Monday, October 08, 2007

Lost Future Royalties vs. Liquidated Damages in Franchise Termination Cases

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

In the recent case of Radisson Hotels v. Majestic Towers (CCH Business Franchise Guide ¶13,680, C.D. Cal., 2007), the franchisee was terminated for failure to pay royalties. The franchisor brought suit "seeking the recovery of (1) past due fees, (2) liquidated damages, and (3) attorneys' fees." The court granted "summary adjudication on the issue of past due fees and liquidated damages." There was no claim for lost future royalties, and the issue was not adjudicated by the court.

But the franchise agreement's liquidated damages clause allowed the franchisor to recover two times the royalties paid during the prior year, because the franchisor alleged that it took them, on average, two years to find a replacement franchisee.

Authorization of Future Lost Royalties

From that reference, it has been argued by many in the franchise bar that, since the decision strongly disagreed with Postal Instant Press v. Sealy (CCH Business Franchise Guide ¶10,893, Cal. Ct. App. 1996), claims for future lost royalties will now be more readily entertained.

The court in Sealy had held that (1) the franchisor's election to terminate the franchise agreement, not the franchisee's failure to pay royalties, was the proximate cause of the franchisor's lost future profits and (2) an award of lost future royalties or advertising fees to the franchisor would be unreasonable, unconscionable, and oppressive, providing the franchisor with disproportionate compensation for the franchisee's breach.

Allowing franchisors to recover lost future profits in such circumstances would improperly enable them to terminate franchise agreements upon the first material breach by the franchisees and then collect all the royalty payments they allegedly would have received from those franchisees over the course of the franchise relationship, the Sealy court reasoned.

Mistaken” Decision

Those arguing that California courts will recognize claims for lost future royalties rely on the language in Radisson that, "this Court believes that the Sealy decision is mistaken . . . In this Court's view, the Sealy court's holding that a franchisor has no remedy but to sue the franchisee over and over again as lost royalties accrue is simply untenable."

Radisson was decided by a federal district court, which noted that it was bound only by decisions of California's highest court --and that the Sealy court was merely an intermediate appellate court.

However, this author believes expansive interpretations of Radisson may be wishful. The criticism of Sealy is clearly dicta and, in fact, is merely footnote dicta. It is not even in the body of the opinion but rather comes in footnote 10. It is only part of the discussion of a claimed defense against the liquidated damages clause in the nature of "causation."

Upholding of Liquidated Damages Claim

As noted, there was not even a claim in the Radisson complaint for lost future royalties. Accordingly, in this writer's opinion, the essence of the decision simply upheld a specifically negotiated liquidated damages clause. Future royalties were only dragged into the argument as a means of computing the liquidated damages amount.

Additional information on valuation of franchises and dealerships is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

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