The GPMemorandum, Issue 104
Here are some of the most recent legal developments of interest to franchisors:
MINNESOTA FEDERAL COURT DENIES CLASS CERTIFICATION IN SUIT BROUGHT ON BEHALF OF FINANCIAL ADVISOR FRANCHISEES
In Good, et al. v. Ameriprise Financial, Inc., 2008 WL 185714 (D. Minn. Jan. 18, 2008), the United States District Court for the District of Minnesota denied class certification to the plaintiffs, two Ameriprise financial advisors who brought an action on behalf of a putative class of over 10,000 advisors – a class that would include franchisees. The plaintiffs alleged that Ameriprise failed to pay its financial advisors the full amount of the commissions to which they were entitled under their contracts.
Ameriprise argued that the case did not present a question of law or fact common to potential class members, as required for class certification. Ameriprise contended that its obligation to pay advisors was limited by the manuals accompanying the franchise agreements, and that the agreements authorized Ameriprise to change the manuals from time to time. The court agreed with Ameriprise, and found that different members of the putative class might have different contractual terms governing their claims against Ameriprise, depending on which manuals and other documentation applied to each member of the class. Plaintiffs’ theory of the case hinged on general
discussions of the pay rate that appeared in documents that were distributed to the individual class members. The court found that determining the pay to which each class member was entitled would depend on a case-by-case analysis of each advisor’s dealings with Ameriprise. As a result, there were no questions of law or fact common to each class member.
Because the court denied the motion for class certification, it then examined whether the lack of a class destroyed the court’s subject-matter jurisdiction over the two named plaintiffs’ claims. The court found that the Class Action Fairness Act provided the only possible basis for federal jurisdiction over the claims. Because the courts are split on whether the denial of class certification destroys subject-matter jurisdiction, the court invited the parties to submit supplemental briefs addressing this issue.
NINTH CIRCUIT REVIVES KODAK-BASED THEORY OF MARKET DEFINITION
Distinguishing the situation in Queen City Pizza as a “contractually-created market power” (which cannot lead to antitrust liability), the United States Court of Appeals for the Ninth Circuit restored claims under the Sherman Antitrust Act in Newcal Industries, Inc. v. Ikon Office Solution, 2008 WL 185520 (9th Cir. Jan. 23, 2008). While this case is not brought against a franchisor, the court’s renewed affinity for the Kodak-based theory of a single-brand market could be cited against franchisors in some scenarios. Ikon, the defendant in this case, saw its district court dismissal reversed and must now defend various claims related to its conduct in the “market” for its own brand of copier equipment.
Like franchisors are sometimes accused of doing to franchisees, plaintiff-competitor Newcal alleges that Ikon exploits its contractual relationships with customers to gain monopoly power in aftermarkets. Newcal says Ikon leverages the contractual relationships to gain advantages that are not disclosed at the time of the original customer contracts. The alleged “lack of disclosure” and subsequent attempt to “leverage a special relationship” beyond the contracted-for rights is what franchisors, at least in the Ninth Circuit, could see cited against them in new attempts to apply Kodak liability to franchise cases.
The Ninth Circuit did acknowledge that its opinion does not mean Newcal will be able to survive a summary judgment motion once evidence and perhaps expert opinions have been produced. It is also possible the United States Supreme Court ultimately will use this case as a vehicle to revisit its 1992 decision in Kodak.
COURT REFUSES TO DISMISS FACTA CLAIM
A recent federal court decision illustrates the judiciary’s occasional reluctance to take judicial notice of the nature of the franchise relationship. In Patterson v. Denny’s Corp., 2008 WL 250552 (W.D. Pa. Jan. 30, 2008), the plaintiff filed a complaint against Denny’s and its franchisee alleging a violation of the Fair and Accurate Credit Transactions Act (“FACTA”). Specifically, the plaintiff alleged that a franchised Denny’s location provided him with a credit card receipt that showed the last four digits and the expiration date of his Visa card, an alleged violation of FACTA. The plaintiff sued both the franchisee and the franchisor, arguing that the franchisor exercised sufficient control over the franchisee to be held liable for its actions.
Denny’s moved to dismiss the complaint, arguing that as franchisor it did not print the receipt at issue or provide it to plaintiff. In support of its motion, Denny’s submitted an affidavit attaching the franchise agreement at issue, which showed that Denny’s lacks control over the day-to-day operation of its franchisee. The court refused to consider that evidence, however, finding that such consideration would be improper on a motion to dismiss. Instead, the court looked solely to the complaint, which alleged that Denny’s did exercise actual control over the franchised business. Finding that allegation alone to be sufficient, the court denied Denny’s motion.
This decision shows the difficulties franchisors sometimes face when confronted with a vicarious liability claim. While courts will often grant a franchisor’s motion for summary judgment, some courts have proved reluctant to grant a motion to dismiss in the early stages of the action.
KENTUCKY SUPREME COURT ADOPTS MAJORITY “CONTROL OVER INSTRUMENTALITY” RULE
In a case of first impression in Kentucky, the state’s Supreme Court turned away from using a mixed bag of respondeat superior and ostensible agency principles and, taking a more precise approach given the ubiquity of the franchise method of doing business, adopted the emerging majority rule on the issue of franchisor vicarious liability. In Papa John’s Int’l, Inc. v. McCoy, 2008 WL 199716 (Ken. Jan. 24, 2008), the state supreme court reversed an earlier court of appeals decision and adopted what it considered the “emerging judicial consensus” by applying a franchisor vicarious liability test that considers the franchisor’s control or right of control over the instrumentality that is alleged to caused the harm.
In adopting the “majority rule” the court was persuaded by the Wisconsin Supreme Court’s decision in Kerl v. Dennis Rasmussen, Inc., 682 N.W.2d 328 (Wis. 2004), a negligent supervision case against Arby’s involving an employee shooting, and the rule adopted by that court that whether a franchisor is vicariously liable depends on the extent of control exerted by the franchisor over the daily operation of the specific aspect of the franchisee’s business that is alleged to have caused the harm. In the Kentucky case, the high court found that the franchisee’s employee was acting outside the scope of his employment and that Papa John’s “had no control over the employee’s intentional, tortious conduct.” Interestingly, the dissent of the court’s chief justice focused on the reliance of the party dealing with the ostensible agent of the franchisor,
not the degree of actual control exercised by the franchisor.
This decision adds Kentucky to the growing majority of courts that require a franchisor to have control over the instrumentality that causes the harm in order to be held vicariously liable – a requirement that is both fundamentally fair and legally sound.
FLORIDA COURT HOLDS FRANCHISOR’S OFFICERS CAN BE SUED IN THEIR INDIVIDUAL CAPACITIES FOR NOT COMPLYING WITH FRANCHISE RULES
In KC Leisure, Inc. v. Lawrence Haber, 2008 WL 195107 (Fla. App. 5 Dist. Jan. 25, 2008), a Florida appellate court reversed a trial court’s dismissal of a franchisee’s claims against a franchisor’s officers for violation of the Florida Deceptive and Unfair Trade Practices Act (“FDUTPA”) and for fraudulent inducement under the Florida Franchise Act. This case is significant because it holds that a franchisor’s employees can be found personally liable for their role in the franchisor failing to comply with disclosure laws.
In its complaint, the franchisee sought rescission and damages based on the franchisor’s failure to timely provide it with complete and accurate disclosure documents and the franchisor’s unsubstantiated earnings claims. The franchisee alleged that the individual defendants consciously and intentionally elected to ignore the disclosure requirements in order to obtain a $50,000 franchise fee before creating and providing a Uniform Franchise Offering Circular and franchise agreement some eleven months later. The franchisee, upon receipt of the documents, determined that the representations contained within them were unsubstantiated, incomplete, and misleading and included pro forma spreadsheets with earnings claims that were created by the franchisor’s employees without any substantive research.
Relying on a case decided under Florida’s Sale of Business Opportunities Act (“FSBOA”), the trial court had held that FDUTPA only imposes corporate liability on the seller of a franchise and, therefore, the franchisee could not maintain its cause of action against the franchisor’s officers in their individual capacities. The trial court further held that the franchisee had not satisfied its burden of demonstrating that the franchisor’s employees intentionally misrepresented the prospects of success of the franchise.
The appellate court found the trial court’s reliance on a case interpreting the FSBOA to be misplaced. In reversing the dismissals, the appellate court held that case law permits individual liability for violations of the statute in the event that corporate liability is found. To prove individual liability, it must be shown that the individual defendant actively participated in or had some control over the deceptive practices. For monetary restitution, the plaintiff must establish that the individual defendant knew or should have known about the misrepresentations. Here, the face of the franchisee’s complaint met that burden. Because the complaint alleged that the individual defendants had actual knowledge of the violations of the Franchise Rule, including the failure to disclose, and that the defendants intentionally assisted in the preparation of
inaccurate spreadsheets, the FDUPTA and Florida Franchise Act claims were sufficient to state a cause of action and survive a motion to dismiss.
