FRANCHSING IN CYBERSPACE; THE DRUG EMPORIUM DECISION SHOULD NOT TRANQUILIZE eCOMMERCE 

by Michael E. Chionopoulos, Esq.  © 2001 

 

I.            INTRODUCTION 

            The advent of technology, and its introduction into our daily lives, has shaken the very foundations of our traditional societal notions.  Being able to recall the world before email is akin to knowing “who shot JR.”  Anyone who can remember when a whole document had to be re-typed to fix a scrivener’s error was probably already a college graduate when President Reagan was shot, and anyone who was practicing law when pleadings were produced on a typewriter (especially on legal sized paper) probably still owns a suit with polyester pants or skirt (maybe even in powder blue).  It cannot be denied that the application of technology to the world at large has caused something more significant than the industrial revolution.  Technological advances have forever changed the practice of law.  Moreover, the application of technology has changed the way lawyers think and solve problems.  Indeed, a combination of the Internet – which has put national and international markets within the reach of small and medium size companies now in need of legal services for the same – and the advancement of online legal research services have come closer to nationalizing the practice of law, at least for those lawyers who are not ludites, than anyone could have imagined just ten short years ago. 

            Technology has also materially impacted each of the substantive areas in which we practice.  In particular, it has caused franchisors and franchisees, which have historically relied upon a well-settled definition of geographic territory, to re-think the traditional boundaries of franchising as a concept and has caused franchisors to re-think some traditional intellectual proper right issues.  This article will explore how the Internet has blurred the lines upon which both franchisor and franchisee have typically relied to enforce their respective legal rights to a particular concept or business model.  More importantly, or perhaps more disturbingly, it must also be noted that many of the franchise relationships in existence today are locked in by Franchise Agreements executed before Internet sales (“eCommerce”) were even contemplated as a retail distribution channel (“eTail”).  The electronic use of franchised Marks is simply not addressed in most of the Franchise Agreements now in play, but more concerning is the fact that when a franchised Mark is electronically marketed (“eMarketed”) it could become the genesis for dispute between franchisor and franchisee of a Balkan type magnitude. 

II.            FRANCHISING CONSIDERATIONS

A.                Anatomy of a Franchise Agreement 

Franchise Agreements, as one would expect, contain a lot of boilerplate language.  Indeed, most franchisors communicate with each other; and some franchisors even exchange contractual language they have found useful to solve or avoid problems.  Most Franchise Agreements represent a historic view of each individual franchisor’s legal perception.  The problem is that most franchisors are quick to add language that they perceive to address experienced or anticipated issues, but are loath to remove anything – even language that is clearly antiquated.  Accordingly, most Franchise Agreements grow annually (some of out control) and are usually between 45 and 75 pages. 

Key elements of most Franchise Agreements include all of the usual terms and conditions, i.e. authorized use of the franchised Name, Mark and/or System, royalty payments; a termination clause; an arbitration clause; and territorial protections, which will be the omphalos of this article.              Typically, a franchisor and a franchisee agree to a specifically defined protected trade radius (“Protected Territory”) i.e. X miles around the existing franchised location.  The franchisor usually agrees not to establish any retail outlets, either company owned stores or additional franchises, within the Protected Territory for substantially the same retail purpose as that of the franchisee.[1]  It is important, for purposes of the discussion below, to note that the franchisor usually does not, in any way, guarantee a franchisee the customers within the Protected Territory.  Rather, the franchisor typically guarantees that it will not establish any retail outlets for substantially the same purpose as a franchisee in the franchisee’s Protected Territory. 

To complicate territorial matters even further, franchisors and franchises may also enter into an Area Development Agreement (“ADA”), whereby certain geographic areas are reserved by and for a specific franchisee.  Typically, a franchisee will pay a franchisor an ADA fee; and in exchange, will have the exclusive right to develop a specific territory so long as the franchisee does so within a specified time.  As part of an ADA, a franchisor and franchisee usually agree to a build out schedule, which requires the franchisee to build and open a specific number of stores within a certain period of time.  For instance, a franchisor might grant an ADA for the northwest quadrant of a city (that would probably be defined by obvious, major highways).  Pursuant to such an ADA, a franchisee would have the right to develop the franchised concept in the northwest portion of that city over a specified period of time, but only so long as franchisee opened no less than the specified number of stores within the enumerated time.  Such an arrangement is good for the franchisee because s/he is granted exclusive development rights.  At the same time, the arrangement benefits the franchisor because proliferation of its business concept is guaranteed; or, in the absence of the franchisee opening the scheduled stores, the franchisor keeps the initial ADA fee and can then re-sell the territory. 

Almost all Franchise Agreements contain a mandatory arbitration clause.  When there is a dispute arising under either a Franchise Agreement or ADA, the aggrieved party will usually file arbitration with the American Arbitration Association (“AAA”).  Most Franchise Agreements require that the AAA Rules be applied to the dispute, but do not actually require the parties to use the AAA for dispute resolution.  A well-represented party will sometimes file a declaratory action and seek an order compelling arbitration therefrom.  One or both parties may even seek a Temporary Restraining Order and/or Preliminary Injunction from the Court to enforce certain contractual provisions o to maintain the status quo between the parties until an ultimate decision is rendered on the merits by the arbitrator(s). 

