Holiday Inn case shows danger of deception

May 13th, 2011

A recent case with compelling facts shows that, despite attempts through written agreements and disclosure documents to shield franchisors from liability, deceptive conduct within the franchise relationship can still result in substantial liability for franchisors.

In Holiday Inn Franchising, Inc. v. Hotel Associates, Inc., 2011 Ark.App. 147 (Ark. Ct. Apps. 2011), the franchisee Hotel Associates, Inc. (“HAI”), is owned by J.O. “Buddy” House, one of the early Holiday Inn franchisees who was close friends with the chain’s founder.  The court found that, over the course of decades, House had developed a relationship with the executives of Holiday Inn Franchising, Inc. (“Holiday Inn”) founded in “honesty, trust and the free flow of pertinent information”, thereby creating a “special relationship” imposing a duty on Holiday Inn to disclose facts material to the ongoing relationship. 

In 1994, HAI, at the suggestion of a Holiday Inn executive, considered purchase of a rundown hotel in Wichita Falls, Texas to convert to a Holiday Inn.  House realized that the property would need expensive renovations and requested a 15 or 20 year term in the Holiday Inn franchise agreement.  Holiday Inn declined, but its Vice President of Franchising  “stated that, if House operated the hotel appropriately, there was no reason to think that he would not receive a license extension at the end of the ten years.” 

HAI signed a ten year franchise agreement in early 1995 and made extensive renovations before opening.  The hotel was successful and HAI received offers to sell for up to $15 million, but declined based on its belief that the franchise would be extended.  Meanwhile, Holiday Inn’s commission franchise salesperson was pursuing conversion of a nearby Radisson hotel at the end of HAI’s term and  prepared a business plan for that conversion in 1999.

In 2001, an employee of HAI spoke to a Holiday Inn representative about early relicensure, and was convinced to send Holiday Inn a $2,500 fee to obtain a Property Improvement Plan (“PIP”) for changes needed for relicensure.  The PIP required changes costing  $2 million dollars, and after going through 2 rounds of Holiday Inn PIPs, HAI spent about $3,000,000 — without ever being informed of  the business plan for the Radisson, which continued to be pursued.

In October 2002, when the hotel was fully renovated pursuant to the PIP and received a quality score of 96.05 (out of 100),  Holiday Inn informed HAI that the Radisson had applied for a license and was being considered as a possible “partial replacement” for HAI’s facility “if it left the system.”  After HAI protested, Holiday Inn stated that the Radisson application had been denied.  However, after several more twists and turns, the new franchise development team “prevailed” over the relationship managers, the Radisson was licensed and HAI’s facility was denied relicensure.  HAI sold it in 2007 for $5 million, before the real estate crash.

After a jury trial, HAI prevailed on claims against Holiday Inn of fraud and promissory estoppel, which means detrimental reliance on promises.  After appeal, HAI’s judgment was for over $10 million in compensatory damages and $12 million in punitive damages.  The case is notable because (a) HAI had no right to relicensure under the parties’ written agreement, but (b) the court found a “special relationship” that imposed a duty to disclose to the franchisee material information about the future of the business relationship, and (c) the court found that Holiday Inn’s course of conduct supported a punitive damages award.

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