Bakery Distributorships Were Not “Franchises” Within the Washington Franchise Investment Protection Act

This posting was written by John W. Arden.

Pepperidge Farm bakery distributorships were not “franchises” within the Washington Franchise Investment Protection Act because Pepperidge Farm did not exercise the level of control over the distributors to satisfy the “marketing plan” requirement, the distributors were not substantially associated with the Pepperidge Farm trademarks, and the distributors did not pay a franchise fee, according to the federal district court in Richland, Washington (Atchley v. Pepperidge Farm, Incorporated, December 6, 2012, Shea, E.).

Since Pepperidge Farm was not a franchisor doing business within Washington, it was not required to register a franchise disclosure document or provide a disclosure document prior to entering a distributorship agreement.

Pepperidge Farm entered into consignment agreements with third-party independent contractors, granting them geographically exclusive distributorships. In 2003, Michael Gilroy purchased an existing distributorship from David Spangler for $299,550. In 2004, John Atchley purchased a distributorship from Jason Godwin for $225,000. For both purchases, payment was nominally made to Pepperidge Farm, which facilitated the transactions. Pepperidge Farm credited the payments to outstanding loans or other financial obligations owed by the selling distributors and then furnished all remaining monies directly to the selling distributors.

Each distributor voluntarily entered into a separate consignment agreement with Pepperidge Farm and received an exclusive right to distribute Pepperidge Farm products in retail stores within their territories. The distributors received commission payments for the sale of Pepperidge Farm goods or a percentage of the net proceeds, depending on the products. Despite the territorial exclusivity provision of the agreements, Pepperidge Farm retained the right to sell and deliver its products to customers in the distributors’ territories.

After business reversals, the distributors brought separate claims against Pepperidge Farm, alleging violation of the Washington Franchise Investment Protection Act and negligent misrepresentation. Both cases were eventually assigned to Senior Judge Fred Van Stickle, who granted partial summary judgment for Pepperidge Farm and then consolidated the cases. Judge Van Stickle granted summary judgment on the remaining negligent misrepresentation claims and held a trial on Pepperidge Farm’s counterclaim for Gilroy’s failure to repay the loan that enabled him to purchase the distributorship. The court found that factual issues regarding whether the forced sale of Gilroy’s distributorship was commercially reasonable precluded summary judgment.

After a three-day trial in February 2009, the court entered a finding that the sale of the distributorship was commercially reasonable. The distributors appealed to the Ninth Circuit, which largely affirmed the district court rulings, but reversed the decision with respect to the Franchise Investment Protection Act, concluding that there was a genuine issue of material fact about whether the distributors paid franchise fees. The appeals court remanded the case for further proceedings.

On remand, the district court dismissed the Franchise Investment Protection Act claims on the ground that the distributorships were not “franchises” within the meaning of the Act. Under the statute, a “franchise” is an agreement by which (i) a person is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan prescribed in substantial part by the grantor; (ii) the operation of the business is substantially associated with a trademark, trade name, or other commercial symbol owned by or licensed by the grantor; and (iii) the person pays or is required to pay a franchise fee.

Marketing Plan

Although Pepperidge Farm controlled pricing of products directly sold and provided pricing schedules for the purpose of calculating commissions, it did not exercise control over many other factors used to determine the existence of a marketing plan, the court found. These factors included: (1) hours and days of operations; (2) advertising; (3) retail environment; (4) employee uniforms; (5) trading stamps; (6) hiring; (7) sales quotas; and (8) management training. While Pepperidge Farm provided the distributors with financial support by guaranteeing the initial loan to finance purchases of the distributorships, it was not show to provide any other financial support.

Thus, the distributors failed to satisfy the marketing plan element of the “franchise” definition of the Washington Franchise Investment Protection Act.

Association with Trademark

To satisfy the “substantial association” element of the “franchise” definition, the distributors were required to show a substantial association with Pepperidge Farm trademarks or trade names beyond the act of distributing the Pepperidge Farm products. Although Atchley used the Pepperidge Farm logo on his business card and on one business form and his delivery trucks, such association was limited and incidental, the court ruled. The use of the Pepperidge Farm trademarks did not rise to the level of “substantial association.”

Payment of Franchise Fee

A “franchise fee” is a payment for the right to enter into a business under a franchise agreement and does not include “any payment for the mandatory purchase of goods or services or any payment for goods or services available only from the franchisee.” Also excluded from the definition are payments for purchases at a bona fide wholesale price. Ordinary business expenses are not “franchise fees” because they are paid during the regular course of business and not for the right to do business.

Thus, the distributors did not pay, agree to pay, or were required to pay a “franchise fee” within the meaning of the Washington Franchise Investment Protection Act, in the court’s view.

The case is No. CV-04-452-EFS.

Howard R. Morrill (Simburg Ketter Sheppard Purdy) for John R. Atchley. Forrest A. Hainline, III (Goodwin Procter LLP) for Pepperidge Farm Inc.

