AAHOA: Decision in Choice Hotels Breach-of-Contract Case Further Highlights Need for Fair Franchising

An arbitrator ruled that Choice Hotels International Inc. is liable to a Franchisee hotel owner for three breach-of-contract claims by finding that Choice Hotels violated terms of its own franchise agreements, including promising volume discounts for products and services for the benefit of Franchisees that Choice Hotels never negotiated or delivered.

In a rare public decision, an arbitrator faulted Choice Hotels for three separate breaches of contract regarding its franchising agreement with Highmark Lodging, LLC, a North Dakota company, owned by a member of AAHOA, the Asian American Hotel Owners Association. The arbitrator concluded that Choice Hotels had failed to negotiate and deliver volume discounts from vendors that supply products to Franchisees; redirected funds earmarked for the benefit of Franchisees to instead solicit new buyers of a franchise; and failed to pass along a volume discount for cybersecurity services.

Choice Hotels is one of the largest hotel companies in the world, with more than 7,000 hotels operating under brands such as Quality Inn, Econo Lodge, and Comfort Inn & Suites. In June 2020, a group of Franchisees sued Choice Hotels in federal court alleging numerous complaints against the company’s operations and programs. The Franchisees asserted that Choice Hotels failed to fulfill promises regarding financial benefits and the costs of the franchise relationship for Franchisee hotel owners. The following year, the court ordered that the claims must be arbitrated separately by each Franchisee. The Highmark Lodging case is one of four “test” arbitrations arising from the federal action.

Following an eight-day arbitration, the arbitrator ruled in favor of Highmark Lodging on three grounds: Choice Hotels breached the franchise agreement by 1) failing to negotiate and deliver volume discounts from vendors that supply products to Franchisees, despite statements in Choice Hotels’ procurement services and marketing materials, in its Franchise Disclosure Document (FDD), and made at CHOC (Choice Hotels Owners Council) committee meetings and conferences that Choice Hotels was obtaining volume discounts by leveraging its size, scale, and distribution to reduce Franchisees’ costs for goods and services; 2) utilizing funds earmarked for the benefit of current Franchisees to instead pay “Key Money” to solicit new buyers of a franchise; and C) not passing along a volume discount for Crowdstrike cybersecurity services to Franchisees.

On the first breach-of-contract claim, the arbitrator noted that “[a]preponderance of the evidence, in both quality and quantity, establishes that Choice [Hotels] made virtually no efforts to leverage its size, scale, and distribution to obtain volume discounts on nonmandated goods. Nonmandated goods constitute 75% of Choice [Hotels]’s procurement revenue. Nonetheless, [Choice Hotels’ Executives] were unable to recall a single vendor or agreement for nonmandated goods with a volume discount throughout his entire tenure in the procurement department. Moreover, nonmandated goods are sold through Choice-selected distributors. Regardless of Choice’s negotiated prices, there is no doubt that those distributors are free to mark up prices at their sole discretion for sale to the Franchisees. Although competition among the distributors themselves may curb the distributors’ desire to increase pricing as Choice [Hotels] argues, this has nothing to do with Choice [Hotels]’s efforts, or lack of efforts, to obtain volume discounts. Indeed, [Choice Hotels’ Executives] testified as a corporate designee that Choice [Hotels] does not even try to do so with nonmandated products.”

The arbitrator also specifically noted that members of Choice Hotels’ procurement team received significant bumps in salary and compensation during the rebate period.

“This case proved what many of our 20,000 AAHOA Members already know to be true: That franchising agreements are frequently one-sided in favor of Franchisors, poorly enforced, and riddled with loopholes or even untrue statements,” said AAHOA President & CEO Laura Lee Blake. “This is why AAHOA has been steadfast in our advocacy for Fair Franchising for our members, whether by supporting a bill in New Jersey to level the playing field or by bringing their concerns to the Federal Trade Commission (FTC). Highmark Lodging is just one of many of our members who have been subject to unfair, and even unlawful practices at times, by one or more of the leading Franchisors.”

In 1998, AAHOA introduced the 12 Points of Fair Franchising to promote sustainable, equitable business practices in the hotel industry. AAHOA has continuously updated the 12 Points to reflect business changes and the long-term, mutually beneficial relationship between industry Franchisors and Franchisees. Earlier this year, AAHOA identified Four Core Pillars of Franchise Advocacy to guide its advocacy work on behalf of its members.

“As the owners and operators of more than 60% of hotels in the United States, AAHOA Members embody the American Dream of entrepreneurship and community,” said AAHOA Chairman Bharat Patel. “As small-business owners who operate under the banner of some of the most recognized brands in the world, AAHOA Members need partnerships that help our industry grow and serve our customers. Fair Franchising and lawful practices must be at the heart of these partnerships. AAHOA stands firm with our members in working toward a smarter, better, and fairer franchise relationship to sustain the franchising model for future generations.”