Landmark Court Ruling Gives Franchisees More Legal Heft

By Robin Lee Allen, Staff Writer

Nation's Restuarant News, The Newsweekly of the Foodservice Industry, Vol. 30, No. 33, August 26, 1996

A landmark court ruling here has given franchisees extra punch in future legal fights against encroachment and other abusive franchisor practices.

In Vylene Enterprises, Inc., vs. Naugles Inc., the Ninth Circuit Court of Appeals found the Naugles, formerly a chain of Mexican restaurants, had breached its covenant of good faith and fair dealing with its franchisee by building a competing, company-owned unit 1.4 miles from Vylene's Long Beach, Calif. location - even though Vylene's contract did not specify territorial exclusivity.

"It represents the highest appellate decision yet approving the concept of how the covenant of good faith and fair dealing may operate in the franchisor-franchisee relationship," said Phillip K. Fife, the Seal Beach, Calif., attorney who represented the franchisee during most of the case's 11-year voyage through various courts.

In rendering the decision the appellate court let stand a previous bankruptcy-court ruling awarding Vylene more than $2.2 million in damages and $550,000 in attorney's fees.  Although there no longer are any Naugles restaurants in operation, the responsibility to pay the award rests with Sizzler International, a prior Naugles owner now in Chapter 11 bankruptcy protection.  William T. Rintala, the Los Angeles attorney representing Naugles, could not be reached for comment.  He already has asked the Ninth Circuit to rehear the case.  The next step would be to request a hearing before the U.S. Supreme Court.

In the decision, the Ninth Circuit panel of judges upheld the 1991 ruling made in Scheck vs. Burger King that states that although Scheck was not contractually entitled to an exclusive territory, he could expect his franchisor would "not act to destroy the right of the franchisee to enjoy the fruits of the contract."

"I think what it's going to do is make certain that franchisors tread more cautiously in balancing franchisee rights versus their own profit-driven greed," said Robert Zarco of Miami-based Zarco & Pardo, P.A., who represented Scheck.

"Franchisors must make the decision on where to place competing units for existing franchisees in good faith and in a commercially reasonable manner - that's the test," he explained.  He added that he is hopeful the Vylene decision will help franchisees in other similar cases now pending.

For franchisors, the Vylene decision may mean rethinking some business decisions said Neil A. Simon, an attorney representing franchisors for the Washington, D.C., office of Hogan & Hartson, L.L.P.

"I'm reluctant to say this is evidence of a trend," he said. "But it does indicate that the words of the franchise agreement with clear disclaimers and forthright disclosures may not be sufficient to protect franchisors from liability for certain types of franchising practices."