United States: Recent Precedents Say Recoveries For Lost Future Royalties Aren´t Likely

When one legal precedent deviates from existing legal prudence, it is called an aberration. When two so deviate, it becomes a trend. A recent Florida decision, Burger King Corp. v. Hinton, could thus be viewed as a trendsetter.

In a 1996 decision, Postal Instant Press, Inc. v. Sealy, a California appellate court ruled that a franchisor could not prevail on its claim against a former franchisee for lost future royalties resulting from the franchisor's termination of its franchise agreement. In the court's view, the franchisee's failure to pay royalties, which led to the termination, was not the cause of the franchisor's loss of future royal-ties. Rather, it was the franchisor's termination of the franchise agreement itself that was the proximate cause; the court was not willing to reward the franchisor when it was the franchisor's selection of remedies, even though justified, that gave rise to the claim. The court also justified its decision by saying in effect that awarding damages for lost future profits under these circumstances would be unconscionable.

Sealy had been viewed by most lawyers as an anomaly. Legal practitioners didn't take the case seriously. It went against logic. It was also a promulgation by a "Left Coast" court. California judicial decisions have often been considered as being out of the mainstream, and routinely viewed skeptically by attorneys in other jurisdictions.

Hinton, however, has given Sealy credibility. A decision from the United States District Court for the Southern District of Florida, Hinton was essentially a routine suit by the franchisor to recover past due royalties, and lost future royalties resulting from the franchisor's early termination of the franchise agreement. Even though the court expressly stated that Sealy was not controlling (notwithstanding the similarity of the material facts), the court reached the same conclusion as in Sealy, although without the gratuitous use of the unconscionability concept which the Sealy court used to bootstrap its decision. The Southern District of Florida, I might note, is the same court that has brought us Weaver (the decision reversing the earlier Scheck encroachment case) and various other pro-franchisor decisions.

As a consequence of Sealy, has the recovery of lost future profits has become a lost art? The answer is clearly no.

First, the case is limited to the situation where the franchisor terminates the franchise agreement. In an earlier Florida precedent, Burger King Corp. v. Barnes, another case involving the Burger King system-the court allowed the franchisor's claim for lost future royalties to proceed. In Barnes, however, the franchisee was the terminator of the franchise agreement, thus making the case distinguishable on its facts from Hinton. In Barnes, the court found that the franchisee's wrongful termination of the franchise agreement, prior to expiration and without cause, gave rise to the claim for lost future royalties. This case, when viewed together with Hinton, leads to the interesting result that he who fires the first salvo fails. To recover lost future profits, the franchisor should manipulate the situation so that the franchisee terminates the agreement, or, at a minimum, the franchisor can at least claim a constructive termination by the franchisee. Where the franchisee continues to operate under the franchisor's marks, this will be no easy task.. And correspondingly, the franchisee may be better off letting the franchisor take the big shot in the separation process.

The Hinton court also noted that the franchisor had an alternative for collecting future royalties, and that was not to terminate the franchise agreement, but to sue for royalties as they periodically accrued. However, continuing litigation is not a practical solution, nor is allowing a franchisee to continue using the marks and franchise system when in breach-a soothing thought for most franchisors.

It is also important to note here that the Hinton decision evolved out of a failing business, which not only may have created a sympathetic feeling by the court toward the franchisee, but also arguably made the level of damages the franchisor might have accrued from the loss of future royalties speculative. If it would be reasonable to assume that the unsuccessful franchisee would not have been in business for the remainder of the term, might it be said that the payment of am future royalties was highly uncertain?

It is not clear that a court would apply Hinton in the situation where a profitable franchisee decides that he would be better off as an independent or, alternatively, flying the flag of another franchisor, and thereby breaches the franchise agreement, but leaves the franchisor with the task of formally terminating the franchise agreement. To allow the franchisor not to recover lost future profits in these circumstances would be almost tantamount to saying that the franchise agreement was terminable at will by the franchisee at any time prior to its expiration.

It is difficult to predict whether the Sealy/Hinton line of reasoning signals the start of a trend. Sealy is not a decision by the California Supreme Court, and Hinton may not yet be concluded, and might be appealed. Nevertheless, the decision gives franchise lawyers food for thought and will certainly cause them to consider other alternatives to protect the integrity of their systems.

© Kilpatrick Stockton LLP.