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Franchisee Waves Goodbye to Car Dealership Due to Ineffective Waiver

A recent decision by the United States District Court for the Sixth Circuit affirmed a lower federal court’s ruling that Chrysler (“Chrysler” or “Franchisor”) had legally terminated one of its car dealers in Riverhead, NY, (“Eagle Auto-Mall”, “Dealer” or “Franchisee”) for the Dealer's failure to have built new dealership facilities within the contractually specified time period set out in the parties’ Letter of Intent (“LOI”).   Finding that the time deadline terms had not been waived or modified, the Court of Appeals (“Court”) held in FCA US LLC v. Eagle Auto-Mall Corp., No. 16-2375, 2017 U.S. App. LEXIS 13232 (6th Cir. July 20, 2017) that Eagle committed a material breach of the agreement by failing to complete its renovations within the LOI's eight-month window.

The facts as related by the Court are as follows. Eagle had been a long-time car dealer selling Chrysler and Jeep vehicles out of a single facility that also housed its Mazda-Kia-Volvo dealership. After Chrysler filed for bankruptcy in 2009, it attempted to cancel its dealership agreement with Eagle; however, Eagle resisted, and Eagle obtained a court order requiring Chrysler to enter into a Letter of Intent (“LOI”) with Eagle for a new dealership. Under the LOI, Eagle was required to complete the construction of a dealer facility before it had a right to obtain a franchise agreement. Specifically, the LOI established three ways in which Eagle could provide for a legally compliant facility, including: (1) create a new facility within eighteen months; (2) renovate an existing facility within eight months; or (3) meet the facility requirements, without renovations, within ninety days. When Eagle signed the LOI in 2014, it informed Chrysler that it was choosing the second option: the renovation of an existing facility within eight months.

Before Chrysler signed the LOI, it sent two representatives to visit the proposed site of the dealership. During this visit, Eagle explained that the plan for the new sales and service facility involved two phases: first, Eagle would renovate an existing building across the street from its dealership into a new car showroom and sales facility, which would be opened as soon as it was complete; and, second, Eagle would construct a stand-alone service facility nearby. Eagle also explained to Chrysler during that visit that while the service facility was being constructed, Eagle would temporarily service Chrysler-Jeep vehicles at its Mazda-Kia-Volvo dealership. Notably, Eagle also explained that completion of both phases would take more than two years. In response, the Chrysler representative stated that everything "looks great" and that "we are moving forward." Shortly after this visit, FCA signed the LOI, making February 27, 2014, the document's effective date.

Upon signing the LOI, Chrysler promptly requested that Eagle provide architectural plans, which Eagle did on March 6, 2014. Chrysler in turn reached out to Eagle offering guidance because the plans "needed work." This prompted Eagle to retain a Chrysler-approved architect. Also, around this time, Eagle called Chrysler to express concerns about completing renovations within the LOI's eight-month time frame. Chrysler replied that timeline problems "come up all the time" and that "we will work with you."

On April 2, 2014, Chrysler refused the new architect’s request for a meeting.  About a month later, on May 6, the architect submitted detailed plans to FCA. On June 2, Chrysler denied the architect’s proposal setting out two main objections, including: (1) that Eagle had not provided an exclusive service department that would be operational within the LOI timeframe; and (2) that Eagle's proposal used the basement, in a split-level design, to meet square footage requirements. Regardless, FCA stated that it would review an amended proposal if "Eagle is able to provide a facility within the specified timeframe as described within the LOI." Eagle in turn submitted a third set of plans; however, these new plans were for the construction of an entirely new facility, not a renovation.

After receiving those plans, during a call between the parties, Eagle explained that it would not be able to complete the new construction within eight months; Chrysler responded that, if the deadline were not achieved, the LOI would be terminated. Eagle objected, arguing that it had told Chrysler in the original discussions back in 2014 "about the sales department" and "the shared service." Chrysler in turn sent a notice of termination of the LOI to Eagle and simultaneously filed a complaint in court to "seek the court's assistance in resolving our dispute with regard to our respective rights and obligations under the LOI."

