Court Watch

Finally, the court considered Passport Health's claims that Travel Med had breached its franchise agreement and that its owners had breached their personal guaranty by terminating the franchise agreement prematurely and failing to pay royalties. Travel Med asserted affirmative defenses, alleging that the unclean hands doctrine and the illegality doctrine defeated Passport Health's breach of contract claims. The court found that Travel Med's assertion that Passport Health had unclean hands because it allegedly committed wire fraud was unfounded and unrelated to the rights and responsibilities of the parties under the franchise agreement. Similarly, the court found that Travel Med had failed to produce any evidence that the franchise agreement was illegal and unenforceable. As a result, the court granted summary judgment in favor of Passport Health on each of its breach of contract claims.

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

Two Franchise Terminations Lead to Further Conflicts Between the Parties

While many franchise terminations result in both parties separating amicably, two recent terminations once again demonstrated that franchise terminations can be contentious affairs for both franchisors seeking to enforce post-termination provisions and franchisees seeking to recover damages stemming from a failed relationship. One suit was brought by a franchisee asserting that its franchisor failed to comply with disclosure laws, made misrepresentations, failed to comply with its franchise agreement, and set up the franchise system to fail. Another suit was brought by a franchisor attempting to enjoin a former franchisee from continuing to use a confusingly similar domain name.

Franchisee's Good Faith and Fair Dealing Claim Survives Summary Judgment After Termination

In JM Vidal, Inc. v. Texdis USA, Inc., 2 Bus. Franch. Guide (CCH) '14,560, (S.D.N.Y. Feb. 2, 2011), a franchisee who had opened a MNG by Mango franchise, a women's clothing retail store originating from Spain, asserted claims that the franchisor, Texdis, violated the Washington Franchise Investment Protection Act (“WFIPA”), violated the New York Franchise Sales Act (“NYFSA”), breached its franchise agreement, made fraudulent and negligent misrepresentations, and breached the covenant of good faith and fair dealing. The franchisee, Vidal, was forced to close its store only two years after its opening, after incurring an initial investment that was nearly double the amount that was expected and experiencing sales that fell far below projected amounts. Texdis moved for summary judgment on each of Vidal's claims.

While the court granted Texdis' motion for summary judgment on a number of Vidal's claims, which were barred by Washington's two-year statute of limitations or failed because the NYFSA did not apply to the transaction, the court found that genuine, material, factual issues existed with respect to a handful of Vidal's breach of contract and breach of the covenant of good faith and fair dealing claims. Specifically, Vidal alleged that Texdis and Dextis, an affiliated wholesaler that was obligated to provide merchandise to franchisees and was also named as a party, breached the franchise agreement between the parties by failing to contribute $10,000 to conduct grand-opening advertising for Vidal's store, failing to commit resources to advertising campaigns, and failing to deliver merchandise in sufficient quantities and varieties. Considering the evidence presented by Vidal and the lack of evidence provided by Texdis to counter the allegations, the court held that a reasonable jury could conclude that Texdis and Dextis had breached the franchise agreement.

In addition to its breach of contract claims, Vidal asserted that Texdis had breached the implied duty of good faith and fair dealing in the franchise agreement and had violated the good faith and fair dealing provision of the WFIPA, because Texdis had allegedly engaged in an unfair business practice by setting up the franchises to fail so that Texdis could then repurchase the stores at a significantly discounted price. In support of these allegations, Vidal provided evidence that Texdis had failed to develop an infrastructure necessary to operate or support a franchise system in the United States and that the problems plaguing its store appeared to be systemic within Texdis' fledgling franchise system. In fact, of the 20 franchises that opened since the first in 2005, 14 had closed by 2010, eight of which were repurchased by the franchisor.

When Vidal's store began to fail, Texdis offered to repurchase the store for $150,000 despite the nearly $2 million that Vidal had invested in the store, $400,000 of which had been due to an unplanned addition of a mezzanine to the store at the request of Texdis. Evidence that Texdis had pushed for a 10-year lease that would be assignable to Texdis upon the termination of the franchise relationship despite the fact that the franchise agreement provided Vidal with only a five-year term gave additional credence to Vidal's allegations that Texdis was not committed to helping its franchises to succeed. Both the common law good faith claim and the WFIPA good faith claim, which potentially allowed for the recovery of treble damages, survived summary judgment.

