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New Legal Gestalt Needed for Franchise Relationships in USA

A recent franchise termination case involving a French franchisee of a French franchisor has many similarities to the prototypical wrongful franchise termination in the United States; the only real difference is that when the case was tried in France the franchisor was found guilty of an unfair franchise termination while if the case had been tried in the United States the franchisor would have walked scot-free. In this case, the French bakery brand Paul operated under a master franchise agreement that called for the opening of 18 outlets in the south of France over a five-year period. After opening, the franchisee found itself facing debilitating financial difficulties after having opened only five of the 18 required outlets.

After the franchisor’s proposed onerous terms for settlement were rejected by the franchisee, the franchisor sent a default notice to the franchisee for failure to open the remaining locations in the franchise agreement. The franchisee was not able to build the new stores, and the franchisor terminated the franchisee. The franchisee’s primary defense was that the franchisor was liable for inaccuracies in the business plan for the opening of 18 outlets in five years and that the plan itself was unrealistic because it was based on overly optimistic and false financial data. On this basis, the franchisee argued that the termination was wrongful based on the franchisor’s pre-contractual duty of disclosure.

In affirming the lower Paris Court of Appeal’s decision against the franchisor on liability grounds, the Supreme Court noted the following:

  • the contract could not be performed without the close and loyal collaboration of the parties;
  • the opening of the new outlets remained associated with the success of the other outlets;
  • the franchisor had the power to check the business plan and to refuse any project that did not meet the success objectives;
  • the franchisor’s duty of loyalty required the franchisor to renegotiate the initial plan of store openings if it turned out that the initial plan was not achievable;
  • the franchisor’s duty of loyalty, relating to the lack of achievability of the initial plan of openings, included an obligation to propose acceptable alternative terms and conditions.

In essence, the Court believed that since the franchisor had the right to approve or refuse each new store opening, this right of consent created a springing duty to assist the franchisee in order to overcome the financial challenges, which the Court, interestingly, viewed to have been created by the franchisor.

Examples of franchisor assistance that could have been provided, according to the Court, included rent reductions and supply concessions. Although the franchise agreement expressly allowed the franchisor to terminate the franchisee in the event that it failed to meet the 18 outlets goal, and even though the franchisee indisputably failed to open 18 units, the Court nevertheless held that the termination was unfair.

In so concluding, the Court pointed out that, before the agreement had been executed, it had provided false and inaccurate financial data to the franchisee that necessarily embellished the original financial forecasts developed by the franchisee. In this regard, the Court came down hard on the franchisor for not sufficiently taking into account relevant local market issues and the competition from the outlets that the franchisor directly operated. Similarly, the Court ruled that the franchisor had overestimated the strength of its concept and its brand. These discrepancies were not insignificant, as the Court found that the financial forecasts differed from the actual financial statements by 30% to 50%.

The most crushing legal presumption used by the Court was that since the franchisor did not correct any of the financial projections provided to it by the franchisee, it had acted unfairly in carrying out its duty of collaboration: “the elaboration of the financial forecasts under these circumstances of collaboration implied that in receiving them without expressing any comment, the franchisor necessarily validated them”. In addition to the above wrongdoing the Court also found that the franchisor had been deceptively silent about certain of the various expenses necessary to open the outlets which the franchisee had included in its financial projections. In sum the Court held that the franchisor “did not collaborate in a loyal manner, did not inform and advise its co-contracting party, and did not assist it in a loyal manner”.

The Court also was hostile to the franchisor’s argument that the franchisee was barred from instituting the suit because one of the clauses in the franchise agreement disclaimed any franchisor liability for incorrect projections. In rejecting this argument, the Court refused to give effect to the agreement’s language that if the franchisor assisted the franchisee with the elaboration of its financial forecasts and provided financial data to it, the franchisee would be deemed to have formulated them under its own responsibility so that the franchisor could not be held liable in this regard.

The Court even held that the franchisee’s sophisticated business background could not relieve the franchisor from its liability. The Court seemed persuaded by the fact that the franchisee had a right to rely on the franchisor’s sales and marketing representations that the franchisor was sufficiently experienced and skilled to allow it to provide the franchisee with commercially successful business data based on its proven technical and commercial know-how.

This decision raises several interesting questions regarding the playbook of franchisee advocates in the United States. In this regard, if this case were heard in the United States, the franchisee would likely have lost on every single issue on which his French comrade prevailed in the Franchise Court in Paris. Notably, the prototypical state ‘good cause’ legislation would not have altered by even one smidgeon the anti-franchisee result that would have been reached by an overwhelming majority of state and federal courts in the United States ruling on the same facts as in the French case. What made the ultimate difference in the result of the French case was the French Court’s determinations regarding the franchisor’s ‘non-termination’ legal obligations, to wit, application of the duty of loyalty, rejection of a contractual disclaimer of expertise and knowledge, and use of the duty of ‘good faith and fair dealing.’ Under the Court’s reasoning, these tangential common law doctrines provided the basis to find an unfair franchise termination.

