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American Motor Inns Inc. v. Holiday Inns Inc.

June 30, 1975



Hastie, Adams and Weis, Circuit Judges.

Author: Adams


ADAMS, Circuit Judge

The largest chain of motor hotels in the nation is operated under the Holiday Inn trademark. Holiday Inns, Inc. (HI), the owner of the trademark, not only licenses the trademark to franchisees who wish to operate Holiday Inns on specified sites, but also owns and manages a number of inns itself. American Motor Inns, Inc. (AMI), HI's largest franchisee, operates 48 Holiday Inns. The antitrust suit which forms the basis for the present appeal was precipitated by HI's denial of AMI's application for a franchise to open a Holiday Inn adjacent to the new passenger terminal at the Newark, New Jersey airport. Pursuant to the terms of its standard licensing agreement, HI also refused to allow AMI to build any other type hotel at the Newark location.

AMI charged in its complaint that HI's franchising practices resulted in a horizontal allocation of the hotel-motel market among HI and its franchisees in violation of the Sherman Act. The district court, sitting without a jury, concluded that HI had transgressed the law.

This appeal by HI from the judgment in favor of AMI raises several important issues regarding the application of section 1 of the Sherman Act*fn1 in the setting of a franchise arrangement:

1. Did the district court err in finding that HI had unlawfully conspired with one or more of its existing franchisees in the Newark vicinity to restrain trade unreasonably when AMI's application for a Holiday Inn franchise at the Newark airport was denied?

2. Did the district court err by misleading HI into believing that the suit involved only the denial of AMI's Newark application rather than a challenge to the national operation of HI's procedures for granting franchise applications?*fn2

3. Does HI unreasonably restrain trade by requiring that its franchisees not operate any hotels or motels which are not franchised by HI?

4. Does the combination of three characteristics of the Holiday Inns franchising system - the "radius letter" practice; the prohibition on franchisees' operation of non-Holiday Inns; and HI's alleged practice of permitting only parent company-owned inns to be established in specified towns - constitute an unreasonable restraint of trade?


The trial judge found that on December 31, 1972 the Holiday Inns system consisted of 1380 Holiday Inns throughout the country. HI and its subsidiaries owned or operated 281 of these Inns. The remaining 1099 were owned by independent parties who operated the motor lodges pursuant to franchise agreements with HI, which licensed the franchisee to use the Holiday Inn trademark.

At the time of the district court's decision, AMI, in addition to operating 48 Holiday Inns, had licenses to build eight inns and commitments from HI for five additional franchises.

Prior to trial the International Association of Holiday Inns was permitted by the trial court to intervene as a defendant. The membership of the Association is composed of all the Holiday Inns, whether franchised or operated by HI. The Association was, on its own motion, dismissed as a defendant at the close of AMI's case, but was allowed to continue to participate in the proceedings as an amicus curiae.

After the parties agreed to a bifurcated trial, the court conducted proceedings on the issue of liability. Following a decision which concluded that HI was liable to AMI, the parties stipulated to treble damages in the amount of $4 million, plus attorneys fees and costs. In addition, both sides agreed to equitable relief including a declaratory judgment that the clause in HI's standard licensing agreement barring HI franchisees from owning non-Holiday Inns*fn3 was unlawful; an injunction against enforcement of that clause by HI; and an injunction against HI's soliciting comments or objections from its existing franchisees when considering an application for a new franchise.

1. AMI's Application for a Franchise at Newark Airport and the Operation of the Radius Letter Procedure

The events which provided the impetus for this litigation between HI and AMI began with AMI's application for a franchise to open a Holiday Inn near the Newark airport. In February, 1971 the City of Elizabeth, New Jersey invited bids for the purchase of a parcel of land close to the proposed site of a new terminal at the Newark airport. AMI submitted the highest bid, and in December, 1971, received a deed for the property, subject to the condition that $1 million worth of construction on a hotel-motel complex be completed at the location within eighteen months. AMI then applied to HI for a license to operate a Holiday Inn on the Elizabeth property.

