Court Watch

Impossibility of Cure Allows Immediate Termination

If a franchise agreement provides that the franchisee has a certain number of days to cure a default under the agreement, but the franchisee commits a violation that is impossible to cure, must the franchisor still wait the required number of days before the agreement is terminated? That question was before the Pennsylvania Supreme Court in LJL Transportation, Inc., et al v. Pilot Air Freight Corporation, CCH BFG 14,058 (Jan. 22, 2009). The concerned franchise agreement gave the franchisee 90 days from notice to cure a default, but the agreement did not contain a specific provision allowing immediate termination. After numerous acts of intentional misconduct by the franchisee, such as diverting business and underreporting sales, the franchisor sent a letter to the franchisee purporting to terminate the franchise agreement immediately, without providing the specified 90 days to cure the defaults. The franchisee argued that the franchisor breached the franchise agreement by terminating the agreement without giving the franchisee the specified time to cure. The franchisor maintained that cure would be impossible since the franchisee engaged in dishonest and improper conduct ' all violations of the terms of the franchise agreement ' and that those actions could not be undone.

The concerned franchise agreement also contained a catch-all provision that stated, “[The franchisor's] election to exercise any remedy available by law or contract shall not be deemed a waiver of nor preclude exercise of any other remedy.” The franchisor argued that this provision provided the franchisor with an alternative to giving the franchisee the required notice and opportunity to cure, since, under this language, giving notice and the opportunity to cure did not preclude the exercise of other remedies available under general contract law.

In making its determination that the franchisor could, in fact, terminate the agreement without providing the required notice and 90-day cure period, the court referred to the principle of contract law holding that when a party commits a material breach of an agreement, that party cannot then insist that the non-defaulting party continue to perform its duties under the contract. As such, the provision allowing the franchisor to exercise all other remedies available to it under law allowed termination of the franchise agreement by the non-defaulting franchisor, since the franchisee engaged in conduct so egregious that it went to the heart of the agreement, destroyed the trust between the parties, and frustrated the purpose of the contract.

The court noted that even if a franchise agreement provides that notice and a cure period are the exclusive remedy available to a franchisor, the franchisor can still argue that an incurable breach so frustrates the purpose of the contract that termination should be allowed without resorting to the specified remedy. However, the court intimated that the presence of a provision making a certain remedy exclusive would make the matter more difficult for the franchisor.

While most well-written franchise agreements contain provisions allowing immediate termination under specified circumstances, it is always wise to include a catch-all provision, such as was done here, allowing a franchisor to enforce all other remedies available to it at law or in equity in addition to the default and termination provisions otherwise specified in the franchise agreement.

Comedy Club Revisited in Wake of 2008 Supreme Court Decision on
Arbitration

The case of Comedy Club, Inc., et al, v. Improv West Associations, et al, returned once again to the U.S. Court of Appeals for the Ninth Circuit, CCH BFG 14,055 (Jan. 29, 2009) (see FBLA, Vol. 14, No. 1, Oct., 2007, pp. 5-6 for a discussion of an earlier opinion in the case). In Hall Street Associates, LLC v. Matel, Inc., 128 S.Ct. 1396 (2008) the U.S. Supreme Court questioned whether “manifest disregard” was a valid ground under the Federal Arbitration Act (“FAA”) to vacate an arbitration award since the FAA did not specifically indicate such a basis for vacatur. In light of Hall Street, the Supreme Court vacated the earlier Ninth Circuit opinion in Comedy Club and remanded the matter for reconsideration.

The Comedy Club case involves, among other things, the question of whether an arbitrator's manifest disregard of the law when interpreting the terms of a “Trademark Agreement” that prohibited nationwide competition allowed the court to partially vacate the arbitrator's decision in the matter. Based on the noncompetition clause in the Trademark Agreement, the arbitrator prohibited Comedy Club from opening comedy clubs throughout the United States for the balance of the term of the Trademark Agreement after its right to expand using the Improv West names and marks was terminated because of a failure to meet the development schedule specified in the agreement. Since under the terms of the Trademark Agreement, Comedy Club continued to have the right to operate the clubs it had open or under construction on the date of the partial termination, the arbitrator treated the prohibition as an in-term covenant against competition. In an earlier opinion in the matter, the Ninth Circuit held that in granting such a broad prohibition the arbitrator manifestly disregarded the law of California. As a result, the court reduced the effectiveness of the noncompetition covenant to the counties in which the existing clubs were located.

Upon reconsideration, the court held that manifest disregard of the law as grounds for vacating an arbitration award is contemplated within '10(a)(4) of the FAA, which allows an arbitration award to be set aside “[w]here the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”

Manifest disregard of the law as the basis for vacating an arbitration award is not universally embraced by the courts. The applicability of that argument may depend on whether the arbitration is conducted or sought to be enforced, or the award set aside, under the FAA or under a state arbitration law. It also may depend on in what venue the motion to vacate is made because various jurisdictions may differ on the issue, at least until the Supreme Court makes a definitive decision.

