Turf Wars

A landmark court ruling could have new implications in franchise relationships.
Magazine Contributor
11 min read

This story appears in the November 1996 issue of Entrepreneur. Subscribe »

For years (though it seems like forever) encroachment has reigned as franchisees' single most important concern. And yet a recent court ruling may have finally prompted the industry to come up with a definitive solution and at last put an end to the scuffles.

The ruling by the 9th U.S. Circuit Court of Appeals found that Mexican-restaurant chain Naugles Inc. breached the good faith and fair dealing clause in its franchise agreement when it opened a restaurant 1.4 miles away from a Long Beach, California, location owned by franchisee Vylene Enterprises Inc., which eventually went out of business.

Besides awarding Vylene damages of $2.2 million, the court handed franchisees considerable ammunition for future encroachment suits against franchisors. The Vylene case is "probably one of the most significant cases in franchising in the past 25 years," says Erik Wulff, a partner with Washington, DC, law firm Hogan & Hartson, who points out the case will likely set a persuasive precedent even for states outside the 9th Circuit's Western region jurisdiction.

Franchisees and their advocates, unaccustomed to the taste of legal victory, are thrilled. "It's obviously a very exciting case for franchisees," says Robert Purvin, chairman of the board of trustees of the American Association of Franchisees & Dealers. "In terms of encroachment, Vylene is a good-news case--the franchisee won. But the real significance of Vylene is that good faith and fair dealing in a franchise agreement have been acknowledged as the law in the 9th Circuit."

In fact, the Vylene case is significant in that it found Naugles had encroached on its franchisee even though the system's franchise contract did not guarantee a protected territory. Moreover, the court did not venture to define just how close is too close. So while franchisees rejoice, franchisors are biting their nails.

"The limits set in one court won't be the limits in another," says Lewis G. Rudnick, partner of Chicago-based law firm Rudnick & Wolfe. "It will be impossible for franchisors to figure out where to put additional units if they have to worry about being second-guessed [by the courts]."

This ambiguity is what's going to spawn litigation, Wulff adds. "Whenever franchisees think there's some impact on their unit and want to make a legal issue out of it," he says, "they've got a case that permits them to pursue that [allegation] to trial."

Meanwhile, Purvin believes the court was right to leave out a specific radial definition of encroachment. "The [issue of] substantive fairness is even more important than focusing strictly on encroachment," he says.

Fairness is ideal. Still, in the real world, most anticipate the case will result in a spate of franchisee-instigated litigation. "Franchisees and their lawyers are going to seize on this decision as giving new life to [their cause]," Rudnick predicts. "It will certainly be widely cited in their claims."

"Will franchisees be emboldened by the fact that over the last six months, they've had [several] significant decisions that went their way? You'd better believe it," says Purvin. "But I think that's going to cause more franchisors to wake up and take a reality check, and get together and negotiate with franchisees so they don't have problems."

Basically, franchisors have a few black-and-white options to offset lawsuits spurred by the Vylene case. "The first is to have a sensible expansion policy and to make decisions that [consider] the interests of franchisees," says Wulff. "The second thing they can do is start giving some radius protection to franchisees--it would be very unusual for a court to question a franchise agreement that contains radius protection, even though it may be relatively small. Or they could take a hard-nosed attitude and articulate in the franchise agreement that a franchisee has no territorial rights, is buying a franchise for a specific location, and that the franchisor has a right to put a location anywhere it wants."

Whatever the franchisor chooses, it's clear some action is necessary. "That way, you have some predictability in these situations," says Wulff. "It's better than leaving it to the vagaries of some court down the road."

Though the ruling requires harsh measures, "it may result in the issue of encroachment being addressed in a more positive way through [franchise] contracts," says Wulff. "Otherwise, as a franchisor, you're just going to end up spending all your time, effort and money on litigation. No one wants to do that."

Adds Purvin, "Franchisors will be crying foul, saying they can't predict what they can or can't open. But from the franchisees' perspective, we're pushing for mechanisms to set these definitions within [individual] systems. If people use their brains and are compassionate upfront, they can set up processes to ensure this whole [problem is solved]."

Room For Interpretation

As a precedent, does Vylene stand as a good law? It depends, of course, on whom you ask. "The Vylene case makes great sense," says Purvin. "All it says is two parties in business with each other should conduct themselves in a way that is win-win. I don't consider Vylene to be pro-franchisor or pro-franchisee. It happens in this case that the franchisee was encroached upon, but if the franchisee doesn't report all royalties or doesn't work his hardest to maximize the market, the franchisor should win the case on the same legal theory."

