Wednesday, December 24, 2008

Wrongfully Terminated Franchisee Denied Damages on Retrial

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A bioremediation service franchisee, whose two franchises were terminated as a result of the franchisor’s breach of contract and breach of fiduciary duty, was denied damages for either lost profits or the value of its businesses.

In a retrial on the issue of damages, the federal district court in Fort Meyers, Florida held that the franchisee had abandoned its lost profits theory of damages, had failed to present competent evidence on lost profits, and had failed to demonstrate business value damages through destruction of its businesses.

Following the expiration of the parties' agreements, the franchisor filed suit against the franchisee for trademark infringement, breach of contract, and other claims, in part, because the franchisee continued to display the franchisor's trademarks. The franchisee filed several counterclaims, including breach of contract and breach of fiduciary duty.

Jury Award

A jury found in favor of the franchisee on all claims and counterclaims and awarded the franchisee $1,224,500 in damages. However, the court had ordered a retrial on the issue of damages only, finding that the award was the result of conjecture and improper measures.

In its brief for the retrial, the franchisee indicated that it did not disagree that with the principle that it could not recover both lost profits and the value of its business, since those remedies were mutually exclusive, the court observed. The franchisee represented in its brief that it desired to proceed solely on the value of the franchises. Thus, to allow the franchisee to recover any lost profits after the close of the damages retrial would be unfair to the franchisor, the court held.

Business Value

The franchisee was denied damages based on the value of its franchised businesses because Florida law, required a showing that the businesses were in fact destroyed. The franchisee failed to demonstrate the destruction of its two franchised. To the contrary, the businesses continued to provide bioremediation services, often to the same customers and using the same equipment as they had during the terms of the franchise agreements, the court observed.

Even assuming that the value of the businesses was an appropriate measure of damages in the retrial, the franchisee failed to offer competent evidence proving the value of its two franchises, the court ruled.

The franchisee presented an expert witness who testified that the value of the businesses on the date of termination was "approximately $58,000." The expert projected the businesses' future cash flows, but relied only on actual financial data from the five-month period prior to the termination to prepare his projection. Further, the expert recognized that if he had relied on any earlier period of income, it would have diminished the value of the businesses.

It appeared to the court that the expert relied on the five-month period because that was the only period that would result in a favorable valuation for the franchisee. A five-month period of income was not a reliable indicator, the court held. A reasonable investor would likely value a business' income over at least a 12-month, if not a 24-month, period.

Reliability of Financial Statements

The reliability of the financial statements forming the basis of the expert's opinion was also doubtful, according to the court. Testimony revealed that the franchisee had created two conflicting financial statements for 2002. Further, the expert admitted that he was not able to confirm the information on any of the financial statements. Most tellingly, the principal of the franchisee admitted in testimony that some of the financial statement provided to the expert was inaccurate. Inaccurate financial statements could not form the basis of reliable testimony on the valuation of a business.

The decision is Environmental Biotech, Inc. v. Sibbitt Enterprises, Inc., CCH Business Franchise Guide ¶14,032.

No comments: