December 1, 2007
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The GPMemorandum, Tenth Anniversary Issue, No.101
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THE MOST SIGNIFICANT CASES IN THE TEN YEARS AND ONE HUNDRED ISSUES OF THE GPMEMORANDUM
The first issue of The GPMemorandum was dated December 19, 1997. This is Issue 101, not counting our publication of The GPMemorandum International, which is numbered separately. In its first ten years and one hundred editions, The GPMemorandum summarized approximately 700 cases for our franchisor clients and friends. We think this Tenth Anniversary Issue (which also launches a new format of our memorandum) provides an appropriate time to look back and determine what we think have been the most significant cases we summarized. In retrospect, we think the top ten cases have been as follows, listed in chronological order:
We welcome your feedback on this list. And we look forward to doing this again ten years and another hundred issues of The GPMemorandum from now.
This section of The GPMemorandum addresses non-judicial developments, trends, and best practices of interest to franchisors. Reports of recent judicial developments begin on page 5.
ALERT YOUR FRANCHISEES: THE COSTS OF RETAINING CREDIT AND DEBIT CARD TRANSACTION DATA CAN BE HIGH
The expanding use of credit and debit cards, including gift and stored value cards, for consumer point of sale (“POS”) transactions generates ever-increasing flows of electronic consumer and transactional data. That data is highly valued by identity thieves. As recent events have demonstrated, unauthorized access to that data by thieves can be extremely costly to the merchant who collects and retains the data.
TJX Companies, Inc., the parent of retail chains T.J. Maxx and Marshalls, announced earlier in 2007 that its computer systems had been subjected to unauthorized intrusions over a several-year period in which hackers had accessed customers’ credit and debit card data related to approximately 94 million cards. Because the cards were potentially compromised, the card-issuing financial institutions issued new credit and debit cards to their customers. The financial institutions then asserted that TJX was liable for the costs of issuing the new cards. Recent reports state that TJX has agreed to pay Visa® and its card-issuing banks up to $40.9 million for the costs incurred by the issuing financial institutions in replacing the compromised Visa®-branded credit and debit cards. TJX took a $118 million charge relating to the data breach.
Reports suggest that TJX’s card data storage system caused unnecessary customer and card data to be retained for an inordinate period of time. In contrast, the respective merchant rules of the Visa® and MasterCard® systems (to which TJX presumably was subject) prohibit merchants from retaining more than the card account number, expiration date, and cardholder name following authorization of a transaction. Even that limited information is to be retained by merchants no longer than needed for bona fide purposes. These limits on the amount and duration of data retention by merchants is designed in part to reduce the likelihood that the data will be compromised.
In a similar vein, in 2007 Minnesota enacted a “first of its kind” data breach statute that prohibits the retention of certain credit, debit, and stored value card transaction data by merchants (and their card-processing service providers), and expressly shifts to non-compliant merchants the costs incurred by card-issuing financial institutions for reissuing cards that are compromised by data breaches.
This statute is significant in several respects. First, it apparently only applies to cards issued by financial institutions (i.e., Visa® or MasterCard® branded cards, but not typical retailer gift cards). Second, it appears to apply to any person or entity doing business in Minnesota, regardless of where the card data is retained or the data breach occurs. Third, it appears to impose direct liability upon the non-compliant business, and in favor of the card-issuing financial institutions, regardless of whether the compromised data is stored directly by the business or by its service providers. Finally, the statute does not explicitly provide a cause of action against a non-compliant business in favor of the consumers whose card data is breached.
Franchisors would be well advised to assess the extent to which they or their franchisees, and any card-processing service providers and point of sale equipment suppliers to their franchise systems, currently retain prohibited types of card transaction information. Even inadvertent retention of prohibited transaction data has the potential, in the event of a data breach, to be very expensive to their franchise systems.
