Can Holdover Franchisees Be Held Liable For Trademark Counterfeiting?

One of the most common lawsuits in franchising involves the “holdover” franchisee.  In these cases, the franchise agreement has either expired (because the term has ended, and the franchisee has failed to renew), or it has been terminated (usually due to an alleged breach of the franchise agreement by the franchisee).  The holdover franchisee, however, continues to operate his or her business as though nothing has changed and continues to use the franchisor’s trademarks and trade dress.

In a typical termination or expiration situation, a franchisee is placed on notice that the franchise contract is no longer in effect and is required to de-identify his or her business by removing all signs and other materials bearing the franchisor’s trademarks.  Additionally, it is mandatory under the contract for a terminated franchisee to alter the look and feel of the business (known as “trade dress”) to disassociate the former franchise from the franchise company.  These changes are required by the franchisor to ensure that the general public no longer associates the former franchised location with the franchise company. 

Sometimes, however, a franchisee will refuse to de-identify his or her business and will keep running it as though the franchise agreement was still in place.  Because the franchise contract has been terminated, however, the prior franchisee no longer has the franchisor’s permission franchisor to continue using the company’s trademarks, trade dress, systems, and methods of operation.  In those circumstances, the franchisor is almost always forced to seek a court order requiring the former franchisee to take down the signs, alter the trade dress, and otherwise force the holdover franchisee to comply with the post-termination obligations under the franchise contract.

Historically, courts have wrestled with the determination of the appropriate measure of monetary damages caused by holdover franchisees.  Under the United States Lanham Act (which protects trademark owners), a defendant in a trademark case can be found liable for either simple infringement – that is, unauthorized use of a trademark owned by another – or counterfeiting, which is using a false mark that is either “identical with, or substantially indistinguishable from, a registered mark.” 15 U.S.C. §1127. 

In the case of ordinary infringement, a court is given the discretion to award treble (three times) the actual damages suffered to the injured plaintiff.  15 U.S.C. §1117(a). In the case of counterfeiting, a court is required to award to an injured plaintiff either: (a) treble damages incurred by the plaintiff; (b) treble profits obtained by the defendant due to the counterfeiting; or (c) statutory damages ranging from $1,000 to $2,000,000, depending on whether the violation was willful.  15 U.S.C. §1117(b) and (c).  As a result, trademark owners often seek claims for counterfeiting – rather than ordinary infringement – as the damages in a counterfeiting case will usually be more significant.

In the recent case Century 21 Real Estate, LLC v. Destiny Real Estate Properties, 2011 WL 6736060 (N.D. Ind., Dec. 19, 2011), the United States District Court for the Northern District of Indiana faced the question of the proper measure of damages where a franchisee continued to use Century 21’s mark after being terminated.  The Court considered the argument that the holdover franchisee’s use of the trademark was not actually “counterfeit” because the mark the franchisee used was actually, at one time, authorized by the franchisor (in other words, pre-termination the marks used by the franchisee were genuine).  In rejecting that argument, the Court noted that it could:

[C]onceive of no reason why an ex-franchisee should escape liability for counterfeiting simply because that person had access to a franchisor's original marks because of the former relationship and therefore did not need to reproduce an identical or substantially similar mark. Indeed, as [General Elec. Co. v. Speicher, 877 F.2d 531 (7th Cir. 1989)] points out, the risk of confusion is greater when an original mark is used to designate inauthentic goods or services.

Century 21, 2011 WL 6736060, at *4.  As a result, the Court found that the holdover franchisee’s unauthorized, post-termination use of Century 21’s marks constituted counterfeiting within the meaning of the Lanham Act.  Id.  The Court awarded the franchisor damages in the amount of two times the fees lost by the company due to the counterfeiting, plus liquidated damages as required by the parties’ franchise agreement. 

There is some disagreement between courts on the issue; notably, in U.S. Structures, Inc. v. J.P. Structures, Inc., 130 F.3d 1185 (6th Cir. 1997)), the U.S. Court of Appeals for the Sixth Circuit reached the opposite result, in finding that a holdover franchisee’s use of a genuine trademark could not counterfeiting.  However, if it is upheld and followed by other courts, Century 21 v. Destiny potentially represents an important new development in franchise case law.  For franchisors, the case provides a potentially powerful new tool in dealing with holdover franchisees.  For franchisees, the case serves as a strong warning about the potential consequences of refusing to de-identify their businesses after termination.

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