Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—WDKy: Owners of KFC franchisee corporations not subject to Kentucky jurisdiction, (Jun 24, 2013)

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

Several individuals who were the owners, officers, and directors of six related franchisee corporations that operate Kentucky Fried Chicken (KFC) restaurants in six states—California, Idaho, Oregon, Alaska, Texas, and Minnesota—were not subject to personal jurisdiction in Kentucky for purposes of an action by KFC Corporation and KFC U.S. Properties, Inc. (collectively KFCC), the federal district court in Louisville has decided (KFC Corp. v. Wagstaff, June 19, 2013, Simpson, C.). Transfer of the action to the federal district court in Minneapolis was warranted.

Background. The individual defendants do not reside in Kentucky. KFCC is a Kentucky corporation and the defendants’ franchisee corporations are all California corporations.

The defendants’ franchisee corporations defaulted on the original franchise agreements governing their collective seventy-seven KFC restaurants by failing to pay royalties and advertising costs they owed KFCC. KFCC then terminated them as franchisees. The default triggered negotiations between the defendants and KFCC for a Reinstatement Agreement, which gave the defendants’ franchisee corporations an opportunity to sell the restaurants, to sign promissory notes for the outstanding debt they owed KFCC, and to upgrade the restaurants for resale. In April 2011, all six of the defendants’ franchisee corporations filed for Chapter 11 bankruptcy in Minnesota.

In this action, in Count I, KFCC requests a declaratory judgment that the individual defendants, as guarantors, are liable to KFCC for the debts that arise out of and relate to the defendants’ KFC restaurant operations, promissory notes, and other contracts with the defendants. In Count II, KFCC alleges that the defendants breached their personal guaranties and KFCC requests an award for past-due and future obligations arising from the defendants’ alleged breach.

Personal jurisdiction based on consent. At issue was whether the forum selection clause in the Notes and Prenegotiation Agreement should be read with the personal guaranties as one contract between the parties.

Under the Prenegotiation Agreement, each individual defendant, in his or her personal capacity along with the defendants’ franchisee corporations, consented to personal jurisdiction in Kentucky. KFCC argued that the individual defendants consented to jurisdiction because the agreement includes the defendants’ individually, along with the franchisee corporations, under the term “Franchisee” in the preamble. The agreement also specifies that each “Franchisee” consents to personal jurisdiction in Kentucky “for all purposes,” and each individual defendant personally signed the agreement.

The link between the Prenegotiation Agreement and the defendants’ intent to consent to personal jurisdiction was weak, according to the court. The Prenegotiation Agreement was a separate and unique instrument from the Notes and guaranties, and the court would not read its forum selection clause in combination with the other documents.

The documents did not make one contract when the entire context of the agreements was taken into account, the court held. The purpose of the Prenegotiation Agreement was to formalize KFCC’s agreement to forgo legal proceedings for the franchisee corporations’ breach of the original franchise agreements in order to allow time to negotiate payment of the franchisee corporations’ existing obligations and possible reinstatement of the franchise agreements for the purpose of facilitating the sale of the seventy-seven KFC restaurants. The Prenegotiation Agreement merely allowed time for the parties to negotiate, while the Notes and guaranties required payment of past-due and future debts. The documents were not sufficiently related for the court to read all three documents together as one.

Also, KFCC’s claims against the individual defendants did not arise from the Prenegotiation Agreement. In this action, KFCC seeks repayment of the debts that the individual defendants’ owe as guarantors of their corporations’ franchise agreements. The Prenegotiation Agreement did not provide for repayment, the court noted.

Following the execution of the Prenegotation Agreement, the defendants’ franchisee corporations entered into Promissory Notes, which the individual defendants’ later personally guaranteed. The Notes contain a forum selection clause naming Kentucky as the agreed upon forum, while the guaranties lack a forum selection clause.