Here are summaries of some of the most recent case decisions of interest to franchisors:
CONSUMER CLAIMS/CLASS ACTIONS
COURT PERMITS CLASS ACTION LAWSUIT AGAINST FRANCHISOR
The United States District Court for the Southern District of New York last month rejected a franchisor’s motion to dismiss a class action claim arising out of the franchisor’s advertising campaign to promote a lower trans fat content in certain of its menu items. In Jernow v. Wendy’s International, Inc., 2007 U.S. Dist. LEXIS 85104 (S.D.N.Y. Nov. 15, 2007), the plaintiff brought suit against Wendy’s claiming that Wendy’s had provided false nutritional information to its customers through its advertising campaign. Specifically, the plaintiff alleged that Wendy’s had engaged in a public advertising campaign touting its decision to reduce trans fats in its food products by switching to a trans fat-free cooking oil. The plaintiff alleged that Wendy’s had informed the public that the trans fat content of certain foods would be reduced by the end of August 2006. The plaintiff, who allegedly learned post-August 2006 that those products contained higher levels of trans fats than had been advertised, brought suit on behalf of himself and all other consumers. He alleged deceptive advertising, breach of implied contract, and unjust enrichment.
Wendy’s moved to dismiss the complaint for failure to state a claim upon which relief could be granted. The court found that the plaintiff was required only to allege that Wendy’s had engaged in a misleading act that caused injury to the plaintiff, however, and the court found that the plaintiff’s allegation that the advertising campaign was inconsistent with the actual trans fat content of certain of the Wendy’s food products would be sufficient to constitute a misleading act under New York law. The court also found that the plaintiff’s allegation that he had paid a premium to purchase those products because of the representations made by Wendy’s about their trans fat content was sufficient to state a claim for damages. The court further found that the plaintiff had stated a claim for damages by alleging harm caused by the ingestion of a higher than anticipated level of trans fats. While the court characterized those damages claims as “weak,” it nonetheless found them sufficient to survive a motion to dismiss.
WISCONSIN FEDERAL COURT GRANTS QUIZNO’S MOTION TO DISMISS FRANCHISEE CLASS ACTION SUIT
A federal district court judge in Westerfield v. Quizno’s Franchise Company, 2007 WL 3274486 (E.D. Wis. Nov. 5, 2007), dismissed for failure to state a claim a class action suit alleging federal and state-law violations brought by several Quizno’s franchisees against the franchisor and several of its area directors. The franchisees claimed that Quizno’s fraudulently included them into purchasing a franchise. In particular, they alleged that the company misrepresented the likely financial performance of the franchise and failed to disclose there were certain costs and the “markups and kickbacks” added to the cost of products that the franchisees were required to purchase from Quizno’s and its suppliers.
The court held, first, that claims based on these allegations were not actionable since all such information was adequately disclosed in Quizno’s UFOC. Even if it were not disclosed, the court noted the merger clause and disclaimers in the franchise agreement clearly barred claims based on statements and promises made by the franchisor that did not appear within the contract. In addition, the court found wanting the franchisees’ contention that the Quizno’s franchise agreements were unconscionable and thus unenforceable. To the contrary, the court held that the franchisees offered “nothing, not even allegations” that would support the conclusion that the franchise agreements were entered into on an unconscionable basis or that the plaintiffs were the kind of “unsophisticated or vulnerable individuals of whom advantage is easily taken.” In fact, the complaint made it clear that the plaintiffs were experienced franchisees (some with six years’ experience in operating their stores) who could be held accountable for their actions. The court further noted that it was “clear” from the UFOC and the franchise agreement that the plaintiffs “were not prevented from carefully considering the Agreement before signing it or obtaining outside counsel.”
Importantly, the court also rejected the franchisees’ claim that Quiznos violated federal and state antitrust laws for tying the purchase of the franchise to the purchase of products necessary to operate the franchise. In order to sustain a tying claim, the court noted, the franchisees would have to demonstrate something that they could not—that Quizno’s had substantial market power in equivalent investment opportunities. Even if the franchisees claimed that Quizno’s had such market power with respect to selling toasted subs (a specialty of the franchise system), the claim would not survive. The court concluded that the existence of unique product did not show market power over investors because identification with a particular product is at the core of franchising. Such a remedy, the court found, could only be sought under contract claims.
