Coast to Coast Stores, Inc. v. Gruschus

Pearson, J.

Plaintiff Coast to Coast Stores (Central Organization), Inc.,¹ a franchisor, appeals a trial court decision requiring plaintiff to purchase the inventory of defendant franchisee's business.

The principal issue presented by this appeal is whether a franchise is terminated when the franchisee's business is suspended by the franchisor's exercising its right under a security agreement to repossess the franchisee's inventory. We hold that repossession of inventory by the franchisor does not, on the facts in this case, constitute termination of the franchise. The trial court therefore erred by requiring the franchisor to pay a fair market value for the inventory under RCW 19.100.180, and we accordingly reverse.

Defendants, Mr. and Mrs. Gruschus, purchased a hardware business in Wenatchee from Mr. and Mrs. Hegstad. The business was operated under a franchise agreement with plaintiff Coast. After purchasing the business and its assets from the Hegstads, defendants entered a franchise agreement with Coast in January 1979, under which they acquired the right to continue to use Coast marks in the business. Defendants obtained from the Hegstads a long-term lease on the building in which the store was located, and an option to purchase.

In February 1979, Coast filed financing statements covering the fixtures, equipment, inventory, and accounts receivable of the hardware store. In May 1979, defendants executed a security agreement granting Coast a security interest in the collateral.

Defendants borrowed money from Rainier Bank to purchase the business. Inventory was obtained from Coast on credit, and from July 1979 defendants were delinquent in their account with Coast. Eventually the defendants owed Coast more than $100,000. Mr. Gruschus discussed the store's financial difficulties with a representative of Coast at a convention in January 1981. At that time, additional capital was necessary to continue the business, but high interest rates and the store's unprofitability prevented defendants' obtaining a loan.

In February 1981, Coast's store finance manager wrote to defendants informing them that shipments of inventory would be withheld until defendants' indebtedness to Coast was reduced to $96,000. On March 12, the finance manager wrote again, this time requesting that the debt be reduced below $100,000 by April 15, 1981. Defendants' attorney contacted Coast on April 10, and advised that defendants could not continue with the business. She informed Coast that unless Coast purchased the store from them, defendants would be forced to discontinue or abandon the business.

On April 17, 1981, Coast informed defendants' attorney that defendants were in default under their security agreement and demanded possession of the collateral. The parties agreed that the best course to protect the collateral was to double-lock the store and provide each party with a key. The store was accordingly double locked on April 17. On April 24, 1981, Coast moved for a temporary restraining order to freeze any dealing with the inventory, equipment, and accounts receivable in the store. A temporary restraining order was entered on May 14. Defendants responded on May 29 with a motion to require Coast to pay fair market value for all inventory, supplies, furnishings and goodwill in the store pursuant to the Franchise Investment Protection Act, RCW 19.100.

A hearing was held on June 19, 1981. Defendants produced testimony from an expert witness who valued the inventory of the store at $232,913.75. Coast produced an expert who valued the inventory at $165,353.10. The court entered a memorandum decision on July 2, 1981. On August 7, 1981, findings of fact, conclusions of law, and an order were entered.

The trial court ordered Coast to purchase all inventory and supplies from the store for $233,413.75. This order was based on a finding that the franchise agreement was terminated on April 17, 1981, and a conclusion that RCW 19.100.180(2)(j) accordingly imposed a duty on Coast to purchase the inventory from defendants at a fair market value. The trial court denied defendants' claim for attorney fees under RCW 19.86.090. Coast appealed the trial court's order and defendants cross-appealed on the issue of attorney fees. The appeals were certified to this court.

This case presents first instance issues of interpretation of this state's Franchise Investment Protection Act (FIPA). RCW 19.100. This act, which provides comprehensive regulation of franchising, is in two parts. The first regulates the offering and sale of franchises, and includes detailed requirements for registration and disclosure similar to provisions regulating the sale of securities. RCW 21.20. The second part of FIPA is designed to resolve problems which arise out of the relationship between a franchisor and a franchisee.

