whole or in part.
1. Find out all you can about the franchisor: How long has the franchisor been in business? How profitable is
the business? Is there a healthy market for the product?
2. Obtain the most recent financial statement from the franchisor and a complete description of the
business.
3. Obtain a clear and complete statement of all fees that you will be required to pay.
4. Will the franchisor help you in training management and employees? With promotion and advertising? By
supplying capital or credit? In finding a good location for your business?
5. Visit other franchisees in the same business. Ask them about their experiences with the product, the
market, and the franchisor.
6. Evaluate your training and experience in the business on which you are about to embark. Are they
sufficient to ensure success as a franchisee?
7. Carefully examine the franchise contract provisions relating to termination of the franchise agreement.
Are they specific enough to allow you to sue for breach of contract in the event the franchisor wrongfully
terminates the contract? Find out how many franchises have been terminated in the past several years.
8. Will you have an exclusive geographic territory and, if so, for how many years? What plans does the
franchisor have in regard to telemarketing, electronic marketing, and mail-order sales to customers within the
territory?
9. Finally, the most important way to protect yourself is to have an attorney familiar with franchise law
examine the contract before you sign it.
III. Franchise Termination
A franchise usually begins with a short term, such as a year, which is extended or increased if everything
works out.
2. Opportunity to Cure a Breach
A franchisee may have the contractual opportunity to cure a breach and avoid termination. But this
is not likely on a breach of the duty of honesty and fidelity.
CASE SYNOPSIS—
Case 1.2: Mac’s Shell Service, Inc. v. Shell Oil Products Co.
For many years, Shell Oil Co. offered its franchisees a rent subsidy that reduced the monthly rent for their
service-station premises. The subsidy was renewed annually, subject to thirty days’ notice. As part of a joint
12 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
venture, Shell assigned some of its franchise agreements to Motiva Enterprises LLC. Motiva ended the rent
subsidy in the agreements. These franchisees filed a suit in a federal district court against Shell and Motiva,
alleging that eliminating the subsidy had constructively terminated their franchise agreements in violation of
the Petroleum Marketing Practices Act (PMPA). The court ruled in the franchisees’ favor. The U.S Court of
Appeals for the First Circuit affirmed. The defendants appealed.
The United States Supreme Court reversed and remanded. “A necessary element of any constructive
termination claim under the Act is that the franchisor’s conduct forced an end to the franchisee’s use of the
franchisor’s trademark, purchase of the franchisor’s fuel, or occupation of the franchisor’s service station. . . .
Conduct that foes not force an end to the franchise . . . is not prohibited.” This distinction falls within the
meaning of “the Act’s plain terms” and “is consistent with the general understanding of the doctrine of
constructive termination” under which “a plaintiff must actually sever a particular legal relationship.” None of
the franchisees here quit any part of their operations.
………………….………….………………………….………………..………..………….………………..…………….
Notes and Questions
Does a franchisee have any recourse when a franchisor changes the terms of their franchise
agreement? Yes, there could be grounds for a breach-of-contract suit, if the changes are imposed without
consent, and they are one-sided and unconscionable, or otherwise arguably in violation of the law. If the
contract had been induced by fraud, there is a basis for a claim. But if the franchisor acted in good faith and
dealt fairly, if the franchisee entered into the contract with full knowledge of its terms, and if the contract
included a notice provision with respect to the franchisor’s changes, there might be little ground on which the
franchisee could obtain relief.
ANSWERS TO LEGAL REASONING
QUESTIONS AT THE END OF CASE 1.2
1. Why might a franchisor want to terminate a franchise? Why might a franchisee want to continue
its association with a franchisor? A franchisor might want terminate a franchise for any of a number of
reasons. A franchisee may not be as profitable for the franchisor as might have been anticipated or as might
be necessary to continue the business relationship. A franchisee might prove incapable of maintaining certain
standards of goodwill, which could affect the public’s perception of all of the franchisor’s operations. A
franchisee might not be protective of a franchisor’s trademarks or other intellectual property.