The Internet has caused significant jurisdictional issues.  While jurisdictional issues will not be developed in this article because the standard arbitration clause found in most Franchise Agreements moots many jurisdictional issues in franchise relationships, it is interesting to note that the traditional legal notion of jurisdiction based upon the minimum contacts doctrine may need to be re-thought.[2]   

B.                Traditional Notions of Franchise 

The franchisor provides a tried and tested business model.  This eliminates the franchisee’s need to learn the business through trial and error, which can be costly, and in most instances, cause a small business to fail for want of financial resources.  The franchisee also gets the benefit of being associated with an established Name, Mark and System as well as advice and guidance from an experienced staff that allows the franchisee to avoid the proverbial pot holes associated with and particular to the franchised business.  Therefore, franchisee will usually have a much shorter ramp-up period and faster return on investment.  In exchange for those benefits, the franchisor is entitled to an initial franchise fee (anywhere from $10,000 to $300,000 depending on the franchise concept).  Thus, franchisor has a front-end loaded investment that pays dividends over time while the reverse is true for the franchisee. 

C.                Traditional Franchise Doctrines 

Territory disputes, in years gone by, were not significant in franchising.  Each party’s rights and responsibilities were fairly clear, and therefore disputes were not as likely.  Either there was or was not a physical store established in a Protected Territory that all could see, touch, photograph, etc.  That is not to say that territorial disputes did not occur before the Internet.  However, the disputes were resolved through a combination of traditional legal doctrine and good old-fashioned common sense. 

One example of a traditional Protected Territory dispute is Cook v. Little Caesar Enterprises. Inc.[3]  Kevin R. Cook and K. Cook Enterprises (“Cook”) signed a Franchise Agreement with Little Caesar Enterprises, Inc. (“LCE”) on April 18, 1991.[4]  Cook read the Franchise Agreement and had an opportunity to consult with an attorney before signing the Franchise Agreement, but chose not to have an attorney review the Franchise Agreement.[5]  Cook’s Protected Territory was a one-mile radius around the franchised location.[6]  Cook and an LCE real estate representative allegedly modified area maps to memorialize what Cook believed to be the Protected Territory.[7]  Cook claimed that at two national franchise conventions, subsequent to execution of the first Franchise Agreement, LCE executives made oral and written representations and/or modifications regarding the Protected Territory.[8]  Cook signed Franchise Agreements for a second restaurant on July 1, 1992 and for a third restaurant on May 20, 1993.[9]  Cook also had the opportunity to read the second and third Franchise Agreements, which contained the same provisions as the first Franchise Agreement, and consult counsel.[10] 

In early 1992, another LCE franchisee opened an LCE restaurant in Clovis, California and Cook claimed that the new restaurant fell within Cook’s Protected Territory.[11]  Cook complained to LCE, and at least one LCE executive wrote a memo opposing the new restaurant.[12]  On August 1, 1994, Cook signed an Agreement to sell all three restaurants to a third party, but LCE’s President was concerned about the buyer’s limited capital and disapproved the Agreement stating that the purchase price was excessive in relation to over-all cash flow.[13]  In May 1996, Cook’s request to close the first restaurant, because it was losing sales to the alleged competing franchisee, was denied by LCE.[14]  Cook brought an action alleging, inter alia, breach of contract by LCE for allowing encroachment of Cook’s Protected Territory.[15]   

The Court noted that each Franchise Agreement contained an integration clause and an acknowledgement by Cook that Cook had no knowledge of any representations by LCE that were contrary to the terms of the respective Franchise Agreements.[16]  The Court held that the written Franchise Agreements were meant to be the complete expression of the parties’ agreement with respect to Protected Territory and that Cook could not use parole evidence to elude the clear provisions of the contract.[17]  Thus, the Court granted Summary Judgment to LCE on the encroachment claim.[18]  The Cook case reinforces that the terms of a Franchise Agreement will control territorial disputes that may arise. 

            As a final note with regard to traditional territorial disputes, it should be mentioned that some franchisors do not grant Protected Territories to their franchisees.  Rather, they provide a non-exclusive license for franchisees to use the franchised Name, Mark and System.  In such cases, a franchisee seeking to prosecute an encroachment claim will not prevail in the absence of specific contractual language granting a Protected Territory.[19]   

            D.            Cyber Territory 

            The traditional notion of Protected Territory is interrupted, to say the least, by eCommerce.  In effect, an eTail site has the potential to draw sales from anywhere that a potential customer is connected.  In other words, if the Protected Territory is the northwest quadrant of city X, but there is a franchisor-operated eTail site of the same concept in operation outside the Protected Territory, a customer of that franchise concept who lives and/or works in the northwest quadrant of city X can buy the franchised products or services via the Internet.  Thus the bricks and mortar retailer, the franchisee, might be heard to complain that the franchisor, through its eTail site, has “poached” within the Protected Territory.  This is, at best, problematic because as noted earlier, Franchise Agreements do not typically guarantee a franchisee the right to customers within the Protected Territory; rather the franchisee is usually guaranteed that the franchisor will not establish, or allow to be established, another retail outlet for substantially the same purpose, within the Protected Territory. 

