Franchise Terminations and Self-Inflicted Harm

In a recent franchise case the United States District Court of New Jersey (the “Court”) hammered another nail in the termination coffin of a former 7-Eleven franchisee Karamjeet Sodhi ("Franchisee Sodhi" or "Mr. Sodhi"), Manjinder Singh, and Karamjit Singh (collectively, "the Franchisees"), when it denied the Franchisees’ Motion for a stay of the Court's Order granting judgment to Plaintiff 7-Eleven. In Sodhi, the Court found that the Franchisees failed to show that they were likely to succeed on the merits of their claims because they breached the franchise agreements by failing to pay payroll and income taxes and then subsequently failing to cure those breaches. 7-Eleven, Inc. v. Sodhi, Civil Action No. 13-3715 (MAS) (JS), 2017 U.S. Dist. LEXIS 14339 (D.N.J. Jan. 31, 2017)

In refusing to grant the Franchisees’ Motion for Stay, the Court initially noted that "the standard for obtaining a stay pending appeal is essentially the same as that for obtaining a preliminary injunction, and that such a stay ‘should be granted only in limited circumstances.’" The Court explained that to obtain the stay, the Franchisees must show all four of the following factors, including; (1) the movant is likely to succeed on the merits; (2) denial will result in irreparable harm to the movant; (3) granting the injunction will not result in irreparable harm to the non-movant; and (4) granting the injunction is in the public interest.

With regard to the first factor, the Franchisees argued that they were likely to succeed on the merits of their appeal because the Court allegedly failed to properly consider their New Jersey Franchise Practices Act ("NJFPA") Counterclaims. In this regard, putting aside the Franchisees’ first weak rejected argument that 7-Eleven had allegedly violated the notice requirement of the NJFPA by improperly defining the effective date of the termination, the Franchisees alleged that 7-Eleven had subjected the Franchisees to "unreasonable standards of performance", a distinct substantive violation of the NJFPA. In support of their argument, the Franchisees made the very vague claim that "7-Eleven insinuated itself into nearly every facet of Mr. Sodhi's business and required him to adhere to overly strict and unduly onerous reporting standards regarding inventory, sales, receipts, and the like." The Franchisees also contended that Plaintiff "micromanaged Mr. Sodhi's hiring and firing practices, unduly influenced the prices of goods, overly filled orders with product in excess of demand, and cultivated a work environment that is hostile toward South-Asian Franchisees.”

7-Eleven, in reply, asserted the normal applicable counter-arguments. First, 7-Eleven argued that the reasonableness of the performance standards was irrelevant to the validity of the preliminary injunction given that the anticipated appeal related only to whether Plaintiff "properly terminated the Franchise Agreements due to Mr. Sodhi's admitted material breaches." In addition, Plaintiff argued that the Franchisees' allegation of workplace discrimination was irrelevant since Mr. Sodhi did not dispute his failure to pay payroll and income taxes. 7-Eleven’s second argument also included the prosaic contention that any alleged ulterior motive was irrelevant to finding that Plaintiff had good cause to terminate the Franchise Agreements.

The Court agreed with the Franchisor’s arguments, concluding that, “even if the Franchisees proved their claim for unreasonable standards of performance under the NJFPA, the Franchisees failed to demonstrate and cited no authority for the proposition that this claim would preclude the termination of a Franchise Agreement.” In so concluding, the Court was assisted by the Franchisees’ weak argumentation; according to the Court, the Franchisees had provided no reasons as to why it the New Jersey Legislature's allegedly intended to allow a NJFPA claim to dispose of a legitimate termination claim. 

Turning to the irreparable harm issue, the Plaintiff argued that the Franchisees failed to show that Mr. Sodhi would be irreparably harmed if the stay were not granted. In franchise and dealer termination cases the harm to the terminated franchisee focuses on losses that are considered incapable of measurement, such as possible bankruptcy and loss of goodwill and reputation. Although the Franchisees in Sodhi were conceptually able to construct the bones of a traditional irreparable harm argument, their showing was nevertheless clearly undercut by certain unique mitigating language that the Court had included in its previous order. Specifically, the prior order included the distinctive requirement that during the pendency of the appeal, Plaintiff will "operate each of the six stores formerly franchised to Franchisee Karamjeet Sodhi . . . as corporate units until the appeal has concluded. 7-Eleven will not close or re-franchise any of those stores while such an appeal is pending." The Court seemed to agree with the Plaintiff’s argument that because Mr. Sodhi "will be able to re-take possession of the stores and collect the store profits that he could have withdrawn had he remained the Franchisee-in-possession during the Franchisees' appeal," he would not be irreparably harmed.

Although the Court could have concluded its analysis of the irreparable harm issue at that point, it did not. Instead, the Court continued to further undercut the Franchisees’ position on this matter by applying what might be called a ‘self-inflicted’ harm test. In this regard, the Court explained that “even if the Franchisees incur an injury [if the stay motion was denied], this injury would not be irreparable because the Franchisees would have brought the injury upon themselves by breaching the Franchise Agreements and failing to pay their taxes. Thus, from the Court’s point of view, the Franchisees "have acted to permit the outcome which they find unacceptable."

Although this rule has facial palatability, and even though it has also been blessed by the United States District Court for the Third Circuit and some other United States District Courts, closer scrutiny reveals that it is in direct conflict with the prevailing framework for assessing risks and costs associated with granting or denying such preliminary relief. To understand why the rule is analytically defective, it is necessary to understand the purpose of a preliminary injunction as opposed to a permanent injunction.

