Til Death Do Us Part (and Perhaps Not Even Then): The Enforceability of Perpetual Business RelationshipsMichael L. Sturm
February 2006 | The Business Suit
The notion of a perpetual business relationship on defined, unchanging terms seems counterintuitive, at best. Businesses change, and personal relationships change, particularly as the individuals involved come and go over time. Agreements that were fair when they were negotiated inexorably become tilted toward one side or the other. Attempts to negotiate a new, “re-balanced” agreement may fail, as one party stands on its rights under the existing agreement while the other party points to technological and market developments to demand what may be significant alterations to the parties’ long-standing bargain.
What are the parties’ rights in this situation? Can the party whose position has become advantageous over time force the other party to continue the relationship on the same terms forever? Or does the law give the disadvantaged party some ability to exit the relationship lawfully (i.e., without paying potentially long-term lost profits as damages for breach), absent a new mutual agreement? If there is a lawful exit strategy for the disadvantaged party, what are the constraints on its use? This article attempts to provide a basic framework for analyzing these questions, which can have overriding significance for the businesses involved. Although the focus is on franchise relationships, in which the issue frequently arises, most of the analysis is equally applicable to other assertedly perpetual business relationships founded on contract.
I. Common Law Background
Because the dangers of a perpetual agreement are so apparent, the word “perpetual” and “forever” rarely are used in business agreements. With surprising frequency, however, business agreements incorporate language that can, as a practical matter, have the same effect. Some agreements provide that they may be terminated for cause, but otherwise do not specify now and when they will end. Other agreements state a term of years, but then provide that they will “automatically renew” or “automatically renew absent mutual consent to terminate.” Numerous other variations are possible. Read literally, all of these formulations could have the effect of forming (perhaps unintentionally) a perpetual relationship.
Under the common law in most states, an agreement with no specifically defined ending point was construed—contrary to what might be considered the natural implications of the language—to be terminable at will by either party upon giving a reasonable notice. This rule arose from the disfavored status of employment relationships that were asserted by either side to be perpetual or for life.
II. Contract Analysis Of Allegedly Perpetual Business Agreements
Although the concept of implied terminability at will is accepted in the employment context, there is wide variability in the application of this principal to business contracts, where the policy interests are more nuanced. The question ultimately posed is whether one party can coerce the other to maintain a business relationship forever. Although many variations are possible, there are two distinctly different approaches to the issue, which lead to diametrically opposed results. Both approaches have been adopted by a number of states; the law of other states remains uncertain. Thus, in analyzing the parties’ rights under a particular contract, the single most important factor—even more important than the particular language employed—generally is the choice of governing law.
One approach is exemplified by the courts of Texas, which generally follow the rule that contracts of indefinite duration may be terminated by either party at will. In Trient Partners I Ltd. v. Blockbuster Entertainment, Inc., 83 F.3d 704, 708 (5th Cir. 1996), the Fifth Circuit considered a license agreement that was to “continue indefinitely” and could only be terminated in the case of noncurable defaults, bankruptcy, death, or improper transfer. Id. Noting that Texas law “‘does not favor perpetual contracts’ and ‘presumes that [any such] contract is terminable at will’” (id.), the Trient Partners court held that the termination provisions were “not the kind of determinable events that transform a contract of indefinite duration into one of definite duration.” Id. at 709 (citation omitted). Instead, the Trient Partners court concluded that the provision allowing termination for noncurable defaults was a “mere transcription” of the universal rule that contracts are terminable upon a material breach and that the four termination conditions “do not limit the duration of the License Agreement or make its duration determinable in any real or concrete way.” Id. Because the license agreement “(1) expressly state[d] that it will ‘continue indefinitely,’ and (2) [wa]s confined in time only by ‘termination provisions’ which contain conditions that are likely never to transpire,” the court held that the contract was of indefinite duration and terminable at will. Id.
