Upon Further Review: Quizno's Lawsuit Revived In Wisconsin
A Wisconsin federal district court recently reversed course and vacated its original holding that The Quizno's Franchise Company, LLC ("Quizno's") was insulated from claims of fraudulent inducement and violation of the federal RICO statute based on the disclosures, disclaimers and non-reliance clauses contained in Quizno's disclosure document ("UFOC") and franchise agreement. Westerfield v. The Quizno's Franchise Company, LLC et al, Bus. Franchise Guide (CCH) ¶13,887 (E.D.Wisc.,2008).
As understood by the court in its initial ruing in November 2007, the 12 Quizno's franchisees claimed that Quizno's fraudulently withheld information that it was required to disclose, such as "the substantial markups and kickbacks that add to the price of food, supplies, services and other materials that must be purchased from Quizno's or its approved suppliers." Certain franchisees further alleged that Quizno's area directors made illegal earnings claims to induce them to invest in the franchise opportunity.
The court dismissed the fraudulent concealment claim because Quizno's did disclose its purchasing arrangements in the UFOC, which stated in part that:
We and our affiliates negotiate purchase arrangements with suppliers for the benefit of Franchisees, which often include volume discounts. Some suppliers pay us and/or our affiliates fees for products purchased through these negotiated agreements, and willingness to pay us and/or our affiliates may be a condition of our approval.
The court also held that the franchisees' causes of action regarding the alleged earnings claims were precluded as a matter of law by Quizno's exhaustive disclaimers and non-reliance clauses, including (i) that Quizno's did not authorize its salespersons to furnish additional written information or any oral information concerning actual or potential earnings, and (ii) the franchisees' specific acknowledgment that no earnings claims had been made outside of the UFOC.
In overturning the dismissal in April 2008, the court acknowledged that it had previously misunderstood the franchisees' theory of fraud: that Quizno's practices of overcharging franchises and requiring kickbacks from approved vendors are directly contrary to the representations in its UFOCs that it negotiates supplier purchase agreements "for the benefit of Franchisees". The court held that this theory satisfied the broad definition of the phrase "scheme to defraud" used in the federal mail and wire fraud statutes, which have been applied to the omission or concealment of material information.
Citing both federal and state law, the court further held that Quizno's disclaimers and non-reliance clauses did not preclude the franchisees' claims as a matter of law, noting that more than contract language was needed to defeat such fraud claims, because "the same public policy that in general sanctions the avoidance of a promise obtained by deceit strikes down all attempts to circumvent that policy by means of contractual devices."
The Westerfield court's self-reversal is significant in that it may directly impact at least two related federal cases involving Quizno's in Illinois and Colorado. The courts in those cases relied heavily upon the original Westerfield decision in dismissing franchisees' fraud and RICO claims. In the wake of the Westerfield reversal, the parties in all three cases are proceeding to private mediation this month.
We are particularly intrigued, however, by the nature of the fraudulent scheme as alleged by the Westerfield franchisees, to wit: that Quizno's is motivated not by a desire to establish stable and economically strong franchisees for the long term, but rather "to inflate Quiznos' profitability and make it more attractive to potential buyers and investors, toward the ultimate goal of allowing . . . Quiznos insiders to sell their ownership interest for billions of dollars."
According to the Westerfield franchisees, Quizno's carries out this scheme as follows:
through their intentional misrepresentations and omissions, the defendants fraudulently induced them to enter into agreements that allow Quiznos to compel them to purchase the services, goods and materials essential to their businesses at grossly inflated prices from which Quiznos directly or indirectly profits. Then, when they can no longer withstand the losses caused by Quiznos' exploitation and go out of business, plaintiffs allege that Quiznos obtains releases of any claims against it by threatening the franchisees with a lawsuit to enforce provisions of the Franchise Agreement that purport to render them liable for payment of royalties over the entire 15-year term of the Agreement. The closures are then used to "facilitate the movement of a lengthy list of equally deceived franchisees awaiting store locations, into the same, now-vacant and bankrupt locations.
As correctly noted by the Westerfield court, such practices would seem to run counter to the interests of any enlightened franchisor whose own long term financial results are deeply dependent upon the success of its franchisees. Profitable franchisees tend to re-invest in the system through expansion and renewals, and they often recommend that others do the same.
The real and larger lesson of Westerfield is that a franchisor that is not consistently focused on its franchisees' bottom line is destined to experience franchisee failures, excessive turnover, discontent and litigation.
