The Franchise Memorandum

In Ohio Learning Centers, LLC v. Sylvan Learning, Inc., 2012 U.S. Dist. LEXIS 41718 (D. Md. Mar. 27, 2012), the United States District Court for the District of Maryland upheld the franchisor’s termination of franchisees who ceased making payments under their license agreement while continuing to use the franchisor’s trademarks. The plaintiffs had entered into contracts with Sylvan to purchase and operate a former company-owned learning center as a franchise and executed two promissory notes to complete the transaction. When the plaintiffs ceased making the required installment payments on the notes, Sylvan issued two notices of default warning them that their license agreement would be terminated if they failed to timely cure their defaults. Instead of paying the amounts due, the plaintiffs filed suit against Sylvan alleging that it had fraudulently induced them to purchase, finance, and run the franchised learning center. When the plaintiffs continued to operate under the Sylvan trademarks without making payments or even creating an escrow account for such payments, Sylvan filed counterclaims for trademark infringement, breach of a covenant not to compete, and breach of contract. Sylvan then moved for summary judgment on its counterclaims, arguing that the plaintiffs breached the license agreement and related sale agreements by failing to pay the amounts owed under the promissory notes while continuing to reap the benefits of operating a franchised Sylvan learning center.

The plaintiffs did not refute any of those facts and instead offered several affirmative defenses to Sylvan’s claims, each of which the court rejected as meritless. As many do, the plaintiffs argued that Sylvan was first to breach the license agreement by failing to provide documents regarding the financial condition of the franchise they purchased and by allowing competing Sylvan franchisees to operate inside their exclusive territory. The court held that the plaintiffs could not respond to Sylvan’s alleged breaches by discontinuing their own performance under the license agreement while continuing to operate the franchise without the payment of any fees. This “you breached first” defense has consistently been rejected. Instead, the plaintiffs were required either to treat Sylvan’s alleged breach, if material, as a repudiation of the license agreement and discontinue their performance and acceptance of benefits under the agreement, or treat the breach as a partial breach and sue for damages. The court ultimately concluded that none of the plaintiffs’ defenses defeated Sylvan’s entitlement to summary judgment on the amounts due under the promissory notes.