Franchise Renewals: They've Got You Coming and Going

Renewals have always been a hot topic in the franchise world. Not surprisingly, most, but not all, of the legal history on renewals shows franchisees to be the definitive losers.

Historically, in most instances, franchisees have argued that a right to renew should always be available, regardless whether such a right exists in the franchise agreement, and franchisors have contended that no such right should exist, unless it is explicitly provided for in the franchise agreement.

Absent the applicability of state or federal franchise legislation, the underlying legal principles that govern most franchise renewal disputes include: (1) any contract, including a franchise agreement, will remain in effect until the end of the term identified in that agreement; (2) unless the agreement contains a right to renew, neither of the parties has a right to renew; (3)  if the agreement does contain a right to renew, and the electing party chooses to renew, the agreement will be renewed only on the terms identified in the agreement.

Where no renewal provision is explicitly included in the franchise agreement, and where no state or federal statute can be used to imply such a renewal right, the court will usually never imply such a term. The common law has a clear and definitive penchant for limiting the duration terms of contracts absent the parties’ expressed crystal clear intention to provide for renewals.

A harsh example of this rigid tendency can be seen vividly in a painful case involving H&R Block back in 2002. The case began when Block franchisees sued Block alleging in part that Block had breached their franchise agreements by selling tax preparation services over the internet in the franchisees’ territories. Block counterclaimed seeking a court order permitting it to terminate the franchisees’ agreements at the conclusion of their current five year terms.

In filing the suit it appears that the franchisees had assumed that they possessed perpetual renewal rights, which would therefore have protected them against any retaliatory terminations by Block. The franchisees’ assumption at that time was reasonable. The duration provision in their agreements stated that“The term of this Agreement shall run for a period of five years from the date hereof, with further provisions that it shall be automatically renewed for successive periods of five years each, unless mutually terminated or terminated [for cause under the agreement].”

Although the court noted that the provision was “unusual” in that it provided for automatic five-year renewals unless both parties assented to termination, it proceeded to apply a legal analysis that was even more unusual, seemingly lifted from a court in 18thCentury England. The court stated that although the practical effect of the duration provision in the franchise agreements was the creation of a perpetual contract, that provision would nevertheless need to be voided since the provision had failed to use the necessary magical words to create an enforceable perpetual contract.

According to the court, to be an enforceable perpetual contract, the perpetual nature of the clause would have had to have been unequivocally expressed in the franchise agreement, which, the court stated, it was not. In fact according to the court, almost unexplainably, the language “automatic renewal” itself actually doomed the conclusion that the term could be viewed as perpetual. The court stated: “That a contract would run for five years, terminate, and be in need of renewal-whether automatically or otherwise-belies any contention that it was to run in perpetuity.”  The Court clearly had no intention of enabling one of the parties, in this case the franchisee, “to coerce the other” into a perpetual cycle of five-year obligations.

The common law principles of renewals, discussed above, are not always the final arbiters of renewal disputes. These black-letter common law principles regarding contractual renewals in some cases are supplemented and modified by a rag-tag group of internally inconsistent state and federal franchise laws. Not all states, however, have enacted such legislation. And, for those that have, none of the statutes is congruous with any other, in language, intent, scope or application. Some of the statutes explicitly address renewals and others touch on renewals indirectly.

The most common provision in these state laws that is drawn into play in renewal disputes is the requirement that the franchisor have “good cause” for nonrenewal. In almost all cases the term “good cause” is defined by reference to the degree to which the franchisee has met its obligations during the term of the franchise. Some of the legislation, however, does define “good cause” to include the legitimate business reasons of the franchisor for nonrenewal. This latter concept has now begun to eat away at franchisee protection that had historically been provided to franchisees by the “franchisee-culpability” program.

With regard to the former, “franchisee-culpability” based standards, some statutes set out explicitly the specific operational defects of the franchisee that would permit nonrenewal, and others define these defects in a more general conclusory definition, such that the franchisee must have been in “substantial compliance” with its obligations during the term of the agreement. These statutes attempt to capture the concept that where the franchisee has materially breached the agreement he will not be eligible for renewal protection of that statute. Repeated defaults by the franchisee are usually sufficient to prevent the franchisee from using these favorable renewal rights. This conditioned-availability trigger itself leads to a significant host of troublesome questions such as what the terms “material breach” and “substantial compliance” mean, and whether the franchisor is applying its renewal criteria in a non-discriminatory manner for purposes of the statute.

Not unlike at common law, franchises in perpetuity are not friends of franchise legislation. Very few state franchise acts have ever been viewed to grant such perpetual franchise renewal rights. New Jersey and Wisconsin are examples where such statutory rights arguably exist. Each state, of course, consistent with the overall pervasive lack of uniformity in direction, design and language among all franchise statutes, addresses the renewal concept very differently.

Under the Wisconsin statute, a franchisor is prohibited from refusing to renew a franchise except for “good cause” which is defined as the failure of a franchisee to “comply substantially with the essential and reasonable requirements … which are nondiscriminatory as compared with the requirements imposed on other similarly situated dealers either by their terms or enforcement.” And, in New Jersey, one court has described the renewal right thusly: “Once a franchise relationship begins, all that a franchisee must do is comply substantially with the terms of the agreement, in return for which he receives the benefit of an “infinite” franchise – he cannot be terminated or refused renewal.”

Last, there are antidiscrimination provisions in state franchise legislation that have been used to decide renewal disputes. The bottom-line on these provisions is that so long as the franchisor publicly offers the same renewal terms to every franchisee – regardless how oppressive those terms might be – they will be held to be lawful. In these states, however, savvy franchisor counsel are easily able to side-step these laws by closely controlling the terms of the renewal deals that their franchisor clients cut. Differences without any meaning become king.

Franchisors have always offensively used renewal rights to cleanse their systems of franchisees that they view to be troublesome, inefficient, and under-funded. With very rare exception, franchise laws enable and support this purging behavior. Not surprisingly, there are no laws on the books prohibiting franchisors from selling franchises to franchisees that they view to be troublesome, inefficient, and under-funded at the time they sell their franchises. From a franchisee’s perspective, “they’ve got you coming and going.”

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Jeffrey M. Goldstein is the founding partner of the Goldstein Law Group, PC, a law firm specializing in representing franchisees and dealers in franchise and dealership disputes. www.goldlawgroup.com(202-293-3947) jgoldstein@goldlawgroup.com