California law exemplifies the opposite approach. Under California law, “a contract may, by its express terms, provide for a term of duration of indefinite length and without specific limitation, tied not to the calendar but to the conduct of the contracting parties.” Zee Med. Distrib. Ass’n. v. Zee Med., Inc., 94 Cal. Rptr. 2d 829, 833 (Ct. App. 2000). In examining contract terms establishing duration, California law calls for a three step analysis: (1) whether there is an “express term” of duration; (2) if not, whether a term of duration “can be implied from the nature and circumstances of the contract”; and (3) if neither an express nor implied term is found, the contract will be “construe[d] as terminable at will.” Id. at 835. A provision stating that a contract shall continue “until grounds arise for termination is a valid, express contractual term of duration.” Id. at 836. Thus, if a contract sets forth grounds for termination, it will be construed as containing an express term of duration and is not terminable absent the establishment of one of these stated grounds.
A related issue was decided by the courts of Missouri, which in 1998 and again in 2002 construed agreements providing for five-year terms that would “automatically renew absent mutual consent to terminate” to be terminable by either party not at will, but at the end of any contract term. See Preferred Physicians Mut. Management Group, Inc. v. Preferred Physicians Mut. Risk Retention Group, Inc., 961 S.W.2d 100 (Mo. Ct. App. 1998); Armstrong Bus. Servs., Inc. v. H&R Block, 96 S.W.3d 867, 877-79 (Mo. Ct. App. 2002). In reaching these decisions, the Missouri Court of Appeals drew on Missouri’s longstanding aversion to perpetual agreements. While such agreements are not per se unlawful, the Court held that the parties’ intent to be bound in perpetuity must be unmistakable from within the four corners of the agreement. It also held that, despite having a practical effect of perpetuity, such “automatic renewal” language did not meet the required standard. The Court also forbade the use of extrinsic evidence to prove intended perpetuity, noting that allowing such evidence would eviscerate the “four corners” rule.
III. Common Law Constraints
Even in states where nonrenewal or termination of an indefinite agreement is permitted, the common law may impose restraints. For example, in Missouri, the Court of Appeals in the H&R Block case noted that the right was limited by Missouri’s recoupment doctrine, in which the franchisee was permitted a sufficient time to recoup its initial investment. This limitation is consistent with the purpose of the doctrine, which is to prevent long-term harm from parties being locked into contractual relationships. As the Court stated, this “doctrine imputes to a terminable-at-will agreement, a duration equal to the length of time reasonably necessary for a dealer to recoup its investment, plus a reasonable notice period before termination.” 96 S.W.3d at 878.
An attempted termination or nonrenewal will almost invariably draw a blizzard of common law defenses and/or counterclaims. For example, the party opposing termination or nonrenewal may assert that it is prevented by antitrust considerations, equitable estoppel, the implied covenant of good faith and fair dealing, or other common law doctrines. Alternatively, the opposing party may seek a damages remedy, claiming that the termination or nonrenewal is contrary to representations or promises made during the course of the parties’ business relationship and that the party seeking to end the relationship therefore is liable for fraud or nondisclosure. All of these potential defenses and counterclaims, however, must be viewed through the terms of the underlying policy permitting termination or nonrenewal; the contractual right to terminate or not renew would have little meaning if its exercise triggered other liabilities.
IV. Statutory Limitations
While the common law provides divergent frameworks for determining whether a party to a business relationship of indefinite duration can unilaterally end that relationship, in the franchise and distribution contexts, there is a substantial body of federal and state statutory law that may—but does not always—trump the common law analysis.
