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You are representing a franchisee, who just received
a letter from the franchisor terminating the franchise. Your immediate concern
is whether you can obtain an injunction to stave off the termination. As in any
case, however, it is important to understand at the outset the nature and amount
of monetary recovery available at the end of the road, after you have
established that your client is a "franchise" under the New Jersey
Franchise Practices Act and that the termination was in violation of the act.
This article outlines the elements of
recovery available in a franchise termination case under the New Jersey law and
discusses some particular issues likely to have a significant impact upon the
amount of the recovery.
Sources of Recovery: The Act and the
Common
Law
The starting point in
analyzing the recovery available to a New Jersey franchise in a termination case
is the act, which allows a franchisee to bring suit to recover any damages
sustained by reason of a violation of the act. If successful, the franchisee
also is entitled to costs of the action, including reasonable attorneys' fees.
Damages available under common law causes
of action should be considered as well. Depending upon the franchise agreement
in place, the termination may give rise to a claim for breach of contract, or
breach of the implied covenant of good faith and fair dealing. In addition,
where the franchisor's conduct has damaged the franchisee's relations with its
customers (e.g., by "bad-mouthing" the franchisee to customers), a
claim for tortious interference also may be alleged. Where recovery for tortious
interference is available, the franchisee should consider whether the
franchisor's conduct is sufficiently egregious to give rise to a claim for
punitive damages.
What Components of Recovery are Available?
Pre-Termination Loss of Profits
In Cooper u Amana ( Cooper II ), the
Third Circuit Court of Appeals held that a reduction in profits sustained by a
franchisee as a result of a franchisor's attempt to terminate the
franchise is recoverable. Thus, where a franchiser notifies the franchisee that
the franchise is being terminated and the franchisee obtains an injunction
barring the attempted termination, if the franchisee later is successful in
establishing that the attempt to terminate was unlawful, recovery will be
permitted for any loss of profits resulting from marketplace uncertainty
concerning the franchisee's ability to survive and fulfill its commitments.
Termination Value of Business
The largest component of any damages recovery in
a franchise termination case is likely to be the value of the business
itself. Where the termination is in violation of the act, such damages are
clearly available. A more difficult question, however, is how the termination
value of the business appropriately may be determined. This issue is addressed
below.
Consequential Damages
With respect to the availability of
consequential damages, an interesting question arises when the franchisee seeks
recovery for those damages sustained by its non-franchise business as a result of
the franchisor's violation of the act. Under the act, a business may qualify as
a "franchise" even though most of its sales are not derived from the
franchise. In Cooper II, for example, the franchisee was a distributor of
Amana appliances, but also distributed to its Amana customers specialty product
lines which complemented, rather than competed with, Amana products. Amana
encouraged Cooper to distribute the "complementary lines" and Cooper
earned considerable profits from them because they required little expenditure
of resources beyond that associated with the distribution of Amana products.
With the termination of Cooper's Amana franchise, it became economically
impractical to continue the complementary lines, and their value to Cooper was
destroyed.
Cooper argued that it should be permitted to
recover for the value of the loss of these complementary lines. Permitting such
recovery, Cooper argued, would be consistent with "the legislative intent
to make franchisees economically whole" and would be analogous to a
recovery for consequential damages in an action for breach of contract. The
Third Circuit disagreed, affirming the district court's denial of any recovery
for the loss of the complementary lines, the court held that
the complementary lines fall squarely within the
category of assets retained by the franchisee ...and the District Court properly
excluded their value from the damage calculation.
While it is clear there can be no recovery for
assets retained by the franchisee, the court's determination that complementary
business lines entirely destroyed by an unlawful termination constitute retained
assets is difficult to understand.
Punitive Damages
The act does not specifically provide for
the recovery of punitive damages. The trial court's decision in Westfield
Serv., Inc. v. Cities Serv. Oil Co., held that punitive damages were
available, but were not awarded, and the issue was not addressed in the
subsequent appellate decisions in the case. In the absence of specific language
in the act controlling case law, an argument that punitive damages are available
under the act is likely to meet formidable resistance.
However, in instances where
the franchisor's conduct in terminating the franchisee is particularly egregious
( e.g., the franchiser terminates a profitable franchisee in order to give the
business to a favored, new franchisee), the franchisee should be able to rely
upon favorable valuation methods not available when the termination is "in
good faith and for a bona fide reason."
Attorneys ' Fees and Costs
The act does not guarantee an
award of attorneys' fees, but provides that a franchisee may recover such fees
"if successful". Even where the franchisee is successful in
establishing liability for an unlawful termination, the extent of the fee
recovery may turn upon the extent of the franchisee's success in recovering the
full damages sought, or in obtaining injunctive relief.
