The popular kick-off to the International Franchise Association’s annual Legal Symposium, the Judicial Update runs the gamut of significant legal developments in franchise law that have occurred over the past year. Joyce Mazero addressed these cases from the perspective of a transactional lawyer trying to translate various court holdings into understandable advice to clients and into franchise system documents that hopefully comply with the law. Mike Lockerby took a trial lawyer’s approach, discussing not only the implications of the cases for franchising but also how the franchisor might, in retrospect, have presented its case better.
By Joyce Mazero and Michael Lockerby
Fiduciary Duty
“I’m not dead yet” seemed to be the message with respect to the doctrine of fiduciary duty that the Oregon federal court delivered in Towne v. Robbins. While acknowledging that most courts have found no fiduciary duty inherent in a franchise relationship, the court suggested that the doctrine could be invoked under certain circumstances. The circumstances of this case were so unusual, however, that they hopefully would not apply to most franchisors. The franchisor, a motivational speaker, had actually hypnotized the franchisees and made them walk on hot coals. This is not a fact pattern likely to be repeated anytime soon. (Or so we hope.)
Exclusive Dealing
On one level, the case of NACCO Materials Handling Group, Inc. v. Toyota Materials Handling USA, Inc. could be viewed as just a “garden variety” preliminary injunction case. The court enjoined the franchisor from terminating a franchisee that had admittedly violated the franchise agreement. The court’s ruling was based on a Tennessee franchise statute that prohibits “coercion.” Would it also represent “coercion” to prohibit a McDonald’s franchisee from selling Burger King Whoppers? A pending Sixth Circuit appeal may help answer this question.
Community of Interest: Wisconsin’s Fair Dealership Law
Dealers trying to seek protection under the Wisconsin Fair Dealership Law are required to show that the parties to the contract have a “community of interest”, which exists when the business interests are so intertwined that there is a threat to the dealer’s financial health. While courts generally consider the arrangement contemplated at the beginning of a relationship to determine possible application of a statute, three recent Wisconsin cases focused on the relationship as it had evolved:
In Home Protective Servs., Inc. v. ADT Security Servs., Inc.,the federal court for the Eastern District of Wisconsin applied the “Over the Barrel” analysis (whether the parties share a continuous financial interest and have an interdependence through common goals) and found that, although 95 percent of the dealer’s income had come through the relationship with the manufacturer, there was no community of interest because the dealer did not have “sunk costs” and had recouped its advertising costs.
The Eastern District Court again addressed the issue in Bay Area Properties, Inc. v. Dutch Housing, Inc., where aseller of manufactured homes failed to convince the court that it shared a community of interest with the manufacturer even though it had annually expended $150,000 on plant and equipment costs and $25,000 on advertising selling the manufacturer’s homes, the court found that the costs were not sunk and that the dealer had been diversifying its business so as not to be under the barrel. However, in Conrad’s Sentry, Inc. v. Supervalu, Inc., the federal court for the Western District of Wisconsin court found a community of interest for two grocers whom the court found had tied their success to the large grocery chain’s name, built up considerable goodwill for the chain and had represented the chain well at its respective locations. Perhaps the difference in outcomes is just a matter of East vs. West?
Termination and Nonrenewal
As discussed later under “Vicarious Liability,” third parties often seek to hold franchisors vicariously liable for the conduct of their franchisees. But in Joy v. BP Products, the court enjoined the franchisor from terminating a franchisee whose employee was selling drugs from the franchised premises.
Meanwhile, in Papa John’s v. Dynamic Pizza, the court strictly enforced the franchise agreements, holding that they barred the franchisee’s claims of fraud, improper earnings claims, and the like. But the judge also held the franchisor to the strict language of the franchise agreements, thus preventing the franchisor from obtaining additional monetary relief (other than lost royalties) for infringement of its intellectual property.
Bankruptcy
In bankruptcy court, franchise agreements are generally considered executory contracts, capable of being assumed. In Twin City Power Equip., Inc., however, the Illinois bankruptcy court held that a dealership agreement was a non-assumable contract because it contained an agreement to extend financing for the purchase of inventory, even though the debtor was not required to finance its inventory under the dealership agreement and the financing provision was merely a part of the overall dealership agreement, thus begging the question whether a traditional franchise agreement that contains financing terms for an initial franchise fee could be deemed a non-assumable contract.
Joint ventures and antitrust
In Dagher v. Saudi Refining, Inc., the Ninth Circuit examined the effect of two Texaco and Shell joint ventures and whether that joint venture might violate antitrust laws. Texaco and Shell created the joint ventures to consolidate certain of their operations and capitalize on numerous cost efficiencies. Each joint venture entity designated one employee to set a single price for both Texaco and Shell branded gasoline sold by each joint venture. Twenty-three thousand service stations owners sued Texaco and Shell alleging that the pricing arrangement constituted a violation of the Sherman Antitrust Act.
Texaco and Shell argued that joint ventures are incapable of committing a per se price fixing violation. The Ninth Circuit rejected this argument and held that a joint venture may only lawfully engage in price fixing if doing so is reasonably necessary to further the legitimate aims of the joint venture. The court reasoned that a blanket grant of immunity for joint ventures would allow competitors to form joint ventures as a front to engaging in illegal price fixing. The Ninth Circuit was careful to recognize the business value of joint ventures, and did not hold that all joint ventures between competitors would pose a risk of a per se violation of the antitrust laws. The court held that there would be no per se violation as long as the parties could demonstrate a sufficient relationship between the price fixing scheme and the legitimate aims of the venture.
