Critical Legal Cases for Chapter 40
40.1 Tort Liability: No. The Costa Mesa 7-Eleven franchisee was not an agent of the franchisor, the
Southland Corporation. Also, the doctrine of apparent agency does not apply to the facts of the case.
Therefore, Southland is not liable for the alleged tortious conduct of its franchisee. In the field of
franchise agreements, the question of whether the franchisee is an independent contractor or an agent
depends on whether the franchisor exercises complete or substantial control over the franchisee. The
Southland agreement recites that the franchisees are independent contractors, and provisions in the
agreement give the Trujillos, the franchisees, the right to make all inventory, employment and operational
decisions. As provided under the franchise agreement, the franchisee exercised full and complete control
over the store’s employees, including the hiring, firing, disciplining, compensation and work schedules.
The franchisee could purchase whatever inventory it chose and from whatever supplier it want to
purchase them from. It was the sole decision of the franchisee to sell clove cigarettes. Southland did not
advertise, promote or merchandise the clove cigarettes sold at the franchisee’s store. Therefore, the Costa
Mesa 7-Eleven franchisee was not an express or apparent agent of Southland, but was an independent
contractor. The Southland Corporation, the franchisor, is not liable for the franchisee’s alleged tortious
conduct in this case. Cislaw v. Southland Corporation, 4 Cal.App.4th 1284, 6 Cal.Rptr.2d 386, Web 1992
Cal. App. Lexis 375 (Court of Appeal of California)
40.2 Franchise Agreement: H & R Block wins. The court held that June and Robert McCart had violated
the covenant not to compete that was part of the franchise agreement with H & R Block. First, the court
held that the covenant not to compete was reasonable in scope (tax preparation), time (for two years after
termination of the franchise), and place (250 miles from the location of the franchise). Second, the court
determined that although Robert had not signed the franchise agreement, he was still bound by its terms.
The court reasoned that Robert had acted together with June to breach her agreement with Block and that
he had knowingly participated in and aided June’s violation of the agreement. The court found that the
opening of the new office under Robert’s name was a mere subterfuge designed to avoid June’s
obligations under the franchise agreement.
The court held that the covenant not to compete was an enforceable provision of the franchise
agreement that had been entered into between the parties. The court found that H & R Block had a
valuable property right in its service mark, which was heavily advertised nationally, and that customers
were attracted to the franchise office because of the company’s name recognition and goodwill. By
including the covenant not to compete in its franchise agreements, Block preserved the value of this
property right to itself alone after termination of the agreement. The court held that the McCarts had
violated the covenant not to compete and issued an injunction enforcing provisions of the covenant.
McCart v. H&R Block, Inc., 470 N.E.2d 756, Web 1984 Ind. App. Lexis 3039 (Court of Appeals of
Indiana).
40.3 Franchise Agreement: .No, McDonald’s is not liable for breaching the franchise agreement with
Libby-Broadway Drive-In, Inc. (Libby). When McDonald’s granted a franchise to a third party to operate
a franchise restaurant on the west side of Turney Road, the franchise agreement granted Libby an
exclusive territory in which the westernmost boundary was simply described as “Turney Road.” The court
held that even assuming by this description the parties intended that Libby’s exclusive territory should
extend to the western edge of Turney Road, it is undisputed that the new franchise is located to the west
of that boundary. Therefore, the granting of this franchise did not infringe upon the exclusive territory
granted to Libby in the franchise agreement. The court held that McDonald’s had not breached the
franchise agreement, and affirmed the trial court’s grant of summary judgment in favor of McDonald’s.
Libby-Broadway Drive-In, Inc. v. McDonald’s System, Inc., 72 Ill. App. 3d 806, 391 N.E.2d 1, Web 1979
Ill. App. Lexis 2698 (Appellate Court of Illinois).
40.4 Franchisor Disclosure: Dowmont, the franchisee, wins on its counterclaim against My Pie
International, Inc. (My Pie). The court held that My Pie had violated the Illinois Franchise Disclosure Act
when it granted the franchise to Dowmont to operate the restaurant in Glen Ellyn, Illinois, because My
Pie had failed to register with the state of Illinois or to qualify for an exemption from registration, and had
failed to provide proper disclosures to Dowmont as required by the act.
