Empty Promises: Contractual Modification Without Consideration Leaves Franchisee Without Recourse

Introduction

Contractual deadline extensions are doled out as a matter of course—and as a matter of courtesy—every day. This is especially the case when the parties are involved in a long-term business relationship, which is frequently the case in a franchisor/franchisee arrangement. The difference a few days, weeks, or months makes is frequently immaterial compared to the benefit of maintaining a profitable business relationship. Yet, as highlighted by a recent decision by the U.S. Court of Appeals for the Fourth Circuit, these gratis extensions, in some instances, should not be relied upon.¹

Issue/Case Summary

A franchisee learned this difficult lesson after years long litigation against the franchisor of his tax preparation business. For several years, Gregory Aime operated a number of tax service locations under various franchise agreements with Liberty Tax (“Liberty”). ²

In 2016, Aime’s IRS Electronic Filing Identification Number (“EFIN”) was revoked, which violated a condition of the franchise agreements.³ This violation entitled Liberty to terminate the franchise agreements.⁴ However, Liberty and Aime instead negotiated a Purchase and Sale Agreement (“PSA”) whereby Liberty would purchase Aime’s franchises and grant Aime an option to repurchase the franchises if he secured the reinstatement of his EFIN before May 8, 2016.⁵

After it became clear that Aime would not be able to meet the reinstatement deadline, Aime and Liberty agreed to extend the deadline to the end of the year.⁶ However, shortly after reaching that agreement, the parties’ relationship deteriorated.⁷ Ultimately, Aime secured his EFIN reinstatement.⁸ However, before that occurred, Liberty filed suit against Aime in the U.S. District Court for the Eastern District of Virginia.⁹  Aime subsequently asserted counterclaims against Liberty.¹⁰

Liberty and Aime each asserted that the other breached the PSA. For his part, Aime alleged that Liberty breached the PSA, in part, by undermining his buyback rights when it arranged to sell Aime’s franchises to a new buyer.¹¹ For this breach, Aime sought to recover lost profits that he would likely have received from operating the franchises after exercising his buyback option.¹² The trial court agreed with Aime and awarded a portion of the $2.7 million total damages to compensate Aime for these lost profits.

However, on appeal, the Fourth Circuit overturned the trial court’s damages award for lost profits.¹³ The appeals court reasoned that Liberty’s offer to extend Aime’s reinstatement deadline from May 8 to December 31 came with no new consideration, i.e., Liberty received nothing in value from Aime in exchange for the extension.¹⁴ As a result, the appeals court held that the parties never reached an enforceable agreement on the reinstatement deadline extension, which left the original deadline intact.¹⁵ Because Aime failed to reinstate his EFIN by that date, the appeals court found that his buyback option would have expired and Aime would not have been able to operate the franchises to generate the “lost profits” the trial court awarded.¹⁶ Aime was left with a drastically reduced recovery and no recourse against Liberty for the now-lost franchises.

Key Takeaways:

The initial contractual agreement that parties reach is usually fussed over and given an inordinate amount of attention, much like a firstborn child. Yet the second child—the contract modification—needs the same attention as the first. It may not be a momentous occasion to extend a contract term for six months, but, as Aime discovered, failing to ensure that even small modifications to an existing contract are supported by adequate consideration (which is frequently a low bar to clear) can be disastrous.