Franchisor Might Be Entitled to Future Lost Royalties from "Abandoned" Franchise

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

A transmission service shop franchisor’s claim for lost future royalties from a franchisee that allegedly abandoned its franchise rose above the level of mere speculation, a federal district court in Chattanooga, Tennessee, has held. Thus, the claim withstood a motion to dismiss by the franchisee.

Tennessee law, which governed the franchise agreement, provides for the award lost future profits for breach of contract, in some circumstances. Although the traditional rule held that anticipated damages were too speculative, courts have recognized that an injured party may recover anticipated profits when their nature and occurrence are established with reasonable certainty.

In defending this case, the franchisee relied upon the decision in Postal Instant Press, Inc. v. Sealy (CCH Business Franchise Guide ¶10,893), which denied future royalties to a franchisor on the ground that the franchisee’s breach of the franchise agreement was not the proximate cause of the franchisor’s loss of royalties. The court found that the franchisor had chosen to terminate the agreement, thus depriving itself of future royalties.

The Sealy decision has come under scrutiny in recent years. Some courts have adhered to its reasoning that future lost royalties are too speculative. Other courts have rejected that reasoning, holding that a franchisor should be entitled to royalties as if the franchise relationship continued for the term of the contract.

More recent cases addressing the issue have focused on individual facts in determining how speculative the future royalties would be.

The franchisee in this case sought to dismiss a significant portion of the damages requested at a very early stage. The motion to dismiss was based solely on the pleadings, and there was very little evidence to consider in determining whether to dismiss such a significant portion of the franchisor’s case.

The amended complaint alleged that the principal of the franchisee contemplated retirement from operating the franchise. Instead of transferring his obligations under the agreement to his son, he abandoned the agreement and transferred the assets of the franchise to his son, who began operating a competing transmission shop.

It could not be determined at this early stage whether the franchisor made factual allegations with respect to all material elements necessary to sustain a recovery under some viable legal theory, the court held.

The decision is Moran Industries v. Mr. Transmission of Chattanooga, CCH Business Franchise Guide ¶14,428.

Lost Future Royalties—Pundits Were Wrong; Sealy Not Dead

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

When the case of Radisson Hotels International, Inc. v. Majestic Towers, Inc. (CCH Business Franchise Guide ¶13,680) was decided in 2007, many claimed that the holding of Postal Instant Press, Inc. v. Sealy (CCH Business Franchise Guide ¶10,893)—that lost future royalties claims would not be allowed where the franchisor terminated the franchisee—was dead.

But as Mark Twain (and this author) said, perhaps the rumors of Sealy's demise were premature. Several recent decisions following Sealy have come down recently.(See e.g. Meineke Car Care Centers, Inc. v. RLB Holdings (W.D. N.C. 2009) CCH Business Franchise Guide ¶14,212; Meineke Car Care Centers, Inc. v. L.A.C. 1603, LLC (W.D. N.C. 2008) 2008 U. S. Dist. LEXIS 33566; and Meineke Car Care Centers, Inc. v. Duvall (W.D. N.C. 2007) 2007 U. S. Dist. LEXIS 27120).

In the recent case of Meineke Car Care Centers, Inc. v. RLB Holdings, (CCH Business Franchise Guide ¶14,212), the argument accepted in Radisson (that it took the franchisor a time certain to find a replacement franchisee) was specifically rejected with the court finding that Meineke's "generic calculation for lost profits based on the CFO's claim that it usually takes two to three years to re-franchise a location" was either irrelevant or not believed. All claims for lost future royalties were denied.

The court also noted that Meineke admitted that it typically did not try to refranchise a shop once it had closed, and there was no evidence that it had done so in this case in an attempt to mitigate damages.

Shaggy Dog Story—Hotel Franchisor Not Liable for Franchisee's Alleged Negligence

Here's a beauty: A hotel franchisor was held not vicariously liable for a franchisee's alleged negligence and violation of the California Unruh Civil Rights Act in connection with an incident at the franchisee's hotel during which an individual was denied accommodations. There was no evidence that the franchisee and its employees were actual or ostensible agents of the franchisor, a California appellate court has decided.

The plaintiff arrived at the hotel with his allegedly disabled cousin and a dog. The plaintiff's cousin declared that he had a form of muscular dystrophy and used the dog to help him maintain mobility. As the incident was recalled by the hotel's desk clerk, a big, unleashed dog walked into the hotel, "just roaming through the lobby," sniffing the hotel's clientele.

According to the clerk, the dog was not wearing anything that would indicate that it was a service dog. The plaintiff, wearing only swim trunks and smelling strongly of alcohol, then proceeded to cut in front of the line at the hotel service desk, butting aside a client that the clerk was assisting. He claimed that the dog was a service animal, and became angry and uttered obscenities when the clerk asked him to leash the dog. The clerk later told the manager that he refused to rent a room to the individual because he was "drunk and surly."

