Evidentiary Requirements To Recover Lost Future Royalties

Novus v. AZ Glassworks

In Novus, the franchisees stopped submitting revenue reports and stopped paying monthly royalties. Novus Franchise, Inc. (Novus) learned that the franchisees had abandoned the franchise and had started operating a competing business. Novus filed a lawsuit against the franchisees to seek injunctive relief to enforce a post-term non-compete provision. Novus also sought to recover past due royalties as well as future royalties for the remaining term of the franchise agreement.

The defendants failed to answer or otherwise respond to the complaint. Novus moved for entry of default judgment. The court entered judgment for the full amount of past due royalties and a permanent injunction enforcing the non-compete provision. However, the court refused to enter an award for future royalties for the remaining term of the franchise agreement, despite the fact that the defendants/franchisees did not oppose the motion.

Novus had asked the court to award all future royalty and maintenance fees required under the terms of the franchise agreement from the date of termination until the end of the term of the franchise agreement in 2019 ' a total of $68,040. The court cited two reasons for rejecting Novus's unopposed motion.

First, the court found that Novus had failed to take into account any costs that it saved as a result of the early termination of the franchise agreement. Without those included in the equation, the court determined that Novus was overstating its future profits.

Second, the court noted that Novus had requested future profits for the entire remaining term of the franchise agreement. The court found that it was highly likely that Novus would establish a new franchisee in that geographic area to replace the defendants prior to 2019 and that the replacement franchisee would eliminate, or at least reduce, future damages. The court stated that awarding future damages for the entire remaining term of the agreement would encourage Novus to “commit economic waste by putting forth no efforts to mitigate its damages.”

Days Inns v. Investment Properties

In reaching this decision, the Novus court cited to a previous decision it had issued, Days Inns Worldwide, Inc. v. Investment Properties of Brooklyn Center, LLC, No. 10-609 (MJD/JJK), 2011 WL 4538076 (D. Minn. Aug. 26, 2011) adopted 2011 WL 4537934 (Sept. 29, 2011). Similar to Novus, in Days Inns the franchisee had defaulted and had not opposed the franchisor's request to recover future royalties. The court in Days Inns rejected the request for the recovery of future royalties by noting that the franchisor had failed to submit sufficient evidence to support an award and, thus, future royalties could not be established with a reasonable degree of certainty. The court noted, among other things, that Days Inns had failed to submit any evidence as to how long it would likely take to locate a new franchisee for the geographic area in question, and awarding future royalties for the remainder of the term would encourage Days Inns to put forth no efforts to mitigate its damages.

Conclusion

The Novus and Days Inns decisions serve as an important reminder to franchisors and their counsel. If a franchisor seeks the recovery of lost future royalties, it must make sure that it provides a thorough submission to support such an award that includes, but is not limited to, specifically addressing saved costs and mitigation due to replacement franchisees. Those reductions may decrease the amount ultimately awarded to the franchisor, however, they will avoid situations like Novus and Days Inns in which the court refused to award any future royalties. While courts are willing to award lost future royalties to a franchisor, the franchisor must be submit sufficient evidence to establish the lost royalties with a reasonable degree of certainty, even if the franchisee has defaulted and/or does not oppose the request.

Jay W. Schlosser is a partner in the Minneapolis office of Briggs and Morgan, P.A. He is a member of the firm's Franchise, Antitrust and Distribution Practice Group and provides counseling and litigation services to various franchise, manufacturing and distribution entities. He can be reached at [email protected] or 612-977-8539.

When franchisors enter into long-term franchise agreements, they expect to receive a steady stream of royalties for the duration of the agreement. In some cases, that can mean 20 years of royalty revenue from one franchise location. However, if the relationship sours and the agreement is terminated prior to expiration, the franchisor faces the prospect of losing the anticipated stream of royalties for the remaining term of the agreement. More and more often, franchisors are turning to the courts to attempt to recover those lost future royalties.

Most courts agree that if a franchisee terminates the franchise agreement, a franchisor is permitted to recover lost future royalties. See, Healy v. Carlson Travel Network Assocs., 227 F.Supp.2d 1080, 1094 (D. Minn. 2002); Vino 100, LLC v. Smoke on the Water, LLC, 864 F.Supp.2d 269, 286 (E.D. Pa. 2012). However, if the franchisor terminates the franchise agreement due to misconduct or a breach by the franchisee, the issue remains unsettled. See, Postal Instant Press, Inc. v. Sealy, 43 Cal. App. 4th 1704 (1996) (court, applying a proximate cause analysis, refused to allow franchisor to recover lost future royalties when it terminated the agreement); but see , American Speedy Printing Centers, Inc. v. AM Marketing, Inc., 69 F.Appx. 692 (6th Cir. 2003) (court, following traditional contract principles, allowed franchisor to recover lost future royalties even though it terminated the agreement).

