Court Watch

Courts Consider Refusing to Enforce Contract Provisions

In two recent decisions, courts declined to rewrite the terms of franchise agreements, despite assertions that the relevant terms were unconscionable, modified by practice, or unenforceable due to equitable estoppel. While both cases ultimately resulted in enforcement of the contracts as written, both suggested that under better fact patterns for the franchisees, a different result could have been reached.

The Bonanno Case

In Bonanno, et al. v. The Quiznos Franchise Co. LLC, et al., 2 Bus. Franch. Guide (CCH) 14,129 (D. Col. 2009), the U.S. District Court for the District of Colorado considered whether a provision in Quiznos' franchise agreement that prohibited franchisees from asserting class actions was unconscionable. The plaintiffs, a group of Quiznos franchisees, alleged that Quiznos misled them to believe that their exclusive market areas would be more profitable than they in fact were and that Quiznos would provide expert assistance to help locate real estate for their restaurants. The plaintiffs alleged that ' in order to keep the entire franchisee fee ' Quiznos failed to provide real estate assistance and routinely terminated franchise agreements after franchisees were unable to open their restaurant within a year. In defense of these allegations, Quiznos asserted that the franchise agreements and disclosure documents had been clear that Quiznos had the right to bar class actions, had no obligation to select a site for its franchisees, did not make representations regarding sales projections, and had the right to terminate franchises that had not opened within one year.

The plaintiffs included two classes of “sold-but-not-opened-franchisees” or “SNOs.” One class included a groups of SNOs that Quiznos had elected to terminate for failing to open their stores within one year of signing the franchise agreement. The second class of SNOs had failed to open restaurants, but had not been terminated by Quiznos.

The first hurdle was the class action bar, which was explicitly included in the plaintiffs' franchise agreements. The plaintiffs argued that the provision was unconscionable under Colorado law. The court noted that “as the parties seeking to escape application of an unambiguous contractual provision, the burden rests on Plaintiffs to show that the Court should not enforce the class action bar provision.” While the plaintiffs drew the court's attention to several decisions relating to class action bars, the court found that these existing cases had little precedential value, because they relied on wholly inapplicable legal standards, involved mandatory arbitration clauses, or involved specific state laws that did not translate well into Colorado law.

Accordingly, the court applied a seven-factor test adopted by the Colorado Supreme Court to determine whether a contractual provision is unconscionable under state law. The first factor considered whether the agreement was a standardized form agreement made by parties with unequal bargaining power. While the court concluded that it was a standard, take-it-or-leave-it contract, the court noted that that alone did not render a contract unconscionable and concluded that the first factor cut mildly in favor of the plaintiffs. The second factor focused on whether the parties had an opportunity to read and become familiar with the document prior to execution. The court held that a 10-day review period was a factor in favor of Quiznos. Next, the court considered whether the provision was buried in fine print. Though the plaintiffs asserted that the provision was hidden in the middle of a paragraph near the end of the 40-page franchise agreement, the court disagreed, holding that this factor favored enforcing the bar because the provision appeared in the same font style and size as the other provisions within the agreement.

Fourth, the court evaluated whether there was a commercially reasonable justification for the class action bar. Quiznos asserted that the bar reduced dispute resolution costs and offered Quiznos more predictability in decision-making, planning, and budgeting. The court agreed that, though the goal of the bar was counter to the interests of the plaintiffs, Quiznos had a commercially reasonable interest in discouraging litigation and enforcing the bar. As a result, the court found that the fourth factor slightly favored enforcement of the class action bar.

Fifth, the court considered whether the provision was substantively unfair. The plaintiffs asserted that because of the large number of SNOs and the small amount of money at stakes for each individual SNO, each franchisee would be unable to assert its rights individually if the class action were barred. The court disagreed, noting that each franchisee could potentially recover in an individual suit $20,000 to $25,000 in franchise fees, treble damages, and attorneys' fees. Moreover, each individual case would not require a large upfront investment of resources and would not require massive, widespread discovery or expert analysis, the court found, so it concluded that economic roadblocks did not exist in bringing litigation. The court noted that the fact that the provision benefitted Quiznos more than the franchisees was not enough to render it unfair, since Colorado does not require bilaterality of contractual terms.

