Monday, December 27, 2010

Requiring Franchisees to Sell Low-Priced Menu Items Did Not Breach Duty of Good Faith

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

A national association of Burger King franchisees failed to adequately allege that Burger King breached the express duty of good faith in the parties’ franchise agreements by requiring franchisees to sell low-priced menu items, a federal district court in Miami has ruled.

The franchisees challenged the franchisor’s Value Meal menu pricing policy, which required them to sell two items—a double cheeseburger and the similar Buck Double—for $1.00, below what it cost the franchisees to produce and sell the items.

In an earlier ruling (Business Franchise Guide ¶14,387), the court held that the agreements expressly granted Burger King the discretion to set maximum prices for products sold by its franchisees.

Bad Faith

The franchisees did not deny that they were required to allege facts indicative of bad faith and that conclusory assertions were inadequate. However, none of the facts they asserted as a basis for their claims were sufficient to support a claim of bad faith, the court held.

The purpose of the provision in the agreements entitling Burger King to set prices was to give it broad discretion in framing business and marketing strategy by adopting those measures it judged necessary to successfully compete. Thus, the franchisees were required to allege some facts suggesting (1) that Burger King did not believe that the prices it set would be helpful to the competitive position of the business and (2) that Burger King deliberately adopted prices that would injure the franchisees operations.

Below-Cost Pricing

The franchisees principally relied on their allegation that they suffered a loss on each double cheeseburger and Buck Double they sold because they could not produce them at a cost of less than $1.00. Even if true, there was nothing inherently suspect about such a pricing strategy for a firm selling multiple products.

There were numerous reasons why a firm selling multiple products could choose to set the price of a single product below cost, the court observed. Such as strategy could help to build goodwill and customer loyalty or serve as loss leaders to generate increased sales or higher-margin products.

The issue of Burger King’s good faith was not about whether such a strategy was wise or ultimately successful, but whether—in the absence of other evidence of improper motive—it was so irrational and capricious that no reasonable person would have made such a decision.

Good Faith Exercise of Judgment

There was nothing about the pricing decision that suggested Burger King was doing anything other than promoting the performance of its franchisees, the court determined. The agreement clearly gave Burger King the discretion to set a below-cost price for any product as long as that pricing decision was one that the franchisor, in the good faith exercise of its judgment, believed to be desirable and necessary.

Furthermore, the franchisees failed to allege the kind of serious injury that would support an inference of bad faith. Rather than a claim of substantial impact of their overall business, the franchisees focused on the losses incurred on the two products sold below cost.

In order to raise a claim of bad faith by pointing to injuries allegedly caused by the pricing decision, the franchisees were required to allege that the damage to their overall business was so severe as to deprive them of their reasonable expectations under the contract. They came nowhere close to such an allegation, in the court’s view.

Since the association failed to plead facts suggesting a breach of an express duty of good faith, it could not assert a claim that Burger King breached an express duty of good faith, the court found.

The decision in National Franchisee Association v. Burger King Corp., CCH Business Franchise Guide ¶14,501.

Further information about CCH Business Franchise Guide is available here.

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