The franchisor normally occupies an overwhelmingly stronger bargaining position and drafts the franchise agreement so as to maximize his power to control the franchisee. Franchisors have used this power to terminate franchises arbitrarily, to coerce franchisees under threat of termination, and to force franchisees to purchase supplies from the franchisor or approved suppliers at unreasonable prices, to carry excessive inventories, to operate long, unprofitable hours, and to employ other unprofitable practices.

(Footnotes omitted.) Chisum, State Regulation of Franchising: The Washington Experience, 48 Wash. L. Rev. 291, 297-98 (1973). FIPA responds to these problems with a "fair practices" or "franchisee bill of rights" section. RCW 19.100.180. It is this section which is before the court in this case.

RCW 19.100.180 is in two parts. The first, RCW 19.100-.180(1), provides the laconic directive: "The parties shall deal with each other in good faith".

The second part is more specific. It provides a lengthy list of proscribed conduct. RCW 19.100.180(2) provides that "it shall be an unfair or deceptive act or practice or an unfair method of competition and therefore unlawful and a violation of this chapter for any person to . . ." perform any of 10 specified acts. The last in this list of proscribed acts is: "Terminate a franchise prior to the expiration of its term except for good cause". RCW 19.100.180(2)(j). This is the provision which the court is now asked to construe.

There is no allegation in this case that the franchise was terminated without good cause. Rather, the dispute centers around the concluding portion of RCW 19.100.180(2) (j) which provides for the franchisor's obligation upon termination of the franchise.

Upon termination for good cause, the franchisor shall purchase from the franchisee at a fair market v^due at the time of termination, the franchisee's inventory and supplies, exclusive of (i) personalized materials which have no value to the franchisor; (ii) inventory and supplies not reasonably required in the conduct of the franchise business; and (iii), if the franchisee is to retain control of the premises of the franchise business, any inventory and supplies not purchased from the franchisor or on his express requirement: Provided, That a franchisor may offset against amounts owed to a franchisee under this subsection any amounts owed by such franchisee to the franchisor.

Defendant argues that the franchise was terminated on April 17, 1981, when the store was locked and business ceased, and that therefore Coast has a duty under the above quoted provision to purchase the inventory at a fair market value. This argument was accepted by the trial court. As a result, Coast was not entitled to exercise its right to repossess the inventory and sell it in a commercially reasonable sale, pursuant to its security agreement and the Uniform Commercial Code, RCW 62A.9-504(3).

The crux of the trial court's decision is the conclusion that the franchise was terminated on April 17, 1981. This conclusion is explained in the trial court's findings of fact 22, 23, and 24.

22. That at the time the store was locked on April 17, 1981, the Central Organization stood willing and able to continue to operate under the Franchise Agreement provided the Gruschuses would meet their financial commitments, or other satisfactory arrangements were made.

23. That at the time the store was locked on April 17, 1981, the Gruschuses were willing to continue operation of the Coast to Coast Store under the Franchise Agreement if they were able to obtain goods and services, but they were unable to do so.

24. That the Franchise Agreement between the Grus-chuses and Central Organization was terminated in fact on April 17, 1981 because the Gruschuses could not meet their financial commitments to Central Organization and because Central Organization would not continue to operate under the Franchise Agreement if the Grus-chuses did not meet their financial commitments, or make satisfactory arrangements.

In other words, the franchise was terminated by the mutually agreed upon double locking of the store at a time when the franchisee was unable to continue to conduct the franchise business. No notice of termination was given as required by RCW 19.100.180(2) (j) and by provision 11 of the franchise agreement.

It appears that the trial court equated cessation of the franchise business with termination of the franchise under RCW 19.100.180(2)(j). This was error. Under FIPA, the franchise is conceptually distinct from the franchisee's business. The term "franchise" is defined in FIPA as an agreement between the franchisor and the franchisee, whereby the franchisee is granted a license to use a trade name, service mark, or the like. This is clear from RCW 19.100.010(4), which provides:

"Franchise" means an oral or written contract or agreement, either expressed or implied, in which a person grants to another person, a license to use a trade name, service mark, trade mark, logotype or related characteristic in which there is a community interest in the business of offering, selling, distributing goods or services at wholesale or retail, leasing, or otherwise and in which the franchisee is required to pay, directly or indirectly, a franchise fee . . .

