December 1, 2006
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The GPMemorandum, Issue 94
To view a pdf. version of The GPMemorandum, Issue 94, please click here.
This section of The GPMemorandum addresses non-judicial developments, trends, and best practices of interest to franchisors.
GIFT CARD ISSUED BY NATIONAL BANK NOT SUBJECT TO STATE GIFT CERTIFICATE LAW
Gift cards are “stored-value” payment cards that may be purchased by a consumer with pre-loaded value in various denominations or may be purchased “empty” and then loaded (and reloaded) with value. Gift cards may be either “closed-system” or “open-system” cards. Closed-system cards, which are most common in the franchise industry, may only be redeemed within the network of the retailer that sold the card to the consumer. In contrast, open-system cards typically are “issued” by banks (although the cards may be co-branded), operate through the VISA® or MasterCard® interchanges, and generally may be redeemed at any merchant that accepts those credit or debit cards regardless of where the gift cards are originally purchased.
The dramatic rise in the popularity of gift cards has resulted in the recent enactment of numerous state laws regulating various aspects of gift cards, such as service fees, dormancy fees, the treatment of lost/stolen cards, and expiration dates. These state gift card or gift certificate (broadly defined to include gift cards) laws often are inconsistent from state-to-state. As a result, a franchisor that offers closed-system gift cards through a national or regional franchise system must offer gift cards that either satisfy the “lowest common denominator” of these various state laws or carry terms and conditions that vary depending upon the state of purchase. Although these state laws do not appear to be curtailing the ever-increasing use of gift cards, they do impose notable compliance burdens on franchisors and other national and regional gift card program sponsors.
The recent decision in SPGGC, LLC, et al v. Ayotte, 2006 WL 2165672 (D.N.H. Aug. 1, 2006), suggests an approach to developing a gift card program that avoids the need for compliance with the various state gift card laws. SPGGC is an affiliate of Simon Properties Group, L.P., which owns and
The state of New Hampshire notified Simon that its gift cards violated the State’s gift certificate law, which prohibits any administration fees that “have the effect of reducing the total amount for which the holder may redeem a gift certificate” and prohibits expiration dates on gift certificates of $100 or less. In response, Simon filed a declaratory judgment action for a determination that the State’s gift certificate law was not applicable to its gift cards and was preempted by federal banking law. Simon argued that federal banking law authorizes national banks and federal savings associations to issue and sell gift cards, both directly and through third-parties, and that federal banking law preempts inconsistent state law that would otherwise be applicable to those gift cards. The State largely conceded that federal banks and savings associations are authorized to sell gift cards in New Hampshire and that such gift cards are not subject to the State’s gift certificate law, but argued that because Simon is not a national bank or federal savings association, the gift certificates sold by it are subject to the gift cards law even though they were issued by a federal financial institution.
The federal court held that national banks and federal savings associations are authorized to issue and sell gift cards and that state laws that restrict that practice are preempted by federal banking law. The court further determined that federal financial institutions are authorized to sell their products through third parties, such as Simon. Finally, the court held that notwithstanding Simon sold the gift cards, the issuing federal financial institutions retained a substantial connection to the gift card purchasers and the application of the gift certificate law to the gift cards would impermissibly restrict the activities of the federal financial institutions.
There undoubtedly will be further developments in this area as national and regional franchisors and other gift card program sponsors attempt to develop gift card programs that build upon this decision to avoid the application of numerous inconsistent state laws.
Here are some of the most recent judicial developments of interest to franchisors:
CALIFORNIA COURT VACATES INTERNATIONAL ARBITRATION AWARD, FINDING NO PREEMPTION OF STATE VACATUR STATUTE
In Gueyffier v. Ann Summers, Ltd., 2006 WL 3028272 (Cal. Ct. App. Oct. 26, 2006), a case involving a franchisor’s appeal of an arbitration award on the basis that the arbitrator exceeded his powers in failing to enforce the terms of the parties’ Franchise Agreement, the California Court of Appeals vacated the arbitration award in question.
