Criminal Conviction of Franchisee President Was Not Good Cause for Termination

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

A pancake restaurant franchisor violated the New Jersey Franchise Practices Act (NJFPA) by terminating a franchise on the basis of the conviction of the president and majority owner of the franchise for endangering the welfare of a child, the federal district court in Newark, New Jersey, has decided.

The conviction was not "directly related to the business conducted pursuant to the franchise" under the meaning of the NJFPA.

The franchisor was not likely to succeed on the merits of its claims that the franchisee’s continued use of the franchisor’s trademarks was unauthorized because, as long as the parties’ agreement remained valid, the franchisee had a license to use those marks. Thus, the franchisor’s motion for a preliminary injunction barring the franchisee from continuing to use its marks was denied.

The franchisor notified the franchisee that it was terminating their agreement pursuant to a provision which granted the franchisor the right to terminate immediately, without notice, upon the conviction of the franchisee or any of its principal shareholders, "of a felony or any other criminal misconduct which is relevant to the operation of the franchise." However, the franchisee continued to operate the restaurant as if it was a franchise and claimed that the termination violated the NJFPA.

The parties’ agreement stipulated that, in order for a termination to be valid, it must be lawful under the NJFPA, the court noted. Under the statute, immediate termination was warranted only when "the alleged grounds are the conviction of the franchisee in a court of competent jurisdiction of an indictable offense directly related to the business conducted pursuant to the franchise."

There was nothing in the record suggesting that the crime occurred at the restaurant or that any other direct factual nexus existed between the conviction and the business of the franchise, the court observed. The court was unwilling to accept that potential damage to the franchisor’s brand, standing alone, was sufficient to satisfy the "directly related" standard of the NJFPA.

The decision is Int’l House of Pancakes v. Parsippany Pancake, CCH Business Franchise Guide ¶14,856.

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.

Preliminary Injunction Halts Termination of Likely New Jersey “Franchise”

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

An engine manufacturer and its authorized dealer likely shared a “community of interest” under the meaning of the New Jersey Franchise Practices Act (NJFPA), a federal district court in Camden, New Jersey, has ruled in a not-for-publication decision. Moreover, the relationship satisfied the Act’s gross sales requirement that more than 20 percent of a franchisee’s gross sales were intended to be derived from the franchise before the franchisee was entitled to statutory protections, according to the court. Thus, the dealer was likely to succeed in establishing that it was a “franchise” protected by the statute, and its request for a preliminary injunction enjoining termination by the manufacturer was granted.

The dealer brought suit against the manufacturer, seeking to enjoin it from terminating their agreement. The manufacturer did not dispute that the dealer would be irreparably harmed if the injunction was not granted, and that the balance of the hardships between the parties, as well as the public interest, favored granting the injunction. The only preliminary injunction factor that the manufacturer disputed was the dealer’s likelihood of success on the merits. The manufacturer argued that the parties did not share the “community of interest” necessary to show that the relationship constituted a “franchise” under the NJFPA.

Caselaw indicated that a community of interest existed “when the terms of the agreement between the parties or the nature of the franchise business requires the licensee, in the interest of the licensed business’s success, to make a substantial investment in goods or skill that will be of minimal utility outside the franchise.

Indicia of Control

The relationship between the parties had the indicia of control that were the hallmark of a community of interest, the court decided. The dealer stood to lose all of the following tangible and intangible indicia of control if terminated: (1) the larger building the dealer moved to in order to accommodate business related to the manufacturer that it would not be able to fully utilize; (2) special tools and a computer system to service business related to the manufacturer, and its intangible investment in mastering such equipment; (3) signage, advertisements, apparel, and its investments in producing such items and in developing a customer basis that associated the dealer with the manufacturer’s products; (4) investments made in training employees in the manufacturer’s products, including approximately $20,000 in travel and expenses; and (5) a substantial inventory of parts for the manufacturer’s products that the dealer would have significantly less opportunity to sell, according to the court.

Unequal Bargaining Power

Courts defining a community of interest under the NJFPA also focused on the importance of unequal bargaining power between franchisor and franchisee, the court noted. A substantial portion of the dealer’s business came from the warranty work it performed for the manufacturer, the consumer relationships that emerged from such work, and customers who found the dealer through listings for dealers of the manufacturer’s products. In sum, the dealer relied heavily upon the manufacturer but the manufacturer could easily send its warranty work elsewhere and the dealer’s sales did not yield a substantial portion of the manufacturer’ profits.

