Franchisors can often control pricing by their U.S. franchisees within certain limits if the circumstances are right and if the franchisors proceed in the proper manner.
Historically, the U.S. antitrust laws have been a major concern for franchisors seeking to control franchisee pricing. This still is true for franchisors who want to limit the minimum prices that franchisees may charge, but the antitrust laws are of less concern for franchisors who want to limit maximum prices.
Before 1997, it was illegal per se for a franchisor and a franchisee to agree on the maximum or minimum prices that could be charged by franchisees. Illegal per se means illegal without any need to show harm to competition. In 1997, the U.S. Supreme Court ruled that an agreement on maximum resale price was not illegal per se but that legality would be determined by the rule of reason. The rule of reason determines the legality of a practice by weighing all of the circumstances to determine whether a restrictive practice should be prohibited because it imposes an unreasonable restraint on competition.
In 2007, the Supreme Court ruled that minimum resale price agreements would also not be illegal per se, but would be judged under the rule of reason. However, minimum price agreements remain highly risky. They remain illegal per se under some state laws (regardless of the Supreme Court’s interpretation of federal law), and some states have taken enforcement actions against such conduct.
Interpreting Franchise Agreements
In recent years, there have been at least two well-publicized disputes between a franchisor and its franchisees over maximum price agreements.
Burger King Prevails on Ambiguous Contract Language
In 2009, Burger King began requiring its franchisees to charge no more than $1 for its double cheeseburger, even though the franchisees had twice rejected this proposal when Burger King asked for a vote of support. The franchisees also claimed that their cost to produce the double cheeseburger was more than $1.The Burger King franchisee association brought suit in Florida challenging the $1 price as a breach of contract, but it did not make an antitrust claim.
In 2010, the Florida District Court found that Burger King was not breaching the franchise agreements. Section 5A of the franchise agreement provided that the franchisee agreed that changes in the franchise standards and specifications may become necessary from time to time and agreed to comply with modifications to the operations manual that Burger King in good faith believes are reasonably necessary. The District Court found this provision sufficient to allow Burger King to amend its manual to require franchisees to adhere to maximum pricing when required by Burger King as part of its value menu. It also found that Burger King had this authority even though Section 5A had been drafted before 1997 (i.e., when maximum resale pricing was still illegal per se) and even as to agreements entered into before 1997.
Even though the complaining franchisees lost in court, in 2010 Burger King took the double cheeseburger off its $1 value menu and raised the suggested price for that product.
Steak n Shake Loses on Ambiguous Contract Language
More recent litigation arose when in June 2010 Steak n Shake adopted a policy requiring that its franchisees follow the company’s menu pricing and promotions, including a requirement that franchisees offer $4 meals. The $4 pricing was challenged by numerous franchisees.
The first challenge was brought by a longtime Illinois franchisee with five restaurants that refused to implement the $4 pricing. When Steak n Shake threatened to terminate the franchise, the franchisee brought a declaratory judgment action seeking a determination that Steak n Shake did not have the contractual power to impose the $4 pricing.
In 2012 the District Court in Illinois hearing the matter found Steak n Shake did not have the contractual right to impose the $4 pricing. The various franchise agreements between the Illinois franchisee and Steak n Shake provided that the franchisee was required to comply with the franchise “System,” which the franchisor could change from time to time. The System was defined as “a unique restaurant concept, including … standardized methods of preparing and serving certain food products and beverages.…” Also, the franchisee acknowledged the importance of “maintaining uniformity in every component of the operation of the System … including a designated menu.…”
The District Court held this language was ambiguous as to whether the franchisor had the contractual right to impose maximum prices. When considering extrinsic evidence, it found the franchisor had no right to impose these maximum prices in light of various factors, such as the past course of dealing (where the franchisee had been allowed to set its own prices), the language of the franchise disclosure document (which also allowed the franchisee to set its own prices) and other factors.
Steak n Shake Prevails on Clear Contract Language
Even though the Illinois decision was issued in 2012, it interpreted the language of prior contracts entered between 1995 and 2006. In contrast, a 2013 case in Colorado interpreted more recent contract language.
When two franchisees in Colorado violated the $4 pricing requirement, Steak n Shake terminated their franchise agreements. The franchisees continued to operate, and Steak n Shake brought an action to enjoin them from doing so. In September 2013 the District Court in Colorado hearing the matter issued a preliminary injunction requiring the franchisees to cease operating the restaurants and cease using any Steak n Shake trademarks.
The two franchisees had entered into franchise agreements in 2012. The agreements, which had been updated from the agreements considered in the Illinois case, provided that the franchisee acknowledged the importance of maintaining uniformity in every component of the operation of the System “including a designated menu (including maximum, minimum and other prices the Franchisor specifies for menu items and mandatory promotions).” This clear authority for Steak n Shake to establish maximum prices enabled the District Court to grant the preliminary injunction.
These cases offer several lessons:
- Franchisors can control the maximum pricing of franchisees in some circumstances.
- A franchisor’s ability to control maximum pricing depends heavily on the contractual language of the franchise agreement.
- Antitrust challenges to maximum or minimum pricing remain viable theoretically, but, as in the cases described above, may not always be used by franchisee counsel to challenge franchisor pricing practices.