IMPLEMENTING SYSTEM UPGRADES AND ENHANCEMENTS: BUSINESS AND LEGAL CONSIDERATIONS

David J. Kaufmann Kaufmann Gildin Robbins & Oppenheim LLP New York, New York

Robert Zarco Zarco, Einhorn, Salkowski & Brito, P.A. Miami, Florida

By: Kenneth A. Cutshaw* Chief Legal Officer Cajun Global LLC (Franchisor of Church’s Chicken) Atlanta, Georgia

International Franchise Association 44th Annual Legal Symposium

May 15-17, 2011

*Mr. Cutshaw is a contributing author of certain segments of this paper.

TABLE OF CONTENTS

I. INTRODUCTION ...... 1 II. CASE LAW ADDRESSING MATURE FRANCHISOR SYSTEM/CONCEPT MODIFICATION ...... 2 A. Systemic Changes ...... 2 B. Price Point Advertising/Resale Price Maintenance ...... 8 C. System Modification Attendant to Franchisor Acquisition...... 12 1. Analyzing the Motives Underlying Proposed Acquisition Activity...... 13 2. The Third Player at the Table ...... 15 3. The Franchise Agreements at Issue...... 16 4. Judicial Decisions Addressing Franchise Network Acquisitions ...... 17 D. Impact of Franchise Relationship Law on Ability to Modify System ...... 23 E. E-Commerce ...... 25 F. Prior Course of Dealing ...... 27 III. SUGGESTED FRANCHISE AGREEMENT PROVISIONS ...... 31 A. Network Modification...... 31 B. Co-Branding ...... 31 C. Uniformity Of Retail Prices Within Network (Retail Price Maintenance Keyed To Price Point Advertising) ...... 32 D. Franchisor’s Right To Acquire Other Businesses, Be Acquired, Go Public, Go Private Or Merge ...... 32 E. Network Reidentification (New Or Additional Marks) ...... 33 F. Franchisor’s Reserved Rights Within Franchisee’s Territory...... 33 G. Franchised Unit Remodeling ...... 35

i

I. INTRODUCTION

A constant source of tension between mature franchisors and their franchisees is the periodic need to modify the network’s concept and system to keep up with (or ahead of) the competition; to incorporate new technologies; to respond to changed consumer demographics, ethnicities, preferences and trends; to introduce new products or services and delete from the system older products and services; to modify existing trademarks/service marks, or abandon them altogether in favor of new trademarks/service marks; to modify the exterior and interior design of the network’s units and the equipment utilized thereat; to establish new advertising platforms and campaigns; to require integration of new technologies; to compel franchisees to undergo additional training regarding the foregoing; and, otherwise to keep the mature franchise network’s image, products and/or services fresh, competitive and responsive.

Sometimes, modifying a mature franchisor’s concept and system requires franchisees to make only slight changes. Other times, substantial unit renovations, franchisee retraining and new product/service offerings are involved. Yet other times, a complete system overhaul is involved, requiring franchisees to retrofit their units completely to the new concept, operate under new trademarks/service marks and deal with entirely new product/service lines in lieu of existing product/service lines (whether attendant to a “conversion” acquisition of the chain -- as when United Parcel Service [“UPS”] acquired the Mail Boxes Etc. network -- or merely to recast the franchise network’s competitive positioning).

Modifying the mature franchisor’s system almost always involves a degree of expense to be absorbed by the franchisee. As reflected by the range of activity set forth above, sometimes this franchisee expense is minimal, and sometimes it is most substantial.

Frequently, the mature franchisor’s attempt to overhaul its system encounters resistance from franchisees, which can range from slight to massive depending upon the degree of franchisee investment required; franchisee uncertainty about what the economic impact will be of the contemplated changes; the sometimes disparate burdens the overhaul will trigger among franchised units; the number of years remaining before franchise expiration; and, truth be told, franchisee inertia (“I’ve been doing this for so long, I don’t want to change my ways now”).

It is useful to remember that a number of McDonald’s franchisees were absolutely aghast when, following many years of tests, McDonald’s informed them three decades ago that the McDonald’s system would now include breakfast. Over the previous decades, McDonald’s restaurants were keyed only to lunch and dinner. The notion of opening their units before dawn, having to add an extra shift, having to learn how to prepare and offer a multiplicity of new menu items and investing the money required to achieve the foregoing (including unit renovations) prompted great fear and, 1 sometimes, hostility on the part of some McDonald’s franchisees. In hindsight, of course, such concerns seem unworthy, since McDonald’s launch into the breakfast arena proved so popular and profitable to all concerned. But at the time, the concerns were very real.

McDonald’s franchisees were not alone in having to confront significant system and concept changes. Pizza Hut franchisees had to get into delivery when Domino’s success thereat started threatening Pizza Hut’s market share. Several commonly controlled franchise networks – such as Dunkin’ Donuts and Baskin Robbins - - had to learn how to co-brand each other’s products to increase both chains’ menu offerings and daypart opportunities. Virtually every guest lodging network over the past decade had to implement a “guest loyalty” program and properly allocate its costs and benefits. And McDonald’s franchisees once again recently confronted a significant system overhaul - - the implementation of the new “McCafe” coffee concept.

The ability of a mature franchisor to effect such system/concept changes largely derives from the reserved contractual right to do so. Franchise agreement language addressing this subject is critical - - and we furnish suggested language below.

But even when franchise agreement language specifically reserving to the franchisor the right to initiate systemwide changes is extant, franchisee lawsuits complaining of the franchisor’s exercise of said right have been forthcoming, as analyzed immediately below. To minimize the risk of such lawsuits, a franchisor is well- advised to be sensitive to the franchisee community’s receptiveness to the change. Even if the contract imbues the franchisor with the authority to require a change, consideration should be given to “selling” the change to franchisees, so that the franchisee perceives the requirement not as a mandate, but rather as a logical business investment. Thus, as a practical matter, the way in which the mature franchisor rolls out system-wide change among franchisees can be just as critical to a successful transition as the enabling contractual language. While the franchise agreement provides the contractual authority for change on the one hand, the well-prepared franchisor will also take proactive measures to present to franchisees a compelling business case for the change. Such efforts on the front end serve to minimize dissent and friction with the franchisees.

II. CASE LAW ADDRESSING MATURE FRANCHISOR SYSTEM/CONCEPT MODIFICATION

A. Systemic Changes

It did not take long for a franchisee to sue its franchisor complaining of imposed system modifications.

2 The franchisor in question - - Burger King - - was not so “mature” at the time, namely 1966. It was then that a franchisee, in Trail Burger King, Inc. v. Burger King of Miami, Inc.,1 complained of Burger King changing certain standards and specifications - - including an increase in the quantity of meat to be used in making hamburgers. The franchisee refused to comply with Burger King’s new standards. According to the Court, the franchisee deliberately sold hamburgers containing less meat than Burger King’s new specifications required; refused to provide adequate condiments on tables; refused to provide background music; refused to paint his building; and, utilized unauthorized drink dispensers. The franchisee filed suit over Burger King’s threatened termination of its franchise.

Following a motion for a judgment on the pleadings, the Court found that there was no question of fact to be determined and held that Burger King had the right “...to set and maintain standards and specifications for the operation of plaintiff(s) restaurant and to make reasonable changes in such standards and specifications from time to time as circumstances may dictate...”.2

Affirming the lower court’s decision in this 1966 case, the judiciary early on sounded a theme that has carried through to today, namely: that a franchisor’s modification of its system is not equivalent to modification of the underlying franchise agreement but, rather, a mere effectuation of that agreement, as follows:

The plaintiff argues that any changes in standards and specifications in the operation of its restaurant from those in existence at the time of the execution of the agreement would be a modification or amendment thereto. It is also argued that since the agreement provides for its modification and amendment only by the written consent of both parties, the (court below) erred in allowing the defendant to make reasonable changes from time to time as circumstances may dictate.

We have found that the (court below) was correct in determining that such changes are not modifications or amendments to the agreement, but were provided for in the agreement. It is clear from the language of the instrument that one of the objects is to provide uniformity among all franchised “Burger King” restaurants. Review of the clauses of the agreement...reveals that this uniformity is accomplished by providing that the defendant set and maintain standards and specifications which the plaintiff must follow or suffer termination of the agreement. The (court below) has interpreted the agreement in accordance with the natural and ordinary meaning of the language employed (emphasis added).3

3 That franchisees complaining of proposed system modifications are actually the intended beneficiaries thereof was made clear in Principe v. McDonald’s Corp.,4 in which the Fourth Circuit Court of Appeals observed:

...(P)ervasive franchisor supervision and control benefits the franchisee... His business is identified with a network of stores whose very uniformity and predictability attracts customers.

Not all courts necessarily admire strict franchisor control and the ability to impose systemwide modifications - - but even when they don’t, they generally rule in the franchisor’s favor regardless. In Frusher et al. v. Baskin-Robbins Ice Cream Co.,5 the Court had before it a franchisee who had failed to implement systemic changes implemented by Baskin-Robbins including remodeling, refurbishing, and selling a wider range of non-Baskin-Robbins products such as Coca-Cola. The franchisee closed her store, filed for bankruptcy and commenced an adversary proceeding against Baskin- Robbins, alleging inter alia that Baskin-Robbins’ refusal to grant her the new product line (including yogurt) unless she remodeled was tantamount to breach of contract.

The Court, on Baskin-Robbins’ motion, dismissed each and every claim advanced by the franchisee, observing:

...(W)e conclude that (the franchisee’s) failure to shape up and live up to the conditions in the new (franchise) agreement gave Baskin-Robbins reasonable cause to refuse her the new product line. In addition, Baskin- Robbins has introduced credible...testimony indicating numerous, although from (the franchisee’s) standpoint, picayune violations of the franchise agreement. Her allegation of breach of contract against Baskin- Robbins is not supported by the evidence, while her own shortcomings as a franchisee are pretty well established.6

Not that the Court seems to have been thrilled by the notion of compulsory compliance with franchisor system standards. To the contrary, while granting Baskin- Robbins its requested relief, the Court took a shot at franchising’s core concept of uniformity:

Running throughout this business relationship is the “theme” that (the franchisee) was paying the price of independence, and that she could not or would not fit the mold required of national franchisees. The fact that (the franchisee) was not willing to become a Baskin-Robbins’ clone is, at the same time admirable, and yet fatal to her case.7

Over the years, virtually every court asked to rule on a mature franchisor’s ability to modify its system and concept have sided with the franchisor. For example, in Economou et al. v. Physicians Weight Loss Centers of America et al.,8 at issue was a 4 franchisee’s claim that its weight loss franchisor’s change of program diet, consequent decrease in the franchise network’s consumer weight loss guarantee and the franchisor’s directive that the franchisee disseminate an information sheet warning about certain risks associated with its diet caused such grave economic harm to the franchisee that it was entitled to declare the contract terminated and to operate free of the subject franchise agreement’s covenant not to compete.

Denying the franchisee’s motion for a preliminary injunction, the Court observed that: “In any event, the fact remains that the franchise agreements specifically allow (the franchisor) to make such changes... These contractual clauses serve to defeat plaintiffs’ breach of contract claim... In sum, this court finds that defendants have shown a substantial likelihood of success on the merits”.9

In turn, the Court granted the franchisor’s cross-motion for a preliminary injunction enforcing its covenant not to compete.

