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Franchisee's Indemnity Insurance Won't Cover Franchisor's Negligence

Marriott International v. AMCO Insurance (2010)

This dispute arose out of an insurance contract between a Missouri franchised hotel, Columbia Hotels, and its insurance company, Amoco. The insurance contract provided coverage to Columbia Hotels when it was required to indemnify third parties, like Marriott. Columbia Hotels alleged that its insurance coverage was triggered because it was obligated to indemnify Marriott under the terms of a Franchise Agreement between Columbia Hotels and Marriott for a rape and murder that occurred at its hotel. Amoco argued that there was no coverage because the Franchise Agreement between Marriott and Columbia Hotels terminated before the rape and murder occurred. It also claimed that the Franchise Agreement did not require Columbia Hotels to indemnify Marriott for Marriott's own negligence, and it is Marriott's own negligence that was at issue. On those issues Amoco sought summary judgment, and the court granted Amoco's motion, dismissing any claims against the insurance company.

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Franchisee Barred From Using More Generous Franchise Act in Washington

Red Lion Hotels Franchising v. MAK, LLC and Mahmoud Karimi (2010)

Under a Franchise Agreement for the Modesto, California Red Lion hotel, MAK, the property management company that was operating the hotel was required to make changes specified in Red Lion's Property Improvement Plan ("PIP"). A new PIP was explained to franchisees during a January 2007 meeting, and on May 1, 2007 Red Lion issued a PIP to MAK that identified 121 improvements for the hotel. All of these substantial improvements were required to be completed by December 31, 2007. When the hotel was unable to make all of the substantial and cost-prohibitive improvements, Red Lion terminated the franchise. In response, the franchisee sued Red Lion alleging violations of the Washington Franchise Investment Protection Act, under which Red Lion would have faced potential significant damages in favor of the franchisee. The franchisor argued that FIPA's protections were not available to the franchisee because the hotel was located outside of Washington in California. It argued that at best the California Franchise Relations Act applied, and that this statute did not provide a traditional damages remedy. The Court accepted the franchisor's argument and limited the franchisee's state statutory damages claim to merely the value of its inventory - the exclusive remedy under the California franchise law for the alleged violations.

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Applicant Of Franchise Not Considered A Franchisee For Purposes Of Suit

Yousif Halloum v. DFO

A prospective restaurant franchisee failed to present evidence showing that his reliance on any alleged promises or misrepresentations made by the franchisor's personnel was reasonable. None of the franchisor's employees that interacted with the prospective franchisee had any authority, either actual or ostensible, to conditionally approve his franchise application. Thus, a California state trial court correctly ruled that the prospective franchisee failed to meet his burden of proving agency to charge the franchisor with the acts of its alleged agent. The franchisor had developed a written procedure for awarding a franchise and it never approved the franchisee's application. No evidence presented by the prospective franchisee showed that the franchisor took any action to cause its employees or the prospective franchisee to believe that any employee of the franchisor possessed any authority to enter into a Franchise Agreement without written consent from the franchisor.

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Franchisee's Termination Of Franchise Agreements Could Not Be Revived In Bankruptcy

In Re: Tornado Pizza, LLC, Chapter 11, Debtor (2010)

A pizza restaurant franchisor was entitled to relief from the automatic stay in bankruptcy to enforce the non-monetary post-termination obligations in its three agreements with a franchisee in bankruptcy. The franchisee continued to operate the restaurants under the franchisor's name and in accordance with the terms stated in the parties' Franchise Agreements following the terminations. However, the court held that the franchisee had no contractual right to continue to operate using the franchisor's name, and the bankruptcy law provided no basis for the reinstatement of that right, the court held. The franchisee asserted that even if there was cause for relief from the stay, the court should issue a restraining order to protect its estate. The rationale for such relief was that the franchisee's ability to reorganize was contingent on its assumption of the Franchise Agreements and the alleged probability of a successful reorganization if the Franchise Agreements were assumed. However, the franchisee's argument was rejected, since, according to the Court, the Franchise Agreements were not executory but instead terminated. Therefore, there was no Franchise Agreement that could have been assumed or rejected.