Sixth, the court considered the relationship between the parties and found that though Quiznos retained the bulk of the bargaining power, this factor weighed only slightly in favor of the plaintiffs. Finally, the court considered the remaining circumstances surrounding the formation of the contract, including its commercial setting, purpose, and effect. The court rejected the plaintiffs' assertion that the allegedly fraudulent nature of Quiznos' sales pitch infected the enforceability of the class action bar, because the sales pitch had no relationship to the dispute resolution provisions, which were unrelated and severable.

Taken together, the court concluded that because the seven-factor test favored enforcing the class action bar, such bar was enforceable under Colorado law. After concluding that the bar would not interfere with the court's ability to manage litigation pursuant to the Federal Rules of Civil Procedure, the court upheld the class action bar, ruling in favor of Quiznos.

The Haynes Case

In Haynes Trans Service Agency, Inc. and Frederick M. Haynes v. American Standard Inc. d/b/a/ The Trane Co., 2 Bus. Franch. Guide (CCH) 14,125 (10th Cir. 1009), a Trane franchisee, Frederick Haynes, claimed that Trane, despite language in the franchise agreement permitting it to terminate the franchise at will upon 30 days' notice, could terminate his franchise agreement only for good cause, because statements and conduct by Trane officials had either modified the agreement or equitably estopped Trane from denying that the agreement required good cause to terminate.

Trane terminated Haynes' franchise agreement after a dispute arose between HaynesTSA, a company Haynes had formed to act as a service wing for his franchise, and Trane relating to a distributorship agreement between HaynesTSA and Trane. HaynesTSA was caught submitting fraudulent invoices to Trane in order to cause Trane to pay HaynesTSA rebates that the distributor had not earned. When Trane learned of the fraudulent invoices, Trane terminated HaynesTSA's distributorship agreement and, soon thereafter, terminated Haynes' franchise agreement without stating a cause.

Haynes initiated suit, asserting that Trane could not terminate the agreement at will and had no cause to do so, since any abuse of the rebate program occurred at Haynes-TSA. In addition, Haynes asserted that Trane breached its fiduciary duty to him. Though, in the suit, HaynesTSA and Trane also asserted claims and counterclaims against each other relating to their distributorship agreement, this article focuses only on the claims relating directly to Haynes' franchise agreement.

Haynes first argued that the franchise agreement could not be terminated without cause because Trane had modified the contract through its practice and policies. To prevail on the modification claim, the plaintiff had to show that Trane acted in a way that was “unequivocally inconsistent with enforcing the franchise agreement as it was written.” To that end, Haynes provided evidence that Trane had consistently provided cause when terminating franchisees in the past. The court rejected this argument because a pattern of terminating for cause was not unequivocally inconsistent with Trane retaining the power to terminate without cause. The court reasoned that Trane may not have had the occasion or inclination to exercise its power to terminate a franchisee at will until this situation arose.

The plaintiff countered this conclusion with a procedural argument that the law-of-the-case doctrine required the appellate court to permit the modification claim to go to the jury on remand because the court had previously ruled that the district court improperly granted a judgment as a matter of law on this claim in the first trial. The appellate court noted that three pieces of evidence presented in the first trial, but not in the second trial, led to the court's initial reversal of the judgment as a matter of law. Namely, the first trial included testimony from Haynes that Trane officials at franchisee meetings had communicated the policy of termination only for cause, testimony from a Trane official that he interpreted the franchise agreements as requiring cause for termination, and testimony of another Trane official that he was not aware of any terminations that were not for cause. The court emphasized that such evidence of a communicated policy of terminating franchises only for cause would be inconsistent with enforcing an at-will provision. However, because the plaintiff had not provided such evidence at the second trial on remand, the court was not bound by its previous determination that the judgment as a matter of law was improperly granted. Thus, the court suggested that had the evidence been presented again in the second trial, the contract modification claim could have escaped a judgment as a matter of law.