FEDERAL COURT DENIES FRANCHISOR’S MOTIONS TO OVERTURN JURY VERDICT ON FRANCHISEES’ COUNTERCLAIM
The United States District Court for the District of Arizona recently denied a post-trial motion filed by Best Western International Inc. for a new trial and for judgment as a matter of law following a set of unfavorable jury verdicts in Best Western International, Inc. v. Patel, et al., 2008 WL 205286 (D. Ariz. Jan. 23, 2008). The hotel at issue had been operated for over 30 years under the Best Western trademarks but was terminated approximately a year after the current franchisees had purchased it. Best Western thereafter brought suit against the franchisees for failing to pay for goods and services provided by the franchisor and for using its trademarks post-termination. The franchisees raised affirmative defenses and a counterclaim, asserting that they were excused from performing under the franchise agreement because the franchisor breached its terms
and/or breached the duty of good faith and fair dealing.
At trial, the jury returned seemingly inconsistent verdicts. It awarded the franchisor nearly $60,000 on its claims. However, it also held that Best Western was liable for the franchisees’ counterclaim and awarded them $445,000. The franchisor argued in its motion for a new trial that the jury had disregarded its instructions because it had failed to use the calculation for trademark infringement set forth in the franchise agreement and ignored the limitations of damages clause in the franchise agreement with respect to the counterclaim. In addition, Best Western pointed out that the since the jury had rejected the franchisees’ affirmative defenses in finding liability on the franchisor’s affirmative claims, it should not have found Best Western liable on the franchisees’ counterclaims because they were based on the same legal theories. The court,
however, found that the jury’s conclusions were supported by the evidence and refused to “speculate as to how the verdict was reached.”
Similarly, the court rejected the franchisor’s assertion that the jury had rendered inconsistent verdicts. There was, as the court noted, evidence “based strictly on the language of the franchise agreement” that supported the jury’s conclusion that the franchisees had breached the contract. Nonetheless, there was also evidence presented to the jury that the franchise agreements had been terminated “in bad faith.” Thus, the court concluded the verdicts were “reconcilable.” In addition, the court found that the franchise agreement’s limitation on counterclaim damages did not apply because the good faith and fair dealing sounded in tort rather than contract. Finally, the court held that it was proper to allow one of the franchisees to testify about the dollar value of the hotel even though he was not qualified as an expert because “[a]
property owner can testify about the value of his property if his testimony is well founded on personal knowledge.”
COURT ENFORCES MANDATORY MEDIATION CLAUSE
In R & F, LLC v. Brooke Corporation, 2008 WL 294517 (D. Kan. Jan. 31, 2008), the federal district court in Kansas granted a franchisor defendant’s motion in part and issued a stay to provide an opportunity for the parties to mediate the dispute, as required by their franchise agreement. Plaintiff R & F, LLC brought suit alleging that franchisor Brooke Corporation breached the franchise agreement by failing to provide contacts with insurance companies in the markets where R & F conducts its business, in order for R & F to offer insurance products to its customers and potential customers. The franchisor in turn sought a court order to enforce the mandatory mediation provision in the franchise agreement. The court granted the order, holding that mandatory mediation provisions are enforceable under Kansas law and rejecting the plaintiff’s
argument that mediation would be a “hollow exercise.” Because the plaintiff agreed to the provision in the franchise agreement, the court held that any “arguable futility of mediation is of no consequence.”
COURT UPHOLDS TWO-YEAR BAN ON POST-TERM COMPETITION
Last month the United States District Court for the District of New Jersey granted franchisor Jackson Hewitt Inc.’s (“JHI”) motion for summary judgment against a former franchisee, finding that the franchisee had clearly violated the post-termination covenant not to compete in his franchise agreement and enjoining him from further competition for a period of 24 months. Jackson Hewitt Inc. v. Childress, 2008 WL 199539 (D.N.J. Jan. 22, 2008).
The franchisee had operated two JHI franchises in Alabama for four years before notifying the company of his intention to cease operations and immediately start up his own accounting and tax preparation business. He did so, opening his own business the next day in the same building where he had previously run his JHI franchise. JHI’s franchise agreement contained a non-compete clause restricting former franchisees from competing within a 10-mile radius of their former JHI business and requiring them to return manuals and other trade secret information.