            A franchisee could also argue that a franchisor-operated eTail site is in breach of the covenant of good faith and fair dealing concomitant to contracts in most states.  While there are no reported eTail decisions applying the covenant of good faith and fair dealing, such a position has, for franchisees and their lawyers, some appeal on its face.  Generally, breach of an express provision is necessary to ground a claim for breach of the implied covenant of good faith and fair dealing.[20]  Moreover, at least one state has held that the covenant of good faith and fair dealing is not an independent source of duties for the parties to a contract; [21] and, at least one other state has held that the implied obligation of good faith cannot be used to vary the terms of an express contract;[22] and, the good faith obligation of the Uniform Commercial Code may not be imposed to override express terms in a contract.[23]  Therefore, a franchisee is hard-pressed to argue that a franchisor has breached the implied covenant of good faith and fair dealing by operating an eTail location when the governing Franchise Agreement is silent on the issue of eCommerce.  Nonetheless, as will be discussed below, business people are always well advised to avoid having to prove the correctness of their position(s) through lawyers. 

            Lawyers and business people alike have said that we have now seen what some call the “Dot Com Failure” or the “Dot Bomb,” and industry will move on by ignoring eCommerce as a viable means of retail distribution.  While it is true that most business have taken the “once bitten, twice shy” approach to eTail opportunities in 2001, particularly in what some would describe as a softening economy with uncertain geopolitical dynamics in the foreseeable future, any entrepreneur will clearly recognize the current conditions as ripe for development of eTail business.  Under the current economic conditions, most investment bankers and venture capitalists are tending toward conservative actions and business people are hesitant to incur additional fixed overhead.  Unlike traditional means of business development, eCommerce can be developed without incurring the excessive costs that were seen from 1998-2000.  Franchise systems could, and should, be used as a springboard to develop low cost eTail markets that can capture large market shares.  When venture capitalists and other risk averse business people awake from economic hibernation, they will be faced with an uphill climb to wrestle solid and significant market share from those intrepid entrepreneurs that have effectively combined franchising and technology to build brand loyalty and capture market share. 

            Franchising provides a unique opportunity to develop eTail business because a system of distribution already exists and provides a foundation upon which to build new and exciting opportunities.  A franchisor, with the assistance and input of its franchisees, must first assay the eTail viability of the franchised concept, i.e. McDonald’s will be hard pressed to eTail their Big-Mac.  Having cleared that hurdle, there are many franchise specific issues that must then be addressed.  There are no reported decisions directly discussing a franchise eTail model, but much to do has been made about the Drug Emporium, Inc. arbitration decision pronounced in July 2000.  While it must be pointed out that arbitration is a private process, and therefore we are unable to view all documents involved, several articles have been written regarding the decision.[24]  Drug Emporium, Inc. stared in 1977 with a business model designed to provide discount prescription medications by virtue of high volume sales.[25]  Twenty years later, in 1997, Drug Emporium, Inc. launched its concept into cyber space by creating an eTail system that was eventually marketed as “your neighborhood drugstore.”[26]  Initially, Drug Emporium, Inc. did not sell within any of the franchisees’ Protected Territories.  Subsequent to what some would call success, Drug Emporium, Inc. revised its eTail system to compensate franchisees for sales occurring within their respective Protected Territory.[27]   

            In August 1999, Drug Emporium.com, Inc. was formed and again the eTail system was modified to increase franchisees profit share on sales originating within Protected Territories.[28]  Some franchisees, however, did not believe that the compensation was fair and equitable and, eventually, retained counsel.  In March 2000, several franchisees initiated an arbitration proceeding against both Drug Emporium, Inc. and Drug Emporium.com, Inc.[29]  The complaining franchisees alleged, inter alia, breach of contract and breach of the implied covenant of good faith and fair dealing through Internet encroachment.[30] 

            The pith of the franchisees’ complaint was that they had a reasonable expectation, at the time they executed their respective Franchise Agreements – between 1980 and 1993, that they would not face direct competition from Drug Emporium, Inc. within their Protected Territories.[31]  The Franchise Agreements at issue defined the Protected Territory and generally stated that Drug Emporium, Inc. would not open “low-margin, high-volume drug store operations” within the Protected Territory.[32]  In late July 2000, Drug Emporium, Inc. announced the proposed sale of Drug Emorium.com, Inc. to HeathCentral.com and the complaining franchisees immediately moved for injunctive relief claiming irreparable harm would occur if Drug emporium, Inc. and Drug Emporium.com. Inc. were not prohibited from continued eTail sales in their respective Protected Territories.[33]   