Vicarious Liability
Two cases this past year reiterated the general premise that franchisors will not be vicariously liable for the acts of their franchisees unless it is shown that they exercised control over the specific activity or conduct giving rise to liability. In Kerl v. Dennis Rasmussen, Inc.,the Wisconsin Supreme Court held that Arby’s was not vicariously liable for the actions of an employee who left his shift and killed his girlfriend.
While the franchise agreement and manual gave advice concerning franchisee employees, it did not give Arby’s the right to control such employee issues. As a result, Arby’s did not have the necessary control or the right to control the physical conduct of the employee for vicarious liability to attach. Similarly, in Fitz v. Days Inn Worldwide, Inc., the court held that a franchisor was not liable for a hit and run accident that occurred near a Days Inn parking lot. The court found that no provision in any agreement or the manual contractually assigned Days Inn the right to control the area where the plaintiff was injured, or gave Days Inn the right to control the method by which the area was maintained. Rather, the agreement stated that the franchisee was an independent contractor with the right to control its own daily operations. Accordingly, the court found that Days Inn was not vicariously liable because there was no evidence that Days Inn exercised affirmative control over the location where plaintiff’s injuries occurred.
Market Withdrawal
The so-called market withdrawal cases decided in the past year included two cases involving “Volvoization” of other manufacturers’ equipment (rebranding) and “rationalization” of overlapping distribution systems: Cromeens, Holloman, Sibert, Inc. v. AB Volvo and Volvo Constr. Equip. N. Am., Inc. v. CLM Equip. Co. The implications of these cases are not limited to product-distribution franchisors like equipment manufacturers. They also have implications for business-format franchisors that seek to terminate franchisees for reasons unrelated to poor performance. Examples include mergers of what were formerly competing franchise systems and changes in business strategy. These cases provide a glimmer of hope that franchisors may be able to do so notwithstanding state “good cause” restrictions.
State Taxation Issues
Several state courts have recently addressed the issue of when a state can collect income and franchise taxes from an out-of-state franchisors or other similar businesses. In Bridges v. AutoZone Properties, Inc. , the Supreme Court of Louisiana decided that an AutoZone entity, receiving dividends from an AutoZone subsidiary that collected rent from 68 retailers selling auto parts under the AutoZone name in Louisiana, would have to pay Louisiana income taxes and franchise taxes.
In Michigan in Rayovac Corp. v. Dept. of Treasury, the Michigan Court of Appeals analyzed the issue and determined that Rayovac had to pay Michigan’s Single Business Tax, because three of Rayovac’s salespersons solicited orders for Rayovac’s products. Finally, in A & F Trademark, Inc. v. Tolson,a North Carolina court held that trademark holding companies located in Delaware, but having contracts with retailers located in North Carolina, had to pay North Carolina’s corporate franchise and income taxes. The takeaway from these cases is that the states are getting more aggressive in finding a nexus to tax out-of-state companies doing business in their state.
Joyce Mazero is a partner with the law firm of Haynes and Boone located in Dallas. She can be reached at 214-651-5336.
Michael Lockerby is an attorney with the law firm of Hunton & Williams located in Richmond. He can be reached at 804-788-7212.
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Legal cases referenced in the IFA Judicial Update
Towne v. Robbins, Bus. Franchise Guide (CCH) ¶ 12,930 (D. Or. Oct. 12, 2004).
NACCO Materials Handling Group, Inc. v. Toyota Materials Handling USA, Inc., Bus. Franchise Guide (CCH) ¶ 12,976 (W.D. Tenn. Nov. 22, 2004)
Home Protective Servs., Inc. v. ADT Security Servs., Inc., Bus. Franchise Guide (CCH) ¶ 12,970 (D. Wis. 2004)
Bay Area Properties, Inc. v. Dutch Housing, Inc.,Bus. Franchise Guide (CCH) ¶ 12,792 (E.D. Wis. Feb. 14, 2004)
Conrad’s Sentry, Inc. v. Supervalu, Inc., Bus. Franchise Guide (CCH) ¶ 13,024 (D. Wis. 2005)
Joy v. BP Products, Bus. Franchise Guide (CCH) ¶ 12,874 (N.D. Ill. July 6, 2004)
Papa John’s v. Dynamic Pizza, 317 F. Supp. 2d 740, Bus. Franchise Guide (CCH) ¶ 12,884 (W.D. Ky. May 6, 2004)
In re Twin City Power Equip., Inc., Bus. Franchise Guide (CCH) ¶ 12,807 (Bankr. C.D. Ill. April 7, 2004)
Dagher v. Saudi Refining, Inc., Bus. Franchise Guide (CCH) ¶ 12,838 (9th Cir. June 1, 2004)
Kerl v. Dennis Rasmussen, Inc., Bus. Franchise Guide (CCH) ¶ 12,859 (Wis. June 29, 2004)
Fitz v. Days Inn Worldwide, Inc., 2004 WL 1159000 (May 26, 2004)
Cromeens, Holloman, Sibert, Inc. v. AB Volvo, 2004 U.S. Dist. LEXIS 21869, Bus. Franchise Guide (CCH) ¶ 12,926 (N.D. Ill. Oct. 20, 2004)
Volvo Constr. Equip. N. Am., Inc. v. CLM Equip. Co., 386 F.3d 581, Bus. Franchise Guide (CCH) ¶ 12,934 (4th Cir. Oct. 8, 2004)
Bridges v. AutoZone Properties, Inc., 2005 WL 675771 (La. 2005)
Rayovac Corp. v. Dept. of Treasury, Bus. Franchise Guide (CCH) ¶ 13,006 (Mich. Ct. App. 2004)
A & F Trademark, Inc. v. Tolson, Bus.Franchise Guide (CCH) ¶ 12,958 (N.C. Ct. App. 2004