Fourth Circuit Reverses U.S. District Court, Instead Allowing Franchisor to Recover "Future Damages" From Terminated Franchisee

02 May 2011 Publication
Author(s): Michael J. Lockerby

Legal News Alert: Distribution & Franchise

For many years, the recovery of so-called “future damages” has been one of the most hotly contested issues in franchising. The issue is whether—following termination of the franchise agreement—the franchisee can be held liable for royalties, advertising fund contributions, and other required payments to the franchisor. Many franchise agreements are long-term contracts (sometimes lasting as long as 20 years). As a result, the liability for “future damages” that some franchisees face can be substantial.

The latest court to weigh in on this issue is the U.S. Court of Appeals for the Fourth Circuit in Richmond, Virginia. In a recent decision, the Fourth Circuit reversed a judgment of the U.S. District Court for the Western District of North Carolina in Charlotte holding that “future damages” are not recoverable. Meineke Car Care Ctrs., Inc. v. RLB Holdings, LLC, 2011 U.S. App. LEXIS 7809, 2011 WL 1422900 (4th Cir. Apr. 14, 2011). The Fourth Circuit’s reversal was of obvious importance to the appellant-franchisor, Meineke. Meineke’s franchise agreement requires dispute resolution in the Western District of North Carolina. The district court’s decision—citing two prior adverse rulings to Meineke in similar cases—had called Meineke’s position “a swing and a miss, strike three.” Meineke Car Care Ctrs., Inc. v. RLB Holdings, LLC, 2009 U.S. Dist. LEXIS 70920 (W.D.N.C. Aug. 7, 2009).

The implications of the Fourth Circuit’s Meineke decision, however, are not limited to potential future federal court litigation in Charlotte between Meineke and its franchisees. To the contrary, the Meineke decision—although not binding precedent—could be persuasive authority in at least three ways.

First, it clarifies a basic principle of North Carolina law that is not limited to franchising. According to the Fourth Circuit, “No principle of North Carolina contract law suggests that in all circumstances a contract must specifically provide for recovery of future damages in order to preserve a party’s right to recover them.”

Second, it addresses a legal issue of interest to the franchising community in general. That issue is whether sending a notice of termination establishes—as a matter of law—that the franchisee’s prior breach of contract cannot be the proximate cause of the franchisor’s claimed future damages. In rendering its opinion, the Fourth Circuit contrasted the various approaches adopted by other courts and concluded that its analysis “is consistent with cases on both sides of the analysis, as the focal point has not been whether the franchisor or the franchisee is seeking lost profits, but whether the party breaching the contract proximately caused the lost profits being sought.”

In one of the leading cases in which the franchisor had been denied future damages, the court concluded that the franchisor’s notice of termination—not the franchisee’s prior breach—was the proximate cause of the lost royalties. Postal Instant Press, Inc. v. Sealy, 51 Cal. Rptr. 2d 365 (Cal. Ct. App. 1996). While denying the recovery of future damages in that particular case, the Sealy court had observed that the franchisor’s “entitlement depends on the nature of the breach and whether the breach itself prevents the franchisor from earning those future royalties.” Id. at 371. In contrast, the U.S. District Court for the Southern District of Florida permitted a franchisor to recover lost future royalties where the franchisee voluntarily ceased operating the franchise—an action that, under the terms of the franchise agreement, automatically terminated the agreement. Lady of America Franchise Corp. v. Arcese, 1006 U.S. Dist. LEXIS 68415 (S.D. Fla. 2006). The court found “as a matter of law that [the franchisee’s] actions were the proximate cause of the termination of the agreement and [the franchisor’s] loss of future royalties.” Id. at *18. Although neither Sealy nor Lady of America was binding upon the Fourth Circuit, the Meineke court observed that its holding was consistent with the rationale of both decisions.

Last but not least, the Fourth Circuit’s opinion in Meineke clarified and explained that the recovery of future damages is not an unduly “conjectural, remote, or speculative” claim of lost profits under North Carolina, even if the franchisee claims to have been unprofitable. The franchisee’s royalty payment obligations were based on its sales, not its alleged profits. By basing its “future damages” claim on the franchisee’s past performance, Meineke adopted what the Fourth Circuit characterized as the “widely accepted methodology” of “using past profits as a basis for calculating future lost profits.” (citations omitted). Of course, this methodology is often used by franchisees claiming wrongful termination.

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss this topic further, please contact your Foley attorney or the following:

Michael J. Lockerby
Washington, D.C.

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