Don’t Let A Rodent Mess Up Your Franchise Relationship
Author: Mahmood Khan
Posted on January 2, 2018
Scheck v. Burger King, the seminal case on good faith and fair dealing, lives on according to a 12-member California jury after a contentious month-long trial pitting grilled chicken giant El Pollo Loco, Inc. against one of its top performing franchisees, Michael and Janice Bryman. After weeks of testimony from current and former executives of El Pollo Loco, Inc., the introduction of numerous exhibits documenting El Pollo Loco, Inc.’s bad faith conduct and unfair dealing, and even a mistrial due to inappropriate statements made by El Pollo Loco, Inc.’s lawyers at the very beginning of trial, a Los Angeles County jury found that El Pollo Loco, Inc. had breached the implied covenant of good faith and fair dealing when two new corporate stores improperly encroached on the non-exclusive territory of a longtime El Pollo Loco, Inc. franchisee.
The principal issues before the jury were whether El Pollo Loco, Inc.’s decisions to construct not one, but two, corporate stores in close proximity, i.e., 2.2 and 4.4 miles, respectively, from the existing franchisee’s location constituted a breach of the implied covenant of good faith and fair dealing. Furthermore, and in what appears to be a case of first impression, the jury found that El Pollo Loco, Inc.’s decision to take the new corporate stores for itself rather than offer those two new corporate locations to its existing franchisee was unfair and unlawful in violation of good faith requirements. According to Robert Zarco, Esq., founding partner of the Miami law firm of Zarco, Einhorn, Salkowski & Brito, P.A., who represented the franchisee at trial, “the decision by this jury has been a long time in the making, and supports the legal principles espoused by the courts in In re Vylene Enterprises which cited the seminal case of Scheck v. Burger King as authority.”
The franchisee, Plaintiffs Michael and Janice Bryman, owned and operated the only El Pollo Loco, Inc. restaurant in Lancaster, California since 1999. At the time that the Brymans purchased the El Pollo Loco restaurant in Lancaster from another franchisee for $1.2 million, the store’s annual sales volume was $1.4 million. By 2007, the franchisee increased the store’s sales to over $2 million despite an increase in competing brands in the Lancaster market. The franchisee’s time, effort, and money developed El Pollo Loco, Inc.’s goodwill in the Lancaster community while the franchisee simultaneously paid increased and substantial amounts of royalties and advertising fees to El Pollo Loco, Inc.
Despite El Pollo Loco, Inc. having set aside and reserved the entire Los Angeles designated market area (“DMA”) as a corporate market, El Pollo Loco, Inc. did not undertake any significant efforts to develop any new restaurants in Lancaster for nearly 15 years. During that same time period of inaction by El Pollo Loco, Inc. in the Los Angeles DMA, the Brymans worked diligently to identify locations in Lancaster to open another El Pollo Loco restaurant. Through no fault of their own, and in part as a result of the recession in the late 2000s and other development impediments, the franchisee was unable to secure a lease for a preferred second El Pollo Loco location in the Lancaster area. Until 2014, El Pollo Loco, Inc. took no action to develop any corporate stores in the ever-growing Lancaster market.
Then in 2014 El Pollo Loco, Inc.’s then-owner, Trimaran Capital Partners, a private equity fund, took the company public. Flush with cash, El Pollo Loco, Inc. began an aggressive campaign to grow the number of restaurants in the system. Using its real-time access knowledge of the Brymans’ electronically reported $3.8 million in gross revenues for 2014, El Pollo Loco, Inc. identified Lancaster as an obvious market to develop additional corporate stores. El Pollo Loco, Inc. ignored the Brymans’ development and growth of the brand’s goodwill, their investment of massive amounts of time, money and effort into their store, and their established relationships, and decided to open not one, but two, corporate stores in close proximity to the Brymans’ location. El Pollo Loco, Inc. relied on its express “reservation of rights” clause under its form franchise agreements which El Pollo Loco, Inc. believed granted corporate the right to place a competing corporate restaurant “in the immediate vicinity of or adjacent to” a franchisee’s location. The Court found such provision was unconscionable and therefore unenforceable. The jury determined it was a breach of good faith and fair dealing to take such action.
