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Zubair Kazi, through co-plaintiff KFC of Pueblo, Inc., owned the only Kentucky Fried Chicken restaurant in Pueblo, Colorado. In 2019, KFC US, LLC licensed a second Kentucky Fried Chicken restaurant in Pueblo. According to the 10th Circuit Court of Appeals opinion, Kazi believed KFC acted improperly in how it went about licensing this second restaurant and sued KFC for breach of contract, bad faith, promissory estoppel and unjust enrichment. His lawsuit went to trial on his bad-faith claim only, and the jury found in his favor.
KFC appealed. The 10th Circuit held Kazi’s claim for breach of the implied covenant of good faith and fair dealing was barred by Kentucky law because KFC’s alleged bad faith didn’t undermine any benefit or protection afforded to Kazi by his franchise agreement with KFC. The 10th Circuit vacated the judgment and remanded for entry of judgment in favor of KFC and against Kazi and KFC of Pueblo, Inc.
KFC licensed the recipes, marketing systems and trademarks for Kentucky Fried Chicken to franchisees across the U.S. This dispute concerned two licensed Kentucky Fried Chicken restaurants in Pueblo, Colorado: Kazi’s south Pueblo restaurant, which he has owned since 1986, and a north Pueblo restaurant KFC licensed in 2019.
Kazi has more than four decades of experience owning Kentucky Fried Chicken franchises. He currently owns more than 80 franchise restaurants, with a yearly franchise revenue exceeding $100 million. Like all KFC franchisees, his South Pueblo restaurant is licensed under the Kentucky Fried Chicken Franchise Agreement. The agreement grants his restaurant a license to trade names, trademarks and service marks owned by KFC and it requires Kazi to operate his restaurant as a Kentucky Fried Chicken, sell specific items, meet certain quality standards and pay royalties to KFC. It also requires Kazi to join the KFC National Council and Advertising Cooperative — the national organization of KFC franchise owners — and to pay a percentage of his sales into the National Council and Advertising Cooperative’s advertising fund. The agreement expressly states KFC had made no representation to Kazi “as to the anticipated profitability” of his restaurant. In June 2017, Kazi renewed the franchise agreement with KFC for a term of ten years. The agreement provided it’s governed by Kentucky law.
According to the 10th Circuit opinion, it isn’t uncommon for a franchisor and a franchisee to have competing interests, as when a franchisor wants to license a new store that could encroach on the franchisee’s market. But the franchise agreement provided Kazi with two express protections against encroachment: under § 3.6, KFC is prohibited from licensing a new store within a 1.5-mile radius of Kazi’s restaurant, creating an exclusivity zone of about seven square miles; and under § 19, if Kazi’s restaurant is the closest to a proposed new location, KFC is required to give Kazi 30 days’ written notice before approving the proposed restaurant, allow Kazi to apply to operate it and negotiate in good faith regarding that application. The notice of the new location is provided through a “Section 19 Letter,” and these rights are known as the franchisee’s “Section 19 rights.”
Kazi and the district court had also relied on the terms of a special incentive program instituted by KFC and the National Council and Advertising Cooperative. Under the program and to encourage the opening of new Kentucky Fried Chicken restaurants, KFC and the National Council and Advertising Cooperative would each contribute 50% of the program’s funding. The National Council and Advertising Cooperative board, which is controlled by franchisees, unanimously supported the program. But some franchisees were concerned new nearby locations might cannibalize sales from their existing restaurants. In response to these concerns, KFC and the National Council and Advertising Cooperative leadership developed the “KFC Impact Study Guidelines,” which describe procedures to reduce the impact of new restaurants on franchisees.
Under the guidelines, when KFC proposes a new location, the closest franchisee is given the option to request an impact study that analyzes the potential impact of the proposal on the existing franchisee’s sales. If the study finds an impact of more than 15%, KFC will not approve the new location; if the impact is between 10 and 15%, KFC will perform further review before deciding whether to approve the location; and if the impact is under 10%, the new location will be approved. With the guidelines in place, the National Council and Advertising Cooperative members voted to approve the incentive program. Two third-party vendors, selected by KFC in consultation with the National Council and Advertising Cooperative, have been approved to perform the impact studies.
