As franchisees struggle to meet their obligations, should they gear up for a legal battle ahead? Not quite yet, lawyers said.
REPORT FROM THE U.S.—With many hotel owners reporting closures of their properties or single-digit occupancy rates, no or little revenue is making it increasingly difficult for hoteliers to meet their financial obligations, including those outlined in their franchise agreements.
While that might typically foreshadow a legal battle, the unique circumstances due to the COVID-19 pandemic could grant some flexibility with contracts, lawyers said.
“I would encourage franchisees, instead of sitting down and reading a contract, to pick up the phone and call their (brand) liaisons,” said Kendall Kelly Hayden, vice-chair and office managing partner at law firm Cozen O’Connor, who now mostly represents franchisors, but has had franchisees as clients over the years.
“What I’m seeing from my clients is that they don’t want franchisees to shut down or terminate their contracts; they want them to stay in business. I would start with being a human and picking up the phone and asking what we can do about it.”
Jim Butler, founding partner and chairman of the Global Hospitality Group of Jeffer Mangels Butler & Mitchell LLP, agreed communication is key right now.
“For the typical owner or franchisee, they are better off contacting the other party and using the magic words ‘COVID-19’ and ‘distressed situation’—if it’s true, though I don’t know anyone who isn’t affected by it right now,” he said. “If an owner goes in with a lawyer, they are probably going to be put in a different pile and looked at differently right now.”
Each contract and franchise agreement is different in terms of how much protection it offers owners in an event such as a pandemic, sources said.
“You’re going to have to throw out the case law on this,” said Mitchell Greene, partner and chairman at Robinson Brog. “It’s not only franchise agreements, but most contracts didn’t foresee this. They foresee certain aspects like the government taking property to widen highways, for example. There’s the force majeure provision, but that’s not geared for the whole world just stopping.”
A force majeure clause in a contract removes liability for natural and unavoidable catastrophes that prevent parties from fulfilling obligations of the contract.
Whether force majeure can apply to franchise agreements depends on how the clause is written, which varies by state and by contract, Butler said.
“This is a matter of state law. First, you have to go to each state and see what that says,” he said.
He added that boilerplate contracts usually include a force majeure clause, and nearly all franchise agreements have them.
“But those clauses are strictly construed. It’s not like, ‘oh well, anything gives you a pass,’” he said. “If it says the contract is voidable if there is a war, general strikes or similar events, then the question is: Is a pandemic a war, a general strike or a similar event? Interpretations tend to be strict.”
Greene said another legal implication that could come into play is the impossibility of performance doctrine. This means that a party can be released from a contract due to unforeseen circumstances that make performance impossible under the contract.
“You could argue that hotels aren’t operating so they can’t pay their obligations like taxes, mortgages, franchise agreements,” Greene said. “As such, there is a heavy burden on the person claiming impossibility of performance, and courts put high standards on it.”
Hotels that have stopped operating due to government stay-at-home orders might or might not qualify under the standard.
“These (government) orders aren’t quite as clear as you’d like,” Butler said. “The U.S. government has not declared it illegal. They have issued guidelines, but it doesn’t say you will get arrested if you go out. Of course, the situation could be different from state to state. But I can’t say it is illegal to operate the hotel.”
The unprecedented circumstances require open communication, in which both parties are likely to be amenable, sources said.
“What I expect all this means is that franchisors don’t want to terminate agreements, but they don’t want to be taken advantage of, either,” Butler said. “We are faced with historic circumstances that make it at the very edges of possibility. Is there a business accommodation that can be worked out? Do you call it a force majeure or a waiver? That’s where I expect this to go. We will be watching some of the big cases, and those will be interesting to watch.”
Greene said brands should be just as proactive in communicating with their franchisees.
“They need to reach out because they’ve got flags to protect,” he said. “Brands have to come out with what they will do and need to try to set some industry-wide standards. They have to set the bar as to how they are going to handle this situation.”
Hayden said a lot comes down to how people act during a crisis because that’s how they will be remembered when it’s over.
“People need to try to set aside the panic and focus on the future of the franchise and the wellbeing of customers,” she said. “What happens now will be looked at later, so put your best foot forward now. A good goal to have is working together, picking up the phone and making this human. That’s what everyone is craving right now: communication.”