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Case Law Update: the do's and don't's of franchise agreements

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Lisa Nguyen

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Silicon Valley

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Keller Paul B
Paul B Keller

Partner

New York

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14 March 2022

Takeaways

  • Do disclaim an agency relationship between the manufacturer and dealership.
  • Do state that the dealership has complete authority over its own operations.
  • Do not impose step-by-step instructions dealerships must follow to sell a vehicle.
  • Don't control the sales process.
    • Provisions related to sales (minimum inventory, sales staff, displaying the manufacturer’s logo, provide sales reports) do not constitute control over the process.

The Issue

With the patent venue landscape changes caused by the 2017 Supreme Court decision in TC Heartland LLC v. Kraft Foods Grp. Brands LLC, can plaintiffs bring a patent infringement action against a car manufacturer in any U.S. judicial district with a car dealership that sells the manufacturer’s vehicles?

Historically Little Guidance

Under the patent venue statute 28 U.S.C. § 1400(b), a patent infringement action may only be brought in the judicial district where the defendant (1) resides or (2) has a regular and established place of business. Prior to TC Heartland, under the first prong, “residence” had a broad definition, including any venue where the corporation is subject to the court’s personal jurisdiction. But in TC Heartland, the Supreme Court decided “residence” under the patent venue statute is limited to a domestic corporation’s state of incorporation.

Given this change, focus shifted to what constitutes a “regular and established” place of business under the second prong of the statute. Falling short on clear guidance, district courts issued conflicting decisions on whether independently owned dealerships constitute regular and established places of business for manufacturers.

The (Current) Answer

On March 9, 2022, the Federal Circuit in In re Volkswagen Group of America, Inc took the opportunity to provide better guidance on this important question. In December 2020, StratosAudio filed patent infringement complaints in the Western District of Texas against Volkswagen and Hyundai, automakers incorporated in New Jersey and California. Volkswagen and Hyundai moved to dismiss the case based on improper venue, but the district court denied the motion. Based in part on the historic case law on the issue, StratosAudio argued that the dealerships established the manufacturers “regular and established” business in the state. StratosAudio emphasized that the manufacturers had agency control over the dealerships through the contractual provisions that required the dealerships to:

  • Employ certain types of employees, such as general manager, and service and sale staff;
  • Maintain a minimum amount of inventory;
  • Perform warranty work on consumer vehicles;
  • Use specified tools when performing warranty and maintenance work;
  • Use manufacturer-approved computer hardware and software;
  • Comply with manufacturers’ standards regarding dealership appearance and use of signs and brand logos;
  • Comply with the distributors’ working capital requirements; and
  • Attend mandatory training sessions or require staff to have certain training certifications.

Based on these arguments, and the-then state of the law, the district court concluded that the franchise agreements did, in fact, give the automakers sufficient control over the dealerships to establish those locations as regular and established places of business for the automakers. The court also concluded that the automakers conducted business through the dealership by distributing vehicles to consumers and providing new purchase warranties and services through authorized dealerships.

Taking up the issue, the Federal Circuit disagreed with the district court and vacated the decision. The Appellate Court reiterated that a regular and established place of business requires the “regular, physical presence of an employee or other agent of the defendant conducting the defendant’s business at the alleged ‘place of business,’” and found that the franchise agreements at issue did not create an agency relationship.

Analyzing each of StratosAudio’s points, the Federal Circuit found that provisions of the franchise agreements fail to give the manufacturers’ interim control over either the dealerships car sales or warranty work. At best, the contractual provision only related to sales but did not evidence control over the sales process itself. The Court emphasized that in cases in which an agency relationship did exist, there were step-by-step instructions on how to conduct the manufacturers’ business. Further, the franchise agreements included provisions disclaiming an agency relationship and expressly stating that the dealerships had complete authority over their own operations. These provisions further reinforced that the manufacturers do not control the dealerships with respect to the sales and warranty processes, and that the dealerships are not their agents. Accordingly, the Federal Circuit found that the manufacturers did not have a regular and established place of business in the district.

Conclusion

Although Volkswagen does not provide a per se rule that dealerships cannot be used to establish venue for patent infringement cases, it does provide a roadmap to guide the structure of franchise agreement to ensure that the dealerships location cannot be used to establish venue.