Similarly, in Great Clips, Inc. v. Levine et al.,10 the Court had before it a franchisee complaining that its franchisor’s policy manual amendments incorporating new retail price restrictions amounted to a breach of contract, violation of the Sherman Act and violation of the implied covenant of good faith and fair dealing. The Court disagreed, granting to franchisor Great Clips its requested declaratory judgment that no Sherman Act violation was extant and that no violation of the implied covenant had transpired.

A recent indication, however, that courts will not necessarily bless any and all franchise system changes characterized as policy manual amendments came down in BKC v. Cabrera, et al.11 In Cabrera, the District Court for the Southern District of Florida denied the franchisor’s motion for a preliminary injunction to oust a purportedly terminated franchisee from its ten restaurants. The franchisor’s grounds for the alleged termination were that the franchisee had failed to comply with a policy manual amendment that required franchisees to install new (and expensive) POS equipment by a certain date. The franchisor relied on commonly-used franchise agreement language wherein the franchisee agreed that complying with changes to the policy manual was “reasonable, necessary and essential to the image and success of all Burger King Restaurants.”

One of the franchisee’s arguments in support of its counterclaims for wrongful termination was that the plain language of the franchise agreement limited the franchisor’s ability to require equipment upgrades to specific situations. The section of the franchise agreement, entitled “Equipment,” specifically described the circumstances under which the franchisor may demand its franchisees to replace a given piece of equipment: (1) when it is obsolete or inoperable; (2) due to a change in menu; (3) due to a change in method of preparation and service of product, or (4) for health and safety considerations. The franchisee argued that none of those scenarios had come to pass, 5 and therefore he was under no obligation to replace his equipment. In response, the franchisor maintained that its authority to make such a demand did not arise from the “Equipment” section of the franchise agreement, but rather from a paragraph of recitals wherein the franchisee agreed that prompt adoption and adherence to changes in the policy manual was “reasonable, necessary and essential to the image and success of all Burger King Restaurants.” The court, however, ruled that the franchisor could not solely rely on this general language, finding that it was a general principle of contract interpretation that a specific provision dealing with a particular subject will control over a different provision dealing only generally with that same subject.12 The injunction was denied. To move forward the franchisor would have to first prove that the termination of the franchisee was valid under the franchise agreement by corralling evidence to demonstrate that one of the contractually enumerated scenarios wherein the franchisor may demand equipment replacement had transpired. As of the date of this publication, this case remains pending. The court in Cabrera also called into question the continuing validity of the presumption of irreparable harm in trademark cases in the wake of the Supreme Court’s decision in eBay Inc. v. MercExchange, LLC.13 In the absence of a finding of a substantial likelihood of success on the merits, the court found the franchisor could not rely on the presumption of irreparable harm to satisfy the requirements justifying injunctive relief.

For two related decisions involving a mature franchisor’s modification of its system - - prompted by government litigation against the franchisor - - see Layton et al. v. Aamco Transmissions, Inc.,14 and Bonfield v. Aamco Transmissions, Inc.15 Both cases involved Aamco’s new requirement of franchisees - - arising from consent judgments the franchisor entered into with various attorneys general - - requiring the franchisees to abandon the previous practice of disassembling transmissions for diagnostic purposes before giving firm price quotations to customers and requiring customers to pay disassembly/reassembly costs in the event they did not choose to have their repair services performed by Aamco. In Layton, plaintiff-franchisees asserted claims for common law fraud, breach of fiduciary duty, breach of the implied covenant of good faith and violation of the Maryland Franchise Act. Same menu in Bonfield, but substitute in the alleged violation of the Illinois Franchise Disclosure Act. In Layton, all causes of action against Aamco either were dismissed or resolved in Aamco’s favor by means of summary judgment to the franchisor. The same result pertained in Bonfield - - except that the Court permitted Bonfield to replead his claim that Aamco’s conduct violated the implied covenant. No record exists of what transpired thereafter - - it appears that franchisee Bonfield determined not to proceed or otherwise settled his differences with Aamco.

For a case holding that a franchisor’s modification of its system in fact breached the implied covenant of good faith and fair dealing and gave rise to tortious bad faith, unfair dealing and fraudulent misrepresentation, see Amos v. Union Oil Company of California, dba Unocal.16 In this case, Unocal dealers complained of their franchisor’s sudden shift in strategy from serving the “upper end” of the market (high octane) to 6 substituting a common place gasoline product without a competitive price that, it was alleged, made it impossible for the dealers to compete. Following a jury trial, it was found that Unocal breached the implied covenant of good faith and fair dealing, engaged in fraud, tortious bad faith and unfair dealing. The Court denied Unocal’s motion for a directed verdict before the case went to the jury, and felt compelled to issue an opinion explaining why:

Plaintiffs presented evidence that the discontinuance of the special grade (of gasoline) and substitution of a commonplace product without a competitive price made it impossible for plaintiffs to compete. The dealers suffered complaints from customers whose cars did not perform well with the lower octane product and confusion as to why they should pay a higher price for a product available everywhere for substantially less. Unocal conducted no prior studies of the effect of the change on the dealers. There was evidence that Unocal recognized and ignored the risk of a dramatic shift in customer base and volume loss with the change to 87 octane without becoming competitive on the price...

Second,...Unocal officially discontinued selling leaded premium and substituted unleaded premium. There was evidence that this change further eroded plaintiffs’ niche in the marketplace...

Third, there was evidence that the company was too slow to respond to rapidly falling gasoline prices... There was evidence that it is essential in a market where a few pennies per gallon is significant, that an oil company react to the market as fast as possible.

A jury could conclude that the severe loss of sales suffered by the plaintiffs resulted from the combination the events described.17

However, the norm remains that absent such allegedly predatory conduct, franchisees challenging their franchisors’ systemwide modifications will usually fail. Even in Canada, where -- in Damack Holdings Ltd. v. Saanich Peninsula Savings Credit Union, et al.,18 - - a pizza franchisor’s claim that its franchisee breached the subject franchise agreement by failing to use a new sauce, sell newly required thick crust pizza and display a new logo was upheld. The Court ruled that the franchisor was entitled to terminate the franchise agreement and to damages for the period required to select a new location and obtain a new franchisee.

Finally, counsel should be aware of yet another legal issue prompted by franchisor systemic changes, namely: whether such changes amount to “constructive termination” of the subject franchise agreement in violation of state “relationship” laws. One case from Connecticut and a plethora of cases from Wisconsin address this issue. See, for example, Petereit et al. v. S.B. Thomas, Inc.;19 Wisconsin Music Network, Inc. 7 v. Muzak Limited Partnership;20 Ziegler Co., Inc. v. Rexnord Inc.;21 and, the recent Wisconsin Supreme Court decision in Jungbluth v. Hometown, Inc.22 The majority opinion: franchisor-imposed system modifications are not to be confused with “constructive termination” of the subject franchise agreements, and no violation of state franchise relationship law “no termination without good cause” provisions will be found to have transpired.

B. Price Point Advertising/Resale Price Maintenance

Over the past decade, it has become increasingly clear to many franchisors that engaging in true “price point advertising” - - that is, advertising a product or service for sale at a unitary price good at every outlet nationwide (and not just “at participating locations only”) - - is of critical import. Simply stated, their non-franchised competitors engage in “price point” advertising all the time, while until only recently - - as elucidated below - - franchisors were absolutely forbidden by federal antitrust law from compelling their franchisees to offer products or services at a predetermined retail price.

But all that changed over the past fifteen years.

Franchisors historically were legally precluded from dictating the prices which their franchisees could charge for goods/services by virtue of a nearly century old U.S. Supreme Court decision23 holding that such activity was a per se violation of Section 1 of the Sherman Act - - a “red light” infraction, if you will, which could result in an award of treble damages and attorneys’ fees.

Since that 1914 U.S. Supreme Court decision, the Court has from time to time provided exceptions from this absolute ban on resale price maintenance. The first exception came in 191924, when the Supreme Court decided that while a manufacturer and retailer could not agree to a minimum resale price program, the manufacturer could nevertheless unilaterally refuse to sell to a retailer that did not adhere to the manufacturer’s minimum resale price - - even though the economic effects of both categories of activity are generally the same.

But fifteen years ago, in State Oil Co. v. Khan25, the Supreme Court eliminated the per se rule against maximum resale price maintenance programs, instead subjecting such programs to the more liberal “rule of reason” analysis. (Importantly for franchisors, the U.S. Supreme Court earlier rejected what had been the per se prohibition on certain non-price vertical restraints - - such as “exclusive territories” - - instead holding that these, too, should fall under the “rule of reason” analytical prism.26)

And in 2007, in a dramatic reversal of its own nearly century old doctrine, the U.S. Supreme Court abandoned its absolute prohibition on minimum resale price maintenance agreements, holding that such agreements must be analyzed under the more liberal “rule of reason” standard (and not automatically declared illegal under the 8 per se standard) when challenged as a violation of Section 1 of the Sherman Act. The Supreme Court’s decision was rendered in Leegin Creative Leather Products, Inc. v. PSKS, Inc.27

Over the past two years, the Eleventh Circuit and the U.S. District Court for the Southern District of Florida have ruled three times that franchisor Burger King Corporation (“BKC”) had the right to impose on franchisees maximum prices for its “Value Menu” items by virtue of the Burger King franchise agreement provision which states that the franchisor could make changes and additions to its operating system “…which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary…”.

In the Eleventh Circuit case28, the court affirmed the lower court’s determination that: “BKC has the right, under the parties’ franchise agreements, to require compliance with the Value Menu. The franchise agreements specifically require Defendants to adhere to BKC’s comprehensive restaurant format and operating system.”29

In a subsequent but entirely parallel case whose impact would be felt systemwide within the Burger King network (since plaintiff was Burger King’s National Franchisee Association (the “NFA”)), the U.S. District Court for the Southern District of Florida issued two opinions. In the first - - rendered in May, 2010 - - the court held that under the above-quoted language of the Burger King franchise agreement, “…(plaintiff’s) claim that (the Burger King franchise agreement) does not grant BKC the authority to impose maximum prices…fails as a matter of law”30.

However, since the subject Burger King franchise agreement language permitted Burger King to compel modifications of its system “which BKC in the good faith exercise of its judgment believes to be desirable and reasonably necessary…”, the Court in its first decision granted Burger King’s motion to dismiss its franchisees’ claim that it did not have the authority under said franchise agreement to set maximum prices but let proceed the franchisees’ claim that Burger King’s imposition of the $1.00 double cheeseburger violated its contractual duty of good faith.

