Franchise agreements are drafted by the franchisor and often franchisees do not, or cannot, negotiate modifications. Frequently, franchisors include provisions that reserve certain distribution rights to themselves or affiliates, often through e-commerce, wholesale, and retail stores. By doing so, franchisors guard against claims by franchisees for encroachment or breach of contract.
Franchisors also retain the right to modify their system, usually to ensure they can modify and protect intellectual property associated with their systems and adapt to meet market demands. Franchisees are usually required to promptly comply with changes implemented by the franchisor, which can be very expensive for franchisees.Before signing a franchise agreement, prospective franchisees should understand the potential impacts on their businesses when franchisors opt to distribute products or modify the system.
Competition
In the 1980s, Haagen-Dazs ice cream shop franchisees experienced a decline in sales after the franchisor began selling its ice cream in supermarkets and convenience stores.1 Franchisees sued for breach of contract and breach of the implied covenant of good faith and fair dealing, among other claims.2 The franchise agreement provided:
• Franchisee acknowledges and agrees that the Franchisor and the Haagen–Dazs trademark owner has the right and may distribute products identified by the Haagen–Dazs trademarks through not only Haagen–Dazs shops but through any other distribution method which may from time to time be established.3
The court determined that the franchisor operated within the purview of its contractual rights and dismissed franchisees’ claims that massdistribution of ice cream products through other channels breached the implied covenant of good faith and fair dealing in their franchise agreements.4
Carvel, a U.S.-based ice cream company that calls itself “America’s first ice cream franchise,”5 experienced a different outcome. In 1992 Carvel began selling its ice cream products out of supermarkets.6 It quickly expanded its supermarket sales program and ultimately, the franchisor advertised, marketed, promoted and subsidised the sale of its products in supermarkets, sometimes at much lower prices than franchisees charged for the same products.7 Aware of its franchisees’ objections to its supermarket program, Carvel brought suit seeking a declaration that the program did not breach its franchise agreements.8 Franchisees counterclaimed to enjoin Carvel from selling ice cream products in supermarkets because the practice directly competed with their businesses.9 The franchisees argued that they would not have purchased Carvel franchises if they expected Carvel would compete with them for sales and revenue by selling Carvel products in supermarkets and at wholesale.10 Carvel argued that the supermarket program was necessary.11 The court examined two versions of the Carvel franchise agreement andheld that the supermarket program did violate any express terms of one version.12 But, the court denied Carvel’s motion for summary judgment in all other respects.13 The court held that while the franchisees were “not entitled to abrogate Carvel’s right to ‘sell or license to sell products under Carvel trademarks…through the same or different delivery systems,” the implied covenant of good faith in the franchise agreements “entitled” the franchisees “to expect that Carvel will not act to destroy the right of the [franchisees] to enjoy the fruits of the contract.”14
System changes
Franchisors usually maintain the right to institute changes through their operations manuals. Common changes typically executed through franchisors’ operations manuals include changes to the computer or pointof- sale system. With the exponential growth of technology, change makes sense, but can be disruptive and costly to franchisees. Courts are looking to the franchise agreements when ruling on claims related to system change.
- In La Quinta Corp. v. Heartland Properties LLC, the hotel franchisor instituted changes to its reservation system expected to cost each franchisee $35,000 over a 10-year period.15 The court determined that the cost was permitted under the franchise agreement. The franchise agreement required the franchisee to, at its sole expense, comply with all system standards and expressly gave the franchisor the right to add, amend and/or delete system standards including for technology and the reservation system
- In Bird Hotel Corp. v. Super 8 Motels, Inc., the franchisor attempted to make changes to its customer loyalty program, which would result in imposing an additional 5% fee on gross room sales to certain customers.16 The court found that the franchise agreement specified a 2% fee and the franchisor could not unilaterally impose a fee for the program’s operation greater than what was provided in the franchise agreement. Thus, the franchisor breached the agreement by requiring franchisees to pay a total fee of 7% for participation in the loyalty program.
Presently, franchisors and franchisees are divided regarding mandated use of third-party delivery services, like Uber Eats and Door Dash. Courts will likely continue to examine the specific applicable contract provisions to determine the parties’ rights and obligations. Adhering to the terms of the franchise agreement and acting in good faith are important for franchisors. Reading and understanding the franchise agreement is crucial for franchisees.
1 Carlock v. Pillsbury Co., 719 F. Supp. 791, 798 (D. Minn. 1989)
superseded by Minn. Stat. Ann. § 80C.21 (choice of law provisions in
franchise agreements).
2 Id.
3 Id. at 802-803.
4 Id. at 816, 817, 820.
5 https://www.carvel.com/about-us (last visited Sept. 5, 2022).
6 Carvel Corp. v. Baker, 79 F. Supp. 2d 53, 56 (D. Conn. 1997).
7 Id. at 57.
8 See Id. at 56.
9 Id. at 59.
10 Id. at 57.
11 Id.
12 Id. at 66.
13 Id.
14 Id.
15 603 F.3d 327 (6th Cir. 2010).
16 2010 WL 572741 (D.S.D. Feb. 16, 2010).