The normal HI procedure upon receiving an application for a franchise was to send written notices of the application - referred to as radius letters - to at least the three Holiday Inns nearest the proposed location. The recipients of the radius letters were invited to forward to HI their written comments on the application, but were under no obligation to respond. Any replies to the radius letters received by HI were referred to the Franchise Committee, which then reviewed the application.

Ordinarily HI's Franchise Committee had the authority to grant or to deny any franchise application. However, the district court found that if, as a result of the radius letters, HI received an objection to the proposed franchise by an existing franchisee, the only definitive action the Franchise Committee could take was to deny the application. It could not approve the application. Once an objection had been lodged, the franchise could be awarded only by the Executive Committee of the Board of Directors of HI. According to the trial judge, in order for the Executive Committee to consider an objection by any existing franchisee, the Franchise Committee must already have recommended that the franchise be granted. In 1972 the Executive Committee reviewed 75 applications for franchises to which one or more existing franchisees had objected, and denied 43 of them. The trial court found as a fact that "these 43 applications would have been granted but for objections from existing franchisees."*fn4

With regard to AMI's application for a franchise for the Elizabeth property, HI sent radius letters to its licensees in downtown Newark and Carteret, New Jersey, as well as to Arthur and Edwin Fleck, the holders of a franchise for a Holiday Inn near the existing passenger terminal at the Newark airport. The Flecks' motel was approximately 1.25 miles from the AMI property. The Flecks previously had plans to expand their own inn, and, prior to AMI's acquisition of the Elizabeth property, had notified HI that they were interested in building another Holiday Inn on the property eventually purchased by AMI. Indeed, the Flecks submitted a bid for that specific property, but were outbid by AMI.

The Carteret franchisee and the Flecks advised HI that they opposed the grant of AMI's application. The district court found that the objections of the Flecks and the Carteret licensee "were dispositive to the [Franchise] Committee,"*fn5 and the Committee rejected AMI's application. HI informed AMI of the denial of its request for the franchise, noting that AMI's proposed inn would have been in competition with the Fleck's existing inn. In discussing with AMI the alternatives available in light of the rejection of the application, the Chairman of the Board of HI recommended that AMI contact the Flecks "to try to 'work something out with them,'" adding later that if AMI and the Flecks "were able to make a deal",*fn6 HI would be satisfied. After consideration of this evidence the trial judge decided that "AMI's application for a franchise located on the [Elizabeth] property was rejected because of Fleck's [sic] objections, which were treated as a veto by HI."*fn7

After the denial of its request for a Holiday Inn license, AMI sought to have HI waive the non-Holiday Inn clauses in AMI's existing licenses to enable AMI to build a Sheraton Inn on the Elizabeth site. HI refused.

With respect to the events surrounding AMI's request for a license to construct a Holiday Inn on the Elizabeth property, the district court concluded that the denial of the application was the result of a combination or conspiracy to allocate territories among competitors. The trial court considered that combination or conspiracy to be essentially horizontal in character, and therefore an unreasonable restraint of trade repugnant to the Sherman Act.

The district court also determined that HI's radius letter policy, as it operated nationally, created in effect a horizontal allocation of territories among competitors, thereby contravening section 1 of the Sherman Act.

2. The Advance Reservation System and the Restriction on Franchisees' Ownership of Non-Holiday Inn Motor Hotels

HI and its franchisees operate a free advance-reservation system which enables the traveler to make a reservation from any Holiday Inn to any other Holiday Inn. Since 1965 such reservations and referrals have been handled by means of the computerized Holidex system. That system links every Holiday Inn in North America to a central computer. Through the computer, reservations may be made and confirmed from one Holiday Inn to another, as well as from a number of reservation offices to the inns. Furthermore, when the computer cannot confirm a reservation at a particular inn, it reflects any space available at the Holiday Inns nearest the desired location.

