The NJ Franchise Practices Act and the Legacy of 'Instructional Systems'

Indeed, due to the significant protections that the NJFPA provides, the issue of who qualifies as a “franchisee” protected by the Act has been the subject of several court decisions, most notably the seminal New Jersey Supreme Court case, Instructional Systems v. Computer Curriculum Corp., 130 N.J. 324 (1992). Decided nearly a quarter century ago, the Instructional Systems case is the foundation of much of the modern case law interpreting the NJFPA's criteria for a business to be subject to the Act, which (subject to exceptions) include the following: 1) a “written arrangement” between the franchisor and franchisee; 2) the grant of a “license” by the franchisor to the franchisee; 3) a “community of interest” between the franchisor and franchisee; 4) the “contemplat[ion] or require[ment]” that the franchisee would establish or maintain a New Jersey “ place of business”; 5) more than $35,000 in annual gross sales of the franchisor's products by the franchisee; and 6) more than 20% of the franchisee's gross sales “intended to be or ' derived” from the franchise. Id. at 56:10-3; 56:10-4.

In Instructional Systems, the NJ Supreme Court analyzed and provided guidance regarding the act's “place of business,” “license” and “community of interest” requirements, three particularly vague elements of the act. In doing so, the court emphasized that the NJFPA covers more than just the stereotypical franchises such as car dealerships or fast-food outlets.

Specifically, the plaintiff, the exclusive distributor of an educational software system in select geographic regions, claimed that the defendant, the manufacturer of the system, violated the NJFPA by failing to renew the parties' distributor agreement and forcing the plaintiff to sign a new agreement that imposed “unreasonable standards” on the plaintiff. The latter claimed that the Act applied despite the absence of the typical trappings of a franchise. For example, the plaintiff operated under its own business name and not under the name of the defendant manufacturer. The defendant argued that the plaintiff was not a franchisee and, therefore, the NJFPA did not apply. The trial court agreed with the plaintiff, finding that the parties' relationship constituted a franchise subject to the NJFPA. On appeal, the Appellate Division reversed, holding that the parties' relationship did not satisfy the NJFPA's requirements.

The Supreme Court reversed, holding that there was sufficient evidence before the trial court for a fact-finder to determine that the defendant had granted the plaintiff a “franchise” subject to the NJFPA's requirements. Regarding the “place of business” element, the court held that the plaintiff provided enough evidence to sustain a finding of fact that the plaintiff satisfied this requirement, despite not having a facility “dedicated exclusively to displaying [defendant's] goods.” 130 N.J. at 350. Instead, the plaintiff demonstrated simply that it had set up “a marketing facility in Hackensack, NJ, where its customers, education professionals, [could] inspect the [defendant's] computer system and receive a sales demonstration of the operation of its complex product.” Id. at 351. The court explained that while the plaintiff's facility did not resemble the typical franchise location, “there is more to the New Jersey Franchise Practices Act than the prototypes of hamburger stands.” Id. at 350. The court further explained that the plaintiff's facility was much more than a mere “office” or “warehouse.”

Regarding the “license” requirement, the Supreme Court found that the plaintiff provided enough evidence to satisfy this element as well. Specifically, the court explained that even though the plaintiff did not use the defendant's name as its own, the evidence supported a finding that the defendant had granted the plaintiff a license because:

By [defendant's] designation of [plaintiff] as an [exclusive distributor] and its [requirement] that [plaintiff] maintain and promote [defendant's] name, trademark, and logo, [defendant] gave its imprimatur to [plaintiff's] business enterprise in respect of [defendant's] product and induced the consuming public to expect from [plaintiff] a uniformly acceptable and quality controlled service endorsed by [defendant] itself.

Id. at 354 (internal quotations omitted).

According to the court, this was the “hallmark” of a “license” under the Act.

Regarding the “community of interest” requirement, the Supreme Court explained that this requirement “addresses the inequality of bargaining power between the parties and is critical in distinguishing franchises from other types of business relationships.” Id. at 356. The court further explained that the telltale signs of a “community of interest” include a “symbiotic relationship” between the parties, as well as a purported franchisee's significant investments in the franchise, which are “sunk costs” should the purported franchisor terminate the relationship. Id. at 356-366. The court held that, in that case, a finding of a “community of interest” was warranted based on the plaintiff's substantial, non-transferable investments, including, but not limited to, at least $250,000 in equipment, engaging in numerous joint sales and marketing activities to promote the defendant's product and developing extensive goodwill for the defendant's business.

