Franchise 101: Sparring Over Successor Liability; and Inhospitable Hotel Software

Franchisor 101: Sparring Over Successor Liability

A New York federal court declined to dismiss certain breach of contract and misrepresentation claims by a franchisee against kick-boxing franchisor, ILKB, LLC, its key personnel and its successor, ILKB Too, LLC.

The franchisee, Golden Polar Bear, LLC (“GPB”) and its owners claimed ILKB provided information and representations that persuaded them to enter into a franchise agreement. When the kick-boxing studio performed poorly, GPB brought arbitration with ILKB. ILKB did not pay its share of the arbitration deposit, which halted the arbitration. ILKB’s personnel then formed a new entity, ILKB Too, which later acquired all ILKB’s assets and took over its business. GPB then sued ILKB, the key personnel, and ILKB Too, who in turn filed a motion to dismiss.

The court ruled that GPB did not have standing to sue on most of its claims, because even though GPB’s owners, the original signers of the franchise agreement, assigned the franchise agreement to GPB with consent of ILKB, they did not provide evidence of written consent to the court.

ILKB Too separately moved to dismiss for lack of personal jurisdiction. GPB’s owners argued the court had jurisdiction under the theory of successor liability. At the pleading stage, the court agreed. ILKB Too purchased ILKB’s assets, had the same owners and key personnel, continued operating ILKB’s business and used ILKB’s intellectual property, including ILKB’s trade names. The court found the acquisition was akin to a merger and, in certain circumstances, the successor can inherit its predecessor’s jurisdictional status. The court found such circumstances and concluded it had personal jurisdiction over ILKB Too.

The court let GPB’s breach of contract claim proceed because GPB’s owners adequately pled that they performed their obligations under the contract. The court allowed GPB’s owners’ fraud and misrepresentation claims based on alleged representations by ILKB’s key personnel regarding past events, historical facts, and statistics to proceed.

The court dismissed GPB’s owners’ claims related to opinions or predictions of future events. There are many reasons a franchisor may want to sell its assets to a related entity and reorganize. Sometimes, shielding the selling entity from existing litigation, debts or other liabilities is one of them. Franchise counsel can advise reorganizing franchisors on such aspects of the transaction, especially one to a related party.

Franchisee 101: Inhospitable Hotel Software

A New Jersey court partly granted and partly denied motions for summary judgement against a hotel franchisor, Baymont Franchise Systems, filed by Baymont’s former franchisee and defendant, SB Hospitality Palm Springs. The court let the franchisee’s counterclaims related to breach of contract and fraudulent inducement proceed.

In 2016, the parties entered into a franchise agreement and agreements related to the franchisor’s booking software and reservation system software. On May 1, 2018, SB Hospitality notified Baymont of its intent to terminate the franchise agreement because of problems with the reservation system. Baymont tried to dissuade SB Hospitality from terminating and claimed software issues had to do with a lack of training and not the software.

SB Hospitality terminated the franchise agreement on June 5, 2018, because the reservation software still was not operable. In response, Baymont sued SB Hospitality for liquidated damages under the franchise agreement for breach of contract. SB Hospitality counterclaimed.

The court denied summary judgement on the breach of contract claims because there was a question of fact as to who first breached the franchise agreement since both parties blamed the other for the reservation software issues. If a trier of fact found Baymont breached before SB Hospitality, then SB Hospitality’s performance may be excused under the franchise agreement.

The court denied summary judgment as to SB Hospitality’s counterclaim for breach of the software warranty provision in the software agreement. The court found disputed issues of fact concerning whether the software functioned properly and whether Baymont used reasonable efforts to fix software issues prior to terminating the franchise agreement.

The court allowed SB Hospitality’s fraud in the inducement claim to proceed related to Baymont’s representative’s stating that bookings would go up 40 to 50 percent if SB Hospitality signed the franchise agreement and misrepresented the effects of seasonal changes in bookings. A jury could find the franchise agreement was voidable based on these misrepresentations.

Franchisees should engage franchise counsel to review franchise agreements and related agreements prior to entering into the agreements. If issues arise from the agreements that affect the success of the franchise, experienced franchise counsel can assist with next steps and strategies to remedy the problem.

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