Franchisor May Be Entitled to Recover for Loss of Franchise Property Through Eminent Domain

This posting was written by John W. Arden.

A purported restaurant franchisor might be entitled to compensation for lost goodwill resulting from the loss of franchise property in California through eminent domain, according to a California state appellate court.

Although the franchisor did not qualify as the “owner” of the business displaced by eminent domain, it may have been entitled to compensation as the assignee of the franchisee’s right to compensation.

Inverse Condemnation Action

An inverse condemnation action brought by the franchisor against a California city was remanded with instructions for the trial court to determine the franchisor’s rights as an assignee and to empanel a jury to determine the amount of compensation for lost goodwill.

The property that the franchisor subleased to a franchisee was taken by eminent domain by the City of El Cajon, California for construction of a police facility. Subsequently, the franchisee assigned any claim it had for lost goodwill compensation to the franchisor.

The franchisor sued the city, alleging that it was entitled to compensation both for ownership of the franchised restaurant and as assignee of the franchisee’s right to compensation.

The proceeding was bifurcated, with the trial court first considering whether the franchisor had any right to compensation, either as the owner of the restaurant or as the assignee of the franchisee’s rights. If that issue were decided in the franchisor’s favor, a jury would determine the amount of goodwill owed the franchisor, if any.

“Owner” or Business

Relying on Redevelopment Agency v. International House of Pancakes, 9 Cal. App.4th 1343 (1992), the city argued that a franchisor was not entitled to compensation for lost goodwill. It further argued that the franchisee was the business owner and the franchisee’s assignment was ineffectual because it already waived its right to receive any condemnation award.

The trial court concluded that the franchisee—not the franchisor—was the owner of the business. It was the party that held a business license. Moreover, an assignment of the franchisee’s right to compensation was ineffectual because the franchisee had no interest to assign, the court held.

Franchise Relationship?

On appeal, the franchisor attempted to distinguish the IHOP case by claiming that it was not a franchisor and the operator of the restaurant was not a franchisee. The court disagreed, pointing out that the franchisor granted the operator the right to use its system, trade name, and trademark. The operator was obligated to run the restaurant in compliance with the franchisor’s operations manual and to purchase supplies only from the franchisor or its approved suppliers.

The agreement between the parties stated that the relationship was not a partnership, joint venture, or agency. The fact that the operator did not pay a franchise fee was unavailing.

Moreover, the focus on the franchisor-franchisee relationship in IHOP was misplaced, the court observed. The claimant was not barred from recovering goodwill damages because it was a franchisor; it was barred because it was not the owner of the business.

In this case, there was no indication of ownership by the franchisor. The agreement between the parties required the operator to indemnify the franchisor of all claims or liabilities related to the premises. Like the claimant in IHOP, the franchisor established a method of operation intending to immunize or insulate itself from the risks and liabilities inhere in the ownership of a business. The court asked how an agreement that insulated the franchisor from the obligations of ownership could make the franchisor an owner of the business for the sole purpose of condemnation proceedings.

Thus, the appellate court held that the franchisor was not the owner of the business within the meaning of California Civ. Proc., §1263.510.

Assignment of Right to Compensation

Even though the franchisor could not receive goodwill compensation as the owner of the franchise premises, it might be entitled to recover compensation under the assignment of the franchisee’s right.

The trial court had based its denial of compensation under the assignment on an agreement in which the franchisee waived all rights to interest in any condemnation award or settlement. The trial court interpreted this provision as a waiver of any condemnation recovery from a condemning governmental agency. If the franchisee had no right to recover from the government, then there was no right to assign to the franchisor, it reasoned.

The appellate court held that the waiver clause was intended to benefit the franchisor, rather than the city. A landlord and tenant may apportion a condemnation award any way they see fit, including having the tenant assign rights to the landlord. It appeared more likely that the parties were defining their respective rights between themselves rather than benefitting a nonparty to the agreement, in the court’s view.

To construe the waiver provision as the city suggested would unjustly allow it to avoid paying any compensation for lost goodwill.

On remand, the trial court was directed to determine whether the franchisor had proven the remaining statutory elements for entitlement to compensation as an assignee. If so, the court had to conduct a jury trial on that compensation.

The June 7 decision is Galardi Group Franchise & Leasing LLC v. City of El Cajon. The decision will appear in CCH Business Franchise Guide.