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Following the Supreme Court's holding in State Oil Co. v. Khan, 522 U.S. 3 (1997) that maximum price fixing was no longer a per se antitrust violation, some franchisors have imposed deep discounting on their franchisees through resale price caps. Among the better known examples of this are the "value menu" pricing systems adopted by many fast food franchisors in which all designated "value" items must be sold at or below a specified price.
In certain instances, franchisees have embraced such maximum pricing caps, particularly where those schemes have maintained or actually increased the franchisees' bottom line profitability. Where pricing restrictions are viewed by franchisees as harmful to their profitability, however, substantial system discord and even litigation can ensue.
A fascinating recent example of the latter scenario can be found in National Franchisee Association v. Burger King Corp., 2010 WL 2102993 (S.D.Fla. 2010), which concerns Burger King's system-wide $1 double-cheeseburger (DCB) promotion. This case epitomizes the collision between the divergent interests of franchisors, for which the top-line revenue of the franchisees is paramount, and franchisees, who live off the bottom line.
The DCB promotion has long been the subject of heated debate between Burger King and its franchisees, which maintain that because it costs more than $1 to produce the DCB — something that is not true of any other item previously placed on the Value Menu — the promotion requires them to sell the DCB at a loss and could lead to bankruptcy of some franchisees. The franchisees were also mindful that Burger King's marketing of the DCB promotion was being funded by the franchisees' advertising contributions. Burger King's decision to implement the promotion in the fall of 2009 marked the first time that it had imposed a maximum price on its franchisees without obtaining their majority consent, the franchise community having twice voted against it.
In November 2009 the National Franchisee Association (NFA), which consists of approximately 83% of all Burger King franchisees in the United States and Canada, filed suit against Burger King in federal court in Florida. The NFA alleges that (1) Burger King does not have the right to set maximum prices under the franchise agreement, and (2) the DCB promotion violates Burger King's duty of good faith under both the express terms of the franchise agreement and the implied covenant of good faith and fair dealing under Florida law.
In response, Burger King moved to dismiss the complaint, challenging the NFA's standing to sue on behalf of individual Burger King franchisees, and arguing that the Eleventh Circuit had previously confirmed Burger King's authority to set maximum prices under the franchise agreement.
While the court agreed that it was bound to follow the previous Eleventh Circuit determination that Burger King does have the right to set maximum prices under the franchise agreement, the court declined to deny the NFA standing to bring its action at the current stage of the litigation, and it ordered that the case proceed with respect to the NFA's claim that Burger King's decision to impose the DCB promotion violated its contractual or implied duty of good faith. Both aspects of the court's decision are significant.
In reaching its decision, the court noted the longstanding principle that an association has standing to sue on behalf of its members when: (a) its members would otherwise have standing to sue in their own right; (b) the interests it seeks to protect are germane to the organization's purpose; and (c) neither the claim asserted nor the relief requested requires the participation of individual members in the lawsuit. In this case, Burger King challenged the NFA's associational standing with respect to the first and third elements.
The court rejected Burger King's arguments that the NFA's standing is contingent upon (i) all Burger King franchisees being members of the NFA, and (ii) the identification of an individual franchisee that has standing. Observing that the NFA brought the action "on behalf of its members and on behalf of a class comprised of all the Franchisees", the court found that, at the current stage, the action is only on behalf of NFA's franchisee members and would only be extended to all Burger King franchisees should the NFA succeed in certifying a class. The court likewise found that the allegation that "at least one" NFA member would be harmed by the DCB promotion satisfied the first element of associational standing.
With respect to the third element of associational standing, the NFA maintained that the participation of individual franchisees in the lawsuit is unnecessary, because the NFA could prove bad faith through Burger King's own internal documents and data, and through expert testimony. The court agreed and concluded that the NFA had sufficiently alleged associational standing at this early stage of the litigation. The court cautioned, however, that because of the nature of the NFA's claims, it must prove, on a franchisee-wide basis, that Burger King imposed the DCB promotion in bad faith, and "it remains to be seen" whether the NFA can prove such bad faith "without resort to individual determinations".
Burger King's duty of good faith to its franchisees is both contractual and implied by law. The franchise agreement provides that Burger King can only make changes and additions to its operating system which Burger King "in the good faith exercise of its judgment believes to be desirable and reasonably necessary . . ." Toward this end, under Florida law, the implied covenant of good faith and fair dealing prevents a party from capriciously exercising discretion accorded it under the contract "so as to thwart the contracting parties' reasonable expectations."
Addressing the NFA's claim for breach of the duty of good faith and fair dealing, the court found that, construed in a light most favorable to the NFA, its allegations plausibly state a claim that Burger King breached its duty of good faith by setting the maximum price at $1, forcing the franchisees to sell the DCB at a loss. The court also noted the NFA's allegation that Burger King has admitted that the sale of the DCB at $1 could lead to bankruptcy of its franchisees.
In our view, in addition to demonstrating the perils of implementing key system changes in the absence of franchisee buy-in, this case should serve as a lesson to franchisors that this kind of overreaching rarely survives legal challenge. Can it really be good faith to require that franchisees sell a key product at a loss? Would Burger King, if it was a chain comprised solely of company owned outlets, impose this promotion on itself? Toward this end, we note that in April 2010 Burger King removed the DCB from its $1 value menu and re-priced it at $1.29. This step has not eliminated the controversy, however, as Burger King now requires the sale for $1 of the "Buck Double" — which differs from the DCB only in that it has a single slice of cheese instead of two — a product that, according to the franchisees, still costs more than $1 to produce.
The case also serves as validation of franchisee associations in general and confirms, contrary to the statements of some franchisor advocates, that the implied covenant of good faith and fair dealing is very much alive and well.
About the authors: This article was written by franchisee attorneys Eric Karp, partner, and by David Meretta, associate, of Boston-based law firm Witmer, Karp, Warner & Ryan LLP. Mr. Karp serves as counsel to numerous franchisee associations in such chains as McDonald’s, Choice Hotels, Dunkin Donuts, Popeye’s Chicken, Cartridge World, TCBY Yogurt, Portable On Demand Storage, Fitness Together, Resort Maps, and Massage Envy. He has also been designated as one of the top 100 franchise lawyers in the U.S. in Franchise Times, as a New England Super Lawyer by Boston Magazine, as one of America’s Leading Franchise Lawyers by Chambers USA, and is listed in The Best Lawyers in America and the International Who’s Who of Franchise Lawyers. Since 1996 Mr. Karp has served on the Franchise Project Group of the Franchise and Business Opportunities Committee of the North American Securities Administrators Association. From 2008 to 2010, he served as Editor-In-Chief of The Franchise Lawyer, published by the American Bar Association Forum on Franchising. He is one of the founders of the International Association of Franchisees & Dealers.
Mr. Maretta received his undergraduate and law school education from the University of Michigan and is admitted to the state bars of Michigan and Massachusetts. He has clerked for the Hon. Lawrence M. Glazer of the 30th Judicial Circuit Court of Michigan.