Eagle’s primary legal defense to Chrysler’s breach of contract claim was that the LOI had been modified by the parties’ conduct. When the U. S. district court rejected Eagle’s argument, Eagle appealed the decision to the U.S. Sixth Circuit Appeals Court. The Court of Appeals began its analysis by pointing out that the LOI was a “valid, binding contract that will be enforced according to its terms.” The Court next acknowledged that “a contract can be unilaterally waived under Michigan law if established by clear and convincing evidence that a contracting party, relying on the terms of the prior contract, knowingly waived enforcement of those terms.” The Court also noted that “such waiver can be inferred from declarations, acts, or conduct.” However, the Court cautioned that “merely identifying words or actions inconsistent with a contract term does not constitute waiver unless the words or actions are ‘unequivocal’ and contrary to ‘any other intent.’"

In reviewing whether Eagle had proved its defense that Chrysler "waived or modified the eight-month deadline for Eagle to complete renovations”, the Court examined Eagle’s three categories of proof, including that: (1) Chrysler’s representatives were authorized to modify the terms of the LOI; (2) FCA "regularly" modifies the terms of its LOI’s with other dealers; and (3) Chrysler’s representatives’ actions and conduct had modified provisions of the Eagle LOI. Initially, the Court ruled that only one of the three categories of proof was legally relevant: “While it may be genuinely disputed that [Chrysler’s representatives] had authority to modify terms of the LOI or that FCA regularly waived terms of LOIs it had with other dealers, those findings (which we accept as true for purposes of this appeal) are irrelevant if there is no genuine dispute as to whether FCA waived or modified terms of the Eagle LOI.” Accordingly, the Court focused solely on the evidence regarding whether the LOI had been waived or modified.

First, Eagle pointed to the comments of Chrysler’s representative asserting that everything "looks great" and that things were "moving forward" following the February 10, 2014 meeting where Eagle's preliminary two-phase, non-compliant renovation plan was discussed. The Court refused to accept this as evidence of a waiver of the time deadline because “any understandings or agreements made during that meeting precede the effective date of the LOI.” For the Court’s conclusion, it relied on the fact that LOI clearly stated that the written agreement was the parties' "entire agreement" and that it "superseded all prior negotiations, understandings, correspondence and agreements."  The Court also relied upon language in the LOI stating that it did not become effective until it was signed by FCA's national dealer placement manager on February 27, 2014.

Second, Eagle argued that Chrysler failed to warn Eagle early on that its two phase renovation would be rejected. However, the Court refused to adopt the principle that mere knowing silence constitutes waiver. In this regard, the Court noted that “this evidence doesn't get Eagle very far; at best, it "establishes only that FCA remained silent despite being aware of Eagle's conduct inconsistent with the terms of their contract.”

Third, Eagle pointed to particular oral comments by Chrysler’s representatives. Specifically, Eagle argued that when it initially expressed concerns about its ability to meet the timeline, Chrysler assured Eagle that the issue "comes up all the time" and that "we will work with you." Also, Eagle emphasized that, in Chrysler’s letter rejecting the proposal, Chrysler stated that it would reconsider its rejection if "Eagle is able to provide a facility within the specified timeframe as described within the LOI." The Court rejected this evidence of waiver concluding that it “does not come close to clear and convincing evidence that FCA, relying on specific terms of the LOI, knowingly waived enforcement of those terms." Fourth, Eagle supported its defense with evidence that Chrysler’s course of conduct waived or modified the eight-month renovation deadline. In rejecting this evidence, the Court stated that “there is no evidence that anyone asked for or agreed to a new deadline, and so, without any evidence of mutual assent to a new term, the original term remains unmodified.”

In sum, the Court held that Eagle’s evidence is “not nearly enough to unequivocally waive a contract term.” As the district court concluded, "Eagle's attempt to turn conversations and stray statements into something more is unavailing."

