Drafting franchise agreements to avoid antitrust “lock-in” tying lawsuits
Franchisors sometimes require franchisees to buy products solely from franchisors or franchisor affiliates to ensure product uniformity, quality, and consistency. These arrangements can be lawful if structured correctly. Arrangements that are not appropriately structured, however, can give rise to franchisee lawsuits against franchisors alleging tying in violation of federal and state antitrust laws. Antitrust lawsuits subject defendants to potential treble monetary damages (i.e.,three times the amount of the plaintiff’s losses) and payment of a prevailing plaintiff’s attorneys’ fees.
The U.S. Supreme Court defines tying as “an agreement by a party to sell one product on the condition that that the buyer also purchase a different (or tied) product, or at least agrees that he will not purchase that product from any other supplier.”1 A tying arrangement is only illegal if the seller has “appreciable market power in the tying market and if the arrangement affects a substantial volume of commerce in the tied market.” 2 While satisfying the market power element is a difficult pleading hurdle for plaintiffs to overcome in many typical tying cases, market power is easier to satisfy in a tying “lock-in” case. A tying lock-in occurs under circumstances “where once a customer buys one product, and he or she is locked in to buying another product because of the seller’s rules.” 3
A successful tying lock-in claim therefore requires that the plaintiff buyer allege he was not aware of an obligation to purchase a second product (the “tied product”) when he bought the first product (the “tying product”). The recent case of Burda v. Wendy’s International, Inc., 659 F. Supp. 2d 928 (S.D. Ohio 2009) is illustrative.
In Burda, the plaintiff Wendy’s franchisee filed a lawsuit against the franchisor for, among other things, tying in violation of federal antitrust laws.4 The plaintiff alleged that because he refused to purchase all of his buns and food supplies from a Wendy’s affiliate – an allegedly new cost-prohibitive franchisor requirement – the plaintiff was “locked-in” inasmuch as he could only sell the real estate upon which his property was located to a Wendy’s approved operator or to one of Wendy’s corporate entities.5The Burda court denied the defendant franchisor’s motion to dismiss, rejecting the defendant’s arguments that the plaintiff failed to allege market power in the tying product under a “lock-in” theory because the plaintiff was aware of his obligation to buy buns and food supplies from a specified supplier pursuant to the terms of the franchise agreement.6 Specifically, the court found that a reasonable franchisee reviewing the franchise agreement at the time the plaintiffs became a Wendy’s franchisee would not have foreseen that the franchisor would impose an exclusive supplier agreement on its franchisees because “the language suggests that supplier competition was welcome so long as prospective suppliers met Defendants ‘standards and specifications’ and ‘possessed adequate quality controls and capacity to supply Franchisee’s needs…..’” 7
The takeaway here is that franchisors have considerable discretion to impose exclusive supplier agreements on franchisees at the outset of the professional relationship without violating antitrust laws. Franchisors should take care, however, to incorporate such requirements into their franchise disclosures and the franchise agreement. Indeed, 20 years ago the Third Circuit held the following language contained in a franchise agreement precluded the plaintiff franchisee’s tying claims:
Franchisor “may in our sole discretion require that ingredients, supplies and materials used in the preparation, packaging, and delivery of pizza be purchased exclusively from us or from approved suppliers or distributors.” 8
If, however, a franchisor attempts to impose exclusivity on franchisees after the execution of the franchise disclosures and the franchise agreement documents, franchisors open themselves up to potential antitrust liability under a “lock-in” tying claim – and the accompanying business disruption and expense such lawsuits inevitably bring.
1. Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 451 (1992).
2. PSI Repair Servs., Inc. v. Honeywell, Inc., 104 F.3d 811, 815 (6th Cir.1997) (quoting Kodak, 504 U.S. at 462).
3. Michigan Division-Monument Builders of N. Am. v. Michigan Cemetery Ass’n, 524 F.3d 726, 733 (6th Cir. 2008).
4. Id. at 930. 5. Id. at 931
6. Id. at 935.
7. Id. at 935-36.
8. Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430, 433 (3d Cir. 1997) (emphasis added).