District Court Broadly Interprets NJFPA 20% Requirement

The Protections of the New Jersey Franchise Practices Act Still Potentially Available to Businesses That Do Not Derive 20 Percent Of Sales From Franchise

On July 11, the District Court of New Jersey held in no uncertain terms that a business seeking the protections of the New Jersey Franchise Practices Act, N.J.S.A. §§ 56:10-1, -15 (“NJFPA” or the “Act”), could fall under the umbrella of the Act if there existed a mere intention of 20% of the business sales deriving from a purported franchise’s products/services.   

Background on the Case

In Ocean City Express Co. v. Atlas Van Lines, Inc., Civil No. 13-1467 (JBS/KMW) (D.N.J. July 12, 2016), Ocean City Express Co, Inc. (“Ocean City” or “Plaintiff”) alleged that Atlas Van Lines, Inc. (“Atlas” or “Defendant”) violated the NJFPA by terminating the parties’ Agency Agreement of March 31, 2016 without “good cause.”  After multiple other motions, Atlas moved for summary judgment claiming that, among other failings, the arrangement between the parties did not qualify as a franchise under the NJFPA because less than 20% of the Plaintiff’s gross sales derived from the Agency Agreement.  Indeed, Ocean City readily admitted that only 2.71% of its actual sales in 2010 derived from the Agency Agreement.  Ocean City, in response, claimed that while its actual gross sales fell below the 20% threshold, the intention in executing the Agreement was for sales to exceed the 20% mark and the failure to meet this mark was as a result of the Defendant’s actions.

Analysis of the NJFPA’s 20 Percent Mandate

The Court rejected Atlas’ argument and ultimately denied summary judgment.  In doing so, the Court explained that, by the plain language of the NJFPA, a mere intention for 20% of sales to be derived from the franchise could satisfy the 20% requirement of the Act.  Indeed, the NJFPA provides, in relevant part, that for a purported franchisee to receive the Act’s protections, “more than 20% of the franchisee's gross sales [must be] intended to be or are derived from such franchise.”  Additionally, the Court cited precedent holding that remedial statutes such as the NJFPA should be read broadly to give effect to the legislative purpose of the law.  Applying these precepts, the Court concluded that the NJFPA “compels, on its face, an inquiry into the scope of intended revenues, in addition to actual revenues.”

The Court also noted that even a cursory look at the factual record demonstrated that at least the plaintiff intended that Ocean City would derive over 20% of its gross sales from the arrangement with Atlas.  As such, the court held that “a reasonable factfinder could well conclude that Ocean City meets the 20% requirement of the New Jersey Franchise Practices Act ("NJFPA"), due to the parties' intent, as a matter of law.”

The New Jersey Franchise Practices Act: Beware the “Constructive Termination”

In any franchise relationship, a franchisor may wish to terminate a franchisee for reasons having nothing to do with a franchisee’s performance. Perhaps the franchisor seeks to downsize the number of franchisees in its fleet or distribute its products through a new business plan in which the franchisee no longer fits.  In any event, a New Jersey franchisor likely knows that, absent good cause, the New Jersey Franchise Practices Act generally prohibits a franchisor from terminating a franchisee.  In other words, the franchisor’s hands may be tied.

What if, however, the franchisee decides to back out of the franchise relationship on its own?  Could a savvy franchisor avoid the prohibitions of the Franchise Practices Act by simply making its franchisee’s life so miserable that the franchisee decides to leave the franchise?  

Not likely.

The Franchise Practices Act generally prohibits both express termination and “constructive termination” of a franchisee without good cause.  As explained by the Appellate Division in Maintainco, Inc. v. Mitsubishi Caterpillar Forklift American, Inc., 408 N.J. Super 461, 479 (App. Div. 2009), “the word “ ‘termination’ in the [Franchise Practices Act] includes constructive termination in accordance with traditional contract law principles.”  

What conduct constitutes a “constructive termination”?  Generally, where a franchisee gives up a franchise because a franchisor acts in a manner that would force a reasonable franchisee to leave a franchise, the franchisor’s conduct may give rise to a “constructive termination” claim.  Indeed, a change in the terms of the relationship could count as a “constructive termination”.  For example, where a franchisor removes a franchisee’s designation as the “exclusive” distributor while still permitting the franchisee to be a non-exclusive distributor of its products, this action may constitute a “constructive termination” under the Franchise Practices Act.  See 408 N.J. Super 479-480.

Bottom line -- franchisors should think twice before attempting to push a franchisee to leave a franchise “voluntarily” or engaging in conduct that would force a reasonable franchisee to give up the franchise.   The franchisor’s actions may constitute a “constructive termination” under the Franchise Practices Act and result in the same repercussions as an express termination of the franchisee.