Following the arbitration that involved foreign parties, but which occurred in the United States, the arbitrator concluded that the franchisor breached its contractual obligations to provide the following to the franchisee: (1) operations manuals; (2) training and assistance; and (3) advertising support. The arbitrator also found that these breaches were incurable. Based upon these findings, the arbitrator held that the franchisee did not have an obligation to comply with the notice and cure provisions under the Franchise Agreement, which require the franchisee to provide the franchisor with an opportunity to cure any alleged breaches.
In response to the franchisee’s motion to confirm the arbitration award, the franchisor moved to vacate the award under the California Arbitration Act. Specifically, the franchisor argued that the arbitrator exceeded his powers when he failed to enforce the Franchise Agreement’s provision requiring the franchisee to provide the franchisor with an opportunity to cure any alleged breaches. In confirming the arbitration award, the trial court found that the arbitrator neither refused to enforce the notice and cure provision of the Franchise Agreement, nor did he exceed his powers in any manner.
On appeal to the California Court of Appeals, the appellate court sharply rejected the arbitrator’s and trial court’s conclusions and found that the Franchise Agreement expressly prohibited the arbitrator’s modification of any material term of the Agreement and that the arbitrator had exceeded his powers by failing to enforce the notice and cure provisions contained in the Agreement. In reaching its decision, the appellate court provided an extensive analysis of whether the California Arbitration Act, which allows an arbitration award to be vacated where an arbitrator exceeds his or her powers, was preempted by the Federal Arbitration Act (“FAA”) and the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“the New York Convention”). The court found it significant that, although the arbitration involved foreign parties, it had been held in the United States, and enforcement was being sought in the United States. The court of appeals ultimately held that: (i) the FAA does not preempt state law grounds for vacating arbitration awards; (ii) the New York Convention reflects no intention to preempt state statutes relating to vacating awards; and (iii) Title 9.3 of the California Code of Civil Procedure, which does not provide for enforcement, confirmation, correction, or vacation of international commercial arbitration awards, was not applicable.
STATE FRANCHISE LAWS/VIOLATIONS/TERMINATIONS
COURT REJECTS FRANCHISEES’ CLAIMS UNDER THE MINNESOTA FRANCHISE ACT
In Kieland v. Rocky Mountain Chocolate Factory Inc., 2006 WL 2990336 (D. Minn. Oct. 18, 2006), the court considered claims brought by two franchisees under the Minnesota Franchise Act, as well as a claim that the franchisor breached the implied covenant of good faith and fair dealing. The franchisee alleged that Rocky Mountain had violated the Minnesota Franchise Act by misrepresenting the cost of a point-of-sale-system that Rocky Mountain required its franchisees to employ. The franchisees further claimed that the franchisor had made an unlawful earnings claim, and had discriminated against them by requiring the franchisees to pay royalty fees while waiving such fees for other franchisees whose sales were below a certain threshold. Finally, the franchisees alleged that Rocky Mountain had violated the implied covenant of good faith and fair dealing by terminating their franchise rights due to their failure to pay required fees.
The court granted summary judgment to the franchisor on each of the claims. The court found that Rocky Mountain was not required to disclose in its UFOC that it occasionally waived the fees owed by some franchisees who were in financial trouble. Nor did the franchisor violate the MFA by requiring its franchisees to purchase a particular point-of-sale-system, as that obligation was clearly set forth in the UFOC. The court also held that there were no facts supporting the franchisees’ argument that Rocky Mountain made unlawful earnings claim. Moreover, the court noted that both the UFOC and the Franchise Agreement provided that the franchisor’s representatives were not authorized to make earnings claims, so that reliance on any such claims would necessarily be unreasonable. The court also rejected the franchisees’ claim that Rocky Mountain had discriminated against them by not waiving their franchise fees. The court found that the franchisees were not similarly situated to those franchisees whose fees had been waived. Thus, Rocky Mountain had no obligation to treat the franchisees similarly.
Finally, the court rejected the franchisees’ claims under the implied covenant of good faith and fair dealing. The court found that Rocky Mountain was contractually permitted to issue notices of default for failure to pay fees. Thus, issuing such notices when the franchisees failed to pay the required fees could not constitute a breach of the implied covenant. Accordingly, the court granted summary judgment to Rocky Mountain on all claims.