            It is appropriate at this point to discuss the standard for injunctive relief.  While Ohio law governed the Drug Emporium decision, injunctive relief generally requires that a four (4) prong test be met: (1) the likelihood that the movant will succeed on the merits of its claim, (2) the threat of irreparable harm to the movant, (3) the balance between that harm and the injury that granting the injunction may inflict on other interested parties, and (4) whether the issuance of an injunction is in the public interest.[34]  Most Franchise Agreements require application of the arbitration rules promulgated and published by the AAA.  Rule 36 of the AAA Commercial Arbitration Rules provides for a procedure whereby a party can seek and obtain a Temporary Injunction.[35]  However, to ensure temporary relief is immediate, the Franchise Agreement must contain language sufficient to invoke application of the expedited procedure provided for the AAA Optional Rules for Emergency Measures of Protection.  Rule O-1 requires that the subject arbitration clause specifically allow for application of the optional rules; or that the parties, by special agreement, consent to application of those rules.[36]  Once the applicability requirement of the Optional Rules is met and the proper motion is filed, the AAA must appoint an emergency arbitrator within one business day,[37] who shall establish a schedule, within two (2) business days of appointment, for consideration of the emergency application[38] and may grant interim relief.[39]  Since arbitration proceedings are private, there is no way to know what specific rules were relied upon by Drug Emporium, Inc. or is franchisees, or by the arbitrators in deciding that case. 

            In September 200, the Drug Emporium, Inc. arbitration panel, made up of three arbitrators, granted franchisees’ Motion for Preliminary Injunction in a 2-1 split.[40]  The panel ordered Drug Emporium, Inc. and Drug Emporium.com, Inc. not to sell drugs and related products to customers physically located within franchisees’ Protected Territories; and, ordered both companies to direct customers from within the Protected Territories to the respective franchised locations.[41]  The arbitrators seem to have wrongfully believed that Drug Emporium, Inc. was obligated to provide its franchisees all customers within the Protected Territories. 

            The majority arbitrators anchored their decision on the advertisement of Drug Emporium.com as “your neighborhood drugstore” and, seemingly, held that the franchisees had met their burden of proof because the advertisement was likely to confuse customers and, therefore would dilute the value of the Drug Emporium Mark.[42]  At first blush this “intellectual property” analysis may seem appropriate, but as pointed out by at least one author: “The franchisees should have had no trademark claim, however, because DEI owned the marks and the parties acknowledged, in the franchise agreements, that DEI owned all good will associated with the marks.”[43]  A full and complete legal analysis of the Drug Emporium decision simply cannot be conducted because many relevant documents, specifically including the written briefs of the parties and the arbitrators’ written decision, are not available to the public.  However, based upon the information available, one could, and probably should, reasonably conclude that the Drug Emporium, Inc. decision: was based upon poorly drafted Franchise Agreements that did not specifically reserve the franchisor’s use of its own mark in alternative channels of distribution; and that Ohio law, which governed the Drug Emporium, Inc dispute, “may take a slightly more expansive view of the implied covenant of good faith and fair dealing” than other states.[44] 

            On June 14, 2001, less than a year after the Drug Emporium, Inc. decision, another eCommerce encroachment arbitration decision with a decidedly different outcome, Hale v. Conroy’s Inc.,[45] was pronounced.  However, before discussing the contrast between the Drug Emporium, Inc. and Hale decisions, it must be pointed out that arbitration decisions do not create binding, or even persuasive, legal precedent.  Indeed, except based upon some very narrow statutory provisions, arbitration decisions cannot be appealed,[46] and therefore, do not usually provide the opportunity to generate binding legal precedent on the issues determined therein. 

            Conroy’s franchises flower shops and is the subsidiary of 1-800-Flowers.com, which uses three channels of distribution: eCommerce, telephone sales, and retail stores.[47]  Hale, a husband and wife franchisee team of Conroy’s, sought to terminate their Franchise Agreement and recover damages allegedly resulting, at least in part, from Conroy’s eCommerce operations.[48] 

            Hale became a Conroy’s retail store franchisee in 1992, and agreed to co-brand with 1-800-Flowers in 1995.[49]  At the time, 1-800-Flowers was primarily a telephone ordering system.[50]  Subsequently, 1-800-Flowers became an affiliate of Conroy’s parent company, 1-800-Flowers.com – that had primary emphasis on eCommerce, and affiliated with a number of web sites, Internet connections and stores that were not Conroy’s franchisees.[51]  Therein lies the problem, because under that system “[o]rders placed through 1-800-Flowers may be filled by non-franchisees that operate within the exclusive territories of franchisees.”[52] 

            Hale claimed that Conroy’s breached the Franchise Agreement, frustrated the purpose of the contract, and competed with their franchisees by encroaching upon the franchisees’ Protected Territories through eCommerce operations.[53]  The arbitrator concluded that Conroy’s eCommerce operation did not breach the Franchise Agreement or the implied covenant of good faith and fair dealing.[54]  Conroy’s prevailed on its counterclaim for past due franchise and advertising fees, and as the prevailing party, was entitled to recover reasonable attorney’s fees and costs.[55]   

            One must ask why there is such a stark contrast in outcomes between the two seemingly similar cases of Drug Emporium, Inc and Hale.  The answer is found, for the most part, in the Franchise Agreements.  A franchise relationship is contractual in nature.  Therefore, the rights and duties of the parties must be strictly construed within the ambit of the instrument giving both birth and continued life to the relationship.  In Drug Emporium, Inc. the Franchise Agreements did not reserve Drug Emporium’s right to use alternative channels of distribution.[56]  In juxtaposition, Conroy’s grant in the governing Franchise Agreement was specifically non-exclusive.[57]  While Conroy’s did agree not to operate, or license any third party operate, a retail flower store within a two mile radius of Hale’s store, Conroy’s expressly reserved the right to use any of its trade names with other business systems.[58]   