The decision is Stites v. Hilton Hotels Corp., CCH Business Franchise Guide ¶14,296.

Expert Witnesses—Testimony of New Expert Limited to First Expert's Report

In a contest between two sandwich shop franchisors (Subway and Quiznos), Subway was permitted to substitute a new expert for its originally-disclosed expert witness. However, the court ruled that the substitute's testimony at trial would be limited to establishing the veracity and integrity of the original expert witness and the conclusions reached in the original witness' expert report.

The substitute's opinion, which sought additional damages, would not be permitted in evidence. Therefore, Quiznos' motion seeking costs and expenses incurred to rebut the damages analysis of Subway's original damages expert was denied.

The decision is Doctor's Associates, Inc. v. QIP Holder LLC (D. Conn. 2009) CCH Business Franchise Guide ¶14,289.

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Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

Franchisee Liability for Lost Future Profits: Another Blow to Sealy?

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

The Texas Court of Appeals for the Second District—applying Georgia law in a case of first impression for both Georgia and Texas—has held that a "terminated" franchisee was liable for lost future profits over the full remainder of a 25-year term (Progressive Child Care Systems, Inc. v. Kids `R' Kids International, Inc., CCH Business Franchise Guide ¶14,018).

Is this the death knell of Postal Instant Press, Inc. v. Sealy (CCH Business Franchise Guide ¶10,893), which invalidated an award of lost future royalties and advertising fees to a franchisor that had terminated a franchisee for failure to pay royalties? I think not.

For one thing, there was no possibility of the franchisor in the Texas case double-dipping or collecting royalties from the same site twice because the "terminated" franchisee simply stopped paying and kept his child care franchises running at the same sites under a different name—Legacy Learning Center, rather than Kids `R' Kids.

For another, the franchisee simply left the system, falling more under the abandonment justification for such lost future royalties found in other cases. See It's Just Lunch Franchise, LLC v. BLFA Enterprises, LLC, CCH Business Franchise Guide ¶12,620.

In that case, the court held that “under Sealy, a franchisor who has terminated the franchise agreement cannot recover for future profits,” but nevertheless found It’s Just Lunch to be outside Sealy. "The Sealy court expressly refused to consider whether damages for future profits would be available where, as alleged in It's Just Lunch's complaint, the franchisee terminated the agreement."

Attorney "Mal Practice"

There was a recent comment thread on "mal practice" on the ABA Franchise Forum's listserv (from whence comes the strange spelling in two words) concerning the practice of franchise law by the ignorant.

As one would expect from such a diverse crowd, the responses ranged from the learned to the mundane, from the sanctimonious to failed attempts at humor. But the point was well taken—proctologists should not perform brain surgery, and the lawyers who do house closings should not prepare franchise documents.

Proof of how bad an outcome can result from such ignorant representation is found in State of Nebraska ex rel Counsel for Discipline of the Nebraska Supreme Court v. Orr(Neb. S. Ct. January 30, 2009, CCH Business Franchise Guide ¶14,064).

As I have repeatedly said, the same problem—lack of expertise—can be extremely troubling when using generalized knowledge experts (as opposed to franchise valuation experts) to establish damages or value franchises in mediation, arbitration or litigation. See, e.g., Schaeffer and Ogulnick, “Why Valuing Franchise Businesses is Different from Valuing Other Businesses,” Institute of Business Appraisers, Business Appraisal Practice (Spring 2008).

Rescission as Punishment

A Colorado trial court in Quizno's Franchising II v. Zig Zag Restaurant Group (D. Colo. 2008) CCH Business Franchise Guide ¶14,046, used rescission as the measure of damages to punish a franchisor’s vendetta of “in-house pique” against a franchisee who was terminated as the result of one unreliable field test of the amount of meat in a sandwich.

The court held the sandwich shop franchisee was entitled to rescission-type damages in the amount of $349,797 and post-judgment interest at the rate of 24 percent for the franchisor’s wrongful termination.

Under well-settled Colorado law, contract damages are normally based on benefit-of-the-bargain. However, the court ruled that when there is a substantial breach with irreparable injury—and ordinary contract damages are inadequate, difficult, or impossible to assess—then it is appropriate to award rescission-type damages. The object was not just to return the parties to the moment before the breach, but to return them to the moment before the contract was entered into.

The franchisor's argument that it terminated the franchise because the franchisee breached its agreement by materially impairing its goodwill was rejected. To the contrary, the court held that the franchisor breached the agreement by wrongfully terminating the franchisee.