CALIFORNIA COURT OF APPEALS UPHOLDS FINDING OF NO FRANCHISE RELATIONSHIP
In Thueson v. U-Haul Int’l, Inc., 2006 WL 3118711 (Cal. Ct. App. Nov. 3, 2006), the California Court of Appeals upheld the trial court’s dismissal of a U-Haul dealership’s claim for wrongful termination on the ground that the plaintiff had not entered into a franchise agreement as defined by California law. The court determined that the dealership contract plaintiff was operating under had not imposed a franchise fee, and thus lacked one of the necessary elements of a franchise agreement.
The plaintiff in Thueson entered into a dealership agreement with U-Haul, but paid no direct fee at the time he entered the contract or anytime thereafter. The plaintiff did, however, pay certain monthly sums to U-Haul, including a small fee for a dedicated telephone line, a directory listing, and a computer terminal that connected to the U-Haul reservation system. After U-Haul issued the plaintiff a 30-day notice of termination, the plaintiff brought suit against the company, claiming that good cause was required to terminate the dealership agreement under the California Franchise Investment Law (“CFIL”) and the California Franchise Relations Act (“CFRA”). Following a bench trial, the trial court held that U-Haul was not liable under either the CFIL or the CFRA because the plaintiff had not been charged any initial or continuing franchisee fee. Thus, there had been no franchise relationship, as defined by either of the statutes.
On appeal, the court of appeals upheld the trial court’s decision in full. Even though the appellate court acknowledged that the CFIL and CFRA should be broadly construed to even the playing field between franchisors and franchisees, it noted that these statutes apply only to franchise agreements that meet all of the statutes’ requirements. Among other things, under both the CFIL and CFRA, a contract is not considered to be a franchise agreement unless the franchisee is required to pay a “franchise fee” of some kind. A franchise fee is defined under both the CFIL and CFRA as “any fee or charge that a franchisee . . . is required to pay or agrees to pay for the right to enter into a business under a franchise agreement, including, but not limited to, any payment for goods or services.” The statutes set a relatively low threshold for payments to be considered franchise fees - $500 annually under the CFIL and $100 under the CFRA.
The court of appeals rejected the plaintiff’s argument that the sums he paid to U-Haul for the dedicated telephone line, the directory listing, and the computer terminal were either fees charged as a condition for entering into the dealership agreement or disguised continuing franchise fees. The court agreed with the trial court’s determination that the costs of the telephone line and the charges for the computer equipment were nothing more than “ordinary business expenses” and, as such, “do not constitute . . . an investment or franchise fee.” Therefore, the court concluded that the dealership agreement was not a franchise agreement, neither the CFIL nor the CFRA applied, and U-Haul had the right to terminate the agreement without good cause.
REQUIRED ADVERTISING CONTRIBUTION CONSTITUTES A HIDDEN FRANCHISE FEE UNDER THE ILLINOIS FRANCHISE DISCLOSURE ACT
In Bly & Sons, Inc. v. Ethan Allen Interiors, Inc., 2006 WL 2547202 (S.D. Ill. Sept. 1, 2006), the plaintiff alleged that Ethan Allen amended and enforced its quality standards in a prejudicial manner and that its License Agreement with Ethan Allen was a franchise that was improperly terminated in violation of the Illinois Franchise Disclosure Act (“IFDA”). The plaintiff sued Ethan Allen for violations of the IFDA and breach of the implied covenant of good faith and fair dealing with respect to Ethan Allen’s enforcement of its quality standards. Ethan Allen filed a motion for summary judgment on the plaintiff’s claims.
As to the IFDA claim, the court held that the two percent advertising contribution that the plaintiff was required to pay constituted a hidden franchise fee. In addition, because the other elements of a franchise were present, the court found that the License Agreement was a franchise under the IFDA and could not be terminated except for good cause. Because Ethan Allen did not claim good cause for the attempted termination, the court ruled that it violated the IFDA. The court, however, limited the plaintiff’s damages on the wrongful termination claim to the attorneys’ fees and costs incurred by plaintiff for the time period from when Ethan Allen sent the termination letter on August 3, 2005, to the time Ethan Allen rescinded the termination on September 29, 2005. The plaintiff asked the court to reconsider its decision, arguing that it had further evidence that Ethan Allen’s attempted termination was otherwise wrongful. The court rejected the plaintiff’s argument, stating that the plaintiff continued to have a franchise after rescission of the termination letter and the attorneys’ fees and costs were the appropriate measure of damages.