The manufacturer pointed out that much of the dealer’s investments in the relationship were not required by the dealer agreement but were voluntary. However, the court’s inquiry was not limited to the four corners of the parties’ agreement. Business relationships evolved and, at the very least, the manufacturer assented to the dealer’s franchise-related expenses. Whether or not the agreement required such investments, it clearly contemplated such future investments, the court reasoned. For example, the agreement set extensive terms for the dealer’s use of the manufacturer’s mark in literature and advertising. The fact that the dealer sold products and services for the manufacturer’s competitors did not defeat the relationship’s character as a franchise.

Symbiotic Relationship

Moreover, the parties shared a symbiotic relationship that was characteristic of a community of interest in that the manufacturer conceded that its dealers were necessary to its profitability and satisfied customers of the dealer were likely to become repeat customers for both parties. The fact that the interests of the parties were sometimes at odds did not defeat the existence of a community of interest, the court ruled.

The July 29, 2010, decision in Engines, Inc. v. MAN Engines and Components, Inc., Civil Action No. 10-277, appears at CCH Business Franchise Guide ¶14,431.

States Keep Passing Franchise and Distribution Laws, but Focus on Special Industries

This posting was written by John W. Arden.

State legislatures continue to pass a significant number of statutes regulating franchise and distribution arrangements, but have turned their focus to enacting special industry laws rather than generally-applicable laws, according to Richard H. Casper, speaking April 29 at Foley & Lardner’s 19th annual Law of Product Distribution and Franchise Seminar in Milwaukee.

In 2009, the states passed 65 laws enacting or amending distribution statutes. There are currently more than 100 bills affecting the field pending in the legislatures.

Themes of Legislation

Casper identified several themes of legislation, including the enactment of laws (1) increasing restrictions on suppliers, (2) tweaking protections afforded motor vehicle dealerships, (3) focusing on specific industries, and (4) expanding anti-termination measures provided to dealers of motor vehicles and farm and construction equipment to watercraft, recreational vehicle, and lawn and garden equipment dealers.

In contrast, the states generally have shied away from further legislation covering independent sales representatives and farm equipment dealerships. The redraft of Uniform Commercial Code Article 2—proposed by the National Conference of Commissioners on Uniform States Laws in 2003—has not been adopted in any state, Casper said.

Three states and the federal government have adopted statutes requiring restaurant chains to disclose the nutritional content of menu items. This year, New Jersey has amended its Franchise Practices Act to govern franchisees maintaining virtually any kind of location within the state. Previously, the law applied to franchisees that maintained a retail location within New Jersey.

Maryland has expanded the scope of its Equipment Dealer Contract Act to cover heating, ventilation, and air conditioning dealers in the business of selling “on commission or at retail.”

Product Distribution Law Guide

The attorneys in the Foley & Lardner Distribution & Franchise Practice group have authored a one-volume treatise based on the firm’s annual Product Distribution and Franchise seminar. CCH Product Distribution Law Guide, Second Edition discusses distribution issues from both the legal and business perspective, providing practice tips, checklists, and a solutions-oriented approach. Further details about the Guide appear here on the CCH/Wolters Kluwer online store.

New Jersey Expands Coverage of Franchise Practices Act

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide, and John W. Arden.

Legislation to extend protections of the New Jersey Franchise Practices Act to wholesale distribution businesses was signed into law on January 16.

The state expanded the coverage of its franchise relationship/termination law by revising the concept of “place of business” within the statutory definition of “franchise.”

Amendments contained in Assembly Bill No. 2491 (Chapter No. 235) were a reaction to the legislature’s finding that “the courts have in some cases more narrowly construed the Franchise Practices Act than was intended by the Legislature.”

Specifically, the legislation changed the previous “franchise” definition, which covered distribution businesses that required customers to come to its “place of business” to buy goods but did not cover distribution businesses that incurred the extra burden of going to its customers to make sales and deliver products.

The previous version defined “place of business” as “a fixed geographical location at which the franchisee displays for sale and sells the franchisor’s goods or offers for sale and sells the franchisor’s services. Place of business shall not mean an office, a warehouse, a place of storage, a residence or a vehicle.”

The enactment adds the following clause (in italics) to the last sentence of the definition:

“Place of business shall not mean an office, a warehouse, a place of storage, a residence or a vehicle, except that with respect to persons who do not make a majority of their sales directly to consumers, `place of business’ means a fixed geographical location at which the franchisee displays for sale and sells the franchisor’s goods or offers for sale and sells the franchisor’s services, or an office or a warehouse from which franchisee personnel visit or call upon customers or from which the franchisor’s goods are delivered to customers.”

