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Fall 2006-10 Change in ownership did not terminate franchise agreement

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Number 65
Fall 2006

Change in ownership did not terminate franchise agreement

A franchise to operate a hotel under the Howard Johnson brand did not terminate by the fact that the property changed owner. Hotel Associates, Incorporated v. Howard Johnson, 2006 U.S. App. LEXIS 19355 (1st Cir.).

The U.S. Court of Appeals faced three related legal issues in considering this appeal from the U.S. District Court for the District of Puerto Rico:

1- Did a change in ownership actually take place? This question the court answered affirmatively.

2- Did failure to notify the change in owner automatically terminate the franchise agreement? The court answered in the negative.

3- Did by granting another franchise in the same area the franchisor breach the franchise agreement? Again the court answered "no."

Change in ownership

Howard Johnson Franchise Systems, Inc. had licensed Hotel Associates, Incorporated to operate a hotel in Isla Verde (the Carib Inn) under the Howard Johnson flag. As a result of a mortgage foreclosure suit filed by a creditor, Hotel Associates lost title to the property to the highest bidder at public auction: a corporation by the name "R.R. Isla Verde Hotel Corp." This normally would be a clear case of change in ownership, except that the sole shareholder of both Hotel Associates and R.R. Isla Verde was the same person: Benito R. Fernandez. This fact led to the claim that no change in ownership had really taken place.

The court did not agree, pointing out that the licensee was the corporation and not its shareholder, citing the New York case of Hotel Esplanade, Inc. v. Herman, 197 N.Y.2d 579 (N.Y. Sup. Ct. 1960), which had rejected the converse argument that ownership of a hotel changed where the identity of the stockholders changed, despite continuity of corporate ownership.

Termination of franchise

The contract required the licensee to notify the licensor in writing at least 30 days in advance of the occurrence of any change in the ownership of the hotel. Failure to notify gave Howard Johnson the right to terminate the franchise agreement. Neither notice of change in ownership nor notice of termination were given. However, termination did not occur automatically. To reach this conclusion the court examined a number of contract clauses.

It pointed to the text of the ownership provision-"Howard Johnson may, in its sole discretion, immediately terminate this Agreement . . ."-and contrasted it to that used for other reasons for termination-the "Agreement shall automatically and immediately terminate . . ." "Based on those language differences . . . Howard Johnson may exercise its discretion to terminate the contract, but the contract does not terminate ex proprio vigore ('by its own force')."

Another franchise

Even though the franchise was found to have survived the transfer of title, Howard Johnson had rightfully licensed another entity to operate a Howard Johnson hotel in the same geographic area. The Court of Appeals so held because the agreement defined the term of the first license to commence "upon the integration of the [hotel] into the Howard Johnson Reservation System," which never took place. "Because the Carib Inn property was never integrated into the Howard Johnson Reservation System, under the unambiguous language of the Agreement, the territorial protection provision . . . was not in effect at the time of the alleged breach."


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