"The decision is wrong from several perspectives, for several reasons," counters Rudnick. "I think it's unfortunate that the Court of Appeals ignored the rather significant amount of case law on the subject, all of which preaches the opposite conclusion."

"The problem with Vylene is that it illustrates the old maxim that bad facts make for bad law," says Wulff. "You've got this court decision which, probably correctly, holds that the franchisor in this situation did something egregious--but in language that is so broad-brush, it affects the entire industry.

"It appears that what Naugles did was try to run Vylene out of business. That's not the way a franchisor normally conducts its expansion program. But the way the facts were [handled] will adversely affect franchisors' legitimate expansion policies."

Wulff believes the furor will eventually die down and that the law will, in time, correct itself. "I think one needs to take this in stride and recognize that each case is decided on its own facts," he says. "I would expect the pendulum to swing in the other direction, given time. Other courts will have the opportunity to address this issue in other factual contexts, and they'll come down with much less sweeping language than Vylene."

Purvin, on the other hand, sees the case as a definite sign of things to come. Pointing out that Vylene is the crest of a recent wave of precedent-setting legal cases favoring franchisees, Purvin says, "I don't ever remember a six-month period of time in which there was such a turning of the tide. [Vylene] did not occur in a vacuum but is the culmination of a trend. Those of us who have been talking about franchising fairness for the past four years seem to be making an impact. The courts have heard us."

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Posting Profits

For PostNet's president, it's all in the delivery.

By Holly Celeste Fisk

Steven J. Greenbaum has come a long way since the early '80s, when he was a consultant for Consolidated Services Corp., a postal business consulting company started by his and a friend's fathers. "Our fathers got us involved," recalls Greenbaum, "but we really took the bull by the horns."

In 1991, Greenbaum bought out the company and started fresh with two new partners--Brian Spindell and Dale Harelik--and an idea for a worldwide network of postal service franchises.

To hear Greenbaum tell it, turning that idea into reality was no big challenge--even though he was barely 30 years old at the time. "We drew from all the experience we had to create one system," says Greenbaum, now 35, of the birth of Henderson, Nevada-based PostNet International Franchise Corp.

"By 1991, the industry was fairly developed, and to enter that market, we needed something special," says Greenbaum. Accordingly, he designed a unique introduction for the PostNet franchising system: He approached 300 former clients of Consolidated Services Corp. and invited them to become PostNet franchisees.

"Within 75 days, more than 100 converted," he says. "They had confidence in us, they were committed to the idea, and they believed in the way we wanted to franchise."

Greenbaum describes the system as a "franchisee-inclusive" organization. "We're more of a partnership," he says. A franchisee advisory council, for example, has a voice in all PostNet decisions, from new products and advertising campaigns to the development of new markets.

Greenbaum takes just as active an interest in the franchises, attending at least one meeting per region each year and visiting franchisees often.

"That way I stay in touch with the people who are representing PostNet to consumers, and I know what [franchisees'] needs are," he explains.

Such commitment takes time. Greenbaum has pared down the 70 to 100 hours he worked per week the first few years to a still-grueling 60-hour week. "It would be nice to work 40," he says. But that won't happen until PostNet achieves dominance in the postal franchise industry.

It's on its way: The company has grown to 300 U.S. franchises and 120 international franchises, and is expanding by about eight to 10 stores a month. Systemwide sales for 1995 reached $6.4 million; projections for 1996 are $7.2 million.

International locations have contributed a large portion of those sales. PostNet has master franchisees in South Africa, Brazil, Canada, Colombia, the Caribbean and the Philippines, as well as plans to enter Japan, France and Italy.

Greenbaum is now looking to expand the PostNet Express concept. Express locations, which offer a pared-down selection of services, do business in host locations such as grocery stores, airports and office buildings, using a fraction of the space of a traditional PostNet store. The first PostNet Express opened in Smith Food and Drug Centers in Las Vegas in November 1994; so far there are 16, and Greenbaum hopes to have a total of 40 Express locations up and running by year-end.

At the other end of the spectrum, PostNet Superstores are in the works as well, with the first one opening last year in Henderson. Future mammoth mail centers will range from 1,800 to 3,000 square feet and offer services such as computer rentals, Web site development, graphic design and Internet access.

"Our goal is to have 1,000 PostNet centers operational by the year 2000," says Greenbaum. "And we're on track for that."

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