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Instructional Systems Inc. v. Computer Curriculum Corp.

Decided: October 19, 1992.

INSTRUCTIONAL SYSTEMS, INC., A CORPORATION OF THE STATE OF NEW JERSEY, PLAINTIFF-APPELLANT AND CROSS-RESPONDENT,
v.
COMPUTER CURRICULUM CORPORATION, A CORPORATION OF THE STATE OF DELAWARE, DEFENDANT-RESPONDENT AND CROSS-APPELLANT.



On certification to the Superior Court, Appellate Division, whose opinion is reported at 243 N.J. Super. 53 (1990).

O'hern, Wilentz, Handler, Stein, King, Annunzio, Clifford

O'hern

The opinion of the court was delivered by

O'HERN, J.

This appeal requires us to adapt legislation enacted over twenty years ago on the model of franchise stereotypes, such as a fast-food outlet, an automobile dealership, or a gasoline service station, to the rapidly-evolving complexities of the computer industry and its various distribution channels. We hold that the contractual relationship between the producer of a computerized educational-learning system and its exclusive regional distributor, a business incorporated in New Jersey, sustains a finding of a "franchise" within the meaning of the New Jersey Franchise Practices Act, N.J.S.A. 56:10-1 to -15 (the Act). The Appellate Division held that the relationship between the producer and the New Jersey entity did not constitute a franchise because the producer had not granted the New Jersey entity a "license to use" its trade name or trademark within the meaning of the Act. N.J.S.A. 56:10-3a. However, the contract documents expressly conferred on the New Jersey entity both the right to use the producer's "name, trademark and logo in its advertising, exhibits, trade shows, public relations materials and manuals," and the duty to use its "best efforts" to promote the producer's products. Although our second determination involves a much closer question, we hold that the evidence sustains the finding of a "community of interest" required under the Act to establish a franchise. N.J.S.A. 56:10-3a. We thus reverse the Judgment of the Appellate Division.

I - BACKGROUND

A. Facts and Procedural History

For purposes of this appeal, we adopt generally the procedural history and the facts of the case as set forth in the brief of defendant, Computer Curriculum Corporation (CCC).

CCC is a Delaware corporation headquartered in Palo Alto, California. It produces and markets an integrated learning system that uses computer technology to teach and monitor a student's progress in such subjects as mathematics, reading, language skills, and computer-science education. From 1974 to 1989, plaintiff, Instructional Systems, Inc. (ISI), a New Jersey corporation with its primary place of business in New Jersey, has served as the exclusive distributor of products sold by CCC in the Northeast. ISI has done so pursuant to a series of written contracts negotiated between the principals of the two companies.

On July 12, 1984, CCC and ISI entered into the contract at issue, entitled "Reseller Agreement." Under that contract, CCC appointed ISI as the exclusive "reseller" of CCC products to certain categories of customers in Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont, and Washington D.C. The contract provided that the agreement "shall * * * continue in effect until July 31, 1989."

In the fall of 1988, ISI proposed that CCC extend the 1984 Reseller Agreement for one more year. CCC declined to do so. CCC believed that ISI was spending a disproportionate amount of its efforts selling in three states -- New Jersey, New York, and Massachusetts -- and was practically ignoring the rest of its sales territory. From 1985 to 1987, ISI's sales outside those three states accounted for only eleven percent of its total sales, notwithstanding the fact that thirty percent of the student population in ISI's territory resided there. In two states, Vermont and New Hampshire, ISI made no sales during that period. In Maine, ISI made no sales in either 1986 or 1987. In the District of Columbia, one of the principal population centers in ISI's territory, ISI's sales for the 1985-1987 time period were less than one percent of ISI's total revenues.

When CCC approached ISI about its allegedly poor sales performance in those states, ISI claimed that its only obligation was to meet certain territory-wide sale quotas. In CCC's view, ISI had told CCC "that it was none of CCC's business" within which territory ISI concentrated its sale efforts.

Instead of allowing the 1984 Reseller Agreement to lapse when it expired, CCC offered ISI a new two-year contract for the three states in which ISI had its major sales activity -- New Jersey, New York, and Massachusetts. CCC decided to take over the marketing of its products in the former ISI territory.

Following lengthy Discussions, ISI and CCC entered into a new contract on January 30, 1989. On August 1, 1989, CCC began to distribute its products in the former ISI territory. ISI continues to sell CCC products in New Jersey, New York, and Massachusetts.

The same day that ISI executed the new agreement with CCC, ISI filed suit against CCC in the Chancery Division. The complaint alleged that the 1984 Reseller Agreement contemplated renewal, that CCC had coerced ISI into signing the new contract, and that CCC had violated the Act by imposing "unreasonable standards of performance" on ISI. The complaint also set forth claims for breach of contract, breach of implied covenant, tortious interference with prospective economic advantage, unfair competition, unjust enrichment, and breach of fiduciary duty.

