Juris, Domino's set the “qualifications” for Sui Juris' employees and the standards for their “demeanor.” Under the terms of the franchise agreement, Sui Juris' employees were not permitted to operate the store without their identities first being disclosed to Domino's. Sui Juris was also provided with a Domino's Manager's Reference Guide (the “Domino's Guide”), describing all hiring requirements, specifying the standards for employees' appearances, identifying employee attendance and sexual harassment policies, and describing the documents to be stored in personnel files. The Domino's Guide also provided “minimum guidelines for the operation of all Domino's Pizza stores ' ,” which covered a variety of requirements from bank deposits, cash limits, mobile phone use, store closing procedures, delivery staffing, holiday closings, wall displays and other items. The appellate court held that the requirements set forth in both the franchise agreement and the Domino's Guide raised reasonable inferences supporting the plaintiff's claim that Sui Juris was not an independent
contractor of Domino's.

But the appellate court did not stop after reviewing the franchise agreement and the Domino's Guide, noting that California courts have concluded that while provisions of a franchise agreement are relevant, they are not the exclusive evidence of the franchise relationship. The appellate court therefore looked at the totality of circumstances to the franchise relationship to determine that there was, at a minimum, a question of fact as to whether Domino's exercised sufficient control over Sui Juris to find Domino's vicariously liable for the acts of Sui Juris' assistant manager.

In holding that there was an issue of fact related to the exercise of control over Sui Juris, the appellate court relied heavily on the deposition testimony of the owner of Sui Juris. The owner testified that his operations were routinely monitored by Domino's inspectors and secret shoppers and that the inspectors' decisions determined whether he could continue his franchise. He also testified that a Domino's area leader instructed him to fire the assistant manager, among others, and if a Domino's franchisee did not comply with such instructions, “you were out of business very quickly.”

Franchisors should take heed of this decision and consider the implications of exercising control over the major aspects of their franchisees' operations. Even when a franchise agreement has carefully drafted language articulating that a franchisee is not an agent and/or is an independent contractor of the franchisor, courts may be increasingly willing to look outside the four corners of the franchise agreement and examine the day-to-day control
exercised by the franchisor.

Jury Trial Waiver Applies to Non-Signatory Under Theory of Estoppel

The U.S. District Court for the Western District of Wisconsin held that a jury trial waiver provision in a franchise agreement applied to a non-signatory who received the principal benefits under the franchise agreement. Novus Franchising, Inc. v. Superior Entrance Systems, Inc., No. 12-CV-204-WMC (W.D. Wis. filed Aug. 16, 2012). In Novus Franchising, Inc., the defendants, a designated franchisee under the terms of a franchise agreement, its guarantor and a third party who used the franchisor's trade name and trademarks, operated the franchise, and sent royalty checks to the franchisor (the “de facto franchisee”), moved the district court for a jury trial, in spite of a provision in the franchise agreement that waived the right to a jury trial. The defendants argued that the jury trial waiver was not valid under the Minnesota Franchise Act and also that the jury trial waiver was not applicable to the de facto franchisee since the de facto franchisee did not sign the franchise agreement. After holding that the Minnesota Franchise Act did not apply to the defendants and that the jury trial waiver in the franchise agreement was valid, the court next turned to whether the jury trial waiver may be enforced
against the de facto franchisee.

In holding that the jury waiver provision applies to the de facto franchisee, the court determined that the doctrine of equitable estoppel provides a basis to bind the non-signatory to the franchise agreement, citing to Onvoy, Inc. v. Shal, LLC, 669 N.W.2d 344 (Minn. 2003) and MS Dealer Serv. Corp. v. Franklin, 177 F.3d 942 (11th Cir. 1999). The court relied upon the “widely-cited test [in MS Dealer] setting forth the circumstances in which equitable estoppel will hold a non-signatory to the terms of a contract.” Under the MS Dealer test, there are two situations in which a non-signatory may be bound to a contract by equitable estoppel: 1) when a signatory to the written agreement relies on the terms of the written agreement in asserting its claims against the non-signatory; and 2) when a signatory to the agreement raises allegations of interdependent and concerted misconduct by both the non-signatory and one or more signatories. In Novus Franchising, Inc., the District Court held the facts satisfied both tests, since the franchisor's complaint, and the defendants' counterclaims, hinged upon the terms of the written franchise agreement and since the de facto franchisee's conduct was intertwined with the conduct of the signatories. The district court held that the de facto franchisee's “stepping into the shoes left vacant” by the designated franchisee belongs “on the first page of an equitable estoppel textbook,” and therefore the de facto franchisee could not reject the terms of the franchise agreement, including the jury trial waiver.

The authors served as counsel for Novus Franchising, Inc. in Novus Franchising, Inc. v. Superior Entrance Systems, Inc.

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

Criminal Conviction Does Not Equal Franchise Termination

A recent case from the Federal District Court in New Jersey highlights the risk involved in terminating a franchisee based on a criminal conviction. International House of Pancakes, LLC v. Parsippany Pancake House, Inc., Bus. Franchise Guide (CCH) ' 14,856 (D. N.J. Jun. 27, 2012). The background of the case is that IHOP, the franchisor, had entered into a franchise agreement with Parsippany Pancake House, Inc. (“Pancake House”) in 2005. The franchise agreement gave Pancake House the right to operate an IHOP restaurant and use IHOP's trademarks during the term of the franchise agreement.