SYSTEM STANDARDS ENFORCEMENT
COURT DENIES FRANCHISEES’ MOTION TO ENFORCE JUDGMENT IN DISPUTE INVOLVING POINT-OF-SALE HARDWARE/SOFTWARE SYSTEM
In Bores v. Domino’s Pizza, LLC, No. 05-2498 (RHK/JSM) (D. Minn. Nov. 6, 2007), the franchisees challenging Domino’s requirement that they purchase a new point-of-sale software and hardware system (“PULSE”), suffered a defeat on their motion to enforce an earlier summary judgment ruling that “Domino’s could not continue to mandate PULSE without providing ‘specifications’ for PULSE hardware and software that would enable Plaintiffs to obtain equipment meeting those specifications ‘from any source.’” The franchisees’ current motion claimed that Domino’s was not complying with the court’s ruling, but the court denied the motion in all respects.
The court noted that the franchisees requested both an enforcement order affirmatively requiring Domino’s to provide “actual computer software specifications” and a finding that Domino’s was in contempt for noncompliance with the prior order. The court, however, rejected the franchisees’ arguments that Domino’s had provided vague specifications, had not acted in good faith by allegedly delaying certification of third-party vendors, and was forcing the franchisees to buy PULSE hardware and software through the “back door.” The Court held: “None of their arguments has merit.”
As to the first argument, that Domino’s had issued vague specifications, the court found the plaintiffs’ point “specious.” Domino’s provided exactly what the franchisees requested—functional specifications. The court found “damning” the proposed vendors’ affidavits acknowledging that their products already met most of Domino’s specifications. As to the second argument, the court did not find any evidence that Domino’s stonewalled the certification process. On the contrary, the court noted that delays are natural and were partially attributable to vendor-initiated negotiations concerning Domino’s non-disclosure agreements. Finally, the court did not believe that Domino’s was forcing its franchisees to purchase PULSE through the “back door.” Franchisees must install new hardware and software by June 30, 2008, and, since certification can be a lengthy process, it was not unreasonable for Domino’s to request that vendors begin six months in advance. The court also viewed the franchisee’s argument as premature since the June 30, 2008, deadline had not yet passed.
TERMINATION UPHELD FOR VIOLATIONS OF FEDERAL IMMIGRATION AND LABOR LAWS AS TO WORKERS PROVIDED BY THIRD PARTY
In Dunkin’ Donuts Franchised Restaurants et al. v. Monroe Donut Co., LLC et al., Case No. 07-10043-JLK (S.D. Fla. Nov. 8, 2007), a case handled by Gray Plant Mooty, the United States District Court for the Southern District of Florida entered a preliminary injunction enjoining a multi-unit franchisee from infringing on the franchisor’s trademarks after the franchisee was terminated for violations of the Fair Labor Standards Act (“FLSA”) and Immigration Reform and Control Act (“IRCA”), which violations breached its franchise agreements. This strongly-worded opinion is a clear indication that franchisees will not escape accountability for labor and immigration laws even when their employees are supplied by third-party professional employer organizations (“PEOs”).
Following an investigation by Dunkin’, it had terminated the agreements based upon violation of the franchisee’s duty to obey all applicable laws, citing violations of federal immigration and labor laws. Dunkin’ also sought to enforce the “cross-default” provisions contained in each franchise agreement, which provided that the termination of one agreement is grounds for the termination of all of the other agreements.
The franchisee argued that immigration forms and overtime wages were not its responsibility because the workers were provided and paid by third-party PEOs. The court disagreed, finding that the franchisee violated the FLSA and the IRCA by failing to pay wages for overtime worked and failing to complete and maintain I-9 forms. Citing the broad definition of “employer” in the FLSA, the court found that the franchisee employed the workers for purposes of the statute because the “economic reality” demonstrated that the workers were economically dependent on the franchisee. The court found that even if the PEOs were also “employers” of the workers, that would not shield the franchisee from liability because the FLSA contemplates “joint employer” liability where more than one party is deemed an employer.