CCC removed the suit to the United States District Court for the District of New Jersey on the basis of diversity of citizenship. Following discovery, ISI moved for a preliminary injunction enjoining CCC from enforcing the 1989 agreement and for partial summary judgment on its claims under the Act. CCC made a cross-motion for summary judgment, arguing that if the Act could be used to enjoin it from terminating ISI's purported franchise in states other than New Jersey, the Act would violate the Commerce Clause of the United States Constitution. U.S. Const. art. 1, § 8, cl. 3.

ISI responded to the cross-motion by moving before the District Court for an order remanding the state-law issues to the New Jersey courts under the Pullman abstention doctrine. See Railroad Comm'n of Texas v. Pullman Co., 312 U.S. 496, 61 S. Ct. 643, 85 L. Ed. 971 (1941). The District Court retained jurisdiction over the case and "application of the principles of the law determined by the state court to the facts of this case," but "administratively * * * terminated" the matter and remitted to the New Jersey courts the following issues:

(a) whether the Act has extraterritorial reach beyond the State of New Jersey and, if so, to what extent; and

(b) what are the definitions and standards of "community of interest," "license" and "place of business" under the Act[?]

After ISI protested that the limited scope of the remand instructions was tantamount to directing the state court to render an advisory opinion, the court clarified its order. That order authorized the New Jersey court to determine "whether or not there is a community of interest between ISI and CCC," and "whether ISI has a place of business" within the meaning of the Act. The District Court acknowledged that the state court would have to consider the facts of the case in deciding those issues and whether the Act could be applied extraterritorially.

When the matter was returned to the Chancery Division, ISI filed a new complaint alleging that the 1984 Reseller Agreement had created a "franchise" and that CCC had violated the Act by failing to renew the agreement without "good cause" and by imposing unreasonable standards of performance. The complaint sought "a declaration of the rights and liabilities of CCC and ISI under their relationship," an order enjoining CCC from terminating its relationship with ISI, damages, attorneys' fees, and costs. Both parties agreed to submit the case to the Chancery Division based on the District Court's record and without further discovery.

The Chancery Division issued a declaratory judgment that the relationship between the parties constituted a "franchise" and that that relationship was subject to the Act.

The Chancery Division ruled first that the importance of New Jersey's interest in protecting its franchisees nullified the 1984 agreement's California choice-of-law provision. Next, the court found there could be "no other reasonable Conclusion" but that CCC and ISI had "contemplated" that plaintiff would have a "place of business" in New Jersey as required by the Act for coverage. The court then found that CCC had granted to ISI a license to use its trade name. The court based that finding on the Conclusions that the school districts buying CCC products had perceived ISI and CCC to be the same entity, and that CCC had "vouched" for ISI's competence by having ISI train customers to use CCC products.

The court found further that there was unequal bargaining power and sufficient mutual dependence between the parties to form the Act's "community-of-interest" requirement. Finally, the court found that the Legislature had not sought to give the Act extraterritorial effect beyond New Jersey. Rather, it was the parties, by defining a market area in their contract which includes states beyond the State of New Jersey, who gave the Act the extraterritorial reach.

The Appellate Division reversed, holding that the 1984 agreement does not constitute a franchise within the meaning of the Act because CCC "did not grant a 'license' to ISI as that term is used within the Act's definition of 'franchise.'" Instructional Systems, Inc. v. Computer Curriculum Corp., 243 N.J. Super. 53, 58 (1990). The Appellate Division declined to consider whether the Act, if it had been applicable to the relationship between CCC and ISI, could have been applied extraterritorially. Id. at 61-62.

We granted ISI's petition for certification, 126 N.J. 318 (1991). Because the Appellate Division had based its decision solely on the license issue, we asked the parties to brief the remaining issues of choice of law, place of business, community of interest, and extraterritoriality. We heard reargument on those issues. We now reverse.

B. Technical Background and Reseller Agreement

In order to understand this appeal more fully, we must attempt to understand something about which we know very little -- computer technology. A computer is not like a manual typewriter, on which we can actually see the physical connection between input -- manually pressing a key, and output -- the hammer striking a sheet of paper. One who presses a few keys on a computer keyboard that produces information or text on a video-display screen is largely unaware of what actually occurs within the machine to allow the information to be presented. However, a rudimentary understanding of computer technology helps one to grasp the relationship between CCC and ISI.

