The U.c.c. and Franchise Act Remedies: Coast to Coast Stores, Inc. v. Gruschus

• Publication year: 1986
• Citation: Vol. 9 No. 03

UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 9, No. 3SPRING 1986

The U.C.C. and Franchise Act Remedies: Coast to Coast Stores, Inc. v. Gruschus

Misty Ellen Mondress

I. Introduction

Coast to Coast Stores, Inc. v. Gruschus(fn1) was the first Washington case to deal with the potential conflict between the Uniform Commercial Code (U.C.C.) and the Franchise Investment Protection Act (FIPA), arising when a franchisor repossesses goods after a franchisee defaults under a security agreement.(fn2) The Washington Supreme Court avoided the conflict, however, by holding that because the franchisor never terminated the franchise, the FIPA protections were not triggered. The U.C.C. remedies therefore applied: the franchisor could collect the proceeds of a liquidation sale of the secured goods-in this case the franchisee's inventory and supplies-in reduction of the franchisee's indebtedness; and the franchisor was relieved of the FIPA burden of purchasing all of the franchisee's inventory and supplies at fair market value.(fn3) Washington franchisors breathed a sigh of relief, no longer fearing that they would be forced to buy out franchisees who fail in business: to avoid the FIPA purchase provision, the franchisor need only repossess its security without explicitly terminating the franchise contract.

In correctly choosing not to apply FIPA, the Washington Supreme Court found basis for its decision in a technical construction of the terms "franchise" and "termination" as they appear within the Act.(fn4) This technical construction, however, need not determine the result, for even when the franchisor terminates, the U.C.C. remedies should apply if the franchisee has defaulted on a secured obligation to the franchisor. As the Coast dissent argued,(fn5) a strict construction of the law probably mandated application of the FIPA purchase provision in lieu of the U.C.C. default sections. That same constructionist interpretation, however, unreasonably burdens the franchisor and exceeds the remedy necessary to implement the protectionist policy that inspired FIPA. The logical interpretation of the franchisor's duty to purchase the franchisee's inventory and supplies denotes their fair market value as the actual proceeds realized at a wholesale level sale.

This Note explains the difference between the U.C.C. and FIPA remedies and why their respective valuations should be interpreted as more similar than different. The Note then examines the Coast court's reasoning and offers additional support for preserving the U.C.C. remedies even if a franchise is terminated when a franchisor repossesses franchised goods after a franchisee defaults on a secured obligation owed to a franchisor.

II. Evaluation of The Franchisor's Duty to Pay "Fair Market Value" For The Franchisee's Inventory and Supplies

Coast-to-Coast Stores (Coast), a franchisor, possessed security interests in the fixtures, equipment, inventory, and accounts receivable of the franchisee Gruschus' hardware store. Within five months of the execution of security agreements, the Gruschus' became delinquent in their account. Less than two and one-half years after the creation of the franchise relationship, Coast locked the hardware store and repossessed all secured goods.(fn6) The superior court held that the franchisor Coast terminated the franchise when it repossessed the collateral given pursuant to the parties' security agreements. Applying FIPA, the trial court ordered Coast to pay the Gruschus' the fair market value of those very items that Coast sought to repossess.(fn7)

Coast appealed the decision, urging the Washington Supreme Court to apply the U.C.C.(fn8) Under the U.C.C., Coast could collect the proceeds from a forced sale of the secured goods,(fn9) while under FIPA Coast would have to pay fair market value for all of the inventory and supplies in the Gruschus' store.(fn10) In dicta, the court stated that the FIPA and U.C.C. remedies are identical because both ensure that the franchisee is not left with franchised inventory but without a license or effective means to sell it.(fn11) However, although the two remedies are identical with regard to the possession of inventory, the Coast parties chose to litigate because they assumed that the remedies differed with regard to financial results.

