j0399041In 2010, the United States Supreme Court famously ruled that in cases under the Petroleum Marketing Practices Act (“PMPA”), 15 U.S.C. § 2801 et seq., a franchisee could not state a claim for constructive termination unless the franchisor’s actions actually caused the franchisee to abandon its franchise. Mac’s Shell Service v. Shell Oil Prods. Co., 559 U.S. 175 (2010). Earlier this month, relying on this rule from Mac’s Shell, a federal district court in New Jersey ruled that two urgent care franchisees likewise could not state a claim for constructive termination under the New Jersey Franchise Practices Act where their franchisor’s challenged conduct did not actually cause them to abandon their franchises. See Pai v. DRX Urgent Care, LLC, Nos. 13–4333, 13–3558, 2014 WL 837158 (D. N.J. March 4,2014).

In granting the franchisor’s motion to dismiss, the court rejected the franchisee’s claims that the Mac’s Shell rule was not binding simply because it was a federal PMPA case, whereas their claims were based on New Jersey’s state franchise law. The court first noted that “Plaintiffs have asserted no reason why the statutes should be interpreted or applied differently, particularly where both statutes share the same purpose of protecting franchisees from termination without cause.” Id. at *8. The court then held explicitly that, “based on the Supreme Court’s holding in Mac’s Shell, a claim for constructive termination requires that a franchisee no longer be operating.” Id. at *9.

The Pai decision is at least the second federal district court decision extending the Mac’s Shell rule to state franchise law claims for constructive termination. See Bell v. Bimbo Foods Bakery Distribution Inc., Case No. 11–C–3343, 2012 WL 2565849 (N.D. Ill. July 2, 2012). Thus, it appears possible a trend may be growing to apply the Mac’s Shellreasoning to state law claims for constructive termination, even outside the PMPA context, thereby giving franchisors a new, potentially outcome determinative defense against state law claims for constructive termination.

Emmanuel Joseph was a franchised gasoline retailer for Chicago-area fuel distributor Sasafrasnet, LLC, who operated a BP-branded gasoline station in Chicago. In November 2010, Sasafrasnet notified Mr. Joseph that it was going to terminate his franchise under the Petroleum Marketing Practices Act (“PMPA”) because, on three separate occasions, it had been unable to electronically debit Mr. Joseph’s account to pay for fuel deliveries because his bank account did not have sufficient funds. Mr. Joseph filed suit and sought a preliminary injunction under the PMPA to enjoin Sasafrasnet from terminating him, but the district court denied the motion.

Mr. Joseph appealed to the Seventh Circuit. The court remanded the case to the district court because it found that it had failed to analyze under the PMPA whether (1) Mr. Joseph’s failure to ensure that sufficient funds were in his bank account was merely a technical failure or was unimportant to the franchise relationship; and (2) the failure was beyond his reasonable control.

On remand, the district court again found against Mr. Joseph, stating that having non-sufficient funds (“NSF”) to pay for motor fuel was not merely a technical failure when, as here, there were multiple instances of late payments of substantial amounts of money. The district court also found that at least two of Mr. Joseph’s NSFs were “failures” within the meaning of the PMPA because the circumstances were entirely within his control as he failed to give notice to Sasafrasnet that he had changed accounts and failed to ensure a smooth transition between his old and new account. Mr. Joseph again appealed to the Seventh Circuit, arguing that the failures were insignificant.

The Seventh Circuit affirmed the district court’s denial of Mr. Joseph’s request for preliminary injunction. See Joseph v. Sasafrasnet, LLC, — F.3d —-, No. 13-1202, 2013 WL 5911137 (7th Cir. 2013). The opinion is noteworthy largely because the court gave broad deference to the district court’s determination of whether the NSFs were important violations or were beyond the franchisee’s reasonable control. Indeed, the court conducted no independent review of Mr. Joseph’s arguments for why the NSFs were unimportant or beyond his control, instead finding that its role was only to determine whether the district court analyzed the key questions and made any “clear error.”