Next, the plaintiff argued that even if the contract had not been modified, Trane should have been equitably estopped from terminating at will. At trial, a jury found that the plaintiff had established each of the elements of Wisconsin's doctrine of equitable estoppel, including: “(1) action or non-action, (2) on the part of one against whom estoppel is asserted, (3) which induces reasonable reliance thereon by the other, either in action or non-action, and (4) which is to his or her detriment.” Despite the jury's conclusion, the district court exercised its right to deny equitable relief to the plaintiff on the grounds that Haynes had engaged in “substantial relevant misconduct” by failing to notify Trane about HaynesTSA's abuses of the rebate program, once he had learned of them. The Tenth Circuit agreed that because of Haynes' unclean hands, it was “not an abuse of discretion to deny equitable relief when the evidence of his misconduct established that he was unworthy of being a franchisee.” The court noted that even though HaynesTSA, a corporate entity, was responsible for the frauds committed against Trane and a jury found that Trane lacked good cause to terminate Haynes' franchise agreement, Haynes could be held responsible for his personal failure to play it straight with Trane during its investigation.

As a final claim, the plaintiff asserted that Trane breached fiduciary duties arising from a confidential relationship. However, the court quickly rejected this argument, noting that the plaintiff had never “reposed trust in Trane,” the first element necessary to prevail on such a claim. In fact, because Haynes had shown evidence of a history of deepening distrust between the parties, the court found no evidence that he trusted Trane in its business dealings with him.

Ultimately, the court affirmed the district court's grant of judgment as a matter of law on both Haynes' contract modification claim and fiduciary duty claim and affirmed the district court's denial of the equitable estoppel claim. However, given the court's dicta, it appears that the case could have turned out quite differently had the plaintiff presented all of his evidence at both trials and had he not had unclean hands that prevented him from asserting his estoppel claim.

Conclusion

Thus, while both of these cases resulted in the court enforcing the written terms of the underlying franchise agreements, a more favorable set of facts for the plaintiffs in each case could have resulted in either court refusing to enforce a material term of each franchise agreement.

Alexander Tuneski is an associate in the Washington, DC, office of Kilpatrick Stockton LLP. He can be contacted at 202-508-5814 or [email protected].

Courts Consider Refusing to Enforce Contract Provisions

In two recent decisions, courts declined to rewrite the terms of franchise agreements, despite assertions that the relevant terms were unconscionable, modified by practice, or unenforceable due to equitable estoppel. While both cases ultimately resulted in enforcement of the contracts as written, both suggested that under better fact patterns for the franchisees, a different result could have been reached.

The Bonanno Case

In Bonanno, et al. v. The Quiznos Franchise Co. LLC, et al., 2 Bus. Franch. Guide (CCH) 14,129 (D. Col. 2009), the U.S. District Court for the District of Colorado considered whether a provision in Quiznos' franchise agreement that prohibited franchisees from asserting class actions was unconscionable. The plaintiffs, a group of Quiznos franchisees, alleged that Quiznos misled them to believe that their exclusive market areas would be more profitable than they in fact were and that Quiznos would provide expert assistance to help locate real estate for their restaurants. The plaintiffs alleged that ' in order to keep the entire franchisee fee ' Quiznos failed to provide real estate assistance and routinely terminated franchise agreements after franchisees were unable to open their restaurant within a year. In defense of these allegations, Quiznos asserted that the franchise agreements and disclosure documents had been clear that Quiznos had the right to bar class actions, had no obligation to select a site for its franchisees, did not make representations regarding sales projections, and had the right to terminate franchises that had not opened within one year.

The plaintiffs included two classes of “sold-but-not-opened-franchisees” or “SNOs.” One class included a groups of SNOs that Quiznos had elected to terminate for failing to open their stores within one year of signing the franchise agreement. The second class of SNOs had failed to open restaurants, but had not been terminated by Quiznos.

The first hurdle was the class action bar, which was explicitly included in the plaintiffs' franchise agreements. The plaintiffs argued that the provision was unconscionable under Colorado law. The court noted that “as the parties seeking to escape application of an unambiguous contractual provision, the burden rests on Plaintiffs to show that the Court should not enforce the class action bar provision.” While the plaintiffs drew the court's attention to several decisions relating to class action bars, the court found that these existing cases had little precedential value, because they relied on wholly inapplicable legal standards, involved mandatory arbitration clauses, or involved specific state laws that did not translate well into Colorado law.

