As many readers may know, the FTC Rule on Franchising’s definition of franchise contains three basic definitional elements: (1) license of a trademark, (2) payment of a fee, and (3) provision of assistance or exertion of control. Additionally, twenty-six states regulate the offer and sale of franchises. Of those twenty-six states, eight define a franchise by incorporating a requirement that a “community of interest” exist between the parties, instead of the assistance/control element of the FTC Rule. This blog post contains refresher on the New Jersey Franchise Practices Act (NJFPA) and its interpretation of this definitional element. New Jersey courts have construed the element narrowly by focusing on the interdependence between the parties. Courts have primarily focused on the perceived abuse that franchisors may exert after a franchisee has made substantial investment in its business.
First, in Neptune T.V. & Appliance Service, Inc. v. Litton Microwave Cooking Products, Division Litton Systems, Inc., the Superior Court of New Jersey held that however “broad, elastic and elusive” the concept of community of interest is, it does not cover relationships that lack the “symbiotic character of a true franchise arrangement and consequent vulnerability of the alleged franchisee to the unconscionable loss of his tangible and intangible equities.” More than a mere sharing of profits is necessary in order to satisfy the element.
Second, in Colt Industries Inc. v. Fidelco Pump & Compressor Corp., the United States Court of Appeals for the Third Circuit relied on Neptune to conclude that a relationship that had equal bargaining power, no advertising requirement for the distributor and no sales quotas lacked the requisite community of interest to qualify as a franchise under the NJFPA, despite the requirement that the distributor provide warranty service for the manufacturer.
Again in New Jersey American, Inc. v. Allied Corp., the Third Circuit, citing Colt and Neptune, ruled that a company that assembled brake pads was not in a franchise relationship with its supplier of brake lining pads affirming that the NJFPA only applies to those business relationships that are particularly susceptible to the types of abuses a franchisor can exert over its franchisees. The seller was not subject to the “whim, direction and control of a more powerful entity whose withdrawal from the relationship would shock a court’s sense of equity” where the seller relied on many brake manufacturers for its supply, most of which are readily available to fill the supplier’s void, and the seller could not demonstrate any “franchise-specific” investment in capital equipment or goodwill.
The Third Circuit struck again in Cassidy Powell Lynch, Inc. v. SnyderGeneral Corp. and found a franchise relationship did not exist where there was a lack of control by the supplier and franchise-specific investment required in the distributorship agreement. The court concluded that unequal bargaining power did not exist because the knowledge and customer base the distributor acquired during the term of the agreement was not franchise specific and the distributor’s reliance on the supplier was self-imposed.
The NJFPA saga took a different turn in the Supreme Court of New Jersey’s decision in Instructional Systems, Inc. v Computer Curriculum Corp. The court found that the distributor established a base of clients in an area where no clients existed before the relationship and the manufacturer restricted the distributor from offering competing products and obligated the distributor to devote the entirety of its energies on development and sales of the manufacturer’s computers. As a result, the court held the distributor had established an interdependence between the parties sufficient to satisfy the community of interest element and thereby a franchise relationship.
Most recently, the United States District Court for the Eastern District of Pennsylvania interpreted the NJFPA narrowly, holding the statute did not apply. In Southern States Cooperative, Inc. v. Global AG Associates, Inc., the court discussed Cooper, Cassidy, Colt and Instructional and focused on whether the non-exclusive local retailer made substantial franchise-specific investments and whether it was required to do so under the terms of the underlying dealer agreement. Notably, the retailer voluntarily participated in the dealer’s advertising program and purchased large amounts of inventory.
Overall, the courts interpreting the NJFPA have established a fairly high bar to surpass in creating a franchise relationship where one was not initially contemplated. Holdings under the NJFPA have established a heavily fact-dependent inquiry with few definitive guidelines. The only successful claimant was the distributor in Instructional that demonstrated it had created an established base of clients where none existed before and was essentially forced to devote the entirety of its efforts to this one product because of the restriction on the sale of competing products. This seems ripe for the post-contract opportunistic behavior the NJFPA seeks to prevent. If you are seeking to avoid franchise designation under the NJFPA a client should focus on limiting the interdependence of the licensee/distributor and allow such party to establish its own business venture. Limiting franchise-specific expenditures will your cause as well. A carefully drafted license/distribution agreement will go a long way in helping you avoid the NJFPA clutches of evil!