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Covenant Not To Compete Survives Expiration of Franchise Agreement

Doyle v. Nutrilawn U.S. (2010)

This case involved a Nutrilawn Franchise Agreement for the operation of a lawn care business. Doyle and Nutrilawn entered into a Franchise Agreement with an initial five-year term running from January 19, 2004, to January 19, 2009. The Franchise Agreement provided that Doyle could renew the agreement by delivering notice of renewal not less than six months prior to the expiration of the initial five-year term. Doyle did not do so. However, the parties engaged in ongoing negotiations regarding renewal throughout the remainder of the five-year term before it had expired. These negotiations continued beyond the date that the original Franchise Agreement expired. The major dispute was whether the post-term non-competition clause in the Franchise Agreement applied. This issue, in turn, depended on whether the term "expiration" in the Franchise Agreement constituted a "termination" of the Franchise Agreement. If the agreement had merely "expired" the post-term covenant would not apply. Relying solely upon its interpretation of the language of the Franchise Agreement, the Court held that an "expiration" in fact constituted a "termination", and therefore the post-term restrictive covenant was applicable to the franchisee. 

Franchisor Barred From Suing Franchisee In A Foreign State

T-Bird Nevada LLC v. Outback Steakhouse (2010)

A group of franchisees (Shannon) sued Outback alleging that Outback and some of its employees had wrongfully induced Shannon to open 46 Outback Steakhouses in the California franchise market by falsely promising to buy Shannon's restaurants and ensure nonrecourse financing until a buy-out was completed. Shannon also alleged that Outback never disclosed these promises in their public filings because they did not want the liability reflected on their financial statements in order to avoid any potential difficulty obtaining shareholder approval for a planned sale of the company. When the $35 million loan became due the franchisees did not repay it, and the loan was not extended. The bank then notified Outback that it would enforce the guaranty against Outback. Outback then paid the loan to the bank and filed suit in Florida seeking to be repaid by the franchisees. The franchisees argued that the franchisor was prohibited by the California Franchise Practices Act from filing suit against the franchisees anywhere but in California. Outback argued that the suit in Florida did not involve the Franchise Agreement and could therefore proceed in that Court. The California Court rejected the franchisor's argument and held that because the loan agreement set forth additional types of default that would be incorporated into the Franchise Agreement, the loan agreement was an "amendment" to the Franchise Agreement and, therefore, the franchisor was required to sue in California, not Florida

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Individual Shareholders of Corporate Franchisee Barred From Suit

Randy Hetrick and Cindy Hetrick v. Ideal Image Development Corporation (2010)

Individual shareholders of a corporate cosmetic laser business franchisee did not have standing to sue a franchisor under the Florida Franchise Act (FFA) as it was the corporate franchisee that signed the Franchise Agreement and thereby invested in the franchise. The relevant question for standing under the FFA was which person "invested" in the franchise. The franchisees argued that the corporate entity did not come into being until after the Franchise Agreement was executed, and therefore they, not the corporation, had "invested" in the franchise. However, the court rejected this argument ruling that the record demonstrated that the individuals were acting as promoters for the unformed corporate franchisee when they signed the Franchise Agreement, and that the corporate franchisee unambiguously adopted or ratified that agreement by implication, causing any rights under the FFA to accrue to it. Thus, for legal purposes, it was the corporate franchisee that signed the Franchise Agreement and "invested" in the franchise. Consequently, Florida's shareholder standing doctrine prevented the individuals from pursuing individual claims under the FFA

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Franchisor Permitted To Compete Directly With Franchisee

Kevin McLaughlin v. The Krystal Company (2010)

A restaurant franchisor did not breach its agreement with a franchisee by attempting to place extra-contractual conditions on the franchisee's exercise of its renewal right and by ultimately terminating the franchisee. After the franchisee submitted a timely renewal request, the franchisor told the franchisee that it recommended that it relocate to a free-standing location or carry out extensive renovations to the existing location. The franchisor granted the franchisee several extensions of their agreement in the two-year period following its expiration date; however, the franchisor eventually terminated the franchise following the franchisee's failure to make the required improvements. The franchisee did not allege that the franchisor did not have the right under the Franchise Agreement to require the upgrades. Instead, the franchisee argued that the franchisor's true motive was to itself open a franchisor-owned free-standing restaurant near the franchisee's location after the franchisee was terminated. However, because the parties' agreement expressly stated that the franchisee did not have a protected territory, the agreement did not prohibit the franchisor from opening up another restaurant in the area even while the franchisee's restaurant was still operating.

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Thanks for your interest in our Newsletter, and we look forward to answering any questions you might have either on the cases discussed in this issue of Franchise Trends, or on general trends in franchise law.
Jeff Goldstein

Goldstein Law Group                                           
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