Franchisee’s Contract Breaches Caused Franchisor Future Damages

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

A motor vehicle repair shop franchisee’s breach of its four agreements with a franchisor—not the subsequent termination of those agreements by the franchisor—proximately caused the franchisor’s lost profits damages under North Carolina law, the U.S. Court of Appeals in Richmond, Virginia, has decided in a not-for-publication opinion.

A federal district court erred by concluding that the franchisor’s termination of the four agreements caused the franchisor’s lost profits.
The lower court’s ruling (CCH Business Franchise Guide ¶14,212) was reversed in part. In addition to the issue of proximate cause, the appellate court determined that the district court erred in several respects in assessing the franchisor’s entitlement to damages.

The dispute began when the franchisee closed each of its four shops well before the end of their contractual 15-year terms. The franchisor responded by sending termination letters to the franchisee and filing suit. The district court granted the franchisee partial summary judgment as to the franchisor’s claim for future damages for any prospective royalties and advertising fund contributions for periods after termination of the franchise agreements.

The issue on appeal was that portion of the district court ruling granting judgment to the franchisee on the franchisor’s claim for future damages.

Proximate Cause

The district court cited no legal authority directly supporting its conclusion about the cause of the franchisor’s damages, and the federal appellate court found none, noting that most of the relevant discourse appeared in various federal district court and state court opinions.

The proper approach to the issue was a straightforward application of the relevant North Carolina law concerning damages recoverable following a breach of contract, according to the appellate court. North Carolina law permitted a non-breaching party to recover damages that were the proximate consequence of a breach of contract and dictated that all damages must flow directly and naturally from the wrong.

The franchisee’s breach of the agreements was so comprehensive as to constitute a de facto abandonment of the agreements, resulting in the franchisor’s loss of royalties and advertising fund revenue that it was entitled to receive under the agreements.

The franchisor’s subsequent decision to terminate the agreements had certain legal consequences, but it did not cause the franchisee to stop operating its shops and generating revenues. Those events had already occurred, the court observed.

Lack of Contractual Authorization

In the absence of an express contractual provision barring future damages, the franchise agreements did not prohibit the recovery of those damages if they were otherwise recoverable under North Carolina law, the court determined. To the extent that the district court required the agreements to specifically provide for prospective damages as a mandatory condition precedent to preserve a non-breaching party’s right to recover such damages, it erred.

Although the agreements established that the franchisee was required to make payments of royalties and advertising fund contributions under the agreements, the contracts made no provision for the franchisor to recover amounts from the franchisee subsequent to the termination of the agreements. However, nothing in the agreements precluded future damages either. No principle of North Carolina contract law suggested that a contract must specifically provide for recovery of future damages in order to preserve a party’s right to recover them.

Calculation Method

The methodology employed by the franchisor to calculate its amount of future damages and the time period for which they were collectible was not unreasonably speculative, hypothetical or the result of conjecture, the appellate court ruled. The district court held that the franchisor's "generic calculation for lost profits" did not assess the specific profitability of each shop and therefore failed to measure the asserted lost profits with reasonable certainty. However, the calculations were not speculative simply because the franchisor used the same formula to calculate lost future royalties for each of the four shops, the court reasoned.

The franchisor used data specific to each shop to calculate the damages it sought from the closure of that shop. By using the shops’ actual past performance to calculate projected future royalties and advertising fund contributions, the analysis was not the sort North Carolina courts rejected as being too remote.

The decision is Meineke Car Care Centers, Inc. v. RLB Holdings, LLC, CCH Business Franchise Guide ¶14,586.

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.