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The GPMemorandum, Issue 98

May 01, 2007 | Alert

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FRANCHISE TRANSACTIONS

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 3.

VIRGINIA AMENDS RETAIL FRANCHISING ACT

On April 5, 2007, Virginia Governor Tim Kaine signed House Bill 2786, amending the Virginia Retail Franchising Act.  Most notably, the revised Act authorizes the State Corporation Commission to: (1) require an escrow or deferral of initial fees (instead of simply denying a registration where a franchisor applicant has a negative net worth); and (2) prescribe rules establishing franchise registration exemptions.  A copy of the amended Act is available at http://leg1.state.va.us/cgi-bin/legp504.exe?ses=071&typ=bil&val=hb2786.

In response to the amended Act, the Division of Securities and Retail Franchising has proposed rules and regulations outlining escrow and fee deferral requirements.  The proposed rules also introduce various new exemptions covering: (1) the transfer of a franchise by an existing franchisee; (2) the sale of an additional franchise to an existing franchisee (if the franchise is substantially the same as the one the franchisee currently operates); (3) the sale of a franchise by a “seasoned” franchisor (i.e., $15,000,000 net worth and 25 franchisees over the past 5 years); (4) the sale of a franchise to a “sophisticated” franchisee (i.e., $1,000,000 initial investment); and (5) the sale of a franchise to certain institutional investors.

The new law and proposed regulations represent a welcome development for franchisors wishing to do business in Virginia.  We are anxious to see how the Virginia regulators apply these new rules, especially the escrow and deferral options.  In those situations where, in the past, the regulators have refused registration to a franchisor, will these new options be offered routinely or only sparingly?  We will be watching closely.

ALERT YOUR FRANCHISEES: UPGRADE POS CREDIT AND DEBIT CARD RECEIPT PRINTERS

The rise in the use of credit and debit cards for consumer point of sale (“POS”) transactions has increased both the convenience and speed of the payment process.  The POS equipment used to process these transactions must, however, comply with certain regulatory requirements intended to prevent identity theft and protect consumer privacy.  A recent court decision under the Fair Credit Reporting Act (FCRA) highlights the need for merchants, including franchisees, that accept credit and debit card payments from consumers to ensure that their POS equipment meets those regulatory requirements.

The FCRA generally governs the preparation, dissemination, and use of consumer reports, such as traditional credit reports, for determining a consumer’s eligibility for credit, insurance, employment, and certain other purposes.  The Fair and Accurate Credit Transaction Act (FACTA) amended the FCRA to provide additional consumer protections against identity theft.  Included in the FACTA amendments is the requirement that electronically-printed point of sale (POS) receipts for payments made using credit or debit cards not include more than the last five digits of the card number or the card expiration date.  While enacted in 2003, this requirement did not become effective for POS equipment put into use prior to 2005 until December 2006.

Although the FACTA card receipt requirement has been fully effective for only a few months, a flurry of putative consumer class action lawsuits already have been commenced alleging violations of this requirement, including a number of lawsuits filed in the United States District Court for the Central District of California against restaurant chains and retailers.  These lawsuits commonly request statutory damages of $100 to $1,000 per violation, punitive damages, and attorneys’ fees under the FCRA’s private right of action for consumers.

In a matter of apparent first impression, a California Federal District Court rejected a retailer-defendant’s argument that the FACTA card receipt requirement may not be enforced by private right of action.  Eskandari v. IKEA U.S. Inc., No. SA-CV 06-1248 JVS (RNBx), minute order (C.D. Cal. March 12, 2007).  In IKEA, the defendant argued that because the card receipt requirement applies to receipts printed for “cardholders,” which include both individual “consumers” and entities, the requirement could not be enforced via FCRA’s private right of action for “consumers.”  The court disagreed, noting that:

Although [the card receipt requirement] applies to all cardholders and not just individual consumers, there can be no doubt that it creates requirements with respect to consumers because many of the cardholders are in fact individual consumers.  Importantly, Congress did not explicitly prohibit private enforcement of [the card receipt requirement] through [the FCRA private right of action for consumers].

Based on that conclusion, the court declined to dismiss the complaint.

The IKEA Court’s decision reemphasizes the need for merchants, including franchisees, to ensure that their POS equipment prints credit and debit card receipts that are in compliance with the FACTA requirements.

