Judical Update 2003

August 13, 2003 Published Work
Franchising World, July/August 2003

If it's true that an area of law can develop by fits and starts by truly momentous cases, or through a slow but steady accretion of sensible decisions, franchising's development in 2002 was more the latter. Most of the reported decisions in 2002 were of the solid, common-sense type that a lawyer on either side of the issues could understand and conclude that the decision made sense and affirmed some general axioms of law and of life.
Bad Actors Lose. The first axiom is that bad actors generally lose. In continuing its efforts to enforce system standards and to aggressively protect its brand, Dunkin' Donuts, Inc. achieved several interesting and important victories in district courts in Florida, New York and Pennsylvania (Dunkin' Donuts, Inc. v. Barr Donut LLC; Dunkin' Donuts, Inc. v. Martinez; and Dunkin' Donuts, Inc. v. Liu). Dunkin's franchise agreements include an "obey all laws" clause, which to justify termination does not require a final conviction of a felony related to the franchised business. The clause simply requires the franchisee to comply with all applicable laws. The franchise agreement also provides that franchisees shall not do anything to harm Dunkin's goodwill.
In Martinez, Dunkin' the Court held that the evidence which Dunkin' had gathered from the franchisees' financial statements, discovery and independent investigation demonstrated that the franchisees had willfully evaded federal tax obligations and had also failed to comply with applicable employment laws. Citing a number of Dunkin' cases, the Martinez court held that a franchisee's failure to comply with federal or local laws violates the "obey all laws" clause and is a material breach of the franchise agreement, warranting termination. The court also stated that once the franchisee's criminal activity is known to the franchisor, the potential danger to the franchisor's goodwill is sufficient to justify termination.
Beyond criminal conduct, courts this year uniformly held that a franchisee's fraudulent conduct toward its franchisor constitutes good cause for termination. In El Pollo Loco v. Hashim, the franchisee represented on his application that he was not operating any competing restaurants. Mr. Hashim, however, did own KFC franchises. Before signing the agreements, El Pollo Loco received a forged letter on KFC stationery stating that Hashim's KFC franchises were being transferred to a third party.
Later, KFC discovered that Hashim owned the competing El Pollo Loco franchises and served him with a notice of default. Hashim then sent a letter to KFC on El Pollo Loco letterhead stating, in substance, that his relationship with El Pollo Loco had ended. The forgery was discovered and El Pollo Loco terminated Hashim's franchise. The Ninth Circuit held that El Pollo Loco satisfied the requirements for a preliminary injunction and had the right to immediately terminate the franchise without notice because of Hashim's material misrepresentations in his application.
Good Faith Actors Usually Prevail. In Viking Supply v. National Cart, the Eighth Circuit upheld summary judgment in favor of a manufacturer who terminated a distributor's contract for frustration of purpose. The parties had agreed that as long as the manufacturer had a distributorship agreement with Viking, Target Stores would be Viking's exclusive customer.
In 1999, Target advised the manufacturer that Target would no longer purchase from Viking. Among other reasons, Target had decided to do business only with manufacturers. The manufacturer terminated Viking and began selling directly to Target. The Eighth Circuit held that dismissal of Viking's claims was proper because once Target independently decided not to buy from Viking, the contract made no sense and the manufacturer was free to terminate the contract and sell directly to Target.
Similarly, in V. Suarez v. Dow, the federal court in Puerto Rico held that Dow's sale of a division and its termination of plaintiff's distribution agreement did not violate the Puerto Rico Dealer's Act. Specifically, Dow's withdrawal from the market was not in bad faith and constituted "just cause" for termination.

Good faith and the ability to prove it, however, are key factors in these decisions. In Beilowitz v. General Motors, plaintiff, who had been an AC Delco distributor for 23 years, successfully enjoined GM's non-renewal of his agreement. GM changed its long-term AC Delco business plan and required plaintiff to either agree to a more restrictive agreement or face non-renewal. Plaintiff showed that the new agreement, which substantially restricted his sales territory, would cost him 40 of his sales or $11 Million.
Finding GM's evidence that the new plan would be to plaintiff's benefit unconvincing, the court concluded that requiring a franchisee to operate at a substantial loss while GM implemented an unproven marketing strategy constituted the imposition of an unreasonable standard of performance in violation of the New Jersey Franchise Practices Act ("NJFPA"). The court also held that because GM offered no reason, other than its change in business strategy, for non-renewal, GM's non-renewal was not for good cause as required by the NJFPA.
Trademark Owners Have Absolute Rights to Protect their Marks. In Howard Johnson Int'l, v. Craven Properties Ltd., a former Howard Johnson franchisee changed its name to Howard's Resort Hotel after the expiration of its franchise agreement. The court first noted that Howard's Resort's sign was very similar to the registered mark. In entering an injunction against defendant, the court held that the resort's prior operation as a Howard Johnson greatly increased the likelihood of confusion.
While franchisors generally prevailed in trademark enforcement actions, other trademark owners had a difficult year. In the most anticipated trademark decision of the year, Moseley v. V. Secret Catalogue, Inc., the Supreme Court held that the owner of a famous mark must show actual dilution of its mark to be entitled to injunctive relief under the Federal Trademark Dilution Act ("FTDA"). The FTDA prohibits the use of a similar mark if "the use . . . causes dilution of the distinctive quality of the famous mark." Until Moseley, at least three circuits interpreted the FTDA to require only a likelihood of dilution, while two others required proof of actual dilution.

V. Secret sued to enjoin the Moseleys' use of the name "Victor's Little Secret" for their adult novelty shop. The district court granted the injunction and the Sixth Circuit agreed, finding that consumers who heard the name Victor's Little Secret were likely to think of Victoria's Secret and link it to the Moseley's' adult novelty shop.

Focusing on the express language of the FTDA, however, the Supreme Court reversed and held that the owner of a famous mark is entitled to injunctive relief against another's use only if that use "causes dilution." The Court specifically required that there had to be evidence of actual dilution, that is, an actual lessening of the capacity of the famous mark to identify and distinguish goods or services. The Court further held that mere mental association between the marks will not necessarily reduce the capacity of the famous mark to identify the goods of its owner. In Moseley, the Court found a complete absence of evidence of any lessening of the capacity of Victoria's Secret mark to identify and distinguish its goods and reversed the lower court's injunction.