New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

For franchisors, there are two realities when it comes to the enforcement of your franchise agreements: "Reality 1" being the rights expressly and plainly stated in your franchise agreements and "Reality 2" being how, in a court room and in litigation, a court may interpret (and even supplement) these rights. For many franchisors - from a business perspective - reality 1 and reality 2 may be very different. That is, many times court are inclined to interpret a franchise agreement in a manor that imposes additional rights and obligations on a franchisor. One such "additional right" - that is a right that cannot be found in your franchise agreement but may be imposed by a court - is an implied covenant of good faith and fair dealing. This "implied covenant" is typically asserted by franchisees in an effort to superimpose additional contract rights in a franchise agreement.

In a recent legal decision - Yamin v. Moe's Southwest Grill, et al. (2011 NY Slip Op 4803) - the New York State Appellate Division evaluated issues involving area development rights, a franchisors site selection discretion and the application of implied covenants of "good faith and fair dealing". Since the franchise agreement included a Georgia State choice of law provision, the court evaluated Georgia's version of the contract law "implied covenant of good faith and fair dealing" - a standard similar to many other states. The courts decision did not involve novel issues and is not ground breaking, but, it was extremely well reasoned and provides some instructive points for franchisors and franchise counsel about commonly imposed covenants of good faith and fair dealing.

Covenants of Good Faith and Fair Dealing. As a matter of basic contract law, courts commonly impose a "covenant of good faith and fair dealing" to contracts. When a franchise agreement affords a franchisor with discretion or right to impose an obligation on a franchisee or approve a franchisee action this "implied" covenant imposes an obligation on the franchisor to act in good faith which typically means that the franchisors decision (approval or non-approval) must be based on some consistent business standards.

An insightful point raised by the court in Yamin, is that the court may (in rare circumstances) disregard imposing this implied covenant "if" the franchise agreement expressly and clearly leaves the franchisor with "complete and absolute discretion". This is a tough standard to meet and ultimately the Yamin court did impose an implied covenant of good faith and fair dealing even though the site selection clause in the Marketing Development Agreement, expressly stated that the "franchisor may reject any proposed site for any reason in it's sole discretion". The court evaluated this seemingly absolute clause within the overall context of the agreement and cited to other agreement provisions - including one stating that the franchisor would "utilize its then current site selection policies and procedures" to evaluate a franchisees site selection - as one mitigating the franchisors "absolute discretion" and opening the door to the implied covenant of good faith and fair dealing.

Question: Is it really necessary to refer to a franchisors "then current site selection policies and procedures"? What value does that add to a franchise agreement?

Ultimately the franchisor prevailed on its motion for summary judgment and it did so for good reason: although the court imposed a covenant of good faith and fair dealing the court nevertheless held that the franchisor met this standard where the franchisor clearly documented the legitimate grounds by which it rejected the franchisees proposed site.   For franchisors it is important to document - as a part of your customary day-to-day business practices - the franchisee communications regarding site selection. These documented communications could very well serve as evidence that helps cut short unnecessary litigation.

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In the recent decision of Maintainco, Inc. v. Mitsubishi Caterpillar Forklift America, Inc., the Appellate Division for the Superior Court of the State of New Jersey affirmed the application of the New Jersey Franchise Practices Act ("NJFPA") to the "constructive" termination of franchisee rights.  That is, actual termination is not required for a franchisee to invoke the protections of the NJFPA.

In the Maintainco decision, utilizing fundamental principals contract law, the Appellate Division held that that the franchisor / manufacturer's actions including (a) the threatened termination of the franchisee / dealer's rights, (b) the failure to disclose customary annual business plans to the franchisee, and (c) the grant of competing rights to a third party franchisee within the plaintiff franchisee's territory, constituted "constructive" acts of termination actionable under the NJFPA.  In the court's well reasoned decision, the following points are instructive:

• Franchisee's faced with the "constructive" termination of their franchise rights possess a claim for violation of the NJFPA;

• "Sound and non-discriminatory" business decisions are insufficient to justify the "non-renewal" of a New Jersey franchise. The failure to renew a franchise must be based on the franchisee's failure to "substantially meet the performance requirements of the franchisor";

•  Performance requirements imposed on franchisees must be "reasonable;

• Attorney fees are recoverable by a franchisee who successfully prosecutes a NJFPA claim; and

• Expert fees are not recoverable under the NJFPA.

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In a recent decision of the United States Court of Appeals for the Second Circuit, In re American Express Merchants' Litig, 2009 WL 214525, *2, *5-*6 (2nd Cir. January 30, 2009), the Second Circuit rejected the enforcement of a "class-action waiver" clause contained in American Express's standard merchant agreement (the agreement between American Express and the restaurants and vendors that accept the American Express card).  Although the Court did not impose a per se prohibition, it held that "class action waiver clauses", may be invalidated where their implementation (i.e., prohibiting the plaintiff from joining together with others in a class action - and forcing the plaintiff to fight American Express on its own) would be to strip a plaintiff of its substantive statutory rights.  In the American Express decision, the plaintiff/vendor was one of many vendors claiming damages based upon American Express's alleged violation of federal law. The problem for this plaintiff was that, if forced to fight American Express alone (whether in court or an arbitration proceeding), it did not possess the resources to litigate against a corporate giant.

What does this mean for franchisees?  Right now, maybe not much.  But, down the line it could serve as a basis for expanding franchisee rights and possibly addressing onerous clauses in franchise agreements that undermine a franchisees "substantive rights".  For the time being, franchisees / individuals considering the purchase of a franchise, must recognize that as a small business owner and franchisee, the contractual rights and obligations specified in your franchise agreement will constitute one of your most important "business assets".  So, before buying a franchise, do your homework, read your franchise agreement, review the franchisor's disclosure document (FDD) and seek out the advice of an experienced accountant and attorney. Also, as discussed in a prior post, speak to existing franchisees. Definitely, ask questions.

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