The Illinois Franchise Disclosure Act provides for a private cause of action to persons who have been
harmed by a franchisor’s noncompliance with the act. The court held that My Pie’s violations of the act
permitted Dowmont to rescind the franchise agreement and recover the royalties it had paid to My Pie
during the course of the franchise. The court of appeals remanded the case to the trial court for
determination of the royalty damages to be awarded to Dowmont.
Note: If My Pie had violated the disclosure requirement of the Federal Trade Commission Disclosure
Rules (FTC Rules), the government could have sued My Pie, alleging a violation of the federal law. The
FTC rules do not, however, provide for a private cause of action. Therefore, Dowmont could not have
sued My Pie to rescind the franchise agreement and recover damages under the FTC Rules. My Pie
International, Inc. v. Dowmont, Inc., 687 F.2d 919, Web 1982 U.S. App. Lexis 16537 (United States
Court of Appeals for the Seventh Circuit).
40.5 Tort Liability: The trial court jury held the Seven-Up Company liable for the carton breaking and
the Seven-Up bottle exploding, causing blindness in one of Sharon Koster’s eyes; the jury awarded her
$150,000 in damages against Seven-Up. The law provides that a franchisor, like a manufacturer or
supplier, may be liable to the consumer for its own negligence. Seven-Up alleged, however, that it could
not be held liable for Koster’s injuries because it did not manufacture, handle, or require its franchisee,
Brooks, to use the cartons manufactured by Olinkraft, Inc. The court rejected this argument, holding that a
franchisor that retains the right to control the design of the product may be held liable for any injury that
product may cause.
The court stated:
In this case, the Seven-Up Company not only floated its franchisee and the bottles of its
carbonated soft drink into the so-called “stream of commerce.” The Company also assumed
and exercised a degree of control over the “type, style, size, and design” of the carton in
which its product was to be marketed. The carton was submitted to Seven-Up for
inspection. With knowledge of its design, Seven-Up consented to the entry in commerce
of the carton from which the bottle fell, causing the injury. The franchisor’s sponsorship,
management, and control of the system for distributing 7-Up, plus its specific consent to
the use of the carton, in our view, places the franchisor in the position of a supplier of the
product for purposes of tort liability.
The court of appeals held that the case had been properly submitted to the jury based on the theory of
breach of implied warranty. However, the court of appeals found that the trial court judge had given the
jury an improper instruction regarding the doctrine of “inherently dangerous” products, and remanded the
case for a new trial. Kosters v. Seven-Up Company, 595 F.2d 347, Web 1979 U.S. App. Lexis 15945
(United States Court of Appeals for the Sixth Circuit).
40.6 Trademark: .Ramada Inns wins. The court held that Gadsden Motel Company (Gadsden) had
infringed on Ramada Inns’ trademarks and service marks by its unauthorized use of such marks. The
franchise agreement granted Gadsden, the franchisee, a license to use the “Ramada Inns” marks during
the course of the franchise. However, when Ramada Inns properly terminated the franchise agreement
with Gadsden on November 17, 1983, Gadsden lost the right to use the Ramada Inn trademarks and
service marks. Evidence showed, however, that Gadsden continued to use the “Ramada Inns” marks for at
least six months past that date. Therefore, the court found that Gadsden had engaged in trademark
infringement in violation of the Lanham Act. The court of appeals affirmed the trial court’s judgment
which awarded Ramada Inns $47,165 in trademark infringement damages, $29,610 in lost franchise fees
for the six-month “hold over” period, $15,000 for advertising to restore Ramada Inns’ good reputation,
and $20,000 in attorney fees. Ramada Inns, Inc. v. Gadsden Motel Company, 804 F.2d 1562, Web 1986
U.S. App. Lexis 34279 (United States Court of Appeals for the Eleventh Circuit).
40.7 Termination of a Franchise: The dealership wins. The court found that Kawasaki USA had
wrongfully terminated the franchise held by Kawasaki Shop of Aurora (Dealer). Illinois franchise law
provides that a franchise agreement may not impose “unreasonable” restrictions on motor vehicle dealers.
