United States: New York Decision On Intentional Interference Has Broad Implications For Franchising Networks

Introduction

This October, the New York Court of Appeals, the state’s highest court, handed down a decision that will have broad implications for franchising nationwide. In Carvel Corp. v. Noonan, the Court of Appeals held that in order to sustain a valid tort claim for intentional interference with prospective economic business relations, in the absence of some independent illegal act or malicious motive, the plaintiff must demonstrate that the defendant engaged in egregious misconduct. The court further held that the franchisor’s acts that induced customers to buy its products from supermarkets rather than from franchise locations were not sufficiently egregious to support the plaintiffs’ tort claim. The court’s opinion makes clear its view that contract claims, not tort claims, are the proper means for managing the relationship between a franchisor and its franchisees.

The Court of Appeals’ decision stems from a long-standing dispute between the ice cream manufacturer Carvel Corporation and its franchisees. Prior to 1992, Carvel distributed its ice cream solely through its system of franchised stores, and the company had long told its franchisees that it had no intention of selling its product in grocery stores. In response to declining profits, however, Carvel changed its mind and announced to its franchisees that it would begin a "supermarket program" to market its ice cream directly. Over the next several years, Carvel’s supermarket program expanded, while many franchised stores went out of business.

In 1994, Carvel brought suit against 50 franchisees in the U.S. District Court for the District of Connecticut seeking a declaratory judgment that its supermarket program did not violate its franchise agreements. In response, several franchisees filed counterclaims asserting a violation of their franchise agreements, a breach of the covenant of good faith and fair dealing, and unlawful interference with prospective business relations. The substance of the franchisees’ claim was that Carvel improperly competed with them by selling to supermarkets at bargain prices and used other incentives to induce customers to purchase Carvel’s ice cream from supermarkets rather than from the franchised stores. The franchisees argued that this competition and inducement caused them direct harm, and their expert witness testified that Carvel’s supermarket program was not "consistent with the customary practices and standards of the franchise industry." Three of the cases went to trial, and Carvel lost all three. In accordance with a contractual choice of law provision, the District Court heard the cases under New York law, and the juries awarded the franchisees a total of $439,599 in compensatory damages and a total of $600,000 in punitive damages.

Carvel appealed the jury verdicts to the U.S. Court of Appeals for the Second Circuit. On appeal, finding two crucial issues to be undecided under New York law, the Second Circuit certified two questions to the New York Court of Appeals. The Second Circuit asked, first, whether the evidence presented in each of the three trials was sufficient to sustain a finding that the plaintiff tortiously interfered with its franchisees’ prospective economic relations, and, second, asked whether public harm is required to assess punitive damages where a franchisee accuses a franchisor of such interference. In response, the Court of Appeals ruled that the evidence at trial was insufficient to support a finding of tortious interference; as a result, the court decided the second question was academic and so declined to rule on it.

In its certification decision, the Second Circuit noted that while it was clear that New York law recognizes the tort of intentional interference with prospective business relations, it was not clear whether the standard for wrongful conduct is different for parties that are in competition with each other, compared toparties who are not. The court noted that, under standard tort principles, non-competitors are held to a higher standard of conduct than are competitors. Non-competitors must avoid conduct that is deemed "improper," while liability for competitors requires the use of "wrongful means" such as physical violence, fraud, or misrepresentation. As part of its certification to the Court of Appeals, the Second Circuit invited the New York court to decide whether the franchisor and franchisees involved were competitors for the purposes of determining the applicable standard of conduct, and, if so, whether a plaintiff must show that the franchisor acted "wrongfully" or only "improperly."

The New York Court of Appeals held that the applicable standard was whether "wrongful means" were employed. It further held that Carvel’s conduct "was not the sort of egregious wrongdoing that might support a tortious interference claim in the absence of an independently unlawful act or evil motive." The court noted that "Carvel did not drive the franchisees’ customers away by physical violence, or lure them by fraud or misrepresentation, or harass them with meritless litigation." The court ruled that since no independent unlawful act was committed and there was no evil motive, the verdicts for the franchisees could not be sustained.