Though many of its claims survived summary judgment, Vidal's common law and WFIPA claims that Texdis made fraudulent and negligent misrepresentations to induce him to purchase the franchise agreement did not. Vidal alleged that he purchased the franchise in reliance on a representation made by a Texdis representative that he expected Vidal's store to achieve annual sales of $1,000 per square foot, which would amount to $3 million in annual revenue. The court concluded that Vidal's claims failed as a matter of law because such earnings claims were explicitly disclaimed in the franchise agreement, which included an integration clause providing that the franchise agreement was the full and complete agreement between the parties. Moreover, Vidal failed to show any evidence of reliance, since Texdis provided evidence that Vidal had been pursuing a Mango franchise for more than five years and had developed its own sales projections estimating annual sales of up to $6 million per year, which far exceeded the representations allegedly made by Texdis.

Franchisee's Use of a Franchisor's Domain Name After Termination May Not Be Cybersquatting

In Passport Health, Inc. v. Travel Med, Inc., 2 Bus. Franch. Guide (CCH) '14,568 (E.D.Cal. Feb. 10, 2011), a franchisor, Passport Health, filed suit against a former franchisee, Travel Med, alleging that the franchisee had infringed on its trademark, violated the Anti-Cybersquatting Consumer Protection Act (the “ACPA”), and breached its franchise agreement by maintaining a website that used a domain name confusingly similar to that of Passport Health. When Travel Med became a franchisee of Passport Health in 2007, Passport Health asked Travel Med to register a domain name that was somewhat close to “Passport Health” to use to direct customers to Travel Med's website. Accordingly, Travel Med registered the domain name “www.passporthealthnca.com” for its website.

In March 2009, Travel Med stopped making royalty payments to Passport Health, but continued to use the “Passport Health” marks through June 2009, when Travel Med unilaterally terminated its franchise agreement, despite having no contractual right to do so. In preparation for terminating the franchise agreement, Travel Med created a new Web address for its site: “www.travelmedinc.com.” Though the franchise agreement provided that Travel Med was required to stop representing to the public that it was affiliated with Passport Health and to stop using the “Passport Health” marks after termination, Travel Med continued to use the “www.passporthealthnca.com” address through July 2010. Visitors to the “www.passporthealthnca.com” address were automatically redirected to the defendant's new “www.travelmedinc.com” website.

Passport Health claimed that Travel Med's continuing use of the trademark “Passport Health” in the domain name “www.passporthealthnca.com” constituted trademark infringement under the Lanham Act. The court agreed that the Lanham Act was violated because Travel Med's use of the domain name was likely to cause confusion among consumers, since the parties offer competing services, and the domain name incorporated the “Passport Health” marks. As a result, the court granted a permanent injunction preventing Travel Med from using the “www.passporthealthnca.com” domain name and requiring Travel Med to transfer the domain name to Passport Health.

Passport Health also sought summary judgment on its claim that Travel Med violated the ACPA by using the “www.passporthealthnca.com” domain name to market and promote Travel Med's website and products. In order for the court to conclude that Travel Med was engaged in cyberpiracy, Passport Health needed to prove that Travel Med registered or used a domain name that is identical or confusingly similar to Passport Health's protected trademark and that Travel Med acted with “bad faith intent to profit from the mark.” While Travel Med was clearly using a domain name confusingly similar to Passport Health's marks, the court did not accept Passport Health's assertion that Travel Med's use of the confusingly similar domain name to direct customers to Travel Med's own site was indisputable evidence of bad faith. Rather, the court concluded that there was a genuine issue of material fact regarding whether Travel Med had acted with bad faith intent, despite the fact that Travel Med was using the domain name to redirect traffic to its own website. Accordingly, the court denied Passport Health's motion for summary judgment on its ACPA claim.

Finally, the court considered Passport Health's claims that Travel Med had breached its franchise agreement and that its owners had breached their personal guaranty by terminating the franchise agreement prematurely and failing to pay royalties. Travel Med asserted affirmative defenses, alleging that the unclean hands doctrine and the illegality doctrine defeated Passport Health's breach of contract claims. The court found that Travel Med's assertion that Passport Health had unclean hands because it allegedly committed wire fraud was unfounded and unrelated to the rights and responsibilities of the parties under the franchise agreement. Similarly, the court found that Travel Med had failed to produce any evidence that the franchise agreement was illegal and unenforceable. As a result, the court granted summary judgment in favor of Passport Health on each of its breach of contract claims.

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