Tuesday, November 24, 2009

Franchisor Could Have Illegally Tied Supplies to Franchises

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

A franchisee of 13 fast food restaurants adequately alleged a tying arrangement against a franchisor under a Kodak lock-in theory, according the federal district court in Columbus, Ohio.

The franchisee claimed that the franchisor (1) used its control over franchise rights to compel the franchisee to accept hamburger buns from a lone approved bun vendor and (2) imposed a four percent surcharge on food supplies from a lone approved food supply vendor.

The franchisor argued that the claim was deficient because it failed to plead a relevant market or facts suggesting that the franchisor had market power over a tying product. However, the franchisee successfully alleged market power in the tying product—franchise rights—through a lock-in theory, the court held.

In Eastman Kodak Co. v. Image Technical Services, Inc. (1992-1 Trade Cases ¶69,839), the U.S. Supreme Court held that market power was inferred under a lock-in theory if the seller had monopoly power in an aftermarket product where, once a customer bought one product, he or she was locked in to buying another product by the seller’s rules.

Changed or Concealed Rules

The assertion of an antitrust claim under a Kodak lock-in theory required specific factual allegations that the defendant either changed its rules after the initial sale was made or concealed the rules from its customers.

The language in the parties’ franchise agreements did not suggest that the franchisor would be able to eliminate all competition by naming an exclusive supplier or could impose a surcharge on approved suppliers. Rather, it suggested that that competition was welcome so long as suppliers met the franchisor’s standards and possessed adequate quality controls and capacity, the court noted.

Indeed, the franchisee alleged that the market for the tied products (hamburger buns and other food supplies) was competitive prior to the alleged tie. Consequently, the franchisor’s alleged naming of an exclusive bun supplier would satisfy the change in policy requirement of an illegal tying claim, the court ruled.

Market Power

The franchisee adequately plead market power under a Kodak lock-in theory because the parties’ franchise agreements did not put a potential franchisee on notice that the franchisor would be able to eliminate all competition by naming an exclusive supplier or could impose a surcharge on approved suppliers, the court held. This was especially true in light of the franchisee’s allegations that the market for the allegedly illegally tied supplies—hamburger buns and food—was competitive prior to the alleged tie.

Thus, the court rejected the franchisor’s assertion that the franchisee’s illegal tying claim should be dismissed because any requirement that the franchisee purchase buns and food from approved suppliers was contract and would not support an antitrust claim.

The franchisor cited Queen City Pizza, Inc. v. Domino’s Pizza, Inc. (1997-2 Trade Cases ¶71,909, Business Franchise Guide ¶11,224) for the proposition that no tying claim would lie where a defendant’s power to force a plaintiff to purchase the alleged tying product stemmed not from the market, but from the plaintiff’s contractual agreement to purchase the tying product.

Queen City did not provide grounds for dismissal because, unlike the franchisees in Queen City, the franchisee in this case was not claiming that the market power was contractually established, the court decided. Instead, the franchisee asserted a Kodak-type lock-in theory of market power, specifically alleging that at the time the franchisee entered into the agreements, he could not have reasonably anticipated being required to purchase buns and food supplies from exclusive suppliers.

The decision is Burda v. Wendy’s International, Inc., CCH Business Franchise Guide ¶14,240. It will also appear in CCH Trade Regulation Reporter.

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