However, on that issue, too, Burger King prevailed. In its second decision31, the Southern District of Florida held:

The purpose of Section 5 (of the Burger King franchise agreement) is to give BKC broad discretion in framing business and marketing strategy by adopting those measures it judges are needed to help the business successfully compete… (T)o adequately raise a claim of bad faith, Plaintiffs must allege some facts suggesting that BKC did not believe that the prices would be helpful to the businesses competitive position, but, for some other reason, deliberately adopted prices that would injure Plaintiffs’ operations. As currently pled, none of the allegations support such an 9 inference of bad faith. Plaintiffs rely principally on their allegation that franchisees could not produce and sell (a double cheeseburger or a double hamburger) at a cost less than $1.00, and therefore that franchisors suffer “a loss” on each of these items sold. Even taken as true, there is nothing inherently suspect about such a pricing strategy for a firm selling multiple products. There are a variety of legitimate reasons where a firm selling multiple products may choose to set the price of a single product below cost. Among other things, such strategy might help build goodwill and customer loyalty, hold or shift customer traffic away from competitors, or serve as “loss leaders” to generate increased sales on other higher margin products.32

Of interest to franchisors is the District Court’s rejection in its first Burger King decision of the NFA’s argument that, at the very least, the franchisor could not enforce maximum price restraints against franchisees who signed their agreements prior to 1997’s Khan decision, because prior to Khan maximum pricing was per se illegal. Instead the court found that, if the rule of reason analysis were satisfied, a franchisor may be capable of imposing maximum prices upon its franchisees under its franchise agreement’s “system modification” language, even for those franchisees who signed their agreements prior to Khan’s shift from per se illegality to the rule of reason test in 1997:

(Plaintiff) also argues that because it was per se illegal to set maximum prices prior to 1997, the terms of the (Burger King franchise agreement) could not grant BKC the right to fix prices because the Agreement was drafted prior to 1997… The date the Agreement was drafted is…irrelevant. The date the Agreement was entered into was the operative date. The (Plaintiff’s) argument would thus apply only to those franchisees who signed their Agreement prior to 1997. Even with respect to those franchisees, this Court sees no reason why BKC’s authority under Section 5 to establish and make changes from time to time to its product specifications would not give BKC the authority to impose maximum prices after the Khan decision. While the Agreement incorporated the law in place at the time the Agreement was signed prior to 1997, (it) also provided that BKC could, from time to time, modify, revise, and add to its comprehensive restaurant format and operating system. It is this provision that allows BKC to impose maximum prices even as to those franchisees who signed their agreements prior to 1997.

Many have found it curious that the NFA invoked anti-trust protections for those franchisees who signed their franchise agreements prior to the Khan decision in 1997, but did not similarly attempt to make any broader antitrust arguments in favor of all franchisees, no matter when they signed. After all, Khan did not make maximum price fixing “legal.” On the contrary, the Khan Court made it very clear that, “[i]n overruling 10 [past precedent], we of course do not hold that all vertical maximum price fixing is per se lawful. Instead, vertical maximum price fixing, like the majority of commercial arrangements subject to the antitrust laws, should be evaluated under the rule of reason.”33 Close readers of the Southern District of Florida’s original May 2010 opinion noticed the judge’s footnote virtually extending an invitation to the NFA to make such a rule of reason argument.34 Nevertheless, the NFA declined to make any broader antitrust allegations in its complaint. It is also worth noting that no antitrust arguments were advanced in the Eleventh Circuit’s Burger King value menu case either. Thus, while the recent Eleventh Circuit’s and Southern District of Florida’s opinions in the Burger King cases demonstrate that Burger King’s franchise agreement language allows for maximum price fixing, the merits of a bona fide antitrust argument, presenting a rule of reason analysis of potential anticompetitive effects of such price fixing in the franchise context, has not yet been presented to or ruled upon by the courts.

Until that day, the general consensus among franchisors is that the Khan and Leegin decisions alleviate most, if not all, worries related to liability on account of federal anti-trust violations. Franchisees no doubt disagree with this position. The ability of franchisors to dictate precisely the minimum and maximum retail prices which their franchisees may charge the public for products/services can dramatically heighten those franchisors’ competitive positions versus other brands.

“Price point” advertising no longer has to be followed by the usual “at participating locations only” disclaimer (with customer dissatisfaction naturally resulting upon a customer’s visiting and being charged more at a non-participating franchised location). Instead, the ability to aggressively engage in price point campaigns on a systemwide basis is facilitated. Further, a uniform retail pricing paradigm will preclude one franchisee from seeking to underprice, and draw market share from, its competitive franchisees - - especially important if the first, underpricing franchisee has large economies of scale enabling it to aggressively underprice its franchisee competitors. (Of course, under the Supreme Court decision addressed herein, it would be quite dangerous for franchisors to mandate maximum prices so low, in response to requests from their larger franchisees, that competitive smaller franchisees suffer injury or even elimination.) In addition, not to miss the obvious, franchisors’ revenues - - based as they are as a percentage of franchisee gross sales - - may more easily be ascertained and predicted, even optimized, as opposed to the generally prevailing situation where a franchisee can lower or raise its retail prices to any points it desires.

However, we must stress that the benefits afforded by the recent U.S. Supreme Court decisions subjecting resale price maintenance agreements to the “rule of reason”, rather than the “per se” standard does not yet enable franchisors to engage in such activity nationwide.

First, and most critically, relatively few franchise agreements reserve to the respective franchisors the right to impose minimum or maximum retail prices upon their 11 franchisees. Absent such a contractual reservation of right, these franchisors - - notwithstanding the Burger King decisions discussed above - - may be held utterly without power to engage in such activity. For your convenience, we set forth at the conclusion of this paper sample language which you may wish to consider incorporating in successor franchise agreements which would, in fact, reserve to franchisors the right to prescribe minimum/maximum franchisee retail prices.

Moreover, and also of critical concern, while the U.S. Supreme Court has declared resale price maintenance as now subject only to a “rule of reason” analysis when legality is determined, it is critically important to understand that the states - - many of which feature their own non-preempted antitrust laws - - have not followed suit and may never do so. In this regard, it is vital that you know that a number of states statutorily declare resale price maintenance agreements to be per se unlawful. And many state antitrust enforcement officials were proponents of maintaining the minimum resale price maintenance per se illegality rule, leading us to believe that both government enforcement activity and private litigants will shift their efforts to preclude minimum/maximum price fixing to those states in which courts are not at all required to follow federal antitrust precedents.

Moreover, as noted above, while proving a “rule of reason” case is often difficult for antitrust plaintiffs, the Supreme Court in its recent decision did outline circumstances under which resale price maintenance programs would be considered problematic and perhaps declared illegal.

Finally, it will now be up to lower courts to recraft resale price maintenance jurisprudence under the Supreme Court’s “rule of reason” analysis - - and one has no way of knowing just how these lower courts will rule on the issue, what disparities among the circuits will evolve and how those disparities will in the future be reconciled by the U.S. Supreme Court.

Accordingly, we recommend that franchisors engage in the following course of conduct: (i) closely analyze state antitrust laws and edicts regarding resale price maintenance agreements and monitor how those may be impacted by, or changed, following the U.S. Supreme Court decisions referenced above, and (ii) feature in successor franchise agreements a reservation of right under which the franchisor may impose minimum/maximum retail prices upon its franchisees to the greatest extent permitted by law (again, a suggested provision is set forth below).

C. System Modification Attendant to Franchisor Acquisition

The acquisition of a franchised network - - whether by a competitor (a “strategic” buyer) or a private equity concern (a “financial” buyer) - - is often followed by significant modifications to that network.

12 Dunkin’ Donuts was acquired by Bain Capital in 2006, with the company shortly thereafter announcing a dramatic nationwide expansion plan and the introduction of a plethora of new food and beverage items. Roark Capital Group over the past decade acquired (among others) the Carvel, Auntie Anne’s, Seattle’s Best, Money Mailer, Cinnabon and McAlister’s Deli networks with the goal of introducing new sales and marketing initiatives; upgrading and enhancing technology; acquiring complementary product lines; and, otherwise effecting significant changes to the acquired networks. TCP Capital Partners acquired The Dwyer Group in December, 2010, including the franchise networks of Rainbow International, Mr. Rooter and Mr. Appliance, with the stated goal of accelerating earnings growth through business model refinements. New York-based investment house Trian acquired Wendy’s in 2007 - - and very recently announced its plans to sell the Arby’s franchised network (which it acquired in 2000). The Blackstone Group acquired Hilton Worldwide, Inc. in 2007 and swiftly implemented a series of changes within and among Hilton’s ten networks of branded hotels (including one of its newest brands, the “Waldorf=Astoria Collection”).

And, of course, the 2001 acquisition of Mail Boxes Etc. by United Parcel Service, which led to the very significant litigation addressed below.

Attendant to each of these franchise network acquisitions (and a plethora of others transpiring over the past decade) was substantial network modification of the acquired system. However, there are significant business and legal issues which may circumscribe an acquiror’s ability to effectuate such network change.

1. Analyzing the Motives Underlying Proposed Acquisition Activity

There are a myriad of positive business reasons which in many instances can virtually compel consideration of merger or acquisition activity. For instance, it may be that a successful company (whether franchised or not) wishes to add a new product or service line to its distribution network. Or that company may wish to acquire a new distribution network (which sometimes will serve as its secondary distribution network). Another valid motive underlying franchise-related merger or acquisition activity is obvious but often missed - - the elimination of competition through acquisition (or, alternatively, a merger or acquisition designed to keep competitive).

The ability to engage in geographic expansion through merger with, or acquisition of, a franchise network is another legitimate motive underlying such activity. So, too, is the need of the merging or acquiring company to obtain the target’s presumably stellar management team.

In other instances, a company considering merging with or acquiring a franchise network is seeking to strategically use its funds, sometimes in a leveraged fashion, other times merely to obtain a return on investment not otherwise available. In other instances, that company may be engaging in such activity to avoid a hostile takeover 13 itself. On a more positive note, frequently companies which are at the forefront of competition will merge with or acquire a franchise network to expand their know-how to new product or service lines. Or, conversely, they may do so to acquire the know-how, confidential information and proprietary products or services of the target.

These are all most salutary motives underlying proposed merger or acquisition activity. However, counsel must beware of one motive that is not nearly so legitimate - - corporate ego. Sadly, it is sometimes the case that companies seek to expand just for the sake of expansion and/or to see news of the merger or acquisition appear in the Wall Street Journal and other publications, with no thought given to synergy; management’s ability to marshall the combined entity; the financial resources required to properly effect the transaction; the revolt of the merged or acquired network’s franchisees which may result; or, even more dangerously, the harsh marketplace reaction which may ensue.

The identification and validity of the motives underlying the planned merger or acquisition activity involving a franchise network are so critical because the financial drain required to effect such transaction is so massive. Aside from the purchase price, liabilities of the target or merger partner will surely be acquired; hefty legal and accounting fees must be paid; public company solicitation, reporting and advertising expenditures may massively accrue; and, there may be significant tax implications involved. Further, if the franchise network is to be “converted” to the acquiror’s identity following the transaction, there will almost always be “hard cost” recompense to the franchisees of the target network - - and there may be encroachment concessions as well (including royalty reductions, an acquiror-sponsored advertising campaign in markets where encroachment is significant, and the distinct possibility that certain target company franchisees must be bought out in extremely harsh scenarios).