In addition, the court found that the both the franchisee and the PEOs were liable under the IRCA because both entities were employing the individuals and were responsible for completing and maintaining I-9s. Further, the court found not only that the franchisee had constructive knowledge that the employees were not authorized to be employed in the United States, but that its own managers were responsible for completing the I-9 forms, which they failed to do for most of the employees.
Citing numerous cases enforcing “obey all laws” provisions in franchise agreements, the court held that the franchisee’s violations of the IRCA and the FLSA constituted grounds for termination of all five of their franchise agreements. The franchisee was enjoined from any further use of Dunkin’s trademarks, trade dress, and trade names, and was ordered to comply with the post-termination obligations contained in the franchise agreement, including surrendering possession of the franchises.
POST-TERMINATION NONCOMPETE COVENANTS
WASHINGTON COURT ENFORCES MODIFIED NONCOMPETE
In HomeTask Handyman Services, Inc. v. Cooper, 2007 WL 3228459 (W.D. Wash. Oct. 30, 2007), the United States District Court for the Western District of Washington enforced a franchisor’s post-termination noncompete for two years within a 25-mile radius, finding the restrictive covenant “reasonable and necessary to protect [the franchisor’s] goodwill, its interest in avoiding unfair competition, and the franchise system it has developed.” Gray Plant Mooty represented the franchisor.
The franchisor, HomeTask Handyman Services, Inc. included in its franchise agreement a post-termination noncompete clause prohibiting former franchisees from operating a competing business for a period of two years within a 100-mile radius of their former territory. After the franchisee left its system and opened a new handyman business in the same territory, HomeTask sought an injunction. The court upheld HomeTask’s restrictive covenant, noting, “Allowing [the franchisee] to exploit the company’s good will and her former customer base would place HomeTask at a distinct disadvantage in attempting to re-franchise the area or otherwise recapture the market.” The court modified the geographic restriction to encompass a 25-mile area around the former franchisee’s territory, finding this to be sufficient to protect the franchisor’s interests.
HomeTask obtained a similar result from the same court two weeks earlier in HomeTask Handyman Services, Inc. v. Szewczyk.
NONCOMPETE ENFORCEABLE BY FRANCHISOR’S SUCCESSOR UNDER FLORIDA STATUTE
The United States District Court for the District of Colorado has denied a dry-cleaning franchisee’s motion to dismiss the franchisor’s claim for injunctive relief to enforce a two-year noncompete agreement. Dry Cleaning To-Your-Door, Inc. v. Waltham, LLC, 2007 WL 3232599 (D. Colo. Oct. 30, 2007.) The franchisee in this case did not take issue with the length or breadth of the noncompete, but argued instead that it was unenforceable because the current franchisor was an assignee/successor of the original franchisor with whom the franchisee had signed the franchise agreement.
Fla. Stat. § 542.335 specifically states that a “court shall not refuse enforcement of a restrictive covenant on the ground that the person seeking enforcement is . . . an assignee or successor to a party to such contract provided . . . in the case of an assignee or successor, the restrictive covenant expressly authorized enforcement by a party’s assignee or successor.” Although the franchise agreement as a whole provided that the original franchisor could assign its rights under the agreement to any party, the franchisee argued that subsection 542.335(1)(f) requires the noncompete clause itself to specifically permit assignment. Aided by Florida cases holding that section 542.335 was “aimed at making enforcement of bona fide restrictive covenants easier and more certain,” the court found the franchisee’s argument unpersuasive.
NEW YORK FEDERAL COURT CONFIRMS ARBITRATOR’S $1.8 MILLION AWARD IN FAVOR OF FRANCHISEES
The United States District Court for the Southern District of New York has confirmed a $1.8 million arbitration award in favor of Dunhill Franchisees Trust, on the grounds that the UFOC and marketing materials provided to the franchisees omitted material facts. Dunhill Franchisees Trust v. Dunhill Staffing Systems, Inc., 2007 U.S. Dist. LEXIS 80317 (S.D.N.Y. Oct. 29, 2007). Dunhill Staffing had brought a motion to vacate the award, asserting that the arbitrator decided an issue that had not been placed before him and had exceeded the scope of his authority. In confirming the award, the court held that the arbitrator’s findings were supported by evidence that Dunhill knew or should have known that the franchise no longer presented a viable opportunity for a new business entrant and that Dunhill omitted material facts from the UFOC.
