Antitrust Law Daily Implied covenant claim in franchise encroachment dispute survives because of KFC’s own guidelines
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Monday, November 16, 2020

Implied covenant claim in franchise encroachment dispute survives because of KFC’s own guidelines

By Robert B. Barnett Jr., J.D.

The franchise agreement did not establish that KFC had the right to award whatever franchises it wanted outside the franchisee’s exclusive area, which implied the use of sound discretion as defined by KFC own guidelines.

A restaurant franchisee’s claim alleging that KFC, the franchisor of KFC fried chicken restaurants, breached the parties’ franchise agreement by agreeing to build another franchise too close to his franchise was dismissed because the guidelines that KFC developed for granting new franchises, upon which the franchisee’s claim depended, were not incorporated into the franchise agreement, the federal district court in Denver has ruled, applying Kentucky law. The franchisee’s claim for breach of the implied covenant of good faith and fair dealing, however, survived the motion to dismiss because the guidelines, though not part of the contract, did provide evidence of what constituted KFC’s "reasonable discretion" in awarding competing franchises (Kazi v. KFC US, LLC, November 12, 2020, Jackson, B.).

Background. Zubair Kazi owns and operates franchises around the U.S., including a KFC franchise in Pueblo, Colorado. Kazi sued KFC for establishing another KFC franchise near his restaurant, alleging claims for breach of contract, breach of the implied covenant of good faith and fair dealing, promissory estoppel, and unjust enrichment. The franchise agreement forbade KFC from licensing any other franchises within one and one-half miles from the franchisee’s restaurant. The new franchise was on the other side of Pueblo, more than a mile and one-half away, but less than 10 miles away. The suit sought a permanent injunction, preventing KFC from opening the new franchise.

At some point after the franchise agreement was signed, KFC issued a document called the KFC Impact Guidelines, which addressed the establishment of new franchises. It gave the closest existing franchisee, if within 10 miles, the right to either buy the proposed franchise or demand an impact study. If the impact study revealed an impact on the existing franchisee’s business of less than 10 percent, KFC could issue the new franchise without reservation. If the study revealed an impact of between 10 percent and 15 percent, KFC would undertake further review. If the study revealed an impact of more than 15 percent, KFC could not issue the new franchise.

After he learned of the plans to build the new KFC franchise nearby, the franchisee, who was the closest franchisee but who did not want to buy the new franchise, demanded an impact study, as was his right. The impact study showed a likely impact of 13.5 percent. Believing that the study was improperly conducted, the franchisee paid for a study by a different firm, which revealed a likely impact of between 33 percent and 36 percent. Undaunted, KFC agreed to franchise the new restaurant and construction began, which prompted the franchisee’s suit for an injunction to stop construction. Although no formal incorporation of the study guidelines into the franchise agreement had ever occurred, the franchisee alleged that the franchise agreement "came to include" the impact guidelines. KFC filed a motion to dismiss the suit.

Breach of contract. As for the franchise agreement itself, the franchisee pointed to no term or provision that KFC was alleged to have breached. The entire claim, therefore, relied on whether the guidelines were incorporated into the contract. Analyzing the contract, the court concluded that the guidelines could become part of the franchise agreement only if (1) the parties amended the agreement in accordance with the modifications clause or (2) the parties mutually assented to modification and provided new consideration.

No evidence existed that the agreement had been amended via the modifications clause. The guidelines were in writing, but they were not signed by either party. They were far less formally drafted than the original contract. No other evidence of modification was pleaded. There was no question, the court concluded, that the parties did not amend the agreement in accordance with the modifications clause.

As for the second path, statements in the complaint that the parties "came to an understanding" were merely conclusory and were insufficient to establish mutual assent. For example, the complaint never established who within KFC wrote the guidelines or how widely they were used. Similarly, the fact that KFC may have intended to comply with the guidelines did not establish assent. In addition, no evidence of any consideration being paid was ever pleaded. The guidelines benefitted the franchisee, so consideration would have to have been paid by the franchisee to the franchisor. As a result, the motion to dismiss was granted as it applied to the claim for breach of contract.

Implied covenant. KFC made four arguments for dismissing the claim for breach of the implied covenant of good faith and fair dealing. First, it argued that the claim should be dismissed because the underlying breach of contract claim was dismissed. Kentucky law, however, permits a stand-alone claim for breach of the covenant, even where the breach of contract claim does not exist.

Second, KFC argued that Kentucky law foreclosed the right to pursue a breach of the implied covenant in franchise encroachment cases. None of those cases cited by KFC, however, were determinative because none of them involved a franchisor issuing a policy that constrained its own actions.

Third, KFC argued that the implied covenant could not prevent a franchisor from exercising its rights under the contract. The court disagreed that this situation merely involved a franchisor exercising its rights, because this franchise agreement did not give the franchisor the right to do what it wanted outside the one-and-a-half mile radius. Whereas other franchise agreements in other cases contained such a rule, this one did not. Furthermore, the court refused to infer such a provision where it did not exist. In the absence of the provision, KFC had an implied right to use its discretion to award additional franchises. The covenant of good faith, however, requires that KFC’s discretion be reasonable. The guidelines provided evidence of what would be reasonable in those situations. The franchisee had the right to expect that KFC would abide by its own guidelines in good faith.

Fourth, KFC argued that it did follow its guidelines. While this was true up to a point, the franchisee alleged that the impact study was fundamentally flawed, including the failure to ask a critical question in the study. These pleadings, therefore, were sufficient to state a claim for breach of the implied covenant.

Promissory estoppel/unjust enrichment. The franchisee had also asserted claims for promissory estoppel and unjust enrichment. Both claims were dismissed because they cannot be asserted in the presence of a valid contract, which the court concluded existed, at least it applied to the claim for breach of the implied covenant.

The court, therefore, granted the motion to dismiss the breach of contract, promissory estoppel, and unjust enrichment claims, and it denied the motion to dismiss the claim for breach of the implied covenant of good faith and fair dealing.

The case is No. 1:19-cv-03300-RBJ.

Attorneys: Margaret R. Pflueger (Campbell Killin Brittan & Ray, LLC) for Zubair Kazi. Bruce Edward Rohde (Campbell Killin Brittan & Ray, LLC) for KFC of Pueblo, Inc. Daniel W. Bobier (Jenner & Block LLP) for KFC US, LLC.

Companies: KFC of Pueblo, Inc.; KFC US, LLC

MainStory: TopStory FranchisingDistribution ColoradoNews

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