Franchise Terms: Is it in the Contract?
The oldest franchisor in the country recently took a hit in federal appeals court on its ability to set prices in its restaurants. The decision suggests that franchisors take a hard long look at the specifics of their contract language before changing course.
Steak N Shake Enterprises, Inc. has overseen the operation of franchised restaurants for 70 years, and until 2010, had allowed its franchisees to set their own prices and promotions. In 2010, after the chain changed ownership, the corporate office attempted to create a more uniform brand image and compelling national advertising campaign, and began to require its eighty operators to comply with system-wide prices and advertising promotions. Stuller, who had operated five restaurants since 1939, refused, and was threatened with termination of its franchises. Stuller sued the franchisor, alleging that the pricing policy could cost it up to $1 million a year in revenue and would force it out of business. Stuller was granted an injunction preventing the corporate office from implementing the policy; after appeal by Steak N Shake, the U.S. Court of Appeals for the Seventh Circuit affirmed in a unanimous opinion:
“The record contains sufficient evidence to find, as a threshold matter, that Stuller would suffer irreparable harm if it was forced to implement Steak N Shake’s pricing policy. Specifically, Stuller has presented evidence that the policy would be a significant change to its business model and that it would negatively affect its revenue, possibly even to a considerable extent.”
2012 U.S. App. LEXIS 17921, Op. No. 11-2656 (7th Cir. Aug. 24, 2012).
Generally, over the last twenty years, court decisions have granted franchisors more freedom to set resale prices as antitrust restrictions have loosened. But here, the franchisee operated its business under franchise agreements that predated the new mandatory price and promotion policy. The agreements required the franchisee to follow a general “system” that set many standards for its operations, and the franchisor argued that the uniform menu prices were part of that system. The district court refused to grant summary judgment, saying that Steak N Shake had a long history of allowing franchisees independence with respect to pricing and promotions and that nothing in the agreement spelled out that prices and promotional discounts could be part of the “system”. It therefore decided that the franchisor’s authority to set prices as part of the system was unclear under the contracts, and left it for the district court to decide at the eventual trial.
The additional feature of note from the court was that this was an injunction preventing the franchisor from either forcing the policy to be implemented, or terminating the franchisee. U.S. courts generally don’t favor this kind of relief; they generally prefer to allow parties to act as they choose and pay any money damages resulting from wrongful behavior afterward. The exception is that such injunctions and temporary restraining orders are granted when a party’s actions would cause “irreparable harm”. Here, the magistrate who first heard the case noted that to show lack of an adequate remedy at law and be granted the injunction, the franchisee needed to show that compliance with the policy would put it out of business.
The district court decided that the damage to the franchisee’s business reputation and goodwill if the policy were put in place would be such “irreparable harm” – not a common result, but the opinion suggests that the judges were influenced by the restaurants’ long-standing history and reputation.
The dispute raises issues for franchisors looking to incorporate control over their systems and flexibility and to address uniformity in areas of operation that may not be foreseeable when a long-term contract is signed. (Franchise agreements signed ten years ago did not address social media use, for example.) They suggest drafting language as broadly as possible to include any element of franchise system that a franchisor might want to control during the term of the franchise. The franchise bar will be following the case and looking for the ultimate trial decision on contract interpretation.
If you have any questions, please contact Margaret Breen at firstname.lastname@example.org or at 206.254.4495.