Despite disagreements, a franchisee might want to continue its relationship with a franchisor to increase
profits. Franchisee, who normally invests a substantial amount of time and financial resources in making a
franchise operation successful, may receive little or nothing for the business on termination. The same
reasons that attracted the franchisee to the franchise in the first place might support its
continuance-association with a national organization, a well-known or familiar brand, national marketing and
advertising, and other factors.
2. In this case, if Shell Oil Products Company wanted to terminate the plaintiffs’ franchises, why
didn’t Shell simply notify the franchisees that the franchises were terminated effective immediately?
The franchisor may have wanted to motivate the franchisees to improve their operations by terminating their
relationships over a period of time. Or the franchisor might have opted to cut only the least profitable outlets
first, anticipating increased business in the remaining locations. And a franchisor’s termination of a franchise
often has adverse consequences for the franchisee, which can lead to litigation involving claims of wrongful
termination. The franchisor may want to avoid the adverse publicity and expense of litigation if there are other
possibilities.
3. The PMPA regulates only the circumstances in which franchisors may terminate a franchise or
decline to renew a franchise relationship. Are there any reasons why Congress might have limited the
scope of the PMPA to just these two aspects of franchising? Explain. In enacting the PMPA, Congress
left undisturbed the body of state law, including contract law and state statutes and regulations, governing
franchising relationships. As noted in this chapter, contract law applies to all contracts, including franchise
contracts. If the franchised business involves the sale of goods, Article 2 of the Uniform Commercial Code
applies. Most states have also enacted legislation governing specific aspects of franchising relationships,
largely for the purpose of protecting franchisees against dishonest franchisors and to prevent franchisors from
terminating franchises without good cause. The federal government has limited its involvement in the
franchising area, restricting its regulation to just certain industries. For example, the Automobile Dealers’
Franchise Act of 1965 offers protections for automobile dealerships. In addition, the 1978 Franchise Rule of
the Federal Trade Commission imposed disclosure requirements on franchisors so that franchisees can
better evaluate the risks and benefits of an investment. When Congress enacted the Petroleum Marketing
Practices Act in 1979, it did not intend to preempt state laws governing franchise relationships in the
petroleum industry. Rather, it focused on the two aspects of franchising in that industry with which it was most
concerned—the termination of and the failure to renew franchise relationships. Congress passed the PMPA
only after concluding that state laws did not offer sufficient protection to franchisees in these areas.
4. Suppose that some of the service-station franchisees, on the expiration of their contracts with
Shell, signed a renewal agreement with Motiva, even though the franchisees believed that the rental
terms of the new agreement were unacceptable. Given the Court’s reasoning on the issue of
constructive termination, would the franchisees have been likely to succeed in a suit against the
franchisor for “constructive nonrenewal” of the franchise agreement? Why or why not? Probably not.
In fact, one of the issues in this case—not included in the excerpt of the Court’s opinion given in the text—
involved this question. The federal district court held for the franchisees on this issue, but the First Circuit
Court of appeals reversed the district court’s judgment, holding that a franchisee cannot maintain a claim for
unlawful nonrenewal under the PMPA “where the franchisee has signed and operates under the renewal
agreement complained of.” The Supreme Court affirmed the appellate court’s decision on this issue. The
Court stated that, “the plain text of the statute [the PMPA] leaves no room for a franchisee to claim that a
franchisor has unlawfully declined to renew a franchise relationship—constructively or otherwise—when the
franchisee has in fact accepted a new franchise agreement.”
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Other cases focusing on the termination of franchises include the following:
• Zeidler v. A & W Restaurants, Inc., 301 F.3d 572 (7th Cir. 2002) (a franchisee’s closing of its restaurant
barred it from establishing that the franchisor wrongfully terminated the franchise, even though the franchisee
asserted that the franchisor acted in bad faith by threatening termination, because the franchisee could not
show a link between the termination threats and the restaurant’s closure and the voluntary abandonment of
whole or in part.
whole or in part.
