Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2007

And the saga continues . . .

 

In Sound of Music Co. v. Minnesota Mining and Manufacturing Co., 477 F.3d 910 (7th Cir. 2007), a music equipment dealer (“plaintiff”) brought suit against its supplier (“defendant”) alleging violation of the Illinois Franchise Disclosure Act and violation of the Minnesota Franchise Act.

 

In 1995, the parties entered into an agreement (“agreement” or “1995 agreement”) whereby plaintiff was to be defendant’s non-exclusive distributor of background music and equipment. This agreement was set to expire on December 31, 1999 “unless earlier terminated by either party as provided herein.” In the years following, the music industry began to experience a rapid change, which made defendant fear that it would no longer be financially advantageous for it to continue in the background music business.

 

Accordingly, defendant had one of its employees evaluate the company’s background music business. The evaluation report recommended that defendant expeditiously shut down its background music business. Acting on this, defendant sent plaintiff a letter in November 1997 that it would no longer be in the background music business as of December 31, 1998—just one year prior to the agreement’s initial expiration date. Plaintiff consulted its attorney shortly after receiving this letter and subsequently brought suit alleging, among other claims, violation of the Illinois Franchise Disclosure Act and violation of the Minnesota Franchise Act. The district court granted summary judgment in favor of defendant and plaintiff appealed.

 

Illinois Franchise Disclosure Act Claim

 

Actions brought under the Illinois Franchise Disclosure Act must be brought within one year “after the franchisee becomes aware of facts or circumstances reasonably indicating that he may have a claim for relief in respect to conduct governed” thereunder. When plaintiff received defendant’s termination notice in November 1997, the court determined that plaintiff had a reasonable indication that it possessed a claim under the Illinois Franchise Disclosure Act. This indication was reinforced when plaintiff consulted its attorney a mere three days after receiving the termination notice. Despite this, plaintiff did not file its complaint until February 2, 1999. Because the one-year statute of limitations had already expired prior to plaintiff’s initiation of the cause of action, the court of appeals rejected plaintiff’s Illinois Franchise Disclosure Act violation claim.

 

Minnesota Franchise Act Claim

 

Turning to plaintiff’s termination without good cause claim under the Minnesota Franchise Act, the court first looked to whether the agreement between the parties was in fact a “franchise,” and thereby rendering it under the purview of the Minnesota Franchise Act. In support of its argument that it paid a franchise fee, plaintiff argued that the $2,400 “dealer reception fee” that it paid under an earlier agreement with defendant was enough to render it a franchisee at the time defendant terminated the 1995 agreement.

 

The court did not find this argument persuasive. First, the earlier agreement, which required plaintiff to pay the dealer reception fee, was terminated two years prior to the 1995 agreement. Second, the negotiations for the 1995 agreement made it clear that the 1995 agreement was to be a stand-alone contract, and not to be considered a renewal or extension of the prior agreement. Third, the court doubted that the dealer reception fee could be considered a franchise fee under the earlier agreement, as “[n]ot all payments made by a purported franchisee over the course of a business relationship constitute franchise fees. Instead, only fees paid for the ‘right’ to enter into a business or the ‘right’ to continue a business qualify.”

 

To expand on this third point, the court found nothing to suggest that plaintiff paid a franchise fee at the time it signed its first agreement with defendant. Although there was a $2,400 fee listed, “the text of the agreement suggest[ed] that this was a fee charged to dealers for the space [defendant] leased on the satellite that transmitted music signals, not a fee for the ‘right to enter’ or continue in the background music business with [defendant].”

 

Takeaway: Although an agreement may require the payment of “fees,” those fees must be for the right to enter into or continue the business in order to satisfy the franchise fee element of the Minnesota Franchise Act.

 

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