Add to this the cost of target company’s management expense (salaries and benefits); “golden parachutes” which may be triggered by the transaction; the possibility that the target company’s labor force is unionized; termination buyouts (when the inevitable “downsizing” occurs to eliminate management overlap); and, the grant or exercise of stock options which may be triggered by the transaction, and the need to ensure that the motive underlying the proposed merger or acquisition is proper becomes startingly evident.

Pro forma after pro forma must be prepared and analyzed. Returns on investment must be scrutinized. Marketing studies must be engaged in, especially if the target company’s network is to be converted to the acquiror’s identity. Swift communication with the target company’s franchisees must be effected, sometimes before the transaction and sometimes immediately afterward, but almost always at great expense. Consumer and trade advertising campaigns must be readied. Programs must be in place so that immediately upon closing of the transaction, the management of the combined entities takes a rational form. The paradigm for combining the subject 14 networks must be in place - - with all programs, projects and contracts ready to go forthwith. If conversion is intended, the massive effort required to accomplish same swiftly - - including unit reidentification and consumer advertising campaigns - - must be in place. Finally, both counsel and the client must anticipate the unexpected - - which always seems to transpire in the course of a franchise-related merger or acquisition.

When the motive underlying the proposed merger or acquisition activity involving a franchise network is sound, well thought out and proper; when the financial resources, analysis and planning are well grounded; and, when the myriad of other activity necessary to properly effectuate the subject merger or acquisition have been carried out in an optimal fashion, then the revenues, synergies and other positive benefits of the transaction can be incredibly salutary.

2. The Third Player at the Table

Outside of the franchise arena, it is typically the case that the cast of characters in a planned merger or acquisition is limited and their responses ascertainable beforehand. The management of both companies will be involved, as will a raft of attorneys, accountants, financial institutions, regulatory agencies, and the press and public at large. Forecasting the positive or negative responses of these populations to the proposed merger or acquisition activity - - or their ability to scuttle same - - is usually sufficiently within the ambit of management such that the risk/reward of proceeding with the transaction is readily measurable.

However, in franchise-related mergers and acquisitions, there is another set of players at the table -- figuratively, but not usually literally -- whose temperaments are frequently unknown and who possess a plethora of weapons capable of, if not defeating the proposed combination, at least making it far more painful, expensive and cumbersome than would otherwise pertain: the franchisees of either the acquiring and/or the target franchise system. Due to the breadth of legal weapons they possess to challenge or even defeat proposed merger or acquisition activity -- ranging from royalty strikes to lawsuits and/or public announcements meant to instill fear in any participating bank or other financial institution -- these franchisees' proclivities, contracts and legal rights must carefully be taken into consideration and measured against the forces motivating the proposed transaction for a rational "risk/reward" analysis to transpire.

Though nowhere reported, the author is familiar with situations where franchisees were instrumental either in advancing or defeating proposed merger or acquisition activity. Whether it was a franchisee's procurement of a preliminary injunction blocking the acquisition of one franchised video rental chain by another, or the franchisee population of a fast food chain being pitched by both participants in a hostile takeover (and allying with the ultimate victor, which was not a coincidence),

15 franchisees have -- in a non-public fashion -- frequently advanced or defeated planned merger or acquisition activity, and will continue to do so.35

Accordingly, our conclusion is simple. To perform any rational risk/reward analysis of proposed franchise-related merger or acquisition activity, the legal rights, temperaments and predilections of the franchisees of the affected franchising entity(ies) must be taken into account.

3. The Franchise Agreements at Issue

The first legal, as opposed to business, issue to be analyzed in connection with a franchise-related merger or acquisition is whether the franchise agreement(s) at issue permits, forbids or is silent about the contemplated activity. Because in the first instance, a court called upon to adjudicate the propriety of the contemplated transaction will refer to the clear and express terms of the franchise agreement(s) at issue.

Unfortunately, it is typically the case that mature franchise systems -- for political and historic reasons -- utilize "older" forms of franchise agreements that are utterly silent on the franchisor's ability to merge, acquire or be acquired. But they are explicit about conferring certain rights upon franchisees and imposing certain obligations upon franchisors -- rights and obligations which may impede or defeat altogether the ability to consummate the proposed merger or acquisition. For example, if the business plan is to merge with or acquire a competing franchise network with units proximate to the acquiror's franchised units and convert those units to the acquiror's brand and system, but the franchise agreement of either the acquiror or the target confers explicit territorial exclusivity upon franchisees (with the subject franchisor reserving few, if any, rights to "invade" any franchisee's exclusive territory other than for failure to meet performance standards or to comply with the terms of the franchise agreement), then consummation of the proposed merger/acquisition transaction will per force result in multiple (perhaps universal) breaches of contract.

Even when the franchise agreement(s) at issue is seemingly clear that no territorial exclusivity is conferred upon franchisees, still great caution must be exercised -- for the courts have, in certain such circumstances, deployed the "implied covenant of good faith and fair dealing" to find territorial protections where the contracts at issue ostensibly afforded none.

Further, absent franchise agreement language expressly authorizing the franchisor to make systemic modifications to its system -- including change of concept, authorized product/services, names, trademarks, service marks, interior/exterior fixturization and advertising philosophy/methods -- then a planned merger or acquisition contemplating the "conversion" of the target company's franchisees may similarly be contractually prohibited.

16 Even when the targeted company's franchise network is to continue operating as before following the planned merger or acquisition, there is no guarantee that litigation -- and perhaps even a preclusionary injunction -- may not be forthcoming.

This is why it is imperative that franchise counsel ensure that their clients' franchise agreements contain explicit, expansive and conclusive language presaging and ordaining future merger or acquisition activity. We present such language for your consideration below.

4. Judicial Decisions Addressing Franchise Network Acquisitions

As referenced above, it is frequently the case that the majority of franchise agreements of mature franchisors are silent on the franchisor's ability to merge, acquire or be acquired.

Frequently, vast numbers of these contracts (with the chains' largest franchisees) date back to the 1960's and 70's, and for political purposes have changed only slightly since then.

Many of these contracts explicitly afford "exclusive territories" upon franchisees; do not presage wholesale modifications to the franchisor's system (including change of name, concept and interior/exterior fixturization and/or co-branding); and, otherwise delineate franchisee rights and franchisor obligations which may make "conversion" of the acquired or merged chain impossible.

Given the clear and unequivocal language of such franchise agreements, it is frequently the case that measures must be taken to mollify, compensate and/or release affected franchisees if conversion of the acquired/merged chain is to be realized.

Of course, if sufficiently express franchise agreement language is extant preordaining franchisor merger, acquisition and resulting conversion activity, then many of the problems alluded to herein can be overcome.

A word of caution, however. Even when the subject franchise agreement explicitly sets forth a franchisor's right to sell out to a third party, the courts may still intervene. For example, in A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc. et al.,36 the subject franchise agreement and franchise disclosure document repeatedly and explicitly authorized the franchisor to sell out to another entity freely so long as only two conditions were met - - that the assignee agreed to assume all contractual obligations to franchisees and that the assignee was financially capable of doing so. Even in such a circumstance, the New York Supreme Court (New York's trial court) permitted a franchisee to proceed with two causes of action (common law fraud and violation of the New York Franchise Act37) alleging that there was some specific, secret, pre-existing plan to have the franchisor sell out that was concealed from plaintiff- 17 franchisee. Accordingly, Union Carbide Marble Care's motion to dismiss these causes of action was denied.

Naturally, if the acquired or merged franchise network is not to be "converted" to the franchisor's name and concept, or if the acquisition is consummated by a franchisor holding company that is merely acquiring another chain, then many of these problems disappear -- but not always.

For example, in First and First, Inc. et al. v. Dunkin Donuts, Inc. et al.,38 in which Dunkin Donuts was set to acquire the Mister Donut chain, 102 Mister Donut franchisees sought to enjoin the proposed acquisition claiming that the merger violated the Sherman Act, was the product of tortious interference with contract and would result in breach of contract. Rejecting plaintiffs' motion for a preliminary injunction, the Court held that the Mister Donut franchisees had not proven a probability of success on their antitrust action. Held the court:

Plaintiffs, for various reasons, do not want the proposed merger to take place and they have tried to define a relevant product market in which Mister Donut and Dunkin Donuts were the principal participants and in which the proposed merger would seem, therefore, to eliminate substantial competition. We are not unsympathetic to their concerns, but a federal antitrust action is not the appropriate vehicle in which to air them. The federal courts have on many occasions rejected self-serving efforts to define away competition would proffered market definitions that resemble the proverbial "strange red-haired, bearded, one one-eyed man-with-a- limp" (citation omitted).39

Further, the Court denied the franchisee-plaintiffs' motion for a preliminary injunction on their claims of breach of contract and tortious interference with business relations. Observed the Court:

We can find nothing in plaintiffs' franchise agreements which prevents Mister Donut from selling its stock. Moreover, the facts give us a clear picture of defendants, who have said over and over again, that they will honor all contractual commitments of Mister Donut. Beyond speculation, we have seen no proof that they will not and believe that if any violations ever do actually occur, they could adequately be handled in an action at law. In short, we find no breach, anticipatory or otherwise, or evidence of a lack of good faith or fair dealing (emphasis added).40

The Court denied Dunkin Donuts' motion to dismiss the underlying action -- but reluctantly:"...(W)e...decline to dismiss plaintiffs' complaint at this point in time, although, as we have noted, we have serious doubts about plaintiffs' ability to prevail"41. 18

Moreover, breach of contract actions within the framework of a franchise-related merger or acquisition can arise if the seller terminates franchise agreements deemed undesirable by the acquiror prior to the acquisition and/or the acquiror converts some, but not other, franchisees to its system. See, in this regard, three related cases: Groseth International v. Tenneco, Inc.42; Karl Wendt Farm Equipment Co. v. International Harvestor Co.43; and, Delta Truck and Tractor, Inc. v. J.I. Case Co.44. As correctly synthesized by our colleague Lee Lundy, Esq.45, these three related cases arose from International Harvester's sale of its farm equipment business to J.I. Case Co., a competitor owned by Tenneco, Inc., which netted International Harvester approximately $500 million dollars. Because numerous territorial overlap situations among the two networks' dealers would be triggered by the transaction, Case and International Harvester agreed in their contract that Case would determine which of the two networks' dealers would remain and which would be terminated. In fact, approximately two thirds of the dealers ultimately terminated were Case dealers, not International Harvester. But some International Harvester dealers who were terminated sued International Harvester, Case and Tenneco, variously alleging breach of contract, violation of state law and breach of fiduciary duty.

In all three cases, the defendants pointed to International Harvester's dire financial condition and cited the contract law doctrines of "frustration of purpose" and "commercial impracticability" as justifications for terminating the subject International Harvester dealer agreements. All three courts rejected this approach and held that the subject franchise agreements had been breached when the dealer was terminated other than in strict accordance with the terms of those contracts. As Mr. Lundy correctly observes, it probably did not escape of any of the three courts' notice that International Harvester did not merely close down the ailing farm equipment business; it sold it for $500 million dollars.

Of course, even when the subject franchise agreement(s) appears to explicitly authorize the merger or acquisition activity in question, still franchisees can invoke the amorphous "implied covenant of good faith and fair dealing" in an effort to have the judiciary substitute notions of "fairness" for what the contract actually says.