As to the implied covenant claim, the court rejected the plaintiff’s argument on the ground that Ethan Allen did not breach the License Agreement between the parties by amending its quality standards. The License Agreement was unambiguous and gave Ethan Allen the right to amend the quality standards from time-to-time.
VIRGINIA FEDERAL COURT GRANTS FRANCHISOR RESCISSION FOR FORMER FRANCHISEE’S BREACH OF TERMINATION AGREEMENT
In JTH Tax, Inc. v. Donofrio, 2006 WL 2796841 (E.D. Va. Sept. 26, 2006), the Eastern District of Virginia granted summary judgment in favor of JTH Tax, Inc. (“Liberty”) on its claim for rescission of a Mutual Termination Agreement with one of its former franchisees. At the time the franchisee’s three franchise agreements were terminated, the franchisee owed Liberty $99,359.85. Under the Mutual Termination Agreement, however, Liberty waived the debt in consideration of the franchisee’s agreement to mutually terminate her franchises. Both the franchise agreements and the Mutual Termination Agreement prohibited the franchisee from competing with Liberty and from soliciting former clients of the franchised businesses for a period of two years and within a specified area. Nonetheless, within one year, the franchisee admittedly opened a competing tax service three doors down from one of her former franchised locations and sent a solicitation letter to her former clients.
On its motion for summary judgment, Liberty sought rescission of the Mutual Termination Agreement and an award of the original $99,359.85 debt that had been waived. The court held that rescission was an appropriate remedy because the franchisee’s breach “defeat[ed] the purpose . . . of the [Mutual Termination Agreement].” Because the purpose of the Mutual Termination Agreement (and Liberty’s waiver of a significant debt) was to ensure compliance with the covenants against solicitation and competition, the court awarded rescission, granted Liberty’s request for injunctive relief, and awarded Liberty damages in the amount of $99,359.85.
COURT FINDS FRANCHISEES LIABLE FOR FEES, LIQUIDATED DAMAGES, AND TRADEMARK INFRINGEMENT ON FRANCHISOR’S MOTION FOR DEFAULT JUDGMENT
In Ramada Worldwide, Inc. v. Jay-Dharma, LLC, 2006 WL 3041080 (D.N.J. October 26, 2006), the United States District Court for the District of New Jersey granted Ramada’s motion for default judgment based on the franchisees’ repeated violations of quality standards, violations of the Lanham Act, and nonpayment of royalties and other recurring fees.
The defendants in this case entered into a Franchise Agreement with Ramada to operate a Ramada in Alabama. The Franchise Agreement required the franchisees, among other things, to comply with Ramada’s system standards. The franchisees were also required to make periodic payments to Ramada for royalties, marketing assessments, taxes, interest, reservation system assessments, and other recurring fees. Under the terms of the Franchise Agreement, failure to make timely payments or comply with system standards constituted a default.
Following their execution of the Franchise Agreement, the franchisees failed three quality assurance inspections within a one-year period. Ramada terminated the Franchise Agreement and sued to enforce, among other things, the post-termination obligations set forth in the Agreement. The franchisees failed to answer or otherwise respond to Ramada’s Complaint and, accordingly, Ramada then moved for default judgment. Upon Ramada’s motion, the court found that Ramada was justified in terminating the Franchise Agreement based on the franchisees’ failure to comply with Ramada’s systems standards. The court also found that the franchisees breached the Franchise Agreement by failing to pay all past-due recurring fees and violated the Lanham Act for continuing to use Ramada’s marks after the Franchise Agreement was terminated. Significantly, the court noted that failure to enter a default judgment would prejudice Ramada’s ability to enforce its rights under the Lanham Act and the Franchise Agreement.
Finding liability, the court then assessed Ramada’s entitlement to damages. The court held that, under the terms of the Franchise Agreement, as well as applicable law, Ramada was entitled to past-due recurring fees, liquidated damages (as set forth in the Agreement), plus interest on the past due fees and liquidated damages. The court also awarded Ramada damages resulting from the franchisees’ infringement of Ramada’s trademarks and trebled the damages after finding that the franchisee’s infringement was willful.
