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Here are some of the most recent judicial developments of interest to franchisors:
In a case with broad implications for those operating under a distributorship agreement, the United States District Court for the Western District of Wisconsin granted a distributor’s request for a preliminary injunction against its manufacturer to enjoin that manufacturer from taking action expressly permitted by the parties’ distributorship agreement. In Techmaster, Inc. v. Compact Automation Products, LLC, 2006 WL 3408241 (W.D. Wis. November 27, 2006), the plaintiff distributor brought suit to challenge its defendant manufacturer’s decision to sell products directly to the plaintiff’s largest customer.
The parties’ distributorship agreement provided that the manufacturer could sell products directly to the distributor’s customers in the manufacturer’s “sole judgment.” Acting under that agreement, the manufacturer began selling products directly to one of the distributor’s largest customers. The manufacturer began making those direct sales only after the distributor informed the manufacturer that the customer had placed a much larger order than usual and that its demand for the manufacturer’s product was increasing. The manufacturer then negotiated directly with the customer, eventually offering the customer a much lower price than had been provided in the past by the distributor.
The distributor claimed that the manufacturer’s actions violated the Wisconsin Fair Dealership Act (“the Act”) and sought a preliminary injunction to prevent the manufacturer from selling directly to the distributor’s customer. The court first considered whether the Act applied to the parties’ relationship. The court concluded that the manufacturer and distributor shared a community of interest, thus bringing their relationship within the terms of the Act. The court then found that the manufacturer had violated the Act by effecting a change in the distributor’s competitive circumstances without providing notice or an opportunity to cure. The court concluded that it was irrelevant that the parties’ agreement expressly gave the manufacturer the right to make direct sales to the distributor’s customers, finding that the manufacturer’s decision to effectively appropriate for itself one of the distributor’s largest customers constituted a change in competitive circumstances that required the manufacturer to provide notice and an opportunity to cure.
The court further found that the distributor would suffer irreparable harm to the goodwill developed by its business if the manufacturer’s conduct were not enjoined, and that the balance of harms and public interest also weighed in favor of the distributor. Accordingly, the court granted an injunction to prohibit any direct sales between the manufacturer and the distributor’s customer.
A decision by the United States District Court for the Northern District of Illinois in Reyes v. McDonald’s, 2006 WL 3253579 (N.D. Ill. Nov. 6, 2006), significantly limited the ability of plaintiffs to bring state law claims arising out of McDonald’s alleged failure to accurately state the nutritional content of its food. The plaintiffs claimed that McDonald’s had understated the amount of fat and calories in its french fries in brochures at its restaurants and on its website. The suit was filed in the wake of an announcement by McDonald’s that the fat and calorie content of its french fries were somewhat higher than previously made known. The plaintiffs raised a variety of causes of action, including claims under the Illinois Consumer Fraud and Deceptive Practices Act (CFA), New York consumer fraud and consumer protection statutes, and common law actions for breach of express and implied warranty.
In response to the lawsuit, McDonald’s filed a motion to dismiss for failure to state a claim. In ruling on the motion, the court dismissed the New York statutory claims on the ground that the plaintiffs had failed to plead actual injury, as required by state law, because the only “damage” identified in the complaint was that the alleged misstatements made by McDonald’s had induced the plaintiffs into purchasing the french fries. In addition, the court dismissed the breach of warranty claims because the plaintiffs had failed to provide notice to McDonald’s as required by the Uniform Commercial Code, as adopted by Illinois and New York.
Finally, the court held that the Nutritional Labeling in Education Act (NLEA), 21 U.S.C. §§ 341 et seq., limited the scope of plaintiffs’ Illinois CFA claim. McDonald’s argued that the NLEA, which prohibits state governments from setting nutrition labeling standards that differ from federal standards, preempted plaintiffs’ state law claims. The court, however, noted that federal labeling laws do not automatically preempt state law claims for breach of express warranties and violations of deceptive trade practices acts. As long as the state law duties do not impose requirements in addition to - or different from - those established by federal law, no preemption is warranted. The court concluded, therefore, that the NLEA did not “unilaterally preempt” an action brought under the CFA. It noted, however, that because the state deceptive practices act imposed broader obligations concerning nutrition labeling than those set forth by the FDA regulations promulgated under the NLEA, the federal standards established a “substantial limitation” on the scope of any claim brought under the CFA. These federal standards, for example, allowed nutrition labeling information to vary by up to 20 percent from the actual nutritional content of the food at issue and allowed restaurants to use “reasonable measures” to establish nutritional content. Therefore, the court held that the CFA claim survived the motion to dismiss, but only to the extent that the standards under which liability was determined were identical to the requirements set forth in the NLEA.