Franchisees threatened or allegedly harmed by their franchisors' conduct -- including planned merger or acquisition activity -- will almost always invoke the amorphous "implied covenant of good faith and fair dealing" (which holds that neither party to a contract may deny the other party the fruits of that contract) to enjoin the conduct in question or recover damages therefor.

Naturally, these very implied covenant territorial conflict encroachment issues will very frequently be raised in litigation challenging franchise-related mergers and acquisitions. However, the implied covenant of good faith and fair dealing in recent

19 years has also been deployed in a more expansive fashion by franchisees challenging their franchisors' merger and acquisition activities - - though only rarely successfully.

For example, in Clark et al. v. America's Favorite Chicken Co. et al.46, owners of several Popeye's Fried Chicken franchises appealed from the U.S. District Court's summary judgment order dismissing their claims complaining of their franchisor's acquisition and operation of a competing franchise system, Church's Fried Chicken. Key among plaintiffs’ contentions was that defendant Popeye's (the corporate predecessor to appellant AFC) violated the implied covenant of good faith and fair dealing by consummating the acquisition. In affirming dismissal of the franchisees' claims, the Court noted that the franchise agreement at issue explicitly authorized the franchisor to "...develop and establish other franchise systems for the same, similar, or different product or services" -- a contractual provision which the franchisees sought to negotiate out but, when this attempt failed, was left intact in the subject contract.

Citing its decision in Domed Stadium Hotel, Inc. v. Holiday Inns, Inc.47, the Court

held:

This (franchise agreement) language unambiguously reserves to AFC the right to enter into (the franchisees' trade) area and compete against them under a different set of proprietary marks. Moreover, the record establishes that appellants were aware of the significance of this provision... They cannot now be heard to argue that actions expressly authorized by this provision constitute a breach of the implied covenant of good faith and fair dealing... In sum, the franchise agreement expressly reserves to AFC the right to do what precisely what appellants now charge it with: to compete against its franchisees under a different set of proprietary marks (emphasis added).48

In contrast, in A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc. et al.49, supra., a franchisee "implied covenant" claim complaining of the sale of its franchisor to a third party was permitted to survive a motion to dismiss even in the face of clear franchise agreement language specifically authorizing such a sale. While the franchisor had the right to sell out, observed the Court, an "implied covenant" inquiry could be had regarding the franchisee's contention that "(Union Carbide Marble Care) sold the system to an entity with no experience as a franchisor, with no reputation, recognition or renown in the marble or stone care business...".

Further, a motion for summary judgment to dismiss an "implied covenant" claim complaining of the acquisition of franchisor Hot 'N Now by PepsiCo, Inc. was denied. In Loehr et al. v. Hot 'N Now, Inc. et al.,50 the essence of the franchisee's suit was that PepsiCo purchased Hot 'N Now solely to use it as an experiment to improve the operations of another of PepsiCo's franchising subsidiaries, Taco Bell. The franchisee 20 alleged that the defendants destroyed his business by materially altering Hot 'N Now's fast food concept, and asserted causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing. In denying defendants' motion for summary judgment, the Court held:

(T)he core of plaintiffs' Complaint is that Hot 'N Now underhandedly destroyed plaintiffs' business by materially changing the Hot 'N Now fast food concept... Defendant responds by arguing that the "express" language of the contract gave defendant discretion to make decisions regarding the franchise. As a result, defendant argues that it did not breach its implied duty of good faith and fair dealing because defendant followed the "express" terms of the contract. However, plaintiffs argue that the duty of good faith and fair dealing was created to protect parties from abuses of discretion (citation omitted). In other words, the good faith and fair dealing standard requires parties to utilize their discretion in light of the "spirit" of the contract (citation omitted).

"...(T)he implied covenant of good faith limits the controlling party's discretion and the controlling party must exercise that discretion reasonably and with proper motive and may not do so arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties" (citation omitted). Therefore, the issue of whether defendant's (sic) breached its (sic) implied duty of good faith and fair dealing is a question of fact most properly resolved by the jury.51

In St. Charles Foods, Inc. v. America’s Favorite Chicken Company52, the Eleventh Circuit Court of Appeals held that a franchise agreement between a chicken restaurant franchisor and its franchisee granting the latter a right of first refusal with respect to the development of new franchises in the same county was ambiguous as to whether it applied to both of the franchisor’s brands (Church’s and Popeye’s) or just the brand under which the franchisee had operated (Popeye’s). Accordingly, the franchisee’s claims against the franchisor for granting a competing franchise in the same county and not offering that franchisee right of first refusal should not, held the Court, have been summarily dismissed:

The evidence in this case can support the district court’s conclusion that AFC did not intend to grant development rights in the Church’s brand and, therefore, that the scope of the right of first refusal was limited to the Popeye’s brand. However, viewing the evidence in the light most favorable to (the franchisee), we find that the evidence also provides sufficient support to allow a rational factfinder to conclude that AFC’s grant of a right of first refusal to (the franchisee) for “any development” (citation omitted)... included both the Popeye’s and the Church’s brands. Specifically, the facts that the Popeye’s franchisees believed that they 21 already had a right of first refusal covering the Church’s brand and that the Church’s logo was printed on the (subject agreements) could lead a rational factfinder to infer that the right of first refusal granted by AFC in the (subject agreements) included both the Popeye’s and Church’s brands (citations omitted)... Moreover, we are persuaded that the rules of contract construction require that the ambiguity in this contract be construed against AFC (citations omitted).

Accordingly, the Eleventh Circuit sent this case back to the district court, where a jury trial ensued.

The most recent body of case law addressing an acquiror’s ability to effect broad and systemic change in an acquired franchise network relates to the acquisition of franchisor Mail Boxes Etc. by shipper United Parcel Service and UPS’ subsequent determination to rebrand all Mail Boxes Etc. stores as UPS stores. Mail Boxes Etc. franchisees, through their independent association, commenced an action against Mail Boxes Etc., claiming that compulsory reidentification coupled with UPS’ new business model caused irreparable harm. In December 2007, the Superior Court of California granted summary judgment to Mail Boxes Etc., ruling that the franchisor had the contractual right to compel franchisee reidentification.53

Concurrently, another MBE franchisee - - which did not convert its store to the “UPS” name - - commenced a separate action asserting inter alia that UPS committed various violations of law by presenting an MBE renewal franchise agreement which would have obligated plaintiff to convert to the UPS name, cease offering competitive shipping services and comply with franchisor UPS’ designated retail prices. In essence, plaintiff-franchisee asserted that its contractual right to renew had been thus abrogated by UPS in violation of law. Given the urgency of the franchise renewal issue, the trial court bifurcated trial, with the first phase to interpret the meaning of the original MBE franchise agreement’s renewal provision.

Following a bench trial in August, 2009, the court ruled against plaintiff- franchisee, holding that UPS had unfettered discretion to eliminate any economic rights or alter any aspect of the Mail Boxes Etc. franchise so long as the same terms were also being offered to newcomers to the franchise system:

A similar result pertained following phase two of trial, with the trial court entering judgment against plaintiff-franchisee based on its prior finding that it was not entitled to renew its MBE franchise agreement and must accept whatever franchise agreement UPS offered.54

Plaintiff-franchisee filed an appeal of this decision to the California Court of Appeal on January 12, 2011, which appeal remains pending.

22 D. Impact of Franchise Relationship Law on Ability to Modify System

Twenty one states have franchise laws on their books specifically aimed not at pre-sale disclosure but at the franchise "relationship" itself.

These laws typically govern when a franchisor may or may not terminate a franchise; must (or need not) renew existing franchises; and, address such areas as territorial protection, franchisee rights of association, impermissible discrimination among franchisees and franchisor imposition of unreasonable standards of performance.

Franchisees challenging planned network modification activity will frequently deploy one or more elements of these statutes, typically claiming that the planned activity will so violate existing franchisee contractual rights and/or alter the network’s identity that a "constructive termination" of the subject franchise agreements will have transpired in violation of the "no termination without good cause" tenets of franchise relationship laws. This theory was advanced in A.J. Marble & Tile, Inc. v. Union Carbide Marble Care, Inc. et al.55 Although this case did not involve a relationship law (New York law governed and that state has no relationship law), still it is illustrative of the force with which the "constructive termination" argument can be advanced.

See, also, Homedical, Inc. v. Sarns/3M Health Care, Inc. 56 and Carlos v. Phillips Business Systems, Inc.57

Probably the most expansive court decision addressing this subject is to be found in Petereit et al. v. S.B. Thomas, Inc. et al.58 In this case, distributors of Thomas' English Muffins -- embittered when their sales territories were dramatically realigned as part of Thomas' effort to significantly increase its sluggish sales -- filed suit complaining that their distributorship agreements had been "constructively terminated" as a result of such realignment. After determining that the distributors were "franchisees" under the Connecticut Franchise Act59, the trial court indeed found that Thomas' territorial realignment did "constructively terminate" the subject distributorships without the "good cause" required by the Act.

On appeal, the U.S. Court of Appeals upheld the finding that the distributors were "franchisees" under the Connecticut Franchise Act and that Thomas' territorial realignment in fact resulted in a "constructive termination" of the subject distributorship agreements:

Although, as noted, Connecticut's courts have not spoken on whether a cause of action exists for constructive termination of a franchise, the remedial nature of the Act supports the view that such a claim lies. If the protections the Connecticut legislature afforded to franchisees were brought into play only by a formal termination, those protections would 23 quickly become illusory. We think it reasonable therefore to believe it was the legislature's aim to have the umbrella of the Act's protection cover constructive as well as formal termination. To hold otherwise would allow franchisors to accomplish indirectly what they are prohibited from doing directly.

We think (that constructive termination) may be found when a franchisor's actions result in a substantial decline in franchisee net income... Whether a decline in net income is substantial will necessarily depend on the particular facts and must be determined on a case-by-case basis (emphasis added).60

Having determined that the Thomas' English Muffin distributors were "franchisees", and that at least some of their contracts may have been "constructively terminated" if substantial declines in revenue could be shown, the Court of Appeals then held that Thomas, in fact, had sufficient statutory "good cause" to so "constructively terminate" the distributorship agreements in question:

The language of the Act leaves no doubt that good cause exists when the franchisee materially breaches the agreement. Equally clear is the legislature's plan that the meaning of good cause is broader than franchisee breach... Allowing the legitimate business concerns of a franchisor to be part of the "good cause" equation does not require a showing of unprofitability... When the franchisor demonstrates that its business decision is legitimate and made in good faith -- even if shown by hindsight to be made in error -- a court should not replace the grantor's decision with its own (citation omitted).

