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Franchisor's President Found
Personally Liable For Franchisor's Misrepresentations

Zantum, LLC, v. Daniel Wencel (June 2010)

The founder and president of a franchisor of remanufactured ink cartridge businesses was liable to one of its area franchisees for making negligent misrepresentations that induced the franchisee to sign an area franchise development agreement. After the franchisor went out of business, the area developer, who had been terminated, sued the franchisor and its President and founder. In finding that the President could be held personally liable, the court applied the general rule that vicarious liability for torts is imposed upon employers for acts of their employees within the course and scope of employment. The specific misrepresentations found to exist included the following: (1) That Caboodle's remanufactured cartridges met OEM quality and specifications; (2) That remanufactured Caboodle cartridges could be sold at a price 50 to 65% lower than OEM prices; (3) That Caboodle remanufactures nearly five hundred different cartridges, and (4) That "all of this is done at our centralized manufacturing facilities.'" Even though the court found that the President made the representations in good faith, it also found that the President lacked a reasonable basis for the representations at the time they were made.

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Franchisor's Claim That Franchisee Violated Post-Term Covenant Denied in Bankruptcy

In re Mohamed E. Khafaga v. Rescuecom Corporation (July 2010)

The franchisor brought adversary proceeding against its Chapter 7 debtor-franchisee, seeking a determination that the debt which resulted from the franchisee's alleged conduct in opening a competing operation, Computer Medics, in his wife's name and secretly diverting business to that operation was excepted from discharge. The franchisor's claim - that  in the course of operating the franchise, the defendant knowingly submitted false financial reports regarding sales and services rendered and revenues earned ... with the specific intent of deceiving Plaintiff as to Defendant-Debtor's true sales and services rendered and true revenues earned through the Computer Medics business -- was dismissed because the franchisor failed to allege that the purported damages were caused by the franchisee's misrepresentations and omissions. Specifically, the court held that "The damages claimed by Rescuecom arose at the point of breach, prior to any alleged false pretense or omission made by the Defendant, and would be 'precisely the same' without a claim of fraudulent conduct."

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Franchisor's Failure to Disclose Plans to Discontinue Franchise Model Not Actionable

Something Sweet, LLC v. Nick-N-Willy's Franchise Company, LLC
(June 2010)

A pizza restaurant franchisor did not violate the Washington Franchise Investment Protection Act by failing to disclose to a prospective franchisee that the franchisor was planning to discontinue its outlet franchises at the time that the franchisee purchased its franchise. The franchisor sold two different models of franchises: an outlet model that sold only "take-and-bake" pizzas, and a restaurant model that sold both take-and-bake pizzas and ready-to-eat pizzas that could be consumed at the store. The proposed franchise agreement between the parties did not require the franchisee to specify which model they would follow, and it provided that the franchisor could change store operating methods in the future.  At trial, the franchisor presented evidence demonstrating that it had not discontinued its outlet stores after the purchase. It offered an affidavit from its CEO stating that it continued to support outlet store franchisees in several locations throughout the country. In response, the franchisee pointed to evidence that approximately seven months after its franchise purchase, the franchisor announced a plan to require new franchises to offer some dining facilities. However, under this plan, existing outlet stores were not required to change their operations and they continued to receive support from the franchisor. The franchisee failed to offer any evidence beyond mere allegations that this prospective policy affected existing outlet stores such as its franchise. At most, it showed that the franchisor was considering a shift in its mix of stores going forward. Moreover, the franchisor disclosed to the prospective franchisee in both its offering circular and the franchise agreement that such a shift could occur if the franchisor decided to change its store operating methods in the future.

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Franchisor's Assignment of Franchise Agreements Upheld Regardless of Costs Imposed

Duncan Services, Inc. v. ExxonMobil Oil Corp. (July 2010)
Sixty-five franchisees of ExxonMobil sued their franchisor ExxonMobil, and the company that had ultimately received the franchise agreements through assignment, for breach of contract associated with the assignment. The franchisees contended that the assignments breached their franchise agreements because the assignments (i) materially increased the plaintiff dealers' burdens and risks, (ii) breached an express term of the franchise agreements, and (iii) resulted in the plaintiffs being unable to purchase their gasoline at the stipulated franchise price that was available from Exxon. The franchisees contended that the assignments were invalid because after the assignment the new franchisor deviated from the course of performance/course of dealing under the contracts, increased the price of motor fuel, relegated plaintiffs to a subtenant status which they previously did not occupy, and materially increased the dealers' risks and burdens. The Court held that the franchisor's assignments had not breached the franchise agreements because when the parties agreed to make the franchises freely assignable in the franchise agreements, they submitted to the risk that such costly increases might come to pass.