The amendment was effective immediately. Text of the amending law appears here on the website of the New Jersey Legislature.

New Jersey Dealership Was Constructively Terminated Without Good Cause

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

A forklift manufacturer’s actions—geared towards forcing a dealer out of its role as an authorized dealer of the manufacturer’s forklifts—amounted to constructive termination without good cause, in violation of the New Jersey Franchise Practices Act (NJFPA), according to a New Jersey appellate court.

A trial court’s ruling and award of compensatory damages for lost profits in the amount of $679,414 were affirmed. An award of $3,533,642 in attorneys’ fees was also upheld, but an award of $477,611 in expert witness fees was reversed.

Effective Termination

The manufacturer argued that the NJFPA prohibited only actual terminations and, because the dealer was never terminated, there was no violation. However, the manufacturer’s conduct was geared to terminating the dealer as a franchisee, the court determined. That conduct included breaching the parties’ agreement by the appointment of a competing dealer in the dealer’s exclusive territory.

Indeed, a letter from one of the manufacturer’s officers to the dealer included the statements: (1) "it's my intent to ask our people to begin a search for another dealer to represent [the manufacturer’s] products in Northern New Jersey;" and (2) "I'm prepared to continue selling [the manufacturer’s] parts to [the dealer] for a year after any new [authorized] dealer is appointed," the court noted. Effectively, it was a termination letter, the court determined.

The record established that the manufacturer’s officers were well aware that the NJFPA prohibited them from terminating the dealer unless they could establish "good cause." The manufacturer's efforts to create the appearance of substantially deficient performance by the dealer, and its assertion that the dealer breached a best efforts provision in the parties' agreement failed, the court ruled. The manufacturer’s effort to force out the dealer was thwarted only by virtue of the dealer’s filing of the instant action.

Requirement of Good Cause

The NJFPA was remedial legislation designed to protect franchisees from the superior bargaining power of franchisors, the court reasoned. In the absence of a substantial failure of franchisee compliance, the statutory requirement of good cause prohibited a franchisor from terminating for other reasons, even if they reflected a sound and nondiscriminatory business strategy.

The legislature’s decision not to recognize a valid business reason as constituting "good cause" for termination in the NJFPA distinguished the Act from the less-protective franchise statutes in other states, the court remarked. Further, the manufacturer provided no persuasive authority to support its argument against liability for constructive termination.

The manufacturer’s assertion that the letter from its officer was merely a suggestion to the dealer to end its relationship with the manufacturer was an obvious revision of history and its claim that it did not constructively terminate the dealer was disingenuous, according to the court.

In addition to the letter, the manufacturer’s decision to stop providing annual business plans to the dealer was further evidence that it expected to abandon the dealer in favor of another dealer. The court rejected the manufacturer’s position that if the dealer wanted to claim damages under the NJFPA for termination, it was required to withdraw from the agreement and thus allow itself to be terminated. Such a requirement would fly in the face of the Act's purposes of leveling the playing field between the typically more powerful franchisor and less powerful franchisee, the court held.

Loss of Exclusivity

The dealer's loss of the exclusivity of its territory, in and of itself, could qualify as such a change in the agreement's terms that constituted constructive termination, the court held. In the instant case, the "change" that the manufacturer proposed for the dealer upon appointing a competing dealer to the dealer’s territory would have gone even further than a mere loss of exclusivity; instead of simply establishing the competing dealer as a second dealer in the franchise territory, the manufacturer would have eliminated the dealer as an authorized dealer by ending its ability to purchase new forklifts and parts.

The manufacturer’s conduct proved its intent for the cessation of exclusivity to undermine the dealer’s franchise, according to the court. It appointed the competing dealer and blanketed the dealer's territory with the message that the competing dealer was its favored dealer in the territory in all regards, without informing the complaining dealer. It also provided discounts, rebates, and other subsidies to the competing dealer that let it undercut the complaining dealer’s prices.

Attorney Fees, Expert Witness Fees

The trial court's awarding of $3,533,642 in attorney fees to the dealer under the NJFPA's attorney fee provision was not an abuse of discretion, the court held. The trial court found that the work, expenses, and fee requests were reasonably required to establish the dealer’s NJFPA claim and to refute the counterclaim that the manufacturer asserted.

The Act’s authorization of an award of “costs of the action" did not encompass the award of expert witness fees, the court decided. Thus, the trial court’s award of costs to the dealer was reduced from $724,817 to $247,206 to reflect the deletion of $477,611 that the trial court had awarded for expert witness fees.