Recovery of future royalties by a franchisor is a two-step process: 1) establishing the legal right to recover future royalties; and 2) submitting sufficient evidence to establish the amount of future royalties to a reasonable degree of certainty. Although several articles have looked at step one, less consideration has been given to step two. This article focuses on step two and some of the obstacles a franchisor may face in submitting adequate evidence to support an award of future royalties. This specific issue was addressed in a recent decision by U.S. District Court for the District of Minnesota, and it illustrates the potential hurdles a franchisor may face ' even if the matter is unopposed by the franchisee. See, Novus Franchise, Inc. v. AZ Glassworks, LLC, Civil No. 12-1771 (MJD/TNL), 2013 WL 1110838 (D. Minn., March 18, 2013).

Novus v. AZ Glassworks

In Novus, the franchisees stopped submitting revenue reports and stopped paying monthly royalties. Novus Franchise, Inc. (Novus) learned that the franchisees had abandoned the franchise and had started operating a competing business. Novus filed a lawsuit against the franchisees to seek injunctive relief to enforce a post-term non-compete provision. Novus also sought to recover past due royalties as well as future royalties for the remaining term of the franchise agreement.

The defendants failed to answer or otherwise respond to the complaint. Novus moved for entry of default judgment. The court entered judgment for the full amount of past due royalties and a permanent injunction enforcing the non-compete provision. However, the court refused to enter an award for future royalties for the remaining term of the franchise agreement, despite the fact that the defendants/franchisees did not oppose the motion.

Novus had asked the court to award all future royalty and maintenance fees required under the terms of the franchise agreement from the date of termination until the end of the term of the franchise agreement in 2019 ' a total of $68,040. The court cited two reasons for rejecting Novus's unopposed motion.

First, the court found that Novus had failed to take into account any costs that it saved as a result of the early termination of the franchise agreement. Without those included in the equation, the court determined that Novus was overstating its future profits.

Second, the court noted that Novus had requested future profits for the entire remaining term of the franchise agreement. The court found that it was highly likely that Novus would establish a new franchisee in that geographic area to replace the defendants prior to 2019 and that the replacement franchisee would eliminate, or at least reduce, future damages. The court stated that awarding future damages for the entire remaining term of the agreement would encourage Novus to “commit economic waste by putting forth no efforts to mitigate its damages.”

Days Inns v. Investment Properties

In reaching this decision, the Novus court cited to a previous decision it had issued, Days Inns Worldwide, Inc. v. Investment Properties of Brooklyn Center, LLC, No. 10-609 (MJD/JJK), 2011 WL 4538076 (D. Minn. Aug. 26, 2011) adopted 2011 WL 4537934 (Sept. 29, 2011). Similar to Novus, in Days Inns the franchisee had defaulted and had not opposed the franchisor's request to recover future royalties. The court in Days Inns rejected the request for the recovery of future royalties by noting that the franchisor had failed to submit sufficient evidence to support an award and, thus, future royalties could not be established with a reasonable degree of certainty. The court noted, among other things, that Days Inns had failed to submit any evidence as to how long it would likely take to locate a new franchisee for the geographic area in question, and awarding future royalties for the remainder of the term would encourage Days Inns to put forth no efforts to mitigate its damages.

Conclusion

The Novus and Days Inns decisions serve as an important reminder to franchisors and their counsel. If a franchisor seeks the recovery of lost future royalties, it must make sure that it provides a thorough submission to support such an award that includes, but is not limited to, specifically addressing saved costs and mitigation due to replacement franchisees. Those reductions may decrease the amount ultimately awarded to the franchisor, however, they will avoid situations like Novus and Days Inns in which the court refused to award any future royalties. While courts are willing to award lost future royalties to a franchisor, the franchisor must be submit sufficient evidence to establish the lost royalties with a reasonable degree of certainty, even if the franchisee has defaulted and/or does not oppose the request.

Jay W. Schlosser is a partner in the Minneapolis office of Briggs and Morgan, P.A. He is a member of the firm's Franchise, Antitrust and Distribution Practice Group and provides counseling and litigation services to various franchise, manufacturing and distribution entities. He can be reached at [email protected] or 612-977-8539.