Hotel Franchising Issues| By Peter M. Ripin, Esq.

1. Good Faith Or Bad
What Constitutes A "Wrongful" Termination Of A Hotel Franchise Agreement?

A wrongful termination occurs when a franchisor cancels a franchise based upon a wrongful "pretext." For example, if a hotel franchisee invests valuable time and resources in building a franchise and establishes a successful local market for the brand, and the franchisor thereafter decides that it would be far more lucrative to own and operate its own hotel or enter into a new franchise agreement with a third party and fabricates a reason or a pretext in bad faith to cancel the franchise, this would constitute a wrongful termination.

Recently, we represented a franchisee who claimed that the franchisor had fabricated health and sanitary violations to capitalize on the franchisee's achievement in building a successful franchise and to, in effect, steal the business without compensating our client. However, our client denied that there were any violations and demonstrated that there was no imminent threat posed to the public's health, safety and welfare. Instead, we were able to persuade the Court that the franchisor was motivated by a wrongful pretext; i.e., a bad faith power grab, and this resulted in the franchisor's request for a preliminary injunction being denied.

Other types of wrongful pretexts might include terminating a franchise based upon (i) the franchisee's membership in or involvement with an independent franchisee association; (ii) a desire by the franchisor to sell the hotels at a higher price than the franchisee is willing to pay for them; or (iii) a franchisee's refusal to agree to some other business term or condition which the franchisor is seeking to impose, such as the failure to subscribe to a franchise renewal.

However, it should also be noted that if a franchisor has legitimate business reasons to justify termination of the franchise such as the failure to pay franchise fees or royalties, the Court may not care that the termination was also motivated by an improper reason and may uphold the termination based upon the legitimate grounds.

2. Does a Hotel Franchise Agreement Contain an Implied
Covenant of Good Faith and Fair Dealing and, If So, What Is It?

The short answer is yes, most courts would agree that a hotel franchise agreement does contain an implied covenant of good faith and fair dealing which is usually defined as an implied obligation on the part of both parties that neither one will intentionally do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.

The more difficult questions are how does this implied covenant get applied in real life and what does it actually mean? Most likely, you’ll receive different answers to these questions from a franchisee than you would from a franchisor. In most cases, a franchisee claims a breach of the implied covenant in response to a notice of termination. In my previous example, the franchisee claimed that the franchisor had violated the implied covenant of good faith by attempting to terminate the franchise based on a pretext of fabricated or "trumped up" health and sanitary violations. In another case, the franchisee claimed that the franchisor violated the implied covenant by diminishing and/or destroying the value of the brand through its ill considered conceived corporate marketing blunders. In yet another case, the franchisee claimed that the franchisor violated the implied covenant by failing to provide adequate training and assistance. When the franchisor disputed this allegation by noting that the contract provided it with complete discretion as to the level of services to be provided, the franchisee responded by arguing that this discretion had to be exercised reasonably and that the franchisor was under a duty to act in good faith.

Generally speaking, it's the franchisee who attempts to use the implied covenant "creatively" to assert rights which may or may not be expressed in the contract. The franchisor, on the other hand, is likely to claim that the franchisee is using the implied covenant as a “blank check” to create a contractual right which doesn't exist and to “rewrite” the contract in a manner which is more favorable to the franchisee.

3. After a Notice of Termination is Served, Should the Franchisor
Or Franchisee, or Both, Run to Court to Obtain an Injunction?

Both the franchisor and the franchisee are well advised to move very quickly after the service of a notice of termination. From the franchisor's perspective, any delay can and will be used against him or her. One of the most important factors that a Court considers in deciding whether to grant an injunction is whether the franchisor will suffer irreparable injury without an immediate injunction. In my case, the franchisor did not move for an injunction until five months after its inspectors issued the health and safety violations. The Court agreed with us that if these violations had really posed a substantial risk to the public's health, safety and welfare, the franchisor would have, could have and should have proceeded far more expeditiously to obtain an injunction. Since the Court concluded that the franchisor would not suffer immediate and irreparable injury without a preliminary injunction, it denied the request.

From the franchisee's perspective, there is also much to be gained by acting quickly. By striking first, and moving for a preliminary injunction to prevent termination of the franchise, the franchisee may be able to focus the Court's attention on the franchisee's strongest argument -- that without an injunction, the franchisee will lose its business, forfeit its investment and have its franchise canceled. There are a number of cases which hold that irreparable harm can generally be assumed under these circumstances. In these cases, the franchisee usually argues that without an injunction, it will be put out of its business and that if it is forced to close even "temporarily," the effect will be permanent, catastrophic and irreversible due to the resulting loss of customers and goodwill so that even if it ultimately prevails on the merits, it will be merely a pyrrhic victory. In addition, the franchisee will argue that the franchisor will not be prejudiced by preserving the status quo for a brief period pending the outcome of the lawsuit since the franchisee has a vested interest in continuing to profitably operate its business while paying the franchisor its royalties and fees.

Peter M. Ripin is a partner with the law firm of Davidoff Malito & Hutcher LLP in New York City where he practices in the areas of business and hospitality law. He has represented numerous institutions and individuals in the hotel and hospitality industries and has written, lectured and been interviewed on legal issues affecting the hotel and hospitality industries. He is a graduate of Columbia University and Georgetown University Law Center.