Franchising is a time based commitment. The franchisor and franchisee enter into a franchise agreement with a term of 5, 10, 12, or 20 years. What happens if the franchise agreement is cut short? Cut short by the default of the franchisee. Relying on basic contract law, Franchisors may seek recovery of future royalties fees. Future royalty fees are fees that the franchisor would have received if the franchisee did not default and the franchise agreement was not terminated.
Let’s play that out. If a franchisee defaults in year 3 of a 12 year franchise agreement and the agreement was terminated, the franchisor could ask the franchisee to pay royalty fees for the remaining 9 years of the franchise agreement? Even though the franchise agreement terminated? And, the franchisee is not in business? Wow! That is the case of Days Inn Worldwide, Inc., Plaintiff v. Investment Properties of Brooklyn Center, LLC.
Investment Properties of Brooklyn Center, LLC (Investment Properties) signed a 12 year franchise agreement with Days Inn. Investment Properties, the franchisee, defaulted when it failed 2 Days Inn quality inspections in 2006. The franchise agreement was terminated in 2007. Days Inn sued Investment Properties for unpaid royalty fees and 9 years of future royalty fees. Investment Properties sold the business to a third party, which did not operate the business as a Days Inn.
Days Inn wanted Investment Properties to pay 9 years of royalty fees even though Investment Properties was no longer in business. The court said no. Quoting the case of RSB Lab. Serv. Inc. v. BSI Corp. “Lost profits are one measure of compensatory damages that may be recoverable in a breach of contract action, if they can be established with a reasonable degree of certainty.” Days Inn’s demand for Investment properties to pay 9 years of future royalties with no consideration for future economic conditions, local demand for hotel accommodations, operating expense,s and the ability to re-franchise the location or territory was unreasonable and uncertain. The court looked to how long it would take Days Inn to re-franchise Property Investment’s location or territory. Days Inn had a duty to mitigate (minimize its loss). Finding that it took an average of 2 years to re-franchise the location, the court awarded only 2 years of future damages.
LESSON FROM THE COURT: FUTURE DAMAGES ARE NOT FOREVER. THE FUTURE IS UNCERTAIN AND ONE MUST MITIGATE ONE’S OWN LOSSES.