Jul 21, 2015 - Franchise Articles by |

Wrongful Constructive Franchise Termination Claim Succeeds

By:

Jeffrey M. Goldstein

Goldstein Law Firm

(202) 293 3947

jgoldstein@goldlawgroup.com

goldlawgroup.com

 

Wrongful Constructive Franchise Termination Claim Succeeds. Tilstra v. BouMatic LLC, United States Court of Appeals, Seventh Circuit, June 30, 2015, 2015 WL 3953403, is a somewhat rare example of a franchisee decimating a franchisor through jury trial on a de facto termination claim. In this pro-franchisee decision by Judge Posner, of the United States Circuit Court for the Seventh Circuit, a dealer in dairy (“milking parlor”) equipment (the corporate plaintiff, owned by Sid Tilstra), in southwestern Ontario, sued a manufacturer of this equipment, BouMatic, a Wisconsin company. Tilstra had been a dealer in BouMatic's dairy equipment for about twenty years. He claimed that the franchisor, in bad faith and deviously, forced him to sell his dealership to a neighboring BouMatic dealer at a below-market price. After a trial, the jury agreed with Tilstra and awarded him $471,124 in damages. The appellate court was asked to rule the district court’s decision upholding the jury verdict.

The record showed the following facts. Each BouMatic dealer was assigned a territory within which it has the exclusive right to sell and service BouMatic products. Tilstra's territory included “arguably the richest dairy county in Canada,” on which 55,000 dairy cows grazed. Tilstra had been making a profit of about $400,000 a year. The dealership contract reserved to BouMatic “the right to change, at its sole discretion, the assigned territory,” but further provided that “BouMatic shall not terminate this [dealership] Agreement or effect a substantial change in the competitive circumstances of this Agreement without good cause and only upon at least ninety (90) days' advance written notice sent by certified mail. The term ‘good cause’ means Dealer's failure to comply substantially with essential and reasonable requirements imposed upon Dealer by BouMatic.”

The record showed that another BouMatic territory assigned to a competing dealer, Dortmans, was adjacent to Tilstra’s territory, and grazed only about half the number of dairy cows as Tilstra's territory. Although Dortmans tried to buy Tilstra's dealership in order to obtain his territory, no agreement was reached because Tilstra was demanding a much higher price than Dortmans was willing to pay.

The BouMatic franchise district sales manager, Ghey, believed that Tilstra was doing a poor job, and in 2009, BouMatic's regional sales manager, Stephane Desjardins, advised Ghey by email that “We [should] approach Sid [Tilstra] again and ask him to sell. If he refuses or makes it too difficult, we would in the short term, modify the territory lines in favor of Advanced [another adjacent BouMatic dealer] and Dortmans. This would … put unbearable pressure on Sid [to sell]—without cancelling him outright or immediately.”

In turn, Desjardins and Ghey told Tilstra that BouMatic would eliminate his territory altogether unless he agreed to sell his dealership, with all its assets, to the Dortmans within a month. Evidence also existed showing that BouMatic threatened to stop selling dairy equipment to Tilstra. Tilstra, although willing to sell his dealership, would not cut his price to the level demanded by Dortmans. On January 8, seven days after the franchisor-imposed sales deadline, BouMatic's North American Director of Sales sent Tilstra a letter reminding him that BouMatic had decided to “have Dortmans … take over the territory covered by your company…. [O]ur decision … is not negotiable and … we will proceed with or without your cooperation.” Within the next month, Tilstra sold the dealership to Dortmans for $500,000 plus a five-year consulting contract under which he would receive a total of $310,000 in consulting fees. The sale closed in March.

According to Judge Posner, Tilstra had valued the goodwill of his dealership at $1.5 million; however, due to the pressure exerted on him by BouMatic, which sided with Dortmans, Tilstra had been forced him to sell it for half that amount to Dortmans, even after factoring in the amount of the consulting contract. Two and a half years later, Tilstra sued BouMatic in this case. The only claim that made it to trial was that BouMatic had violated the dealer agreement.

Judge Posner agreed with the lower court that “The jury was entitled to find that BouMatic, though it did not purport to terminate its contract with Tilstra, in fact terminated it, and did so without complying with the provision, quoted earlier, forbidding termination ‘without good cause and only upon at least ninety (90) days' advance written notice sent by certified mail.’” In so agreeing, the Court of Appeals explicitly noted that it had taken into account that BouMatic didn't formally terminate the agreement; the termination was more indirect, based on a threat to terminate: “But by telling Tilstra that unless he sold out to Dortmans his territory would be shrunk to zero, BouMatic was telling him that he was finished, his dealership doomed; for without a territory his position as a BouMatic dealer would be untenable.”

The Court of Appeals next examined the territorial clause of the dealership agreement which stated that the “Dealer shall purchase BouMatic products only … for resale to purchaser-users in Dealer's assigned territory … [and] shall solicit sales only in their assigned territory unless allowed by BouMatic in writing prior to any solicitation.” Continuing, the Court of Appeals reasoned that “if Tilstra's territory were eliminated, Tilstra wouldn't be able to buy any products from BouMatic for resale to anyone, or solicit any sales from anyone. In other words, no territory, no dealership.”