Distributors Could Have Paid “Franchise Fee” Under Washington Law

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

A genuine issue of material fact existed as to whether two purchasers of geographically exclusive baked goods distributorships paid a “franchise fee” under the meaning of the Washington Franchise Investment Protection Act to a baked goods manufacturer either through a $30 deduction from commissions the purchasers were paid for their participation in the manufacturer’s Pallet Delivery Program (PDP) or through any suspected fee, according to a federal district court in Spokane, Washington.

The issue had been remanded to the district court by the Eighth Circuit, which held that the district court had erred in an earlier ruling (CCH Business Franchise Guide ¶13,338) in granting summary judgment to the manufacturer after finding that the purchasers had not paid a franchise fee.

The purchasers did not argue that they paid a direct franchise fee to the manufacturer. Instead, they contended that the $30 deduction from the commissions they earned in the PDP, representing a portion of the costs the manufacturer incurred to shrink-wrap, palletize, and deliver the products to consumers’ warehouses, was a charge for the “mandatory purchase of goods or services, “available only from the franchisor,” under the meaning of the Washington Act and that none of the statutory exceptions applied.

Because the PDP was a fee-for-services agreement, it did not fall under the Franchise Investment Protection Act’s fair-market-value exception, the court determined. That statutory exception applied only to supplies, fixtures, and real property. Further, the Washington Supreme Court has not recognized a fair-market-value exception for the mandatory purchase of services.

The manufacturer cited to a law review article and two unpublished federal cases to argue that the deduction from commissions was not a franchise fee because it (1) was an ordinary business expense for services rendered and (2) lacked an unrecoverable capital investment. However, the manufacturer identified no binding precedent upon which the court could find that an ordinary business expense for services was exempted from Franchise Investment Protection’s Act’s definition of “franchise fee,” according to the court.

One of the cited cases did find that a payment of more than $6,000 for training was not a franchise fee but rather an ordinary business expense, but that case was unpublished, over 17 years old, and relied on nonbinding precedent from another Circuit. The other cited case similarly failed to persuade the court.

Although at least one Washington court considered an unrecoverable investment as one factor in determining whether a franchise fee was present, it was not a necessary component of a franchise fee. With no binding or persuasive authority on point, a genuine issue of material fact existed.

The decision in Atchley v. Pepperidge Farm, Inc. will appear at CCH Business Franchise Guide ¶ 14,793.

Inventory Requirement, Control of Supplies Might Be “Franchise Fee” Under Washington Law

This posting was written by John W. Arden.

A supplier’s requirement that distributors maintain a particular level of inventory and its control over the supplies sent to the distributors might constitute a “franchise fee” within the Washington Franchise Investment Protection Act, according to the U.S. Court of Appeals in San Francisco.

Summary dismissal of the distributors' franchise law claims (CCH Business Franchise Guide ¶13,338 and ¶13,437)—based on its failure to establish that it paid a “franchise fee”—was reversed, and the claim was remanded to the federal district court in Spokane, Washington.

Mandatory Purchases

Payments for “the mandatory purchase of goods or services” are considered franchise fees under the Washington Franchise Investment Protection Act’s definition of “franchise.” (Wash. Rev. Code §19.100.010 (12)), the appeals court held.

The complaining distributors claimed that their supplier (Pepperidge Farm) effectively required them to purchase goods by mandating inventory levels and controlling pallet shipments “and then requiring [them] to pay for some product that went stale prior to sale.”

While the district court ruled that the distributors were never required to purchase a set quantity of Pepperidge Farm products, the distributors “submitted evidence to support their claim to the contrary,” the appeals court said, finding a genuine dispute of material fact that precluded summary judgment.

Business Opportunity Law

The appellate court upheld the summary dismissal of other claims brought by the distributors—including claims brought under the Washington Business Opportunity Fraud Act and negligent misrepresentation. It was not apparent that a distributorship was a “business opportunity” under the statute, and the distributors offered no counter argument, the court held.

The negligent misrepresentation claim was rejected on the ground that the distribution agreement specifically required the distributor to remove stale Pepperidge Farm products from store shelves and provided that Pepperidge Farm had no obligation to accept stale goods.

Commercially Reasonable Sale

The district court’s finding that Pepperidge Farm’s sale of the distributorship to the complaining distributor was commercially reasonable under the Washington Uniform Commercial Code (CCH Business Franchise Guide ¶14,145) was upheld on appeal.

“Pepperidge Farm undertook efforts in excess of ordinary procedures for marketing a distributorship, easily satisfying the standard for a commercially reasonable sale,” the Ninth Circuit ruled.

The May 14 not-for-publication opinion is Atchley v. Pepperidge Farm Inc., No. 09-35275. Text of the decision will appear in the CCH Business Franchise Guide.