Fighting Encroachment Claims with Clear Contract Language

While providing continuing legal guidance as to how courts will view encroachment claims, these two recent court decisions show how critically important it is for franchisors to carefully, completely, and continually review each and every provision of the franchise agreement.

Jay W. Schlosser is a partner in the Minneapolis office of Briggs and Morgan, P.A. He is the current chair of the firm's Trade Regulation Practice Group, and provides counseling and litigation services to various franchise entities. Schlosser can be reached via e-mail at [email protected] or via telephone at 612-977-8539.

Two relatively recent court decisions addressing the common franchise issue of encroachment re-confirm the importance of carefully drafting each provision in a franchise agreement and shed some additional light on how courts will view and address encroachment claims going forward. In both cases, the court dismissed a franchisee's claim that a franchisor had breached the franchise agreement by encroaching on an alleged protected territory. Importantly, for the franchisor, in both cases the encroachment claims were dismissed very early in the litigation based on the franchisor's motion to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. The court's focus in each decision was the specific and unambiguous language of the relevant territory provision, as well as other provisions in the franchise agreement.

In addition to providing legal guidance regarding encroachment claims, these decisions re-emphasize how important it is that franchisors and/or their counsel take the time to carefully and thoroughly read, draft, and revise (if necessary) the language in their franchise agreements to fully protect their rights and ensure that their intentions in entering into the franchise agreement are enforced. By drafting and maintaining precise, unambiguous, and complete language in their franchise agreements, the franchisor in each case was not only able to escape liability on an asserted claim, thereby avoiding a potential large monetary judgment, it was also able to avoid spending a significant amount of money on protracted litigation attempting to interpret and apply ambiguous language.

Black Angus Holdings

The first case, In re Black Angus Holdings, LLC, Bankr. Case No. 09-21349-11, 2010 WL 3613946 (D. Kan. Sept. 2010), was decided in September 2010 by the U.S. District Court in Kansas. The case started as an adversary bankruptcy proceeding. The plaintiff/debtor/franchisee had asserted an encroachment claim alleging that the franchisor had breached the protected territory provision set forth in the franchise agreement by granting and establishing another franchisee whose territory overlapped with the plaintiff's protected territory.

The facts of the cased showed that after entering into the franchise agreement with the plaintiff, the franchisor granted a new franchise that opened a location that was 2.17 miles from the plaintiff's location, but had a protected territory that extended for one mile around its location. Because the initial franchisee had a protected territory of two miles, the protected territories of the two franchise locations overlapped. The overlapping territories led the plaintiff to file its encroachment claim.

The primary, if not exclusive, focus of the case was the precise language set forth in the protected territory provision. That provision provided as follows:

Territory. Franchisor [defendant] agrees that, during the term of this Agreement, it will not sell or establish any other franchised or company-owned Restaurant or any other restaurant which sells hamburgers and/or chicken sandwiches in the following territory: A site located at 124 North Clairborne, Olathe, Kansas 66062 [the location of plaintiff's restaurant] with a one (1) mile exclusive radius (the “Territory”), except in or in conjunction with any military installation, zoo, amusement park or stadium/arena/coliseum. (Emphasis in original.)

In the complaint, the franchisee had alleged that the provision was later amended to extend to a radius of two miles ' a fact not disputed by the franchisor for purposes of the motion to dismiss.

The franchisor brought a motion to dismiss the complaint pursuant to Fed. R. Civ. P. 12(b)(6), based on what it argued was the plain, unambiguous language of the franchise agreement. The franchisor argued that the plain language of the franchise agreement allowed it to establish or grant a franchise in any location as long as the new franchisee did not have a physical location within the exclusive territory of the established franchisee.

The bankruptcy court denied the franchisor's motion, ruling that the language of the franchise agreement could be interpreted in the manner suggested by the franchisee, thereby allowing the case to proceed. Focusing on the language in the protected territory provision, the bankruptcy court concluded that the word “exclusive” in front of “radius” in the territory provision suggested that it could be read to prohibit the franchisor from establishing a restaurant with a territory that extended into the “exclusive radius” of the existing franchisee. The franchisor was granted leave to appeal the decision on an interlocutory basis, which it did to the U.S. District Court in Kansas.

On appeal, the district court reversed the decision and held that the unambiguous language of the franchise agreement allowed the franchisor to establish the new franchisee ' even if it negatively affected the exclusive territory of the existing franchisee. Similar to the bankruptcy court, the court's decision focused on the explicit language of the territorial provision in the franchise agreement. However, the court, in dismissing the encroachment claim, concluded that the unambiguous language only precluded the franchisor from establishing another restaurant with a physical location within the plaintiff's exclusive territory. The court held that the protected territory provision did not provide the plaintiff with the right to exclusivity from all competition within its protected territory. Thus, the fact that the new franchisee's territory overlapped with the protected territory of the plaintiff was not a violation of the franchise agreement

The franchisor in this case was ultimately able to prevail because of the explicit language set forth in the territory provision of its franchise agreement.

Cottage Inn Carryout & Delivery

The second case, Cottage Inn Carryout & Delivery, Inc. v. True Freedom Investments, LLC, No. 10-12833 2010 WL 4188311 (E.D. Mich. Oct. 2010), was decided a month later, in October 2010, by the U.S. District Court for the Eastern District of Michigan (and it was summarized in detail in the Court Watch section of the December 2010 issue of FBLA). Similar to Black Angus, the Cottage Inn decision involved the interpretation of the specific language contained in a “protected area” provision in the franchise agreement.

The key to Cottage Inn was the court's determination that the language of the territory provision was not ambiguous and, therefore, must be interpreted and applied based on its plain language. Based on the unambiguous language and a broad integration clause, the court concluded that it would not consider the franchisee's parol evidence, which suggested that the franchisee had received oral assurances that the franchisor would not allow other franchisees to deliver food into the franchisee's protected territory. The precise and direct language of the franchise agreement was instrumental in allowing the franchisor in the Cottage Inn case to have the counterclaim dismissed early in the litigation.

While providing continuing legal guidance as to how courts will view encroachment claims, these two recent court decisions show how critically important it is for franchisors to carefully, completely, and continually review each and every provision of the franchise agreement.

Jay W. Schlosser is a partner in the Minneapolis office of Briggs and Morgan, P.A. He is the current chair of the firm's Trade Regulation Practice Group, and provides counseling and litigation services to various franchise entities. Schlosser can be reached via e-mail at [email protected] or via telephone at 612-977-8539.