Because the Seventh Circuit showed no willingness to review the factual basis for the district court’s ruling, the case stands as a strong reminder that any request for injunctive relief under the PMPA remains almost entirely within the district court’s discretion. The Seventh Circuit will not conduct any independent analysis of the facts, so long as the district court analyzes whether the basis for the termination was more than a merely technical or unimportant failure or was beyond the franchisee’s control, and that decision is not so clearly in error that it constitutes a “clear abuse of discretion.”

Recently, the United States District Court for the Southern District of Indiana denied franchisor Steak n Shake’s motions to compel the non-binding arbitration of three consolidated lawsuits filed by three franchisees. The decision highlights the importance of a franchisor carefully monitoring and updating its dispute resolution policies in the context of the legal risks facing its system.

In April and May 2013, three franchisees sued Steak n Shake seeking, inter alia, a declaratory judgment regarding whether a menu pricing and promotions policy of Steak n Shake constitutes grounds for termination of their respective franchise agreements and alleging breach of contract, fraud, and violation of respective state franchise laws based on the same conduct. The franchisees’ agreements with Steak n Shake contain a dispute resolution provision, in which the franchisor “reserves the right to institute at any time a system of nonbinding arbitration or mediation.” At the time the lawsuits were filed, Steak n Shake did not have any such dispute resolution policy. More than a month after the lawsuits were initiated, however, Steak n Shake purported to implement a new policy requiring non-binding arbitration of any claims arising out of a Steak n Shake franchisee agreement, stating: “this policy does not represent a change, but is merely implementing a right previously reserved by the Company in certain of its franchise agreements.” Steak n Shake then moved to compel non-binding arbitration of all the franchisees’ claims and for a stay of the litigation under the Federal Arbitration Act (“FAA”).

The court denied Steak n Shake’s attempt to compel non-binding arbitration on several grounds. First – on an issue subject to a split among many Circuit Courts of Appeals, but not yet addressed by the Seventh Circuit – the court found that because they apply only to “non-binding arbitration or mediation,” the clauses do not constitute an agreement “to settle by arbitration a controversy” under Section 2 of the FAA; therefore, the dispute is not “referable to arbitration.” Second, the court found that the dispute resolution provision in the franchise agreements was illusory, hence unenforceable, because there was no limit on Steak n Shake’s “ability to avoid arbitration and/or its promise to arbitrate on a whim.” Thus, performance by Steak n Shake was entirely optional, which “cannot form the basis for a valid contract.” Third, the court found that, even if the dispute resolution provision was not illusory, the arbitration policy could not be applied retroactively to already pending lawsuits, unless expressly reserving such a right.

The decision highlights that the best practice is for a franchisor to regularly evaluate its dispute resolution procedures in the context of its current legal risk and emerging case law. If the policy does not fit current business and legal objectives, the franchisor should explore ways to change the policy system wide before a dispute occurs. The case is Druco Restaurants, Inc., et al. v. Steak n Shake Enterprises, Inc., et al., 1:13-CV-00560-LJM, 2013 WL 5779646 (S.D. Ind. Oct. 9, 2013). Plaintiffs are represented by Kirsten M. Ahmad, Joshua A. Stevens and Beth M. Conran in the litigation.

The United States District Court for the Eastern District of Pennsylvania recently enforced a non-compete clause in a franchise agreement and granted a franchisor a preliminary injunction against its former franchisee. The court noted that Pennsylvania law recognizes that a franchisor has a legitimate business interest that can be protected by a non-compete clause, and that there was adequate consideration for the non-compete clause in that the clause was entered into as a condition of the franchise relationship. The court then analyzed if the non-compete clause was “reasonably limited in both time and territory.” The non-compete clause at issue had a duration of two years and the geographic scope of the clause was limited to ten miles from the perimeter of the franchisee’s former territory or the territory of any other franchisee.

The court found that a two-year restriction was enough time for the franchisor to protect its legitimate business interest. The court further found that ten miles was a reasonable geographic limit because ten miles was the approximate distance a customer is willing to travel for the franchisor’s products. The court held that the franchisee was violating the non-compete clause by operating a business similar to franchisor’s business in the same location where the franchisee previously operated his franchise business. The court also noted that a franchisor’s business reputation is irreparably harmed when a former franchisee continues to operate at a franchise location after the expiration of a franchise agreement in violation of a non-compete clause.