In the case at hand, Thomas determined it could increase sales by increasing service frequency. This result it thought best accomplished by rationalizing its distributors' haphazard routes. The Act protects franchisees from the arbitrary exercise of the franchisor's greater economic strength. But this case does not concern such arbitrary action. Here we are faced with a legitimate business need to increase sales and the steps taken to further that goal. Thomas' goal of increasing sales constitutes "good cause" within the meaning of the Franchise Act. Thus, the Act does not prevent defendant from realigning plaintiffs' territories (emphasis added).61

Synthesizing the foregoing, the standards promulgated by the U.S. Court of Appeals in this critical franchise "relationship" statute decision are: (i) if a franchisor realigns territories, those of its franchisees who suffer a "substantial decline" in franchisee net income may be deemed to have had their franchise agreements constructively terminated, entitling them to recompense for breach of contract, but (ii) a 24 franchisor may not be held liable for wrongful termination without good cause under the Connecticut Franchise Act (as opposed to breach of contract) if its territorial realignment was prompted by good faith business motivations.

Where does this leave a franchisor planning systemic network changes and concerned about franchise "relationship" laws? In a quandary. For unless a franchisor is thoroughly prescient, it cannot know whether a territorial realignment or other substantial network modification will result in a "substantial decline" in franchisee net income (a jury issue) sufficient for it to be held liable for "constructive termination"; whether its business motives will be deemed sufficiently "in good faith" to surmount the "good cause" relationship law standard governing franchise termination (constructive or otherwise); or, whether other states with relationship laws will agree at all that franchisor termination of franchise agreements (whether in good faith or not) -- for anything other than franchisee breach -- is not violative of those states' "good cause" termination requirements.

E. E-Commerce

When e-business became the norm a decade ago, and franchisors established protocols under which their network’s goods or services could be sold to the public, it was only a matter of time until a franchisee claim of “virtual encroachment” arose – a claim in which a franchisee complained that its franchisor’s internet offer and sale of goods or services breached that franchisee’s “exclusive” or other territorial rights.

That time arrived in 2000, when an American Arbitration Association panel rendered a decision on September 2, 2000 holding that a franchisor – Drug Emporium Inc. – could not use its web site to complete with its own franchisees62.

The panel ordered Drug Emporium – which operated a web site denominated “DrugEmporium.com” – not to sell to any potential customer physically situated within a Drug Emporium franchisee’s territory, and to place notice on its web site that products cannot be shipped to customers so situated. Further, the panel directed Drug Emporium to have its web site direct such customers to the nearest franchised outlet.

The underlying dispute arose from the fact that Drug Emporium’s standard franchise agreement affords to each of its franchisees the exclusive right to conduct business within a defined geographic area. The affected franchisees claimed that their franchisor violated these so-called “exclusive territories” by using its Web site to sell directly to customers within those territories. The arbitration panel was asked to enjoin the chain from doing so.

In ruling on the franchisees’ request for injunctive relief, the arbitration panel framed the issue as “… (w)hether a virtual drug store is a drug store for purposes of a franchise agreement.” In its decision, the arbitrators held: “It is not for this panel to 25 define whether a virtual reality is real or whether it is a phantom.” Noting that Drug Emporium marketed its Web site as “the full service on-line drug store” and that the company described the site as a “drug store” in Securities and Exchange Commission filings – and noting further that the company advertised the site as “your neighborhood pharmacy for 20 years” – the arbitration panel issued a preliminary injunctions concluding that the franchisees established a strong likelihood of prevailing on the merits of their “encroachment” claim.

The arbitral decision in Drug Emporium was only the first addressing the subject of “virtual encroachment.” What happened was simple. Many franchise agreements currently in effect were drafted many years ago and neither contemplated nor set forth protocols for franchise network internet activity. Today, many franchisors have already succeeded in developing such internet protocols, dividing up web commerce with their franchisees in one fashion or another. Sometimes, it is the franchisor alone which reserves the right to conduct all internet sales – either with no compensation to its franchisees (if the subject franchise agreement does not afford territorial exclusivity to franchisees or very limited territorial exclusivity which would not preempt franchisor web activates) and sometimes with limited consideration paid to franchisees (typically, a “reverse royalty” paid to franchisees for web commerce transacted with individuals or businesses situated within those franchisees’ exclusive territories). A few other franchisors yield all internet transactional activity exclusively to their franchisees. (If this is the case, wise franchise counsel should make sure that adequate contractual language exists carefully delineating those franchisees’ rights and obligations with regard to their web sites.)

Recent decisions addressing the issue of alleged “web encroachment” proved more favorable to franchisors. In an arbitration proceeding in which a franchisee of tax preparation service H&R Block asserted that its franchisor was contractually precluded from offering tax preparation services over the internet, the arbitration panel denied the claim and instead held that H&R Block did not violate its franchise agreement by engaging in such activity63. The panel found that H&R Block did not violate the subject franchise agreement’s exclusive territory provision and determined that the franchisor’s web-based activity was directed to a different market. (It may not have helped the franchisee in this arbitration proceeding that, at least according to the arbitration panel, its customer accounts and revenues actually increased following H&R Block’s introduction of web-based tax preparation services.)

A similar result pertained in an action brought against Pro Golf of America in which a franchisee asserted that its franchisor breached the subject franchise agreement by offering and selling golf merchandise over the web (including within the franchisee’s exclusive territory)64. Denying the franchisee’s request to reconsider the court’s denial of a motion for summary judgment on the issue, the court narrowed its focus to a remarkable extent, identifying the critical issue to be where title to golf equipment sold by the franchisor over the internet technically passed. According to the 26 court, the franchisees presented no evidence on this issue and the court refrained from simply positing that the title to golf equipment sold by the franchisor technically passed within the franchisees’ territories. As well, noted the court, the Pro Golf franchisees possessed no exclusive right to all customer business within their territories, since otherwise every time a customer in one of those franchised territories purchased golf equipment from another Pro Golf franchisee outside those territories, under the franchisees’ argument a breach of contract would arise.

When properly established, a franchisor’s web protocol can give rise to a seamless and profitable “virtual marketplace” that can do wonders for the franchisor and its franchisees alike. But there are great dangers to be anticipated and avoided – including the possibility that, as the Drug Emporium, the franchisor’s internet activity will be deemed in violation of the subject franchise agreement.

F. Prior Course of Dealing

Notwithstanding well established law that extrinsic or parol evidence (including prior course of performance) may only be considered to construe a contract which is either ambiguous or silent when addressing a vital matter, nevertheless franchisees occasionally challenge a franchisor’s modification of its system by arguing that it clashes with, and is precluded by, that franchisor’s prior course of dealing.

However, the courts have almost universally held that the parties’ post-execution course of conduct under a franchise agreement may only be referred to and analyzed when that franchise agreement is ambiguous. Stated conversely, when a contract is unambiguous, no such reference to the parties’ course of performance may be had.

The court in Burger King Corporation v. Austin et al.65 clearly expressed both corollary principles in its decision. One of the franchisee’s allegations in this case was that Burger King failed to expend monies on local advertising. But the court held: “The Agreement states that BKC retains discretion over advertising spending; accordingly, BKC could not have breached the express terms of the contract by failing to spend monies on local advertising”. However, addressing the franchisee’s allegation that Burger King breached the implied covenant of good faith “to provide down store support” to plaintiffs, and noting that Burger King had in the past pursued a course of performance in which it furnished such support, the court held: “In order to define the term ‘advise and consult’, the Court may eventually have to apply a standard of reasonableness that encompasses all relevant circumstances surrounding the transaction, together with any prior negotiations between them and any applicable course of dealing, course of performance or usage (citing 2E. Allan Farnsworth, Farnsworth on Contracts §7.10) (emphasis added)”.

Similarly, in Elliott & Frantz, Inc. v. Ingersoll-Rand Company,66 in which a distributor of industrial construction equipment sued the manufacturer alleging breach of

27 contract - - and suggesting that the parties’ conduct following the execution of that contract somehow modified the agreement - - the court held:

Under New Jersey law, parties to an existing contract, by mutual assent, may modify their contract, and modification can be proved by an explicit agreement to modify by the actions and conduct of the parties, so long as the intention to modify is mutual and clear (citation omitted). A proposed modification by one party to a contract must be accepted by the other to constitute mutual assent to modify and unilateral statements or actions made after an agreement has been reached or added to a completed agreement clearly do not serve to modify the original terms of a contract.

The Elliott & Frantz court went on to observe: “…(I)t seems strange that if Elliott & Frantz really thought that its Agreement had been modified as it now contends, that it did not seek to protect its rights by having the modification memorialized in writing. Indeed, it has been noted that while continuous dealings between parties to a contract may lead to emotional expectations that in any event might or might not happen, that subjective feeling, while ‘reasonable’, does not have contractual significance. Absent ambiguity, or proof of an actual contract modification, course of dealing or course of performance are not contract modifiers.”67

In another decision involving claimed rights under a distribution agreement arising from one parties’ unilateral performance thereunder, the court in Pepsi Cola Bottling Company of Pittsburg, Inc. v. PepsiCo, Inc. et al.68 strongly rebuffed the bottler- distributor’s efforts. The distributor contended that PepsiCo’s decades long practice of offering Exclusive Bottling Appointments for all new products developed by PepsiCo entitled it to the same right going forward - - that is, to Exclusive Bottling Appointments (“EBA”) for all products PepsiCo developed in the future. The court strongly rejected plaintiff’s contention in this regard, holding:

Pittsburg Pepsi contends that as a result of PepsiCo’s past practice of offering Pittsburg Pepsi EBA’s for new products, Pittsburg Pepsi has a contractual right to be offered EBAs for new Pepsi products. Pittsburg Pepsi argues that the parties’ 39 year course of dealing modify the original Pepsi-Cola EBA to include a provision entitling Pittsburg Pepsi to be offered appointments for new Pepsi products…

Applying New York law to the parties’ contract and subsequent actions, we are unable to modify the original EBA based on the parties’ course of performance to now require that PepsiCo offer Pittsburg Pepsi appointments for new Pepsi products. The original Pepsi-Cola EBA requires that any modification of the agreement must be in writing and agreed to by the parties. It states that “this Appointment expresses fully the understanding… and no future changes in the terms of this 28 Appointment shall be valid, except when and if reduced to writing and signed by both (parties)…”… Pittsburg Pepsi cites several cases holding that the parties’ course of performance waived the terms of their original contract… Pittsburg Pepsi’s contract modification claim differs from these cases because here, the parties’ repeated actions did not modify an existing contract entitling Pittsburg Pepsi to any new products…

Accordingly, the Tenth Circuit affirmed the district court’s grant of summary judgment to PepsiCo on Pittsburg Pepsi’s “contract modification by course of dealing” claim.

To escape this conclusion, Pittsburg Pepsi went on to suggest that a new “implied-in-fact” contract had been created entitling it to new PepsiCo products. Affirming the district court’s grant of summary judgment to PepsiCo on this claim, the Tenth Circuit held: “…(T)heories of express contract and a contract implied in fact are mutually exclusive: a contract cannot be implied in fact where an express contract covers the subject matter involved… Additionally, although New York law permits a prior course of dealing to interpret existing contracts, a prior course of dealing may not be used to establish contract formation (citation omitted)” (emphasis in original).