JURY TRIAL WAIVER PROVISION UNENFORCEABLE UNDER INDIANA DECEPTIVE FRANCHISE PRACTICES ACT
In Carrel v. George Weston Bakeries Distribution, Inc., 2006 WL 2524124 (S.D.Ind. Aug. 29, 2006) the court held that a jury trial waiver provision contained in the Distribution Agreement between the parties was unenforceable under the Indiana Deceptive Franchise Practices Act (“the Indiana Franchise Act”). After a disagreement arose between plaintiffs and George Weston, the plaintiffs commenced an action seeking a trial by jury. In response to the lawsuit, George Weston brought a motion to strike the plaintiffs’ request for a jury on the ground that the Distribution Agreement contained a jury trial waiver provision in which the parties “knowingly, voluntarily and intentionally” agreed to waive their right to a jury trial.
The plaintiffs argued that the jury waiver provision was illegal under the Indiana Franchise Act and thus unenforceable. Specifically, the plaintiffs contended the clause violates that portion of the Indiana Franchise Act that prohibits provisions in franchise agreements “limiting litigation brought by breach of the agreement in any manner whatsoever.” In finding that the jury trial provision was unenforceable under the Act, the court held that the provision violated the plaintiffs’ substantive right to a trial by jury. The court also held that the parties cannot contractually agree to do something that is clearly trumped by the Indiana Franchise Act.
MICHIGAN FRANCHISE INVESTMENT LAW MAY BE VIOLATED BY FAILING TO DISCLOSE FINANCIAL ARRANGEMENT WITH AFFILIATED ENTITY
In Tubby’s # 14, Ltd. v. Tubby’s Sub Shops, Inc., 2006 WL 2796181 (E.D. Mich. Sept. 27, 2006), the federal district court denied a franchisor’s motion for summary judgment on counts alleging violations of the Michigan Franchise Investment Law (“MFIL”) for failure to disclose relevant financial information regarding the franchisor’s affiliated entity.
The franchisor, Tubby’s Sub Shops, Inc. (“Tubby’s”), formed an entity in 1997 named “SUBperior Distribution Services, Inc. (“SDS”) to enter into agreements with food manufacturers and other distributors of products required to be used by Tubby’s franchisees. The plaintiff franchisees alleged that SDS was created for the sole purpose of generating substantial rebates/kick-backs to Tubby’s.
The plaintiffs brought suit against Tubby’s alleging that Tubby’s had failed to disclose the amount of rebates it received from SDS. The plaintiffs alleged that Tubby’s had a duty to disclose that it was receiving kick-backs from SDS and that Tubby’s was earning a substantial amount of its revenues through the payments from SDS in the form of kick-backs for purchases made by the franchisees. Tubby’s disclosed that it received no more than 2% from its affiliates for required purchases to operate a franchise store. In reality, Tubby’s was receiving 35% from SDS for requiring franchisees to purchase goods and supplies through SDS.
Tubby’s moved for summary judgment on the two counts alleging violations of the MFIL for failure to disclose financial information regarding certain rebates it receives from SDS and that SDS was an affiliate of Tubby’s. The court found that there were genuine issues of material fact regarding both counts and denied Tubby’s motion. The court also found there to be a genuine issue of material fact whether Tubby’s was required to disclose that SDS was its affiliate.
Attorneys who wrote or edited articles for this issue include:
Michael R. Gray, Jeffrey L. Karlin, Gaylen L. Knack, Craig P. Miller, Kevin J. Moran, Kirk W. Reilly, Iris F. Rosario, Max J. Schott, II, Jason J. Stover, Henry Wang, and Quentin R. Wittrock.
For more information on our Franchise and Product Distribution Practice and for recent back issues of this publication, visit the Franchise and Product Distribution group page.
GRAY, PLANT, MOOTY, MOOTY & BENNETT, P.A.
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The GPMemorandum is a periodic publication of Gray, Plant, Mooty, Mooty & Bennett, P.A., and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult your own franchise lawyer concerning your own situation and any specific legal questions you may have.
This article is provided for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have.
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