Tuesday, December 28, 2010

Payroll Tax Violations Constituted Good Cause for Termination of Franchises

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

Donut shop franchisees’ failure to comply with payroll tax laws violated their contractual obligation to obey all laws and constituted good cause for termination of three franchises under the meaning of the New Jersey Franchise Practices Act, the federal district court in Newark has ruled.

The franchisees breached the franchise agreements’ “obey all laws” clause by failing to comply with payroll tax laws and did so in a non-curable manner. The payroll violations were not inadvertent or isolated mistakes, but were part of a calculated effort to disguise the true nature of the payments.

Evidence overwhelmingly showed that the franchisees inappropriately failed to treat various payments made on behalf of their employees (for things such as rent, travel, and tuition) as wages, according to the court.

The “obey all laws” clause authorized the franchisor to terminate the agreement without cure if it had “proof” that the franchisee had committed a felony. Nothing in the agreement, however, suggested that the proof must rise to a level to support a criminal conviction, the court noted. Thus, for the purpose of this civil proceeding, it was sufficient for the franchisor to show at trial that it had proof sufficient to establish a criminal conviction by a preponderance of the evidence.

The franchisor presented proof demonstrating by the preponderance of the evidence that the franchisees committed all three elements of tax evasion:

(1) A tax deficiency,

(2) The affirmative act of attempted evasion of payment of taxes, and

(3) Willfulness.
The tax violations clearly fell within the purview of the “obey all laws” clause because compensation of the franchise employees pertained to the operation and maintenance of the franchises, the court determined.

Furthermore, the fact that the franchisor did not prove damages was not relevant. The franchisor did not seek damages, but merely declaratory relief. The franchisees’ attempt to argue that the franchisor had unclean hands in terminating the franchises and in bringing suit was rejected.

The decision in Dunkin’ Donuts Franchised Restaurants LLC v. Strategic Venture Group, Inc. will appear at CCH Business Franchise Guide ¶14,494.

1 comment:

michael webster said...

I found this an odd result.

The franchisor, or master servicer, did not alert the tax authorities, but simply gave evidence as if the proceeding was in the appropriate forum.

Frankly, it is appalling misuse of the "obey all laws clause", which calls for the franchisee association to require that, in this case, the master servicer to obey all laws on pain of losing the service contract.