Franchise 101: No Need for Good Cause; and Injunction A-Berted

January 2019

Franchisor 101: No Need for Good Cause

A Wisconsin federal judge granted summary judgment in favor of a food service and cleaning equipment maker (“Stoelting”), ruling that minimum purchase requirements under two dealer agreements were not a franchise fee under California or Washington law.

The dealer agreements set purchase requirements of equipment, parts and accessories from Stoelting, required sales goals to be met, and permitted termination without cause on 30 days’ notice. Each agreement had a choice of law—California law for one dealership (AFTT) and Washington for the other (Prism).

Stoelting terminated both dealer agreements, without cause, by giving 30 days’ written notice. The dealers claimed both states’ franchise laws applied, meaning the termination provision was not effective since each law requires good cause to terminate a franchise. Coverage of the franchise laws turned on whether Stoelting’s minimum purchase requirements were a franchise fee.

Under California law, goods purchased at bona fide wholesale prices are not a franchise fee, if there is no obligation to buy more than a reasonable inventory. California Department of Business Oversight guidance defines bona fide wholesale price as “the price at which goods are purchased and sold by a manufacturer or wholesaler to a wholesaler or dealer where there is ultimately an open and public market in which sales of the goods are effected to consumers of the goods.”

The court noted that AFTT bought equipment at 45 percent of list price and parts and accessories at 50 percent, but Stoelting showed that the prices AFTT paid were in line with prices paid by all Stoelting’s domestic distributors and were consistent with wholesale pricing in the frozen treat equipment industry. The dealer provided no contrary evidence. Thus, the court held that the prices were wholesale prices under California law.

Regarding the required inventory level, AFTT was expected to maintain an inventory worth only 3.8 percent of AFTT’s expected annual sales goal, which AFTT exceeded. The court concluded that this required inventory level at wholesale prices did not exceed a reasonable inventory, and found the mandatory purchases were not a franchise fee under California law.

In Washington, to qualify as a franchise fee, a payment must be an “unrecoverable investment” by the franchisee in the franchisor. Under this standard, the court held that the minimum purchase requirement at wholesale prices under Prism’s agreement was not a franchise fee. Prism could sell the equipment after termination and the contract had an option for Stoelting to buy back the items. Therefore, the required purchases of inventory were recoverable.

While a minimum inventory level of only 3.8 percent of expected annual sales was not a franchise fee, minimum inventory requirements can exceed a reasonable startup or ongoing inventory. Prudent manufacturers should be certain that all inventory requirements in a distributorship or similar agreement that has hallmarks of a franchise (i.e., a trademark license, supplier control and a fee) are commercially reasonable.

PW Stoelting LLC v. Levine, W.D. Wis., ¶16,321

Franchisee 101: Injunction A-Berted

Sandwich shop franchisor Erbert and Gerbert (“E&G”) was unable to demonstrate a “better than negligible” likelihood of succeeding on allegations that a former franchisee infringed its trade dress in establishing a new restaurant at the franchised location.

The former franchisee (“Janik”) had operated an E&G sandwich shop in Plano, Texas. E&G terminated the franchise agreement and sued after Janik failed to close its shop. E&G moved for an order to enjoin Janik’s continued operation of the restaurant. Janik then removed E&G’s marks and opened a new restaurant serving sandwiches and salads at the same location. E&G renewed its motion for an injunction, claiming infringement of trade dress and breach of the agreement’s non-compete clause.

The court denied the motion. Though E&G registered its trademarks, it had not registered its trade dress. E&G claimed it had a “distinctive food service system,” reflected in the “distinctive premises of its franchises,” which, in turn, “feature characteristic interior and exterior style; design, décor, furnishings, equipment layout and interior and exterior signage.” As a threshold matter, E&G was required to identify “discrete elements” that made up the trade dress and show the trade dress was not functional. The court found E&G’s layout of the counter and tables and placement of lighting appeared to have only a functional purpose. Thus, E&G’s trade dress was not entitled to protection.

Regarding the non-compete provision, the court noted that E&G had no restaurants in Plano or anywhere in Texas. The closest E&G franchised restaurant was in Colorado. The court found no basis to hold that Janik’s new restaurant would compete with an existing E&G franchised restaurant.

While this decision is welcome news for franchisees, the outcome might have gone the franchisor’s way if it had other franchised restaurants near Janik’s location. Former franchisees should comply with de-identification requirements in their franchise agreements. The case is a warning for franchisors about potential consequences of not registering their trade dress and asserting generic claims for trade dress violations.

E&G Franchise Systems Inc. v. Janik, W.D. Wis., ¶16,301

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