United States: California Decision Clarifies Franchise Termination Damages

What damages are available to a franchisee under the California Franchise Relations Act (CFRA) for a wrongful termination or nonrenewal? In JRS Products, Inc. v. Matsushita Electric Corp. of America, 115 Cal. App. 4^th 168, 8 Cal. Rptr 3d 840 (Cal. App. 2004), modified on denial of reh’g, a California court of appeals clarified that a franchisee who alleges that it was terminated without good cause in violation of the CFRA is not limited to the repurchase of inventory as its exclusive remedy. However, the court determined that a termination without good cause sounds fundamentally in breach of contract and that a franchisee must pursue its action and its remedies under contract law, rather than tort law. The significance of this is that terminated franchisees are less likely to be able to recover punitive or exemplary damages.

Prior to the decision in JRS Products, the scope of remedies available for violations of the CFRA had not been firmly established. The CFRA, by its own terms, provides that a franchisor must offer to repurchase the franchisee’s remaining inventory when it terminates or fails to renew a franchise consistent with the terms of the CFRA. While it is reasonable to conclude from the text of the CFRA that repurchase of inventory is the only remedy available for a CFRA violation, the CFRA also provides that nothing under that provision shall abrogate the right of a franchisee to sue under any other law. In Motor Mart v. Sea Ray Boats, Inc., 825 F.2d 1285 (9^th Cir. 1987), the court evaluated remedies available under the CFRA where a manufacturer failed to provide 180 days’ notice of nonrenewal, but still permitted the dealer to sell its business to a purchaser meeting the manufacturer’s then-current dealer requirements. The court held that repurchase of inventory was the exclusive remedy under the CFRA for failure to provide the required notice. However, it declined to decide what remedy the dealer would have had if the manufacturer had failed to allow the dealer to sell the business to a qualified buyer. In Dale Carnegie & Assoc., Inc. v. King, 31 F. Supp.#2d 359 (S.D.N.Y. 1998), the court cited Motor Mart for the proposition that repurchase of inventory is the only remedy available under the CFRA. However, because Dale Carnegie based its statement on Motor Mart and because the "franchisor" in Dale Carnegie likewise afforded its "franchisee" the opportunity to transfer its franchise, Dale Carnegie did not appear to expand the holding of Motor Mart. Prior to JRS Products, there were no other published decisions interpreting the scope of remedies available under the CFRA when a franchisor terminates a franchise without good cause or declines to renew a franchise agreement in circumstances violative of the Act.

The franchisor in JRS Products contended that an obligation to repurchase inventory was the exclusive remedy under the CFRA for a termination lacking a good cause basis. As support, the franchisor relied primarily on the Motor Mart and Dale Carnegie decisions discussed above. However, the court of appeals found that neither of these decisions supported the franchisor’s position. The court of appeals observed that the franchisee in Motor Mart had waived its right to recover damages for breach of contract. Therefore, it found that the Motor Mart court was limited to considering whether the CFRA created a statutory right to damages, which right was found not to exist by the Ninth Circuit in Motor Mart. The court in JRS Products held that such analysis did not apply in this case because the franchisee in JRS Products did not waive its right to contractual damages.

In evaluating the types of remedies available, the court in JRS Products determined that there is nothing in the CFRA indicating that the repurchase of inventory is the exclusive remedy when a termination lacks good cause. The court focussed on the language in Section 20037 of the California Business and Professional Code, which provides that "[e]xcept as expressly provided herein, nothing in this article shall abrogate the right of a franchisee to sue under any other law." The court interpreted this to mean that "a franchisee may seek any common law or statutory remedy for wrongful termination of the franchise, including a breach of contract action." Because the court found the language in Section 20037 to be clear, it declined to examine the legislative history of the CFRA. Moreover, the court found that any interpretation which limited the franchisee’s remedy to a repurchase of inventory would conflict with the purpose of the CFRA to protect franchisees.

The court then determined that a party could seek damages for breach of contract based on an impermissible termination. In the case, the parties’ contract provided that it could be terminated by either party, without cause, upon 90 days’ notice. The court held that the requirement of good cause for termination under the CFRA rendered this provision void as a matter of law. Once that provision was removed from the contract, the termination could have violated the agreement, resulting in damages for breach of contract. The court rejected the franchisor’s contention that the franchisee’s action was an action under the CFRA merely because the franchisee relied upon the CFRA to strike the clause providing for termination without cause. The court held that "[t]he fact that the Act renders a provision in the agreement void as a matter of law . . . does not convert a common law claim into a statutory claim."

The case was, however, reversed and remanded because the initial trial had taken place under a theory of tortious interference with prospective economic advantage, resulting in an award of compensatory and punitive damages in favor of the franchisee. The court found that, once the provision permitting termination without cause had been determined to be void as a matter of law, the franchisee’s complaint was fundamentally a claim that the franchisor terminated the agreement without cause, a count which "sounds in contract, not tort." Recognizing the well-established principle that a party to a contract cannot recover damages in tort for a breach of contract, the court reversed the jury’s award to the plaintiff based upon the claim for tortious interference with prospective economic advantage and remanded for further proceedings under the breach of contract claim.

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While franchisors, we believe, attempt to effectuate any necessary terminations in compliance with the applicable laws, the JRS Products decision increases the risks. Because JRS Products has now determined that a franchisee may recover other forms of damages and is not limited to the repurchase of inventory as an exclusive remedy, franchisors under the CFRA should be aware that additional damages may be available to a franchisee when a termination or nonrenewal is not performed in compliance with the requirements of the Act.

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