In Choice Hotels v. Wright (In re Wright), 2006 WL 3440336 (Bankr. C.D. Cal. 2006), the Bankruptcy Court in the Central District of California held that damages resulting from violations of the Anti-Cybersquatting Consumer Protection Act (“ACPA”) were nondischargeable because violation of the ACPA required a finding of willful and malicious injury caused by the debtor. Section 523(a)(6) of the Bankruptcy Code excepts from discharge a debt that was incurred based upon the debtor’s conduct that causes both willful and malicious injury.
Choice Hotels operates and franchises inns and resorts under various names, including COMFORT INN® and COMFORT SUITES®. Scott Wright manufactured shoes under the name “Happy Feet-The World’s Most Comfortable Shoe.” In 1990 Wright obtained the toll free number 1-800-COMFORT for his Happy Feet business. Immediately after obtaining the toll free number, Wright received calls from people seeking reservations for COMFORT INN® or COMFORT SUITES®. Initially Wright told those people inquiring about reservations that they had the wrong telephone number, but later he decided to take advantage of the calls and partnered with a travel agency to book reservations for people calling the 1-800-COMFORT number. By 1997, the travel agency had booked approximately $1.2 million in room reservations. After learning of the arrangement, Choice Hotels terminated the travel agency’s service agreement and rejected overtures from Wright to become a travel agent for Choice Hotel franchisees.
After failed attempts to partner or settle with Choice Hotels, Wright made a fateful decision to expand his connections to Choice Hotel’s protected service marks. Wright registered internet domain names for: (1) “comfortcallcenter.com”; (2) “1-800-comfort.com”; (3) “Comfort Call Center.com”; (4) “1-888-comfort.com”; (5) “comfortgoldcard.com”; (6) “comfortsilvercard.com”; (7) “comfortbronzecard.com”; and (8) “comfortowners.com”. Wright used all of these websites to direct Choice Hotel customers to Wright’s web pages or 1-800-COMFORT. Choice Hotels sued Wright and obtained a temporary restraining order, as well as summary judgment on various counts of trademark infringement and ACPA violations. The Court entered judgment for Choice Hotels in the amount of $45,000 in royalties and $525,000 in statutory fines under the ACPA ($75,000 for each of the infringing domain names). Wright filed Chapter 7 bankruptcy shortly after the judgment was entered against him and sought to have the judgment discharged.
Choice Hotels sought nondischargeability under 11 U.S.C. § 523(a)(6) based upon the summary judgment that had been entered in the federal district court. The bankruptcy court held that the ACPA violations that resulted in the underlying judgment included a finding that Wright had acted with a “bad faith intent to profit” from his infringing internet domain names. Because the statutory requirements to prove a violation of the ACPA were established, Choice Hotels was able to rely upon its prior summary judgment as evidence of willful and malicious injury under 11 U.S.C. § 523(a)(6). The bankruptcy court ruled that Choice Hotel’s judgment against Wright was nondischargeable.
In God’s Glory & Grace v. Quik International, 938 So. 2d 730 (La. Ct. App. 2006), the plaintiff contracted with a Quik International, Inc. franchisee for creation of a website that would allow plaintiff to sell specialty consumer goods over the internet. Quik International is the franchisor of the Quik Internet concept, and provides web-hosting services for websites that are designed and maintained by its franchisees. The plaintiff alleged numerous delays with development of its website, terminated its relationship with the franchisee, and filed suit, naming both the franchisee and Quik International as defendants. Prior to trial, the plaintiff dismissed the case against the franchisee, proceeding solely against Quik International under theories of actual and apparent authority. At trial the court held that Quik International was not liable for the damages allegedly suffered by plaintiff as a result of the contract it had entered into with the franchisee.
On appeal, the appellate court upheld the finding that no actual authority existed between the franchisor and the franchisee—holding that the lower court had properly interpreted the express terms of the franchise agreement, which stated that the franchisee was an independent contractor and not an agent of Quik International. The court also found that the franchisor did not have a contract or any dealings with the plaintiff. In support of its apparent authority claim, plaintiff argued that the Quik International logo appeared on the franchisee’s business cards and that the franchisee’s website linked to the website of Quik International, which described the kinds of services provided to Quik International customers. The appeals court rejected this argument and determined no apparent authority existed because the plaintiff’s principals admitted that they knew they were dealing with a franchisee of Quik International and had made no effort to determine what support services Quik International provided to its franchisees.
