Franchise Law Case Analysis - Essay Example

Franchise Law Take Home Exam Joe’s Franchise Renewal In general, a franchise renewal involves the expiration of an existing franchise agreement and the formation of a new franchise agreement. In other words, a renewal operates to replace the expired franchise contract. All state laws refer to the right of refusal to renew or non-renewal parameters with a general understanding that should the parties renew the franchise, it is on very different terms and conditions (Barkoff and Selden). The main issue is usually whether or not the terms and conditions for renewal constitute good faith and fair dealing grounds for refusing to renew (Barkoff and Selden). Therefore, each of the renewal terms raised by Joe must be examined in terms of whether or not, the proposed conditions and terms constitute good faith and fair dealing grounds for refusing renewal of the expiring franchise contract. In general, Joe takes issue with the requirement to purchase meat and cheese from Hoagie Land in Philadelphia when it is more convenient for him to purchase the same from Hoagie Land in New York, the payment of what Joe considers an excessive legal fee, the payment of a renewal fee, the installation of a point of sales systems, adoption of a new sign and remodelling. The question for consideration is whether or not each of these terms and conditions can be characterized as inconsistent with the concept of fair dealing and good faith. The concept of fair dealing and good faith was considered in the case of Payne v McDonald’s Corp. In this case, the franchisor’s renewal was conditional upon the franchisee’s consent to rebuild the restaurant. The court held however, that the requirement for rebuilding was not inconsistent with the concept of good faith and fair dealing (Payne v McDonald’s Corp.). However, the facts of Joe’s case can be distinguished from the facts of Payne v McDonald’s Corp. In the Payne case, there original franchise contract reserved the right of renewal to the franchisor which made no promise to renew. Thus there was no reasonable expectation that once the franchise expired, the franchisee would be able to continue with the franchise, albeit on similar and fair terms. In Joe’s case, there was an express renewal term at the discretion of the franchisee. The ruled in Payne that since there was no express right to renewal, the franchisor was not under a duty to renew the franchise and in deciding to do so could condition renewal on requirements that suited its business ends (Payne v McDonald’s Corp.). Some guidance is found in the case of Bresler’s 33 Flavors Franchising Corp. v Woksin. In the case, the court ruled that in order to satisfy a claim that a refusal to renew on terms and conditions that were inconsistent with the concept of fair dealing and good faith, the claimant must show that the terms and conditions were only applied to the claimant and not to any other franchisor. Specifically, when the renewal term was for remodelling, the claimant must also show that to the satisfaction of the court that remodelling would have a negative impact on profitability (Bresler’s 33 Flavors Franchising Corp. v Woksin). I would therefore advise Joe to provide as much evidence as possible demonstrating that remodelling would negatively impact profitability and that purchasing meat and cheese from Philadelphia rather than from New York would negatively impact profitability. In looking at the requirement to purchase meat from Philadelphia as opposed to New York, it is unlikely that Joe can excise this term as it appears to be applicable to all franchisees and is stated to be for quality control and for economies of scale. To begin with, it may be argued that purchasing from the Philadelphia suppliers may be more convenient for Joe since his restaurant is located in Cherry Hill, New Jersey which is nearer to Philadelphia than it is to New York. Moreover, the requirement to purchase meat and cheese from the Philadelphia supplier applies to all franchisees and does not discriminate against Joe. Similar considerations must be given to the requirement to install a point of sales system and to adopt a new sign. If these requirements are equally applicable to all franchisees, the franchisor will not be said to be discriminating against Joe and it will be difficult to successfully argue that the renewal conditions are inconsistent with the tenets of good faith and fair dealing. In Thompson v Atlantic Richfield Co. it was held that discomfort with the new terms of a renewal contract that is offered to all of the franchisor’s franchisees are not discriminatory and will not constitute refusal to renew on the grounds that it is inconsistent with the concept of good faith and fair dealing (Thompson v Atlantic Richfield Co.). Therefore if the requirement to pay legal fees of the type that Joe is required to pay, and each of the other terms and conditions are equally applicable to other franchisees, Joe will not be able to have the terms excised from the new franchise contract. In fact, the clause for renewal in the original franchise contract specifically states that: ..upon renewal, the franchisee