            There were also factual differences between the Drug Emporium, Inc. and Hale cases.  For instance, in Drug Emporium, Inc. there was evidence that the franchisor was eTailing product for prices well below that in the retail stores,[59] and therefore, evidence of continued economic harm to the franchisees was presented.[60]  The Drug Emporium, Inc. panel was also seemingly convinced that Drug Emporium, Inc. tipped its hand by first seeking permission from its franchisees to conduct its eCommerce operations.[61] 

            A franchisor, therefore, who does not guarantee a franchisee customers within the Protected Territory, but rather guarantees that the franchisor will not establish a retail outlet within the franchisees’ Protected Territories will not violate traditional notions of Protected Territories when initiating an eTail site as long as that eTail site is not within the Protected Territories.[62]  A customer is free to shop where ever and how ever that customer chooses – physically or electronically.  Accordingly, a customer that reaches out to an eTail opportunity is not any different than a customer that lives near a franchised store but decides to buy that franchised product or service at another franchised or company owned location in a different town.  There is certainly no violation of the Protected Territory in that scenario.  Nonetheless, any franchisor with an insightful, effective management team will clearly realize that perception is as important as reality and, to quote an effective franchise executive, “[f]ranchising is all about relationships.”[63]  Thus, while the solutions recommended herein are not exhaustive, franchisor and franchisee must bridge the gap to create a successful franchise-system-wide eCommerce opportunity that benefits everyone.

            E.            Why Traditional Doctrines Fail

            eCommerce removes physical proximity as a necessary element of sales.  Accordingly, pre-Internet, a franchisee was reasonably assured that the defined customer demographic within the Protected Territory would patronize the franchised location.  Post-Internet, the customer can purchase goods or services from distant merchants without donning little more than his/her robe and slippers. 

            Traditional franchise concepts acknowledge geographic boundaries based upon physical shopping habits of the target consumer, i.e. a franchisor will not establish a retail store, for substantially the same purpose as its franchisee, within the Protected Territory.  However, eCommerce knows no such boundaries and makes the genesis of an eTail transaction the only true discriminator.  Thus, eCommerce requires a wholesale revision of Protected Territory thought. 

            The pith of franchising is to avoid re-creation, and thereby reward both the business model creator (the franchisor) and the owner/operator (franchisee).  In order to affect these goals in an eTail system, both parties must re-think the traditional notion of Protected Territory.  The Drug Emporium, Inc. arbitration panel ruled on a basic notion of equity – a perception, however misguided, that the franchisor was taking from the franchisee by “poaching” within the Protected Territory.  Even if one were to blindly accept the Drug Emporium, Inc. conclusion by ignoring the fundamental infirmity that to poach the franchisor would first have to be contractually bound to provide a franchisee with all customers who live, work, or, for that matter, even enter into the Protected Territory, a franchise eTail system could still be effective.  One approach would be to identify the origin of each sale through sophisticated geo-coding technology and work out a profit sharing formula with the effected franchisee(s) thereby benefiting the entire franchise system.  There are also many other ways that a franchisor could divest itself of eTail profits originating in a Protected Territory:  A franchisor could give all profit to the protected franchisee (which would likely mean that franchisees would have to bear some significant but proportionate cost of building the eCommerce infrastructure necessary to create a successful eTail market); franchisor could profit share - as a bonus to its franchisees (the argument can be made, with good effect, that the eTail customer and retail customer are two different people and, absent an eCommerce channel of distribution the sale(s) would not have occurred); or the franchisor could divest itself of all net eCommerce system profits by using the same exclusively for system-wide advertising or improvement of other system-wide infrastructure needs such as point-of-sales software, etc.  The point is that neither franchisor nor franchisee should be unjustly enriched at the other’s expense. 

            F.       Franchise Lessons for Developing an eTail System 

            Notwithstanding the fact that a thorough legal analysis of the issues presented by Drug Emporium, Inc. or Hale cannot be had for want of private information; there are some guideposts erected by those decisions, which franchisors and franchisees alike should use to navigate as they pioneer the new, and sometimes dark, eTail path.  The first lesson is that, much like a family fighting over internal resources, franchisors and franchisees both lose when either or both engage in aggressive litigation or arbitration.  While litigation or arbitration is sometimes necessary to resolve material disputes between parties, an eTail system should be designed to eliminate, and not cause, litigation or arbitration.  Therefore, the first order of business is to develop an eTail system by mutual consent.  It is true that most Franchise Agreements provide for vesting of the rights to any system enhancements in the franchisor.  However, franchisees are usually entitled to the non-exclusive use of those system enhancements during the term of their respective Franchise Agreement.  Thus, franchisor and franchisee both have significant economic motivation not to give any benefits or profits from the system enhancements to litigation counsel.