In Allen v. Choice Hotels Int’l, 942 So. 2d 817 (Miss. Ct. App. 2006), the Mississippi Court of Appeals upheld a trial court’s summary judgment ruling that a hotel franchisor, Choice Hotels International, was not liable for the injuries to a guest and the death of her husband, both of which occurred during an armed robbery of their hotel room. Plaintiff alleged that Choice Hotels failed to provide reasonable security to protect guests in the hotel and, as a result, she and her husband were harmed by an intruder’s criminal acts. In entering summary judgment for the franchisor, the trial court found that Choice Hotels was not vicariously liable because it did not control or have the right to control the day-to-day operations of the hotel.
On appeal, the plaintiff raised issues involving the existence of traditional agency, liability in the franchise context, apparent authority, the role of franchises and trademarks, and negligence. The appellate court noted that this case was one of first impression in Mississippi.
In upholding summary judgment for the franchisor, the court of appeals first relied on the extensive body of Mississippi case law addressing when a third party can be held liable for acting as the master of another party. Mississippi agency law centers around the concept of control, and the one who controls or has the right to control the work of another may be liable as the master of that party. The non-exclusive list of factors considered in determining control includes the power to terminate the contract, whether there is control of the premises, the right to supervise and inspect the work, the right to direct the details of the manner in which the work is done, and the right to employ and discharge employees. While some of the factors weighed in favor of finding a master relationship, the court determined that, on a whole, Choice Hotels did not act as master to its franchisee because it did not have the right to: (1) hire or terminate the hotel’s employees; (2) tell the franchisee how to conduct its day-to-day business; and (3) tell the franchisee which rates to assign to its rooms.
The appellate court also found that even though Choice Hotels established specific requirements for guest room entry doors, including the thickness of the door and requiring a “peephole,” deadbolt locks, and security bars on any sliding doors, these requirements were not enough to establish control. In addition, the court found that the parties’ franchise agreement was intended to provide a system of uniformity for Choice Hotel franchisees but was not intended to establish the franchisor’s control over the franchisee – a concept bolstered by the specific language of the franchise agreement. The court also determined that while the Lanham Act requires a franchisor to exert a certain level of control over its trademarks, exerting control to protect trademark rights is not the same as controlling the day-to-day operations and establishing a master/servant relationship.
In Carris v. Marriott International, Inc., 466 F.3d 558 (7th Cir. 2006), an Illinois resident sued Marriott, the franchisor for the Marriott system, for injuries he suffered in a jet ski accident at a franchised hotel in Nassau, Bahamas. The United States District Court for the Northern District of Illinois dismissed the complaint, which had been filed solely against the franchisor, for failing to state a claim upon which relief could be granted. The Seventh Circuit affirmed and held that, under Illinois conflict of laws principles, Bahamian law governed.
The plaintiff broke his leg when he fell off a jet ski rented from a concessionaire at a franchisee’s hotel in Nassau. The plaintiff argued that the franchisor was liable for his injuries under Illinois tort law because: (1) he believed the hotel was a company-owned location; (2) he made his reservation on-line through Marriott’s website; and (3) the franchised hotel’s own website advertised recreational activities, including jet skiing. Plaintiff argued that Marriott, as franchisor, was vicariously liable for the purported negligence of the franchisee’s hotel in failing to supervise the concessionaire, warn him that the concessionaire was not supervised by the hotel, alert him to the hazards of jet skiing, and teach him to operate the jet ski, among other alleged failures.
Illinois conflicts principles require the courts to select the law of the jurisdiction that has the “most significant relationship” to the events giving rise to the action and to the parties. Here, the accident and the acts that allegedly caused plaintiff’s injuries occurred in the Bahamas. The court held that plaintiff’s only “link” to Illinois - other than his residency - was the franchisor’s website and the website, alone, was insufficient to invoke Illinois law. Otherwise, “any hotel chain that has a website (and it is doubtful that any hotel chain does not) subjects itself to the tort law of every country whose nationals stay at one of the hotels in the chain.”
Alternatively, citing public policy and his belief that the franchised hotel was company-owned, the plaintiff argued that the apparent authority doctrine applied. He reasoned that the franchisor was vicariously liable for the franchised hotel’s alleged failures because the franchised hotel, through its advertisements, had the apparent authority to act on Marriott’s behalf. The court found this argument unpersuasive, explaining that it was unreasonable to assume the hotel was company-owned because “[a]lmost everyone knows that chain outlets, whether restaurants, motels, hotels, resorts, or gas stations, are very often franchised rather than owned by the owner of the trademark that gives the chain its common identity in the marketplace.”