The decision is Maintainco, Inc. v. Mitsubishi Caterpillar Forklift, CCH Business Franchise Guide ¶14,195.

Lighting Manufacturer Restrained from Terminating Likely New Jersey “Franchise”

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

A manufacturer of lighting for emergency response vehicles was temporarily restrained from terminating an entity that sold and installed the manufacturer’s products, a federal district court in Camden, New Jersey, has ruled.

After deciding the threshold issue that the New Jersey Franchise Practices Act (NJFPA) was likely applicable to the dispute, the court determined that the termination likely violated both the Act’s notice requirement and its “good cause” for termination requirement. Because the other prerequisites for injunctive relief were satisfied, the requested relief was granted and a preliminary injunction hearing scheduled.

The seller brought suit against the manufacturer after the manufacturer issued it a notice of termination. In addition to seeking the order prohibiting the manufacturer from terminating the parties’ Master Distributor Agreement and compelling the manufacturer to honor its obligations under the agreement, the seller alleged common law claims, including breach of contract.

What is a Franchise?

A franchise exists under the NJFPA if: (1) there is a “community of interest” between the franchisor and the franchisee; (2) the franchisor granted a “license” to the franchisee; and (3) the parties contemplated that the franchisee would maintain a place of business in New Jersey, according to the court.

In addition, in order to meet the Act’s definition of a “franchise,” a purported franchisee was required to establish that it made sales of the alleged franchisor’s products in excess of $35,000 per year and that those sales constituted at least 20 percent of the purported franchisee’s business.

Place of Business

The seller’s complaint asserted that at its Cherry Hill, New Jersey location, it established and maintains a sales/service desk at which it (1) displays the manufacturer’s products, banners, and logos; (2) offers for sale and sells the manufacturer’s products; and (3) demonstrates and trains technicians regarding the capabilities and use of the products.

Thus, the seller would likely prove that it maintained a place of business in New Jersey, the court held.

Trademark License

The seller was likely to prove that it was granted a license to use the manufacturer’s trademarks and trade name, the court determined.

The manufacturer contended that it had not granted the seller a license as contemplated by the NJFPA; rather, it merely granted the seller limited permission to sell a brand name product.

However, the manufacturer authorized the seller to use its mark solely for the purpose of promoting the manufacturer’s products in accordance with the parties’ agreement and required the seller to maximize the sale and use its best efforts to promote, introduce, demonstrate, and solicit orders for, and sell such products, and to protect and promote the good name of the manufacturer. Therefore, the license granted to the seller was more than just a limited license given to any retailer of a product, the court reasoned.

Community of Interest

The seller was likely to prove that it had a “community of interest” with the manufacturer under the meaning of the NJFPA, the court decided. Case law explained that a community of interest under the NJFPA existed when the terms of the parties’ agreement or the nature of the franchised business required the licensee to make a substantial investment in goods or skill that would be of minimal utility outside the franchise.

The seller’s argument that it had a community of interest with the manufacturer could be boiled down to a single sentence in its brief, indicating that, without the manufacturer’s products, the seller would have no business, the court noted.

The seller’s complaint asserted that, since 2001 when the parties’ relationship of over eight years began, the seller had invested in common marketing and promotional campaigns with the manufacturer pursuant to their agreement. Further, the seller alleged that its efforts resulted in converting a significant number of customers to the products of the manufacturer from the products of competing manufacturers. Those efforts would only inure to the benefit of the manufacturer if the parties’ agreement was terminated, according to the court.

Moreover, the agreement clearly required the seller to make such investments. It required the seller to maintain both inside and outside sales forces, use its best efforts to promote and sell the manufacturer’s products, and to offer promotions on those products at least twice each year.

Minimum Sales Threshold

The NJFPA’s minimum sales threshold for a “franchise” was also likely satisfied by the parties’ relationship, the court held. Under the NJFPA, an entity was required to establish that it made sales in excess of $35,000 per year of a franchisor’s products and that those sales accounted for at least 20 percent of the entity’s overall business to qualify the entity as a franchisee entitled to the Act’s protections.

A declaration submitted by the seller stated that in the preceding 12 months, the seller’s sales of the manufacturer’s products amounted to more than $1.9 million, and those sales represented approximately 37 percent of the seller’s overall business.

Because the seller had thus demonstrated that it would likely satisfy all of the Act’s requirements for a franchise, the NJFPA applied to the parties’ dispute.

Further details of the court’s ruling in Emergency Accessories & Installation, Inc. v. Whelen Engineering Co., Inc. will appear in the CCH Business Franchise Guide.