Franchisor Not Required to Consider “Eleventh Hour” Dealership Purchaser

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

A motor vehicle franchisor did not violate the Massachusetts motor vehicle dealer law or breach its agreement with a dealer by failing to consider the application of a prospective purchaser of the dealership made only one week before the termination date of the parties’ agreement, the U.S. Court of Appeals in Boston has decided.

Both by statute and the parties’ agreement, the franchisor had the right to a longer period to make due diligence enquiries about the buyer than the remaining period of the franchise. Thus, a federal district court's ruling (CCH Business Franchise Guide ¶14,360), granting summary judgment to the franchisor on the dealer’s breach of contract and statutory claims, was affirmed.

The dealer law gave the franchisor at least 30 days and up to 60 days to decide whether to approve the prospective purchaser’s application to purchase the dealership. The parties’ franchise agreement allowed the manufacturer 45 days, the court noted.

The court rejected the dealer’s contention that the franchisor must exercise due diligence and come to a decision on the prospective purchase (or be bound by a default approval under the dealer law) beyond the remaining effective period of the parties’ agreement.

One week prior to the scheduled termination date of the dealer’s franchise, the dealer sent a purchase-sale agreement to the franchisor for its approval. The dealer requested that the franchisor send the prospective purchaser an application form in accordance with the franchise terms, but the franchisor declined, and the dealer filed suit.

The parties then executed a "stand-still" agreement, requiring the franchisor to continue to do business with the dealer during litigation, but expressly saving the franchisor’s rights and claims.

On appeal, the dealer argued that the district court erred in concluding that the dealer’s diminished franchise right negated the franchisor's obligation to consider a franchise application from the buyer. However, a reasonable reading of the agreement was that the franchisor must consider a dealer’s proposed successor only when the remaining duration of the franchise agreement included sufficient time for the period of enquiry by the franchisor that the statute and the agreement allowed, the court held.

The decision in South Shore Imported Cars, Inc. v. Volkswagen of America, Inc. appears at CCH Business Franchise Guide ¶14,635.

Wrongful Termination: "Community of Interest" Under the Wisconsin Fair Dealership Law

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

A conflict seems to have developed between the federal courts' interpretation of the Wisconsin Fair Dealership Law and that of the Wisconsin courts. The Seventh Circuit in Home Protective Services, Inc. v. ADT Security Services, Inc., CCH Business Franchise Guide ¶13,266, affirmed a district court ruling finding no "community of interest" for a plaintiff that derived 95 percent of its revenue from the defendant and devoted 95 percent of its personnel hours to its arrangement with the defendant.

This decision was recently followed by the federal district court in Milwaukee. Stucchi USA, Inc. v. Hyquip, Inc. (E.D. Wis. July 28, 2010), CCH Business Franchise Guide ¶14,437.

However, the Wisconsin Court of Appeals, in the case of Water Quality Store, LLC v. Dynasty Spas, Inc., CCH Business Franchise Guide ¶14,426, held that the federal construction of Wisconsin statutes need not be followed by Wisconsin courts, citing particularly the Home Protective Services v ADT case.

It referenced a subsequent decision by the Wisconsin Supreme Court, Central Corp. v Research Products Corp., CCH Business Franchise Guide ¶13,560, which resurrected earlier case law, Ziegler Co., Inc. v. Rexnord, Inc.(Wis. S. Ct. 1983), CCH Business Franchise Guide ¶8882.

The Wisconsin Court of Appeals found there was a "community of interest" between a spa distributor and manufacturer, even though the manufacturer did not require an investment and even though the distributor was immediately able to find a replacement brand of spas to distribute --though not at the same volume.

Franchisor Could Be Liable Under Workers' Compensation Act

In an unusual situation, a Kentucky appellate court found that a franchisor of sandwich shops could be liable for the payment of workers' compensation benefits for an injured employee of a franchisee under the Kentucky Workers' Compensation Act because the nature of the relationship between the franchisor and the franchise could have constituted "remuneration" under the Act, and the franchisee could fit the Act's definition of a "subcontractor." Uninsured Employers' Fund v. Brown (Ky. Ct. App. September 3, 2010), CCH Business Franchise Guide ¶14,453.

Thus, the court reversed decisions of an administrative law judge and the Kentucky Board of Workers' Claims. Classification as a subcontractor is usually desired by franchisors, but in this case, it may have backfired.

Discovery Limited for Experts' Reports and Communications

Federal Rules of Civil Procedure 26 (3) (A) and (B), relating to experts' draft reports and expert-attorney communications, have been changed, effective December 1, 2010. This means such documents will no longer be discoverable except for:

(1) Those that relate to the expert's compensation;
(2) Facts and data provided by counsel that the expert considered; and
(3) Assumptions provided by counsel that the expert considered.

(Report of the Judicial Conference Committee on Rules of Practice and Procedure to the Chief Justice of the United States and Members of the Judicial Conference of the United States.)

