Exclusive Electronic Game Distributorship Was Not a Hawaii “Franchise”

This posting was written by John W. Arden.

An exclusive Hawaii distributorship of electronic games that was not substantially associated with its supplier’s trademarks and did not pay a franchise fee to its supplier was not a “franchise” within the Hawaii Franchise Investment Law, the federal district court in Honolulu has ruled (Prim Limited Liability Co. v. Pace-O-Matic, Inc., December 13, 2012, Mollway, S.). Thus, the supplier’s termination of the exclusive distributorship, allegedly without cause, could not be held to violate the statute.

In November 2008, electronic game supplier Pace-O-Matic entered into an agreement making Prim Limited Liability Co. an exclusive distributor of “amusement devices” in an area that included Hawaii. In October 2010, Pace-O-Matic sent Prim a letter, alleging it was in default and terminating the exclusivity portion of the agreement. Shortly thereafter, Prim filed a lawsuit, asserting breach of contract, tortious interference with prospective business advantage, unfair methods of competition in violation of the Hawaii “little FTC Act,” violation of the Hawaii Franchise Investment Act, breach of express warranty, breach of implied warranty, and a right to indemnification.

Pace-O-Matic filed a motion for partial summary judgment on the unfair competition, franchise law, and implied warranty claims. The court granted summary judgment on the franchise law and implied warranty claims, but denied summary judgment on the unfair competition claims.

“Franchise” Definition

In its motion, Pace-O-Matic argued that it was entitled to summary judgment on the franchise law claim because the parties never had a franchise relationship as defined by the Hawaii Franchise Investment Law. Under the statute, a “franchise” is an agreement “in which a person grants to another person, a license to use a trade name, service mark, trademark, logotype or related characteristic … and in which the franchisee is required to pay, directly or indirectly, a franchise fee.” Haw. Rev. Stat. §482E-2. However, Prim failed to show that there was a triable issue regarding the existence of a franchise between Prim and Pace-O-Matic.

Association with trademark. Prim’s claim that the distributorship agreement allowed it to use Pace-O-Matic’s name, trademarks, and proprietary software was at odds with the language of the agreement. The agreement did not suggest that Prim was authorized to use Pace-O-Matic’s trademarks or software. Rather, the agreement made clear that Pace-O-Matic was only authorizing Prim to “purchase games and fills from Pace and exercise its best efforts to develop markets for the games and distribute the games.”

A distributorship is different from a franchise, the court observed. The distribution agreement allowed Prim to distribute Pace-O-Matic’s products; it did not “substantially associate” Prim with Pace-O-Matic’s trademarks.

“The very essence of a franchise relationship is that the franchisee represents the franchise to the public; a franchise is not created whenever one company purchases and distributes another company’s products.”

Franchise fee. Similarly, Prim failed to provide evidence that it paid Pace-O-Matic a franchise fee. It contended that its payment for “fills” constituted a franchise fee because the price of the fills far exceeded the cost of a few keystrokes to generate a fill. However, Pace-O-Matic’s profit margin is not proof that Prim’s payment for fills constituted a franchise fee, the court held.

“Hawaii law does not provide that a distributor’s profit on a distributorship agreement transforms a relationship into a franchise,” the court noted. “Moreover, there is no evidence that the cost of the fills constituted an ‘unrecoverable investment’ in Pace.”

“Little FTC Act”

Prim’s claim that Pace-O-Matic committed unfair competition in violation of the Hawaii “little FTC Act” raised genuine issues of fact. Prim’s pleadings alleged that Pace-O-Matic’s conduct caused injury to Prim’s business or property and was likely to result in damages exceeding $75,000. Prim also alleged that it was injured by the termination of its exclusive distributorship and the direct sale of fills to one of its customers. Pace-O-Matic did not dispute the termination or the direct sales.

“When the supplier itself takes on the role of competitor and seeks to do business with the exclusive distributor’s customer, it may indeed be . . . an aggravating circumstance sufficient to support a claim” under the Hawaii “little FTC Act,” the court found. Thus, the claim survived the motion for summary judgment.

The case is Civil No. 10-617 SOM/KSC.

Dean L. Franklin (Thompson Coburn) for Prim Limited Liability Co. Effie Ann Steiger for Pace-O-Matic.

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.

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.

Sub-Distributor Failed to Adequately Allege Illinois “Franchise”

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

A sub-distributor of electrical components failed to adequately allege that its relationship with a distributor was a "franchise" under the meaning of the Illinois Franchise Disclosure Act, according to the federal district court in Chicago.

Accordingly, the sub-distributor’s counterclaim against the distributor for violations of the Act’s registration, anti-fraud, and "good cause" for termination provisions was dismissed.

After the distributor terminated the parties’ agreements and brought suit for failure to pay for delivered goods, the sub-distributor responded with several counterclaims, including the alleged violations of the Illinois Franchise Disclosure Act.