16 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
………………….………….………………………….………………..………..………….………………..…………….
Notes and Questions
A jury awarded HAI compensatory damages of $13 million, but the trial court reduced this amount
to $10 million. What most likely served as the jury’s basis for its award? Why did the court reduce it?
The jury based its award on $3 million for the cost of the renovations undertaken at Holiday Inn’s request
before the franchise extension was denied, and $10 million as the cost of the lost opportunity to sell the hotel.
The court reduced this amount by about $3 million, however, in consideration of the amount that HAI earned
from the hotel before it was sold for $5 million.
A jury awarded HAI $12 million in punitive damages. The state court reduced this to $1 million, but
the appellate court reinstated the original award. What is the purpose of punitive damages? Did
Holiday Inn’s conduct warrant the $12 million punitive damages award? Explain. The purpose of
punitive damages is to punish a defendant and deter similar future conduct. Yes, Holiday Inn’s conduct
supported the increased amount of punitive damages. The harm to HAI was substantial. Holiday Inn—which
is a wealthy, a multi-national corporation—failed to disclose significant information to House with whom it had
worked for decades on a basis of good faith and trust. Holiday Inn caused House to spend $3 million on a
hotel that he believed would be granted an extended franchise when a denial of the extension was already
planned. The failure to disclose the plan, which Holiday Inn knew that House and HAI were entitled to,
suggests a deliberate attempt to keep them unapprised. This supports the appellate court’s conclusion that
“Holiday Inn’s degree of reprehensibility” justified the original punitive damages award.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 1.3
Why should House and HAI have been advised of Holiday Inn’s plan to grant a franchise to a
different hotel in their territory? House and HAI should have been informed of Holiday Inn’s plan to grant a
franchise to a different local hotel in order to evaluate the economic risk of spending millions of dollars on the
franchisor’s requested renovations. This might not be as warranted in a case involving a different relationship
between the parties, but these parties had done business on a basis of trust for decades.
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 1.3
A jury awarded HAI $12 million in punitive damages. The state court reduced this to $1 million, but
the appellate court reinstated the original award. What is the purpose of punitive damages? Did
Holiday Inn’s conduct warrant the $12 million punitive damages award? Explain. The purpose of
punitive damages is to punish a defendant and deter similar future conduct. Yes, Holiday Inn’s conduct
supported the increased amount of punitive damages. The harm to HAI was substantial. Holiday Inn—which
is a wealthy, a multi-national corporation—failed to disclose significant information to House with whom it had
worked for decades on a basis of good faith and trust. Holiday Inn caused House to spend $3 million on a
12 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
whole or in part.
venture, Shell assigned some of its franchise agreements to Motiva Enterprises LLC. Motiva ended the rent
subsidy in the agreements. These franchisees filed a suit in a federal district court against Shell and Motiva,
alleging that eliminating the subsidy had constructively terminated their franchise agreements in violation of
the Petroleum Marketing Practices Act (PMPA). The court ruled in the franchisees’ favor. The U.S Court of
Appeals for the First Circuit affirmed. The defendants appealed.
The United States Supreme Court reversed and remanded. “A necessary element of any constructive
termination claim under the Act is that the franchisor’s conduct forced an end to the franchisee’s use of the
franchisor’s trademark, purchase of the franchisor’s fuel, or occupation of the franchisor’s service station. . . .
Conduct that foes not force an end to the franchise . . . is not prohibited.” This distinction falls within the
meaning of “the Act’s plain terms” and “is consistent with the general understanding of the doctrine of
constructive termination” under which “a plaintiff must actually sever a particular legal relationship.” None of
the franchisees here quit any part of their operations.
………………….………….………………………….………………..………..………….………………..…………….