shall be required to sign the then-current franchise agreement offered to franchisees of Hoagie House, pay the then current renewal fee and remodel the premises within six months of renewal. Therefore, Joe was well aware of that remodelling and renewal fees were conditions for renewal when he signed the original franchise agreement. Joe is bound by the terms and conditions of the original agreement requiring that all disputes be resolved in Pennsylvania and it would be a breach of the choice of law clause should he file the dispute in New Jersey. Should he file the suit in New Jersey, the franchisor may refuse to submit to the jurisdiction and can file a suit in Pennsylvania requiring the New Jersey court stay Joe’s action which would only incur unnecessary expenses to Joe (Morrison). As for the FDD, the franchisor has up to 14 days before Joe is expected to sign the renewal to furnish the FDD (Barkoff and Selden). Unless the fourteen days has expired, Joe needs to wait until such time as the 14 days expires before filing an action. He will have one year from the date the action accrued to file a suit and should file it in Pennsylvania pursuant to the choice of law clause contained in the original franchise contract. Before filing suit, Joe should carefully consider whether or not he can prove that remodelling will negatively impact profitability and that each of the other terms and conditions or at least some of them are discriminatory. Otherwise he should accept the terms and conditions for renewal or simply reject the renewal offer altogether. 2. George’s Lease In getting out of the sublease, George may claim that a primary clause within the lease was unconscionable pursuant to Section 2A-108 (1) of the Uniform Commercial Code. Section 2A-108(1) of the Uniform Commercial Code provides that should the court find that a lease or “any clause of a lease contract” is “unconscionable at the time it was made” the court can deny the validity and enforceability of the lease of any part of the lease or may “limit the application of any unconscionable clause as to avoid any unconscionable result” (Uniform Commercial Code, Section 2A-108(1)). The Uniform Commercial Code does not define what amounts to unconscionability and it is therefore assumed that it is up to the courts to determine each case on its own merits and its own special facts and circumstances (Marrow). It is generally assumed that where a lease or a contract is assumed between two commercial entities, there is conscionability, based on the perception that two business entities have equal bargaining positions (American Dredging Co. v Plaza Petroleum, Inc.). Even so, courts have found unconsionability in situations where a business party was deliberately deprived of information effecting or transforming the effect of a term of the contract (Marrow). In Aviall Inc. v Ryder Systems, Inc. the court came to the conclusion that although the two parties negotiating and concluding a contract were two businesses, one party was weaker than the other. Such weaknesses could be as a result of one party not availing himself of legal representation while the other party did. According to the facts of the case for discussion, George did not seek legal advice prior to signing the sublease. However, the matter does not end there. The court also ruled that unconscionability will be found in a specific set of circumstances where the weaker party is placed under undue pressure to agree to the terms and conditions of a contract (oppression) or one party used deception in negotiating the terms of the contract (Aviall Inc. v Ryder Systems, Inc.). While there is no evidence of oppression, there is evidence of deception. The deception exists because the primary obligation under the contract is for George to use the business name and Tropicanical. As it turns out, Tropicana is taking issue with George using the tradename and is claiming trademark infringement. It can therefore be assumed that the lessor used deception in negotiating with George to use Tropicanical when it did not have permission to use the same and by leasing the premises and name to George, has left George vulnerable to a law suit for trademark infringement and has left George with no possibility of practicing his trade, given the restrictive covenant. It can therefore be argued on George’s behalf that the sublease is unconscionable and therefore null and void. I would therefore advise George to get out of the lease altogether on the grounds that the lease itself is unconscionable. Regardless, George may also have a claim rendering the restrictive no-compete clause unenforceable. No-compete restrictive covenants in franchise and business arrangements are usually regulated by the common law and are not generally regulated by statute (Klarfeld and VanderBroek). The general rule under Federal law is that no-compete restrictive covenants in a franchise arrangement such as the one that George has with the lessor are subject to the anti-trust rule of reason (Klarfeld and VanderBroek). This usually means that the no-compete restrictive covenant is necessary for protecting the business interest of the franchisor/lessor