RECENT CASES

Here are some of the most recent judicial developments of interest to franchisors:

STATE FRANCHISE LAWS/VIOLATIONS/TERMINATIONS

SEVENTH CIRCUIT HOLDS THAT FRANCHISEE WHO ABANDONS HIS FRANCHISE CANNOT SUSTAIN AN ACTION UNDER THE ILLINOIS FRANCHISE DISCLOSURE ACT

In Zeidler v. A&W Rest., Inc., 2007 WL 528921 (7th Cir. Feb. 15, 2007), an Illinois franchisee opened an A&W® restaurant next to a DAIRY QUEEN® store, against the wishes of A&W.  From the start, the franchisee had problems complying with A&W’s system standards and failed to timely submit profit and loss statements, as required by the Franchise Agreement.  The franchisee also had financial difficulties due, in large part, to competition from the neighboring DAIRY QUEEN® store.  Upon the franchisee’s request, A&W allowed the franchisee to close his restaurant during the winter months on the condition that he reopen his restaurant in the spring.  Despite this agreement, the franchisee failed to reopen his A&W® restaurant, telling A&W that he could “no longer continue to subsidize” the restaurant.

A&W thereafter wrote to the franchisee and advised him that A&W considered the restaurant “abandoned.”  A&W, however, never issued a formal notice of termination.  The franchisee then sued under an assortment of legal theories, including unlawful termination under the Illinois Franchise Disclosure Act (“IFDA”).  The district court granted A&W’s summary judgment motion on all claims.  The franchisee appealed.

On appeal, the franchisee alleged that the district court misunderstood his IFDA claim, asserting for the first time that A&W violated the IFDA by failing to issue a notice of termination.  The Seventh Circuit rejected this argument, noting that the complaint was very clear that the franchisee alleged that he had been unlawfully terminated by A&W.  The court also noted that this was nothing more than an attempt “to skirt the rule that a franchisee who abandons his franchise by closing it before the end of the license agreement’s term cannot prevail on a wrongful termination claim under the IFDA against the franchisor.”  Zeidler, 2007 WL at *3.  Accordingly, the Seventh Circuit affirmed the district court’s decision granting A&W’s summary judgment motion.

PENNSYLVANIA FEDERAL COURT HOLDS THAT PAROL EVIDENCE RULE BARS AREA DEVELOPER FROM RELYING ON ALLEGED ORAL STATEMENTS MADE BY FRANCHISOR

In Domino’s Pizza LLC v. Deak, 2007 WL 916896 (W.D. Pa. March 23, 2007), Domino’s Pizza commenced a lawsuit against one of its area developers, Robert J. Deak, seeking a declaratory judgment that its area agreements with the developer had expired and no longer bound the parties.  In response to the lawsuit, the developer asserted, among other things, a counterclaim seeking a declaration that Domino’s was estopped from refusing the developer’s request to renew the area agreements.  Thereafter, Domino’s moved to dismiss the developer’s counterclaim.

The developer had entered into area agreements with Domino’s to develop certain geographical areas in Pennsylvania and Maine.  Each area agreement contained identical integration clauses, as well as standard renewal and expiration provisions.  At some point, Domino’s informed the developer that it would not renew his area agreements.  In response, the developer asserted that Domino’s had made oral representations to him prior to the execution of the area agreements that no time limits would be placed on those agreements.

In granting Domino’s motion to dismiss the developer’s counterclaim, the court concluded that evidence of an alleged prior oral promise made by Domino’s was barred by the parol evidence rule and the express integration clauses contained in the area agreements.  The court noted that the developer conceded the existence of these integration clauses, which the court found to consist of unambiguous integration language.  The court also found that the area agreements explicitly set expiration dates, which superseded any previous alleged oral agreements regarding renewal.

With respect to exceptions to the parol evidence rule, the court found that none applied.  The court first noted that the developer sought to introduce evidence of the alleged oral promise solely to vary the terms of the integrated area agreements, and not to explain some non-performance.  The court then found that the developer failed to allege specific facts demonstrating that the oral promise constituted an admission by Domino’s.  Further, the court held that Domino’s was not estopped from enforcing the terms of the area agreements, and that Domino’s did not fraudulently, accidentally, or mistakenly omit its alleged oral promise from the agreements.  Finally, the court stated that the developer failed to allege specific facts demonstrating that Domino’s acted in bad faith or that the area agreements were unconscionable.

