Jan 18, 2021 - Reformist Thoughts by |

Franchise and Dealer Renewals: Every Minute Counts in Texas to Classicalists

By: Jeffrey M. Goldstein

In Pizza Inn, Inc. v. Clairday, 979 F.3d 1064 (5th Cir. 2020), a recent decision from the United States Circuit Court for the Fifth Circuit a franchisee entered into an area development agreement with a franchisor, which included an option to renew. However, the franchisee failed timely to notify the franchisor that he wished to renew and submitted a late notice of renewal. In turn, the franchisor did not honor the tardy notice of renewal. After the district court ruled in favor of the franchisee at trial, the Circuit Court reversed finding that the district court had erred in finding that the notice of renewal was sufficiently timely under the doctrine of equitable intervention. In denying the franchisee recovery, the Court of Appeal held that the equitable intervention doctrine was not applicable to support a recovery for the franchisee because the franchisee did not suffer an unconscionable hardship from the franchisor’s failure to honor the tardy notice of renewal since a partial forfeiture of the purchase price, a forfeiture of future profits, and the shuttering of a franchise store were not sufficient hardships warranting strict enforcement of the renewal deadline.

The Pizza Inn case is very troubling for several reasons.

First, it appears to be a shot over the bow by Texas courts (both state and federal) aimed at neoclassical contracts theory; however, the neoclassical contracts boat left the dock safely in 1950 with the UCC and again in 1980 with the Second Restatement of Contracts. The 5th Circuit Panel’s apparent intent is to re-establish an anachronistic classical contracts beachhead in 2021 against contracts realism. Not surprisingly, Pizza Inn’s ‘precedent’ is very thin, and the initial source for the current ‘law’ on equitable intervention appears to be an unprincipled term the Texas courts kidnapped from a 1922 Connecticut decision. Although over the last 60 years it does not appear that there have been many Texas cases regarding the appropriate standard for whether an optionee should be held to strict compliance with the terms of an option agreement, a cursory review shows that these cases failed to focus on whether the standard could be supported by some principled or well-structured justification. Most notably, the genesis and continued use of the concept of unconscionability to establish an excuse for strict compliance; the use of unconscionability in its borrowed and reconditioned role will create a thousand deaths by conflation.

Second, even recognizing that the exception should be narrow, there is no reason – nor has any reason been presented by a Texas court – as to why the equitable excuse must be bound with unconscionability. Instead, for instance, a sliding weighted scale among the three factors (with the magnitude of harm to the optionee substituted for unconscionability) is the stuff of equity and would have performed perfectly in this context. (The three factors include [1] the delay has been slight, [2] the loss to the lessor small, and [3] when not to grant relief would result in such hardship to the tenant as to make it unconscionable to enforce literally the condition precedent of the lease.) And, for those like the court concerned about a situation where an optionee would get a free pass (for instance, where the harm and prejudice to the optioner were zero), the substantive contours of the hardship to the optionee could easily be set ‘above zero’ (in other words, a significant hardship) but below an unconscionable level. Courts are very familiar with using interconnected sliding scales for multi-part showings. Using the already ‘impossible to meet’ standard of unconscionability will certainly weed out optionees who should otherwise be protected by the equitable excuse. This sliding weighted scale concept also adequately addresses the court’s later erroneous conclusion that allowing lost future profits to show unconscionability would allow a complaining optionee to satisfy his burden ‘in every case.’

Third, by using unconscionability in particular as part of a litmus test to establish an equitable excuse, the Panel has successfully jammed a square peg into a round hole. Although the Panel forcefully (but successfully) sledge-hammered it in, the court permanently damaged both the peg and the hole in so doing. Unconscionability, for purposes of voiding or vacating an otherwise lawful contract (to establish that someone ‘did something bad or something bad exists’), is not the same harm as unconscionability for purposes of showing ‘tangible harm of a physical nature to an optionee’ (to establish an equitable excuse). There was no need to design ‘the Conflation Express’ for purposes of establishing a test for equitable intervention. Moreover, the concept of unconscionability set forth by the court is ambiguous – in one breath the court discusses substantive unconscionability per se (nevertheless still not distinguishing between absolute and relative), but in the next breath it refers to a different concept of unconscionability as a process screener.

Fourth, as if the above were not sufficiently knotty, the Panel also unexplainably faltered in its application of the ‘unconscionability’ sub-prong to the facts. According to the court, the optionee’s harm was not cognizable because (1) it was not the loss of an improvement or tangible asset; and (2) upon expiration of the option, the option holder has received the full agreed equivalent of the price he paid for his option, and a refusal to give effect to an acceptance that is one minute late results in no forfeiture. The former is a meaningless and soulless requirement; it seems untethered in any regard to the equitable considerations that drive recognition of and the need for the excuse. The latter point seems unhinged as well, this time to reality. The renewal option in the case was not a naked option; instead, it was a component of the underlying franchise development agreement. The two agreements (the development agreement and the renewal agreement/provision) should have been read as one. Accordingly, it is difficult to understand how the court concluded that the developer suffered no forfeiture in this case: when the developer paid his initial $1,250,000 fee, that theoretically included the discounted future value of the renewal options. What if the optionee had paid this amount over time, and not up front as a fixed fee, such that he paid $200,000 one year before the expiration? Would this have sufficed?

Pizza Inn should not be viewed in isolation – in this regard it is notable that Texas law will not imply or impose a covenant of good faith and fair dealing requirement in common law contracts cases. To the extent that neoclassical contracts rules increase economic efficiency by allowing contracts disputes to be decided in a less analytically rigid and more realistic decision-framework, courts, like the one in Pizza Inn, which refuse to budge from classical literalistic contracts rules, tend to undercut economic efficiency as well as overall confidence in the process of stare decisis.

 

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