By A. Christopher Young and Thomas T. Watkinson
Copyright 2009 Pepper Hamilton LLP. Reprinted with permission. All other rights reserved.
In a case of first impression in Pennsylvania, the Supreme Court of Pennsylvania held that certain types of dishonest conduct are so egregious that the franchisor may terminate the franchise immediately despite the existence of an express notice and cure provision in the franchise agreement. See LJL Transp., Inc. v. Pilot Air Freight Corp., PICS Case No. 09-0108. In doing so, the court rejected the franchisee's argument that an absolute right to cure any default exists under Pennsylvania law.
When Pilot, a freight forwarding company with numerous stations throughout the country, became aware that one of its franchisees, LJL Transportation, Inc. (LJL), was improperly shipping freight through companies other than Pilot despite its exclusive obligation, it terminated LJL's franchise without providing it an opportunity to cure its default. Pilot asserted that any attempt to cure the breach by LJL was impossible because LJL's dishonesty destroyed the trust that Pilot required to do business with LJL. In its suit against Pilot for breach of the franchise agreement, LJL claimed it was not given an opportunity to cure its admitted breach of the agreement within 90 days as expressly provided in the franchise agreement. LJL argued that the right to cure clause was absolute and, no matter what type of breach, it must be given an opportunity to cure by paying Pilot the royalties on the improperly diverted shipments.
Recognizing it as a matter of first impression in Pennsylvania, the Supreme Court agreed with the lower courts and found in favor of the franchisor. The court relied primarily on precedent from other jurisdictions, which held that certain types of dishonest conduct are so egregious and of such a nature that the aggrieved party may terminate the contract immediately even when a cure provision is specifically provided in the contract. Two fundamental principles of contract law underlay the court's decision: first, a material breach that goes to the root of the matter or the essence of the contract constitutes grounds for rescission without opportunity to cure, and 2) all franchise agreements imply a covenant of good faith requiring the parties not to engage in conduct that deprives the other of its rightful expectations. See 13 P.S. § 1203 "[e]very contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.") and 13 P.S. § 1201(20) (defining good faith in the commercial context of the sale of goods as "honesty in fact and the observance of reasonable commercial standards of fair dealing."). Generating business for each other was a core element/purpose of the franchise. LJL's diversions of business away from Pilot constituted a material breach of the implied covenant of good faith such that Pilot was not obligated to afford LJL an opportunity to cure the breach.
The court further rejected the franchisee's claim to an absolute right to cure under these circumstances, noting that the inclusion of an additional contract clause, which specified the parties retained other remedies at law and equity, could be fairly read as an "express indication" by Pilot of the right to exercise all remedies available to it after a breach by LJL, including its inherent power to terminate the contract without notice in the event of an essential breach.
The court stopped short of definitively holding that all dishonest conduct, no matter how insubstantial, gives rise to an immediate termination remedy. LJL's alternative argument that its breach was de minimus and, for that reason, it should have been given an opportunity to cure, was rejected because it was not encompassed by the court's order granting review. The Superior Court, although ruling the argument ultimately waived, had commented on the possibility that the trier of fact could have found the breach was not so egregious to warrant termination of the franchise agreement. See LJL Transp., Inc. v. Pilot Air Freight Corp., 905 A.2d 991, 993 (Pa. Super. 2006). Determining when dishonest conduct warrants summary termination of the franchise agreement must be made on a case-by-case basis. Examples of conduct that may allow for immediate termination without opportunity to cure are: Warehouseman's conversion by short-weighting deliveries of fertilizer, Olin v. Central Indus. Inc., 576 F.2d 642 (5th Cir. 1978); franchisee's scheme to hide revenue from franchisor, Southland Corp. v. Mir, 748 F. Supp. 969 (E.D.N.Y. 1990); manager engaging in self-dealings, Larken, Inc. v. Larken Iowa City P'ship, Ltd., 589 N.W.2d 700 (Iowa 1999); and employee misappropriating corporate funds and usurping business opportunities for himself, Leghorn v. Wieland, 289 So. 2d 745, 748 (Fla. Dist. Ct. App. 1974).
Although a case of first impression in Pennsylvania, the LJL decision follows authority from other jurisdictions and relies on established principles of contract law. Fortunately, the Supreme Court resisted the temptation to strictly follow the letter of the franchise agreement. Doing so would have only created an intolerable outcome that excuses - indeed encourages - dishonest conduct.
Endnotes
1 The diverted shipments amounted to only 0.5 percent of total billings and deprived Pilot of only $5,500 in royalties.
| About the Authors: |
A. Christopher Young is a partner in the Philadelphia office of Pepper Hamilton LLP and chairman of the Franchise, Distribution and Marketing Section of the Commercial Litigation Practice Group.
Thomas T. Watkinson, II is an associate in the Philadelphia office of Pepper Hamilton LLP, who concentrates his practice in commercial litigation, with a particular focus in federal securities, contract, antitrust, complex commercial litigation, media law, white collar crime and governmental investigations. |
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