The Franchise Memorandum

In Ammirato v. Duraclean Int’l., Inc., 2011 U.S. Dist. LEXIS 75305 (E.D.N.Y. July 13, 2011), the United States District Court for the Eastern District of New York held that a franchisor was not vicariously liable for a franchisee’s default on loans. A Duraclean franchisee (not a party to this case) obtained a series of loans from plaintiffs to finance cleaning projects by the Duraclean “National Team,” a marketing program whereby the franchisee would obtain large national accounts. When the franchisee failed to repay the loans, plaintiffs sued Duraclean International, Inc., the franchisor, for breach of contract, alleging that Duraclean was an ultimate beneficiary of the loans and was liable for the debt incurred by its franchisee as a joint venture partner, an entity with control over the borrower, or a principal whose agent had apparent authority to bind it.

After an eight-day bench trial, the court concluded that Duraclean was not liable for its franchisee’s unpaid loans. The court found that there was no joint venture between franchisor and franchisee resulting from the formation of the National Team. Specifically, the court found that plaintiffs were unable to prove the essential elements of a joint venture: (1) an agreement to share in the potential profits of the National Team; (2) an agreement to share the losses of the National Team; and (3) joint proprietorship or control over the National Team. The court further found that Duraclean could not be held vicariously liable for its franchisee’s unpaid debt because Duraclean did not exercise the requisite control over its franchisee. Finally, the court found the franchisee did not have apparent authority as an agent to bind Duraclean.

Franchisors need to be cognizant of the legal criteria for joint venture and similar business arrangements, and then make sure to craft relationships with franchisees that do not subject the franchisor to vicarious liability for a franchisee’s debts or other liabilities. This decision provides important guidance in that area.