TRADEMARK INFRINGEMENT

TERMINATED FRANCHISEE HELD LIABLE FOR CONTRIBUTORY TRADEMARK INFRINGEMENT DESPITE RELINQUISHING CONTROL OF THE FRANCHISED LOCATION

In Days Inns Worldwide, Inc. v. Lincoln Parks Hotels, Inc., 2007 WL 551570 (N.D. Ill. Feb. 22, 2007), the United States District Court for the Northern District of Illinois found a former franchisee to be liable for contributory trademark infringement despite relinquishing control of the formerly franchised hotel location to a subsequent, but unauthorized, purchaser.

Days Inns Worldwide licensed Lincoln Parks Hotels to operate a DAYS INN® hotel in Illinois.  Thereafter, in late 2005, Lincoln Park Hotels, the franchisee, sold the DAYS INN® hotel to an unauthorized third party buyer with the franchisor’s trademarks still displayed on the hotel premises.  Upon learning of the unauthorized transfer of the hotel, the franchisor quickly terminated the Franchise Agreement.

The franchisor subsequently sued the franchisee, its guarantor, and the unauthorized buyer for trademark infringement.  In response, the defendants raised a “relinquishment of control” theory as a defense, whereby the former franchisee and its guarantor argued that they had relinquished control of the hotel at the time they made the unauthorized sale, and thus could not be held liable for trademark infringement after that date.  The court rejected that argument, finding that “a party can be ‘held responsible for their infringing activities’ if the party ‘intentionally induces another to infringe a trademark, or if it continues to supply its product to one whom it knows or has reason to know is engaging in trademark infringement….’”  In addition, the court stated that “[a] party can be held liable for contributory infringement if the party had ‘[w]illful blindness’ to the trademark infringement, which is determined by assessing ‘what a reasonable prudent person would understand….’”

The court concluded that the franchisee and its guarantor knew that the unauthorized buyer planned to continue using the trademarks at the time of sale of the hotel.  Accordingly, the franchisee and the guarantor were held liable for contributory infringement despite having relinquished control of the hotel at the time of the alleged trademark infringement.

VICARIOUS LIABILITY

FRANCHISOR NOT VICARIOUSLY LIABLE FOR INJURIES RESULTING FROM ACTIVITIES OF REAL ESTATE AGENT

In Oliveira-Brooks v. Re/Max Int’l, Inc., 2007 WL 846509 (Ill. Ct. App. March 21, 2007), the plaintiff appealed the trial court’s order granting summary judgment in favor of the franchisor.  The plaintiff, as guardian of the estate of Ana Maria de Oliveira Fernandes, alleged that Re/Max International, Inc. (“Re/Max”) was vicariously liable for injuries Fernandes sustained in an auto accident as a passenger in a RE/MAX® agent’s car.  The RE/MAX® agent was driving Fernandes and her son to look at real estate property when the accident occurred.  The plaintiff alleged that Re/Max was liable for Fernandes’ injuries because the RE/MAX® agent was an actual or apparent agent of Re/Max.

The Illinois Court of Appeals found that no actual or apparent agency relationship existed between the RE/MAX® agent and Re/Max.  In this case, Re/Max signed an agreement with a sub-franchisor responsible for selling franchises in the state of Illinois.  The sub-franchisor then sold a franchise to RE/MAX® Midtown, which hired the RE/MAX® agent involved in the accident.  The court found that because there was no franchisor/franchisee contractual relationship between Re/Max and RE/MAX® Midtown, and because the plaintiff did not demonstrate the existence of an agency relationship, no actual agency relationship existed.  Further, even though Re/Max promulgated policies and procedures intended for franchisees, there was no evidence that Re/Max retained the right to control RE/MAX® Midtown’s day-to-day activities.

The court found particularly persuasive that the RE/MAX® agent involved in the accident had complete discretion over his daily real estate sales activity, including his time in the franchisee’s offices, and that he handled his own leads and prospects without interference from Re/Max.  Further, the court found that even though the agent was required to name Re/Max as an additional insured on his auto insurance, the evidence of insurance without any other evidence of the right-to-control was not enough to establish an agency relationship.  Finally, the court found that even though Fernandes’ son convinced his mother to work with the RE/MAX® agent because Re/Max was “a good company,” this was nothing that neither Re/Max nor the agent “held out” to Fernandes.  As a result, there was no agency relationship.

