Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—EDPa: 7-Eleven Granted Permanent Injunction Ejecting Terminated Franchisees from Store Premises , (Mar 6, 2013)

By Peter Reap, J.D., LLM

Convenience store franchisor 7-Eleven, Inc., was entitled to a permanent injunction against the owners and employees of a terminated Philadelphia franchise (collectively, the “defendants”) to surrender the premises of their leased store to 7-Eleven and ejecting them from the premises, the federal district court in Philadelphia has decided (7-Eleven, Inc. v. Upadhyaya, March 4, 2013, Dubois, J.). The husband and wife franchisees, Milind L. Upadhyaya and Minaxi M. Upadhyaya (the “franchisee-defendants”) breached their franchise agreement with 7-Eleven by systemically defrauding the franchisor over a period of several months, justifying the franchisor’s termination of the parties’ agreement without notice and an opportunity to cure, the court explained.

Background. In April 2012, James Pasarella, 7-Eleven’s Senior Manager, Asset Protection, began investigating franchisee-defendants’ store for possible fraudulent activity. The investigation was initiated because Pasarella noted in a Point-of-Sale (POS) report that the franchisee-defendants’ store reported high use of certain POS keys associated with a risk of fraudulent activity.

On September 28, 2012, 7-Eleven issued to franchisee-defendants a non-curable notice of material breach and termination describing certain alleged breaches of the franchise agreement and terminating the franchise as of the date the notice was delivered. Specifically, the notice stated that due to “intentional” and “fraudulent” activity, such as the high use of certain POS keys and failed “secret shops,” the franchise agreement was terminated immediately without any notice or opportunity to cure.

Following the termination, franchisee-defendants refused to vacate the store, and they have continued to operate the store. However, following the notice of termination, 7-Eleven shut off the store’s lottery machine and removed both the money order machine and the EBT (food stamp) machine from the store.

Presently before the court is 7-Eleven’s Motion for a Mandatory Preliminary Injunction. By agreement of the parties, that motion was treated as a Motion for Permanent Injunction, the court noted.

Legal standard. Under the Lanham Act, the court has the “power to grant injunctions, according to the principles of equity and upon such terms as the court may deem reasonable, to prevent the violation of any right of the registrant of a mark registered in the Patent and Trademark Office . . . ” 15 U.S.C. § 1116. Under well-established principles, a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief. A plaintiff must demonstrate: (1) that it has suffered an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant[s], a remedy in equity is warranted; and (4) that the public interest would not be disserved by a permanent injunction.

By remaining in the store after the franchise agreement has terminated, 7-Eleven argued that franchisee-defendants continue to use 7-Eleven trademarks, trade dress, and trade names in a manner likely to cause confusion among consumers. However, in order to establish a claim of trademark infringement, 7-Eleven first had to show that the franchise agreement was properly terminated.

The defendants argued that the agreement was not properly terminated because they were entitled to notice and opportunity to cure their alleged breaches. To show that it properly terminated the agreement, 7-Eleven must thus demonstrate that such notice was not required.

Proper termination. A contract may be terminated without notice and opportunity to cure in specific circumstances, even where contractual provisions require such notice, the court stated. Notice and opportunity to cure provisions, such as those in the parties’ franchise agreement, are not enforceable where a breach goes directly to the essence of the contract, which is so exceedingly grave as to irreparably damage the trust between the contracting parties.

Here, there was more than sufficient evidence of fraud to warrant termination of the contract without notice or opportunity to cure, because the fraud went directly to the essence of the contract, the court held.

The court did not need to address each of the individual elements of fraud as the defendants argued only that there was no evidence they knew or were reckless as to the unrecorded and under-recorded sales, and no evidence that they intended to mislead or defraud 7-Eleven. That argument was rejected by the court.

At the hearing 7-Eleven presented substantial evidence of defendants’ repeated failure to properly record sales over a period of several months. There were four general categories of such evidence: (1) over-use of certain “high risk” POS transactions, (2) failure of numerous “secret shops” conducted by 7-Eleven, (3) video from inside the store showing rampant misreporting of sales, and (4) significant discrepancies between reported sales and inventory purchased by the store.