The court held that the site-control provision in the franchise agreement that required the franchisor’s
written approval before the franchisee could relocate within its exclusive territory was an unreasonable
restriction in violation of the law. The court cited evidence that Kawasaki USA had objected to the move
because the dealer was creating a multiline franchise location from which it would sell Honda, Suzuki,
and Yamaha motorcycles as well as Kawasaki motorcycles. The court held that a multiline franchise
dealership was expressly permitted by the franchise agreement. Thus, Kawasaki was wrongfully using the
site-control provision to violate the multiline dealership provision in the franchise agreement. Based on
the evidence, the court held that Kawasaki USA had wrongfully terminated the Dealer and awarded the
Dealer $323,690 as compensatory damages and $79,422 in attorney fees. Kawasaki Shop of Aurora, Inc.
v. Kawasaki Motors Corporation, U.S.A., 188 Ill. App. 3d 664, 544 N.E.2d 457, Web 1989 Ill. App.
Lexis 1442 (Appellate Court of Illinois).
VI. Business Ethics Cases
40.8 Ethics: Campbell was not an agent of Southland. Only Campbell managed the day-to-day activities
of the store: she hired and fired employees, and set their wages; and the contract provided that the
relationship was one of independent contractor. The only evidence of agency is the fact that the liquor
license was issued to “Campbell Valerie Southland #13974,” but this is simply an identification of the
licensee as a franchisee of Southland. The license was not issued to Campbell and Southland. The issue of
agency is a matter of fact. Here, the factfinder determined that there was no agency relationship and that
finding is supported by substantial evidence. Wickham v. The Southland Corporation, 168 Cal.App.3d 49,
213 Cal.Rptr. 825, Web 1985 Cal. App. Lexis 2070 (Court of Appeal of California).
40.9 Ethics: The Kentucky Fried Chicken Corporation (KFC) is the franchisor of Kentucky Fried
Chicken restaurants. Franchisees must purchase equipment and supplies from manufacturers approved in
writing by KFC. Equipment includes cookers, fryers, ovens, and the like; supplies include carry-out
boxes, napkins, towelettes, and plastic eating utensils known as “sporks.” These products are not trade
secrets. KFC may not “unreasonably withhold” approval of any suppliers who apply and whose goods are
tested and found to meet KFC’s quality control standards. The 10 manufacturers who went through
KFC’s approval process were approved. KFC also sells supplies to franchisees in competition with these
independent suppliers. All supplies, whether produced by KFC or the independent suppliers, must contain
“Kentucky Fried Chicken” trademarks.
Upon formation in 1972, Diversified Container Corporation (Diversified) began manufacturing
and selling supplies to Kentucky Fried Chicken franchisees without applying for or receiving KFC’s
approval. All the items sold by Diversified contained Kentucky Fried Chicken trademarks. Diversified
represented to franchisees that its products met “all standards” of KFC and that it sold “approved
supplies.” Diversified even affixed Kentucky Fried Chicken trademarks to the shipping boxes in which it
delivered supplies to franchisees. Evidence showed that Diversified’s products did not meet the quality
control standards set by KFC. KFC sued Diversified for trademark infringement. Who wins?
Both the trial court and the U.S. Court of Appeals found that Diversified had infringed upon KFC's
trademarks. Diversified argued that KFC had created illegal tying agreements by forcing franchisees to
purchase their goods from only approved vendors. Diversified had never requested that they be certified
as an approved vendor. KFC had never denied any supplier that had requested permission to use the
trademarks, upon the supplier supplying proof of the quality of their goods. The courts also noted that
there are nine independent suppliers that have been approved.
The appeals court found, applying the per se rule, that there was no illegal tying agreement. Franchisees
were able to nominate other suppliers, all of which had been approved, to date. Further, the franchisor has
a strong argument in that requiring specific standards for the merchandise ensures a maintenance of the
quality standards expected for the goods sold and distributed under the KFC label to consumers.
Finally, as to the matter involving the trademark infringement, the courts found that Diversified had
willfully infringed in using the tradenames, trademarks, and colors of KFC on boxes, bags, and other
items. They had not indicated anywhere on the packaging that the product was made by Diversified, or
was not authorized by KFC. Under the circumstances, the courts determined that the intent to mislead the
public was there, and that confusion was highly likely; for these reasons, Diversified was found to have
infringed upon KFC's marks. Kentucky Fried Chicken Corporation v. Diversified Container Corporation,
549 F.2d 368, Web 1977 U.S. App. Lexis 14128 (United States Court of Appeals for the Fifth Circuit).