Below are summaries of recent case decisions of interest to franchisors, along with an article on franchise mergers and acquisitions.
Minnesota FEDERAL Court Dismisses Franchisee’s
The United Stated District Court for the District of Minnesota recently dismissed several claims by a Party City franchisee premised on the franchisor’s operation of an online store. Newpaper, LLC v. Party City Corp., 2013 U.S. Dist. LEXIS 137396 (D. Minn. Sept. 25, 2013). Gray Plant Mooty represents Party City in this matter. The franchisee’s complaint alleged that the operation of an online store by the franchisor breached the franchisee’s contractual right to an exclusive territory. It also alleged that certain aspects of Party City’s online store, including its return policy, online pricing, and the alleged use of advertising funds to promote the online store, constituted breaches of the covenant of good faith and fair dealing.
Party City moved to dismiss the franchisee’s claims, arguing that the language of the parties’ agreements expressly permitted Party City’s operation of an online store and the manner in which Party City operated it. The court held that the franchisee’s contractual exclusivity rights did not preclude an online retail presence by Party City. Likewise, under the parties’ agreements the franchisee expressly agreed to accept returns from online store purchases and agreed that Party City could use advertising funds to promote the system’s website as long as that promotion did not inure solely to the benefit of Party City. Thus, the court determined that the franchisee failed to state a claim based on those allegations. The franchisee’s good faith and fair dealing claim, which alleged that Party City’s low online retail pricing harmed the plaintiff’s business, survived Party City’s motion to dismiss. The court opined that if Party City’s online pricing was designed to undermine the benefit of the bargain for the franchisee, a good faith and fair dealing claim might be sustainable.
KANSAS FEDERAL COURT ALLOWS CLAIM FOR BREACH OF CONTRACT
In Lenexa Hotel, LP v. Holiday Hospitality Franchising, Inc., 2013 U.S. Dist. LEXIS 125240 (D. Kan. Sept. 3, 2013), a federal district court in Kansas denied a hotel franchisor’s motion to dismiss a franchisee’s claims for breach of contract and breach of the implied duty of good faith and fair dealing, and for a declaratory judgment regarding the parties’ obligations under their license agreement. The plaintiff’s allegation was that Holiday Hospitality Franchising, the franchisor of the Holiday Inn, Crowne Plaza, and InterContinental brands, repeatedly represented during the course of the parties’ pre-contract negotiations that it could effectively market the franchisee’s property as an upscale metropolitan hotel and generate sufficient customer demand through its reservation system. After the hotel opened and failed to perform up to expectations, the franchisee sued, claiming that Holiday Hospitality did not properly market the hotel on the internet or through its call centers. Holiday Hospitality moved to dismiss the complaint, arguing that (1) Lenexa had not identified any specific provision of the license agreement that Holiday Hospitality purportedly breached, (2) Lenexa consequently could not assert a breach of the implied duty claim, and (3) the facts alleged did not give rise to a case or controversy such that the court could grant declaratory relief.
The court determined that the franchisee had adequately stated its claims. Viewing the complaint in the light most favorable to Lenexa (and without relying on the pre-contract statements alleged by Lenexa), the court held that the complaint sufficiently alleged that the parties’ license agreement imposed marketing and reservation obligations on Holiday Hospitality and that it breached those provisions by not permitting Lenexa to use advertising programs for which it paid a monthly fee. In light of its finding that the complaint sufficiently stated a claim for breach of contract, the court further concluded that the franchisee sufficiently alleged a breach of the implied duty of good faith and fair dealing. Finally, the court preserved the franchisee’s request for a declaratory judgment because it arose out of the same set of operative facts as the contract claim.
