Thursday, February 24, 2011

KFC Franchisees Had Ultimate Authority Over Advertising

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

The governing committee of the franchisee-controlled national advertising cooperative for restaurant franchisor KFC had the authority to adopt an advertising program and to amend the franchisor’s advertising proposals, according to the Delaware Chancery Court.

The franchisor’s position—that it had an effective veto power over the council—was rejected by the court.

Formation of the Advertising Cooperative

The KFC National Council and Advertising Cooperative (NCAC) was formed more than 40 years ago to deploy advertising funds raised from KFC franchisees under the franchise agreements, the court noted. In lieu of a board of directors, the NCAC committee served as the NCAC’s governing body and consisted of 17 members—13 franchisees and four franchisor-representatives.

The NCAC brought suit against the franchisor after an impasse developed over which entity (the NCAC or KFC) had authority to generate advertising plans for the KFC brand. Each party sought a declaration that the NCAC’s affairs should be governed as it saw fit.

Role of Cooperative

KFC claimed that the NCAC certificate of incorporation created a power-sharing arrangement between itself and the NCAC in which KFC had the sole authority to develop advertising plans and to present them to the committee for approval.

In KFC’s view, the committee could accept or reject those plans in total, but could not amend those plans over KFC’s objection and implement the amended plan. This view gave KFC veto power over the NCAC.

In contrast, the franchisees (using their majority control of the NCAC committee to bring this action) argued that the NCAC committee, like any corporate board, retained ultimate authority to manage the corporate and controlled its major function of determining the advertising plans and strategy for deploying the funds raised through franchisees.

The franchisees conceded that KFC had bargained for and won the sole authority to hire, fire, and direct a national advertising firm, but argued that KFC’s singular authority stopped there.

The franchisees contended that the NCAC Committee had the authority to modify KFC’s advertising proposals, consider alternatives proposed by franchisees, and to implement by majority vote an advertising plan that KFC did not approve. In the dispute, both parties sought declaratory relief that the NCAC’s affairs should be governed as it desired.

Ambiguous Certificate

The provisions of the NCAC certificate that bore directly on the division of power between KFC and the Committee were, to a certain extent, internally contradictory and overlapping, the court found. On balance, a close consideration of the certificate’s provisions setting out the respective roles of KFC and the Committee did not rule out either party’s interpretation as unreasonable, the court decided.

Although the language of the Certificate of Incorporation titled in the franchisee’s favor, the terms were ambiguous. Thus, parol evidence must be considered, the court held.

The interpretive rules normally applicable to construing certificates of incorporation under Delaware law did not apply with their normal force under these circumstances because the process by which the NCAC Certificate came into existence was dissimilar from a typical corporation. The franchisees bargained vigorously over the terms of the Certificate.

Extrinsic Evidence

Taken as a whole, extrinsic evidence of the parties’ course of conduct supported the franchisees’ position, the court determined. The evidence suggested that the parties never adhered to a strict franchisor proposes/Committee approves bifurcation that was the essence of the franchisor’s position.

KFC’s strongest argument in favor of its position was that its reading of the Certificate was more sensible as a business matter because the NCAC did not have the capability to effectively plan the advertising for a brand the size of KFC, in the court’s view.

Even though the franchisee’s position left KFC in a compromised position as against some of its competitors, the implementation of the franchisees’ position was not absurd given the history of the NCAC and the fact that the advertising dollars came from the franchisees themselves, the court ruled.

The franchisees had a strong incentive to be good shepherds of the KFC brand, and the NCAC was obligated to use the KFC marks “in good taste and consistent with the then current Bylaws of the NCAC.”

Moreover, the NCAC’s ability to advertise products was limited by the fact that the franchisees were permitted to sell only items that were approved by the franchisor.

The declaration requested by the franchisees was granted, at least in part, tempered by the realities regarding the franchisor’s continued role in the process.

The decision is KFC National Council v. KFC Corp., CCH Business Franchise Guide ¶14,542.

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