Notably, the majority opinion did not thoroughly address the issue of whether the relationship at issue involved the kind of competition that might invoke the less stringent standard of conduct. Indeed, the majority held that it was irrelevant whether Carvel and its franchisees were "competitors." The court reasoned that the crucial factor in its analysis was the purely contractual nature of the parties’ relationship, not whether they were in competition with each other. According to the court, "the franchise relationship is a complex one; while cooperative, it does not preclude competition." All that Carvel did was compete directly with its franchisees, and this, said the court, was perfectly legitimate, especially when the franchise contract explicitly addressed competition.

In reaching its decision, the court noted the distinction between a claim for breach of contract and a claim for interference with future business relations. The first kind of claim, the court noted, is one which may be made in the absence of illegal or otherwise wrongful conduct independent of the breach of contract. In contrast, the second claim, the court held, was not the kind of claim that could be made without a showing of some other violation. The court held that in order to constitute unlawful interference with prospective economic relations, the interference alleged must amount to an independent crime or tort. Whereas a party can be liable for breach of contract even when it acts wholly within the law, the court reasoned, a party will not be liable for interference with economic relations unless the means employed were themselves wrongful.

The fact that Carvel’s franchise agreements contained express contractual provisions dealing with when competition would and would not be allowed was an important factor in the court’s decision. The court reasoned that "the extent to which competition should be allowed should be determined by the contracts between the parties, not by courts or juries seeking after the fact to devise a code of conduct." The purpose of contracts is to establish the boundaries of permissible behavior between the parties prior to the commencement of their relationship. It is in the interests of the parties and the court system to use contracts to structure economic relationships to achieve predictability and stability. Here, the court noted, the franchisees could and did sue for breach of their contract and for breach of the implied covenant of good faith and fair dealing. However, the Court ruled that the franchisees cannot attempt to claim after the fact that business competition that was previously contracted for is now unlawful interference.

In a concurring opinion, two judges expressed their position that the standard adopted by the majority was too restrictive. In their view, the majority failed to pay sufficient attention to the importance of the distinction in traditional tort law between competitors and non-competitors for purposes of intentional interference with prospective business relations. The concurring judges reasoned that the relevant inquiry for purposes of assessing whether the tort in question was committed was the status of the parties as competitors or non-competitors. They further argued that the relationship at issue was not one of standard market competition. Nor was it a pure contractual arrangement. According to the concurring judges, the franchisor and franchisees "were more akin to economic partners, whose relationship contemplated cooperation, mutual promotion of Carvel products and a joint interest in maintaining consumer loyalty." This kind of relationship, they argued, does not involve "true market competition, since Carvel was in a position of dominance by virtue of its franchisor-franchisee relationship." This special relationship, they asserted, justifies the adoption of the more lenient "improper conduct" standard governing conduct between non-competitors instead of the more restrictive "wrongful means" standard applied to parties engaged in economic competition.

Despite their adoption of the more lenient standard, however, the concurring judges nonetheless agreed with the majority because they found that the factual record in the case did not support a finding that Carvel had acted improperly. Carvel’s decision to sell ice cream in supermarkets, they reasoned, was not in itself improperly coercive and was not itself compelling evidence of improper interference. Moreover, the judges concluded that, when viewed in light of the circumstances faced by Carvel, its decision was a reasonable response to changing economic conditions, and there was insufficient evidence of improper motive.

The Carvel decision makes clear the New York Court of Appeals’ view that the primary solution to contract disputes should be found in contract law and not in tort law. According to the court, "the intervention of tort law to regulate when a franchisor may or may not compete with its franchisees is neither necessary or useful." The Carvel decision is also significant for its recognition of the complex nature of the franchise relationship and the need for courts to be flexible in the face of changing economic realities. No economic relationship is static, and change is inevitable. As franchise networks continue to evolve and continue to experiment with nontraditional distribution models, New York’s approach to this issue will no doubt play an important role in shaping the law’s response.

The Court of Appeals decision reminds both franchisees and franchisors that the franchise relationship is one that must adapt to new conditions and, as the court notes, the most efficient and effective method for managing disputes in a complex and evolving contractual relationship is to anticipate them and address them prior to forming a contract, not to fight them out in a courtroom after the fact. Not only will careful contractual planning save franchisors and franchisees a lot of time and money after the franchise contract is signed, it will also help to create a predictable and stable franchise relationship.

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