James Pasarella testified with precise detail regarding each of the above findings, and described videotaped transactions evidencing fraud in franchisee-defendants’ store. Defense counsel failed to impeach any of Pasarella’s testimony regarding the defendants’ failure to accurately record sales, the court explained.

The franchisee-defendants’ testimony, to the extent that it offered any explanation for their actions, was not credible, the court held. The argument that the rampant failures to record sales stemmed merely from “mistakes” of the franchisees who had operated a 7-Eleven store for 23 years was unacceptable, in the court’s view. Further, 7-Eleven presented voluminous evidence painstakingly assembled from store video and POS data, which showed defendants repeatedly failing to record sales on several days over a period of months. Despite being provided with the store video, and having viewed numerous transactions identified by 7-Eleven as fraudulent at their depositions over a month before the hearing, franchisee-defendants failed to credibly explain such misrecording and under-recording.

7-Eleven proved all elements of fraud by clear and convincing evidence, and the fraudulent actions of the defendants constituted a breach going to the essence of the contract. Thus, the September 28, 2012 termination of the agreement without any notice or opportunity to cure was proper, and the agreement was terminated as of that date.

Likelihood of success. 7-Eleven’s trademark infringement claim required a showing that the defendants’ unauthorized use of 7-Eleven’s valid trademarks is likely to cause confusion, the court observed. Having concluded that the agreement in this case was terminated properly, defendants’ use of 7-Eleven’s trademarks was unauthorized.

The franchisee-defendants did not dispute that they continue to utilize 7-Eleven’s exact trademarks, trade names, and trade dress. Accordingly, there was a substantial likelihood of confusion on the part of consumers as to franchisee-defendants’ affiliation with 7-Eleven. 7-Eleven therefore demonstrated actual success on the merits of its trademark infringement claim, the court decided.

Irreparable harm and unavailability of remedies at law. The Third Circuit has previously held that a showing of trademark infringement alleges irreparable injury as a matter of law. However, even if irreparable injury could not be based solely on a finding of trademark infringement, 7-Eleven made a sufficient showing of irreparable injury to justify its requested relief, the court held.

As the franchisee-defendants continue to operate the store after the termination, 7-Eleven has lost control of those trademarks in and relating to franchisee-defendants’ store. There was clear potential for damage to 7-Eleven’s trademarks as, for instance, defendants were no longer bound by the agreement regulating store operations. 7-Eleven has shown irreparable injury resulting from loss of control of its marks, which cannot be compensated for in monetary terms.

In addition, 7-Eleven has established irreparable injury stemming from defendants’ continued occupancy of the store and interfering with 7-Eleven’s property rights. Interference with the real property of another may constitute irreparable harm due to the unique opportunities offered by certain real property.

Balance of hardships. The defendants, who have been found to have committed fraud, could not now complain of an injunction that resulted from their misconduct, the court reasoned. Any cognizable hardship to the defendants was outweighed by the immeasurable damage done to 7-Eleven, through the loss of control over its trademarks, as well as interference with its property. This factor also weighed in 7-Eleven’s favor.

Public interest. The public’s general interest in the prevention of fraud would be aided by the entry of an injunction here, according to the court. Further, an injunction would aid in the future accurate disclosure of sales and consequently the proper collection of taxes by the state and federal government.

Unclean hands. The defendants claim that 7-Eleven acted in bad faith and thus has “unclean hands,” by failing to provide notice and opportunity to cure the contractual breaches at issue, by disabling the Lottery machine, and removing the money order and EBT machines from the store. That argument was without merit, the court ruled.

Having concluded that the defendants breached the franchise agreement through fraudulent conduct, 7-Eleven was entitled to terminate the agreement without notice or opportunity to cure. Accordingly, such termination did not constitute bad faith and 7-Eleven’s shut-down or removal of various machines was not in bad faith either.

The case is Civil Action No. 12-5541.

Attorneys: Susan V. Metcalfe (Lebensfield Borker Sussman & Sharon LLP) for 7-Eleven, Inc. David F. McComb (Zarwin Baum DeVito Kaplan Schaer Toddy P.C.) for Milind L. Upadhyaya.

Companies: 7-Eleven, Inc.

Cases: FranchisingDistribution PennsylvaniaNews