May 01, 2018 Substantive Law

Precision in Drafting Franchise Agreements: Expiration Versus Termination

By Benjamin B. Reed

Reprinted with permission from The Franchise Lawyer, Spring 2018 (21:2), at 12-14. ©2018 by the American Bar Association. Reprinted with permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.

In litigating cases involving the end of a franchise relationship—be it holdover situations, efforts to enforce post-term noncompetes, or disputes over the parties’ respective rights and obligations after the agreement ends—the question of whether the relationship has actually ended can often be at issue. A franchisee might contend that the franchisor had no right to terminate the agreement, that the reason given for the termination was a pretext, or that the parties agreed by conduct to continue the relationship after expiration of the initial term. A franchisor might assert that its termination complied with the letter of the franchise agreement, that the franchisee cannot undermine the right to terminate by asserting prior breach by the franchisor, or that the franchisee must comply with certain post-termination obligations.

While franchise litigators commonly deal with issues concerning whether the agreement has properly ended or not (and the impact of that conclusion on the parties’ rights and obligations), another related question can have ramifications on cases involving the end of the relationship: how the relationship ended. In this context, “how” does not mean the actions that led to the end of the relationship. Rather, “how” means whether the agreement ended as a result of the running of the term of the agreement—expiration—or as a result of some affirmative act or omission giving one party or the other the right to declare the agreement at an end prior to the running of the term—termination.

In a number of agreements, the term “terminates” or “termination” is often used to generally cover any end of the relationship, be it affirmatively ending the agreement or through expiration of the term. So, for example, provisions in a franchise agreement setting out the obligations that a franchisee has when an agreement ends often read “upon termination of this Agreement” or “after this Agreement terminates.” In other situations, agreements specify similar obligations “upon termination or expiration” or “if this Agreement expires or terminates.” The distinction between provisions that rely only on the word “termination” and those that also use the term “expiration” may appear to be form over substance. However, the precision in which an agreement defines the ending event on which certain rights or obligations are triggered can be an issue. An example comes from two cases from the Fourth Circuit.

In the first, Hamden v.Total Car Franchising Corp., 548 Fed. Appx. 842 (4th Cir. 2013), the Fourth Circuit Court of Appeals examined the use of the terms “termination” and “expiration” in deciding the application of restrictive covenants after the end of a franchise relationship. In the franchise agreement at issue Hamden, a section entitled “Rights and Duties of Parties upon Expiration, Termination, or Non-renewal” included a post-term noncompete that was to run “for 2 years following termination of this Agreement.” Id. at 844. It also required the franchisee to return certain proprietary materials on termination “for any reason.” Id. Separately, the parties executed a separate confidentiality and noncompetition agreement, incorporated by reference into the Franchise Agreement, which included three additional restrictive covenants:

  • The first covenant provided that if the franchise agreement “terminated before its expiration” that the franchise owner would not “for a period of two years after termination” own or engage in a similar business to the franchised business within a certain area. Id.
  • The second covenant was a nondisclosure provision that applied “during the term of the Franchise Agreement and thereafter” and prohibited the franchise owner from using confidential information “if there is any termination of this Agreement.” Id.
  • The third covenant restricted the franchise owner from soliciting or diverting customers “during the term of the Franchise Agreement and for 2 years after its termination.” Id.

When the franchisee decided not to renew his franchise agreement at the end of its term, the agreement expired. The franchisee continued to operate his business as an independent business, and the franchisor sued to enforce the post-term noncompete. Id. at 845.

The franchisor asserted that the post-term noncompete applied to the franchisee’s continued operation after the expiration of the franchise agreement. The franchisor argued that there was no difference between the terms “terminate” or “expire” when construing a contract. Id. at 846. The court agreed that a termination would include expiration, citing the Black’s Law Dictionary definitions of termination and expiration. And the court noted that the use of both terms in the agreements did not establish on its own that the terms had different meanings. Id.

However, the court refused to rely solely on the definitions, and instead looked at how the terms were actually used in the parties’ agreements. The court noted that the renewal provisions of the franchise agreement discussed events surrounding expiration (and did not use the term “termination), and that a separate section described events that would result in termination prior to the expiration of the term. Because the terms were not used together or interchangeably, the term “termination, as used in the agreements before us, does not encompass expiration.” Id. at 849. Notably, the court ignored the title of the section including the noncompete: “Rights and Duties of Parties upon Expiration, Termination, or Non-renewal.” As a result, the court concluded that the non-solicitation, noncompetition, and a portion of the nondisclosure covenants—which were triggered by “termination before expiration,” “if the agreements terminated,” “following the termination of this Agreement,” or “if there is any termination”—did not apply following expiration of the franchise agreement and could not be enforced to prevent the former franchisees post-term operation of a competing business.

In the second case, Frye v.Wild Bird Centers of America, Inc., 237 F. Supp. 2d 302 (D. Md. 2017), a Maryland federal court refused to vacate an arbitration award that ordered a former franchisee to comply with a two-year post-term noncompete. The noncompete in Frye prohibited competition by the franchisee for “a period of 24 months after termination” of the franchise agreement. 237 F. Supp. 2d at 305. As a result, the franchisee, relying heavily on the Hamden decision, argued that the noncompete was not applicable because, as in Hamden, the franchise agreement had expired rather than terminated. Id. at 309. However, the Frye franchise agreement also contained a separate section setting forth the parties’ obligations upon termination of the franchise agreement, which included the following language:

In the event of termination or expiration of this Agreement for any reason . . . you agree to perform the following obligations: . . . [y]ou will comply with your obligations under [the noncompetition covenant].

Id. at 305.

The arbitrator had relied on this language to conclude that compliance with the noncompete was required upon termination or expiration, and that “termination” as used in the noncompete encompassed both affirmative acts of termination prior to the end of the term and to termination via expiration of the term. Because the court’s review was limited to the high standard necessary to vacate an arbitration award (to wit, did the arbitrator’s award draw its essence from the contract), the court refused to vacate the award because the arbitrator’s interpretation was plausible, drew from the essence of the contract, and was not in manifest disregard of the law.

Obviously, the standard of review applied in Frye prevents us from knowing whether or not the court agreed with the arbitrator’s interpretation on the merits. Perhaps the court, viewing the case as the finder of fact, would have followed the Hamden decision. Regardless, these cases—and experience from the trenches—teach that the terms “expire” and “terminate” in a franchise agreement should not be viewed as automatically interchangeable, even in the section headings. As a franchisor, in drafting provisions that will come into play after the agreement ends—for whatever reason—precision is needed to ensure that those provisions are applicable under all of the right circumstances. At the same time, franchisees should carefully review and assess whether their franchise agreements distinguish between obligations that only arise from a franchisor’s termination, expiration, or either. In a recent decision, the United States Court of Appeals for the Third Circuit affirmed the dismissal of a franchisee’s claim that the franchisor’s termination decision violated the New Jersey Franchise Practices Act (“NJFPA”) because it was motivated by racial animus. While that decision is limited to the NJFPA, it raises the question whether other statutes require analysis of a franchisor’s subjective motivation or good faith for a termination decision. The answer is that very few do, but courts in some states will also imply an obligation even if not explicitly written into the statute. This article will identify and analyze which state relationship laws expressly require a franchisor to show its termination decision was made in good faith and which jurisdictions’ courts have fashioned a good faith requirement under the statute.

Entity:
Topic:

Benjamin B. Reed

Benjamin B. Reed, Plave Koch PLC.