Court Closes Dairy Queen Franchise in Franchise Termination
By: Jeffrey M. Goldstein
Goldstein Law Firm, PLLC
American Dairy Queen Corporation v. Wardlow, 2015 WL 5178454, United States District Court, D. South Dakota (September 4, 2015)
When a Dairy Queen franchisee failed to show up in federal court to defend against its franchisor’s (ADQ or Dairy Queen) emergency motion to enforce the franchisee termination by getting a court order to shut it down, the Judge, embracing a very traditional legal analysis, ordered that the franchisee cease operations. Not surprisingly, preliminary injunctions arising out of disputes in the fast food franchise industry are prolific.
The traditional test for determining whether to grant emergency relief to shut down a franchisee normally, in some fashion, encompasses four equitable issues, including: (1) the threat of irreparable harm to the movant; (2) the state of the balance between this harm and the injury that granting the injunction will inflict on other parties litigant; (3) the probability that movant will succeed on the merits; and (4) the public interest.
Regarding the first point, the Court pointed out that irreparable harm occurs when a party has no adequate remedy at law, typically because its injuries cannot be fully compensated through an award of damages. Interestingly, rather than ruling that the franchisor would suffer per se damages as a result of the trademark infringement, the Court examined the factual basis underlying this claim. In so doing, the Court ironically further solidified the jurisprudential principle that ‘irreparable harm’ may be shown by a company's loss of goodwill and reputation among its customers. The concept is that harm to reputation and goodwill is difficult, if not impossible, to quantify in terms of dollars. (On the flip-side, as a franchisee lawyer, this point is absolutely indispensable when arguing that a franchisee will be irreparably harmed if the court fails to grant the franchisee’s motion to bar a franchise termination.) Not all courts, unfortunately, have adopted this concept.
Applying the irreparable harm principle to the franchisor’s plight, the Court reasoned that the franchisees were displaying ADQ trademarks at their restaurant and serving food labeled as official Dairy Queen products despite no longer having a franchise agreement with Dairy Queen. The Court was specifically troubled that without a franchise agreement, ADQ could not ensure that the franchisee was selling authentic Dairy Queen products, preparing the products appropriately, and meeting ADQ's standards for cleanliness and sanitation. Adopting standard economic theory, the Court explained that if customers at the franchisee’s restaurant were to have a bad experience, they might improperly attribute this experience to the entire Dairy Queen franchise system. This, according to the Court, could cause the public to avoid Dairy Queen restaurants in the future.
The Court next balanced the harm to ADQ and the injury that granting the injunction would impose on the franchisee. Recognizing that the franchisee would suffer some harm should the preliminary injunction be granted (the franchisee would need to rebrand the restaurant and would probably lose profits as a result of no longer being able to use ADQ's marks), the Court pointed out that the franchisee caused this harm. In this regard, the Franchise Agreement made clear that the franchisee’s right to use ADQ's marks was conditioned on, among other things, on the payment of monthly license fees. By failing to pay these fees, according to the Court, the Defendant breached the Operating Agreement and gave ADQ the option of termination. The Court also appeared annoyed that the franchisee had been given the opportunity to cure its breach, but declined to do so. In essence, the Court held that the balance of harms tilted in favor of the franchisor because the franchisee’s wound was self-inflicted.
The third factor focused on the probability that the franchisor would at a later trial succeed on the merits. In this context, this means that the franchisor had to show that it had a fair chance of prevailing on the merits. The Court explained that this did not require that the moving party demonstrate that it had a greater than fifty percent likelihood of prevailing on the merits of the claim. The Court quickly found against the franchisee on this factor given that the franchisee failed to submit its monthly statements and license fees and refused to carry out its post-termination obligations to remove all ADQ trademarks, signs, and products from their restaurant.
Regarding the fourth and last factor of the traditional emergency injunction test, the Court held that the public interest also favored granting the preliminary injunction to the franchisor. The Court wasted little time or analysis on this issue finding very simply that the public had an interest in being able to rely on a franchisor's marks when choosing whether to buy the franchisor’s particular products. From the Court’s perspective, the public interest disfavors those who act beyond their contractual rights and hold themselves out as something they are not. Interestingly, if this were the sole ultimate determinant of liability — whether the franchisor held itself out as something it was not (a consistent provider of profitable franchises) — the franchisee might have had a chance of winning. As a franchise lawyer representing exclusively franchisees and dealers I would embrace such a legal yardstick.
Jeffrey M. Goldstein
Goldstein Law Firm, PLLC