In Wilmington Trust Co. v. Burger King Corp., 2006 WL 3438458 (N.Y. App. Div. Nov. 30, 2006), the plaintiff-lender sued Burger King and Burger King’s financial consultant alleging that Burger King interfered in certain loan agreements involving insolvent Burger King franchisees. Specifically, the lender alleged that Burger King encouraged the franchisees to pay off their debts with Burger King first and that Burger King fraudulently concealed its relationship with the financial consultant, who helped the franchisees restructure their debt. A lower court granted Burger King’s summary judgment motion and dismissed the case. The lender appealed.
The appellate court noted that, as a creditor, Burger King had an economic interest in the matter justifying its alleged interference with the lender’s loan agreements. Moreover, Burger King did not fraudulently conceal its relationship with the financial consultant because Burger King had disclosed to the franchisees that it would be paying the financial consultant’s fees. The court further noted that the franchisees were in breach of their loan agreements with the lender long before Burger King allegedly interfered with those agreements. For these reasons, the appellate court affirmed the lower court’s decision granting Burger King’s summary judgment motion.
In Synergistic Int’l, LLC v. Korman, 470 F.3d 162 (4th Cir. 2006), the United States Court of Appeals for the Fourth Circuit affirmed the district court’s award of summary judgment as to the plaintiff’s trademark infringement and unfair competition claims under the Lanham Act and state law, but vacated the district court’s damages award. The court of appeals determined that the defendant’s THE WINDSHIELD DOCTOR mark was likely to result in confusion by consumers and infringed on the plaintiff’s rights in the GLASS DOCTOR® mark. The court found, however, that the district court had erred in awarding damages without specifying which factors it had considered.
The plaintiff is a nationwide franchisor and operator of glass installation and repair businesses. The defendant had operated a windshield repair business since 1987, which she called “THE WINDSHIELD DOCTOR.” Unaware of the plaintiff’s mark, which had been registered since 1977, the defendant began using the names “GLASS DOCTOR” and “THE WINDSHIELD DOCTOR” interchangeably in 2000. Following a remedies trial, the district court awarded $142,084 in damages to the plaintiff on the Lanham Act claims. This award represented the defendant’s net profits during the period when she used the names “GLASS DOCTOR” and “THE WINDSHIELD DOCTOR” interchangeably.
On appeal, the Fourth Circuit agreed that the plaintiff owned a commercially strong mark because it had conducted extensive nationwide advertising and sustained a 133-unit franchise business. The court concluded that the plaintiff’s mark was suggestive and not descriptive, warranted a broad scope of protection against similar marks, and was conceptually strong. An injunction against further infringement was affirmed. All of these findings occurred even though the Patent and Trademark Office (“PTO”) had required the plaintiff to disclaim an exclusive right to the word “GLASS,” which left “DOCTOR” as the dominant word in the mark. Interestingly, the court also rejected the defendant’s argument that the plaintiff registered its GLASS DOCTOR® mark only for the installation of glass in buildings and vehicles, but not for the repair of vehicle windshields. The court declined to follow the narrow view adopted by the Third Circuit, and held that the PTO’s registration of a suggestive mark should be broadly construed.
As to the award of damages, the court of appeals remanded the case back to the district court and identified six equitable factors for the court do consider in assessing damages, with willful infringement being an important but not an essential factor. The court concluded that a trial court should consider and discuss any relevant equitable factors, and explain its reasoning, when assessing Lanham Act damages.
John F. Fitzgerald, Michael R. Gray, Jeffrey L. Karlin, Gaylen L. Knack, Craig P. Miller, Kevin J. Moran, Kirk W. Reilly, Iris F. Rosario, Jason J. Stover, Stephen J. Vaughan, Henry Wang, Quentin R. Wittrock, David E. Worthen.
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The GPMemorandum is a periodic publication of Gray, Plant, Mooty, Mooty & Bennett, P.A., and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult your own franchise lawyer concerning your own situation and any specific legal questions you may have.
This article is provided for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have.
Gray Plant Mooty is recognized as one of the leading corporate law firms in Minnesota and one of the top franchise firms in the world. Our roots go back to 1866. Today, we are a full-service firm with nearly 180 attorneys and offices in Minneapolis and St. Cloud, Minnesota; Washington, D.C.; and Fargo, North Dakota.