Accordingly, the court applied a seven-factor test adopted by the Colorado Supreme Court to determine whether a contractual provision is unconscionable under state law. The first factor considered whether the agreement was a standardized form agreement made by parties with unequal bargaining power. While the court concluded that it was a standard, take-it-or-leave-it contract, the court noted that that alone did not render a contract unconscionable and concluded that the first factor cut mildly in favor of the plaintiffs. The second factor focused on whether the parties had an opportunity to read and become familiar with the document prior to execution. The court held that a 10-day review period was a factor in favor of Quiznos. Next, the court considered whether the provision was buried in fine print. Though the plaintiffs asserted that the provision was hidden in the middle of a paragraph near the end of the 40-page franchise agreement, the court disagreed, holding that this factor favored enforcing the bar because the provision appeared in the same font style and size as the other provisions within the agreement.

Fourth, the court evaluated whether there was a commercially reasonable justification for the class action bar. Quiznos asserted that the bar reduced dispute resolution costs and offered Quiznos more predictability in decision-making, planning, and budgeting. The court agreed that, though the goal of the bar was counter to the interests of the plaintiffs, Quiznos had a commercially reasonable interest in discouraging litigation and enforcing the bar. As a result, the court found that the fourth factor slightly favored enforcement of the class action bar.

Fifth, the court considered whether the provision was substantively unfair. The plaintiffs asserted that because of the large number of SNOs and the small amount of money at stakes for each individual SNO, each franchisee would be unable to assert its rights individually if the class action were barred. The court disagreed, noting that each franchisee could potentially recover in an individual suit $20,000 to $25,000 in franchise fees, treble damages, and attorneys' fees. Moreover, each individual case would not require a large upfront investment of resources and would not require massive, widespread discovery or expert analysis, the court found, so it concluded that economic roadblocks did not exist in bringing litigation. The court noted that the fact that the provision benefitted Quiznos more than the franchisees was not enough to render it unfair, since Colorado does not require bilaterality of contractual terms.

Sixth, the court considered the relationship between the parties and found that though Quiznos retained the bulk of the bargaining power, this factor weighed only slightly in favor of the plaintiffs. Finally, the court considered the remaining circumstances surrounding the formation of the contract, including its commercial setting, purpose, and effect. The court rejected the plaintiffs' assertion that the allegedly fraudulent nature of Quiznos' sales pitch infected the enforceability of the class action bar, because the sales pitch had no relationship to the dispute resolution provisions, which were unrelated and severable.

Taken together, the court concluded that because the seven-factor test favored enforcing the class action bar, such bar was enforceable under Colorado law. After concluding that the bar would not interfere with the court's ability to manage litigation pursuant to the Federal Rules of Civil Procedure, the court upheld the class action bar, ruling in favor of Quiznos.

The Haynes Case

In Haynes Trans Service Agency, Inc. and Frederick M. Haynes v. American Standard Inc. d/b/a/ The Trane Co., 2 Bus. Franch. Guide (CCH) 14,125 (10th Cir. 1009), a Trane franchisee, Frederick Haynes, claimed that Trane, despite language in the franchise agreement permitting it to terminate the franchise at will upon 30 days' notice, could terminate his franchise agreement only for good cause, because statements and conduct by Trane officials had either modified the agreement or equitably estopped Trane from denying that the agreement required good cause to terminate.

Trane terminated Haynes' franchise agreement after a dispute arose between HaynesTSA, a company Haynes had formed to act as a service wing for his franchise, and Trane relating to a distributorship agreement between HaynesTSA and Trane. HaynesTSA was caught submitting fraudulent invoices to Trane in order to cause Trane to pay HaynesTSA rebates that the distributor had not earned. When Trane learned of the fraudulent invoices, Trane terminated HaynesTSA's distributorship agreement and, soon thereafter, terminated Haynes' franchise agreement without stating a cause.

