Franchisee 101: Franchisor’s Impact Study Fails to Influence Court

Lewitt Hackman

A federal district court denied KFC’s defensive summary judgment motion, enabling its franchisee to go to trial on claims against KFC for breach of the implied covenant of good faith and fair dealing by opening a competing restaurant near the franchisee’s existing restaurant.

The franchisee operated a KFC in Colorado. The franchisor explored opening a restaurant near the franchisee’s location, notified the franchisee about the potential new restaurant and, pursuant to the franchisee’s request and the franchisor’s guidelines, commissioned an impact study to determine the impact on the franchisee’s restaurant. Under the franchisor’s guidelines, it would either (i) permit development of the location if the potential impact was less than 10 percent on the existing location; (ii) conduct further review if the potential impact was between 10 percent and 15 percent on the existing location; or (iii) not permit development if the potential impact was more than 15 percent on the existing location.

A company called JAG performed the study. The JAG report concluded that the proposed restaurant would impact the franchisee’s restaurant by 13.4 percent. The franchisee believed the study was invalid and commissioned his own, which concluded that the proposed restaurant would hurt the franchisee’s restaurant by 33 percent to 36 percent. The franchisor decided to move forward with opening the new restaurant, without doing further review.

The court ruled a jury could find circumstantial evidence that the franchisor knew the JAG study was flawed and accepted it regardless. Virtually every study JAG completed for the franchisor resulted in finding low impact and meeting KFC’s criteria for a new restaurant, suggesting the study could be designed against existing franchisees by underestimating impact. In addition, KFC ignored the franchisee’s suggestion to use a bilingual surveyor. That could imply ambivalence by KFC about getting accurate survey data. A jury could find KFC considered no new information after its initial approval, and thus did not conduct “further review” that its own guidelines required for the establishment of new franchises within the 10 percent to 15 percent impact range upon existing franchises.

Franchisors generally have the right to open new franchised businesses near an existing franchisee’s business. Many franchisors have internal processes to determine potential impact of the new business on a current franchisee’s business. However, a franchisor’s determination of an acceptable impact is not necessarily acceptable to a franchisee. Franchisees should have counsel review their FDD, franchise agreement, and ancillary documents, including any impact study guidelines, to help determine territorial rights if the franchisor decides to open a new location near the franchisee’s business.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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