FRANCHISEE 101: Pay Now or Pay Later – Liquidated Damages & Future Royalties

Lewitt Hackman
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Super 8 Worldwide, Inc. v. Anu, Inc. serves as a reminder to franchisees that, in general, courts will hold franchisees and their guarantors liable to their franchisors for losses suffered when franchisees abandon their franchises before their franchise agreements have expired.

Super 8 sued its former franchisee and the franchisee's guarantors for breach of contract alleging the franchisee unilaterally terminated the franchise when it stopped operating the facility without Super 8's prior consent. Applying New Jersey law, the court granted Super 8's motion for summary judgement against the franchisee's guarantors and awarded Super 8 liquidated damages, lost royalties and attorney's fees (the court had earlier granted Super 8's Motion for Default Judgment against the franchisee and awarded Super 8 $317,591.65 in liquidated damages and recurring fees).

The result in this case would likely have been the same had it been tried in California. California generally follows the rule that a non-breaching franchisor "... is entitled to recover damages, including lost future profits, which are proximately caused by the franchisee's specific breach." Postal Instant Press, Inc. v. Sealy, 43 Cal.App.4th 1704. Therefore, if a California franchisee's actions, such as abandonment of the franchise, are the cause of the franchisor's failure to realize future profits, the franchisor may recover its lost profits from the franchisee. Interestingly, though, a district court interpreting California law in Radisson Hotels Intern., v. Majestic Towers, Inc. went a step further. It ruled, based on a specific provision in the franchise agreement, that Radisson's franchisee was liable to Radisson for lost future profits, even though Radisson had terminated the franchisee for its failure to pay past due royalties.

Most states, though, including Washington and New York, follow the general rule that "a [franchisor] is entitled to recover lost profits [future royalties] if the [franchisor] demonstrates that (1) the [franchisee's] breach caused [the franchisor's loss of future royalties]; (2) the loss may be proved with reasonable certainty; and (3) the particular [lost future royalties] were within the contemplation of the parties to the contact at the time it was made." ATC Healthcare Services, Inc. v Personnel Solutions, Inc., 2006 WL 3758618; see also Ashland Mgt, Inc. v. Janien, 82 N.Y.2d 395 (1993); and see Tiegs v. Watts 135 Wash.2d 1. Following this rule, a franchisor would not be able to collect lost future royalties if it terminates its franchisee for failing to pay past due royalties, but could for acts by the franchisee, such as abandonment, which proximately cause the franchisor's damages.

Many franchise agreements provide a provision calculating the damages the franchisor will be entitled to receive if the franchisee abandons or otherwise terminates the franchise before its expiration date (i.e. 2 years' royalties based on the past 12 months). As the Super 8 case demonstrates, these provisions are typically enforceable, even against the franchisee's guarantors

Click: Super 8 Worldwide, Inc. v. Anu, Inc.

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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