Scheck v. Burger King, the seminal case on good faith and fair dealing, is still alive and well according to a 12-member California jury after a contentious month-long trial which pitted grilled chicken giant El Pollo Loco, Inc. against one of its top performing franchisees. After weeks of testimony from current and former executives of El Pollo Loco, Inc. (El Pollo Loco), the introduction of numerous exhibits documenting the company’s bad faith conduct and unfair business practices, and even a mistrial due to inappropriate statements made by the company’s lawyers at the very beginning of trial, a Los Angeles County jury found that El Pollo Loco had breached the implied covenant of good faith and fair dealing when two new corporate stores improperly encroached on the non-exclusive territory of longtime El Pollo Loco franchise owners, Michael Bryman and Janice Handler-Bryman, and cannibalized their sales.
The principal question for the jury was whether El Pollo Loco’s decisions to construct not one, but two, corporate stores in close proximity (2.2 and 4.4 miles) to the existing franchisee’s location constituted a breach of the implied covenant of good faith and fair dealing. Furthermore, and in what appears to be a case of first impression, the jury found that El Pollo Loco’s decision to take the new corporate stores for itself rather than offering them to its existing franchisee was unfair and unlawful in violation of good faith requirements. The decision by this jury has been a long time in the making, and supports the legal principles espoused by the courts in another case known as Vylene Enterprises, which cited the case of Scheck v. Burger King. Zarco handled that case as well.
Zarco Einhorn Salkowski & Brito, P.A., represented the Brymans, who, since 1999, owned and operated the only El Pollo Loco restaurant in Lancaster, California. At the time the Lancaster restaurant was purchased from another franchisee for $1.2 million, its annual sales volume was $1.4 million. By 2007, the Brymans had increased the store’s revenues to over $2 million despite an increase in competing brands in the Lancaster market. Their time, effort, and money developed El Pollo Loco’s goodwill in the Lancaster community, even as they simultaneously paid their franchisor substantial – and ever-increasing – royalties and advertising fees.
Despite having reserved the entire Los Angeles designated market area (DMA) as a corporate market, El Pollo Loco did not undertake any significant efforts to develop any new restaurants in Lancaster for nearly 15 years. During that time, the Brymans worked diligently to identify locations in Lancaster where they could open another El Pollo Loco restaurant. In 2014, before the Brymans could secure a lease for a preferred second El Pollo Loco location in the Lancaster area, El Pollo Loco’s then-owner, the private equity fund Trimaran Capital Partners, took the company public. Flush with cash, the company began an aggressive expansion effort. Using its real-time electronic access to financial reports the Brymans’ filed daily showing $3.8 million in gross revenues for 2014, El Pollo Loco identified Lancaster as a large and obvious market to develop additional corporate stores.
As the jury found, El Pollo Loco ignored the Brymans’ investment in the market, the local goodwill they had earned and the relationships they had established and relied on the express “reservation of rights” clause under its form franchise agreements, which the company believed granted it the right to place a competing corporate restaurant “in the immediate vicinity of, or adjacent to,” a franchisee’s location, in order to make its decision.
During pre-trial proceedings, El Pollo Loco had argued that its actions were justified, claiming that this “reservation of rights” clause expressly permitted the company to put stores wherever it wanted because franchisees did not have exclusive territories. But, Los Angeles County Judge Randolph A. Rogers found this provision to be unconscionable and therefore unenforceable as a matter of law because El Pollo Loco “place[d] itself at such a competitive advantage when it opens a company restaurant, which is not paying royalties, near or adjacent to a franchise restaurant so as to constitute unfair competition.”
Although the central issue of the case was whether El Pollo Loco violated the implied covenant of good faith and fair dealing, the company’s lawyers focused their entire defense on whether the new corporate sites fell within the existing franchisee’s 50,000 population “notification radius.” We argued that this focus on the “notification radius” was a smokescreen set up by the defense to distract and confuse the jury. In actuality, the “notification radius” provision only applied in situations when a franchisee chose to seek recourse through an alternative dispute resolution process and not a jury trial. The jury recognized that the provision did not apply and clearly identified El Pollo Loco’s actions as bad faith.
At trial, we elicited testimony and presented evidence supporting the Brymans’ claim that while they performed whatever the franchise agreement required them to, El Pollo Loco had unfairly interfered with their right to receive the benefit of the franchise agreement. El Pollo Loco’s own witnesses, including its former Vice President of Development and its current Chief Financial Officer, testified that they knew that opening corporate sites would negatively impact the existing franchisee, but, basically, they didn’t care.
Further testimony – from witnesses for El Pollo Loco – supported the Brymans’ contention that El Pollo Loco’s decision to construct the corporate stores in Lancaster, California was deliberate, arbitrary, capricious, and undertaken in bad faith with the intent to rely on existing customers of the Brymans to support the newly developed corporate stores.
When El Pollo Loco’s lawyers recognized that the facts as presented at trial could not support a verdict in the company’s favor, they deployed a number of tactics in an attempt to distract the jury. Those tactics included: focusing on the franchisee’s wealth, which ultimately resulted in an instruction to the jury to disregard any testimony concerning the Brymans’ socio-economic standing; putting on an expert witness on liability whose testimony was severely limited by the presiding judge as a result of the expert’s clear bias and prejudice in favor of the defense; and ultimately scraping the bottom of the ethics barrel by repeatedly undertaking personal attacks on the Zarco legal team in the presence of the jury.
By the end of trial, however, it was clear to the jury that El Pollo Loco engaged in multiple wrongful acts, which constituted a breach of the implied covenant of good faith and fair dealing.
The judge will hold a hearing in the coming weeks to determine what monetary and equitable damages El Pollo Loco will be responsible for. The franchisee will potentially recover damages for the lost sales of their encroached-upon store due to the financial impact from each of the two newly built corporate stores, plus damages for over 20 years of future lost net income actually being earned from each.
Damages could run into several millions of dollars, but more importantly, this jury verdict will resonate throughout the franchising, and hospitality industries and potentially help level the playing field between franchisors and franchisees. •
Robert Zarco, Esq., Founding Partner, Robert F. Salkowski, Esq., Senior Partner, and Margaret T. Lai, Esq. are with the law firm of Zarco Einhorn Salkowski & Brito, P.A. headquartered in Miami, Florida.