Requests for preliminary injunctive relief are ruled upon before a full and complete trial can be held. In such abbreviated hearings, given that there is not a full opportunity to comprehensively litigate all of the relevant issues, there is a significant associated risk of error in ruling on the preliminary injunction. Accordingly, most academics and commentators agree that the appropriate analytical apparatus to decide preliminary injunctions is that which serves to minimize the expected costs of ruling in error, to wit, the costs associated with incorrectly granting a preliminary injunction (which should have been denied because the defendant will eventually win at trial) and the costs arising from incorrectly denying a preliminary injunction (which should have been granted because the plaintiff will eventually win at trial).

The most abstractly concise judicial cost minimization rule for preliminary injunctive relief was formulated by Judge Richard Posner from the Seventh Circuit. In describing the relative potential errors associated with preliminary injunctive relief, Judge Posner stated:

If the judge grants the preliminary injunction to a plaintiff who it later turns out is not entitled to any judicial relief -- whose legal rights have not been violated -- the judge commits a  mistake whose gravity is measured by the irreparable harm, if any, that the injunction causes to the Franchisee while it is in effect. If the judge denies the preliminary injunction to a plaintiff who it later turns out is entitled to judicial relief, the judge commits a mistake whose gravity is measured by the irreparable harm, if any, that the denial of the preliminary injunction does to the plaintiff.

Judge Posner further noted that these related potential mistakes can be compared, thereby allowing the less costly alternative to be chosen, by using a simple formula: “Grant the preliminary injunction if but only if P x Hp > (1-P) x Hd, or, in words, only if the harm to the plaintiff if the injunction is denied, multiplied by the probability that the denial would be an error (that the plaintiff, in other words, will win at trial), exceeds the harm to the Franchisee if the injunction is granted, multiplied by the probability that granting the injunction would be an error.”

Using Posner’s error-minimization rule, the self-inflicted harm rule (used by the Sodhi court) unjustifiably entirely wipes out the “Hd” of the equation. This ‘wiping out’ of harm process under the self-inflicted harm rule does not occur through a rigorous analysis of the deficiencies of the specific type of harm that will befall the terminated franchisee in a franchise context. Indeed, the rule in application it has nothing whatsoever to do analytically with the degree or character of the irreparable harm that would allegedly be suffered by the franchisee. The best argument that can be made for the self-inflicted harm rule is that if it is truly part of the error-minimization equation it belongs in the (1-P) provision of the equation, not in the Hd component. A ‘bucket readjustment’ in this regard would protect franchisees and dealers to some extent from the ludicrous results brought about by courts unrealistically discounting their irreparable harm down to zero.

So, assuming, for instance, the hypothetical where a plaintiff franchisor has a 55 percent chance of winning at trial, and the defendant franchisee has a 45 percent chance of winning at trial, and assuming further that the franchisor has $30 of projected irreparable harm and the franchisee $65 of projected irreparable harm, the left-hand side of the equation would be 16.5, and the right-hand side would be 29.5; hence, the preliminary injunction should not be granted, because the probability of an erroneous denial weighted by the cost of denial to the plaintiff does not exceed the probability of an erroneous grant of the preliminary injunction weighted by the cost of grant to the defendant. However, if one applies the ‘self-inflicted’ harm rule to the situation, the harm to the defendant would be severely diminished or perhaps recalculated to zero. In the face of such a precipitous downward adjustment, the balance of the equation would now suddenly shift in favor of granting the injunction to the franchisor – even though the irreparable harm to the franchisee in equitable terms is identical both before and after the artificial adjustment for self-infliction.

What makes matters even worse for franchisees under this analysis is that it is possible in almost every franchise termination case for the franchisor to argue that the terminated franchisee brought the harm on itself by refusing to comply with the franchise agreement. Accordingly, under the self-inflicted harm rule, the balance of harms analysis would almost always be skewed against the terminated franchisee; this would result in an inherent and strong judicial bias that would give short shrift to the projected irreparable harm to franchisees and dealers in preliminary injunction termination litigation. As the United States Circuit Court for the Fourth Circuit stated: “If self-made harm is given substantially less weight … then the balance of the harms will almost always favor the plaintiff, thus transforming a preliminary injunction from an extraordinary remedy into a routine occurrence.” Luckily for franchisees not every one of the thirteen federal circuit courts has embraced the irreconcilable self-inflicted harm rule.

Sodhi was a bad decision not only for Sodhi and his co-defendants, but also for franchisees in the future that will be facing termination proceedings in a Third Circuit court. First, the ability of a franchisee to use a violation of the NJFPA as a defense to a requested preliminary injunction was brought into serious question. Second, application of the analytically nonsensical ‘self-inflicted’ harm rule will fatally obstruct a terminated franchisee’s ability to demonstrate that it will suffer irreparable harm if a threatened termination is permitted to proceed.

It is difficult to argue that the Franchisees in Sodhi were not saddled with difficult relevant facts (having admitted that they failed to pay required pay roll taxes). However, by failing to fully articulate and explore the failings of the self-inflicted harm rule, as well as not establishing the legal authority to use a violation of the NJFPA to defend against a contractual breach, the Sodhi franchisees, ironically, may have themselves inflicted, in part, their own harm regarding the Motion for Stay.

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