On April 30, 2012, the president and 50% owner of Pancake House pled guilty to a charge of endangering the welfare of a child, for which he will be incarcerated for a minimum of three years and will have to register as a sex offender. Given the nature of the crime and the potential damage to the IHOP brand, on May 24, 2012, IHOP sent Pancake House a notice of immediate termination of the franchise agreement. IHOP based the termination on Section 12.02 of the franchise agreement, which provides for immediate termination upon a conviction of a shareholder of the franchisee “of a felony or any other criminal misconduct which is relevant to the operation of the franchise.”

Despite the letter, Pancake House continued operating the restaurant using IHOP's trademarks. Therefore, on June 1, 2012, IHOP commenced litigation, claiming trademark infringement and requesting injunctive relief. The New Jersey District Court issued a temporary restraining order, enjoining Pancake House from using the marks until a preliminary injunction hearing was held on June 18, 2012. In spite of the temporary restraining order, Pancake House was continuing to use IHOP's trademarks at the time of the June 18 hearing. IHOP also moved for contempt based on Pancake House's failure to comply with the temporary restraining order.

In considering the motion for preliminary injunction, the court decided that Pancake House could only be enjoined from use of the marks if the termination by IHOP was proper. In other words, if the method of immediate termination by IHOP was found to be improper, then Pancake House not only was not properly terminated as a franchisee, but it also was not terminated at all, in which case it had a continuing license to use IHOP's trademarks.

The court then turned to the issue of whether IHOP's purported immediate termination pursuant to Section 12.02 of the franchise agreement was proper, and thus effective to terminate the franchise agreement. Pancake House argued that regardless of Section 12.02, the termination also must comply with the New Jersey Franchise Practices Act (“NJFPA”), which allows for immediate termination based on a criminal conviction only where the offense is “directly related to the business conducted pursuant to the franchise.” The court found that the more restrictive statutory termination provision applied in this case because Section 12.04 of the franchise agreement, which had not been cited by either party, states that if any law limits the termination rights in the franchise agreement, then the franchise agreement should be interpreted in conformity with the minimum requirements of such law. Thus, the court concluded, the more restrictive requirements of the NJFPA were incorporated
into the franchise agreement.

Because the crime had not occurred at the Pancake House franchised restaurant, IHOP had not received adverse publicity, and neither party had become less profitable as a result of the conviction, the court declared that there was no direct factual nexus between the conviction and the business conducted under the franchise agreement. As a result, the court found that IHOP failed to present sufficient evidence that the conviction satisfied the immediate termination standard of the NJFPA, and therefore it was not likely to succeed on its claim that the franchise agreement had been terminated and the trademark license had expired.

This case reminds franchisors of the care that must be taken in terminating franchisees. In addition, it stands for the proposition that an improper termination may not be a termination at all.

'Franchisor's Actions Speak Louder Than Words' in CA Vicarious Liability Action

A California Court of Appeal recently reversed the dismissal of an employee's claims for harassment and assault under the California Fair Employment and Housing Act against franchisor Domino's Pizza, holding Domino's Pizza exercised sufficient control over its franchisee to subject Domino's Pizza to vicarious liability. Patterson v. Domino's Pizza, LLC , 143 Cal. Rptr. 3d 396 (Cal. Ct. App. 2012).

In Patterson, the plaintiff was a teenage employee of Domino's Pizza franchisee Sui Juris, LLC (“Sui Juris”). The plaintiff commenced legal action against Sui Juris and Domino's Pizza, alleging she was sexually harassed and assaulted at her job by an assistant manager. She claimed both Sui Juris and Domino's were the assistant manager's employers and were therefore vicariously liable for the assistant manager's actions. Domino's filed a motion for summary judgment, claiming that Sui Juris was an independent contractor of Domino's under the terms of a written franchise agreement and that there was no principal-agency relationship between the franchisee and the franchisor. The trial court granted summary judgment in favor of Domino's, holding that because the franchise agreement articulates that the franchisee is responsible for “supervising and paying the persons who work in the Store,” Domino's can have no role in Sui Juris' employment decisions and therefore does not exercise the requisite control for a finding of vicarious liability. The trial court held Sui Juris was an independent contractor and that the assistant manager was not an employee or agent
of Domino's. Patterson appealed.

In reversing the decision of the trial court, the California Court of Appeal looked more closely into the franchise relationship between Domino's and Sui Juris, reviewing not just the franchise agreement but also the course of dealings between the franchisor and the franchisee. The appellate court, relying upon California case law, found a franchisor may be subject to vicarious liability where it assumes substantial control over the franchisee's local operations, its management, employee relations or its employee discipline. Domino's claimed that the language in the franchise agreement stating that Sui Juris “shall be solely responsible for recruiting, hiring, training, scheduling for work, supervising and paying the persons who work in the Store and those persons shall be your employees, and not [Domino's] agents or employees,” as a matter of law, absolved Domino's from any finding of control over franchisee-employee matters. However, other language in the franchise agreement, as well as the conduct of the parties, showed substantial control over the franchisee's operations by Domino's.