which includes the franchisor/lessor’s goodwill and consumer base (Piercing Pagoda, Inc. v. Hoffner). The common law of most states generally agree that in order for a no-compete restrictive covenant to be enforceable between a franchisee and a franchisor, the restrictive covenant must first be a part of a legally binding contract and form a part of the contract’s legitimate objectives (Keller Corp. v Kelley, 187). Arguably, the lessor wants to protect its business interest in the Philadelphia area and does not want George to use knowledge and skills as well as trade secrets acquired while using the premises and the business to the lessor’s disadvantage. It is also necessary to protect the lessor from the possibility that George would upon starting a rival business in the area, take some of the lessor’s customers with him. Under ordinary circumstances these are legitimate business interests and good will and thus are consistent with the exception to the antitrust rule of reason. However, George has only been operating at the business for several weeks. It is therefore questionable whether or not a two year moratorium is proportionate to the intended safeguards of the lessor. In the circumstances a two year moratorium is an unreasonable restraint of trade. Moreover, when the legitimate interest of the lessor is considered it must be considered in light of the facts and circumstances of the case. George has been served with a cease and desist notice by Tropicana. Should he continue to operate under the lease as Tropicanical, he faces an expensive legal battle in which he cannot practice his trade under the lease nor can he practice his trade under a new name. It is therefore unlikely that the court will side with the lessor and force the restrictive covenant against George. This is because, it does not appear to be a legitimate or reasonable means of protecting the business interest of the lessor and given the outcome for George, it appears to be merely punitive and as such an unreasonable restraint of trade contrary to the Federal anti-trust rule of reason. Moreover, George may have a legitimate claim under the doctrine of frustration or discharge by legal impossibility or impracticability. According Section 262 of the Restatement (Second) of Contracts a contract can be rescinded on the grounds of impracticability when its continued performance is likely to create “extreme or unreasonable difficulty, expense, injury or loss” to either or the parties to a contract. Therefore, Section 262 of the Restatement (Second) of Contracts contemplates situations in which unexpected difficulties arises. Certainly the cease and desist notice from Tropicana and a trademark infringement claim is not only an unexpected difficulty, but it also functions to cause significant cost to both George and the lessor. If George continues to use Tropicanical, he faces the prospects of an action in which he will have to account for profits and will have no choice but to serve third party notice on the lessor with the expectation that he would be indemnified for any costs and damages incurred in fighting the trademark infringement claim by Tropicana. The doctrine of frustration was considered by the Commonwealth court of Pennsylvania in Pocono Springs Civic Association, Inc. v. Rovinsky. In this case, the court ruled that the Supreme Court of Pennsylvania has already established that the doctrine of frustration operates as an implied condition of a contract holding that a contract cannot continue when the subject matter of the contract dissolves or is rendered unavailable. When parties enter into a contract with the expectation that performance of the contract depends on the availability of something which subsequently becomes unavailable at no fault of the parties to the contract, the contract ends (Pocono Springs Civic Association, Inc. v. Rovinsky). The name leased by George is unavailable and while it is certainly not George’s fault, the lessor may also be blameless, depending on whether or not the lessor believes that he has a right to use the term Tropicanical. Regardless, cease and desist notice, will put George to significant expense, for which the lessor will likely also be responsible. Therefore it is not in either parties’ best business interest to continue with the lease. At the very least, the lessor cannot insist upon George continuing to lease Tropicanical’s shop since to do so would be inconsistent with the original intention of the parties. In order to change the name, a new contract would have to be negotiated and the old contract would terminate automatically. George has a right to insist that he intended to operate Tropicanical and now that the option is no longer available to him, he wishes to move on. In this regard, the original sublease is unenforceable. I would therefore advise George to negotiate with the lessor for a termination of the lease arguing that the service of a cease and desist notice puts an end to his contractual obligations and will tie the parties to legal fees and possible damages which far exceed any value that the contract may have for the lessor or for George. George should also point out that since the name Tropicanical is no longer available for him to use, the contract itself is frustrated or impractical and therefore he is no longer bound by its terms and conditions. This would include the obligations associated with the no-compete restrictive covenant. If George is unable to convince the lessor to release him from the sublease, George may file a suit for breach of contract on the grounds that the contract was frustrated or in the alternative, that the no-compete restrictive covenant is unconscionable or is an unreasonable restraint of trade given the special facts and circumstances of the case. I believe that George will likely succeed in his action against the lessor. 