Establishing Diversity Jurisdiction in Franchise Disputes: The Value of Injunctive Relief

Vol. 15, No. 2

By

Larkin Hoffman Daly & Lindgren Ltd.

Susan E. Tegt was one of the attorneys representing Novus Franchising, Inc. in the Novus Franchising Inc. v. Livengood case described in this article.

I. Introduction

Litigants often seek injunctive relief to limit the damage caused by the breach of a distribution or franchise agreement or to otherwise obtain relief where damages are not easily quantifiable. In doing so, the plaintiff may desire to venue the action in federal court over state court. While there are many different reasons for bringing an action in federal court, parties to a franchise or distribution agreement may find that federal courts are faster moving and consist of a judicial panel with greater expertise in corporate and franchise transactions. Of course, federal courts do not have subject-matter jurisdiction over all disputes. In the absence of a federal question, the plaintiff must plead diversity of citizenship, meaning the parties to the action must be citizens of different states and the amount in controversy must “exceed[] the sum or value of $75,000, exclusive of interest and costs.” 28 U.S.C. § 1332(a) (2006).

If a complaint alleges in good faith the jurisdictional minimum, jurisdiction is conferred on the federal court. St. Paul Mercury Indem. Co. v. Red Cab Co., 303 U.S. 283, 288-89 (1938). But, if the amount in controversy is challenged, a complaint will be dismissed if it “appear[s] to a legal certainty that the claim is really for less than the jurisdictional amount.” Id. The amount in controversy is measured by “the value of the object of the litigation,” meaning, in actions seeking only injunctive relief, the value of the injunction. Glenwood Light & Water Co. v. Mut. Light, Heat & Power Co., 239 U.S. 121, 125 (1915). Thus, the calculation of the value of an injunction may be critical to establishing, and overcoming challenges to, diversity jurisdiction.

The federal courts vary by circuit in their application of the “value of the object” rule. Several circuits, including the Second, Third, Eighth, Ninth and Eleventh Circuits, look strictly at the value of the injunction from the plaintiff’s perspective, even if the financial effect of an injunction on the defendant will far exceed the jurisdictional threshold. In contrast, other circuits, including the Fourth, Fifth, Sixth, Seventh and Tenth Circuits, determine the “value of the object” with reference to the greater of the value of the injunction to the plaintiff or the cost an injunction will impose on the defendant, but not the sum of both.  This article provides a brief survey of the different applications of the “value of the object” rule in the contexts of the enforcement of post-termination covenants not-to-compete and the valuation of a wrongfully-terminated franchise.

II. The Value of an Injunction Enforcing a Covenant Not-to-Compete

In Novus Franchising, Inc. v. Livengood, the United States District Court for the District of Minnesota recently denied the defendant franchisee’s motion to dismiss for lack of diversity jurisdiction by valuing the injunctive relief pleaded in the franchisor’s amended complaint.  No. 11-1651 (MJD/TNL), 2012 WL 38580, at *5 (D. Minn. Jan. 9, 2012). In Novus Franchising, Inc., the franchisor filed an amended complaint alleging, in part, that a former franchisee and the former franchisee’s shareholders violated, and continued to violate, a post-term covenant not-to-compete by operating a competitive business within the franchisee’s former franchised territory.  Id. at *3. The franchisor’s amended complaint sought monetary damages for the franchisee’s alleged failure to pay royalties and other fees, preliminary and permanent injunctive relief, costs and attorneys’ fees, and prejudgment interest. Id. The defendants moved to dismiss the franchisor’s complaint on two grounds, one being a lack of subject matter jurisdiction on the basis that the franchisor failed to establish a claim in excess of $75,000. Id. at *4. The defendants challenged the factual truthfulness of the franchisor’s averments that its damages exceeded the jurisdictional minimum, requiring the franchisor to submit evidence of the value of its claims by affidavit. Id. at *4, 6.

Applying Eighth Circuit law, requiring the value of the injunction to be analyzed solely from the perspective of the plaintiff, the court first addressed the franchisor’s difficulty attracting a new franchisee to the territory where its former franchisee continued to operate. Id. at *5. The value to the franchisor was calculated by adding initial franchise fees, training fees, and profits from the sale of equipment and other materials that the franchisor would collect from the placement of a new franchisee in the territory. Id. at *6. The court then added to that figure the minimum monthly royalty fees projected under the franchisor’s current franchise agreement over the ten-year term of the agreement and concluded the sum exceeded $75,000. Id. The court also acknowledged the amount in controversy may be calculated in a another way, by averaging the royalties paid by the former franchisee, since a new franchisee in the same territory would arguably generate similar sales. Id. (citing Grow Biz Int’l, Inc. v. MNO, Inc., No. 01-1805 (DWF), 2002 WL 113849, at *2 (D. Minn. Jan. 25, 2002)).