Notes and Questions
Does a franchisee have any recourse when a franchisor changes the terms of their franchise
agreement? Yes, there could be grounds for a breach-of-contract suit, if the changes are imposed without
consent, and they are one-sided and unconscionable, or otherwise arguably in violation of the law. If the
contract had been induced by fraud, there is a basis for a claim. But if the franchisor acted in good faith and
dealt fairly, if the franchisee entered into the contract with full knowledge of its terms, and if the contract
included a notice provision with respect to the franchisor’s changes, there might be little ground on which the
franchisee could obtain relief.
ANSWERS TO LEGAL REASONING
QUESTIONS AT THE END OF CASE 1.2
1. Why might a franchisor want to terminate a franchise? Why might a franchisee want to continue
its association with a franchisor? A franchisor might want terminate a franchise for any of a number of
reasons. A franchisee may not be as profitable for the franchisor as might have been anticipated or as might
be necessary to continue the business relationship. A franchisee might prove incapable of maintaining certain
standards of goodwill, which could affect the public’s perception of all of the franchisor’s operations. A
franchisee might not be protective of a franchisor’s trademarks or other intellectual property.
Despite disagreements, a franchisee might want to continue its relationship with a franchisor to increase
profits. Franchisee, who normally invests a substantial amount of time and financial resources in making a
franchise operation successful, may receive little or nothing for the business on termination. The same
reasons that attracted the franchisee to the franchise in the first place might support its
continuance-association with a national organization, a well-known or familiar brand, national marketing and
advertising, and other factors.
2. In this case, if Shell Oil Products Company wanted to terminate the plaintiffs’ franchises, why
didn’t Shell simply notify the franchisees that the franchises were terminated effective immediately?
The franchisor may have wanted to motivate the franchisees to improve their operations by terminating their
relationships over a period of time. Or the franchisor might have opted to cut only the least profitable outlets
first, anticipating increased business in the remaining locations. And a franchisor’s termination of a franchise
often has adverse consequences for the franchisee, which can lead to litigation involving claims of wrongful
termination. The franchisor may want to avoid the adverse publicity and expense of litigation if there are other
possibilities.
3. The PMPA regulates only the circumstances in which franchisors may terminate a franchise or
decline to renew a franchise relationship. Are there any reasons why Congress might have limited the
scope of the PMPA to just these two aspects of franchising? Explain. In enacting the PMPA, Congress
left undisturbed the body of state law, including contract law and state statutes and regulations, governing
franchising relationships. As noted in this chapter, contract law applies to all contracts, including franchise
contracts. If the franchised business involves the sale of goods, Article 2 of the Uniform Commercial Code
applies. Most states have also enacted legislation governing specific aspects of franchising relationships,
largely for the purpose of protecting franchisees against dishonest franchisors and to prevent franchisors from
terminating franchises without good cause. The federal government has limited its involvement in the
franchising area, restricting its regulation to just certain industries. For example, the Automobile Dealers’
Franchise Act of 1965 offers protections for automobile dealerships. In addition, the 1978 Franchise Rule of
the Federal Trade Commission imposed disclosure requirements on franchisors so that franchisees can
better evaluate the risks and benefits of an investment. When Congress enacted the Petroleum Marketing
Practices Act in 1979, it did not intend to preempt state laws governing franchise relationships in the
petroleum industry. Rather, it focused on the two aspects of franchising in that industry with which it was most
concerned—the termination of and the failure to renew franchise relationships. Congress passed the PMPA
only after concluding that state laws did not offer sufficient protection to franchisees in these areas.
4. Suppose that some of the service-station franchisees, on the expiration of their contracts with
Shell, signed a renewal agreement with Motiva, even though the franchisees believed that the rental
terms of the new agreement were unacceptable. Given the Court’s reasoning on the issue of
constructive termination, would the franchisees have been likely to succeed in a suit against the
franchisor for “constructive nonrenewal” of the franchise agreement? Why or why not? Probably not.