Applying New Jersey law as chosen by the parties in the franchise agreement, the court found that the franchisee was clearly operating a competing business in violation of his JHI franchise agreement, likening covenants not to compete in franchise agreements to agreements ancillary to the sale of a business. Citing to Jiffy Lube Int’l, Inc. v. Weiss Bros., Inc., 834 F. Supp. 683, 691 (D.N.J. 1993), the court noted that “[u]nlike the sale of a business, however, once the franchise relationship terminates, the good will is conveyed back to the franchiser.” The court also held that franchisee had failed to return JHI’s confidential and proprietary information, and entered an order enjoining him from competing against JHI for a period of 24 months and requiring him to return JHI’s proprietary information. It rejected the franchisee’s defense that JHI
had improperly induced him into signing the franchise agreement, noting that the integration clause and disclaimers in the agreement made his argument “frivolous.”
The case is yet another example of how a carefully drafted franchise agreement can protect franchisors from post-termination competition.
TEXAS COURT OF APPEALS HOLDS THAT DISPUTE ARISING FROM MUTUAL TERMINATION AGREEMENT WAS SUBJECT TO ARBITRATION PROVISION CONTAINED IN FRANCHISE AGREEMENT
In In re Bath Junkie Franchise, Inc., 2008 WL 324760 (Tex. Ct. App. Feb. 7, 2008), a Texas Court of Appeals held that a dispute arising from a franchisor and franchisee’s mutual termination agreement was subject to the arbitration provision contained within the parties’ franchise agreement. The franchisee filed the lawsuit seeking damages after the franchisor failed to make the required “buy out” payment pursuant to the mutual termination agreement executed by the parties. Approximately 14 months after the franchisee commenced its lawsuit, the franchisor moved to compel arbitration in accordance with the arbitration provision contained within the franchise agreement.
In response to the franchisor’s motion, the franchisee argued that the arbitration provision was no longer applicable because the legal obligations contained in the mutual termination agreement had replaced the parties’ obligations under the franchise agreement, thereby making the arbitration provision unenforceable. The franchisee also claimed that the franchisor waived its right to compel arbitration because it waited 14 months after commencement of the lawsuit to commence arbitration.
The appellate court held that because the mutual termination agreement was conditional and only required a release of the parties’ obligations to one another under the franchise agreement if the parties performed their obligations under the mutual termination agreement, the mutual termination agreement did not replace the franchise agreement and the arbitration provision was enforceable. The court of appeals also concluded that the franchisor did not waive its right to compel arbitration by waiting 14 months to make its motion, because the franchisee failed to establish or show that it had been prejudiced by the franchisor’s delay in making the request for arbitration.
Minneapolis, MN Office
John W. Fitzgerald, Co-Chair (612-632-3064) *Kirk W. Reilly, Co-Chair (612-632-3305)
Megan L. Anderson (612-632-3004) Gregory R. Merz (612-632-3257)
Wade T. Anderson (612-632-3005) *Craig P. Miller (612-632-3258)
Phillip W. Bohl (612-632-3019) *Bruce W. Mooty (612-632-3333)
*Jennifer C. Debrow (612-632-3357) John W. Mooty (612-632-3200)
Elizabeth S. Dillon (612-632-3284) Kevin J. Moran (612-632-3269)
*Collin B. Foulds (612-632-3388) Max J. Schott II (612-632-3327)
*Michael R. Gray (612-632-3078) Daniel R. Shulman (612-632-3335)
Laura J. Hein (612-632-3097) * Jason J. Stover (612-632-3348)
Kelly W. Hoversten (612-632-3203) Michael P. Sullivan, Sr. (612-632-3351)
Franklin C. Jesse, Jr. (612-632-3205) Michael P. Sullivan, Jr. (612-632-3350)
Cheryl L. Johnson (612-632-3271) Henry Wang (612-632-3370)
Jeremy L. Johnson (612-632-3035) Lori L. Wiese-Parks (612-632-3375)
*Gaylen L. Knack (612-632-3217) *Quentin R. Wittrock (612-632-3382)
Washington, D.C. Office
*Robert Zisk, Co-Chair (202-295-2202)
Jimmy Chatsuthiphan (202-295-2217) *Stephen J. Vaughan (202-295-2208)
*Ashley M. Ewald (202-294-2221) *Katherine L. Wallman (202-295-2223)
*Jeffrey L. Karlin (202-295-2207) David E. Worthen (202-295-2203)
*Iris F. Rosario (202-295-2204) *Eric L. Yaffe (202-295-2222)
* Wrote or edited articles for this issue.
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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.