Non-compete clauses can be a powerful way for franchisors to protect their legitimate business interests and to prevent former franchisees, who have access to a franchisor’s confidential and proprietary information, including product preparation, assembly techniques, sales techniques, merchandising and display techniques, and business and management practices, from infringing upon those legitimate business interests. A franchisor, however, should be cautious when including non-compete clauses in franchise agreements because each state’s laws are different when enforcing such provisions. It is important that franchisors consult with their legal counsel to determine the enforceability of any non-compete clauses contained in franchise agreements, which would include the state’s law regarding reasonableness of the duration and geographic scope of the non-compete clause. The case is Soft Pretzel Franchise Systems, Inc. v. Taralli, Inc., Civil Action No. 13-3790, 2013 WL 5525015 (E.D. Pa. October 4, 2013).

In Wells v. Holiday Companies, Inc., No. A12–1476, 2013 WL 777384 (Minn. Ct. App. 2013), the Minnesota Court of Appeals reversed an order granting a motion to dismiss a class action lawsuit alleging that car wash receipts constitute gift cards that cannot expire under state law.

Under Minnesota state law, gift certificates and gift cards cannot expire. In this case, when a customer purchased a car wash, the defendant convenience store printed a receipt that stated the price of the car wash and the fact that the car wash ticket was “good for 30 days.” The named plaintiff filed a class action lawsuit alleging that the ticket constituted a “gift card” under Minnesota state law, and therefore could not expire.

After the trial court granted the convenience store’s motion to dismiss, the plaintiff appealed, and the state appellate court reversed. The appellate court found that upon review of the requirements of Minnesota state law, the car wash receipt could constitute a “gift certificate” because it was a (1) tangible record, (2) promising that good or services would be provided, (3) made for consideration, (4) to the value shown in the record (i.e., for a specific amount of value/money). The court then remanded the case to the state trial court for further proceedings.

This case highlights the fact that under both state and federal law, a “gift card” is not necessarily limited to the traditional understanding of a plastic card that states the phrase “gift card” on the front. Instead, there is a possibility in many states and under the federal gift card law (Regulation E) that any tangible record (card, receipt, certificate, etc.) that stores value or represents money a consumer paid might be a “gift card” for legal purposes. Thus, retailers should be careful to ensure that any tangible record that they issue entitling a customer to goods or services – such as coupons, tickets, etc. – does not constitute a “gift card” before they allow those items to expire.

At the 36th Annual Forum on Franchising, Beata Krakus was recognized by the ABA with the Chair’s Future Leader Award. This award recognizes young and/or diverse Forum members who have demonstrated a substantial commitment to the Forum by undertaking significant leadership efforts, such as mentoring other Forum members or law students interested in pursuing careers in franchise law; working on membership marketing or other outreach efforts; assistance with special projects undertaken by the Forum Governing Committee or a Forum Division; or assisting with the Forum’s annual meeting.

The North American Securities Administrators Association, Inc. (NASAA) has released, for both public and internal comment, a proposed Multi-Unit Commentary related to disclosure of multi-unit franchising arrangements under the various state franchise disclosure laws.

The proposed Multi-Unit Commentary describes 3 multi-unit franchising structures and provides practical guidance related to disclosing such structures, which were not previously addressed under the NASAA’s 2008 Franchise Registration and Disclosure Guidelines or the Federal Trade Commission’s Franchise Rule. The proposed commentary also includes answers to questions concerning disclosure of multi-unit franchising arrangements specifically raised by franchise attorneys and state franchise examiners.

Beginning October 15, 2013 and continuing for a 30 day period, the public may submit comments to the proposed commentary. During the comment period, the Franchise and Distribution Group plan to prepare and submit its comments to the proposed Multi-Unit Commentary.

