Many franchise agreements contain a standard provision that reads something like this: Franchisee must comply with all civil and criminal laws. And, a second provision that reads: Franchisee shall be in default of the Franchise Agreement if the Franchisee or its owners or principals commit a felony or crime involving moral turpitude, or any other crime or offense that is injurious to either the System or the goodwill enjoyed by the Marks.
It seems like a rather benign provision. Sure, sure, complying with the law seems elementary. How about if the franchisee is not convicted of an unlawful act? How about if the franchisee is not even charged with a crime? Can the franchisee be held in default? Can the franchise agreement be terminated?
You guessed it. The answer is yes! The case is Dunkin’ Donuts Franchising LLC v. Oza Brothers, Inc. The case all started with an employee whistleblower. An employee of Oza Brothers, Inc., a Dunkin’ Donut Franchisee, contacts the franchisor Dunkin’ Donuts to report that franchisee Oza Brothers is pocketing wholesale revenues generated from auto dealer sales and not reporting the income to the franchisor. Sounds like a simple under reporting case. Dunkin’ Donuts completes an audit of franchisee Oza Brothers and sure enough the Oza Brothers are not reporting or paying royalty fees on auto dealer sales. With further investigation, Dunkin’ Donuts also discovers that the Oza Brothers are not paying taxes on the auto dealer sale either.
Dunkin’ Donuts terminates the Oza Brothers’ franchise agreement without an opportunity to cure and files a claim against the Oza Brothers. The Oza Brothers reply by saying that Dunkin’ Donuts must give them an opportunity cure, (i.e. pay the royalty fee on the unreported auto dealer sales) unless Dunkin’ Donuts can prove intentional under reporting. Dunkin’ Donuts counters by saying ‘Hey, you committed a criminal act, tax evasion. We do not need to give you an opportunity to cure.’
The court agreed. The court agreed even though Oza Brothers had not been charged or convicted of tax evasion. In coming to its decision, the court reviewed the elements required to substantiate a tax evasion case. Conclude, yes, if the franchisee was charged with tax evasion, the franchisee could in fact be found guilty of tax evasion. Wow. The court came to its determination with no IRS investigation, conviction, or participation. Taking this court’s holding, think of what this could translate into. Franchisee commits an act the franchisor views as criminal, franchise agreement terminated.
Lesson from the Court: Expect the unexpected when presenting your case to the court.