The Franchise Memorandum

A federal court in North Carolina has awarded franchisor Choice Hotels International, Inc. liquidated damages after granting its motion for reconsideration. Choice Hotels Int’l, Inc. v. Smith Hotel Props., LLC, 2011 U.S. Dist. LEXIS 48928 (E.D.N.C. May 6, 2011). In an earlier opinion, the court found in favor of the franchisor on its motion for summary judgment with regard to its claims for trademark infringement, unfair competition, and unfair and deceptive trade practices against a franchisee that was terminated for nonpayment. The court also found in favor of Choice Hotels with regard to liability on its breach of contract claim, but denied the request for liquidated damages provided for in the franchise agreement. In denying liquidated damages, the court found that the franchise agreement provision did not meet the elements required for liquidated damages under Maryland law, the governing law chosen by the parties.

The provision stated that damages would be calculated based on the franchisee’s revenue, but would be no less than $40 multiplied by the number of rooms, multiplied in turn by the greater of the number of months left in the agreement or thirty-six. The court found that the provision did not provide in “clear and unambiguous” terms for a certain sum, as required under Maryland law, because the potential amount of damages was unbounded and the formula did not even allow for a “ball-park” determination. The court also found that the liquidated damages did not reasonably anticipate the potential value lost by the franchisor because the formula was based on the franchisee’s revenues. Thus, the court originally held the liquidated damages provision was an unenforceable penalty.

On reconsideration, the court noted that the “sum certain” element does not require a specific dollar amount, but merely requires a means of calculating damages at the time of the breach. The court then found that the provision was not an unenforceable penalty; rather, it was a reasonable attempt to put Choice Hotels in the position it would have been absent the breach, and was not grossly excessive. Lastly, the court noted that the provision complied with the Maryland requirement that liquidated damages provisions must not be alterable. The court ultimately granted Choice Hotels $158,400 in liquidated damages.