JURISDICTION AND PROCEDURE
Federal Court Finds that size of Underlying Arbitration Claims Should be Used to measure diversity Jurisdiction in Court Case
The United States District Court for the Eastern District of Pennsylvania held last month that the amount at stake in an underlying arbitration should be used to determine the amount in controversy in a related federal court action for injunctive relief. Soft Pretzel Franchise Systems Inc. v. Taralli, Inc., 2013 U.S. Dist. LEXIS 127242 (E.D. Pa. Sept. 5, 2013). This dispute involved the termination of a franchise agreement for failure to report sales and to pay royalty, advertising, and legal fees. Soft Pretzel initiated an arbitration action to recover the fees owed and to obtain a permanent injunction. It also filed a federal court action to preliminarily enjoin the former franchisee from operating a competing business at the formerly franchised location pending the outcome of the arbitration. Taralli moved to dismiss the injunction action, alleging that the amount in controversy did not exceed the jurisdictional minimum of $75,000.
The Pennsylvania court reviewed existing Third Circuit case law regarding how to calculate the amount in controversy on a petition to compel arbitration and found it sufficiently analogous. The court then ruled that the amount in controversy at arbitration should be used to establish jurisdiction in federal court on a related case. Because Soft Pretzel’s damages claims in the arbitration exceeded $75,000, the court held that Soft Pretzel met the federal court’s jurisdictional threshold and denied Taralli’s motion to dismiss.
TEXAS FEDERAL COURT DETERMINES CLAIMS FOR INJUNCTIVE RELIEF
ARE NOT SUBJECT TO ARBITRATION
In Dickey’s Barbecue Restaurants, Inc. v. Mathieu, 2013 U.S. Dist. LEXIS 133204 (N.D. Tex. Sept. 18, 2013), a dispute arose when Mathieu failed to comply with various terms of his franchise agreement, including failure to (1) operate the franchised restaurant, (2) make payments, (3) meet food safety standards, and (4) purchase and sell approved products. After Mathieu advised Dickey’s Barbeque that he was ceasing operations of his franchised business, Dickey’s commenced a lawsuit to seek, among other things, a declaration that Mathieu violated the material terms of the franchise agreement and an injunction preventing him from displaying or using Dickey’s Barbecue’s name or trademarks. In response, Mathieu moved to dismiss Dickey’s claims or, alternatively, to stay litigation and compel mediation/arbitration pursuant to the parties’ franchise agreement.
Relying on the franchise agreement’s broad arbitration provision requiring submission of any claim, controversy, or dispute arising out of or relating to the franchise agreement first to nonbinding mediation and next to binding arbitration if necessary, the court held that the franchisor’s claims for declaratory relief, breach of contract, and fraudulent inducement were subject to mediation and/or arbitration. Because the franchise agreement included a “carve out” provision for claims for injunctive relief, however, the court denied Mathieu’s motion to stay Dickey’s claim for an injunction. As part of its holding, the court rejected the argument by Dickey’s that its claim for declaratory relief is really a claim for “monies owed” and, therefore, specifically “excepted” from the franchise agreement’s arbitration provision.
FRANCHISE MERGERS & ACQUISITIONS
ARTICLE HIGHLIGHTS WAYS TO INCREASE PRICE PAID FOR FRANCHISE SYSTEMS
Franchisors interested in selling a franchise system—whether in the near future or longer term—should take steps now to maximize its value. In the April 2013 issue of Franchising World magazine, Gray Plant Mooty attorneys Gaylen Knack, Sandy Bodeau, and John Brower highlighted key legal issues for franchisors to consider in preparing a franchise system for a sale. They examined proactive steps the selling franchisor can take that can improve the purchase price paid for the system. These include, among other actions, ensuring the franchise agreements give the franchisor flexibility in responding to dynamic changes in the marketplace, conducting an audit of key intellectual property, and establishing a release program as a defense against future claims. Readers can find the article, Selling the Franchise System: Laying the Legal Groundwork to Optimize Value, at http://www.franchise.org/IFA_NEWS/Selling_the_Franchise_System__Laying_the_Legal_Groundwork_to_Optimize_Value/. Those who wish to learn more can attend the Capital Roundtable on Franchising M&A, which Gray Plant Mooty will sponsor, in New York City on November 14, 2013.