Association with Distributor’s Trademark

The sub-distributor argued that it pled sufficient facts to permit the court to infer the existence of a franchise relationship under federal notice pleading standards. However, the sub-distributor’s counterclaim was devoid of any allegation that it used the distributor’s name or mark in marketing the distributor’s electrical components, as required by the statutory definition of "franchise," the court ruled.

Although it could be inferred that the sub-distributor used the distributor’s tradename or mark because the components at issue were alleged to be unique, it was certainly not a necessary inference, the court commented. Moreover, there was no allegation that the operation of the sub-distributor’s business was substantially associated with the distributor’s mark.

Franchise Fee Requirement

The sub-distributor cited caselaw and argued that it was not required to make allegations specific to the Franchsie Disclosure Act's requirements for a "franchise." However, the sub-distributor failed to allege that it operated a business under the distributor’s mark or paid the distributor a "franchise fee," two of the elements necessary to establish a franchise.

Notice pleading required a plaintiff to plead sufficient facts to make a claim plausible on its faith and the sub-distributor’s alleged facts did not reach even that low threshold.

The decision is BJB Electric v. North Continental Enterprises, CCH Business Franchise Guide ¶14,317.

License Agreement Was Not “Franchise” Under FTC Rule

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

An agreement that permitted a dealer to produce, sell, and install a licensor’s patented and trademarked gutters in a limited territory was not a "franchise" under the meaning of the FTC franchise disclosure rule, a federal district court in Florence, South Carolina, has ruled.

Thus, the dealer could not proceed with its claim that the licensor violated the South Carolina "little FTC Act" by failing to provide it with a disclosure statement as required by the FTC rule.

The licensor notified the dealer in 2001 that it was terminating their agreement and requested the payment of accrued royalties and the return of a gutter-fabricating machine, as required by the agreement. When the dealer failed to comply, the licensor filed the instant suit, seeking injunctive relief and asserting other claims.

Subsequently, the dealer asserted various counterclaims—including one brought under the South Carolina “little FTC Act”—and continued to use the fabricating machine without paying royalties during the eight years the suit has been pending in both state and federal court.

Caption of Agreement

The actual contract was captioned as a license agreement and had been described by both a South Carolina appellate court and the South Carolina Supreme Court as a license agreement. However, that was not determinative of whether a franchise agreement existed.

As noted by the dealer, an FTC staff advisory opinion provided that "[w]hether a business relationship constitutes a franchise, is not dependent upon what the parties call the relationship …[r]ather, a relationship is covered by the Franchise Rule if it satisfies the definitional elements of a franchise set forth in the Franchise Rule" (FTC Informal Staff Advisory Op. 98-4, 1998, CCH Business Franchise Guide ¶6493).

“Franchise” Definition

In determining whether a commercial relationship constitutes a franchise for purposes of the FTC rule, courts have looked to see (1) whether the relationship involved the distribution of goods or services associated with a franchisor’s trademark or trade name; (2) whether the franchisor had authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and (3) whether the franchisor must pay at least $500 within six months after the franchise business began.

The first prong of the analysis was not in dispute, as the agreement involved the sale or distribution of goods associated with the licensor’s trademark. However, as to the second prong, the controls or assistance had to be related to the franchisee’s entire method of operation, not merely its method of selling a specific product or products which represented a small part of the franchisee’s business, according to the court.

Control Over Method of Operation

The dealer pointed to numerous terms from the agreement—including limitations on territory, limitations on the ability to sell the product through lumberyards and home centers, and accounting and sales reporting requirements—as evidence that the licensor exercised a great deal of control over the dealer’s method of operation. However, it was readily apparent from the terms of the agreement that these limitations only restricted the dealer’s operations with respect to the gutter product line, the court determined.

It was not disputed that the sale and installation of those gutters was but one of multiple products and services provided by the dealer. Thus, the level of control exerted by the licensor over the dealer’s method of operation was not significant for purposes of the FTC franchise rule, the court held.

Franchise Fee

There was no evidence that any franchise fee was paid to the licensor by the dealer as required by the third prong of the analysis, the court determined. Although the dealer paid the licensor a sum of money at the inception of the business relationship, that payment was made in exchange for the purchase of the gutter-fabricating machine. It was not in the form of a franchise fee as required by the rule. Thus, the agreement was not a franchise as a matter of law.

Therefore, the dealer was denied partial summary judgment on its "little FTC Act" counterclaim. Even if the business relationship between the parties was a franchise, the dealer still would be required to establish that the failure to comply with the FTC franchise rule constituted a per se violation of the Act, an issue on which the dealer failed to provide persuasive authority, the court noted.

The decision is Englert, Inc. v. LeafGuard USA, Inc., CCH Business Franchise Guide ¶14,297.

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.