The franchise, therefore, is the agreement between the parties, and not the business operated by the franchisee. The franchise might exist quite independently of the franchisee's business, as for example where the franchise agreement is concluded before any business operations commence. It follows, therefore, that cessation of the franchisee's business operations does not necessarily constitute termination of the franchise.

The language of RCW 19.100.180(2)(j) itself provides a clear indication that cessation of the franchisee's business does not constitute termination of the franchise. The second proviso of that section provides that in certain circumstances the franchisor may terminate a franchise without giving notice or an opportunity to cure the default. These circumstances are present where the franchisee:

(1) Is adjudicated a bankrupt or insolvent; (ii) makes an assignment for the benefit of creditors or similar disposition of the assets of the franchise business; (iii) voluntarily abandons the franchise business; or (iv) is convicted of or pleads guilty or no contest to a charge of violating any law relating to the franchise business.

This language suggests that not even the bankruptcy or insolvency of the franchisee, or the abandonment of the business by the franchisee will terminate the franchise. Even in those events, termination must be accomplished by the franchisor, who is under those circumstances relieved of the duty to give notice.

We conclude therefore from the plain words of FIPA that a franchise is terminated only when the agreement between the franchisee and franchisor is brought to an end, terminating the franchisee's right to use the franchisor's trade name, service mark, or the like.

No hardship is imposed upon the franchisee by this interpretation. The franchisor with the security interest in inventory would be entitled to repossess and dispose of the collateral by a commercially reasonable sale. RCW 62A.9-504. If that sale realizes more than the amount of the indebtedness, the franchisor must account to the franchisee for the surplus. If the sale realizes less than the amount of the indebtedness, the franchisee is liable for the deficiency. RCW 62A.9-504(2). This is exactly what would occur if the secured party with a security interest in the inventory were any entity other than the franchisor. There appears to be no reason to require a different result merely because the secured party is the franchisor.

On the contrary, the U.C.C. achieves the same result as that sought by RCW 19.100.180(2)(j). The franchisor is required by subsection (2) (j) to purchase the inventory following termination to protect the franchisee from being left without a franchise, but with a substantial investment in inventory which , he cannot sell. If the franchisor exercises his right to repossess that inventory, the same objective is achieved.

In fact, the only significant practical difference between the two procedures in the present case is the method by which the inventory is valued. Under the U.C.C. repossession procedure, the value is the price paid by a buyer at a commercially reasonable sale. Under the enforced repurchase procedure of subsection (2)(j), the value is the estimated "fair market value". The price obtained for the inventory at an actual sale, conducted in accordance with all the safeguards of the "commercially reasonable" requirement of RCW 62A.9-504, is a better basis for valuation than the hypothetical "fair market price". As the present case illustrates, expert opinions of fair market price may vary widely. The actual price obtained at a commercially reasonable sale is a considerably more reliable indication of the true value of the inventory.

Moreover, this interpretation gives effect to the provisions of the U.C.C. without violating the intent or purposes of FIPA. The trial court's approach, on the other hand, ignores the U.C.C. and renders the franchisor's security interest redundant in the very circumstances (financial failure of the debtor) in which it was intended by the parties to operate.

The provisions of RCW 19.100.180(2)(j) will not operate in the present case unless the franchise agreement between the parties has been terminated. No evidence of such termination appears in the record; on the contrary, the trial court specifically found the parties willing to continue their performance of the agreement had defendants been able to obtain financing. Accordingly, the franchise was not terminated and Coast is entitled to éxercise its rights as a secured party in respect of the inventory.

Our resolution of this issue makes it unnecessary to consider the other matters raised by the parties.

The trial court is reversed.

Williams, C.J., and Stafford, Utter, Brachtenbach, Dolliver, and Dimmick, JJ., concur.

1 Hereinafter referred to as Coast.