In the wake of a recent ruling by an Ohio federal district court in Burda v. Wendy's Int'l, Inc., Bus. Franchise Guide (CCH) ¶ 14,240 (S.D. Ohio Sept. 21, 2009), franchisors may wish to re-examine the approved supplier provisions in their franchise agreements to ensure that the provisions expressly permit the franchisor to designate an exclusive supplier for products or services used in the operation of the franchise in order to avoid franchisee claims of an illegal tying arrangement.
The franchisee in Burda contended that the franchisor, Wendy's International, Inc. (Wendy's), used its control over franchise rights to force the franchisee to purchase hamburger buns from a Wendy's affiliate and other food products from a Wendy's third-party supplier. The court agreed, holding that the franchisee, who relied on a Kodak lock-in theory, adequately alleged an unlawful tying arrangement between franchise rights and food supplies.
At the time that the franchisee secured the first of his 13 Wendy's franchises in 1996, there were multiple Wendy's-approved suppliers. One year later, Wendy's insisted, under threat of termination, that the franchisee change its then-current hamburger bun supplier and purchase buns exclusively from a Wendy's affiliate.
With respect to other food products used in the operation of the franchise, the franchisee had a practice of requesting that the two suppliers in his region submit competing bids. In 2004, Wendy's granted one of the two suppliers exclusive rights to supply food products in the franchisee's region and imposed a four-cent-per-case surcharge on any food products that the franchisee purchased from another approved supplier. In doing, so, Wendy's effectively eliminated the franchisee's ability to select a different supplier and negotiate prices. The franchisee further alleged that Wendy's received a percentage of the exclusive supplier's revenues from sales to Wendy's franchisees.
Relying on Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451 (1992), the court rejected Wendy's contention that the franchisee failed to plead adequately that Wendy's had market power in the tying product-franchise rights to operate a Wendy's restaurant. While acknowledging that a tying arrangement is only illegal under Section 1 of the Sherman Act if the seller has "appreciable economic power in the tying product market" and the "arrangement affects a substantial volume of commerce in the tied market," the court explained that market power may be inferred in a lock-in case-i.e., where after purchasing one product, the customer is locked in to buying another because of the seller's rules. The court clarified that a tying claim under Kodak "requires specific factual allegations . . . that the defendant either changed its rules after the initial sale was made or concealed its rules from its customers."
Analyzing the approved supplier provision in the Wendy's franchise agreement, the court found that there was no language in that section "that would put a potential franchisee on notice that [Wendy's] would be able to eliminate all competition by naming an exclusive supplier or that [Wendy's] could impose a surcharge on approved suppliers." The court noted that the provision, in fact, suggested that competition was welcome, provided the proposed supplier met Wendy's standards and specifications, and possessed adequate quality controls and capacity to meet the franchisee's needs. The court's interpretation of the approved supplier provision was supported by allegations that, prior to the alleged tie, the market for the supplies was competitive.
The court rejected Wendy's assertion that Wendy's right to insist that the franchisee purchase certain products from specific suppliers arose from contract, not the assertion of market power, which would render the antitrust claim untenable under Queen City Pizza, Inc. v. Domino's Pizza, Inc., 124 F.3d 430 (3d Cir. 1997). The court distinguished the approved supplier provision in the Wendy's franchise agreement from that in the Domino's franchise agreement at issue in Queen City Pizza, which provided that Domino's "may in [its] sole discretion require that ingredients, supplies and materials used in the preparation, packaging and delivery of pizza be purchased exclusively from [Domino's] or approved suppliers or distributors." The court explained that the Domino's franchisee, unlike the Wendy's franchisee, knew about the potential for exclusive purchasing arrangements prior to becoming locked-in as a franchisee.
As the ruling in the Burda case comes in the context of a motion to dismiss, its ultimate significance is uncertain. Nevertheless, to avoid claims of an illegal tie by franchisees heartened by the ruling, franchisors should carefully re-evaluate their approved supplier provisions.