3. The Area Representative The Florida Franchise Act will allow rescission of a franchise contract in certain circumstances, namely: where the person in the course of distributing, selling or establishing a franchise makes misrepresentations as to the proposed outcome relative to the franchise (Florida Franchise Act, Section 817.416(a)(1)). The question is therefore whether or not Bobby misrepresented to Sally what she stood to make once she became a part owner of the JLow Cafe Florida franchise in Miami. On the facts of the case for discussion, Bobby promised Sally that she would earn more as a holder of 51% of JLow’s of Florida than she was earning as an air traffic controller. All she was required to do was to pay the US$60,000 franchise fee to JLow’s Cafe franchise. Within a month of agreeing to and paying the franchise fee, Sally learned that Bobby had pleaded guilty to tax evasion. This revelation would arguably damage the prospects of JLow Florida making a profit as the Federal government will be looking to receive back taxes from Bobby and this would likely subject JLow Florida’s assets and profits to control by the Federal government until such time as the back taxes are satisfied. In the meantime, the franchise’s reputation will be called into question and this might result in a significant decline in business. More importantly, the fact that Bobby pleaded guilty to tax evasion in just a month after inducing Sally to pay the franchise fee indicates that he knew all along that his representations to Sally about the prospects of making a significant profit were false. He would have known at the time that he was under investigation and that he had little or no chance of escaping responsibility and that his legal troubles would undermine JLow Florida’s ability to be profitable. Nevertheless, he misrepresented JLow Florida’s prospects with respect to profitability to Sally and convinced her to pay the US$60,000 franchise fee. Under the Florida Franchise Act, the remedy for inducement relative to franchise sale, distributorship or establishment by virtue of misrepresentation is for the return of all funds advanced as a result of the misrepresentation or rescission. However, in order to take advantage of the statutory relief accorded the aggrieved party must be determined to be doing business in Florida. The facts of the case do not reveal where Sally was working as an air traffic controller. However, a Florida court held in held in Burger King Corporation v Austin that even where a franchise holder was out-of-state, provided the franchise was in-state, the aggrieved party would have standing under the Florida Franchise Act. Therefore, if Sally does not live in Florida, the mere fact that she has a share in a franchise doing business in Florida, she is a person doing business in Florida for the purpose of the Florida Franchise Act and will therefore be entitled to pursue a claim for rescission on the grounds of misrepresentation. In order to succeed, Sally will have to prove that Bobby deliberately mislead her by misrepresenting the prospects of her making a profitable return on her investment. Since the standard of proof is on a preponderance of the evidence or on a balance of probabilities, she is likely to succeed. It is highly probable that Bobby knew that he could not deliver on his promise to Sally and that he withheld his legal troubles from her for fear that had she known of the tax evasion investigation and the likelihood that he would be held accountable, she would not have agreed to become his business partner. It therefore follows that Sally will likely be able to compel the rescission of the franchise contract between her and Bobby and will be entitled to the return of the US$60,000 franchise fee that she paid on behalf of JLow Florida. Sally will also be entitled to all legal fees and costs associated with having to pursue the claim (Florida Franchise Act). It is unlikely that Sally will be able to claim the return of the US$60,000 franchise fee from JLow Cafe since she did not have an agreement with them per se. Jlow Cafe received the fee from Bobby who at the time finalized an agreement with JLow Cafe. It was only after paying the fee and finalising the franchise arrangements that he sought to transfer part of the franchise ownership in JLow Florida to Sally. Therefore Sally’s claim is against JLow Florida and not against JLow Cafe. In the event Sally decides to pursue a claim against JLow Cafe she would have to prove fraudulent inducement or in the alternative that JLow Cafe acted in a manner that was inconsistent with good faith and fair dealing. However, these claims are more appropriate against Bobby and JLow Florida LLC as JLow Cafe had no dealings with Sally and as such cannot be said to have acted in a manner inconsistent with good faith and fair dealing in regards to Sally. At the time of negotiating and completing the franchise agreement with Bobby and JLow Cafe Florida, Sally was not a party to the agreement with Bobby and JLow Cafe Florida. Therefore Sally was not within the contemplation of JLow Cafe at the time (Hotels of Key Largo, Inc. v RHI Hotels, Inc. Bus. Franchise Guide, 11.189. 