The Court of Appeal did not justify the reversal by pointing to any specific wrongdoing on PIP's part. The trial court had made explicit findings of fact that the franchise agreement was clear, unambiguous, and integrated; the Sealys operated a financially successful business under the PIP trademark until PIP terminated the agreement; PIP performed all its material obligations under the agreement; and the Sealys' failure to pay royalties and advertising fund contributions constituted a material breach of the franchise agreement that justified PIP's termination thereof.
The Court of Appeal based its opinion on the legal principle that the non-breaching party to a contract is entitled to collect damages for its lost profit under the contract only if the damages were caused by the breaching party's wrongful conduct. The appellate Court held that PIP's loss of royalties for what would have been the remaining term of the Sealys' franchise was not proximately caused by the Sealys' breach of the franchise agreement, but instead resulted from PIP's own decision to terminate the contract. The opinion explained, "the franchisor could have remained entitled to those future royalties for the full term of the franchise contract even if it sued to collect the past payments...at worst, if the franchisor had not terminated the franchise agreement it might have been required to sue again or perhaps again and again to compel the franchisee to pay those future royalties in a timely fashion as those royalties accrued."
The Court of Appeal then stated that it had a second, independent reason for reversing the future damages award: the Court voiced its belief that PIP's right to recover unpaid past royalties totalling $70,000 and advertising fees, attorney fees, and costs, together with its ability to put a new franchisee into what was formerly the Sealys' exclusive territory, is all the compensation that PIP needed to make itself whole. If, in addition, the court were to uphold the future profits award, it would be "unreasonable, unconscionable, and a grossly oppressive imposition" on the franchisee and would:
so unbalance the relationship between franchisors and franchisees as to threaten to convert every franchise agreement allowing such damages into an unconscionable and oppressive contract. Imagine the position of a small business person operating a franchise involved in some minor contract dispute with the franchisor during the 20-year term of the agreement. Don't do exactly everything the way the franchisor demands and the franchisee risks declaration of a material breach backed up by the whip of a giant lost future profits award. Such an award would leave the franchisee enslaved for five or ten or twenty years working primarily for the franchisor's benefit but without its trademark or other services. Franchisors would seldom have to apply that whip, of course. It would be enough to crack it now and then to keep their franchisees in line. This is nearly the definition of oppression.
Not surprisingly, PIP has applied to the California Supreme Court to hear an appeal of the decision. The Court has not yet indicated if it will hear the appeal.