It was undisputed that the individual defendants’ are the owners, officers, and directors of the franchisee corporations which are bound by the Notes; that the Notes reference the individual defendants’ personal guaranties; and that the Notes indicate that guarantors submit to Kentucky jurisdiction, the court observed. However, the individual defendants named in this action did not sign the Notes, the defendants were not parties to the Notes, and the guaranties did not contain a forum selection clause. Thus, the Notes and guaranties were not one indivisible contract, and the court declined to exercise personal jurisdiction over the individual defendants who did not consent to such an exercise of jurisdiction, the court determined.

Jurisdiction under Kentucky long-arm statute. Kentucky's long-arm statute authorizes personal jurisdiction over, among others, a person whose actions arise from transacting any business in Kentucky.

Under KRS § 454.210(2)(a)(1), for the court to exercise personal jurisdiction over a person who is transacting business in Kentucky, the plaintiff must also show that the claims “arise from” those activities in Kentucky. However, KFCC’s cause of action did not “arise from” the defendants’ transaction of business in Kentucky, the court held.

Although four defendants traveled to Kentucky, their infrequent travel was unrelated to the Notes or guaranties at issue here. Further, although the individual defendants signed the guaranty agreements, minimum contacts with a forum state cannot be established solely on the basis of a contract between a resident and a non-resident.

Merely executing personal guaranty agreements outside of Kentucky for restaurants that were not located in Kentucky or owned by Kentucky corporations is not a reasonable and direct nexus between KFCC’s claims and the defendants’ business activity in Kentucky. By signing the personal guaranties the defendants risked their names and financial worth to aid in the establishment of the franchises. However, the franchisee corporations were not Kentucky corporations. The defendants did not have any property or financial interests in a Kentucky corporation. Because KFCC’s claim did not arise from any enumerated provisions in the long-arm statute, the court lacked personal jurisdiction.

Transfer of venue. 28 U.S.C. § 1412 provides for transfer of cases or proceedings “under title 11.” Lower courts in the Sixth Circuit have held that a case falls within the purview of § 1412 if it is “related to” a bankruptcy proceeding as that term is used in § 1334(b).

The possibility of multiple indemnification claims by the defendants against the franchisee debtors—if the defendants are found liable to KFCC—along with the effect that such indemnification claims could have on the Minnesota Bankruptcy proceeding and the franchisee debtors’ estates and reorganization plans, indicated that this action “relates to” the proceedings of the Bankruptcy Court of the District of Minnesota, the court decided. Therefore, it applied § 1412’s transfer provisions.

Application of the relevant factors indicated that transfer to the District Court of Minnesota served the interest of justice, the court explained. The first three factors militated toward transfer. The first factor is a “strong presumption” in favor of transfer to the District Court of Minnesota because the bankruptcy proceeding is pending in the Bankruptcy Court for the District of Minnesota. The second factor, the economics of estate administration, also leaned towards transferring this case. The third factor, judicial efficiency, weighed in favor of transfer because the Minnesota court already has before it a large number of the parties and witnesses relevant to this suit by virtue of the defendants’ roles as the franchisee debtors’ shareholders, officers, and members of the boards of directors.

The fourth, fifth, and sixth factors––the ability to receive a fair trial, the state’s interest in having local controversies decided within its borders, and the enforceability of any judgment rendered––did not weigh strongly against transfer of the case to the District Court of Minnesota. The seventh factor––the plaintiff’s original choice of forum––weighed in favor of retaining venue in this court.

In light of all of the factors, the defendants’ motion to transfer venue to the District Court of Minnesota under 28 U.S.C. § 1412 was granted, the court reasoned.

The case is No. 3:11-CV-00674-CRS.

Attorneys: Charles J. Cronan , IV (Stites & Harbison, PLLC) for KFC Corp. David S. Kaplan (Miller Wells PLLC) for Denman E. Wagstaff.

Companies: KFC Corp.

Cases: FranchisingDistribution KentuckyNews