 BouMatic defended this result based on the language in the dealership contract that reserved to it “the right to change, at its sole discretion, the assigned territory.” The Court of Appeals quickly brushed aside this excuse pointing out that when the argument was taken to its extreme it would absurdly read out of the agreement the explicit termination provision. On this point Judge Posner made clear that “Elimination of a dealership's entire territory is certainly a change, but were it a change permitted by the contract, it would amount to allowing termination ‘without good cause,’ contrary to an explicit contract term. The Appeals Court refused to adopt such an ‘untenable interpretation’ of the contract.

Interestingly, and notably, Judge Posner chose to discuss how the covenant of good faith and fair dealing played into the case, describing initially that “Contract law imposes on both parties to a contract a duty of good faith in the performance of their contractual obligations.” From there, the Appeals Court then segued to the concept of “bad faith”, stating that “One form of bad faith that Wisconsin law recognizes is ‘evasion of the spirit of the bargain.’” In turn, the Court identified BouMatic's conduct as blatant bad faith. Moreover, Judge Posner characterized the termination as a “de facto termination” or “constructive termination” since the franchisor had taken away or “cancelled” the dealer's entire territory. Judge Posner then proceeded to identify another form of bad faith recognized in Wisconsin law as an “abuse of a power to specify terms,” which, in this case, arose out of the power to specify the size and shape of the dealer's territory. The Court of Appeals then noted that BouMatic had “backhandedly” admitted that it had acted in bad faith by arguing that it had good cause to terminate Tilstra.

Tellingly, however, BouMatic had “never told Tilstra that [it was terminated], as required by the contract, or proved at trial that Tilstra had failed “to comply substantially with essential and reasonable requirements imposed upon [Tilstra] by BouMatic.” Examining BouMatic’s apparent motive for its conduct, the Appeals Court recognized that BouMatic thought it would make more money if Dortmans rather than Tilstra managed Tilstra’s territory; however, the Court was very clear that the dealership contract was not an “at will” contract: “But the dealership contract did not authorize BouMatic to terminate a dealer merely because it had found a substitute that it thought it could make more money from. That would have made the contract terminable at will by BouMatic. In The dealership agreement specified that Tilstra may terminate it at will but BouMatic may terminate only if it has good cause to do so.

The issue of remedy, or amount of damages, was also heavily disputed in the trial court and on appeal. As Judge Posner expressed, “With regard to remedy, BouMatic fires a blunderbuss of objections” to the calculation of damages by Tilstra's financial expert, Sciannella. BouMatic, for instance, attacked the expert because Sciannella did not have Tilstra's financial statements, which were prepared in the ordinary course of business, verified by outside accountants. The Appeals Court rebuffed that assessment concluding that “an expert witness is not required to verify all the facts on which he relies; he can rely on hearsay (in this case, what the accountants stated in the financial statements) provided that such reliance is an accepted practice in his profession, as it is.” BouMatic’s next attempt to disparage the expert opinion pivoted off of a provision in the dealership agreement that “regardless of which party terminates this Agreement, Dealer shall not be entitled to any termination compensation or to any compensation for goodwill.” The Court effortlessly rejected this line of declaring that “the section of the agreement in which this provision appears conditions BouMatic's right to terminate a dealer on good cause and 90–day written notice, and BouMatic did not comply with those conditions and so cannot rely on the provision we quoted.” Very simply, according to Judge Posner, there was little hope for BouMatic legally after it broke the agreement: “It broke its contract with Tilstra, thereby exposing itself to a liability that would have been excluded only if BouMatic had terminated Tilstra's dealership for good cause.”

BouMatic asserted additional more technical arguments attacking the franchisee’s expert’s testimony. First, BouMatic objected that the expert assumed – as impermissible speculation — that had Tilstra not been terminated, his dealership would have remained as valuable as it had been in recent years. As before, Judge Posner disregarded this attack: “But the damages calculated by the expert under the rubric of “goodwill” were the sum of the discounted future earnings of the dealership based on that assumption, and that is a standard method of business valuation, known as the ‘capitalized earnings’ approach.” BouMatic’s argument on this path continued, when it pointed out that even if it couldn't lawfully shrink Tilstra's territory to zero, it could shrink it some, and that would reduce Tilstra's dealership profits. Again the Court of Appeals rebuffed the contention: “But the jury was entitled to find that any shrinkage attempted by BouMatic would have been a further attempt to transfer the dealership to Dortmans without complying with the contractual provisions governing termination or with the duty of good faith performance imposed by contract law.”

Incredibly, BouMatic’s arguments did not end there with respect to causation and damages. BouMatic also argued that Tilstra could have mitigated its damages by obtaining a comparable dealership from another supplier of milking-parlor equipment, or remaining independent. And, again, Judge Posner, in one lengthy sentence, refused to recognize the alleged defect: “But there was evidence that it is difficult to secure a new dealership and that a dealership is necessary to remain competitive—indeed, without a dealership and thus an assured source of supply of milking-parlor equipment, Tilstra might be relegated to manufacturing its own such equipment, which would hardly be a realistic option.”

Based on the above, the Court of Appeals affirmed the judgment of the district court, which had upheld the jury verdict in favor of the franchisee.

 

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