The Franchise Memorandum

In Palermo Gelato, LLC v. Pino Gelato, Inc., 2013 U.S. Dist. LEXIS 9931 (W.D. Pa. Jan. 24, 2013), the United States District Court for the Western District of Pennsylvania dismissed a licensee’s action based on the FTC Rule for lack of subject matter jurisdiction. The parties had entered into a development and supply agreement that gave Palermo exclusive rights to sell Pino’s gelato product in certain designated counties. The dispute arose when Palermo allegedly discovered that Pino had misrepresented its manufacturing method. Palermo filed suit seeking a declaratory judgment that the agreement was invalid on the grounds that the parties had entered into a franchise relationship and that Pino had violated the FTC Rule when it failed to provide a presale disclosure document. Palermo also raised state law claims of unjust enrichment and fraud in the inducement. Pino moved to dismiss the declaratory judgment cause of action, arguing that no franchise relationship existed and that Palermo could not invoke the FTC Rule to void their contract.

Without reaching Pino’s argument, the court held that the claim that the FTC Rule voided the contract did not provide a basis for federal subject matter jurisdiction. The complaint needed to establish that Palermo’s right to relief necessarily depended on resolution of a substantial question of federal law. The court determined that the complaint failed to meet this standard because the application of federal law did not arise in Palermo’s original cause of action but by way of a defense to that action. The court also found that the case lacked an important federal interest given that the FTC Rule does not confer a private right of action and that no government actors were involved. In addition, no “substantial” federal question was presented, as numerous courts had determined that violation of FTC requirements cannot negate an agreement.