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Zombie Contracts. What Happens if You Keep Performing Beyond Expiration?

In the commercial world there exist myriad fixed term goods and services contracts. Some contracts renew automatically, but the agreement may state how it can be terminated or renegotiated. Other contracts may contain no extension rights.

When a contract comes to an end, the fact that the parties continue to deal under some sort of informal arrangement does not always mean that all terms of the expired formal contract continue to apply.

But the critical question that the cases usually do not answer remains – what are the terms of the implied, new agreement? Once a court has determined that an implied contract exists post-expiration, at least some of the terms related to the material rights and obligations may have to be clarified. Does the implied contract have the same renewal terms or post-termination obligations? Does the implied contract have the same restrictive covenants? Does the implied contract have the same royalty rates? The Fourth Circuit of Court of Appeals, in Hamden v. Total Car Franchising Corporation, involved a two-year, post-term noncompete clause. The noncompete only referenced the "expiration" of the agreement in the heading of the franchise agreement section and not in the language of the covenant itself. A separate, additional restrictive covenant agreement only referenced what would happen upon "termination" of the agreement prior to its natural expiration date. Id. at 844. For five months after the expiration of the agreement, the franchisee continued to operate. The franchisor sent a notice of the expiration of the franchise agreement and of the franchisee's opportunity to renew. The Fourth Circuit upheld the lower court's decision that the restrictive covenants in the franchise agreement – in large part – did not bind the franchisee.

In a case from Nebraska, Donut Holdings, Inc. v. Risberg, 294 Neb. 861, 885 N.W.2d 670 (2016), neither the franchisor nor franchisee did anything to renew the franchise agreement when it expired. The parties continued to operate as if the franchise agreement were in effect for five more years until 2009. In 2009, the franchisee stopped making payments. The franchisor sent a letter stating that the agreement had expired in 2004, and that the franchisee should review the post-expiration obligations in the franchise agreement. The franchisee continued to operate without making payments until 2012.

The franchisor sued for breach of the franchise agreement to recover lost royalties from 2009 through 2012. The trial court denied the franchisor’s breach of contract claim and the Nebraska Supreme Court agreed, holding that while the parties had an implied-in-fact contract from 2004 to 2009, the franchisor’s 2009 letter terminated it.

When parties don't clearly document their expectations in a clear written agreement, a course of conduct can lead to unexpected or unwanted outcomes. If and when necessary, ensure that all your correspondence is sufficiently conditioned. If in doubt, seek legal advice. Strategic input could be invaluable.