Court Watch

The court stated that “[a]s a matter of general principle, if a state law does not have limitations on its geographical scope, courts will apply it to a contract governed by that state's law, even if parts of the contract are performed outside of the state.” Because the Washington legislature included territorial limitations to the sale-related provisions of WFIPA but did not include any territorial limitation in the franchisee bill of rights, the court concluded that the legislature did not intend such a limitation to apply. Thus, the dismissal of the franchisee's WFIPA claim was reversed.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392.

Distributor Not a Franchisee Under Connecticut Franchise Act

In Echo, Inc. v. Timberland Machines & Irrigation, Inc. , 661 F.3d 959 (7th Cir. Oct. 25, 2011), the Seventh Circuit held that a supplier and distributor did not have a franchise relationship where less than 50% of the distributor's sales resulted from the supplier's products. The case arose out of the termination of the relationship between a distributor, Timberland Machines & Irrigation, Inc. (“TMI”), and a supplier, Echo, Inc. The parties entered into a distributor agreement in 2004, under which TMI distributed outdoor power equipment supplied by Echo in a territory covering several states in New England. On Oct. 21, 2008, Echo gave TMI written notice of its intent to terminate the distributor agreement in 60 days. After the notice period, Echo terminated the distributor agreement and gave the territory to another distributor.

Echo commenced a lawsuit alleging breach of contract and stated claims against TMI which were based on unpaid invoices. TMI filed a separate suit against Echo asserting violations of the Connecticut Franchise Act. Both cases were filed in the Northern District of Illinois and were later consolidated. The district court granted summary judgment in favor of Echo, and TMI appealed.

Under the Connecticut Franchise Act, a franchisor cannot “terminate, cancel, or fail to renew a franchise except for good cause.” One requirement for a business to meet the definition of a “franchise,” however, is that the franchisee's business is “substantially associated” with the franchisor's trademark. The appellate court noted that the “substantially associated” language has been construed as requiring that “most, if not all” of the franchisee's business derives from association with the putative franchisor, and that courts in other jurisdictions have found that a franchise exists “only where at least half of the [franchisee]'s business resulted from its relationship with the [franchisor].” The court then considered the percentage of TMI's sales that derived from its association with Echo. In addition to Echo products, TMI sold a number of other products from nine separate suppliers. In fact, TMI had a completely separate division within its company to sell irrigation equipment. According to Echo, TMI's sales of Echo products accounted for just 30%-35% of TMI's total sales and gross profits. TMI, on the other hand, argued that Echo products accounted for more than 50% of its sales, relying on supporting affidavits asserting that the sales of the irrigation division should be ignored in the court's analysis due to its non-profitability.

After ruling that portions of TMI's supporting affidavits were properly stricken from the record, including the affidavit opining that the sales of the non-profitable division should be ignored, the Seventh Circuit determined that TMI's sales of Echo products accounted for less than 50% of its total sales and found the final figure to be between 29% and 35%. Therefore, it concluded that Echo's trademark and TMI's business were not “substantially associated,” the Connecticut Franchise Act did not apply, and the district court properly granted summary judgment on TMI's claim. Specifically, the circuit court stated that “TMI failed to show that more than 50% of its business resulted from its relationship with Echo, and thus failed to establish the requisite franchise relationship.”

Courts in Connecticut had not previously held that 50% is a strict cut off for the “substantially associated” test. Although the Seventh Circuit's decision is not binding on Connecticut courts, application of a 50% threshold in this case may provide some guidance to litigants and companies in Connecticut.

Washington's 'Franchisee Bill of Rights' Is Given Extraterritorial Effect

In another case dealing with application of a state franchise statute, the Ninth Circuit Court of Appeals reversed the ruling of the district court and held that the lack of a geographical limitation within Washington's state franchise statute allowed an out-of-state franchisee to assert certain claims against an in-state franchisor. Red Lion Hotels Franchising, Inc. v. MAK, LLC , 663 F.3d 1080 (9th Cir. Dec. 7, 2011). The lower court's decision was previously covered by this publication (see FBLA, July 2010).

Red Lion Hotels Franchising, Inc. (“Red Lion”) had a franchise agreement with Mahmoud Karimi. Karimi operated a franchised Red Lion hotel in Modesto, CA. Red Lion is incorporated and has its headquarters in the state of Washington. Red Lion terminated the franchise agreement and sued Karimi for breach of contract due to the alleged failure of Karimi to complete certain required improvements to the hotel. Karimi answered with a counterclaim based on the “franchisee bill of rights” found in the Washington Franchise Investment Protection Act (“WFIPA”).

The district court dismissed the WFIPA claim on summary judgment, finding that the statute did not apply extraterritorially, and therefore did not provide protection to a California franchisee. Karimi appealed the decision.

Under the choice of law provision in the Franchise Agreement, Washington law applied to the dispute. The court recognized that the choice of law provision did not require the court to apply a Washington statute that would not otherwise govern the situation. Thus, the Ninth Circuit carefully examined the statute to determine whether it was meant to have extraterritorial effect. The Ninth Circuit decided that because several sections of WFIPA expressly provide a statewide territorial limitation, and WFIPA's bill of rights does not contain language limiting its application to franchisees, that section was not limited to Washington franchisees.

The court stated that “[a]s a matter of general principle, if a state law does not have limitations on its geographical scope, courts will apply it to a contract governed by that state's law, even if parts of the contract are performed outside of the state.” Because the Washington legislature included territorial limitations to the sale-related provisions of WFIPA but did not include any territorial limitation in the franchisee bill of rights, the court concluded that the legislature did not intend such a limitation to apply. Thus, the dismissal of the franchisee's WFIPA claim was reversed.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392.