There are three basic components involved in the computer process: hardware, operating-system software, and application software. All of those components have distinct responsibilities that must be carried out with precision and in harmony. See 11 McGraw-Hill Encyclopedia of Science & Technology 124-26 (7th ed. 1992) (McGraw-Hill); Encyclopedia of Computer Science 641-49 (1976).

Hardware, the most obvious component of the computer process, consists of all of the physical objects that make up a computer; i.e., a central processing unit, or CPU (the part of the computer that contains the electronic circuits), a keyboard, a video display, and a printer. See generally Linda G. Christie & John Christie, The Encyclopedia of Microcomputer Terminology (1984) (Microcomputer Terminology) (defining computer-related terms). Operating-system software interacts directly with the hardware and tells the computer how to perform the most basic functions. For example, without a software-operating system, a computer would not know how to place a character on the video-display screen and would be nothing more than a useless mass of silicon and plastic. Simply stated, operating-system software turns the hardware into a usable machine. See McGraw-Hill, supra. at 125-26. The operating-system software often accompanies the computer's major hardware component, the CPU. See Microcomputer Terminology, supra.

Application software interacts directly with operating-system software to comprise the final set of instructions required to make a computer perform a given task. Application software ranges from "off-the-shelf" packages, such as familiar word-processing programs like WordPerfect, which may be purchased at the neighborhood-software store, to custom designed, user-specific programs. Application software does not interact with the computer hardware but interacts exclusively with the operating-system software. See McGraw-Hill, supra, at 125-26. Therefore, application software is usually designed to interact with one type of operating-system software. Ibid. Because of that limitation, the computer industry has developed standard operating-system software packages that run with a great majority of computer hardware. Two of the most notable standard operating systems are "MS-DOS" and "UNIX."*fn1 See Time-Life, supra, at 96-97.

The CCC computer-assisted learning system consists of hardware, operating-system software, and application software. The CCC system's hardware is the amalgamation of numerous physical components that CCC has assembled together into what it calls the "Microhost." The Microhost's operating-system software, also developed by CCC, is a modification of the UNIX operating system. CCC system's application software is essentially the heart of the CCC product line. CCC has spent over twenty years researching and developing an extensive library of educational-curriculum software, which CCC describes as "Courseware."

The CCC integrated-learning system reinforces what is being taught to the student in the classroom. Visualize a "computer laboratory" of students working at numerous computer terminals. When a student punches into the computer a four-digit identification number followed by the student's first name, the words "Hello, Student * * *" flash on the terminal screen. Each computer session begins where the student finished the previous day. When the student types an incorrect answer, the computer politely suggests "Try again." When the student finishes the lesson, the screen displays the student's results and the computer records the student's performance.

Students use the CCC computer-assisted instruction system to extend their classroom lessons and to enhance learning and performance. Teachers accompany their classes to the computer laboratory, where they help students understand the problems and relate the instructions from the classroom to the computer laboratory. Teachers need no expertise as computer operators or programmers. The teachers are trained on how the system works and are familiarized with the available software curriculum, or Courseware.

CCC is in large measure the creation of Dr. Patrick Suppes, formerly of Stanford University, who spent over two decades researching and developing the CCC system. Except in the Northeast, CCC markets, distributes, and sells its products directly to educational institutions throughout the United States.*fn2 Over the past fifteen years, CCC has developed a distribution arrangement in the Northeast with Phyllis Kaminer (Kaminer), the President and CEO of ISI. Evidently, Kaminer developed some expertise in the field of education and computers, and, in 1972, became associated with a company known as Educomp of Connecticut. In her position at Educomp of Connecticut, Kaminer developed a relationship with CCC. Following Educomp of Connecticut's refusal to make an arrangement with CCC for the promotion of CCC products, Kaminer left Educomp of Connecticut and sought her own arrangement with CCC.

CCC entered its first distribution contract with Kaminer in 1975. At that time, Kaminer was the principal of a company known as Educomp of New Jersey, located in Tenafly, New Jersey. The 1975 agreement gave Educomp of New Jersey the exclusive right to market CCC products in the states of New York, New Jersey and Connecticut and in the region of Eastern Pennsylvania.*fn3 The 1975 agreement was to run until 1980.

The record suggests that sometime between 1975 and 1980, Kaminer changed the name of her company to ISI and moved the headquarters to Englewood Cliffs, New Jersey. In 1980, CCC entered into a new distribution agreement with ISI. The 1980 agreement gave ISI the "exclusive right to purchase or license the CCC products * * * for purposes of selling, leasing or renting such products to the market in the States of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Washington D.C." The 1980 agreement was to run until 1984.

The 1984 agreement between CCC and ISI, labeled "ReSeller Agreement," contained many of the same provisions as the 1980 agreement. ISI highlights several provisions contained in the 1984 agreement that it deems relevant:

1. CCC conferred on ISI an exclusive right to sell and license CCC's products within ISI's territory.

2. CCC required ISI to use "its best efforts to develop a demand for and Resell the [CCC] Products within the Market * * * ."