Without some substantial and tangible modification to the scope and applicability of common law constructs that could be relevant to franchise disputes in the United States, franchisees will, for the most part, continue to be mauled in most courtrooms. Franchisor advocates, in joyful faux denial, like automatons, wax eloquently about the myriad of valuable common law doctrines that are available to assist franchisee litigants, including unconscionability, waiver, estoppel, good faith, fraud, and duress. Such proclamations are not only disingenuous, but knowingly disingenuous. Every one of these doctrines is fundamentally and undeniably ‘broken’ in a franchise context. Unless the assaulted or terminated franchisee is a blind disabled war veteran, who received a day before the sale an FDD with the Item 19 financial disclosures dexterously ‘cut out’ of the hard-copy document by the franchise salesman, and who received for his first year of operations not even one box of proprietary muffin mix (out of the 300 he should have received each week for a muffin franchise), the franchisee will most probably be headed for the scrap heap of history, punctuated merely by a prior costly and emotionally debilitating stint in court.

Organizations that seek reform through franchise termination legislation serve a very valuable, but inherently limited, role in obtaining true comprehensive legal reform of franchise law. Such legislation by itself cannot solve the prolific problems afflicting franchisees in 2017. Although the leading franchisee organization, the Coalition of Franchisee Associations, provides an incredible laser-focused mission geared towards obtaining pro-franchisee termination legislation, the other remaining franchisee organization based in California spends its time and resources collecting hundreds of thousands of dollars in fees from franchisee groups with the mission of trying to rewrite limited provisions of their client groups’ franchise agreements; and where this micro-management re-writing strategy proves woefully inadequate (as it frequently does over time), and the franchisees run out of money or end up in litigation, the organization then steers the franchisee disputants to a few contributing favored outside lawyers, who in turn, repatriate some of these funds to the organization. In addition, problematically, many of the lawyers on the front roster represent franchisors, as well as franchisees. Whatever costly benefits might be obtained they are limited drastically in time and by number of franchisees.

The key to winning the franchise battle in the long run is to inspire a revolution of sorts in how franchising is viewed by society, including courts, legislators, arbitrators, lawyers and businesspeople. Historically, franchising got off on the wrong analytical foot: franchising was viewed to be ‘closer to’ the situation involving two individual independent businesses than to two inextricably linked, and highly dependent entities. Although generally obligations emanating from trust and loyalty are not imposed on parties in the former relationship, they many times are expected of parties in the latter affiliation. Specifically, duties of loyalty, good faith, cooperation, as well as the duty ‘not to hinder’, for instance, are frequently required (and actively policed by courts) in a myriad of relationships similar to franchising, in which cooperation and collaboration are indispensable to producing the putative product or service. There are no incontrovertible theoretical or empirical reasons why these obligations should not be thrust upon the parties – either by courts or legislatures – in the franchising realm. Indeed, on this issue, the franchising literature is littered with prolific bastardized, mutated, and inaccurate economic theories and empirical studies supporting only the notion that ‘he who has money’ controls the legal rules. With the number of true national franchisee-side law firms having dwindled to only three, it is not realistic to expect the change in gestalt to be brought about solely by these lawyers on a case by case basis.

My enlightened gut feeling is that the imposition of such additional common law obligations on franchisors and franchisees will increase both aggregate demand for and supply of franchises. Efficiency under both the Kaldor-Hicks and Pareto optimality criteria would be augmented. The intuition for this counter-intuitive conclusion will be provided in a future column. In the meantime, I think the goal of seeking to procure many more successful franchisors, franchise systems and franchisees is not controversial. Perhaps the identification and review of franchise termination cases from other countries can, in part, begin to change the prevailing gestalt regarding franchising in this country. Certainly the decision of the French Court in the above case in which the franchisor was found to have violated its duty of loyalty has not led to the destruction of franchising in France. Similarly, a recent entry on Google for the French franchisor shows that, despite its legal obligations to treat its franchisees fairly and in good faith, and despite France’s clear proscription of unfair franchise terminations, the franchisor remains vibrant:

"Paul, a family-owned French bakery chain, is heading to South African shores, thanks to Famous            Brands. The bakery, which began in 1880 in Northern France, has stores in 41 countries across                  Europe, Africa, Asia, America and the Middle East."

Case facts from http://www.internationallawoffice.com/Newsletters/Franchising/France/Fra...

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