For more information on submitting comments to the proposed Multi-Unit Commentary or to obtain a copy of the proposed commentary, visit https://www.nasaa.org/nasaa-proposals/.

Recently, the Eighth Circuit affirmed a ruling upholding Missouri’s liquor statute requiring a corporation that wants to obtain a wholesaler license for the sale of intoxicating liquor containing alcohol in excess of five percent to be a “resident corporation.” Pursuant to Missouri’s statute, to qualify as a “resident corporation” requires that, among other things, all officers and directors be residents of Missouri for the three years immediately prior to filing the application. Additionally, all resident stockholders must own at least sixty percent of all the financial interests in the business.

Missouri uses a tier system to regulate the sale of alcohol, with a wholesaler the middleman between the producer and the retailer. Southern Wine and Spirits of America brought suit after its wholly owned subsidiary, Southern Wine and Spirits of Missouri, was denied a wholesaler license. Missouri’s Division of Alcohol and Tobacco denied its application because ninety-seven percent of the parent corporation’s voting shares, and fifty-one percent of its total shares, are owned by four Florida residents.

Upholding the residency requirement, the Eighth Circuit found that in enacting the statute the legislature could have believed that a resident wholesaler “is more apt to be socially responsible” and respond to the concerns of the state and its residents. The court also found that states may regulate the sale of alcohol so long as the state policies “treat liquor produced out of state the same as its domestic equivalent.” Therefore, the court concluded that the statute is constitutional because it does not treat out of state liquor differently as it only regulates wholesalers, and it is rationally related to the regulation of alcohol sales by the state. The case is Southern Wine and Spirits of America, Inc. v. Division of Alcohol and Tobacco Control (8th Cir. September 25, 2013).

Thank you to everyone who attended the 2013 Distribution Symposium. Below are some key points for you to keep in mind when bringing your products or services to the market. We look forward to seeing you at the 2014 Distribution Symposium.

  • Be prepared to adapt to change quickly to continue growing your business.
  • Keep in mind Dave Peacock’s principles for effective distribution:
  • Transparency: Always be clear on intentions and expectations
  • Accountability: Consequences for failure to perform
  • Discipline: Routine, financial, “inspect what you expect”
  • Integrity: Do what you say you are going to do
  • Ambidexterity: Must be able to adapt/change with business
  • Ownership: Active owners are key – owners make the difference
  • Great People: Great people attract more of the same
  • Make sure your contracts are adapted to your business and reflect your current practices.
  • Ensure objectives are communicated down the distribution chain and that information is sent back up.
  • Make your company a learning organization: track failures and what you learned from them. If an initiative is unsuccessful, be sure to record your learnings so they are not lost.

In response to the rapid growth of gift card sales and the variety of ways in which they are sold and redeemed, the IRS has been issuing guidance to address accounting issues associated with such sales. Most recently, the IRS issued Rev. Proc. 2013-29, which addresses the tax treatment of gift cards sold by one entity and redeemable by an unrelated entity. Prior to the issuance of Rev. Proc. 2013-29, if a taxpayer sold gift cards redeemable by an unrelated entity, the taxpayer would recognize as income the full value of the gift cards in the year of sale. The new guidance, however, allows a taxpayer to sell gift cards in one year, and in some circumstances, delay recognizing income from those sales until the subsequent year.

Under Rev. Proc. 2013-29, which modifies and clarifies Rev. Proc. 2011-18 and Rev. Proc. 2004-34, if a gift card is redeemable by an entity whose financial results are not included in the taxpayer’s applicable financial statement, the taxpayer only has to recognize the payment for the gift card in its income to the extent the gift card is redeemed during the tax year. Any payment received by a taxpayer that is not recognized in income in the year of receipt, must be recognized in the subsequent year. This is particularly relevant in the franchise context, because often one franchisee will sell a gift card, but the consumer will redeem the gift card at a different franchisee’s location. In addition, the new guidance would also apply to a franchisor who sells gift cards from its website for redemption at franchisee locations. If you have questions or would like more information related to the new guidance, contact a member of Greensfelder’s franchise and distribution team or its tax team.