Franchisee 101: No Excuse for Late Notice

Lewitt Hackman

The U.S. Court of Appeals for the Fifth Circuit reversed a trial court judgment against a Texas franchisor, finding the lower court erred in excusing an untimely renewal notice of area development agreements. The Court held a franchise developer may not invalidate plain terms of an option agreement when the developer failed to timely exercise the option.

The developer Clairday, entered into two area development agreements. Under the agreements Clairday would recruit and develop franchises in an assigned territory of several states. To renew, Clairday was required to provide notice of renewal at least six months prior to expiration.

Clairday timely exercised his first five-year renewal option when the initial 20-year term of the agreements neared expiration. But his notice of intent to renew under the second option was two months late. The franchisor did not renew, and ultimately sought a declaratory judgement that nonrenewal was proper.

Clairday counterclaimed for breach of contract for failure to renew the agreements. Clairday relied on the equitable-intervention doctrine. That doctrine provides an exception to strict compliance with contract terms, where failure to strictly comply may be excused to prevent unconscionable hardship if the failure was due to a justified honest mistake and not due to willful or gross negligence. The trial court upheld the jury verdict for the franchisee, concluding the equitable-intervention doctrine excused strict compliance with the option agreement terms.

The Fifth Circuit assumed the franchisee’s delay was slight and financial loss to the franchisor small. Still, rejecting the renewal would not create any unconscionable hardship. The appellate court was not convinced that Clairday lost part of the initial investment of $1.25 million, because he “indisputably received” the benefit of his bargain for rights as an area developer. As an option holder, he stood to lose no more than his power to exercise the option. Clairday’s claim of lost profits was not unconscionable, because Texas law says losing the opportunity to turn a profit does not “shock the conscience.” Nor did the Fifth Circuit connect the franchisor’s decision not to renew the agreements with Clairday’s closure of a franchised store. This was because the store was in a different entity, not associated with the development agreements.

Franchise and area development agreements generally expire after a defined term. The franchisee or area developer may have an option to renew. Franchisees should be vigilant to comply with renewal terms to avoid loss of the benefits of renewal. This is especially so in states lacking franchise relationship laws. Franchisees should contact franchise counsel well in advance of the period when a renewal may be exercised, to consult on compliance with all renewal procedures and possibly evaluate if any terms should be or may be revised prior to renewal.

Pizza Inn, Inc. v. Clairday, 979 F.3d 1064 (5th Cir. 2020)

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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