Counterclaims in Franchise Litigation: A Complex Relationship

January 21, 2021Articles The Legal Intelligencer

Franchisors frequently claim trademark infringement when enforcing termination of franchise agreements. The defenses brought by franchisees in such cases can range from simple denials to complex counterclaims involving federal and state rules and legislation, common law contract claims and tort claims.

Freedom to contract allows the freedom to control or circumscribe the risk and amount of damages. In contrast, tort claims are limited only by foreseeability and proximate cause, and damages can exceed those in contract claims. Our jurisprudence limits tort claims where the parties sought to control their risks by contract. Deciding whether tort claims can be properly asserted in franchise dispute can be difficult.

The district court in Mr. Sandless Franchise v. Karen Cesaroni, __ F. Supp. 3d ___ (E.D. PA, 2020) explains the complex relationship between state law contract claims, state and federal trademark laws, and tort claims in connection with franchise litigation in the context of a counterclaim.

Mr. Sandless Franchise sued a former franchisee, and its successor entity, for breach of contract, service mark infringement and among other things, unfair competition. Mr. Sandless franchisees the district court’s memorandum opinion dealt primarily with the counterclaims and third-party claims asserted by the defendants. The counterclaims arise from a territorial dispute in New England during the franchise relationship. The former franchisee claims that the franchisor invaded its protected territory under the guise of servicing “regional customers,” a carve-out from the territorial protections. Under the carve-out, the franchisor could retain the regional customers but the defendant pursuant to the franchise agreement should be given the option to service the customer. The defendant claimed that the customer was diverted from the defendant and serviced by another franchisee. The franchisee that surreptitiously served the customer was also joined in the counterclaim.

Tortious Interference with contract claims against the other franchisee.

Karen Cesaroni LLC brought a claim against the franchisee who serviced the regional customer “outside business hours and under cover of darkness” to evade the exclusive territorial protections. However, the court dismissed this claim for lack of personal jurisdiction over this other franchisee. General jurisdiction was unavailable because this franchisee only worked in New England. Specific jurisdiction was unavailable because none of the contracts with the Eastern District was specific to this transaction. A specific finding by the court was that the language of the other’s franchise agreement requiring venue in Pennsylvania in disputes with the franchisor did not accrue to the benefit of a franchisee-franchisee dispute. No general jurisdiction could be found based merely on that contractual language. The court also rejected jurisdiction based on the “absent co-conspirator” doctrine because no specific acts of conspiracy were alleged.

Contractual limitations of one year held enforceable.

Counterclaimant sought to invalidate the one-year contractual limitations on claims as unconscionable. The district court applied Pennsylvania law to determine that the provision was not manifestly unreasonable and has been upheld in other cases. The court also determined that the record had not been sufficiently developed to determine whether the limitations bar should be applied.

Insufficient record to determine the “gist of the action” doctrine.

The “gist of the action” doctrine bars tort claims when the gist or gravamen of the action sounds in contract. The question is whether the counterclaims were really contract claims recast as tort claims. The court determined that the record was not sufficiently developed to rule on that issue.

The parole evidence rule did not preclude breach of contract claims.

The franchise agreement contained a proper integration clause which the franchisor claimed eliminated breach of contract claims for violation of the exclusivity clause. The court found that the counterclaim plausibly alleged that the exclusivity clause was violated.

The trademark laws may provide counsel fees in exceptional cases to the defense.

The complaint alleged service mark infringement, and the counterclaim sought reimbursement of counsel fees for defense of that claim. The court determined that such relief was available under certain circumstances, and that the plausible allegations could state a recovery of fees under state and federal trademark laws.

Failure to mediate is actionable as a breach of contract.

One of the counterclaims alleged failure to mediate as a condition precedent to filing the complaint. The defendant argued that the right to mediate the claims in the complaint was waived, and accordingly, the right to mediate the counterclaims was waived. The court agreed with the defendant franchisee on this issue. The opinion did not address any remedy except waiver of the provision.

This thoughtful memorandum opinion appears to have been written not merely for the parties, as it explains some of the cutting-edge legal issues in depth. The decision is worth reviewing when preparing any defense or counterclaim in franchise litigation.

Reprinted with permission from the January 21 issue of The Legal Intelligencer. (c) 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.