In fact, one of the issues in this case—not included in the excerpt of the Court’s opinion given in the text—
involved this question. The federal district court held for the franchisees on this issue, but the First Circuit
Court of appeals reversed the district court’s judgment, holding that a franchisee cannot maintain a claim for
unlawful nonrenewal under the PMPA “where the franchisee has signed and operates under the renewal
agreement complained of.” The Supreme Court affirmed the appellate court’s decision on this issue. The
Court stated that, “the plain text of the statute [the PMPA] leaves no room for a franchisee to claim that a
franchisor has unlawfully declined to renew a franchise relationship—constructively or otherwise—when the
franchisee has in fact accepted a new franchise agreement.”
ADDITIONAL CASES ADDRESSING THIS ISSUE —
Other cases focusing on the termination of franchises include the following:
• Zeidler v. A & W Restaurants, Inc., 301 F.3d 572 (7th Cir. 2002) (a franchisee’s closing of its restaurant
barred it from establishing that the franchisor wrongfully terminated the franchise, even though the franchisee
asserted that the franchisor acted in bad faith by threatening termination, because the franchisee could not
show a link between the termination threats and the restaurant’s closure and the voluntary abandonment of
whole or in part.
whole or in part.
16 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS
………………….………….………………………….………………..………..………….………………..…………….
Notes and Questions
A jury awarded HAI compensatory damages of $13 million, but the trial court reduced this amount
to $10 million. What most likely served as the jury’s basis for its award? Why did the court reduce it?
The jury based its award on $3 million for the cost of the renovations undertaken at Holiday Inn’s request
before the franchise extension was denied, and $10 million as the cost of the lost opportunity to sell the hotel.
The court reduced this amount by about $3 million, however, in consideration of the amount that HAI earned
from the hotel before it was sold for $5 million.
A jury awarded HAI $12 million in punitive damages. The state court reduced this to $1 million, but
the appellate court reinstated the original award. What is the purpose of punitive damages? Did
Holiday Inn’s conduct warrant the $12 million punitive damages award? Explain. The purpose of
punitive damages is to punish a defendant and deter similar future conduct. Yes, Holiday Inn’s conduct
supported the increased amount of punitive damages. The harm to HAI was substantial. Holiday Inn—which
is a wealthy, a multi-national corporation—failed to disclose significant information to House with whom it had
worked for decades on a basis of good faith and trust. Holiday Inn caused House to spend $3 million on a
hotel that he believed would be granted an extended franchise when a denial of the extension was already
planned. The failure to disclose the plan, which Holiday Inn knew that House and HAI were entitled to,
suggests a deliberate attempt to keep them unapprised. This supports the appellate court’s conclusion that
“Holiday Inn’s degree of reprehensibility” justified the original punitive damages award.
ANSWER TO “THE LEGAL ENVIRONMENT DIMENSION”
QUESTION IN CASE 1.3
Why should House and HAI have been advised of Holiday Inn’s plan to grant a franchise to a
different hotel in their territory? House and HAI should have been informed of Holiday Inn’s plan to grant a
franchise to a different local hotel in order to evaluate the economic risk of spending millions of dollars on the
franchisor’s requested renovations. This might not be as warranted in a case involving a different relationship
between the parties, but these parties had done business on a basis of trust for decades.
ANSWER TO “THE ECONOMIC DIMENSION”
QUESTION IN CASE 1.3
A jury awarded HAI $12 million in punitive damages. The state court reduced this to $1 million, but
the appellate court reinstated the original award. What is the purpose of punitive damages? Did
Holiday Inn’s conduct warrant the $12 million punitive damages award? Explain. The purpose of
punitive damages is to punish a defendant and deter similar future conduct. Yes, Holiday Inn’s conduct
supported the increased amount of punitive damages. The harm to HAI was substantial. Holiday Inn—which
is a wealthy, a multi-national corporation—failed to disclose significant information to House with whom it had
worked for decades on a basis of good faith and trust. Holiday Inn caused House to spend $3 million on a