Franchise termination provisions with strikes: How many strikes until you're out?
Many franchise agreements include termination provisions that involve “strikes,” permitting franchisees to incur and cure a certain number of violations of the franchise agreement within a certain time period until they may be subject to termination. Examples of provisions like this may include the franchise agreement is subject to termination if the franchisee receives three or more violation notices within one year; or the franchise agreement is subject to termination if the franchisee receives four or more violation notices within two years, and fails to cure such violation(s) within 30 days of receiving such notice, among other variations. The District Court for the Eastern District of Michigan recently addressed whether such provisions are valid and not unconscionable in the case captioned 7-Eleven, Inc. v. CJ-Grand, LLC, No. 19-12624, 2021 WL 429332 (E.D. Mich. Feb. 8, 2021), and the opinion brings additional insight to both franchisees and franchisors who may be concerned about how these provisions play out in practice and align with state franchise laws.
The case involved a franchisee of the 7-Eleven convenience stores in Detroit, Michigan. When the franchisee signed the franchise agreement in 2013, the franchisee agreed to operate the store in accordance with the 7-Eleven system, offer products that are consistent with the franchise’s image, only offer products that were allowed under the franchise agreement, maintain certain inventory standards, maintain the store in good condition, meet with 7-Eleven representatives as required, and operate the store in compliance with applicable law and regulations. These requirements, along with certain other regulations, allow the franchise operation to work as it should; provide opportunities for individuals to take ownership of certain stores while operating under certain national standards that provide consistency for customers. The franchise agreement also included a “strike provision” regarding termination; if the franchisee received three separate notices of breaches of the agreement, and the fourth notice of breach was delivered within two years after delivery of the first notice, the franchise agreement could be terminated (regardless of whether any of the breaches were cured).
Beginning in 2018 and continuing for approximately a year, however, the franchisee received six notices of breach of the franchise agreement, relating to violations of cash report requirements, video recording regulations, and store conditions, among other circumstances. While the franchisee fixed or promised to fix the problems listed in the violations, 7-Eleven sent a further notice relating to four more breaches of the franchise agreement a few months later. These multiple violation notices entitled 7-Eleven to terminate the franchise agreement pursuant to the terms of the franchise agreement, and 7-Eleven filed a complaint for declaratory relief requesting a determination that a) the terms of the franchise agreement allowing termination were valid and enforceable, and b) the 10 incidents breaches were “good cause” for termination of the franchise agreement under Michigan’s Franchise Investment Law (Mich. Comp. Laws § 445.1527).
7-Eleven and the franchisee did not dispute that a valid contract existed or that the franchisee received numerous notices of breach of the franchise agreement; however, Michigan’s Franchise Investment Law “prohibits any provision in a franchise agreement that permits a franchisor to terminate a franchise prior to the expiration of its term except for good cause.” Lakeside Surfaces, Inc. v. Cambria Co., LLC, No. 18-110, 2020 WL 1227047 (W.D. Mich. Mar. 13, 2020). The franchisee alleged that because they cured a number of the breaches alleged by 7-Eleven, their non-performance was not “good cause” to terminate the franchise agreement prior to the expiration of its term. The term “good cause” is not defined in the franchise agreement specifically, but states that it includes “the failure of the franchisee to comply with any lawful provision of the franchise agreement and to cure such failure after being given written notice thereof and a reasonable opportunity, which in no event need be more than 30 days, to cure such failure.” Mich. Comp. Laws § 445.1527(c).
The franchisee argued that because they had cured the breaches, there was not “good cause” to terminate the franchise agreement according to the Michigan state law. The court disagreed, however, noting that 7-Eleven’s “four strikes” provision satisfies the statue’s “good cause” requirement because “[i]t plainly intended to address the problem of serial breachers.” Unlike other state franchise laws, however, the Michigan state franchise law “has been drafted broadly” and does not specifically list specific situations that constitute “good cause” for termination of a franchise agreement. The court noted that the franchisee would often cure the breaches after receiving notice from the franchisor, and then fall out of compliance again in numerous areas (involving complying with video surveillance, inventory requirements, and reporting requirements). While the franchisee argued that these instances were not “material” breaches that justified termination, the court held that the franchisee’s continual violation of numerous requirements that are specifically outlined in the franchise agreements justified termination.
The court also held that the provisions of the franchise agreement regarding termination were not “unconscionable,” as the franchisee argued – the court held that both parties willingly chose to contract with each other, and that the franchisee could have chosen not to sign the contract if it disagreed with certain provisions regarding termination.
The 7-Eleven opinion is certainly favorable to franchisors who include “strike provisions” regarding termination in their franchise agreements – if the number of violations that are allowed is clearly delineated in the franchise agreement, this provision is likely not going to be held to be unenforceable by a court (as long as it complies with state franchise laws). Franchisors should be advised to confirm that their franchise agreement termination provisions comply with the applicable state franchise laws in all states where they have operations. Likewise, franchisees should carefully review the termination provisions and any breach notices that they receive from franchisors to make sure that they are not unwittingly subjecting themselves to termination of the franchise agreement.