See, also, Fickling v. Burger King Corp.69 (holding that in the face of express and unambiguous contractual provisions, a franchisee’s claim of violation of customary practices had been properly dismissed by the lower court as contrary to the terms of the subject franchise agreements); Payne v. McDonald’s Corp.70 (“plaintiff’s contention that McDonald’s has violated its policy… must fail because of unambiguous provisions in the franchise agreements which disavow the existence of any such policy”); Hoffman v. Midas International Corp.71 (in which the court upheld Midas’ contractual right to open new locations despite claims that it was doing so in a matter contrary to Midas’ longstanding prior practice).

In stark contrast to the above-cited line of cases holding that a franchise agreement’s grant of complete discretion to the subject franchisor may not be modified by that franchisor’s prior course of performance is the confusing (and internally confused) decision in Keshock et al. v. Carousel Systems, Inc. et al.,72 a truly “one of its kind” decision. In Keshock, plaintiff-franchisee sued the defendant-franchisor of “Goddard Schools” asserting breach of defendant’s contractual obligations to assist plaintiffs with site selection, construction, advertising and training. Defendants moved for summary judgment, which was granted in part and denied in part.

The Keshock court began its analysis by strongly affirming the principles heretofore enunciated in this memorandum, as follows:

In this action… there is only one reasonable interpretation of Carousel’s obligation to provide advisory assistance to (plaintiffs). The Franchise 29 Agreement’s use of the discretionary phrase “as it deems appropriate” unambiguously grants Carousel discretionary authority to define the terms of its assistance. Indeed, upon reviewing a similar contract, which placed key decisions “within the sole discretion of” the franchisor, the Third Circuit noted, “It is difficult (if not impossible) to read Article 4.3 as anything other than a provision making the relocation decision a matter for [the franchisor’s] own discretion”. GMC v. New A.C. Chevrolet, Inc. (citation omitted); see also Ernie Haire Ford, Inc. v. Ford Motor Co., (citation omitted) (finding no ambiguity where franchise agreement reserved franchisor’s right to use its “best judgment” in choosing dealership locations). As there is no ambiguity in the Franchise Agreement’s requirement that Carousel provided advisory assistance “as it deems appropriate”, this Court need not look beyond the four corners of the contract to determine the parties’ intent.

However, the court went on to deny summary judgment to defendant Carousel, holding that Carousel’s prior performance under franchise agreements with other parties could be used to determine whether it breached its franchise agreement with plaintiff in this case, as follows:

Plaintiffs now contend that Carousel breached its obligation to provide ongoing advisory assistance with respect to the construction, opening, and operation of the Avon School, and that any assistance actually provided was too limited to ensure the school’s profitability. The discretionary language of the Franchise Agreement, however, clearly establishes that the adequacy of Carousel’s efforts must be judged by Carousel’s own standards, rather than by Plaintiffs’ subjective preferences or unjustified expectations (citations omitted)… This court finds that Plaintiffs have identified sufficient evidence of Carousel’s customary standards to withstand summary judgment on the issue of continuing advisory assistance. Plaintiffs have enumerated specific facts within the record which suggests that the support provided to the Avon School fell below Carousel’s standards for comprehensive assistance in construction, opening and operations.

Then, to really complicate matters, the court in Keshock went on to observe: “This Court recognizes that Carousel’s customary procedures in dealing with other Goddard Schools by no means established that Carousel deemed a similar level of assistance to be “appropriate” with respect to the Avon School. However, in producing evidence that the assistance requested by Plaintiffs was typically made available to other franchisees, Plaintiffs have raised issues of fact that may be relevant to the instant motion”.

30 We view the court’s decision in Keshock to be internally confused and remarkably confusing. Perhaps for this reason, the court designated its opinion as “not for publication”. We view Keshock as utterly aberrant and in conflict with every other judicial decision addressing the issue of whether a franchisor’s post-contractual course of dealing may be used as evidence of that franchisor’s contractual duty when the franchise agreement at issue is clear, unambiguous and thus not susceptible to further judicial construction or interpretation.

III. SUGGESTED FRANCHISE AGREEMENT PROVISIONS

A. Network Modification

In the exercise of our sole business judgment, we may from time to time modify any components of the [franchise] System and requirements applicable to you by means of Supplements to the Manual or otherwise, including, but not limited to, altering the products, programs, services, methods, standards, accounting and computer systems, forms, policies and procedures of the [franchise] System; adding to, deleting from or modifying the products and services which your franchised Business is authorized and required to offer; modifying or substituting the equipment, signs, trade dress and other [Business/Shop/[name for base or center]/Restaurant/School] characteristics that you are required to adhere to (subject to the limitations set forth in this Agreement); and, changing, improving, modifying or substituting for the Proprietary Marks. You agree to implement any such System modifications as if they were part of the System at the time you signed this Agreement.

You acknowledge that because uniformity under many varying conditions may not be possible or practical, we reserve the right to materially vary our standards or franchise agreement terms for any franchised [franchise] Business, based on the timing of the grant of the franchise, the peculiarities of the particular territory or circumstances, business potential, population, existing business practices, other non-arbitrary distinctions or any other condition which we consider important to the successful operation of the franchised [franchise] Business. You will have no right to require us to disclose any variation or to grant the same or a similar variation to you.

B. Co-Branding

We may determine from time to time to incorporate in the [franchise] System products or services which we either develop or otherwise obtain rights to, which are offered and sold under names, trademarks and/or service marks other than the Proprietary Marks and which your [franchise] [Business/Shop/[name for base or center]/Restaurant/School], along with other [franchise] [Businesses/Shops/[names for base or center]/Schools], will be required to offer and sell (this activity, colloquially referred to as “cobranding”, may involve changes to the Proprietary Marks and may require you to make modifications to your [name for base or center]’s building and 31 premises and the furniture, fixtures, equipment, signs and trade dress of your [name for base or center]). If you receive written notice that we are instituting a cobranding program, you agree promptly to implement that program at your [franchise] [Business/Shop/[name for base or center]/Restaurant/School] at the earliest commercially reasonable time and to execute any and all instruments required to do so. Under no circumstance will any cobranding program increase your Continuing Royalty, System Advertising Contribution [(if any)] or local advertising expenditure obligations under this Agreement.

C. Uniformity Of Retail Prices Within Network (Retail Price Maintenance Keyed To Price Point Advertising)

Because enhancing [franchise]’s interbrand competitive position and consumer acceptance for [franchise]’s products and services is a paramount goal of us and our franchisees, and because this objective is consistent with the long term interest of the [franchise] System overall, we may exercise rights with respect to the pricing of products and services to the fullest extent permitted by then-applicable law. These rights may include (without limitation) prescribing the maximum and/or minimum retail prices which you may charge customers for the goods and/or services offered and sold at your franchised [Business/Shop/[name for base or center]/Restaurant/School]; recommending retail prices; advertising specific retail prices for some or all products or services sold by your franchised [Business/Shop/[name for base or center]/Restaurant/School], which prices you will be compelled to observe; engaging in marketing, promotional and related campaigns which you must participate in and which may directly or indirectly impact your retail prices (such as “buy one, get one free”); and, otherwise mandating, directly or indirectly, the maximum and/or minimum retail prices which your franchised [Business/Shop/[name for base or center]/Restaurant/School] may charge the public for the products and services it offers. We may engage in any such activity either periodically or throughout the term of this Agreement. Further, we may engage in such activity only in certain geographic areas (cities, states, regions) and not others, or with regard to certain subsets of franchisees and not others. You acknowledge and agree that any maximum, minimum or other prices we prescribe or suggest may or may not optimize the revenues or profitability of your franchised Business and you irrevocably waive any and all claims arising from or related to our prescription or suggestion of your franchised Business’s retail prices.

D. Franchisor’s Right To Acquire Other Businesses, Be Acquired, Go Public, Go Private Or Merge

We will have the right to assign this Agreement, and all of our rights and privileges under this Agreement, to any person or business entity, provided that: (i) the assignee must, at the time of assignment, be financially responsible and economically capable of performing Franchisor’s obligations under this Agreement, and (ii) the assignee must expressly assume and agree to perform these obligations. 32

You agree and affirm that we may sell our company, our assets, our Proprietary Marks and/or System to third party; may go public; may engage in a private placement of some or all of our securities; may merge, acquire other business entities or be acquired by another business entity; and/or, may undertake a refinancing, recapitalization, securitization, leveraged buyout or other economic or financial restructuring. With regard to any such sale, assignment, merger, acquisition or financial activities, you expressly and specifically waive any claims, demands or damages arising from our related to the substitution of our name, Proprietary Marks (or any variation thereof) and System; the loss of association with us or identification of us as the “Franchisor” under this Agreement; and, any and all other claims, demands or damages arising from or related to such activities.

If we assign this Agreement, as provided herein, you expressly agree that immediately upon and following such assignment, we will no longer have any obligation – directly, indirectly or contingently – to perform or fulfill the duties and obligations imposed upon “Franchisor” hereunder. Instead, all such duties and obligations will be performed solely by our assignee, and you will never assert, contend or complain otherwise.

E. Network Reidentification (New Or Additional Marks)

You agree that at any time we may direct you to modify or discontinue the use of any Proprietary Mark and/or adopt and use one or more additional or substitute Proprietary Marks and that, under such circumstance, you will be required promptly to comply with any of our directions or instructions. If this happens, our only obligation will be to reimburse you for your documented reasonable expenses (“hard costs”) of complying with our directions or instructions, including expenditures you make for changing signs, [vehicle decals,] [uniforms,] stationery and any incremental cost of modifying any preexisting advertising or promotional material. We will not be liable to you for any other expenses, losses or damages sustained by you as a result of any Proprietary Mark addition, modification, substitution or discontinuation except as provided herein. You waive any claim for any such other expenses, losses or damages and covenant not to commence or join in any litigation or other proceeding against us for any of these other expenses, losses or damages.

F. Franchisor’s Reserved Rights Within Franchisee’s Territory

You agree that we and/or our affiliates may engage in any business activity whatsoever in or outside the Territory except as we are restricted by Section X.XX of this Agreement, and that this Agreement does not confer upon you any right to participate in or benefit from any such other business activity (regardless of whether it is conducted under the Proprietary Marks or not). Our rights to engage in other business activities are specifically reserved and may not be qualified or diminished in any way by 33 implication. We thus may engage in, or authorize others to engage in, any form of business offering and selling any type of product or service except as restricted by Section X.XX above. By way of example, we and/or our affiliates may own, operate or authorize others to own or operate any type of business at any location whatsoever, including within your Territory, so long as such other business does not sell under the Proprietary Marks the type of products or services which your franchised [franchise] [Business/Shop/[name for base or center]/Restaurant/School] offers and sells (except as permitted below). Further, we and/or our affiliates may own, operate or authorize others to own or operate [franchise] [Businesses/ Shops/[names for base or center]/Restaurants/Schools] at any location outside of your Territory (including immediately proximate thereto).

In addition, you understand and agree that we and/or our affiliates alone have the right to offer and sell within and outside your Territory, and under the Proprietary Marks, any and all products or services and/or components or ingredients thereof (including those used or sold by your franchised [franchise] [Business/Shop/[name for base or center]/Restaurant/School]), and whether or not a part of the [franchise] System, through any method of distribution other than a [franchise] [Business/Shop/[name for base or center]/Restaurant/School] situated within your Territory including, without limitation, the internet/worldwide web; any other form of electronic commerce; “800” or similar toll-free telephone numbers; mail order; catalogs; television sales (including “infomercials”); or, any other channel of distribution whatsoever except for a [franchise] [Business/Shop/[name for base or center]/Restaurant/School].