Under the U.C.C, when a debtor defaults, the secured creditor usually chooses to repossess the goods, sell them in a commercially reasonable sale, apply the proceeds (less costs of sale) to the debt owed, and sue for a deficiency judgment for the difference between the indebtedness and sale amount.(fn12) Courts uphold sales conducted in a reasonable manner and will hold debtors liable for deficiencies between the amounts owed and the proceeds of the sales. A low selling price is usually attributed to low market demand.(fn13) As a consequence, a court may uphold a commercially reasonable sale even though the net proceeds amount to less than ten percent of the goods' optimal retail market value.(fn14)

FIPA, on the other hand, requires that the franchisor pay fair market value for the franchisee's inventory and supplies upon termination of the franchise relationship.(fn15) Washington is unique in that this obligation to purchase inventory and supplies prevails even when the franchisor has terminated because the franchisee breached statutory and contractual obligations or filed for bankruptcy, or for some other enumerated "good cause."(fn16)

The franchisor is relieved of this duty to purchase only with respect to goods "which have no value to the franchisor" and to the extent that the franchisor may offset amounts owed by the franchisee.(fn17) Courts have defined fair market value as the price placed on a product by a willing buyer and seller, neither of whom is compelled to purchase or sell-that is, the price paid for goods in an optimal setting.(fn18) In the context of FIPA, the more accurate definition, however, is the amount recoverable by a sale in an established market.(fn19)

At first glance, the U.C.C. and FIPA appear to prescribe different financial outcomes because the focus of commercially reasonable sale is the manner of sale(fn20) while the focus of fair market value is often quoted as the price paid for goods in an optimal setting.(fn21) The U.C.C. sale value need not, however, be interpreted as theoretically different from the FIPA fair market value. Both should be interpreted as actual wholesale value.

Although the legislature failed to characterize the FIPA value as wholesale or retail, the logical market is wholesale. The wholesale level precludes a windfall to the franchisee and undue hardship to the franchisor: the franchisee is reimbursed at the market level at which he or she originally purchased, and the franchisor is able to resell the goods to other franchisees without forfeiting his or her legitimate expectations of profit at the time of the original sale to the franchisee. Also, purchase at the wholesale level does not undercut the judicial desire to not leave the franchisee with unsaleable inventory.(fn22)

Moreover, wholesale level sales for franchised goods are more likely to yield a greater net profit, to the benefit of both the franchisor and the franchisee, even though retail sales after default may provide a higher gross amount for the franchised goods. Retail sales entail significant costs that do not exist at the wholesale level, in the form of retail facilities, personnel with expertise, and other essentials that the franchisor may lack. These costs, although chargeable to the debtor,(fn23) lower the net sale proceeds. The franchisor will realize greater value by directly selling or by purchasing the goods himself and reselling them to other franchisees in the wholesale level market to which he or she is accustomed.(fn24)

In addition to denoting the proper level of valuation as wholesale, the price placed on inventory and supplies to be purchased by the franchisor should be measured by actual market demand at the time of the franchisee's default.(fn25) To otherwise value goods according to the price paid when originally sold to the franchisee by the franchisor, rather than according to actual sale at the time of default, creates an inequitable windfall for the franchisee at the expense of the franchisor and other franchisees.(fn26) The franchisee, by retaining the goods, accepts the risk of declining market value and depreciation.(fn27) Also, as a matter of economic efficiency, the value of goods should be determined according to objective market demand, not the franchisee's subjective valuation.(fn28)

Thus, by denoting the FIPA "fair" market as wholesale and measuring the "value" from actual resale, the franchisee recoups loss according to the actual market demand sale price for inventory and supplies, and the franchisor is afforded no more or less than his reasonable expectations when he sold those goods to the franchisee. To otherwise denote the FIPA fair market value purchase price as a hypothetical optimal retail value burdens the franchisor and other franchisees with the risk of loss to the extent that the optimal retail value exceeds the actual sale proceeds.

III. The Coast Court Correctly Chose to Apply the U.C.C.

The Washington Supreme Court reasoned that because the franchisor did not terminate the franchise agreement, the FIPA purchase remedy did not apply.(fn29) The court's...