V. COMPLIANCE WITH STATE RELATIONSHIP LAWS

Sixteen states have laws that govern certain aspects of the franchise relationship, including termination or non-renewal of a franchise. The remaining states do not have franchise relationship statutes, but may have industry-specific (i.e., petroleum or auto dealer) statutes.

Unlike the FTC Rule, which principally mandates disclosure of material terms, state relationship laws seek to override certain contractual provisions by requiring certain "notice" and "good cause" requirements for termination and/or non-renewal and by regulating other aspects of the franchise relationship.

For example, New Jersey's relationship Statute, codified at N.J.S.A. 56-10-1. et. seq., states in pertinent part that:

It shall be a violation of this act for any franchisor… to terminate, cancel or fail to renew a franchise without having first given written notice setting forth all the reasons for such termination, cancellation, or intent not to renew to the franchisee at least 60 days in advance of such termination, cancellation, or failure to renew, except (1) where the alleged grounds are voluntary abandonment by the franchisee… in which event the written notice may be given 15 days in advance…; and (2) where the alleged grounds are the conviction of the franchisee… of an indictable offense directly related to the business conducted pursuant to the franchise in which event the termination… may be effective upon the delivery and receipt of the written notice at any time after the conviction. It shall be a violation of this act for a franchisor to terminate, cancel or fail to renew a franchise without good cause. For the purposes of this act, good cause… shall be limited to failure by the franchisee to substantially comply with those requirements imposed upon him by the franchise.

N.J.S.A. 56-10-5.

By way of further example, the Delaware statute, at 6 Del. Code §2252, states in pertinent part that:

(a) Termination of a franchise by a franchisor shall be deemed to be "unjust," or to have been made "unjustly," if such termination is without good cause or in bad faith.

(b) The failure of a franchisor to renew a franchise shall be deemed to be "unjust" or to have been made "unjustly," if such failure to renew is without good cause or in bad faith.

(g) No franchisor may unjustly terminate a franchise.

(h) No franchisor may unjustly fail or refuse to renew a franchise.

6 Del. Code §2254 further provides that "[n]otwithstanding any provision of the franchise agreement which provides otherwise, any termination of a franchise or election not to renew a franchise must be made on at least 90 days notice."

The practical result of such statutes is that, as the New Jersey Supreme Court stated, "…once a franchise relationship begins, all that a franchisee must do is comply substantially with the terms of the agreement, in return for which he receives the benefit of an 'infinite' franchise - he cannot be terminated or refused renewal." New Jersey courts even go one step further to ensure that New Jersey franchisees will receive these protections by refusing to enforce forum selection clauses which require litigation to be conducted outside of New Jersey (usually in the franchisor's home state).

It is important to note that if a state relationship statute applies, it supersedes any less-stringent requirements in the franchise agreement. Additionally, many state relationship statutes impose a mandatory cure period that may serve to extend or otherwise affect the franchise agreement cure period.

Not surprisingly, a great deal of post-termination litigation involves the definition of good cause. While good cause may ultimately be determined by the finder of fact, a judge or jury, most states with relationship laws find good cause to exit, based upon a franchisee's:

(1) failure to pay monies owed to the franchisor;

(2) failure of a franchisee to obtain prior consent to an assignment of its franchised business in violation of the franchise agreement;

(3) failure to meet contractual sales quotas;

(4) the sale of competing goods;

(5) failure to adhere to the quality standards of the franchise system;

(6) failure to comply with the required hours of operation;

(7) misuse of trademarks; and

(8) the abandonment of the franchised business.

It is always in the franchisor's best interest to keep a well-documented file of any franchisee defaults. It is also helpful if the franchisor can document prior warnings of defaults by the same franchisee as well as any history involving the same defaults in the past.

State relationship statutes provide franchisees with a number of remedies, including: (1) compelling the repurchase of inventory; (2) compelling payment for goodwill; (3) injunctive relief; (4) an award of damages, including lost profits, expenses and punitive damages; and (5) attorneys' fees. The specific remedies vary from state to state.

Even in states which do not have relationship statutes, such as Pennsylvania, all reasons for termination should be carefully documented. The common law in Pennsylvania requires that, ". . .in the absence of a provision in a franchise agreement authorizing termination or non-renewal without cause, a franchisor must act in good faith and in accord with the franchisee's commercially reasonable expectations in terminating a franchise relationship."

If a franchisor wants to reserve the right to terminate without cause, that right should be expressly set forth in the franchise agreement. The franchise agreement should also identify grounds for termination and any cure periods. Even with an express contractual right to terminate without cause, it is still advisable to document the basis supporting the decision to terminate and to anticipate a franchisee's claim for breach of the implied covenant of good faith and fair dealing. Even if no statute is applicable, reasonable advance notice and an opportunity to cure may be useful to diffuse a franchisee's anger and reduce the likelihood of litigation.

Of course, a franchisor must also anticipate common law causes of action which may arise from termination or non-renewal, such as breach of the implied covenant of good faith and fair dealing, breach of contract, fraud and other related claims. In order to present the strongest defense possible, any notice of termination should be prepared with these possible actions in mind.

A notice of termination must not only comply with the requirements of any state relationship statute but also should state with specificity the reason(s) for the termination and should set forth every reason for termination. These notices should be drafted with the assumption that they will be used as evidence of good cause and should be straightforward, objective and unemotional. Any notice of termination should also specifically state that the franchisor is not waiving any rights or remedies it may have with respect to any other defaults under any other agreements between the parties, whether or not such defaults are presently known.

Often, the franchisor will wish to impose new or different terms at the time of renewal. The renewal franchise agreement may, therefore, contain terms materially different from the former franchise agreement, such as increased royalty payments or advertising contributions, remodeling requirements or other substantial changes. Franchisors must recognize that new or different terms can so substantially change the existing relationship that they may be deemed to be a refusal to renew the franchise on the existing terms. Any potentially applicable state relationship statute and applicable case law should be carefully reviewed at each renewal.

Footnotes:

⁹ The states with relationship laws are: Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, Washington and Wisconsin. The District of Columbia, Puerto Rico and the Virgin Islands also have statutes that govern the termination of franchises. South Dakota and Virginia's statutes do not directly address termination but they arguably restrict a franchisor's discretion in refusing to renew a franchise.

¹⁰ Dunkin' Donuts of America, Inc. v. Middletown Donut Corp., 495 A.2d 66, 76 (N.J. 1985).

¹¹ Atlantic Richfield Co. v. Razumic, 390 A.2d 736 (Pa. 1978).