Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D. Kan.: Hotel franchisee’s breach of contract, implied duty claims proceed against franchisor, (Sep 4, 2013)

By Peter Reap, J.D., LL.M.

A hotel franchisor, Holiday Hospitality Franchising, Inc., was not entitled to dismissal of a franchisee’s claims for breach of contract, breach of the implied duty of good faith and fair dealing, and a declaratory judgment, the federal district court in Kansas City, Kansas, has ruled (Lenexa Hotels, LP v Holiday Hospitality Franchising, Inc., September 3, 2013, Vratil, K.). Thus, the franchisee’s claims, based on the perceived failure of the franchisor’s reservation system and marketing of the franchisee’s hotel, could proceed.

Background. In early 2007, the franchisee began contemplating converting its hotel to another brand and it entered into negotiations with the franchisor about a possible conversion of its hotel to a branded Crowne Plaza hotel. The franchisor gave the franchisee a Uniform Franchise Offering Circular (“UFOC”), which included financial performance representations and reinforced oral representations about the franchisor’s ability to drive demand to the franchisee’s hotel.

On May 13, 2008, the franchisee executed the Crowne Plaza Conversion License Agreement (“the License Agreement”). The agreement focused on the franchisee’s access to “the System,” which was operated and licensed to “provide a distinctive, high quality hotel service to the public under the name Crowne Plaza. The License Agreement assigned certain responsibilities to each of the parties. For example, during the term of the agreement the franchisor was to “afford [the franchisee] access to reservation service for the Hotel on terms consistent with this License.”

The franchisee was obligated to pay a “Services Contribution” equal to 3% of gross revenue, and the franchisor was to use those funds for marketing, reservations, and related activities. Because marketing was the franchisor’s obligation, the License Agreement precluded the franchisee from engaging in local and regional marketing programs without the franchisor’s permission. Based on the License Agreement representations about the System, the franchisee believed that the franchisor would design and provide a marketing program tailored to fit and drive demand to the hotel, the court noted.

According to the franchisee, two major failings on the franchisor’s part have plagued the hotel: (1) the hotel has not been visible on the Internet in searches for Kansas City hotels; and (2) the franchisor’s Central Reservation Office has failed to find and recommend the hotel to potential customers, even those calling a line said to be dedicated to Crowne Plaza reservations. The complaint provided five pages of detailed allegations as to how the franchisor’s Internet marketing efforts were deficient, how the franchisor’s call centers sent almost no business to the hotel, and how the franchisee investigated the issue and communicated with the franchisor to try to obtain better marketing and reservation service.

As a result of the franchisor’s alleged reservation system and marketing failures, the franchisee claimed that its hotel had performed worse as a Crowne Plaza than as a Radisson or Holiday Inn. The franchisee believed that, by revenue, it was one of the franchisor’s worst performing hotels in the Kansas City market. The franchisor’s UFOC listed averages for occupancy percentage, average daily rate, and revenue per room available for 53 other Crowne Plaza Hotels in suburban markets. In 2009, 2010 and 2011, the franchisee’s hotel did not approach any of those averages.

Breach of contract. The franchisor argued that the amended complaint failed to state a claim for breach of contract because it did not identify specific contractual provisions that were breached. Although the franchisor acknowledged that the License Agreement “does set forth various affirmative obligations” on its part, the franchisor asserted that it had no obligation to the franchisee with respect to its reservation system because the License Agreement made it clear that the franchisor “enjoys absolute and total discretion with regard to its control” over the reservation system.

Defendant’s argument overreached, the court held. While the License Agreement indeed granted discretion to the franchisor, that same Agreement also granted the franchisee a license to use the System, which included marketing programs and many other services in addition to reservations. The License Agreement obligated the franchisor to pay several monthly fees, many of which were specifically tied to the franchisor’s marketing association, and obligated the franchisor to afford the franchisee access to reservation service for the hotel which was paid for in part by the franchisee’s mandatory Services Contribution fee, the court explained. The franchisor was effectively arguing that under the License Agreement, it had no legal obligations to the franchisee with respect to reservations or marketing.

The franchisee’s amended complaint alleged otherwise, according to the court. It listed a number of obligations that the franchisor had under the License Agreement and alleged that the franchisor breached those obligations by failing to provide reservation, marketing, and advertising services, and refusing to permit the franchisee to use the System for which the franchisee provided consideration. Viewing the allegations in the light most favorable to the franchisee, the court could not conclude as a matter of law that the License Agreement on its face imposed no marketing or reservations obligations on the franchisor.

Implied duty. The franchisor argued that the franchisee could not state a claim for breach of the implied duty of good faith and fair dealing because Georgia law did not allow such claims unless the franchisee set forth facts showing breach of an actual term of the agreement. By rejecting the franchisor’s motion to dismiss with respect to the breach of contract claim, the court concluded that the amended complaint sufficiently alleged breach of contract. Accordingly, the franchisor’s motion was likewise overruled with respect to the breach of implied duty claim.

Declaratory judgment. The franchisor sought dismissal of the franchisee’s claim for declaratory relief, arguing that the franchisee did not allege facts sufficiently demonstrating a case or controversy and that considering the claim would serve no useful purpose. The franchisor did concede, however, that a court’s decision on whether to grant declaratory relief was discretionary.

The Tenth Circuit Court of Appeals articulated five factors for district courts to evaluate when determining whether to decline jurisdiction over a declaratory judgment action: (1) whether a declaratory judgment would settle the controversy; (2) whether it would serve a useful purpose in clarifying the legal relations at issue; (3) whether the declaratory remedy is being used merely for the purpose of procedural fencing or to provide an arena for a race to res judicata; (4) whether use of declaratory action would encroach upon state court jurisdiction; and (5) whether an alternative remedy would be better or more effective.

Here, the franchisee’s amended complaint demonstrated a case or controversy between the parties. The franchisor did not file its own action, nor did it represent that it intended to do so. The declaratory judgment count was but one part of the franchisee’s suit, and it arose out of the same set of operative facts as the franchisee’s other claims, the court noted. Thus, the franchisor raised no compelling reason for the dismissal of the declaratory judgment claim.

The case is Civil Action No. 12-2775-KHV.

Attorneys: Brennan P. Fagan (Fagan Emert & Davis LLC) for Lenexa Hotel, LP. David A. Jermann, II (Armstrong Teasdale LLP) for Holiday Hospitality Franchising, Inc.

Companies: Lenexa Hotel, LP; Holiday Hospitality Franchising, Inc.

Cases: FranchisingDistribution KansasNews