DAMAGES / ATTORNEYS’ FEES

SEVENTH CIRCUIT REJECTS FRANCHISEE’S CLAIM FOR UNPROVEN DAMAGES

In Moran Foods, Inc. v. Mid-Atlantic Market Development Company, 476 F.3d 436 (7th Cir. 2007), a grocery store franchisor obtained summary judgment against its franchisee for over $3 million on unpaid invoices and interest for groceries purchased, but not paid for, by the franchisee.  The franchisee counterclaimed on the grounds that the franchisor breached the parties’ agreement when it failed to provide the franchisee with several quarterly financial statements for the franchisee’s business, as it had contracted to do.  The franchisor admitted to this breach, but disputed the franchisee’s calculation of damages.  The counterclaim was tried to a jury, which awarded the franchisee counterclaim damages in the exact amount of the franchisor’s judgment for unpaid groceries and interest—in effect negating the franchisor’s award in its entirety.

On appeal, the Seventh Circuit Court of Appeals concluded that, although the franchisee was entitled to seek damages for the franchisor’s admitted and unjustified failure to provide the franchisee with financial statements, the franchisee failed to prove that it suffered any damages from the breach—much less the full amount of its outstanding debt to the franchisor.  To collect counterclaim damages, the franchisee would have had to have shown that: (a) receiving its quarterly financial statements from the franchisor induced the franchisee into making different business choices; and (b) those choices would have changed subsequent events so dramatically that the franchisee would either not have incurred the debt in the first place or would have been able to pay it back.  Because the franchisee did not prove either point, the award on the franchisee’s counterclaims was reversed.

The court also rejected a claim made by one of the franchisee’s personal guarantors for discrimination on the basis of marital status under the Equal Credit Opportunity Act.  The court found that a personal guarantor was not an “applicant” for purposes of the Act and that discrimination on the basis of marital status was not proven simply because the franchisor required both spouses to personally guarantee its franchise agreements.

CALIFORNIA COURT OF APPEALS AFFIRMS AWARD OF ATTORNEYS’ FEES

In Thueson v. U-Haul Int’l, Inc., 2007 WL 841937 (Cal. Ct. App. March 21, 2007), the California Court of Appeals affirmed the trial court’s award of attorneys’ fees to defendant U-Haul International, Inc. (“U-Haul”).  The motion for attorneys’ fees was granted following a trial over the termination of plaintiff Thueson’s U-Haul dealership.

At trial, U-Haul successfully defeated Thueson’s breach of contract and California franchise law claims.  Thueson appealed from the trial court’s order granting attorneys’ fees, arguing that the award of fees was improper because his claims were primarily statutory claims under California franchising laws, rather than claims seeking to preserve or enforce contractual rights under the dealership agreement, which contained a provision allowing for attorneys’ fees.  The court disagreed and held that because all of Thueson’s claims were interrelated with his efforts to enforce his contractual rights, an award of fees was appropriate.  The court also noted that while not all of Thueson’s claims against U-Haul were contractual in nature, in order to prevail U-Haul was also required to litigate on the statutory claims.  As a result, the court found that the statutory claims were inextricably intertwined with Thueson’s efforts to enforce his contractual rights and, thus, the award of fees under the dealership agreement was proper.

COURT AWARDS ATTORNEYS’ FEES TO FRANCHISOR UNDER FRANCHISE AGREEMENT

In Zeidler v. A&W Restaurants, Inc., 2007 WL 723460 (N.D. Ill. March 5, 2007), the court granted the franchisor’s motion for attorneys’ fees following the franchisor’s successful motion for summary judgment.  While the Franchise Agreement provided that attorneys’ fees could be awarded to the franchisor if it prevailed in a legal proceeding, the franchisee nevertheless argued that he should not be required to pay fees because he was fraudulently induced into entering the franchise agreement.  Specifically, the franchisee alleged that the franchisor’s CEO told him, after he signed the franchise agreement, that the type of restaurant the franchisee planned to open would not be viable.  The franchisee alleged that the CEO’s statement made the franchise agreement void.

The court rejected the franchisee’s contention.  The court noted that the franchisor had advised the franchisee of the problems with his restaurant four months before it opened, even going so far as to offer to refund the franchisee all of his money.  The court also found that the CEO’s statements had been made six years after the restaurant opened.  For that reason, the franchisee’s allegations of fraud were without merit and the attorneys’ fees provision contained within the Franchise Agreement was enforceable.

