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Franchisors Should Not Continue Business Relationships with Holdover Franchisees

On Behalf of | Feb 14, 2017 | Franchise Law |

Franchisors and franchisees enter into what is known as a holdover period when a franchise agreement has expired, but the franchisee continues daily operations. A holdover period may be unlawful when a franchisee has continued to use the franchisor’s trademark without permission. In those situations, franchisors may be entitled to treble damages under the Lanham Act, 15 U.S.C. §1117. However, holdover periods also extend to circumstances in which the franchisee and franchisor have continued acting under the terms of the franchise agreement as an implied in fact contract. This recent case discussed below is relating to the latter situation where both the franchisor and franchisee willingly continue the business relationship beyond the term of the franchise agreement.

In Donut Holdings, Inc. v. William Risberg, 294 Neb. 861 (Neb. Sept. 30, 2016), the Nebraska Supreme Court affirmed a trial court decision holding that a franchisee had no contractual obligation to pay royalty and advertising fees to franchisor after the contract had been terminated. The parties had entered into a franchise agreement with a 10-year term extending from 1994 to 2004. Upon expiration, the parties continued to function under an implied in fact contract. The franchisee continued to operate its store and continued to pay all royalty and advertising fees to franchisor.  Franchisor accepted payments and received reports of franchisee’s sales. The parties never took any action to formally extend the terms of the franchise agreement and operated under these terms for a period of three years.

In 2009, the franchisee stopped making payments to franchisor and was served with a notice that franchisor was terminating the franchise agreement. Franchisee was to cease operations and discontinue use of franchisor’s signage. Instead, franchisee continued to operate under franchisor’s system and used its signage through 2010. Franchisor sued franchisee for all unpaid royalty and advertising fees during the period that franchisee unlawfully used its trademark and recipes.

Under the facts of the case, the court found that the franchisor was not entitled to compensation for the use of its trademark and recipes for the period extending from 2009 through 2010. Because the parties were not operating under a franchise agreement, all obligations to pay had ceased upon franchisor’s 2009 notice that it would be terminating the agreement due to default. Although there would have been a cause for unjust enrichment by franchisee’s use of franchisor’s trademark and recipes, the franchisor did not argue those theories on appeal.

The issue decided before the court was in respect to the fees that franchisor would have been entitled to from 2009 to 2010. However, in this case, franchisor was not entitled to the royalty and advertising fees because franchisor had terminated the implied in fact contract and had discontinued extending benefits to the franchisee.

Franchisors should be cautious of continuing business relationships with holdover franchisees. As was the case in Donut Holdings, a franchisor forfeited the opportunity to recover damages under a franchisee agreement because the franchisee’s default occurred during the holdover period.

Nick Fernandez
Law Clerk