For example, under the terms of the franchise agreement between Domino's and Sui Juris, Domino's set the “qualifications” for Sui Juris' employees and the standards for their “demeanor.” Under the terms of the franchise agreement, Sui Juris' employees were not permitted to operate the store without their identities first being disclosed to Domino's. Sui Juris was also provided with a Domino's Manager's Reference Guide (the “Domino's Guide”), describing all hiring requirements, specifying the standards for employees' appearances, identifying employee attendance and sexual harassment policies, and describing the documents to be stored in personnel files. The Domino's Guide also provided “minimum guidelines for the operation of all Domino's Pizza stores ' ,” which covered a variety of requirements from bank deposits, cash limits, mobile phone use, store closing procedures, delivery staffing, holiday closings, wall displays and other items. The appellate court held that the requirements set forth in both the franchise agreement and the Domino's Guide raised reasonable inferences supporting the plaintiff's claim that Sui Juris was not an independent
contractor of Domino's.

But the appellate court did not stop after reviewing the franchise agreement and the Domino's Guide, noting that California courts have concluded that while provisions of a franchise agreement are relevant, they are not the exclusive evidence of the franchise relationship. The appellate court therefore looked at the totality of circumstances to the franchise relationship to determine that there was, at a minimum, a question of fact as to whether Domino's exercised sufficient control over Sui Juris to find Domino's vicariously liable for the acts of Sui Juris' assistant manager.

In holding that there was an issue of fact related to the exercise of control over Sui Juris, the appellate court relied heavily on the deposition testimony of the owner of Sui Juris. The owner testified that his operations were routinely monitored by Domino's inspectors and secret shoppers and that the inspectors' decisions determined whether he could continue his franchise. He also testified that a Domino's area leader instructed him to fire the assistant manager, among others, and if a Domino's franchisee did not comply with such instructions, “you were out of business very quickly.”

Franchisors should take heed of this decision and consider the implications of exercising control over the major aspects of their franchisees' operations. Even when a franchise agreement has carefully drafted language articulating that a franchisee is not an agent and/or is an independent contractor of the franchisor, courts may be increasingly willing to look outside the four corners of the franchise agreement and examine the day-to-day control
exercised by the franchisor.

Jury Trial Waiver Applies to Non-Signatory Under Theory of Estoppel

The U.S. District Court for the Western District of Wisconsin held that a jury trial waiver provision in a franchise agreement applied to a non-signatory who received the principal benefits under the franchise agreement. Novus Franchising, Inc. v. Superior Entrance Systems, Inc., No. 12-CV-204-WMC (W.D. Wis. filed Aug. 16, 2012). In Novus Franchising, Inc., the defendants, a designated franchisee under the terms of a franchise agreement, its guarantor and a third party who used the franchisor's trade name and trademarks, operated the franchise, and sent royalty checks to the franchisor (the “de facto franchisee”), moved the district court for a jury trial, in spite of a provision in the franchise agreement that waived the right to a jury trial. The defendants argued that the jury trial waiver was not valid under the Minnesota Franchise Act and also that the jury trial waiver was not applicable to the de facto franchisee since the de facto franchisee did not sign the franchise agreement. After holding that the Minnesota Franchise Act did not apply to the defendants and that the jury trial waiver in the franchise agreement was valid, the court next turned to whether the jury trial waiver may be enforced
against the de facto franchisee.

In holding that the jury waiver provision applies to the de facto franchisee, the court determined that the doctrine of equitable estoppel provides a basis to bind the non-signatory to the franchise agreement, citing to Onvoy, Inc. v. Shal, LLC , 669 N.W.2d 344 (Minn. 2003) and MS Dealer Serv. Corp. v. Franklin , 177 F.3d 942 (11th Cir. 1999). The court relied upon the “widely-cited test [in MS Dealer] setting forth the circumstances in which equitable estoppel will hold a non-signatory to the terms of a contract.” Under the MS Dealer test, there are two situations in which a non-signatory may be bound to a contract by equitable estoppel: 1) when a signatory to the written agreement relies on the terms of the written agreement in asserting its claims against the non-signatory; and 2) when a signatory to the agreement raises allegations of interdependent and concerted misconduct by both the non-signatory and one or more signatories. In Novus Franchising, Inc., the District Court held the facts satisfied both tests, since the franchisor's complaint, and the defendants' counterclaims, hinged upon the terms of the written franchise agreement and since the de facto franchisee's conduct was intertwined with the conduct of the signatories. The district court held that the de facto franchisee's “stepping into the shoes left vacant” by the designated franchisee belongs “on the first page of an equitable estoppel textbook,” and therefore the de facto franchisee could not reject the terms of the franchise agreement, including the jury trial waiver.

The authors served as counsel for Novus Franchising, Inc. in Novus Franchising, Inc. v. Superior Entrance Systems, Inc.

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