Franchise 101: Pizza Termination in 30 Days or Less; and Match-Taker

Franchisor 101: Pizza Termination in 30 Days or Less

An area developer entered into three agreements with a pizza franchisor and developed 50 franchises in Texas. The franchisor, Pizza Inn, Inc., tried to terminate all three contracts, though each had a twenty-year initial term and allowed two five-year renewals. The area developer sued for wrongful termination. A federal court in Texas denied Pizza Inn’s motion to dismiss the breach of contract claim.

At issue was whether the agreements’ termination provisions required the franchisor to give notice of the developer’s breach and time to cure. The agreement said the franchisor “may” give thirty days’ notice. The area developer argued that “may” meant the franchisor had discretion to give thirty days or a longer cure period, not discretion to give less than thirty days’ notice or no cure period. The court agreed. The franchisor had no discretion to terminate immediately; notice and a chance to cure were required. Only the amount of time between notice and the termination date was discretionary. The court ruled this was the only reasonable interpretation of the agreements [see: Division One Foods Inc. v. Pizza Inn Inc., N.D. Tex. Dallas Div. (July 27, 2021)].

The franchisor also argued that the area developer did not adequately plead its damages. The complaint alleged “Pizza Inn abruptly terminated the three Area Development Agreements, without cause” and claimed the area developer was denied its right to fifty percent share of all royalty, franchise fees and transfer fees generated in its territories. The court ruled these allegations adequately showed that Pizza Inn’s termination without notice or opportunity to cure resulted in damages to the area developer for the lost share of fees from franchisees.

Before issuing a notice of default or terminating a franchisee, area developer, area representative or subfranchisor, franchisors should consult franchise counsel and confirm compliance with all contract terms and state relationship laws. The default notice and cure periods in the agreement need to be followed to avoid breaching the agreement and reduce the risk of a claim for damages. There may be laws governing termination of franchisees to be considered, depending on the state where the area developer or franchisee is located.

Franchisee 101: Match-Taker

A San Francisco franchisee of the It’s Just Lunch matchmaking system received an offer to buy the franchised business for about $146,000 with the final price to be determined. Under the offer, the actual purchase price would depend on future revenues. The franchise agreement gave the franchisor a right of first refusal and right to approve the transfer. A California appellate court ruled the franchisee did not receive a valid third-party offer for the franchisor to invoke its right of first refusal under the franchise agreement.

The franchisor exercised its right of first refusal, with some modifications. The franchisee rejected the franchisor’s offer, which had changed some terms and, therefore, did not mirror the third-party’s offer as required in the franchise agreement. The franchisee also claimed it preferred selling to the third-party because it had a stronger financial record and operating history.

The franchisor sued in California state court to enforce its right of first refusal. The third-party purchaser joined the suit to enforce its rights in the transaction. The trial court held that the third-party offer was invalid because it was not a fixed purchase price, as required by the agreement. Because it was invalid, there was no bona fide offer for the franchisor to match and no right of first refusal to be exercised.

The appellate court agreed [see: IJLSF LLC v. It’s Just Lunch International, LLC, Cal. App., 4th Dist. (July 16, 2021)]. The franchise agreement required the offer to state a “dollar amount.” Depending on future revenue, the purchase price could be anywhere between $146,000 and $1,460,000. On that basis, the appellate court held the third-party offer was uncertain and affirmed the trial court’s ruling.

The franchisee also argued the franchisor waived any claim of invalidity by exercising its right of first refusal. The appellate court remanded the case for a further determination whether the franchisor waived its right to object to the sale.

Many franchise agreements outline a process for franchisees to present franchisors with bona fide purchase offers for their businesses, and procedures for franchisors to exercise a right of first refusal. Franchisees should consult franchise counsel when attempting to sell their business to a third-party to ensure the offer terms conform to the franchise agreement. Franchisees should be aware of rights the franchisor may have to match a third-party offer.

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