In more complex cases, a sizable
component of the franchisee's monetary outlay in bringing the case to trial will
be fees paid to expert witnesses, such as accountants retained to determine the
appropriate value of the franchise. In state court actions, the issue should be
one purely of whether, under the act, "costs of the action" should
include monies paid to experts. There are no published decisions addressing this
issue directly. However, a good argument can be made that recovery of such
expert fees is consistent with the remedial purposes of the act and ensures that
a terminated franchisee is made whole. In federal court actions, a franchisee
will have to contend with the argument that recovery for expert fees is subject
to the limits provided by federal statute. However, the district court may look
to the act and New Jersey case law to determine whether, and in what amount,
expert costs may be recovered.
What is the Appropriate Valuation Date for
Measuring the Value of the Franchise?
While at first glance this may seem a
rather unimportant issue, it can have significant implications. In many cases,
it might be expected that the actual termination of the franchise is preceded by
a period when there was friction between the franchisor and franchisee, and
possibly even an attempted termination that was prevented by an injunction.
Where the franchise is valued as of the date of the actual termination, any
decline in franchisee sales in the pre-termination period may impact negatively
the calculation of the franchise's value. The franchisee can argue that such
sales figures are aberrational and, therefore, ought not to be relied upon, but
there is still some risk that the factfinder will accept the idea that a
hypothetical "willing buyer" would not pay much for the franchise
under a cloud of an attempted termination.
A franchisee may seek to avoid this problem by
valuing the franchise as of the date of the attempted termination. However, the
Third Circuit has held that valuing the franchise at a date prior to the actual
termination was not proper because the franchisee would receive
both (I ) the value of the franchise as of the
earlier date ( which would include the present value of the future earnings from
that date to the date of judgment ) and ( 2)the actual profits derived from the
franchise between the date of the attempted termination and the date of the
judgment.
Thus, unless the "double recovery"
problem is resolved, franchisees will need to direct their experts to determine
the value as of the date of the actual termination.
How Should the Termination Value of the Franchise
be Measured?
Should the termination value of the franchise be
the amount the franchise would have garnered in a hypothetical sale on the open
market, or may the franchisee base its valuation on some alternate formula, such
as the present value of future profits the franchise would have earned had there
been no termination? A franchisee may wish to avoid a valuation based upon a
hypothetical willing buyer/willing seller, because that valuation approach
presumes that there is a change in ownership of the franchise. The franchisor's
valuation expert will argue that this change in ownership introduces an element
of uncertainty that should be reflected in the valuation.
In Westfield Centre Serv.,lnc.
v. Cities Serv. Oil Co., the New Jersey Supreme Court stated:
Limiting
our consideration to the situation in which the franchisor acts in good faith
for a bona fide reason, the damages should be measured...in terms of the actual
reasonable value of the franchisee's
business when the franchisor cuts off the business...
Reasonable
value would be that price upon which willing parties, buyer and seller, would
agree for the sale of the franchisee's business as a going concern. Several
techniques of evaluation may be used.
In the first Cooper v. Amana case
considered ( Cooper I ), the Third Circuit stated that a franchise may be
valued as either "the present market value of lost future earnings or the
present value of the lost business" However, in Cooper II, the Third
Circuit backed off of its prior endorsement of alternative valuation measures
and expressed a strong preference, if not an outright requirement, for the use
of market value ( i.e., value based on the hypothetical willing buyer/willing
seller). The Cooper II court rejected the franchisee's arguments that the
value could be based upon the present value of lost future earnings expected if:
(1) the franchise remained in the hands of the present franchisee: or (2) the
franchise was taken over by the franchiser (as actually occurred). According to
the Cooper II court, the expropriation of the franchise by the franchiser
as part of national consolidation is a termination " in good faith and for
a bona fide reason" and thus requires use of the hypothetical
willing buyer/seller formula.
It can be argued that Cooper II turns the
act on its head by encouraging franchise termination. If the valuation is
limited to the value to the hypothetical buyer, and that value is less than the
value of the franchise when operated by the franchiser, then termination becomes
an economically attractive option for the franchiser. This approach arguably
fails to make the franchisee whole in that the franchisee is forced to accept a
value that is less than the value of the business to the franchisee.
Conclusion
The law in the area of
franchise termination damages is evolving. The Westfield and Cooper decisions
provide some guidance in terms of assessing what components of recovery will be
permitted and how recovery should be measured, but many questions remain.
Practitioners need to adopt a creative approach and may wish to look to other
areas of law for guidance in attempting to predict how issues relating to
franchise termination damages will be resolved.
Kenneth
K. Lehn, Esq.
Brian
J. Neff, Esq.
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