Franchise 101: Delivering Timely Terminations; and Extra Cheesed Franchisee
Franchisor 101: Delivering Timely Terminations
A trial judge for the United States Bankruptcy Court in Illinois denied a franchisee’s motion to enforce an automatic stay against The UPS Store (“TUPSS”), concluding that TUPSS’ termination of the franchise agreement was timely and did not violate the automatic stay provision of the bankruptcy code.
The franchisee entered into franchise agreements to operate two The UPS Stores in Chicago (the “Franchise Agreements”). On January 12, 2024, TUPSS sent the franchisee notices of default, due to the franchisee’s failure to remain current on its payment obligations to TUPSS. The notices stated the Franchise Agreements would terminate unless the franchisee cured the defaults within 30 days. As of March 2024, the franchisee remained in default.
On March 14, 2024, TUPSS issued notices stating that the Franchise Agreements would terminate on March 16, 2024, without providing another opportunity to cure. The termination notices cited the Illinois Franchise Disclosure Act (the “Act”) and asserted that the franchisee repeatedly failed to comply with the Franchise Agreements.
On March 18, 2024, the franchisee filed a Chapter 11 bankruptcy petition. The bankruptcy court denied the franchisee’s request to enforce an automatic stay against TUPSS.
The bankruptcy court rejected the franchisee’s contentions that TUPSS had no right to terminate the Franchise Agreements, and even if it did, TUPSS did not terminate the Franchise Agreements before the franchisee sought bankruptcy protection.
The franchisee alleged TUPSS could not terminate the Franchise Agreements because (i) TUPSS owed the franchisee more than the franchisee owed TUPSS and TUPSS was required by law to setoff its own obligations before placing the franchisee in default; and (ii) TUPSS could not rely on the Act, because the franchisee did not “repeatedly” fail to comply with the Franchise Agreements.
The court disagreed and held that even if the setoff rule was applicable, the Franchise Agreements contained a provision clearly stating that the franchisee was required to pay TUPSS without deducting any amounts owed by TUPSS to the franchisee, or that the franchisee believed were owed to the franchisee by TUPSS or any affiliate.
The court also held that while the Act does not define the meaning of “repeatedly,” the court could rely on the dictionary’s definition of “more than once.” The court determined that taken together, the dictionary definition of “repeatedly” and examination of the Act in its entirety, TUPSS’ actions were consistent with the Act as a whole.
The bankruptcy court also dismissed the franchisee’s contention that the Franchise Agreements are not property of the debtor’s bankruptcy estate since the termination occurred after the franchisee filed its bankruptcy petition. The court rejected the franchisee’s reliance on Illinois law, which does not consider Saturday a business day, arguing the notice of termination was not effective until Monday, March 18, the day the franchisee filed its bankruptcy petition since the franchisee received the notices on Saturday, March 16. The court explained the Franchise Agreements contained a California choice of law provision, making California law, not Illinois law, applicable, and under California law, Saturdays are considered business days rendering the notices effective as of March 16. The court further explained that even if Illinois law applied, the notices would have been effective as of midnight on March 18 and the franchisee’s petition was not filed until hours later at 9 a.m. on March 18.
If a franchisee’s bankruptcy petition is imminent or anticipated, franchisors should consult franchise counsel to discuss strategy and determine what steps should be taken to preserve the franchisor’s ability to collect fees owed to it by a franchisee.
In re The Neely Group, Inc. Bankr. Ct. Dec (LRP) (Bankr. N.D. Ill. June 11, 2024)
Franchisee 101: Extra Cheesed Franchisee
A federal district court in Texas denied a preliminary injunction filed by a franchisee (“EYM”) after Pizza Hut, as franchisor, terminated the franchise agreements.
In 2021, EYM failed to remain current on their payment obligations to the franchisor and its vendors. In 2022, the franchisor sent EYM several default notices. In 2023, the franchisor entered into a forbearance agreement with EYM and agreed not to terminate the franchise agreements provided EYM complied with the forbearance conditions.
After EYM received additional default notices, the franchisor notified EYM that the forbearance agreement was subject to immediate termination due to EYM’s failure to comply with the terms of the forbearance agreement. EYM filed suit in Texas state court alleging breach of contract, tortious interference with contracts and prospective business relations, and breach of fiduciary duty. The franchisor removed the case to federal court, where EYM moved for a preliminary injunction to enjoin Pizza Hut from terminating EYM’s ability to operate their restaurants, removal of the franchisee’s restaurants from the Pizza Hut online ordering system, and disrupting the franchisee’s ability to receive supplies, among other conduct. The court denied EYM’s motion for a preliminary injunction, concluding the franchisee had not shown a substantial likelihood of success on the merits on its three claims.
Under Texas law, to prove breach of contract the following four requirements must be met: (1) a valid contract; (2) plaintiff’s performance or tendered performance; (3) defendant’s breach; and (4) damages. EYM admitted that it had not performed under the terms of the forbearance agreement. Additionally, EYM did not specify or provide evidence as to which contract was subject to the franchisor’s interference and EYM’s assertion that the franchisor owed fiduciary duties to EYM as the franchisee ignored that six of the seven contracts EYM entered into with the franchisor explicitly stated that no fiduciary duty is created among the parties. Accordingly, the court found EYM was not likely to succeed on the merits.
Franchisees should consult franchise counsel if they are unable to comply with their franchise agreement or upon receipt of a notice of default from their franchisor to evaluate their options, including understanding risks and consequences, which often depend on both the terms of the franchise agreement and applicable law.
EYM Pizza of Georgia LLC, et al. v. Pizza Hut LLC, No. 3:24-CV-0646-X (N.D. Tex. Apr. 2, 2024)