Nebraska Attorney Reprimanded for Franchise Failings

Lawyers who specialize in franchise law are occasionally called upon to review franchising documents prepared by non-specialists. Often, those documents are sorely lacking, even though they may not rise to the level of incompetence. However, in State of Nebraska v. Orr, 277 Neb. 102, CCH BFG 14,064 (Jan. 30, 2009), an attorney was given a public reprimand for not providing competent representation to his client in the preparation of a franchise agreement and disclosure document and advising the client regarding compliance with the FTC Rule. Despite being advised by an attorney who was retained to assist in protecting the client's trademark that franchising was a specialized field, the attorney felt preparing a franchise agreement was just a matter of contract drafting and that, based on a “disclosure statement” he had reviewed on behalf of a franchisee, only a minimal “disclosure statement” was required by the FTC.

After the client-franchisor sold numerous franchises, an abundance of problems emerged. Franchisees and prospective franchisees made several complaints; one franchisee obtained a personal judgment against the franchisor's principals in a lawsuit; and the FTC initiated an investigation into the franchisor's practices. At that point, the attorney's firm sought a review of the franchising documents by an outside attorney specializing in franchise law. That attorney found major deficiencies in the documents. After receiving that advice, the drafting attorney withdrew from the representation, since failure to create competent documents and comply with applicable law created a conflict of interest with his clients.

Formal charges were filed against the attorney in 2007, alleging violation of several sections of the Nebraska Rules of Professional Conduct. The Rules provide that
“[c]ompetent representation requires the legal knowledge, skill, thoroughness, preparation and judgment reasonably necessary for the representation,” and that a lawyer should not handle legal matters “which the lawyer knows or should know that he or she is not competent to handle, without association with a lawyer who is competent to handle it” or “without preparation adequate in the circumstances.” The court found that since the attorney had been practicing for 40 years, he should have been aware that he was not competent to represent franchisors. In fact, he was warned early in the process that franchising was a specialized area of practice.

While formal recognition as a franchise law specialist is not necessary to practice in franchising, attorneys should realize by this time that franchise law requires many years of experience to master. In 2008, the California Board of Legal Specialization of the State Bar of California began certifying attorneys as Legal Specialists in Franchise and Distribution Law. Certification is granted only after an attorney passes a rigorous written examination, demonstrates a high level of experience in the specialty area, fulfills specialized education requirements, and receives favorable evaluations by other attorneys and judges familiar with his or her work.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. He can be reached by phone at 415-956-1900.

Impossibility of Cure Allows Immediate Termination

If a franchise agreement provides that the franchisee has a certain number of days to cure a default under the agreement, but the franchisee commits a violation that is impossible to cure, must the franchisor still wait the required number of days before the agreement is terminated? That question was before the Pennsylvania Supreme Court in LJL Transportation, Inc., et al v. Pilot Air Freight Corporation, CCH BFG 14,058 (Jan. 22, 2009). The concerned franchise agreement gave the franchisee 90 days from notice to cure a default, but the agreement did not contain a specific provision allowing immediate termination. After numerous acts of intentional misconduct by the franchisee, such as diverting business and underreporting sales, the franchisor sent a letter to the franchisee purporting to terminate the franchise agreement immediately, without providing the specified 90 days to cure the defaults. The franchisee argued that the franchisor breached the franchise agreement by terminating the agreement without giving the franchisee the specified time to cure. The franchisor maintained that cure would be impossible since the franchisee engaged in dishonest and improper conduct ' all violations of the terms of the franchise agreement ' and that those actions could not be undone.

The concerned franchise agreement also contained a catch-all provision that stated, “[The franchisor's] election to exercise any remedy available by law or contract shall not be deemed a waiver of nor preclude exercise of any other remedy.” The franchisor argued that this provision provided the franchisor with an alternative to giving the franchisee the required notice and opportunity to cure, since, under this language, giving notice and the opportunity to cure did not preclude the exercise of other remedies available under general contract law.

In making its determination that the franchisor could, in fact, terminate the agreement without providing the required notice and 90-day cure period, the court referred to the principle of contract law holding that when a party commits a material breach of an agreement, that party cannot then insist that the non-defaulting party continue to perform its duties under the contract. As such, the provision allowing the franchisor to exercise all other remedies available to it under law allowed termination of the franchise agreement by the non-defaulting franchisor, since the franchisee engaged in conduct so egregious that it went to the heart of the agreement, destroyed the trust between the parties, and frustrated the purpose of the contract.

The court noted that even if a franchise agreement provides that notice and a cure period are the exclusive remedy available to a franchisor, the franchisor can still argue that an incurable breach so frustrates the purpose of the contract that termination should be allowed without resorting to the specified remedy. However, the court intimated that the presence of a provision making a certain remedy exclusive would make the matter more difficult for the franchisor.

While most well-written franchise agreements contain provisions allowing immediate termination under specified circumstances, it is always wise to include a catch-all provision, such as was done here, allowing a franchisor to enforce all other remedies available to it at law or in equity in addition to the default and termination provisions otherwise specified in the franchise agreement.