In the franchise arena, issues of modification and waiver arise frequently in the context of termination where the franchisee argues that the franchisor has ‘waived’ or ‘modified’ the franchise agreement’s requirement upon which the termination was based. For instance, a franchisee can make a strong argument that a franchisor has waived a menu-offerings requirement where the franchisee was terminated for selling an unapproved menu item that he has been permitted to sell by the franchisor for many years without objection. On the other hand, a franchisee’s argument that the royalty payment due date deadline has been waived because the franchisor has historically accepted late payments is not likely to be recognized.

In the free market, parties bargain with each other because they individually expect to benefit from their completed transactions. Interestingly, in Chrysler, the Court began its analysis recognizing this traditional principle: “Eagle Auto-Mall wants to sell new Jeeps and Chryslers in Riverhead, New York, and FCA wants its vehicles sold in that market.” Contract modifications and waivers should be employed, recognized and enforced when they augment economic efficiency. However, the goal of efficiency in the context of modifications and waivers is elusive. Although in some circumstances modifications or waivers will stimulate inefficient opportunistic behavior (e.g., higher wage demands by sailors mid-voyage), in others situations modifications or waivers will promote efficiency because they truly reflect the parties’ views of how to best deal with unforeseen circumstances. Arguably, the best rule of thumb for modifications and waivers is a broad equitable one. Such a rule theoretically will tend to minimize the sum of the overall costs of negotiating and enforcing franchise agreements in the face of future potential waivers and modifications.

In addition, it is important to note that some franchise agreements contain explicit “no modification” or “no oral modification” clauses; however, they are not uniformly enforced by courts. Although the arguments for and against enforcement of such clauses are myriad, cryptic and diverse, the best argument against enforcement is that such modifications and waivers violate free market principles: just as parties are free to enter into agreements to begin with, they should be free to modify those agreements ex post.

Last, in addition to the modifications and waivers arguments in the Chrysler case, Eagle also argued that the car manufacturer had violated the covenant of good faith and fair dealing by refusing to modify the terms of the LOI to allow the franchisee additional time to complete the renovations. The Court resoundingly rejected this argument.

First, the Court held that conceptually there are two varieties of covenants of good faith and fair dealing: first, a broad or weak version that allows such a term to be inserted into a contract as a free-standing obligation of the franchisor to act fairly and reasonably; and, second, a strong or narrow genre that permits such a term to be implied into a contract to regulate a franchisor’s unmodified discretion regarding certain identified affirmative obligations of a franchisor. Second, based on this distinction, the Chrysler Court concluded that, under relevant state law, the first type of discretion could not be implied, and under the language of the Dealer Agreement, the second type of discretion could not be found. As the Court explained, “while Eagle may be right that some discretion was baked into FCA's performance under the LOI and that such discretion required good faith, FCA is right that explicit terms account for what Eagle alleges was FCA's bad-faith exercise of any discretion.” Specifically, terms of the unmodified LOI required Eagle to provide an exclusive facility within "eight months" and Chrysler simply had “no obligation to extend any time periods."

The Court’s rejection of the franchisee’s good faith breach argument was not surprising, even though unfortunate. Indeed, the belief that all parties to a franchise agreement must act reasonably towards each other is the biggest myth in the franchise field. However, the falsehood goes a long way to preventing the enactment of meaningful franchise legislation. Interestingly, the myth of ‘reasonableness’ is not perpetuated solely by franchisor advocates; indeed, at a national gathering of franchisees last week, the Moderator of the excellent lunch panel, through his naïve leadership on this issue, allowed the audience to embrace the mistaken belief that franchisees who are forced to submit to costly franchisor demands can effectively fend them off using merely the covenant of good faith and fair dealing.

The Chrysler case offers two important lessons for franchisees. First, franchisees must regularly consult with and be guided by counsel; a good franchise lawyer would undoubtedly have flagged and resolved the ambiguities inherent in the Chrysler parties’ post-execution negotiations regarding the time deadlines in the LOI. Second, franchisees must come to terms with the concept that their franchisors are not their partners in any traditional sense of the word. Although both franchisors and franchisees operate as valuable individual members of the free market, their relative attempts to profit maximize are unique, incomparable, and frequently in direct theoretical and practical conflict with each other.

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