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Constructive Termination under New Jersey's Franchise Practices Act


In Maintainco v. Mitsubishi Caterpillar Forklift America, plaintiff-franchisee alleged that Mitsubishi constructively terminated its franchise agreement through a series of actions designed to establish a competing dealership within plaintiff's "area of prime responsibility." The Court agreed that "Mitsibushi's course of conduct was geared to forcing out plaintiff," and noted that the New Jersey's Franchise Practices Act prohibits a franchisor from indirectly terminating a franchise without good cause. The Court agreed with plaintiff that it was constructively terminated because Mitsibushi intended to terminate plaintiff by actively supporting a competing dealership. The second issue was whether the constructive termination was for "good cause." Mitsubishi argued that termination was justified because plaintiff failed to meet Mitsubishi's performance standards. However, the Court ruled that Mitsubishi imposed unreasonable performance standards, specifically noting that the performance standards' "absence from plaintiff's agreement meant that plaintiff's failure to satisfy it would not have been good cause for termination." The ruling is especially significant because it implies that in New Jersey, a franchisor cannot terminate a franchisee for failing to meet performance standards that are absent from the franchise agreement.


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Future Royalties for Remaining Term of Contract Upheld as Enforceable Liquidated Damages

In Captain D's v. Arif Enterprises, the franchisor sought liquidated damages in excess of $700,000 after terminating defendant-franchisee for failing to operate five Captain D's franchise restaurants according to the standards and uniformity of operation provisions in the License Agreements. The parties agreed that under the License Agreements, franchisee would be liable to pay royalty fees for the remaining term of the contract in the event of termination. The License Agreements at issue were all for 20-year terms, with expirations in 2012, 2013, 2024, 2025 and 2026. The defendant-franchisee argued that the liquidated damages provision amounted to an unenforceable penalty clause. After surveying a number of cases nationwide that specifically analyzed the issue of future royalties, the Court found that Captain D's liquidated damages provisions were reasonable. Of particular note, a driving factor in the Court's decision was that the franchisee failed to cite any supporting evidence that the clause constituted an unenforceable penalty or that Captain D's did not suffer damages due to the breach of contract. The holding cautions us to avoid, where possible, such exorbitant liquidated damage provisions and to present as much evidence as possible when asserting that they amount to penalty clauses.

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Claims for Tortious Interference with Contract and Civil Conspiracy Require Greater Specificity

In DLC Dermacare v. Castillo, the franchisor sued numerous franchisees, their spouses and others for breach of contract, breach of covenant of good faith and fair dealing, misappropriation of trade secrets, trademark and service mark infringement, unfair competition, tortious interference with contract and civil conspiracy. Defendant-franchisees filed motions to dismiss most of the counts. While the Court held that DLC Dermacare's complaint sufficiently pled facts to support the majority of claims, it agreed with franchisee-defendants that claims for tortious interference with contract and civil conspiracy claims contained only conclusory allegations that "lack[ed] the 'heft' under Twombly to permit the Court to infer more than the mere possibility of a conspiratorial agreement to tortiously interfere with franchise agreements and commit other wrongs." Specifically, the complaint did not provide sufficient details of the alleged agreement between the franchisees, nor did it describe the factual basis for each Defendant's liability. The lesson learned: Under Twombly, counts such as tortious interference with contract and civil conspiracy require additional 'heft,' or particularized facts, and franchisee attorneys should pay special attention to these claims when either alleging or challenging such claims. 

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In cases where a customer is able to show that statements a salesman made are fraudulent, salespeople accused of fraud regularly invoke various legal rules and contract clauses to shield themselves from liability. Franchisors often use these rules and contract clauses to defend themselves when franchisees claim the franchisor misrepresented the terms of a deal. First, many businesses, including franchisors, put terms in their written agreements that are called "merger" clauses or "integration" clauses.


Basically, these clauses state that the franchisee forgives the salesman for any fraudulent statements the seller may have made to the customer during the sales process. Such clauses also state that the customer agrees never to argue or claim that the seller made misleading statements. Further, a merger or integration clause states that the written agreement is the complete statement of all the agreed-upon terms. The merger or integration clause therefore keeps out of the legally binding agreement any statements or promises made in conversation (unless those statements or promises are finally written into the agreement's text). This means that in the face of merger and integration clauses in a franchise agreement, a franchisee cannot rely on any promise or statement made by the franchisor or its sales staff if that promise has not been clearly written in the franchise agreement.


Like other businesses, franchise companies regularly rely upon merger clauses and integration clauses included in franchise agreements to protect themselves from potential fraud claims. An example of a merger clause in a franchise agreement is:


"Neither [the Franchisor] nor any other person on [the Franchisor's] behalf has made any oral or written representation to Licensee not fully set forth herein on which Licensee has relied in entering into this Agreement, and Licensee releases any claims against [the Franchisor] or its agents based upon any oral or written representation not set forth herein."


An example of an integration clause in a franchise agreement is:


"This Agreement, together with all instruments, exhibits, attachments and schedules hereto, constitutes the entire agreement (superseding all prior representations, agreements, and understandings, oral or written) of the parties hereto with respect to the facility."


In addition to relying on merger and integration clauses to shield themselves from fraud claims, businesses defending themselves against fraud claims in court regularly attempt to hide behind what is known as the "parol evidence rule." Unlike merger and integration clauses, which are terms explicitly included by the seller in the written agreement, the parol evidence rule is a rule of contract law that is applied by courts. The parol evidence rule basically says that the final written agreement is the only agreement a court will enforce, not any prior negotiations nor any oral promises made by salesmen. Moreover, earlier tentative agreements, negotiations and promises cannot be introduced at trial by a franchisee to prove fraud. When a court strictly applies the parol evidence rule it prohibits a customer from testifying at trial about the false statements made to him by the seller.


Although there are legitimate reasons for recognizing merger clauses and the parol evidence rule (for example, to prevent fraud at trial, as well as to make contracts dependable for business), in the opinion of this author, such reasons should never "trump" the goal of punishing those guilty of fraud. Some courts, agreeing with this position, have created a fraud exception to the applicability of merger clauses and the parol evidence rule. Under this exception, neither a merger clause nor the parol evidence rule will be applied to keep out evidence used to show misrepresentation or fraud in forming a contract.


Other courts, however, are more eager to uphold a business's right to rely on a written agreement, regardless of whether the business made fraudulent statements to get the customer to sign the agreement. These courts refuse to recognize the fraud exception, and therefore prohibit the introduction of evidence of fraud at trial. In the following case involving a franchisee, the court unfortunately refused to recognize the fraud exception and applied the parol evidence rule and the franchise agreement's merger clause to dismiss.


As the above discussion makes clear, regardless of how skilled a negotiator you may be, you should never execute a written agreement of any significance without having an experienced litigator review the final written document. And remember, based on the many inconsistent rulings by courts on the fraud issue, you should never rely on any promises or representations made to you by a salesman that have not been specifically put in the written agreement.  

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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

GOLDSTEIN, P.O. Box 1707, Leesburg, VA 20177 MAIN: 202-293-3947 FAX: 202-315-2514
2011 Goldstein Counselors At Law
This newsletter is advertising material and is not intended to be legal advice of any nature. In order to protect any rights you might have, you should promptly retain an attorney.