United States District Court for the District of New Jersey Finds Franchisee’s Felony Conviction is Not a Valid Basis for Immediate Termination of a Franchise Agreement Under the New Jersey Franchise Practices Act When the Crime is Not “Directly Related to the Business Conducted Pursuant to the Franchise”
All franchisors and distributors should be aware of a June 27, 2012, decision in which the United States District Court for the District of New Jersey reaffirmed the New Jersey Franchise Practices Act’s (“FPA”) strong policy of protecting the rights of franchisees and limiting a franchisor’s ability to terminate a franchise agreement without first providing 60 days written notice — even in the face of a franchisee’s felony conviction — so long as that conviction is not “directly related to the business conducted pursuant to the Franchise.”
In International House of Pancakes, LLC, et al. v. Parsippany Pancake House Inc., Civil Action No. 12-03307 (WJM) (MF), the District Court denied International House of Pancakes’ (“IHOP”) request for a preliminary injunction enforcing IHOP’s termination of Defendant Parsippany Pancake House, Inc.’s (“Pancake House”) franchise and prohibiting Pancake House from continued use of IHOP’s logos and other marks. IHOP terminated the franchise, effective immediately, after learning that Pancake House’s president and majority owner pleaded guilty to the crime of endangering the welfare of a minor, and admitted during his plea hearing to having engaged in sexual conduct with a minor, a felony.
IHOP ended Pancake House’s franchise based upon language in the franchise agreement providing for immediate termination if the franchisee is convicted a felony. Pancake House countered that the provisions of the FPA trumped the franchise agreement and that the FPA required 60 days written notice as a prerequisite for effective termination because the crime did not relate directly to the franchisee’s business. The relevant section of the statute provides that:
It [is] a violation of this act for any franchisor… to terminate… a franchise without having first given written notice setting forth all the reasons for such termination… to the franchisee at least 60 days in advance of such termination…, except… where the alleged grounds are the conviction of the franchisee in a court of competent jurisdiction of an indictable offense directly related to the business conducted pursuant to the franchise in which event the aforementioned termination… may be effective immediately upon the delivery and receipt of written notice of same at any time following the aforementioned conviction. It shall be a violation of this act for a franchisor to terminate… a franchise without good cause.
N.J.S.A. § 56:10-5 (emphasis added).
The District Court, while recognizing that a franchisee’s criminal conviction may constitute “good cause” for termination under the FPA, held that unless the conviction at issue is directly related to the franchise’s business, it would be insufficient to support an immediate termination of the franchise relationship and, at best, would only allow a franchisor to terminate after providing 60 days written notice. The Court reasoned that it was “unwilling to accept that potential damage to a franchisor’s brand, standing alone, is sufficient to satisfy the ‘directly related’ standard of the FPA.” In reaching this conclusion, the Court noted a lack of evidence suggesting that the crime occurred at the franchise location, caused any adverse publicity or loss of profits, or had any other direct connection to Pancake House’s business. The Court reached this conclusion despite the Franchise Agreement’s specific language that authorized the immediate termination in the event that the franchisee was convicted of a felony.
Franchisors and distributors faced with the issue of terminating a New Jersey franchisee should remain mindful that, even if a termination appears to be appropriate under the terms of the relevant contract, the more stringent protections of the FPA govern, opening franchisors to potential liability for wrongful termination.