Other Courts Have Followed Suit

Several New Jersey courts have relied on Instructional Systems to find franchise relationships in seemingly unexpected places. For example, in Atlantic City Coin & Slot Serv. Co. v. IGT, 14 F. Supp. 2d 644 (D.N.J. 1998), the District Court of New Jersey granted a slot machine distributor's motion for a preliminary injunction barring the defendant manufacturer from invoking its contractual right to terminate the plaintiff's exclusive distributorship agreement with the defendant. As in Instructional Systems, the plaintiff in Atlantic City Coin & Slot conducted business under its own name and not under the name of the purported franchisor. Nevertheless, relying heavily on the Supreme Court's analysis in Instructional Systems , the district court found that the plaintiff slot machine distributor was likely to establish that its relationship with the defendant manufacturer constituted a “franchise” protected by the NJFPA.

Specifically, the district court explained that the plaintiff had presented evidence that the plaintiff made numerous substantial franchise-specific investments, including, but not limited to, investing in a facility to sell, service and modify the defendant's products, purchasing promotional materials, and developing a client base for the defendant. The plaintiff had also demonstrated that the parties depended on each other by, for example, engaging in joint marketing and training sessions. The district court therefore found that the plaintiff likely would succeed in establishing that a “community of interest” existed between the plaintiff and defendant. The court also found that the plaintiff and defendant held the slot machine distributor out to the public in a way that established that the defendant vouched for the activities of the plaintiff, and therefore the defendant had granted the plaintiff a “license” as defined by the NJFPA.

Similarly, in Beilowitz v. GMC, 233 F. Supp. 2d 631 (D.N.J. 2002), the plaintiff, an authorized distributor of certain GM car parts, sought a preliminary injunction against GM for its alleged violation of the NJFPA based on GM's attempt to terminate the parties' distribution agreement and replace it with a new agreement. The new agreement would have allegedly caused the plaintiff to lose 40% of its business. GM claimed that the relationship between the parties did not constitute a franchise pursuant to the NJFPA. The district court disagreed and granted the preliminary injunction, finding that the distributor was likely to succeed on the merits of its claim. The court, relying on Instructional Systems, found that a “community of interest” likely existed between the parties based both on the plaintiff's tangible investments in the business, as well as intangible investments, such as the goodwill the plaintiff had developed for the defendant's products.

In Engines v. MAN Engines and Components, Civil Action No. 10-277 (RMB/KMW) (D.N.J. 2010), the district court granted a preliminary injunction to prevent the defendant, an importer and seller of MAN diesel engines, from terminating its agreement with the plaintiff, a MAN diesel engine authorized dealer and repair shop. The plaintiff argued that it was a “franchisee” of the defendant, and therefore the defendant could not terminate the parties' dealer agreement without good cause, pursuant to the NJFPA. The district court held that that the plaintiff was likely to succeed on the merits of its claim and granted the preliminary injunction. Notably, the court held that the plaintiff likely satisfied the “community of interest” element where the dealer agreement between the parties merely “contemplated” ' though not necessarily required ' the plaintiffs' investments in the franchise. Additionally, the court found the relationship to likely satisfy the NJFPA despite the fact that the defendant sold products and services for MAN's competitors.

The court noted that this fact was of little consequence to the analysis because the NJFPA merely requires a franchisee to derive more than 20% of its sales from the franchise. As such, by the NJFPA's plain language, a franchise can sell a number of other products without falling outside the act's protections.

Conclusion

The Instructional Systems case and its progeny demonstrate that the NJFPA protects more than the car dealerships and hamburger stands of the world. Indeed, although courts have certainly denied the protections of the NJFPA to businesses claiming they fall under the Act's umbrella, in 2010, the legislature amended the NJFPA to expressly provide that “courts have in some cases more narrowly construed the Franchise Practices Act than was intended by the Legislature.” N.J.S.A. 56:10-2. As such, New Jersey practitioners who advise businesses that rely on a supplier or manufacturer for more than 20% of their business would be wise to review whether these businesses qualify for the Act's significant protections.

Marisa Rauchway Sverdlov is the founder of the Law Office of Marisa Rauchway Sverdlov in Short Hills, NJ. She focuses her practice on business litigation, franchise law and securities litigation. This article also appeared in the New Jersey Law Journal, an ALM sibling publication of this newsletter.