Executive Summary:
In an unpublished decision, Circuit Judge Griffin of the United States Court of Appeals, Sixth Circuit, affirmed the United States District Court for the Middle District of Tennessee’s dismissal of Defendants’ California Franchise Relations Act (“CFRA”) counterclaim and affirmed the District Court’s grant of summary judgment on Defendants’ breach of contract counterclaim relying on brand standards related language.
Citation:
ServPro Industries, Inc. v. Woloski, 2022 WL 633844 (6th Cir. Mar. 4, 2022).
Relevant Background:
Servpro Industries, Inc. (“Franchisor”) is a Tennessee franchisor who operates nationwide cleaning and damage-restoration services. Tammy and Paul Woloski own Delta Dawgs Construction (“Franchisee”), which operated a ServPro franchise near Los Angeles, California. While the Franchise Agreement states that Tennessee law governs the relationship, an addendum to the Franchise Agreement states the following in relevant part:
This Addendum to Franchise License Agreement is made in recognition of the requirements of the California Business and Professions Code Sections 20000 to 20043. The parties to the attached ServproIndustries, Inc. Franchise License Agreement (the “Agreement”) agree as follows:
1. Section 1.2, Renewal, and Section 10, Default and Termination, are amended by adding: California Business and Professions Code Sections 20000 to 20043 provide rights to [Delta Dawgs] concerning termination or non-renewal of a Franchise and further provide if the Agreement is inconsistent with California law, California law will control.
6. Section 13.10, Governing Law, is amended by adding: The Agreement requires application of the law of the State of Tennessee. This provision may not be enforceable under California law.
Franchisor received several serious complaints about Franchisee’s operation of the franchise including allegations of price gouging, excessive demolition, fraudulent billing, and unprofessional billing practices. “Servpro determined that these complaints placed its reputation at risk so it terminated the agreement.” When Franchisee chose to cease operations, Franchisor sued Franchisee and Franchisee countersued Franchisor alleging violations of the CFRA and breach of contract. During the course of the litigation, the District Court granted Franchisor’s motion to dismiss Franchisee’s CFRA claim and granted Franchisor’s motion for summary judgment dismissing Franchisee’s breach of contract claim. This appeal follows.
Decision:
The Court of Appeals provides a unique but well-stated analysis for why the District Court properly dismissed Franchisee’s CFRA and breach of contract claims for relief.
First on the CFRA claim, the relevant findings were as follows:
- Franchisee’s argue that the California Addendum to the Franchise Agreement operates as a choice of law provision and affords them rights under the CFRA.
- “The Franchise Agreement contains a clear choice-of-law provision designating Tennessee law.” *2
- “[T]he California Addendum modifies the text of [the Franchise Agreement]… That is, the rights conferred by … the California Addendum are contract rights, enshrined in the Franchise Agreement as amended by the California Addendum [and] … does not provide any standalone rights. Therefore … any alleged failure to comply with those provisions is necessarily part of defendants’ breach of contract claim.” *2
- The “California Addendum provides that if the Franchise Agreement is inconsistent with California law, California law will control… [D]efendants argue only that the CFRA is inconsistent with a wholly inapplicable provision of Tennessee law … Defendants do not argue that any other Tennessee law is inconsistent with California law, so Tennessee law–not the CFRA–continues to govern the dispute.” *2
Second, on the breach of contract action, the relevant findings were as follows:
- Franchisees argue that “questions of fact remain regarding whether Delta Dawgs actually engaged in the alleged misconduct, creating triable issues that preclude summary judgment.” *3
- Franchisee’s “generic we-did-nothing-wrong statement is unsupported by any evidence and is therefore not enough.” *3
- Further, “[a g]ood faith belief of the franchisor that the franchisee is untrustworthy or engages in fraudulent practices undermines the entire franchise relationship.’” Humboldt Oil Co., Inc. v. Exxon Co., U.S.A., 695 F.2d 386, 389 (9th Cir. 1982).
- “The Franchise Agreement provides that it may terminate a franchisee for any “conduct that reflects materially and unfavorably” upon Franchisor and its reputation. Franchisor “presented sufficient evidence to demonstrate [Franchisee] was engaged in conduct that was likely to have an adverse effect on [Franchisor]’s reputation… Servpro has a legitimate concern, represented in the Franchise Agreement, with the public’s opinion about whether it is a reputable company, and a dozen complaints might reasonably affect that opinion.” *3
- “[S]o the Franchise Agreement allowed Servpro to terminate Delta Dawgs’s franchise when it had a good faith belief that Delta Dawgs was acting in a way that might harm Servpro’s reputation.” *4
Looking Forward:
While there remains open questions regarding how the District Court or the Court of Appeals would have decided the CFRA claim if the Franchisee would have pled it properly (see *3), the Court of Appeals’ decision on the issue of reputational harm is clear.
A critical element of a franchise is that “[t]he franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark.” 16 CFR § 436.1(h)(1). When a franchisee acts in a way that is inconsistent with brand standards or otherwise brings disrepute on the franchise system, its effects are not isolated but can cascade throughout the franchise system. As a result, it is an almost universal precept that franchisors must be allowed to protect their trademarks from reputational harm. While this is tempered by certain circumstances (i.e., franchisors cannot terminate franchisees who whistleblow about the franchisor’s illegal conduct), the decision of the Court of Appeals here should encourage franchisors to continue to vigilantly defend the franchise system for their sake and the sake of their franchisees.
As always, our team stands ready to assist your business with all of its franchising needs. If you have questions or need assistance, please contact the authors listed below.
Thomas O’Connell – Tom O’Connell is a Shareholder at Buchalter APC, where he serves as Chair of the firm’s Franchise Law Practice and Chair of Litigation for the firm’s San Diego office.
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