Comedy Club Revisited in Wake of 2008 Supreme Court Decision on
Arbitration

The case of Comedy Club, Inc., et al, v. Improv West Associations, et al, returned once again to the U.S. Court of Appeals for the Ninth Circuit, CCH BFG 14,055 (Jan. 29, 2009) (see FBLA, Vol. 14, No. 1, Oct., 2007, pp. 5-6 for a discussion of an earlier opinion in the case). In Hall Street Associates, LLC v. Matel, Inc. , 128 S.Ct. 1396 (2008) the U.S. Supreme Court questioned whether “manifest disregard” was a valid ground under the Federal Arbitration Act (“FAA”) to vacate an arbitration award since the FAA did not specifically indicate such a basis for vacatur. In light of Hall Street, the Supreme Court vacated the earlier Ninth Circuit opinion in Comedy Club and remanded the matter for reconsideration.

The Comedy Club case involves, among other things, the question of whether an arbitrator's manifest disregard of the law when interpreting the terms of a “Trademark Agreement” that prohibited nationwide competition allowed the court to partially vacate the arbitrator's decision in the matter. Based on the noncompetition clause in the Trademark Agreement, the arbitrator prohibited Comedy Club from opening comedy clubs throughout the United States for the balance of the term of the Trademark Agreement after its right to expand using the Improv West names and marks was terminated because of a failure to meet the development schedule specified in the agreement. Since under the terms of the Trademark Agreement, Comedy Club continued to have the right to operate the clubs it had open or under construction on the date of the partial termination, the arbitrator treated the prohibition as an in-term covenant against competition. In an earlier opinion in the matter, the Ninth Circuit held that in granting such a broad prohibition the arbitrator manifestly disregarded the law of California. As a result, the court reduced the effectiveness of the noncompetition covenant to the counties in which the existing clubs were located.

Upon reconsideration, the court held that manifest disregard of the law as grounds for vacating an arbitration award is contemplated within '10(a)(4) of the FAA, which allows an arbitration award to be set aside “[w]here the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.”

Manifest disregard of the law as the basis for vacating an arbitration award is not universally embraced by the courts. The applicability of that argument may depend on whether the arbitration is conducted or sought to be enforced, or the award set aside, under the FAA or under a state arbitration law. It also may depend on in what venue the motion to vacate is made because various jurisdictions may differ on the issue, at least until the Supreme Court makes a definitive decision.

Nebraska Attorney Reprimanded for Franchise Failings

Lawyers who specialize in franchise law are occasionally called upon to review franchising documents prepared by non-specialists. Often, those documents are sorely lacking, even though they may not rise to the level of incompetence. However, in State of Nebraska v. Orr , 277 Neb. 102, CCH BFG 14,064 (Jan. 30, 2009), an attorney was given a public reprimand for not providing competent representation to his client in the preparation of a franchise agreement and disclosure document and advising the client regarding compliance with the FTC Rule. Despite being advised by an attorney who was retained to assist in protecting the client's trademark that franchising was a specialized field, the attorney felt preparing a franchise agreement was just a matter of contract drafting and that, based on a “disclosure statement” he had reviewed on behalf of a franchisee, only a minimal “disclosure statement” was required by the FTC.

After the client-franchisor sold numerous franchises, an abundance of problems emerged. Franchisees and prospective franchisees made several complaints; one franchisee obtained a personal judgment against the franchisor's principals in a lawsuit; and the FTC initiated an investigation into the franchisor's practices. At that point, the attorney's firm sought a review of the franchising documents by an outside attorney specializing in franchise law. That attorney found major deficiencies in the documents. After receiving that advice, the drafting attorney withdrew from the representation, since failure to create competent documents and comply with applicable law created a conflict of interest with his clients.

Formal charges were filed against the attorney in 2007, alleging violation of several sections of the Nebraska Rules of Professional Conduct. The Rules provide that
“[c]ompetent representation requires the legal knowledge, skill, thoroughness, preparation and judgment reasonably necessary for the representation,” and that a lawyer should not handle legal matters “which the lawyer knows or should know that he or she is not competent to handle, without association with a lawyer who is competent to handle it” or “without preparation adequate in the circumstances.” The court found that since the attorney had been practicing for 40 years, he should have been aware that he was not competent to represent franchisors. In fact, he was warned early in the process that franchising was a specialized area of practice.

While formal recognition as a franchise law specialist is not necessary to practice in franchising, attorneys should realize by this time that franchise law requires many years of experience to master. In 2008, the California Board of Legal Specialization of the State Bar of California began certifying attorneys as Legal Specialists in Franchise and Distribution Law. Certification is granted only after an attorney passes a rigorous written examination, demonstrates a high level of experience in the specialty area, fulfills specialized education requirements, and receives favorable evaluations by other attorneys and judges familiar with his or her work.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. He can be reached by phone at 415-956-1900.