Tuesday, August 31, 2010

Franchisor Might Be Entitled to Future Lost Royalties from "Abandoned" Franchise

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

A transmission service shop franchisor’s claim for lost future royalties from a franchisee that allegedly abandoned its franchise rose above the level of mere speculation, a federal district court in Chattanooga, Tennessee, has held. Thus, the claim withstood a motion to dismiss by the franchisee.

Tennessee law, which governed the franchise agreement, provides for the award lost future profits for breach of contract, in some circumstances. Although the traditional rule held that anticipated damages were too speculative, courts have recognized that an injured party may recover anticipated profits when their nature and occurrence are established with reasonable certainty.

In defending this case, the franchisee relied upon the decision in Postal Instant Press, Inc. v. Sealy (CCH Business Franchise Guide ¶10,893), which denied future royalties to a franchisor on the ground that the franchisee’s breach of the franchise agreement was not the proximate cause of the franchisor’s loss of royalties. The court found that the franchisor had chosen to terminate the agreement, thus depriving itself of future royalties.

The Sealy decision has come under scrutiny in recent years. Some courts have adhered to its reasoning that future lost royalties are too speculative. Other courts have rejected that reasoning, holding that a franchisor should be entitled to royalties as if the franchise relationship continued for the term of the contract.

More recent cases addressing the issue have focused on individual facts in determining how speculative the future royalties would be.

The franchisee in this case sought to dismiss a significant portion of the damages requested at a very early stage. The motion to dismiss was based solely on the pleadings, and there was very little evidence to consider in determining whether to dismiss such a significant portion of the franchisor’s case.

The amended complaint alleged that the principal of the franchisee contemplated retirement from operating the franchise. Instead of transferring his obligations under the agreement to his son, he abandoned the agreement and transferred the assets of the franchise to his son, who began operating a competing transmission shop.

It could not be determined at this early stage whether the franchisor made factual allegations with respect to all material elements necessary to sustain a recovery under some viable legal theory, the court held.

The decision is Moran Industries v. Mr. Transmission of Chattanooga, CCH Business Franchise Guide ¶14,428.

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