The court rejected Dunhill’s arguments that the arbitrator disregarded well-defined and clearly applicable principles of law, such as federal and state laws governing franchise disclosure and contract law regarding integration and disclaimer clauses. The court also was unmoved by the arguments that federal law does not recognize a private right of action for an alleged violation of the FTC franchise disclosure rules, and that the statute of limitation bars the claims of some of the franchisees under New York statute.
FRANCHISOR HELD NOT A THIRD-PARTY BENEFICIARY OF AGREEMENT TO TRANSFER FRANCHISED BUSINESS
In Precision Franchising LLC v. Pate, 2007 U.S. Dist. LEXIS 80589 (E.D. Va. Oct. 31, 2007), franchisor Precision Franchising LLC sued a former manager of a franchised location after the manager, who had once expressed interest in purchasing the franchised business, later refused to sign the purchase agreement or the franchise agreement. The franchisor claimed, among other things, that the former manager was liable to it for breaching the purchase agreement, on the theory that the franchisor was a third-party beneficiary of the purchase agreement and was damaged by the breach. The district court, however, granted summary judgment to the former manager on that claim, concluding that nothing in the purchase agreement reflected an intention to confer a direct benefit to the expected franchisor.
The district court did grant summary judgment to the franchisor on its trademark infringement claims. The former manager had continued to operate the auto service business while displaying a “Precision Tune Auto Care” sign on the premises without authority from the franchisor.
OHIO APPEALS COURT UPHOLDS DISMISSAL OF PLAINTIFF’S CLAIM FOR EQUITABLE ESTOPPEL AGAINST FRANCHISOR
In Abdallah v. Doctor’s Associates, Inc., 2007 WL 3377258 (Ohio Ct. App. Nov. 15, 2007), the Ohio Court of Appeals affirmed the dismissal of a plaintiff’s complaint based on his failure to state a claim for equitable estoppel. The facts giving rise to the plaintiff’s complaint began in 1997 when the plaintiff and his partner, through their corporation, purchased a Subway store from an existing Subway franchisee. In 1998, the plaintiff’s partner executed a “Limited Power of Attorney to Sell or Transfer a Franchise” pursuant to which he granted the plaintiff the right to represent his partner in the sale or transfer of the franchise. The very next month, the plaintiff’s partner sold all of her shares in the corporation to the plaintiff. The plaintiff, however, never used the authority given to him by the power of attorney to sell or transfer his partner’s franchise rights. Following termination by DAI, the plaintiff filed a complaint seeking a declaration that he was the lawful franchisee of the shop. In response to the complaint, DAI filed a motion to dismiss the complaint, which was granted by the trial court. The plaintiff appealed.
On appeal, the plaintiff contended that DAI should be equitably estopped from denying his right to the Subway franchise. The court of appeals disagreed and held that the express terms of the franchise agreement and other documents demonstrated that the plaintiff could not have reasonably believed that he was the franchisee. The court noted that the plaintiff had participated in establishing his partner as the franchisee under the agreement and the plaintiff had over four years to transfer his partner’s franchise rights to him but failed to do so. Finally, the appellate court noted that equitable estoppel is a shield – not a sword – and does not provide a basis for damages.
ATTORNEYS WHO WROTE OR EDITED ARTICLES FOR THIS ISSUE INCLUDE:
Phillip W. Bohl, Jennifer C. Debrow, Elizabeth S. Dillon, Ashley M. Ewald, Michael R. Gray, Jeffrey L. Karlin, Craig P. Miller, Kevin J. Moran, Iris F. Rosario, Jason J. Stover, Katherine L. Wallman, Quentin R. Wittrock, David E. Worthen, and Robert Zisk.
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
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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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