Franchise 101: Termination Is Not Enforcement; and Precluding Competition

March 2019

Franchisor 101: Termination Is Not Enforcement

A federal district court upheld an arbitration panel’s decision to deny attorneys’ fees to Benihana, even though Benihana won a dispute with its licensee. The licensee started arbitration claiming Benihana breached the parties’ license agreement. The licensee claimed Benihana unreasonably withheld approval of menus, advertisements, coupons, and signs and prevented the licensee from opening a restaurant in Hawaii. Benihana counterclaimed for breach by the licensee for refusing to comply with brand standards governing menus, advertisements, coupons, and signs.

The arbitral panel denied the licensee’s claims and found Benihana had good cause to terminate the agreement. Benihana requested attorneys’ fees and costs pursuant the license agreement. However, the arbitration panel declined to award Benihana attorneys’ fees and costs on the grounds that Benihana sought to terminate the license agreement, not to enforce it.

Benihana tried to vacate the part of the award that denied its request for attorneys’ fees. The court found support for Benihana’s claim that termination was one method for contractual enforcement. But while the arbitration panel’s reasoning was questionable, the court was obligated to confirm the award if there was “even a barely colorable justification for the outcome reached.” The court concluded that because deference to the panel was required, the award had to be upheld, including denial of attorneys’ fees.

This case illustrates a risk parties take by choosing arbitration to solve disputes. Although arbitration provisions are common in franchise agreements, and have some benefits, the case serves as a warning that arbitration can result in an unsatisfactory construction and application of the agreement.Benihana Inc. v. Benihana of Tokyo, LLC, No. 18 Civ. 7506 (PAE) (S.D.N.Y. Jan. 17, 2019)

Franchisee 101: Precluding the Competition

A commercial real estate relocation and consulting business franchisor (Relo) succeeded in getting a preliminary injunction to enforce a non-compete covenant against a former franchisee.

During the term of the franchise, a franchisee formed a competing company to offer similar services to those of Relo. The new company employed all the franchisee’s employees. The franchisee sent notice of the new business name to industry contacts, announcing it was “rebranding” the franchise. The franchisee gave notice to Relo that it was terminating the franchise agreement to work for the new company. Relo notified the franchisee that it was in breach of the non-compete covenant and sought a preliminary injunction to enjoin the franchisee from operating the competing business.

The franchisee argued the agreement was unenforceable under the Ohio Business Opportunity Act and common law because Relo fraudulently induced the franchisee to enter into the agreement with improper financial performance representations. Relo admitted showing the franchisee profit and loss statements but not until the franchisee’s “training week” which was after the franchisee received disclosures and signed the franchise agreement. The court found that Relo complied with the law regarding financial disclosures and that the franchisee did not have the allegedly false statements when it entered into the franchise agreement and thus could not have relied on them in deciding to sign the franchise agreement.

Franchisees should carefully review non-compete clauses in their franchise agreements. If the relationship with the franchisor goes sour, a non-compete covenant can preclude the franchisee from forming and operating a competing business. This is true even if the franchisee believes the franchisor breached the franchise agreement or committed fraud to convince the franchisee to enter into the franchise agreement.

Relo Franchise Services, Inc. v. Connor Gilman, et al., Case No. 1:18-cv-578 (S.D. Ohio Jan. 25, 2019)