            Assuming the franchisor is going to be responsible for development of an eTail system, a complete overview of the Franchise Agreements currently in play must be conducted.  Each version of the Franchise Agreement must be analyzed for issues such as Protected Territory and reservation of rights to the respective Mark in other or non-traditional channels of distribution.  It is a good idea to revise the concepts’ Franchise Agreements, but such revisions only impact on a going forward basis.  So, while future problems can be eliminated with additional language addressing the precise eTail system issue(s), the Franchise Agreements previously executed and currently in play must be dealt with on their own terms.  Existing Franchise Agreements could, of course, be amended.  However, such an amendment will almost always require mutual consent of the parties.  Attempting to amend each individual Franchise Agreement could, and probably would, create the quintessential prisoner’s dilemma that might motivate some franchisees to hold out for a better deal.  Ultimately, the over-all integrity of any franchise system is materially impacted by the uniformity, or lack thereof, found in its Franchise Agreements.  Economy of scale is found on almost every level of franchising and to individualize or tailor Franchise Agreements is to weaken the over-all strength of the entire system.  Even those franchisees that benefit short term from a special or individual deal will eventually feel the negative and global impact of such things as system-wide cost increases for Franchise Agreement administration and/or enforcement. 

            Obviously, developing an effective and competitive eTail system will require the assistance of qualified technical people, but it is rare to find technicians that truly understand the complexities specific to franchising.  For that reason, once the comprehensive compilation and legal analysis of the Franchise Agreements is completed, counsel must work closely with the technical people to ensure that they understand the rules of franchising and the impact that each sale has or can have on the franchise relationship. 

            Equally as obvious is the need for consensus between franchisor and franchisee.  Of course, there is going to be some rub here – much like siblings discussing how family assets should be divided up or spent.  In the end, one can only trust that, at least in a healthy franchise system, the economic improvement of both franchisor and franchisee will drive reasonable compromises that take into consideration risk of capital development costs and proportionate risk/reward incentives.  The most difficult portion of this combined process will necessarily be working through the short term, intermediate and long term goals of a system-wide eCommerce strategy and thereafter developing a conceptual eTail model.  Implementation, which will be most difficult for the ‘techies’, will be fairly simple for the franchisor and/or franchisee.  It is during the conceptual phase that the genesis of litigation/arbitration will most likely be created or avoided.  Therefore, it is that conceptual development which is most critical to long-term success.  If want of profit does not destroy the eTail market, the weight of litigation/arbitration could cause the system to implode leaving the franchisor facing the loss of valuable capital and leaving the franchisee with a system that has been weakened by both strife and temporary inattention to conventional development. 

III.            CONCLUSION 

            As with most things in life, the safest alternative is abstinence.  However, the risk/reward of a free market economy demands that franchisors and franchisees alike perform an effective cost/benefit analysis of all available opportunities.  Internet abstinence is not only unrealistic it is also unreasonable.  In order to stay viably competitive, business leaders cannot “just say no.”  Therefore, any Internet strategy must include a comprehensive and disciplined approach to the Internet scope within any particular business model, i.e., Internet as an advertising medium, eCommerce and/or eTail strategies, and must provide adequate protection for the specific franchise system as a whole. 

            Franchisees are, by nature, entrepreneurs.  The typical franchisee is a smart, independent, motivated businessperson; and more importantly, someone who desires control of his/her own destiny.  However, the typical franchisee also wants to identify with a system or group larger than s/he could build independently in order to gain the economy of scale associated with a national, and sometimes international, chain.  If a franchisor fails to address the Internet, franchisees will typically not want to miss an opportunity and may fill such an entrepreneurial void.  The result can be ad hoc use of the Internet – use by some franchisees as a mere advertising tool; or use by other franchisees for actual eCommerce.  Some franchisees will seek to develop their own web sites, while others will seek to partner with online auction houses such as Half.com or eBay.  In the end, the entire franchise system is weakened by not having a structured, disciplined and focused approach to maximizing eCommerce or eTail opportunities. 

            If a franchisor decides the franchised concept is cyber friendly, then the first step toward creating an eTail market must be building a consensus in and among the franchise community.  Notwithstanding that eTail sales do not violate Protected Territories, any Internet strategy will likely need to include a way of divesting the franchisor of profit generated within its franchisees’ Protected Territories in order to build the consensus necessary to avoid costly litigation/arbitration and effectively develop an eTail market.  Pitching a logical, well-structured and mutually beneficial eTail strategy to the franchise community is likely going to be well received and pave the way for increased market share and economic gain.  However, one should be mindful that the Drug Emporium, Inc. arbitration panel found such an offer by the franchisor to be evidence that the franchisor had knowledge that its eCommerce operation encroached Protected Territories. 

            The obvious solution is to amend prospective Franchise Agreements so that this problem will be addressed at the beginning of each new relationship.  However, for those Franchise Agreements already in play without such language, a creative and cooperative approach is necessary to ensure mutual success.  Ultimately, eTail opportunities must not be missed by franchise systems for want of cooperation or, in the long run, the system will go the way of the dinosaur.  Critical mass of operations is essential to any effective eTail opportunity.  Accordingly, franchisor and franchisee alike must put aside the traditional (and sometimes petty) issues in favor of a larger vision that brings significant economic gain to all involved.  