22 Fla. Law Weekly D952 (Fla. Dist. Ct. App. 3. Dist., April 16, 1997)). There is no evidence that JLow Cafe knew or was aware of Bobby’s legal troubles. At the time of negotiating the franchise contract with Bobby, he was merely under investigation for tax evasion. If he had been charged or arrested at the time, it is not revealed in the facts of the case for discussion. It can only be surmised from the facts of the case for discussion that Bobby had been arrested, charged and arraigned May 2, some two months after concluding his franchise agreement with JLow Cafe. It can therefore be concluded that even if JLow Cafe conducted a background check and conducted due diligence they could not have discovered that Bobby was under investigation for tax evasion. Even if they discovered the fact that Bobby was under investigation for tax evasion they were at liberty to assume the risk of getting into a franchise arrangement with Bobby. Moreover, they did not have Sally to consider at the time and could not have known that Sally would partner with Bobby at some future date and would consider a partnership with him a risky undertaking. At the end of the day, JLow Cafe is as much a victim of Bobby’s deception as Sally is. Since they were paid the franchise fee by the party with whom they contracted with, Sally does not have a privity of contract with JLow Cafe and therefore she may not reclaim the franchise fee from JLow Cafe. JLow Cafe may terminate the franchise contract with JLow Florida under the Florida Franchise Act for the same reasons that Sally can, provided they can prove that Bobby misrepresented his prospects of gaining a profit for JLow Cafe and misrepresented the value that he can bring to JLow Cafe generally. It is obvious that Bobby was under investigation for tax evasion and knew that he would eventually get caught and that would subject the franchise to investigation and possible retention of assets by the federal government. While it may not directly involve JLow Cafe and may only effect JLow Florida, the reputation of the franchise as a whole is at stake. It is also likely, the JLow Cafe may be able to claim loss of future earnings depending on the impact that the fallout from Bobby’s conviction has on the franchise’s income as a whole. However, in order to be successful in a claim for loss of future earnings, JLow Cafe will have to prove that income prior to the arrest and conviction was better than it was after the arrest and conviction and that there is a connection between the arrest and conviction and the loss of profits (Hotels of Key Largo, Inc. v RHI Hotels, Inc. Bus. Franchise Guide, 11.189. 22 Fla. Law Weekly D952 (Fla. Dist. Ct. App. 3. Dist., April 16, 1997)). In the final analysis, Sally and JLow have a reasonable chance of success in rescinding their contracts with JLow Florida Cafe. However, Sally has little to no chance of succeeding in a claim for a refund of the franchise fee from JLow Cafe. Bibliography American Dredging Co. v Plaza Petroleum, Inc. 799 F. Supp. 1335 (E.D.N.Y. 1992). Aviall Inc. v Ryder Systems, Inc. 110 F. 3d 82 (2d Cir. 1997). Barkoff, Rupert, M. and Selden, Andrew, C. Fundamentals of Franchising. Chicago, Ill: American Bar Association Publishing, 2008. Bresler’s 33 Flavors Franchising Corp. v Woksin 491 F. Supp 1533 Bus. Franchise Guide 8229 (E.D. Wis. 1984). Burger King Corporation v Austin 805 F. Supp. 1007 (S.D. Fla. 1992). Florida Franchise Act. Hotels of Key Largo, Inc. v RHI Hotels, Inc. Bus. Franchise Guide, 11.189. 22 Fla. Law Weekly D952 (Fla. Dist. Ct. App. 3. Dist., April 16, 1997). Keller Corp. v Kelley, 187 P.3d 1133 (Colo. Ct. App. 2008). Klarfeld, Peter, J. and VanderBroek, Mark, S. “Law on Covenants Against Competition Shift Toward Greater Enforceability by Franchisors.” Franchise Law Journal, (Fall 2011): 76-84. Marrow, Paul, Bennett. “Contractual Unconscionability: Identifying and Understanding Its Potential Elements.” Journal (February 2000): 18-29. Morrison, A. B. Fundamentals of American Law. Oxford, UK: Oxford University Press, 1996. Payne v McDonald’s Corp.957 F. Supp. 749 Bus. Franchise Guide (D.Md.1997). Piercing Pagoda, Inc. v. Hoffner, 465 Pa. 500, 351 A.2d 207 (Pa. 1976). Pocono Springs Civic Association, Inc. v. Rovinsky Commonwealth Court of Pennsylvania 845 S. 24.200 (2004). Restatement (Second) of Contracts. Thompson v Atlantic Richfield Co. 649 F. Supp. 969 Bus. Franchise Guide (W.D. Wash. 1986). Uniform Commercial Code. Read More