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Editor's note: The Radisson Hotels v. Majestic Towers case is one of the most influential lawsuits of 2007 impacting franchisees — or even franchisors for that matter. Kirk Reilly, Esq., of Gray Plant Mooty in Minneapolis, Minnesota was counsel for Radisson Hotels International, Inc. With his help, the franchisor was confirmed in its ability to enforce liquidated damages when a material breach by the franchisee occurred.
The article below, reprinted in its entirety with Mr. Reilly's permission, is his recap of the case and why the ruling is significant.
In Radisson Hotels International, Inc. v. Majestic Towers, Inc., et al., 488 F. Supp. 2d 953 (C. D. Cal. 2007), the U.S. District Court for the Central District of California granted Radisson Hotels International, Inc. summary judgment in the amount of $1,006,714.55 for past due fees and liquidated damages. In doing so, the court held that Radisson’s contractual liquidated damages clause was reasonable and enforceable. The court also determined that California’s leading case on a franchisor’s ability to collect future lost profits in the context of a termination for cause, Postal Instant Press, Inc. v. Sealy, 43 Cal. App. 4th 1704 (1996), was inapplicable to the facts of the case and decided in error. This decision should provide franchisors with powerful ammunition in their efforts to overcome the negative influence of Sealy in obtaining lost future royalties when a franchisee commits a material breach resulting in termination.
Radisson terminated the franchisee’s franchise rights after the franchisee refused to comply with its payment obligations under the parties’ License Agreement. After termination, Radisson commenced a lawsuit seeking payment of past due fees and liquidated damages pursuant to a provision in the License Agreement that allowed Radisson to collect two years worth of royalties from a terminated franchisee. In support of its motion for summary judgment, Radisson argued that the liquidated damages amount was designed to estimate the revenue and future royalties that will be lost by Radisson while it searches for a replacement franchisee, which, on average, takes a period of two years to accomplish.
In response to Radisson’s claim for liquidated damages, the franchisee argued that the provision was unenforceable because: (1) the two year loss of royalties estimate used by Radisson is unreasonable; (2) the provision constitutes an unenforceable penalty; and (3) Radisson’s termination of the License Agreement due to the franchisee’s failure to pay was not the proximate cause of Radisson’s lost future royalties under the holding of PIP v. Sealy.
In rejecting the franchisee’s arguments, the court ruled that the franchisee carried the burden of demonstrating that Radisson’s two-year timeline for replacing terminated franchisees was unreasonable and that the franchisee failed to satisfy its burden. The court also dismissed the franchisee’s argument that the liquidated damages provision constituted a penalty because (1) the license agreement was terminated within its first year; and (2) it is improper to use the revenues earned by the predecessor hotel operator in the calculation of lost future royalties. In rejecting this argument, the court held that the plain language of the liquidated damages clause did not support the franchisee’s contention.
Finally, with respect to the franchisee’s argument that Radisson’s claim for lost future royalties is not allowed under the holding of PIP v. Sealy, the court determined that PIP v. Sealy was distinguishable from the facts of the case. The court noted that in Sealy, the franchise agreement contained a vague statement that the franchisor would be entitled to the “benefit of the bargain” in the event of franchisee’s material breach, while in the present case, the parties included a specific contractual provision functionally requiring franchisee to indemnify Radisson for lost future profits in the event the contract is terminated due to franchisee’s failure to pay royalties. Thus, the court found that the parties made a valid contractual agreement that renders Sealy’s rule inapplicable to the facts of the case. In addition, the court noted that:
Alternatively, this Court believes that the Sealy decision is mistaken. * * * * In this Court’s view, the Sealy Court’s holding that a franchisor has no remedy but to sue the franchisee over and over again as lost royalties accrue is simply untenable. * * * Similarly, the Court believes that where a franchisee breaches a contract and demonstrates that it is unable or unwilling to meet its obligations, lost future profits are a proximate result of the breach because the franchisee’s actions are a substantial factor in bringing about that loss or damage.
The holding in this case clearly takes cases involving liquidated damages clauses outside of the scope of the Sealy decision, while at the same time providing franchisors with a strong argument against the application of Sealy whenever termination is the result of a franchisee’s breach.
Kirk Reilly, Esq.
Gray Plant Mooty