            The Internet is here to stay.  Thus, long term eCommerce and eTail strategies that work must be devised.  Understanding the power of an eTail opportunity is as simple as the aged-old maxim known even to the Carthaginian traders of Hannibal’s time, summed up and subsequently stated as the doctrine of supply and demand.  The Internet creates a worldwide pool of demand, which dramatically increases the value of one’s supply.  How many American cigar smokers would pay such a premium for Cohiba cigars while traveling outside of the United States if those cigars were readily available in the United States?  In closing, the Internet increases the value of one’s goods by making accessible previously unrealized demand.  To miss the eTail opportunity is to turn the clock back to the mid-1980s and laugh at Bill Gates offering you Microsoft stock at $3/share.  Franchisors and franchisees simply must find a way to hurdle obstacles through cooperation and heterodox thought in order to maximize mutual financial gain.

END NOTES

 

[1] However, one must be careful to assay state specific law.  For instance, “Iowa Code Section 523H.6(1), Encroachment, provides: Notwithstanding the terms, provisions, or conditions of an agreement or franchise, if a franchisor seeks to establish a new outlet, company-owned store, or carry-out store within an unreasonable proximity of an existing franchise, the existing franchisee, at the option of the franchisor, shall have either a right of first refusal with respect to the proposed new outlet, company-owned store, or carry-out store or a right to compensation for market share diverted by the new outlet”) (emphasis added).  Holiday Inns Franchising, Inc. v. Brandstad, 557 N.W.2d 724, 731 (IA..S.Ct.1995).

[2]  For instance, the traditional doctrine inquires into whether or not a sale or transaction took place within certain geographic boundaries.  In the case of an eTail transaction the customer could be in Colorado, the eCommerce server maintained at a server farm in New Jersey and the Company headquartered in rural Oklahoma.  In that case, did the Company “project itself into the customer’s jurisdiction?”  Did the customer leave his/her home and reach out to conduct the transaction in New Jersey?  Did the transaction occur in Oklahoma?  The Court will need to decide whether to use a push or pull jurisdictional analysis.

[3] 972 F.Supp. 400 (E.D. Mich. 1997).

[4] Id,. at 404.

[5] Id.

[6] Id.

[7] Id, at 403.

[8] Id, at 405.

[9] Id.

[10] Id.

[11] Id, at 404.

[12] Id.

[13] Id, at 405.

[14] Id.

[15] Id, at 406.

[16] Id, at 407.

[17] Id, at 405.

[18] Id, at 409.

[19] “Plaintiffs argue that the conduct of McDonald’s challenged here is inconsistent with their reasonable expectations under the License Agreements.  This Court cannot agree.  There is no provision in the agreements, which imposes a limitation on McDonald’s right to open new restaurants near existing franchises.  The agreements are not ambiguous in this respect.”  Payne v. McDonald’s Corp., 957 F.Supp. 749, 758 (U.S.D.C. MD 1997).

[20] Burger King Corporation v. Weaver, 169 F.2d 1310, 1316 (11th Cir.1999).

[21] The covenant of good faith and fair dealing has never been an independent source of duties for the parties to a contract.  A lack of good faith does not by itself create a cause of action.  Instead, the covenant guides the construction of explicit terms in an agreement.  Thus, the implied covenant will not overrule or modify the express contract of the parties.  Ceridian Corporation v. Franchise Tax Board, 44 F.Supp.2d 1251, 1259 (Court of Appeal, First District, Division 3, California, 2001).

[22] Riviera Beach v. John’s Towing, 691 So.2d 519, 521 (Fla.Dist.Ct.App.1997).

[23] Flagship National Bank v. Gray Distribution Systems, Inc., 485 So.2d 1336, 1340 (Fla.Dist.Ct.App.1986).

[24] Opposing views on this issue were expressed in the following articles:  Knack, G.L. & Bloodhard, A.K. (2001), Drug Emporium: The Reality of the Virtual, Do Franchisors Need to Rechart the Course to Internet Success?  Franchise Law Journal, American Bar Association, 20.  Garner, W. Michael (2001).  Drug Emporium: The Reality of the Virtual, Inside the Drug emporium Decision, Franchise Law Journal, American Bar Association, 20.

[25] Knack, G.L. & Bloodhart, A.K. (2001).  Drug Emporium: The Reality of the Virtual, Do Franchisors Need to Rechart the Course to Internet Success?  Franchise Law Journal, American Bar Association, 20, 134.

[26] Id, at 134-135.

[27] Id, at 135.

[28] Id.

[29] Id.

[30] Id.

[31] Id.

[32] Id.

[33] Id.

[34] Country Kids ‘n City Slicks, Inc., v. Sheen, 77 F.2d 1280, 1283 (10th Cir. (OK) 1996).

[35] R-36 Interim Measures:

(a)     The arbitrator may take whatever interim measures he or she deems necessary, including injunctive relief and measures for the protection or conservation of property and disposition of perishable goods.

(b)     Such interim measures may take the form of an interim award, and the arbitrator may require security for the costs of such measures.

(c)     A request for interim measures addressed by a party to a judicial authority shall not be deemed incompatible with the agreement to arbitrate or a waiver of the right to arbitrate.

