The Bright-Line Rule of Constructive Termination in Franchises

July 22, 2019Articles The Legal Intelligencer

For over 40 years, Azmi Takiedine had been a 7-Eleven franchisee when he sued his franchisor in the U.S. District Court for the Eastern District of Pennsylvania. The case, Takedine v. 7-Eleven, has two published decisions by U.S. District Court Judge Gene E.K. Pratter of the Eastern District of Pennsylvania, which are summarized here. The case presents a fine explanation of the state of the law in Pennsylvania regarding the elements of breach of contract and the implied covenant of good faith and fair dealing.

Takiedine alleges that 7-Eleven was attempting to force older franchisees to end their franchise relationship so the franchisor could enter into franchise relationships with new franchisees on more favorable terms. He alleged that he was being coerced into doing so by 7-Eleven withholding store maintenance and repairs the franchisor was obligated to perform, being required to buy goods from expensive preferred vendors, and falsely accused of violating the franchise agreements. He claimed that this conduct was tantamount to termination and a violation of the implied covenant of good faith and fair dealing while he continued to operate his franchise.

The implied covenant of good faith and fair dealing has been the subject of many court opinions, some seemingly conflicting and others that take it for granted. Many judges will ask in settlement context, “How can you come to my court and say your client is not required to act in good faith in the performance of the franchise agreement?” Others will say the UCC requires in the sales of goods that all parties act in good faith, so why is franchising different where livelihoods are at stake?” The answer lies in the nature of the franchise relationship, where the bargaining power in favor of the franchisor seems overwhelming, but the consequences to the franchisor in the event of franchisee breach are disproportionate. Courts should be reluctant to imply contractual terms in these settings, and will often limit the instances where the implied covenant of good faith and fair dealing should apply.

In this case, Pratter in her June 27, 2018, decision dismissed the claim that the implied covenant of good faith and fair dealing applies when the franchisee continues to operate the franchise. Unlike the UCC, good faith and fair dealing is not implied in every contract under Pennsylvania law. Pennsylvania provides that “in the context of franchise agreements, a franchisor has a duty to act in good faith and with commercial reasonableness when terminating a franchise for reasons not explicit in the agreement.” This conclusion is compelled because the implied covenant cannot override explicit language in a franchise agreement, so it can only apply where the grounds for termination are not explicit in the agreement and only where the relationship is being terminated. The court acknowledged that although the Pennsylvania Supreme Court had inferred that the implied covenant might apply to franchise disputes outside of termination issues, the federal courts in the district have followed the explicit limitation of the Supreme Court to apply the covenant only in the termination context.

The same logic compels the same conclusion when dismissing the constructive termination claim because the business continued to operate. The court analogized this situation to where constructive termination of an employment relationship or a landlord-tenant relationship does not occur until the employee separates from employment. Similarly, using Mac’s Shell Service v. Shell Oil Products, 559 U.S. 175 (2010), franchise termination under the Petroleum Marketing Practices Act does not occur until one of the elements of the franchise is eliminated so that the business must be abandoned. Pratter concluded that this bright-line test for constructive termination is a workable solution and that Takiedine’s constructive termination claim was dismissed. Takiedine was permitted to amend his complaint to address the breach of contract claims to address the specific contract provisions breached.

Pratter’s second opinion in this case dated Feb. 22, 2019, discusses the application of the elements of contract breach to various claims by the franchisee. Takiedine alleged that 7-Eleven failed to provide fair and accurate merchandise audits. This breach of contract claim was dismissed for failure to timely object to the audit as required by the franchise agreement. Takiedine next argued that 7-Eleven failed to market and advertise as agreed. This claim was dismissed because the franchise agreement reserves the right to spend advertising in the sole discretion of 7-Eleven. Takiedine then claimed that 7-Eleven will increase its share of the profits at his expense unless the recommended vendor requirement is met. The recommended vendor claim was dismissed because Takiedine did not show how this provision violated or harmed the plaintiff.

The court did sustain three contractual claims of Takiedine. 7-Eleven was contractually obligated to repair and maintain the roof and parking lot as it deemed necessary. The court held that it was a factual issue whether these repair and maintenance issues were actually necessary. Takiedine also argued that 7-Eleven breached the provision of the franchise agreement to treat the franchisee as an independent contractor. The court held that it was premature to determine whether this provision was breached as there were allegations that 7-Eleven controlled the means and manner of operation. Finally, an open contract claim remained regarding conflicting agreements regarding credit card fees because the record had not yet been developed sufficiently.

The last opinion is noteworthy because it also compels arbitration of claims involving vendor negotiating practices and allow unjust enrichment and conversion claims to proceed past the pleading stage. The case provides useful direction on how to proceed and analyze complex tort and contract claims which arise in long term franchise relationship.

Reprinted with permission from the July 22 issue of The Legal Intelligencer. (c) 2019 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.