Constructive Trust Imposed on Defense Counsel's Fees

In a cautionary tale for franchise attorneys who represent clients that walk on the wild side, the Federal Trade Commission's imposition of a constructive trust on attorneys' fees paid to defense counsel who should have known their clients were crooks was upheld by the U.S. Court of Appeals in San Francisco. Federal Trade Commission v. Network Services Depot, Inc., CCH Business Franchise Guide ¶14,447.

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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’s Solicitation of Minor over Internet Warranted Immediate Termination

This posting was written by John W. Arden.

A franchisee’s arrest for soliciting a minor over the Internet warranted immediate termination of a franchise, without an opportunity to cure, under a “Damage to Goodwill” provision of the franchise agreement, according to a Florida circuit court.

A breach of contract claim brought by the franchisee’s wife and partner—arguing that she should not be bound by the actions of the franchisee—was rejected by the court.

In 1999, the husband and wife purchased an AmeriSpec franchise, with territory in Rhode Island and Massachusetts. In late 2004, the couple sold the franchise and purchased another existing AmeriSpec franchise in Sarasota, Florida, taking assignment of the franchise agreement.

Notice of Immediate Termination

On January 26, 2006, the husband was arrested and charged with transmitting harmful material to a minor by use of a computer and with using a computer for child exploitation. After learning of the arrest and negative publicity, the franchisor terminated the agreement immediately by letter dated February 6, 2006.

The termination letter cited a provision of the franchise agreement permitting termination of the franchise agreement upon receipt of notice for the franchisee’s engaging “in conduct which reflects materially and unfavorably upon the operation and reputation of the Franchised Business or the AmeriSpec system.”

Subsequently, the franchisee was convicted and/or pled guilty to multiple violations of Florida Statutes 847.0138. He currently is registered with the Florida Department of Law Enforcement as a sexual offender.

Liability for Acts of Partner

The franchisee’s wife and partner then brought an action against the franchisor for breach of contract and unjust enrichment, among other claims. The franchisor moved for summary judgment on the contract and unjust enrichment claims. The court framed the issue as whether the wife and partner “is bound by the actions of her partner and husband under the terms of the franchise agreement and Florida law.”

Initially, the court noted that both the husband and wife signed the franchise agreement as the franchisee. “Only one ‘franchise’ was granted, and there is no indication in the agreement that the rights of [the husband and wife] were divisible or separate.”

Florida law holds that individual partners are liable jointly and severally for all obligations of the partnership and that a partnership is liable for a partner’s actionable conduct. Florida Statutes 620.8305. Thus, the husband and wife were liable for the actions of the other.

The decision is Cleveland v. AmeriSpec, Inc., Circuit Court of the 12th Judicial Circuit, Case No. 2007 CA 008747 NC, November 16, 2009. Full text of the decision will appear at CCH Business Franchise Guide ¶14,267.

Closing of GM, Chrysler Dealerships Raises Termination Issues for Bankruptcy Courts

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

With the noticed closings of so many GM and Chrysler dealerships, wrongful termination statutes have become a question before the bankruptcy courts.

Simply put: Does the right of a bankrupt undergoing reorganization to reject contracts supersede the wrongful termination statutes that afford protection to dealers under many state relationship laws?

Rather than face the issue head on, however, an accommodation was reached. On July 5, 2009, the attorneys general (AGs) of 30 states reached an agreement in principle with GM regarding protections afforded under state laws to dealers and consumers.

The agreement requires New GM, a newly formed entity created by the U.S. Treasury, to comply with state relationship laws. It was formally ratified by the U.S. Bankruptcy Court, and additional states are expected to participate.

The AGs had filed objections to GM’s plan to reduce the number of its dealerships by 2,641—from 6,246 to 3,605—by the end of 2010, contending that the plan would have permitted GM to ignore state statutes that protect dealerships from unfair terminations and other oppressive conduct by motor vehicle manufacturers.

Greater Statutory Protections

And in light of the current economic slump particularly affecting the automotive industry, state legislatures appear to be moving to provide greater protections for their in-state dealerships and distributorships.

For example, the new Alabama Heavy Equipment Dealer Act prohibits suppliers from unilaterally amending, terminating, or refusing to renew a dealer agreement without "good cause," which is limited to withdrawal by the supplier from the market and certain performance deficiencies. The law also requires suppliers to provide advance written notice and an opportunity to cure in most instances of an amendment, termination, or failure to renew a dealer agreement. (Senate Bill No. 308 was approved and became effective May 22, 2009. See CCH Business Franchise Guide ¶4105).

In another attempt to protect its auto dealers, Illinois went further, recently amending its statute to eliminate language in the motor vehicle dealer law that a manufacturer has good cause to cancel, terminate, or fail to extend or renew the franchise or selling agreement to all franchisees of a line make when the manufacturer permanently discontinues the manufacture or assembly of such line.

