Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. Ariz.: Best Western franchisee could not use substantial compliance theory to challenge termination, (Mar 17, 2017)

By Edward L. Puzzo, J.D.

A hotel franchisee could not use a theory of substantial compliance to challenge the termination of its franchise agreement, after it corrected most but not all of the shortcomings revealed in the franchisor's inspections, because that theory applied only to construction contracts, not to contractual disputes, the federal district court in Phoenix has ruled. The court also dismissed the franchisee's claims of breach of implied covenant of good faith and fair dealing, and its claim for a declaratory judgment (Regency Midwest Ventures LP v. Best Western International, Inc., March 15, 2017, Burns, M.).

In 2004, plaintiff Regency Midwest Ventures entered into a membership agreement, akin to a franchise agreement, with Best Western International, making its existing 230-room hotel in Casper, Wyoming, a Best Western branded property. (Instead of offering franchises in a traditional sense, Best Western is organized as a nonprofit membership association, in which each franchisee acts and votes as a member of the association.) Best Western terminated the membership agreement on April 21, 2015, based upon Regency's alleged failure to make necessary improvements to the Casper property in a timely manner. On April 27, 2016, Regency filed a complaint in federal court, alleging that the termination was wrongful and a breach of the membership agreement, a breach of the implied covenant of good faith and fair dealing, and sought relief and damages. Best Western moved to dismiss the complaint.

Best Western generally inspects its member hotels approximately twice a year. Best Western grades each hotel in the number of categories. A passing score for the entire inspection, which includes all scores for each category, is an average of 800 points. In October 2006, Best Western gave Regency’s hotel a failing score for the Guest Room—Public Areas assessment, but an overall average score of all categories of 918. After the hotel failed another inspection in November 2006, Best Western issued a review and action plan to Regency which set forth corrective actions for Regency to take.

In response, Regency replaced the hotel’s general manager and completed a significant property improvement project, which $2.34 million in capital improvements. In May 2013, Best Western notified Regency that the hotel failed an inspection and that it was considering cancelling Regency’s membership for failing two quality assurance scores during an 18-month period. Best Western, however, after a hearing before the Best Western board in which grounds for cancellation were found, deferred the membership cancellation, pending Regency’s completion of a proposed corrective action plan. After multiple extensions to correct the defects, Best Western terminated the membership agreement on April 21, 2015, on the grounds that Regency failed to make the agreed upon improvements in a timely manner.

Substantial compliance. Best Western argued that it did not breach the contract with Regency because there were numerous grounds under the agreement for termination, including after Regency accepted conditional extensions to bring the facilities into compliance. In response, Regency relied on a theory of "substantial compliance." They alleged that their total investment in the hotel was more than $4.6 million and that they completed 194 of 197 of the improvements requested by Best Western. Regency claimed that under a substantial compliance theory, Best Western was required to meet its end of the bargain after Regency substantially performed. In response, Best Western argued that the substantial compliance theory only applied to construction disputes, not a contractual dispute where the agreement at issue expressly addressed what constituted a breach and what remedies resulted from any such breach.

The court ruled for Best Western, finding the dispute to be a contractual dispute, not a construction dispute. This was not a situation where one party put up the majority of consideration for the contract and the other party avoids paying what it owes due to an immaterial breach, the court noted. Regency received all of the benefits of the renovations at the hotel. The governing documents made it clear that Best Western was entitled to terminate the membership agreement if Regency did not meet explicit conditions. Thus the court granted Best Western's motion to dismiss the breach of contract claim.

Good faith and fair dealing. Regency argued that Best Western breached an implied covenant of good faith and fair dealing because Regency had reason to believe that as long as they made adequate progress towards meeting Best Western's standards, then the agreement could not be terminated. Best Western countered that the implied covenant of good faith and fair dealing does not entitle a party to protection in excess of what is provided for in the contract. Regency cannot argue that the termination was outside the contemplation of the parties, the court stated, since it was done pursuant to the parties’ express and repeated understandings that termination would occur if the entire plan was not completed on time. Thus the court also granted Best Western's motion to dismiss the breach of good faith and fair dealing claim.

Declaratory judgment. After termination, Regency made some effort to remove Best Western trademarks from the hotel, but certain marks remained, including those on a highway billboard. Regency argued that, even though they failed to remove the marks in a timely manner, they were not precluded from seeking a declaratory judgment since they may not have violated applicable statutes. In order to prevail on a claim of trademark infringement, Regency argued, Best Western would have to show that Regency used the Best Western mark without consent and that the mark was used in such a way that it was likely to cause confusion among ordinary consumers as to the source, sponsorship, affiliation, or approval of the hotel. Regency argued that they may be able to prevail on its claim if they can establish that they were operating with the implicit consent of Best Western, or that they were not using the mark in a way that would cause consumer confusion. Best Western argued that it had clearly issued a notice to Regency in a letter of October 2015 that Regency was not authorized to continue to use Best Western marks. The court agreed, stating that Regency clearly used the trademarks without the consent of Best Western, and therefore granted Best Western's motion to dismiss the declaratory judgment claim.

The case is No. 2:16-cv-02491-MHB.

Attorneys: Barbara A. Bagdon (Dady & Gardner PA) for Regency Midwest Ventures LP. Randall Papetti (Lewis Roca Rothgerber Christie LLP) for Best Western International, Inc.

Companies: Regency Midwest Ventures LP; Best Western International, Inc.

Cases: Advertising FranchisingDistribution ArizonaNews