The Fourth Circuit follows the second approach in determining the value of an injunction for purposes of diversity jurisdiction, taking into account either the benefit to the moving party or the detriment to the party to be enjoined. For example, in JTH Tax, Inc. v. Frashier, II, the Fourth Circuit Court of Appeals reversed the dismissal of a franchisor’s complaint, holding the district court erred when it determined the amount in controversy failed to exceed the $75,000 requirement for diversity jurisdiction.  624 F.3d 635, 636 (4th Cir. 2010). In contrast to circuits examining only the value of the injunction to the plaintiff, the Fourth Circuit Court of Appeals indicated the value of the injunction may be determined “by reference to the larger of two figures: the injunction’s worth to the plaintiff or its cost to the defendant.” Id. at 639.  From the perspective of the plaintiff franchisor, the appellate court valued the benefit of the injunction forbidding competition in the former defendant franchisee’s territory by applying the franchisor’s standard accounting practice of valuing a franchise using the previous year’s net receipts. Id. The court added to that figure the loss of goodwill, estimated by the amount spent on advertising in the year the franchise agreement terminated. Id. In determining the cost of an injunction to the defendant franchisee, the court found an injunction prohibiting the franchisee from operating in a location subject to a five-year lease would cost the franchisee the monthly rent multiplied by the five-year term. Id. Adding this amount to the damages claimed in the complaint satisfied the jurisdictional minimum. Id. at 636.

III. The Value of a Wrongfully-Terminated Franchise

A franchisee may seek injunctive relief barring the wrongful termination of a franchise. The federal courts have yet to address the value of a wrongfully-terminated franchise as it may apply to the “value of the object” for diversity jurisdiction. Many courts have, however, addressed the valuation of a terminated franchise for the purpose of assessing damages, and these cases may be useful by analogy when seeking to establish or defend diversity jurisdiction.

However, the valuation of a terminated franchise is never a simple matter. For example, in Cooper Distributing Co., Inc. v. Amana Refrigeration, Inc. (“Cooper I”), the Third Circuit Court of Appeals held a franchise should be valued on the date of termination using either the “present value of lost future earnings or the present market value of the lost business.” 63 F.3d 262, 278, 287 (3d Cir. 1995). In Cooper I, a distributor commenced an action for wrongful termination of a franchise agreement and obtained a preliminary injunction, halting the termination of the franchise relationship for approximately two and a half years. Id. During the term of the injunction, the manufacturer refused to provide critical support to the distributor, arguably resulting in a loss of profits. Id. at 268. More than two years after the injunction issued, a jury held the manufacturer’s attempted termination of the distribution agreement violated the New Jersey Franchise Practices Act. Id. The district court entered judgment for the distributor and dissolved the preliminary injunction. Id. To value the terminated franchise, the district court instructed the jury to value the franchise as of the date the manufacturer first attempted to terminate the franchise. Id.at 278; see also Baur Truck & Equip., Inc. v. Svedala Indus., Inc., Bus. Franchise Guide (CCH) ¶ 10,193, at *3 (Wis. Ct. App. Feb. 2, 1993) (valuing a terminated franchise by calculating the distributor’s sales figures in the years leading up to the “substantial change in competitive circumstances”).

The Third Circuit Court of Appeals initially held this valuation method was in error, stating the proper valuation date is the date when the franchise ceased to operate, or the date of dissolution of the preliminary injunction. Cooper I at 278.  The court held valuing the franchise on the earlier date would bestow a double recovery because the distributor would recover both the value of the franchise as of the earlier date and also the actual profits derived from operating the franchise during the term of the injunction. Id. The appellate court remanded for a new trial on the issue of damages. Id. at 285.

On appeal after remand, the Third Circuit Court of Appeals changed its mind. Cooper Distributing Co., Inc. v. Amana Refrigeration, Inc., 180 F.3d 542, 546 (3d Cir. 1999) (“Cooper II”). In Cooper II, the appellate court held certain pre-termination amounts should have been included in the valuation of the franchise, particularly the profits lost by the distributor when the manufacturer ceased providing sales support to the distributor during the term of the preliminary injunction. Id. Thus, even though Cooper I held the franchise should be valued as of the date of termination, the Cooper II court held evidence of lost profits based upon the distributor’s “uncertain status” during the pendency of the preliminary injunction should be included in the valuation. Id. at 547 (citation omitted). The Cooper II court also rejected its earlier support for alternative valuation methods, holding that a market-value analysis, or the value “hypothetical buyers and sellers” would assign to the franchise, is the appropriate valuation method. Id. (citation omitted).

IV. Conclusion

The value of preliminary or permanent injunctive relief may be properly included to reach the jurisdictional threshold for diversity jurisdiction in federal courts. Since the circuits are split on whether the value of the injunctive relief should be measured solely by the benefit to the plaintiff, or by the greater of the benefit to the plaintiff or the cost to the defendant, litigants must be certain to understand the law of their circuit when faced with a jurisdictional challenge. Moreover, given the complexities and vagaries of the methods of valuing a franchise, attorneys representing parties to franchise disputes are advised to retain valuation experts who understand the complexities of the franchise business model and are capable of presenting more than one valuation method to the court.

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