Kazi had owned and operated four Kentucky Fried Chicken restaurants in Pueblo, but in 2012 and 2013 three of the four closed, leaving his south Pueblo location as the only KFC in town. By 2019, however, KFC wanted to expand its presence in Pueblo. An algorithm predicted a new restaurant in north Pueblo would impact Kazi’s sales by only 8.1%.
In February 2019, Denis Schoenhofer, a franchisee who owned several KFC restaurants in the Southwest, applied to open a restaurant at the new location in the north Pueblo trade area. The following month KFC’s site-review committee approved a location 4.6 miles from Kazi’s restaurant, and in April 2019, KFC sent Kazi a Section 19 Letter notifying him of the approval. The letter informed Kazi under the franchise agreement he had the right to apply to operate the new restaurant, and he could also request an impact study under the guidelines. According to the 10th Circuit opinion, Kazi didn’t apply to operate the new restaurant because he didn’t have a good relationship with KFC and he didn’t think his application would be approved. Instead, he requested an impact study under the guidelines, believing the impact would be more than 15%, the opinion added.
The impact study was performed by the James Andrew Group and found the proposed North Pueblo restaurant would impact Kazi’s sales by 13.4%. KFC undertook the further review required under the guidelines and on June 18, 2019, it notified Kazi and Schoenhofer of its decision to approve the north Pueblo KFC.
Kazi disagreed, the 10th Circuit opinion noted, with the results of the James Andrew Group impact study. Thinking the methodology used by the James Andrew Group was flawed, he sent a list of his concerns to KFC. In August 2019, Kazi hired a different company — not one approved by KFC and the National Council and Advertising Cooperative — to conduct a second impact study, which found an impact of 35%. He sent those results to KFC, but nothing came of it, the opinion added.
In October 2019, Schoenhofer informed KFC there was a real-estate issue with the approved site, and he planned to purchase a substitute parcel that was 5.3 miles away from Kazi’s restaurant. KFC’s director of development strategy and construction testified at trial this wasn’t an uncommon occurrence, and because both sites were in the previously approved north Pueblo trade area, KFC needed only to review the site change. KFC nonetheless asked the James Andrew Group if the change would affect the results of its impact study, and the James Andrew Group said if there was a difference in the result, it would be a lower impact. Kazi wasn’t sent a new Section 19 Letter and he wasn’t otherwise notified of the site change.
On appeal, KFC challenged the sufficiency of the evidence, the jury instructions and the award of damages. It also complained of an allegedly prejudicial statement by the district court in the presence of the jury and contended the district court erred in determining Kazi’s claim for breach of the implied covenant of good faith and fair dealing was permitted under Kentucky law. All but the last issue are moot, according to the 10th Circuit opinion, because KFC is entitled to judgment under Kentucky law.
Neither the district court nor Kazi had cited any Kentucky case law in support. And a previously discussed decision by the Kentucky Supreme Court couldn’t be reconciled with the district court’s theory. In the decision Farmers Bank & Tr. Co. of Georgetown v. Willmott Hardwoods, Inc., the court held the bank had not violated the covenant of good faith and fair dealing when it refused to grant a loan that couldn’t be closed by the date set forth in the agreement between the bank and the prospective borrower. To be sure, the bank could have extended the time to close; it had full discretion to do so. According to the 10th Circuit opinion, the bank had no obligation to act in good faith when deciding whether to extend the date. Similarly, KFC had full discretion to refrain from licensing a new franchise outside the exclusive area, but no duty of good faith and fair dealing confined that discretion.
According to the 10th Circuit opinion, when the covenant of good faith and fair dealing comes into play, it restricts the discretion of the party bound by the covenant. But not every exercise of discretion is so bound. The 10th Circuit didn’t think the covenant restricted the actions of KFC of which Kazi complained.
The 10th Circuit vacated the final judgment of the district court and remanded for entry of judgment in favor of KFC.