In 2010, the U.S. Supreme Court ruled that a franchisee who sues her franchisor for constructive termination of the franchise contract must abandon her franchise unit before filing the suit. Dr. Uri Benoliel, head of the Commercial Law Department at the Academic Center of Law & Business, recently published an article in the Rutgers Law Journal noting that the decision was problematic. The AAFD is pleased to have Dr. Benoliel explain his opinion on the AAFD Franchisee Voice blog.
By Uri Benoliel
Assume a franchisor takes destructive economic actions toward his franchisee in order to force the latter to give up the franchise. The franchisee, in turn, sues the franchisor for constructive termination of the franchise contract. Can the franchisee file such a suit before actually abandoning the franchise unit? This central question was discussed by the United States Supreme Court in Mac’s Shell Services Inc. v. Shell Oil Products (130 S. Ct. 1251 (2010)). The Supreme Court ruled that a franchisee must abandon her franchise before suing for constructive termination of the franchise contract. This ruling was based on one central factual assumption: that franchisee abandonment costs—namely the costs and risks borne by a franchisee in exiting a franchise relationship—are not uniquely high.
I believe that such an assumption is problematic. Normally, franchisee abandonment costs are in fact exceptionally high. Franchisees normally undertake significant specific investments that are lost, entirely or partially, if the franchisees abandon the franchise. To begin with, a franchisee often invests in leasehold improvements, namely to fixtures that are attached to the retail or commercial space and installed by the franchisee when setting up a new location. Examples of such improvements include walls, doors, cabinets, light fixtures, and floor coverings. Depending upon the conditions of the space and the particular business model, the required leasehold improvements can be extensive. For example, a Subway franchisee may be required to invest up to $130,000 in leasehold improvements. Leasehold improvements are often lost if the franchisee abandons the franchise. This loss is incurred mainly because many franchisors require the franchisee to rent from them, rather than own, the land upon which the outlet is located.
In addition, if the franchisee should abandon the franchisee before suing for constructive termination, as required under Mac’s Shell, her specialized equipment must be resold at a substantial loss. For example, a McDonald’s franchisee may be required to invest more than one million dollars in specialized equipment, including signs, seating and décor. Oftentimes, much of the equipment purchased cannot be used outside the franchise.
Since abandonment costs are typically highly burdensome, many franchisees may be unlikely to abandon their franchise prior to suit, as required by the Supreme Court, rendering such a requirement unreasonable.
Uri Benoliel is the Head of the Commercial Law Department at the Academic Center of Law & Business. He holds a doctoral degree from the University of California, Berkeley. He has published several articles on franchise and distribution law. This blog is based on an article recently published at the Rutgers Law Journal. To read the article in full, please visit: http://lawjournal.rutgers.edu/sites/lawjournal.rutgers.edu/files/issues/03BenolielVol.43.1.pdf