Franchise Relationship Laws

• Author: Kerry L. Bundy and Robert M. Einhorn
• Pages: 183-232

183

Franchise Relationship Laws

CHAPTER 5

Kerry L. Bundy and Robert M. Einhorn

Contents

I. Brief History and Overview of Franchise Relationship Laws . . . . . 185

A. Abuses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

B. Federal Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

C. State Legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187

II. Definition of “Franchise” Under State Relationship Laws . . . . . . . . 1 89

A. Breadth of Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 9

B. A Closer Look at the Elements of a Franchise . . . . . . . . . . . . . . 189

1. Trademark . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

2. Marketing Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

3. Community of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192

4. Fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

III. “Good Cause” for Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 96

A. Statutory “Good Cause” Requirements . . . . . . . . . . . . . . . . . . . 1 96

B. Cases Interpreting Good Cause . . . . . . . . . . . . . . . . . . . . . . . . . 197

1. Underreporting Sales or Failure to Report Sales or Pay

Royalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

2. Failure to Maintain Standards and Other Contractual

Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 8

3. Failure to Meet Sales and Other Performance

Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 8

4. Sale of Competing Products . . . . . . . . . . . . . . . . . . . . . . . . . 1 99

5. Damage to Franchisor’s Reputation . . . . . . . . . . . . . . . . . . . 2 00

6. Market Withdrawal by the Franchisor . . . . . . . . . . . . . . . . . 200

7. Unfair Actions by Franchisors . . . . . . . . . . . . . . . . . . . . . . . 201

8. Termination upon Transfer by the Franchisee . . . . . . . . . . . 202

9. Incurable Conduct by the Franchisee . . . . . . . . . . . . . . . . . . 202

IV. Procedural Requirements for Termination . . . . . . . . . . . . . . . . . . . . 202

A. Statutory Procedural Requirements . . . . . . . . . . . . . . . . . . . . . . 20 2

184 Fundamentals of Franchising

B. Cases Interpreting Procedural Requirements . . . . . . . . . . . . . . . 2 03

1. Compliance with Notice Requirements . . . . . . . . . . . . . . . . 203

2. Franchisor Compliance during Notice Period . . . . . . . . . . . 2 04

3. Giving Reasons for Termination . . . . . . . . . . . . . . . . . . . . . . 204

4. Procedural Requirements for Insolvent and Bankrupt

Franchisees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 04

5. Incurable Breaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 05

V. Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206

A. Statutory Renewal Requirements . . . . . . . . . . . . . . . . . . . . . . . . 206

B. Cases Dealing with Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . 208

VI. The Perpetual Agreement Issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

A. The Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

B. Types of Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209

C. The Franchisor’s Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 11

D. Judicial Relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212

E. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 3

VII. Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 13

A. Types of Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213

B. Repurchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214

C. Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216

D. Injunctive Relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217

E. Lost Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 8

VIII. Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219

A. Grounds for Withholding Consent to Transfers . . . . . . . . . . . . . 219

B. Procedural Requirements for Transfer . . . . . . . . . . . . . . . . . . . . 22 1

C. Stock Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 22

D. Transfer upon the Death of a Franchisee . . . . . . . . . . . . . . . . . . 2 22

IX. Common Law Theories Affecting the Franchise Relationship . . . . . 2 23

A. Breach of Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3

B. Promissory Estoppel and Recoupment . . . . . . . . . . . . . . . . . . . 224

C. Non-Compete Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

D. Consent to Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

E. Encroachment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226

F. Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 28

G. Fiduciary Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228

H. Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 229

I. Antitrust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 1

X. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 31

Chapter 5 Franchise Relationship Laws 185

I. Brief History and Overview of Franchise

Relationship Laws

A. Abuses

In the 1950s and 1960s, the early period of modern business format franchising,

abuses were common. These abuses were exacerbated by the retrenchment and

vertical integration in the motor vehicle fuel industry following the OPEC oil

embargo in 1973. Franchisees argued that these abuses were not adequately

addressed by common law or antitrust remedies. The result was the passage of

both franchise registration and relationship laws, mostly in the 1970s. The abuses

that relationship laws address include:

•Unjust Terminations: Either by contract or by economic or other pres-

sures, the franchisor would attempt to terminate the franchise relation-

ship, thereby depriving the franchisee of the fruits of his labor and

investment.

•No Renewal Rights: The franchise agreement typically was for a time-

limited, and often short, duration, with no renewal opportunity, or,

contractual renewal opportunities would be unjustly frustrated, allowing

the franchisor to capture the benefits of the business that the franchisee

had developed once the stated term of the agreement had expired.

•No Right to Assign: The franchisor would prohibit the franchisee from

transferring all or a portion of his or her interest in the franchise to a bona

fide purchaser, or perhaps to a qualified family member, depriving the

franchisee of the opportunity to liquidate the equity in the franchised

business.

•Other Abuses: The franchisor would place another unit (either com-

pany-owned or franchised) in close proximity to an existing franchised

unit. This placement, known as encroachment, would result in the

franchisee’s business being “cannibalized”—sales diverted to the new

location. Franchisors also engaged in other practices objectionable to

franchisees, such as restricting the right of free association among franchi-

sees, discriminating in their treatment of franchisees, and imposing un-

reasonable standards of performance on franchisees.

B. Federal Legislation

No franchise relationship law of general application exists at the federal level.