[36] AAA Rule O-1 Applicability

 Where parties by special agreement or in their arbitration clause have adopted these rules for emergency measures of protection, a party in need of emergency relief prior to the constitution of the panel shall notify the AAA and all other parties in writing of the nature of the relief sought and the reasons why such relief is required on an emergency basis.  The application shall also set forth the reasons why the party is entitled to such relief.  Such notice may be given by facsimile transmission, or other reliable means, but must include a statement certifying that all other parties have been notified or an explanation of the steps taken in good faith to notify other parties.

[37] AAA Rule O-2

Within one business day of receipt of notice as provided in Section O-1, the AAA shall appoint a single emergency arbitrator from a special AAA panel of emergency arbitrators designated to rule on emergency applications.  The emergency arbitrator shall immediately disclose any circumstances likely, on the basis of the facts disclosed in the application, to affect such arbitrator’s impartiality or independence.  Any challenge to the appointment of the emergency arbitrator must be made within one business day of the communication by the AAA to the parties of the appointment of the emergency arbitrator and the circumstances disclosed.

[38] AAA Rule O-3

The emergency arbitrator shall as soon as possible, but in any event within two business days of appointment, establish a schedule for consideration of the application for emergency relief.  Such schedule shall provide a reasonable opportunity to all parties to be heard, but may provide for proceeding by telephone conference or on written submissions as alternatives to a formal hearing.

[39] AAA Rule O-4

If after consideration the emergency arbitrator is satisfied that the party seeking the emergency relief has shown that immediate and irreparable loss or damage will result in the absence of emergency relief, and that such party is entitled to such relief, the emergency arbitrator may enter an interim award granting the relief and stating the reasons therefore.

[40] Knack, G.L. & Bloodhart, A.K. (2001).  Drug Emporium: The Reality of the Virtual, Do Franchisors Need to Rechart the Course to Internet Success?  Franchise Law Journal, American Bar Association, 20, 135.

[41] Id.

[42] Id, at 137.

[43] Id.

[44] Id.

[45] Lokker, Ellen, K (2001).  Internet Flower Sales Fare Better in Arbitration Than Virtual Drug Store.  The Franchise Lawyer, American Bar Association Forum on Franchising, Fall 2001, 1.

[46] 9 USC § 10

(a)     In any of the following cases the United States court in and for the district wherein the award was made may make an order vacating the award upon the application of any party to the arbitration

(1)    Where the award was procured by corruption, fraud or undue means.

(2)    Where there was evident partiality or corruption in the arbitrators, or either of them.

(3)    Where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or any other misbehavior by which the rights of any party have been prejudiced.

(4)    Where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final and definite award upon the subject matter submitted was not made.

(5)    Where an award is vacated and the time within which the agreement required the award to be made has not expired the court may, in its discretion, direct a rehearing by the arbitrators.

It should also be pointed out that if arbitration is had pursuant to a specific state arbitration act, then one must look to that specific act to determine potential appellate issues.  For instance, the Oklahoma Arbitration Act differs substantially from the Federal Arbitration Act, see Okla. Stat. Tit. 15 § 817.

[47] Lokker, Ellen, K (2001).  Internet Flower Sales Fare Better in Arbitration Than Virtual Drug Store.  The Franchise Lawyer, American Bar Association Forum on Franchising, Fall 2001, 1.

[48] Id.

[49] Id.

[50] Id.

[51] Id.

[52] Id.

[53] Id.

[54] Id, at 6.

[55] Id.

[56] Knack, G.L. & Bloodhart, A.K. (2001).  Drug Emporium: The Reality of the Virtual, Do Franchisors Need to Rechart the Course to Internet Success?  Franchise Law Journal, American Bar Association, 20, 135.

[57] Lokker, Ellen, K (2001).  Internet Flower Sales Fare Better in Arbitration Than Virtual Drug Store.  The Franchise Lawyer, American Bar Association Forum on Franchising, Fall 2001, 6.

[58] Id.

[59] Garner, W. Michael (2001).  Drug Emporium: The Reality of the Virtual, Inside the Drug Emporium Decision, Franchise Law Journal, American Bar Association, 20, 147.

[60] Id.

[61] Id.

[62] Ellen K. Lokker, when comparing the Drug Emporium, Inc. and Hale arbitration cases states that “[I]n Conroy’s, there was no evidence of economic harm to the franchisee from the franchisor’s Internet activity,” (Lokker, supra, at 6.) yet earlier in her article she notes that “[o]rders placed through 1-800-Flowers may be filled by non-franchisees that operate within the exclusive territories of franchisees” (Id., at 1).  Possible reconciliation of Lokker’s seemingly inconsistent statements can be found in her conclusion that “[u]nlike in Drug Emporium, the arbitrator easily concluded that Conroy’s had not opened a retail store in the franchisee’s territory” (Id., at 6), at least in part, because “Conroy’s online activity was never described as a virtual store” (Id.).  Lokker, albeit tacitly, seems to also conclude that Conroy’s was not found to have encroached Hales’ Protected Territory because Conroy’s did not guarantee Hale all the customers within the Protected Territory.

[63] Matthew G. Allen, Vice President of Franchising, CD Warehouse, Inc.


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