During pre-trial proceedings, El Pollo Loco, Inc. argued that its actions were justified, claiming that this “reservation of rights” clause in its form franchise agreements expressly permitted corporate to put stores wherever it wanted because franchisees did not have exclusive territories. Specifically, the provision stated that “[n]othing contained in this Agreement, whether express or implied, shall be deemed in any way to prevent or limit Franchisor and its subsidiaries from opening and/or operating, or granting the right to any person to open and/or operate, restaurants in the immediate vicinity of or adjacent to the Restaurant.” Presiding Judge Randolph A. Rogers found this provision to be unconscionable and therefore unenforceable as a matter of law because El Pollo Loco, Inc. “place[d] itself at such a competitive advantage when it opens a company restaurant, which is not paying royalties, near or adjacent to a franchise restaurant so as to constitute unfair competition.”
Although the central issue of the case was whether El Pollo Loco, Inc. violated the implied covenant of good faith and fair dealing, El Pollo Loco, Inc. instead focused its entire defense at trial on whether the new corporate sites fell within the existing franchisee’s 50,000 population “notification radius.” Zarco argued that this focus on the “notification radius” was a smokescreen set up by the defense merely as an attempt to distract and confuse the jury. However, this “notification radius” provision only applied to when a franchisee chose to avail him or herself of the provided-for alternative dispute resolution process and not a jury trial and therefore was simply an argument crafted to confuse the jury that El Pollo Loco, Inc.’s encroachment on the Brymans’ location was not an act in bad faith. The jury was not confused and clearly saw the bad faith.
At trial, the franchisee elicited testimony and presented evidence supporting its claim that while the Brymans did all, or substantially all, of the significant things that the franchise agreement required them to do, El Pollo Loco, Inc. had unfairly interfered with the franchisee’s right to receive the benefit of the franchise agreement. El Pollo Loco, Inc.’s own witnesses, including its former Vice President of Development and its current Chief Financial Officer, testified that they knew that the opening of the corporate sites would impact the existing franchisee’s store but they did not consider such fact in their decision. Further testimony came out from El Pollo Loco, Inc.’s own witnesses which supported the Brymans’ contention that El Pollo Loco, Inc.’s decision to construct the corporate stores in Lancaster, California was deliberate, arbitrary, capricious, and undertaken in bad faith with the intent to rely on existing customers of the Brymans to support the newly developed corporate stores.
When El Pollo Loco, Inc.’s lawyers recognized that the facts as presented at trial could not support a verdict in the company’s favor, they deployed a number of tactics in an attempt to distract the jury. Those tactics included: focusing on the franchisee’s wealth, which ultimately resulted in an instruction to the jury to disregard any testimony concerning the Brymans’ socio-economic standing; putting on an expert witness on liability whose testimony was severely limited by the presiding judge as a result of the expert’s clear bias and prejudice in favor of the defense; and ultimately scraping the bottom of the ethics barrel by repeatedly undertaking personal attacks on the Brymans’ legal team in the presence of the jury.
By the end of trial, however, it was clear to the jury that El Pollo Loco, Inc.’s multiple wrongful acts constituted a breach of the implied covenant of good faith and fair dealing. According to Robert Zarco, Esq., lead trial attorney for the franchisees, the jury verdict “will have a significant impact on the other 250 franchise agreements existing between El Pollo Loco, Inc. and its system franchisees,” a fact that El Pollo Loco, Inc. has recognized in its recent financial filings. According to Robert F. Salkowski, Esq., who assisted Robert Zarco at trial, “this verdict will have a significant impact on franchising nationally, and will help level the playing field between franchisors and franchisees.”
Because the trial lasted over four weeks, the presiding judge elected that the monetary and equitable damages that El Pollo Loco, Inc. is responsible for would be determined at a subsequent hearing to take place sometime in early 2018. During the damages phase, the franchisee will be able to recover damages for the lost sales of their encroached-upon store due to the financial impact from each of the two newly built corporate stores. The franchisee will also be entitled to recover damages for over 20 years of future lost net income actually being earned from each new corporate store (currently $500,000 for one store as well as hundreds of thousands for the other) that the franchisee would have realized had the corporate stores been awarded to the Brymans. The total anticipated damages figure is expected to be several millions of dollars.
The Brymans were represented at trial by Robert Zarco, Robert F. Salkowski, and Margaret T. Lai, with the law firm of Zarco, Einhorn, Salkowski & Brito, P.A. headquartered in Miami, Florida.
El Pollo Loco, Inc. was represented at trial by James Mulcahy, Kevin Adams, and Douglas Luther with Mulcahy Law Firm, P.C. in Irvine, California.