CHOICE OF FORUM

FRANCHISOR PREVAILS IN GETTING FLORIDA FEDERAL COURT CASE TRANSFERRED TO TEXAS

In Moss v. Curves International, Inc., No. 06-21876 (S.D. Fla. March 30, 2007), a federal court in Florida upheld the choice of a Texas venue clause contained in the Franchise Agreements of a Texas-based franchisor.  The case currently involves claims by franchisees in Florida related to the purchases of their franchises and the franchisor’s compliance with the Franchise Agreements subsequent to the purchases.  The franchisees filed their case in the Southern District of Florida, despite a Texas venue provision contained in the Franchise Agreements.  In response to the lawsuit, the franchisor moved to dismiss the case for lack of venue, or, in the alternative, to transfer to Texas pursuant to federal procedures.

In transferring the case, the Florida court boiled the issue down to whether the “convenience of the parties and the interests of justice” would be best served by honoring the forum selection clause.  The court held that because the parties agreed, by contract, to a Texas forum, and because the clause was legally enforceable, it was the franchisees’ burden to demonstrate why Florida was the better forum.  None of the franchisees’ arguments, however, were persuasive.  For example, the court noted that the presence of potential claims under Florida law did not preclude the transfer to Texas.  Moreover, the language in the venue clauses were mandatory, not permissive.  In addition, the clauses were broad enough to cover the types of substantive claims found in the case.  Finally, there were documents and witnesses in both Florida and Texas.  Therefore, because there was no compelling convenience or “justice” factor to outweigh the parties’ own choice of forum, the case was transferred to Texas.

FRAUD

MARYLAND COURT REJECTS FRANCHISEE’S CONTRACT AND FRAUD CLAIMS, BUT ALLOWS INTERFERENCE CLAIM TO PROCEED

In Montrose Educ. Servs., Inc. v. Sylvan Learning Sys., Inc., 2007 WL 979923 (D. Md. Mar. 30, 2007), the plaintiff, Montrose, alleged that franchisor Sylvan Learning Systems and its related entities made fraudulent misrepresentations to induce Montrose into entering a franchise agreement and then breached their contractual duties by failing to provide Montrose with the requisite level of support and assistance.  Montrose also asserted a claim for tortious interference with business relationships, claiming that Sylvan thwarted Montrose’s potential purchase of two other SYLVAN® franchises from other franchisees by telling those franchisees they could get a higher purchase price if they allowed Sylvan to broker the sale to outside buyers rather than selling to Montrose.

In response to the lawsuit, Sylvan filed a motion to dismiss or, alternatively, for summary judgment.  The court found that Montrose’s claims in contract and fraud were time-barred under Maryland’s three-year statute of limitations.  Montrose opened its SYLVAN® facility in January 2001, but did not file its lawsuit until February 6, 2006.  Under Maryland’s discovery rule, a cause of action accrues when the claimant knew or should have known of the wrong.  The court found that Montrose had to have known of the facts giving rise to its contract and fraud claims within the first two years of the contract, rendering those claims untimely.  The court rejected Montrose’s argument that Sylvan’s actions were continuous and that under the discovery rule a new cause of action arose each time Montrose became aware of a new breach.  The court observed that the “continuing breach” rule was not broad enough to apply in this case.

Montrose was, however, allowed to proceed with its tortious interference claim.  That claim was timely because it was based on actions that occurred after February 2003.  Sylvan argued instead that the claim must fail because Montrose did not “allege the existence of a contract between itself and any of the identified third parties.”  The court disagreed, citing Maryland case law holding that a plaintiff need not have entered into an actual contract with a third party in order to bring a claim for tortious interference with business relationships.


ATTORNEYS WHO WROTE OR EDITED ARTICLES FOR THIS ISSUE INCLUDE:

John W. Fitzgerald, Elizabeth S. Dillon, Michael R. Gray, Kelly W. Hoversten, Craig P. Miller, Kevin J. Moran, Kirk W. Reilly, Iris F. Rosario, Max J. Schott, II, Jason J. Stover,  Henry Wang, Quentin R. Wittrock, David E. Worthen, 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, MOOTY & BENNETT, P.A.

500 IDS Center
80 South Eighth Street
Minneapolis, Minnesota  55402-3796
Phone:  612-632-3000
Fax:  612-632-4444

2600 Virginia Avenue, N.W.
Suite 1111 - The Watergate
Washington, DC 20037-1905
Phone: 202-295-2200
Fax: 202-295-2250

franchise@gpmlaw.com

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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