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Forum Selection Clause Upheld Despite Financial Hardship to Franchisees

RM Yogurt Hawaii LLC, v. Red Mango Franchising Co. (June 2010)
 A franchise area developer in Hawaii filed suit against the franchisor in a state court in Hawaii and the franchisor moved to transfer the case to a court in Texas, the home state of the franchisor. The forum selection clause in the frozen yogurt shop franchise agreement identifying Texas as the exclusive forum for litigating disputes was valid and enforceable. The court held that the franchisee failed to carry its heavy burden of showing that enforcement of the forum selection clause would be unreasonable and unjust, or that the provision was invalid for fraud or overreaching or against public policy. The franchisee argued that the financial burden that would be imposed on it if it were forced to litigate in Texas would greatly affect its ability to have a meaningful day in court. In rejecting that argument the court set forth the principle that even a financial burden that greatly affects the franchisee's financial ability to have a meaningful day in court does not amount to effective deprivation of its day in court. Finally, the court held that the regulation of franchises in Hawaii by its Franchise Investment Law did not amount to a strong public policy against forum selection clauses that prohibited venue in a forum outside the state.

Franchisor Barred From Obtaining Lost Future Franchise Fees in Termination

Medicine Shoppe International, Inc. v. TLC Pharmacy, Inc. (July 2010)

Under Missouri law, a pharmacy franchisor was not entitled to recover future franchise fees from a franchisee after an early termination of the parties' agreement. The court therefore denied the franchisor's request for future fees in the amount of $748,000. The issue of whether a licensee could recover future license fees from a franchisee following termination had not yet been decided by Missouri courts. Accordingly, the court applied the general requirements for lost profits in general relating to a breach of contract stating that lost profits were recoverable provided the loss was the natural and proximate result of the breach, was ascertainable with reasonable certainty, was not speculative or conjectural, and was within the contemplation of the parties when the contract was made. In this case, the court observed that nowhere in the parties' agreement was it evident that either party contemplated the payment of future license fees in the event of termination. Indeed, the contract stated that in the event of termination, the franchisee would be responsible only for past due amounts. Further, the agreement did not expressly provide that the licensee's obligation to pay franchise fees survived termination. Thus, the franchisor failed to support its assertion that it was entitled to future license fees and none would be awarded.

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Even Though Third Party Owned Competing Business Franchisee Nevertheless Terminated

Bonus of America, Inc. v. Angel Falls Services, LLC (July 2010)

A cleaning business franchisee was likely to irreparably harm the goodwill of its franchisor if its continued operation of a competing cleaning business was not enjoined. Despite denials by the competing business that there was no connection between it and the franchisee, substantial evidence showed that the franchisee played a role in the day-to-day operations of the competing business and that the competing business was using the intellectual property of the franchisor. For example, the competing business used images and other features from the franchisor's materials in its own proposals. Although the evidence revealed that the competing business was owned by a third party, it also showed that the franchisee played an active role in the competing business. The franchisee could not avoid the terms of the non-compete covenant by doing through the owner of the competing business what he agreed not to do himself.

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Claims For Violations of Covenant-Not-To-Compete Not Subject to Arbitration

Jewelry Repair Enterprises, Inc. v. Dilshad Ajani (May 2010)

Pursuant to the franchise agreement, jewelry franchisees agreed "not [to] be actively engaged in any jewelry sales or jewelry repair business other than the Franchised Business without the written consent of the Franchisor." The franchisor learned that the franchisees were operating two jewelry repair enterprises that were in direct competition with its franchise.  The franchisor sent a letter notifying the franchisees that their conduct constituted a breach of the agreement.  The franchisees responded stating that they had resigned as managers of the competing businesses, and that they had divested their interests in the competing businesses.  The franchisor alleged that the competing stores were still under the franchisees' control, and requested that the court shut down the competing businesses and terminate the franchise agreement. The franchisees moved to dismiss the court action claiming that they were entitled to go to arbitration for all disputes. The trial court agreed, only to have its decision overturned. The reviewing court thought the issue very clear even though the franchise agreement stated that if the franchisor terminates the agreement and the termination is disputed by the franchisees, "the parties shall submit said dispute for binding arbitration...." However, noted the court, the franchise agreement excepted from the arbitration provision "claims related to noncompetition covenants [or] .... the obligations of the Franchisee upon termination or expiration of this Franchise Agreement." Accordingly, the court of appeals ordered that the trial proceed in court, not in arbitration.

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Thanks for your interest in our Newsletter, and we look forward to answering any questions you might have either on the cases discussed in this issue of Franchise Trends, or on general trends in franchise law.
Jeff Goldstein

Goldstein Law Group                                           
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