Franchisee’s Wrongful Termination Claim Is Rejected for Failure to Obtain Franchisor Consent to Its Franchise Purchase

In a recent case in the United States District Court for the Eastern District of Wisconsin, a federal court reversed its own initial decision in which it had upheld a franchisee's wrongful termination claim against its franchisor. Tex. Ujoints, LLC v. Dana Holding Corp., 2015 U.S. Dist. LEXIS 70468 (E.D. Wis., May 30, 2015). Granting a motion for reconsideration, the District Court held that the plaintiff was not a "franchisee' under the relevant franchise law because, although the plaintiff had purchased the 'franchise rights to distribute' from a former franchisee, it had done so without first obtaining the consent of the franchisor for the purchase.

The Court's reconsideration decision focused on an asset purchase agreement (APA) under which an entity created by Daniel Zahn and Martin Brown, called DanMar Holdings LLC, acquired substantially all of the assets of a Texas company, called Automotive Industrial Supply Co., Inc. (AISCO). The purpose of the transaction was for Zahn and Brown's entity to acquire AISCO's purported right, based on an alleged oral agreement, to distribute Dana's "GWB" product line, which consisted of heavy duty industrial drive lines and universal joints used in the fracking industry. After the APA transaction, the distribution assets acquired were then transferred from DanMar Holdings to Texas Ujoints LLC in a second separate deal.

There was no dispute in the case that Dana did not consent to the sale of AISCO's assets, including the alleged right to distribute Dana's product. In what turned out to be a deadly fact for the plaintiff, during negotiations over the terms of the APA, Zahn (DanMar Holdings) asked Gary Stoddard (AISCO), to guarantee Zahn's access to the GWB product "once Dana detects the change in ownership;" however, Stoddard refused, even though the APA transaction proceeded.

Also undisputed, according to the Court, no written distributorship agreement existed at any time between Dana and AISCO nor between Dana and Texas Ujoints. Although the Court recognized that representatives of Dana met with Texas Ujoints' Zahn and Brown following the acquisition of AISCO's assets, Zahn and Brown never made it clear to Dana that it was dealing with a new entity that was separate and distinct from AISCO. Worse yet, for the plaintiff, were comments made by Dana's representative to Zahn and Brown, during the underlying negotiations, that: "I don't care what you are going to do or how you are going to do it as long as it includes this man," pointing to Stoddard (the owner of AISCO).

Somewhat troubling was that Dana and Ujoints appeared to engage in business for very many months with no objection by Dana to the previous transfer. After about six months of doing business, Dana's sales manager notified Zahn that Dana had reached a decision not to enter into any long term distributorship agreement with Zahn's company. Dana's somewhat disingenuous position was that the parties' dealings up until that point showed that Zahn's company was merely "auditioning" to become an "authorized distributor" of Dana's product. In this regard, Dana claimed that the orders that it had filled before that time were filled under AISCO's account, and that Dana did not know that Texas Ujoints was an entity separate from AISCO until shortly before it provided notice of termination.

In reversing its original decision in favor of the franchisee, the Court stated that it "believes the reasoning that led to the summary judgment decision was flawed." Specifically, the Court explained that it had improperly re-written the good-cause provision of the FPA ("What § 57.154(a)(4) must mean, then, is that a supplier has good cause to terminate a dealer agreement where 'there has been a sale or other closeout of a substantial part of the dealer's assets related to the business' without an assignment of the dealership agreement or, in cases where consent of the supplier is contractually required, the dealer has either transferred the business without notice to the supplier or the supplier's consent has been reasonably denied"). The Court further explained that this view of the law had been based upon the erroneous belief that "section 57.102 implied that dealer agreements must be freely assignable ("Where, as here, the supplier's consent is not contractually required, the necessary implication [of § 57.102] is that the dealer may freely transfer its business without such consent.")."

According to the Court, "such an interpretation is not consistent with the plain meaning of the words in the good-cause provision." First, the FPA unequivocally states (in a subsection that the court had not previously considered) that a supplier has good cause to terminate a dealer agreement if "the dealer or dealership has transferred a controlling ownership interest in its business without the supplier's consent." § 57.154(a)(2). Based upon this section alone, and regardless of whether a distributorship agreement would be assignable without the consent of the supplier under Texas common law, "the Texas legislature directly addressed the transferability of a 'dealer agreement' under the FPA: selling a dealership without the supplier's consent is grounds for termination without notice or an opportunity to cure. All section 57.102 adds is the explicit protection that in cases where the supplier has retained contractual authority to approve or deny a sale and the dealer actually requests such approval, the supplier may not unreasonably withhold it." Contrary to the Court's original understanding, "that section, read properly and in conjunction with 57.154(a)(2), does not imply that any dealer can freely sell the dealership without the supplier's consent." In turn, the Court promptly, under section 57.154(a)(4), held that Dana had good cause to terminate any dealer agreement Texas Ujoints might have acquired from AISCO in the assets purchase.

In so ruling, the court also rejected the plaintiff's argument that Dana implicitly admitted that Texas Ujoints was a dealer or franchisee because it did not terminate the dealer agreement at the very time when it first learned of the APA. Instead, the facts showed that it continued to do business with Texas Ujoints for several months." Relying upon the argument made by Dana, the franchisor, the Court explained that "Dana did not even know about the APA until after it had decided not to enter into a long-term business relationship with Zahn." From the Court's perspective, "it was not until Zahn replied to Dana's June 12, 2013 notice that Dana learned Texas Ujoints' position that it had acquired a "dealer agreement" from AISCO. Dana therefore cannot be faulted for failing to terminate a dealership it did not believe even existed."

Last, the Court gave short shrift to the plaintiff's argument that the parties had allegedly independently entered into a dealer agreement as evidenced merely by their business dealings in the ordinary course directly with each other, even though it recognized that under the FPA, the definition of a "dealer agreement" is broad — "to establish a dealer agreement with a supplier, a business must do something more than simply pay the purchase price on a few orders. There must be a formal or informal agreement—i.e., a manifestation of mutual assent by the parties, that gives rise to rights and obligations on both their parts." In a relatively weak portion of its decision, the Court held that because Dana did not know that a transfer or purchase had in fact occurred, its conduct in transacting business with Texas Ujoints could not show an agreement; very simply, "a party cannot surreptitiously enter into an agreement with another party."

The moral to this story for franchisees and dealers is that, in almost every circumstance, before agreeing to the purchase of distribution or franchise rights from third parties, written consent for the transfer or purchase must be obtained from the franchisor or manufacturer. Interestingly in this case the plaintiff appears to have factored-in the risk of proceeding without obtaining consent from the franchisor. In this regard, the record shows that DanMar Holdings asked AISCO to guarantee its access to the GWB product "once Dana detects the change in ownership." Despite failing to obtain such an assurance, however, Texas Ujoints proceeded with the legally defective transaction; ultimately, to its detriment

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