Seventeen states have enacted statutes that address various aspects—including termination and renewal of the relationship—of franchise and distribution relationships within their jurisdiction, regardless of the nature of the business. See e.g., Ark. Code Ann. §§ 4-72-202, 4-72-204; Cal. Bus. & Prof. Code §§ 20020, 20030; Conn. Gen. Stat. § 42-133f; Del. Code. Ann. Tit. 6 §§ 2252, 2254; Haw. Rev. Stat. § 482E.6; Ill. Comp. Stat. § 705/19; Ind. Code §§ 23-2-2.7-1, 23-2-2.7-3; Iowa Code § 523H.7; Mich. Comp. Laws § 445.1527; Minn. Stat. § 80C.14; Miss. Code. Ann. § 75-24-53; Mo. Rev. Stat. § 407.405.1; Neb. Rev. Stat. § 87-404; N.J. Rev. Stat. § 56:10-5; Va. Code. Ann. § 13.1-564; Wash. Rev. Code § 19.100.180; Wis. Stat. §§ 135.02; 135.03, 135.05. In most of these states, franchisors are forbidden from terminating the relationship without “good cause,” a term which, although defined differently from state to state, generally relates to some violation of the terms of the franchise relationship. In addition, most of these states require the franchisor to provide advance notice of the termination and an opportunity to cure. Thus, if a particular business relationship falls within the scope of one of these statutes, the common law right to terminate may be limited.
Many of these states also restrict a franchisor’s ability to choose not to renew an expiring franchise if the terms of the relationship provide for optional or automatic renewal. See e.g., Ark. Code Ann. § 4-72-204; Cal. Bus. & Prof. Code §§ 20025; Conn. Gen. Stat. § 42-133f; Del. Code. Ann. Tit. 6 §§ 2252, 2254; Haw. Rev. Stat. § 482E.6; Ind. Code §§ 23-2-2.7-2, 23-2-2.7-3; Iowa Code § 523H.8; Minn. Stat. § 80C.14; Miss. Code. Ann. § 75-24-53; Mo. Rev. Stat. § 407.405.1; Neb. Rev. Stat. § 87-404; N.J. Rev. Stat. § 56:10-5; Wash. Rev. Code § 19.100.180; Wis. Stat. §§ 135.02; 135.03, 135.04. As with termination, these statutory provisions often require good cause and advance notice of the nonrenewal, or, in some instances, require the franchisor to repurchase the franchisee’s/dealer’s business assets and waive post-termination restrictions on competition in connection with the decision not to renew. While “good cause” for nonrenewal may be different than “good cause” for termination, these statutory provisions nonetheless may curb the ability of one party to decide unilaterally to end a relationship that would otherwise renew at the end of a term.
Many of these generally-applicable state laws governing the franchise relationship contain anti-waiver provisions that invalidate choice-of-law provisions in franchise agreements that would serve to circumvent the application of state franchise acts. However, in the H&R Block case, the Missouri Court of Appeals held that the parties’ contractual choice of Missouri law superseded any contrary requirements of the state statutes. 96 S.W.3d at 873. Thus, the potential applicability of a state statute is not necessarily dispositive.
In addition to these state law provisions that are generally applicable to franchises and distributorships operated in those states regardless of the nature of the business, every state has statutory restrictions on termination and nonrenewal that are applicable to particular industries. For example, statutory restrictions on the termination or nonrenewal of franchises, dealerships and distributorships that sell motor vehicles are common. Other industries protected by state statutes include farm implement and other similar equipment dealers, petroleum and service station franchisees, and liquor and beer distributors. For one or more of these specific industries, every state prevents termination or nonrenewal absent good cause and/or some manner of prior notice. Many also require repurchase of inventory. Similarly, in the context of petroleum dealerships and service station franchises, the federal Petroleum Marketing Practices Act (15 U.S.C. § 2801 et seq.) forbids petroleum distributors from terminating or choosing not to renew a dealer without good cause and prior written notice. Thus, in these particular industries, the common law framework generally is supplanted by these statutory requirements.
Originally appeared in the February 2006 issue of The Business Suit, a publication of DRI's Commerical Litigation Committee. Reprinted with permission.
RECENT NEWSWiley Rein Appellate Group Files Certiorari Petition with Supreme Court in Important Case Involving ERISA Preemption
Andrew McBride Named One of 50 “Litigation Trailblazers” Nationwide by The National Law Journal
Wiley Rein Wins Law360’s “Practice Groups of the Year” Honors for Government Contracts, Insurance, and International Trade