Wednesday, September 20, 2023
I love me a good franchise case. We all encounter franchises with great frequency, and they involve us in interactions both with large multi-national corporations and with their local and often small-time agents. The relationship between franchisees and franchisors is complicated and often vexed. Franchising strategies can make or break large chains, and as this case illustrates, can also enrich the franchisees -- or do them great economic harm. Here, the franchisee is also extremely well-to-do, but I suspect he worked his way, over decades, to his current station from a much more humble one.
As an added bonus, this case was decided by friend-of-the-blog Judge Harris Hartz (right) . The case involves a claim that KFC (which now officially stands for KFC) breached an agreement with a Pueblo, Colorado franchisee, or at least the duty of good faith and fair dealing, by allowing for a second franchise in the town. In Kazi v. KFC, US, LLC, the Tenth Circuit vacated a jury verdict in favor of the franchisee and remanded for an entry of summary judgment in favor of KFC.
Plaintiff Zubair Kazi has been the proud owner of a KFC franchise in South Pueblo since 1986. He most recently renewed his franchise for ten years in 2017. He owns a total of eighty franchise restaurants, which generate over $100 million in annual revenue. In 2019, KFC licensed a new franchise in north Pueblo.
The case provides a great history of the economic context in which the case arose. In short, KFC downsized early in the 21st century, and during that time, Mr. Kazi lost three of his four Pueblo franchises. In 2016, KFC was ready to start establishing new franchises again, but it did so through a cooperative agreement with franchisees to protect their profitability. Before a new franchise was opened, a feasibility study had to be undertaken with an eye to the impact on existing franchises. No new franchise could be built within a fixed radius of an existing franchise and the closest existing franchisee was to be offered an opportunity to own the new franchises. The feasibility studies were undertaken by a firm designated in cooperation with the franchisees.
In this Pueblo case, the feasibility study indicated that the impact on Mr. Kazi's franchise would be within acceptable parameters. Mr. Kazi did not seek the franchise for himself. Instead, he demanded a second feasibility study, which came out higher, but still within acceptable parameters. Mr. Kazi then undertook his own study of the projected impact of the new franchise on his business. According to KFC's agreement with its franchisees, anything above a 15% decline in revenue was unacceptable; Mr. Kazi's study indicated that the new franchise would cause his revenues to decline by 35%. KFC ignored Mr. Kazi's study, and that seems fair, as the entity that undertook the original study was approved by KFC's franchisees.
Then something procedurally messy occurred. Real estate issues caused KFC to move the new franchise to a new location. It was now farther away from Mr. Kazi's franchise. KFC consulted the appraisers, and they advised that no new feasibility study was necessary. If anything, the move would lessen the impact on Mr. Kazi's franchise. And so KFC proceeded. Mr. Kazi was not informed of the change.
Mr. Kazi brought his suit in November 2019. The District Court dismissed most of his claims, but his claim for a breach of the implied duty of good faith and fair dealing went to the jury, and the jury found for Mr. Kazi, awarding him nearly $800,000 in damages. On appeal, the Tenth Circuit found that the District Court erred. Mr. Kazi could not state a claim for breach of the duty of good faith and fair dealing under Kentucky law.
Following case law from Kentucky and the Sixth Circuit, the Tenth Circuit concluded that, in order to state a claim for a breach of the duty of good faith and fair dealing, a party must allege that the other party's bad faith defeated "an expectation created by the language of the contract." Mr. Kazi could make no such allegation. The KFC franchise agreement specifically addresses the issue of encroachment of new franchises on the domain of existing franchisees and provides a contractual solution. The Tenth Circuit surveyed other case law involving franchise agreements and found near unanimity that "if the franchise agreement addresses encroachment, the franchisee cannot invoke the good-faith covenant to expand its protections against encroachment beyond the contract terms." The only circuit court to go the other way was the Ninth, which relied on a Florida case subsequently rejected by the Eleventh Circuit.