Each inn must have a Holidex terminal in operation 24 hours a day. The costs of operating the Holidex system are borne by the individual inns, through installation charges and a monthly fee that is based on the number of rooms at each inn served by the system. In exchange for these payments an inn may receive - through the computer - reservations referred from the other inns, from reservation offices, or from Holidex terminals located in the offices of several major corporations.

The district court found that the reservation referral concept had been "very important to the growth and success of the Holiday Inn System."*fn8 For the three years between January, 1970 and December 31, 1972, approximately 30 to 38% of the total occupancy of all Holiday Inns originated through Holidex, and reservations made by one inn for another inn accounted for 21.4% of total occupancy.

Each Holiday Inn franchise agreement now requires the licensee "to use every reasonable means to encourage use of 'Holiday Inns' on a national basis by the traveling public." To this end, the Holiday Inn franchise agreement has, since 1958, provided that the franchisee may not directly or indirectly own or operate any hotel, motel or motor inn which is not a Holiday Inn. This is referred to as the "non-Holiday Inn clause." There are no restrictions, however, on a former franchisee's ownership of non-Holiday Inns as soon as the franchisee has relinquished all the licenses it has received from HI. HI contended in the district court, as it does here, that the non-Holiday Inn clause is necessary in order to preserve the viability of the inn-to-inn referral system.

The trial judge found that between 1953 and 1958 each franchise agreement conferred upon the franchisee an exclusive license within a specified geographic area, and the "best efforts" clause and the "non-Holiday Inn" clause were limited in their effect to that specific locale. Since 1958, Holiday Inn franchise agreements no longer grant exclusive territories.

In 1957 or 1958, however, HI became disturbed over an incident involving a franchisee who utilized his Holiday Inn to promote his own non-franchised motel rather than the Holiday Inn near that motel. Albert Pick operated not only five or six Holiday Inns but also several non-Holiday Inn motels. An inspector from HI found pamphlets at one of Pick's Holiday Inns which advertised Pick's motel in Montgomery, Alabama rather than the Holiday Inn located in that city, that Pick did not own. HI subsequently extended the non-Holiday Inn and the best-efforts clauses to apply to the Holiday Inn system nationwide, rather than merely to the geographic area in which a franchisee's Holiday Inn is located.

The best efforts clause of the Holiday Inn franchise agreement was interpreted by the trial judge to impose on the licensee the obligation to refer the customers of his Holiday Inn to the other Holiday Inns throughout the country rather than to any non-Holiday Inn, whether owned by the licensee or not. Thus, if an individual owned a Holiday Inn in Philadelphia and a non-Holiday Inn in New York City, he would, according to the trial judge, be required by the best-efforts clause to refer the customer of his Philadelphia Holiday Inn to the Holiday Inn in New York rather than to his own New York City motor lodge. HI claimed that, although the best efforts clause imposed that obligation on the franchisee, the duty was difficult to enforce in the absence of the non-Holiday Inn clause, which removed any financial incentive to violate that obligation. The trial judge found, however, that the two clauses were equally troublesome to enforce. Furthermore, the district court determined that, in this modern age, non-computerized reservations systems are too costly and inefficient to be practicable, that the Holiday Inn franchisees were precluded from having on the Holiday Inn premises any reservation system or computer terminal other than Holidex, and that such prohibition is readily enforceable by HI's periodic inspections.

Other hotel-motel chains or referral groups, the district court found, do not place nationwide restrictions on their franchisees' ability to own hotels or motels not licensed by the respective groups. Instead, according to the trial court, other trademark licensors merely preclude their franchisees from owning motor lodges not operated under that trademark within a limited distance from the franchisee's licensed establishment.*fn9 Alternatively, some chains prohibit their members from operating motor hotels under other trademarks without the licensor's consent, but the licensor contracts not to withhold its consent unreasonably.