Haynes initiated suit, asserting that Trane could not terminate the agreement at will and had no cause to do so, since any abuse of the rebate program occurred at Haynes-TSA. In addition, Haynes asserted that Trane breached its fiduciary duty to him. Though, in the suit, HaynesTSA and Trane also asserted claims and counterclaims against each other relating to their distributorship agreement, this article focuses only on the claims relating directly to Haynes' franchise agreement.

Haynes first argued that the franchise agreement could not be terminated without cause because Trane had modified the contract through its practice and policies. To prevail on the modification claim, the plaintiff had to show that Trane acted in a way that was “unequivocally inconsistent with enforcing the franchise agreement as it was written.” To that end, Haynes provided evidence that Trane had consistently provided cause when terminating franchisees in the past. The court rejected this argument because a pattern of terminating for cause was not unequivocally inconsistent with Trane retaining the power to terminate without cause. The court reasoned that Trane may not have had the occasion or inclination to exercise its power to terminate a franchisee at will until this situation arose.

The plaintiff countered this conclusion with a procedural argument that the law-of-the-case doctrine required the appellate court to permit the modification claim to go to the jury on remand because the court had previously ruled that the district court improperly granted a judgment as a matter of law on this claim in the first trial. The appellate court noted that three pieces of evidence presented in the first trial, but not in the second trial, led to the court's initial reversal of the judgment as a matter of law. Namely, the first trial included testimony from Haynes that Trane officials at franchisee meetings had communicated the policy of termination only for cause, testimony from a Trane official that he interpreted the franchise agreements as requiring cause for termination, and testimony of another Trane official that he was not aware of any terminations that were not for cause. The court emphasized that such evidence of a communicated policy of terminating franchises only for cause would be inconsistent with enforcing an at-will provision. However, because the plaintiff had not provided such evidence at the second trial on remand, the court was not bound by its previous determination that the judgment as a matter of law was improperly granted. Thus, the court suggested that had the evidence been presented again in the second trial, the contract modification claim could have escaped a judgment as a matter of law.

Next, the plaintiff argued that even if the contract had not been modified, Trane should have been equitably estopped from terminating at will. At trial, a jury found that the plaintiff had established each of the elements of Wisconsin's doctrine of equitable estoppel, including: “(1) action or non-action, (2) on the part of one against whom estoppel is asserted, (3) which induces reasonable reliance thereon by the other, either in action or non-action, and (4) which is to his or her detriment.” Despite the jury's conclusion, the district court exercised its right to deny equitable relief to the plaintiff on the grounds that Haynes had engaged in “substantial relevant misconduct” by failing to notify Trane about HaynesTSA's abuses of the rebate program, once he had learned of them. The Tenth Circuit agreed that because of Haynes' unclean hands, it was “not an abuse of discretion to deny equitable relief when the evidence of his misconduct established that he was unworthy of being a franchisee.” The court noted that even though HaynesTSA, a corporate entity, was responsible for the frauds committed against Trane and a jury found that Trane lacked good cause to terminate Haynes' franchise agreement, Haynes could be held responsible for his personal failure to play it straight with Trane during its investigation.

As a final claim, the plaintiff asserted that Trane breached fiduciary duties arising from a confidential relationship. However, the court quickly rejected this argument, noting that the plaintiff had never “reposed trust in Trane,” the first element necessary to prevail on such a claim. In fact, because Haynes had shown evidence of a history of deepening distrust between the parties, the court found no evidence that he trusted Trane in its business dealings with him.

Ultimately, the court affirmed the district court's grant of judgment as a matter of law on both Haynes' contract modification claim and fiduciary duty claim and affirmed the district court's denial of the equitable estoppel claim. However, given the court's dicta, it appears that the case could have turned out quite differently had the plaintiff presented all of his evidence at both trials and had he not had unclean hands that prevented him from asserting his estoppel claim.

Conclusion

Thus, while both of these cases resulted in the court enforcing the written terms of the underlying franchise agreements, a more favorable set of facts for the plaintiffs in each case could have resulted in either court refusing to enforce a material term of each franchise agreement.

Alexander Tuneski is an associate in the Washington, DC, office of Kilpatrick Stockton LLP. He can be contacted at 202-508-5814 or [email protected].