Franchise 101: Waive Before Checkout; and No Shaking Franchisor’s TRO

FRANCHISOR 101: Waive Before Check Out

A Georgia district court declined to dismiss a breach of contract case by a hotel franchisor against a franchisee. The court rejected the franchisee’s argument that the franchisor waived its rights under the parties’ license agreement and found the liquidated damages clause could be enforceable.

Holiday Hospitality Franchising sued for breach after its franchisee failed to timely construct and open a Hotel Indigo. The license agreement had a liquidated damages provision, which the franchisor used to claim damages of more than five million dollars.

In a motion to dismiss the action, the franchisee argued the franchisor waived its rights by allowing multiple extensions of deadlines and waiting too long to demand the liquidated damages.

Noting that waiver is generally a question for a jury to decide, the court found the franchisee had not shown such a strong case that a jury trial could be avoided. While Georgia law lets parties waive contract provisions by conduct, the court noted “the law will not infer the waiver of an important contract right unless the waiver is clear and unmistakable.”

The franchisee also argued the liquidated damages were unenforceable because the time frame for damage calculation—from the time of execution of the license agreement to the date of the final construction deadline—was excessive. Additionally, using average daily revenue of all Hotel Indigo locations to calculate the liquidated damages was an unreasonable estimate of potential losses.

Again, the court noted that a decision was premature, “while the reasonableness of the liquidated damages provision represents a question of law for the court, that determination rests upon a factual inquiry.” The court found the franchisor’s complaint for liquidated damages met the required elements to be enforceable.

Franchisors sometimes give extensions to franchisees on deadlines for construction and opening. Franchisors should document any extension and possibly include a nonwaiver statement to help ward off franchisee claims of inaction or waiver. A franchisor that wants to include liquidated damages in its agreement, should work with franchise counsel to draft the clause so if challenged, there is a better chance of it being upheld.

Holiday Hosp. Franchising, LLC v. N. Riverfront Marina & Hotel, LLP, Case No. 21-CV-2584 (N.D. Ga. Aug. 26, 2021)

FRANCHISEE 101: No Shaking Franchisor’s TRO

An Indiana federal court granted hamburger and milkshake franchisor, Steak n Shake, a temporary restraining order (“TRO”) against a franchisee to enforce post-termination obligations under franchise and area development agreements.

The parties entered into an area development agreement and several franchise agreements. The franchisor terminated the agreements due to the franchisee’s breaches and sued the franchisee for trademark infringement and breach of contract. The franchisor requested a TRO to enjoin claimed infringement of the Steak n Shake trademark and unfair competition, and to order the franchisee to comply with post-termination obligations, including the covenant not to compete.

The court noted that, to obtain a TRO, the franchisor must show “[1] it is likely to succeed on the merits, [2] it is likely to suffer irreparable harm in the absence of preliminary relief, [3] the balance of equities tips in its favor, and [4] issuing an injunction is in the public interest”. The court first concluded the trademark and unfair competition claims were moot after the franchisee deidentified the restaurants.

The court found the franchisor established a likelihood of success on the breach of contract claims, including breach of the covenant not to compete. The court was persuaded that the franchisor’s noncompete provision was reasonable and enforceable. First, the claim was supported by the franchisor’s future interest in refranchising in the same area. Second, the geographic scope of the noncompete provision was not unreasonably large at five miles from the franchisee’s former locations or then-existing Steak n Shake restaurants. Finally, the noncompete provision was not overly broad, being limited only to restaurants operated by the franchisee that either (1) derive 25 percent or more of annual revenue from the sale of ground beef sandwiches; or (2) offer both ground beef sandwiches and ice cream products.

The court held the franchisor would suffer irreparable harm if the TRO were not granted, because the franchisor’s ability to refranchise the area would be compromised if a former franchisee was allowed to operate there under a different name. The court also found that permitting continued operation of a business violating noncompete agreements could undermine the purposes of such provisions, such as limiting geographic association with a business, curtailing misappropriation of insider “know how,” and providing a franchisor the ability to refranchise absent unfair competition.

Ruling on the balance of harms, the court found the franchisor would suffer irreparable harm in absence of the TRO. Finally, the court determined that granting the TRO would promote public interest by upholding and enforcing contractual agreements.

Franchise agreements generally have post-termination non-compete covenants. These may or may not be enforceable, depending on state law and the language of the covenant. Franchisees looking to operate a competing business after leaving a franchise system should consult with franchise counsel to assess enforceability of any non-compete clause in their franchise agreement.

Steak N Shake Enterprises, Inc. v. iFood Inc., Case No. 21-CV-02131 (S.D. Ind. Aug. 25, 2021)