The effect of the non-Holiday Inn clause, according to the trial judge, "is the intended one of reducing and preventing competition among Holiday Inn franchisees and between franchised inns" and those owned and operated by HI itself.*fn10 Protection of the reservation-referral system, the court decided, "was and is available through other provisions of its contract . . ., and was and is available through less restrictive provisions utilized by other national hostelers."*fn11

The trial judge concluded that the non-Holiday Inn clause was an unreasonable restraint of trade. He reasoned that the Holidex referral system could be adequately protected without a device so restrictive of competition as the non-Holiday Inn clause. That clause, according to the district court, resulted in a foreclosure of all competing hotel chains and referral systems from doing any business with any Holiday Inn franchisee. Moreover, the court stated, "'Even otherwise reasonable trade arrangements must fall if conceived to achieve forbidden ends.'"*fn12 The trial judge in this regard appears to have believed that the non-Holiday Inn clause was illegal because he had found that it was adopted in order to prevent competition among franchisees and between franchisees and company-owned inns. Thus the district court held that the non-Holiday Inn clause was an unreasonable restraint of trade which affronted section 1 of the Sherman Act.

HI asserted as a defense that the clause in question was, in effect, merely an exclusive dealing contract. The parties agreed that all exclusive dealing agreements must comply with the standards of section 1 of the Sherman Act. In addition, if the contract involves the sale or lease of goods, a lawful exclusive dealing agreement must also satisfy the more rigorous standards of section 3 of the Clayton Act.*fn13 The parties further agreed that although the Clayton Act is not applicable to the non-Holiday Inn clause because no goods were involved, if the clause did not infringe upon the stiffer standards of anti-competitiveness under the Clayton Act, it would, a fortiori, be lawful under the less restrictive provisions of the Sherman Act.*fn14

The trial judge, who assumed arguendo that the clause is an exclusive dealing agreement, declared, however, that as an exclusive dealing agreement, the non-Holiday Inn clause does not comply with the Clayton Act's standard for lawfulness because it forecloses competitors of HI from dealing with 14.7% of the relevant market.*fn15 Therefore, the court concluded "[since] wholly apart from the exclusive dealing analysis I have held above that the non-Holiday Inn clause violates Section 1 [of the Sherman Act], if I were to hold the clause to constitute an exclusive dealing arrangement, it would still violate section 1."*fn16

3. Parent-Company Towns.

The district court also found that HI has been following a general practice of not granting franchises in the 152 cities in which the 281 HI-wned inns are located. "[A] significant number of cities are 'parent company towns' in which franchisees may not compete with company-owned inns by building a Holiday Inn or [because of the non-Holiday Inn clause] a non-Holiday Inn."*fn17 AMI had applied for franchises to operate Holiday Inns in several of these "company towns,"*fn18 but its requests were denied in spite of a need, according to the trial judge, for additional motels in those areas.

The district court concluded that the company-town policy in itself was not unlawful. Because the policy was unilaterally imposed by HI, there was, according to the trial judge, no "conspiracy," no "contract" and no "combination." However, the aggregate of the company-town policy together with the radius letter policy and the non-Holiday Inn clause resulted, in the words of the trial judge, in "a horizontal allocation of territories." This is so, the trial court stated, because the radius letter policy and the company town policy prevent Holiday Inns, whether owned by franchisees or by HI, from competing with one another, while the non-Holiday Inn clause prevents HI's franchisees from competing with one another or with the parent company by opening a motor hotel not franchised by HI.

4. Damages and Injunctive Relief.

After the district court's decision on liability, the parties stipulated to treble damages in the amount of $4 million. In addition, the final judgment of the court provided for injunctive relief which had also been agreed upon by HI and AMI following the court's liability determination. The injunctive relief included a permanent restraint on HI's enforcing the non-Holiday Inn clause against any of its franchisees and a permanent restraint on HI's soliciting from its franchisees comments on applications for new franchises. HI was also directed to grant AMI's application for a franchise at the Newark airport.


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