Several cases recently decided in different states illustrate how difficult it can be for a manufacturer or franchisor to terminate a relationship with a distributor or franchisee. The causes vary, but these cases illustrate three: broad interpretation of the coverage of distributor or franchise protection statutes, ambiguous contract language and difficulties of proof or procedure.
State statutes protecting distributors and franchisees come in a variety of forms. Some protect distributors in general; some protect franchisees and distributors classified as franchisees. Under the Wisconsin Fair Dealership Law, for example, the grantor of a dealership may not terminate a dealership without good cause. This provision applies only to a dealer with a “community of interest” with its supplier in the business of distributing goods or services. Wisconsin courts developed two “guideposts” and a nonexclusive list of 10 factors to help determine whether a dealership exists.
With so many guideposts and factors, it is often hard to predict what a court will decide. One factor is the percentage of gross proceeds or profits the alleged dealer derives from a supplier’s products or services. In February 2012, a Wisconsin court of appeals decided in Kelley Supply v. Hansen that a community of interest existed between a distributor of food ingredients and its supplier, even though the supplier’s products averaged only 14 percent of the distributor’s overall sales. A 1987 Supreme Court of Wisconsin decision had found a community of interest even when the percentage was only 8 percent or 9 percent. In that situation and in Kelley, the court cited other factors to support its decision. In Kelley, the other factors included significant capital investments by the distributor (although some investments might have been for the benefit of other suppliers as well) and a 26-year relationship.
In February 2012, a U.S. federal district court in Washington state decided in BP West Coast Products v. Shalabi that a gasoline station/convenience store operator was properly classified as a franchisee and protected by the Washington Franchise Investment Protection Act. The operator met all of the definitions of a franchise, including payment of a “franchise fee.” The oil company did not charge a fee to be a gasoline station operator, but the court found a fee existed because the operator was required to pay more than a reasonable wholesale price for gasoline due to the oil company’s zone pricing scheme and faulty deliveries.
Contractual Interpretation & Management
Two recent cases illustrate how poor contract drafting or mistakes in contract management can make termination difficult or impossible. In a July 2011 case, Southern Wine v. Mountain Valley, the U.S. Court of Appeals for the Eighth Circuit upheld a jury verdict in favor of a terminated distributor on the basis that the distribution agreement granted the distributor a perpetual term.
That distribution agreement provided the distributor relationship would remain in effect until terminated by mutual consent or for cause. The manufacturer argued it should be interpreted as having an indefinite term, allowing termination at will. Interpreting Nevada law, the appellate court found that because the grounds for termination were stated, the contract should be regarded as perpetual unless either ground was met, even though the term perpetual did not appear in the distribution agreement.
A second contract interpretation case, Husain v. McDonald’s, was decided by a California appellate court in April 2012. In this case, McDonald’s consented to a franchisee’s assignment of its franchise agreements to the Husains. The Husains argued that when McDonald’s consented, it agreed to “rewrite” the terms of the franchise agreements. A rewrite normally grants franchise rights for a 20-year term.
No rewrite occurred, and McDonald’s allowed three of the franchise agreements to expire based on the Husains’ poor financial condition as reflected in a past failure to timely pay their debts to McDonald’s and a breach of certain contractual reinvestment obligations. The Husains then sought an injunction to prevent McDonald’s from removing them from the restaurants whose terms had expired.
The assignment agreement between the selling company and the Husains stated that, “In consideration of McDonald’s consent to this Assignment and the issuance of a rewrite to Assignee, Assignor waives … any claim for a rewrite of the franchise” for a location that previously had been refused a rewrite. The court agreed with the Husains that by this assignment, McDonald’s had agreed to a rewrite of the franchise agreements. In addition to the ambiguous contract language, McDonald’s had a general policy, which had been communicated to franchisees, of providing new 20-year terms to franchise purchasers. McDonald’s also drafted the assignment agreement.
Even when the bare facts support a case for termination, problems of jurisdiction and proof may prevent success. In the April 2012 case of Capriotti’s v. Taylor, the district court in Delaware enjoined the franchisor, Capriotti’s, from terminating the franchisee of one of its sandwich shops in Las Vegas.
The dispute arose when Capriotti’s learned that Crazy Horse III, a Nevada “gentlemen’s club,” was offering a happy hour promotion by which customers could purchase a six-inch Capriotti’s sandwich and a beer for $5. A Crazy Horse flyer advertising the deal featured an exotic dancer along with one of Capriotti’s trademarks. It also advertised the deal on its Facebook page and a local ESPN radio affiliate, and several Las Vegas-based blogs mentioned it. Capriotti’s determined the franchisee had, without authorization, teamed up with Crazy Horse to promote Capriotti’s sandwiches in connection with topless dancing. This gave rise to Capriotti’s cause of action. It sought an injunction to prohibit the franchisee from continuing to operate.
Crazy Horse’s general manager signed an affidavit that the franchisee had fully approved the promotion, but the franchisee denied she had given Crazy Horse permission to advertise with the mark. The court denied Capriotti’s injunction on the basis that, in light of this dispute, the decision required the testimony of the general manager from Nevada, and the court was unable to exercise personal jurisdiction over this critical witness.
Difficulties in terminating franchisees and distributors are preventable by clearer contract language in many cases. But in other cases they are harder to overcome, particularly when applicable statutes protect distributors and franchisees.