3. CCC obligated ISI to "devote all of its energies and resources to developing a demand for the [CCC] Products."

4. CCC prohibited ISI from selling any products competitive with CCC's products.

5. CCC required ISI to maintain at least four full-time sales representatives to promote and sell CCC's products.

6. CCC obligated ISI to "maintain adequate facilities * * * to promote demand for and Resell [CCC's] Products."

7. CCC required ISI to promote CCC's products through "advertising and exhibition at trade shows, conventions and the like."

8. CCC authorized ISI to extend its use of the CCC name, trademark and logo in ISI's "advertising * * * public relations materials and manuals."

9. CCC gave ISI the right to sublicense the CCC copyrighted Courseware.

10. CCC allowed ISI to receive sublicense fees from its customers for the CCC Courseware and to pay CCC license fees for each sublicense in accordance with a price schedule established by CCC.

11. CCC required ISI to prepare customers' sites for installations of the CCC product in accordance with CCC specifications; CCC installed the products.

12. CCC required ISI to "establish and maintain a program for the benefit" of the users of the CCC products so that they may obtain training in the use and operation of the CCC products.

13. The agreement was to be interpreted in accordance with the laws of the State of California.

In ISI's view, under the terms of the 1984 agreement, it had the responsibility of locating customers, persuading them to purchase CCC's products, selecting the site at which the product was to be installed, and placing the purchase orders with CCC. Following CCC's installation of the product, ISI would train the teachers and instructors to use the product. Thereafter, ISI had a duty to follow-up with the customer to provide continuing training at those locations. Ninety-seven percent of ISI's revenue came from the sale of CCC's products.

In 1988, in an effort to remain competitive within the computer-assisted-instruction industry and to avoid product obsolescence, CCC decided to change the direction of its business. Around that time, CCC began negotiations with IBM to allow its application software, or Courseware, to run on the MS-DOS standard operating system. By allowing its Courseware to run on MS-DOS, CCC would increase the accessibility of its product line. Thus, such an arrangement would allow CCC's Courseware to run on the popular IBM Personal Computer family, thereby eliminating CCC's need to assemble and market its own Microhost hardware. Presumably, such an arrangement would allow CCC to market its products more competitively to smaller school districts because the smaller districts would not be "locked-in" to purchasing the CCC Microhost, and could purchase a less expensive and more versatile IBM-PC instead.

CCC's efforts to change business directions caused CCC to reconsider its relationship with ISI. In 1989, CCC offered to ISI a new written agreement (the 1989 agreement) that modified the 1984 Reseller Agreement. That agreement reduced ISI's marketing territory to three states: New Jersey, New York, and Massachusetts. The balance of ISI's prior territory comprising Maine, New Hampshire, Vermont, Rhode Island, Connecticut, Delaware, Maryland, and the District of Columbia was taken over by CCC and has been marketed directly by CCC since August 1, 1989. The 1989 agreement eliminated ISI's exclusive right to sublicense the CCC Courseware in the assigned territory.

II

What is a "franchise" under the New Jersey Franchise Practices Act?

We now turn to the issue of whether the business relationship between CCC and ISI constitutes a franchise protected under the Act. CCC asserts that the 1984 agreement does not constitute a franchise because (1) CCC never granted to ISI a "license," as that term is contemplated under N.J.S.A. 56:10-3a; (2) there is no "community of interest" between CCC and ISI; (3) the parties did not "contemplate" that ISI would maintain a "place of business" within the State of New Jersey; and (4) ISI never maintained a "place of business" in the State of New Jersey. We address each of those arguments in turn.

Although franchise arrangements take many different forms,

"in its simplest form, franchising involves a company with a product or service which arranges for a group of dealers to handle its distribution. The company with the product, product line or service is known as the franchisor, and the dealers who acquire the right to sell the product or service exclusively are known as franchisees."

[Ernest Gellhorn, Limitations on Contract Termination Rights -- Franchise Cancellations, 1967 Duke L.J. 465, 465 n.1 (quoting Lewis & Hancock, The Franchise System of Distribution 1 (1963) (Gellhorn)).]

There are three general categories of business franchises:

(1) Product Franchises, under which a "franchisee[ ] distributes goods produced by the franchisor * * * and which bear the franchisor's trademark. * * * Typical product franchises include automobile and truck dealers, gasoline service stations, and soft drink bottlers."

(2) Package or Format Franchises, under which "the franchisee is licensed to do business under a prepackaged business format established by the franchisor and identified with the franchisor's trademark. * * * Examples of format franchises ...


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