It also (1) makes it a violation for a manufacturer to require or coerce a motor vehicle dealer to underutilize their facilities by requiring them to cease operations for the selling or servicing of any vehicles with another manufacturer and (2) provides an itemized list of reasonable compensation for the value of a motor vehicle dealer's business and business premises. (Senate Bill No. 1417 was approved and became effective May 22, 2009. See CCH Business Franchise Guide ¶4135).

Maine too amended its motor vehicle dealer law by deleting language stating that good cause for termination exists when a manufacturer discontinues production or distribution of the franchise product. (Senate Bill No. 483 was approved and became effective June 11, 2009. See CCH Business Franchise Guide ¶4195).

Impairment Write-Downs and Loan Guarentee Ratios—A Problem?

Many venture capital firms and other buyers of franchise companies over the past decade used substantial leveraging in their acquisitions. Many of these loans have certain financial ratios that must be maintained often involving net worth. In some instances, there are also personal guarantees.

As we have written often, Financial Accounting Standards Board (FASB) 141 and 142 require purchasers of intangible property (IP)—as opposed to owners of self-created IP—to test their IP assets (including “goodwill”) at least annually for impairment. If, as in many cases, the value of purchased franchise agreements, distributorship, or dealership agreements has been reduced (“impaired”), such as Chrysler dealerships purchased within the past 10 years, prudent auditors will be asking whether franchise company management is honestly valuing their IP in light of potential loan problems that could affect them personally. Beware!

Lost Future Royalties: Must Expenses Be Proven? Is There a Mitigation Defense?

In a recent decision, a franchisor’s claim for lost future royalties was denied because it failed to submit any evidence as to its own operating expenses. (Rocky Mountain Chocolate Factory v. SDMS, DC Colo., CCH Business Franchise Guide ¶24,093)

Under Colorado law, future royalties, like all future damages, are subject to the “rule of certainty.” On that basis, a federal district court ruled that a franchisor’s claim for lost future royalties was basically a claim for lost profits and that without evidence of both revenues and expenses, the court was left to speculate about the amount.

Additionally, the court left open the possibility of a mitigation defense against a claim for lost profits based on imminent franchisee failure. The court noted that it was not clear that the franchisor would have been entitled to future damages even if it had provided evidence of expenses because the franchisee cast doubt at trial on its continued financial viability because of its persistent operating losses.
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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.

Bankruptcy Court Allows Chrysler to Terminate 789 Franchises

This posting was written by John W. Arden.

A bankruptcy court ruled yesterday that auto maker Chrysler LLC could immediately terminate 789 Chrysler, Dodge, and Jeep franchises in accordance with its plan to cut costs and quickly emerge from bankruptcy, according to an Associated Press report.

In an oral ruling late Tuesday afternoon, Judge Arthur J. Gonzalez of the U.S. Bankruptcy Court for the Southern District of New York allowed Chrysler to terminate approximately one-quarter of its dealership base.

More than 25 attorneys, representing hundreds of franchisees across the country, had argued that termination of the franchises was unnecessary and would not result in substantial savings.

A written decision on the ruling is forthcoming

Further information regarding the Chapter 11 bankruptcy case—In re Chrysler LLC, Case No. 09 B 50002 (AJG)—appears on the court website.

Bill Requires Bankrupt Auto Makers to Reimburse Dealers from Federal Funds

This posting was written by John W. Arden.

A bill to require bankrupt automobile manufacturers that receive funds from the federal government to use such funds to fully reimburse dealers for inventory of vehicles and parts has been proposed in House Bill No. 1256.

The measure—proposed as the Auto Dealers Assistance Amendment (#1270)—would require manufacturers to use any funding received from the U.S. Treasury while in bankruptcy to:

(1) Fully reimburse dealers rejected in bankruptcy for the cost of all parts and inventory in the dealer’s possession on the date of the bankruptcy and all other obligations owed under franchise and dealership agreements, and

(2) Provide dealers rejected in bankruptcy with at least 180 days to shut down their businesses and sell off their inventories through a “wind down period.”

The amendment further specifies that a bankruptcy court may not allow a bankrupt dealer to obtain access to debtor-in-possession funding unless the credit agreements expressly provide for reimbursement and wind-down as provided by the measure.

U.S. Senator Bob Corker (R-Tenn.) introduced the amendment on June 4.

“We continue to receive assurances from Chrysler and GM that their dealers across Tennessee and across the country will be treated fairly,” said Corker. “We understand that a bankruptcy is inherently painful and our efforts aren’t to interfere.

“We filed this amendment to apply pressure on the automakers to keep their word to rejected dealerships and fully reimburse them for their inventories of vehicles and parts,” he continued. “We hope Chrysler and GM will take these appropriate actions and make this amendment unnecessary.”

A statement by Senator Corker and text of the amendment appear on the Senator’s website.