You also understand and agree that we and/or our affiliates alone have the right to offer and sell [franchise] System products and services at any and all nontraditional locations, including nontraditional locations situated in your Territory, through the establishment of [franchise] [Shops/[names for base or center]/Restaurants/Schools]., kiosks, mobile units, concessions or “shop in shops”, and that, by contrast, you are precluded in engaging in such activity. “Nontraditional locations” includes [customize the following:]sports arenas and venues; theatres; resorts; [food retailers (including supermarkets, grocery stores and convenience stores)]; malls and mall food courts; schools and universities; hospital and healthcare facilities; airports; guest lodging facilities; day care facilities of any type; government facilities; condominium and cooperative complexes; the premises of any third party retailer which is not a [type of business, e.g. restaurant] (including shops, stores and department stores); military bases and installations; airlines, railroads and other modes of mass transportation; and, any other location or venue to which access to the general public is restricted.

You further agree that, both within and outside the Territory, we and/or our affiliates alone have the right to sell [franchise] System products and services to national, regional and institutional accounts. “National, regional and institutional accounts” are organizational or institutional customers whose presence is not confined to your Territory, including (by way of example only): [customize the following:] business 34 entities with offices or branches situated both inside and outside of your Territory; government agencies, branches or facilities; guest lodging networks; healthcare networks; the military; and, any other customer whose presence is not confined to your Territory. Only we will have the right to enter into contracts with national, regional and/or institutional accounts (which may include facilities within your Territory). If we receive orders for any [franchise] products or services calling for delivery or performance in your Territory as a result of our engaging in commerce with National, Regional and Institutional Accounts, then we will have the right, but not the obligation, either to require you to fulfill such orders at the price we agree on with the customer or to give you the opportunity to fulfill such orders at the price we agree on with the customer. If we give you the opportunity to fulfill such orders and if, for any reason, you do not desire to or cannot serve the customer, or if the customer desires for any or no reason to deal exclusively with us, our affiliate or another franchisee and not with you, then we, our affiliate or any other [franchise] franchisee may serve the customer within your Territory, and you will not be entitled to any compensation. The procedures governing our National, Regional and Institutional Accounts program are set forth in our Manual.

You also agree that we may purchase, merge, acquired, be acquired by or affiliate with an existing competitive or non-competitive franchise or non-franchise network, chain or any other business regardless of the location of that other business’ facilities, and that following such activity we may operate, franchise or license those other businesses and/or facilities under any names or marks other than, while this Agreement is in effect, the Proprietary Marks regardless of the location of these businesses and/or facilities, which may be within the Territory or immediately proximate thereto.

You waive and release any claims, demands or damages arising from or related to any of the above activities and promise never to begin or join in any legal action or proceeding, or register a complaint with any governmental entity, directly or indirectly contending otherwise.

G. Franchised Unit Remodeling

We have the right to require you [once][twice] during the Initial Term of this Agreement, at your sole expense, to update, remodel, refurbish, renovate, modify or redesign the [franchise] [name for base or center] so that it reflects our then-current standards. If any such direction of ours requires you to expend more than $______to effect the directed activity, then you will have six months following your receipt of our notice to comply with our direction, otherwise compliance must be effected at the earliest commercially reasonable time. In addition, we will relieve you from any such direction of ours if the term of this Agreement will expire within three (3) years of the date you receive our direction and you state in writing your intent not to renew this Agreement, in which event the direction will take effect, as applicable, either immediately upon any subsequent redetermination of yours to renew this Agreement (in 35 accordance with the procedures governing renewal set forth above) or as a binding obligation upon the purchaser, assignee and/or transferee of your franchise, set forth in any applicable contract of sale, assignment and/or transfer between you and such individual or entity, to comply with such direction at the soonest commercially reasonable time following your assignment, sale or other disposition of your franchised business to such individual or entity.

36 ENDNOTES

1 187 So.2d 55 (Dist.Ct. of App. of Fla, 3d Dist. 1966).

2 Id. at 57.

3 Id. at 58.

4 631 F.2d 303 (4th Cir. 1980) cert. denied 451 U.S. 970 (1981).

5 146 B.R. 594 (D.R.I. 1992).

6 Id. at 598.

7 Id. at 598, fn4.

8 756 F.Supp. 1024, CCH Bus. Franchise Guide ¶9771 (N.D.Ohio 1991).

9 Id. at CCH page 22,001.

10 Not reported in F.Supp., 1991 WL 322974 and 1991 WL 322975, CCH Bus. Franchise Guide ¶9933 (D. Minn. 1991).

11 2010 WL 5834869 (S.D. Fla. 2010), aff’d by 2011 WL 677374 (S.D. Fla. 2011).

12 2010 WL 5834869 at *5.

13 547 U.S. 388 (2006).

14 717 F.Supp. 368, CCH Bus. Franchise Guide ¶9471 (D.Md. 1989).

15 708 F.Supp. 867, CCH Bus. Franchise Guide ¶9469 (M.D.Ill. 1989).

16 663 F.Supp. 1027, CCH Bus. Franchise Guide ¶8891 (D.Ore. 1987).

17 Id. at CCH pages 17,828-17,829.

18 B.C.Sup. Ct., No. 001548/79 Victory Registry, CCH Bus. Franchise Guide ¶7985 (1982).

19 63 F.3d 1169 (2d Cir. 1995).

20 5 F.3d 218, CCH Bus. Franchise Guide ¶10,283 (7th Cir. 1993).

21 147 Wis.2d 308, 433 N.W.2d 8, CCH Bus. Franchise Guide ¶9317 (Wisc.Sup.Ct. 1988).

22 201 Wis.2d 320, 548 N.W. 2d 519, CCH Bus. Franchise Guide ¶10,936 (Wisc.Sup.Ct. 1996).

23 Doctor Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1914).

24 United States v. Colgate & Co., 250 U.S. 300 (1919).

25 522 U.S.3 (1997).

26 Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S.36 (1977).

27 551 U.S. 877 (2007).

28 Burger King v. E-Z Eating 41 Corp., 572 F.3d 1306 (11th Cir. 2009).

29 Id. at 13-14.

30 National Franchisee Association v. Burger King Corporation, 715 F.Supp. 2d 1232 (S.D.Fla. May 20, 2010).

31 National Franchisee Association v. Burger King Corporation, Slip Copy, 2010 WL 4811912 (S.D. Fla, November 19, 2010).

32 Id. at 9.

33 Khan, 522 U.S. at 22.

34 National Franchisee Association, 715 F.Supp. 2d at 1245, fn 7.

35. See, for example, Garner, "A Franchise Lawyer's Perspective on the Duties of a Merging Franchisor", Joining Forces: Successful Strategies for Making Purchases and Sales of Franchise Companies Work for Everyone, supra at endnote 62.

36. 618 N.Y.S.2d 155, 162 Misc.2d 941, CCH Bus. Fran. Guide ¶10,523 (S.Ct., N.Y.Cty. 1994). Mr. Kaufmann's firm represented the Union Carbide defendants in this action.

37. General Business Law of New York, Article 33, 680 et seq.

38. Not reported in F.Supp.; 1990 WL 36139, CCH Bus. Fran. Guide ¶9595 (E.D.Pa. 1990).

39. Id. at CCH, page 21,174.

40. Id. at CCH, page 21,176.

41. Id. at CCH, page 21,176.

42. 440 N.W.2d 276 (S.D. 1989).

43. 931 F.2d 1112 (6th Cir. 1991).

44. CCH Bus. Fran. Guide ¶10,121 (5th Cir. 1992).

45. Vines, Editor, Mergers & Acquisitions of Franchise Companies, supra. at endnote 62.

46. 110 F.3d 295, CCH Bus. Fran. Guide ¶11,147 (5th Cir. 1997).

47. 732 F.2d 480 (5th Cir. 1984).

48. Id.

49. CCH Bus. Fran. Guide page 26,010.

50. - - F.Supp.-B, CCH Bus. Fran. Guide ¶11,352 (S.D.Fla., 1998).

51. Id. at CCH page 30,387.

th 52. 198 F.3d 815 (11 Cir. 1999).

53 Independent Association of Mailbox Center Owners, Inc. et al. v. Mail Boxes Etc. USA, Inc. et al., 2007 WL 5635421 (Cal. Superior 2007).

54 G.I. McDougal, Inc. et al. v. Mail Boxes Etc., Inc. et al., 2008 WL 2152911 (Cal. App. 2 Dist. 2008) (nonpublished/noncitable).

55. Supra. at note 7.

56. 875 F.Supp. 947 (D.P.R. 1995).

57. 556 F.Supp. 769 (E.D.N.Y. 1983).

58. 63 F.3d 1169, CCH Bus. Fran. Guide ¶10,741 (2d Cir. 1995) cert. denied 116 S.Ct. 1351 (1996).

59. Connecticut General Statutes, 42-133e et seq.

60. Supra. at note 31, CCH Bus. Fran. Guide pages 27,106-27,107.

61. Id. at 27,108-27,109.

62 Emporium Drug Mart, Inc. of Shrevport et al. v. Drug Emporium, Inc. et al., American Arbitration Association, Dallas, Texas, Case No. 71 1140012600 (September 2, 2000); Bus. Franchise Guide (CCH) ¶11,966.

63 In the Matter of Arbitration Between Franklin 1989 Revocable Family Trust v. H&R Block, Inc., American Arbitration Association, Minneapolis, Minnesota, Case No. 16114005401 (2002), Bus. Franchise Guide (CCH) ¶12,473.

64 Pro Golf of Florida v. Pro Golf of America, 2006 WL 508631 (E.D. Mich. 2006) Bus. Franchise Guide (CCH), ¶13,316 (E.D.Mich. 2006).

65 805 F.Supp. 1007 (S.D. Fla. 1992).

66 457 F.3d 312 (2006) (applying New Jersey law).

67 Barkoff, Dady and Silberman, Are Franchise Agreements Without Written Borders? Oral Evidence of Contract Terms and the Concept of “Integrated Contracts”, American Bar Association Forum on Franchising, 2000, citing Division of Triple Serv., Inc. v. Mobile Oil Corp., 304 N.Y.S.2d 191 (Sup. Ct. 1969) aff’d 311 N.Y.S.2d 961 (App. Div. 1970); Blalock Machine and Equipment Co. v. Iowa Manufacturing Co., 576 F.Supp. 774 (N.D. Ga. 1983).

68 431 F.3d 1241 (10th Cir. 2006) (applying New York law).

69 843 F.2d 1386 (4th Cir. 1988).

70 957 F.Supp. 749 (D.Md. 1997).

71 No. 95 L 9878 (Ill. Cook County Cir. Ct. July 17, 1997), affirmed No. 1-97-2896 (Ill. App. Ct. 1998), leave to appeal denied, 706 N.E.2d 496 (1998).

72 2005 WL 1198867, CCH Bus. Franchise Guide ¶13,079 (E.D.Pa. 2005).