Court Watch

As a result, the franchisees were allowed to go forward with their misrepresentation claims. The disclaimer contained in the franchise agreement and the execution of the Disclosure Acknowledgment Statement were not sufficient to bar claims of fraudulent inducement and misrepresentation.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Meredith A. Bauer is an associate in the firm's Minneapolis office. She can be contacted at [email protected] or 952-896-3263.

Hawaii District Court Examines What Constitutes an Indirect Franchise Fee

In JJCO, Inc. v. Isuzu Motors America, Inc., Bus. Franchise Guide (CCH) 14, 146 (May 22, 2009), a motor vehicle dealer in Hawaii alleged violations of the Hawaii Franchise Investment Law (“HFIL”), motor vehicle law, and contract law. The plaintiff, JJCO Inc. (“JJCO”), was a licensed dealer of Isuzu vehicles and was terminated by defendant Isuzu Motors America, Inc. (“Isuzu”). JJCO subsequently demanded that Isuzu purchase all of JJCO's inventory, supplies, equipment, and furnishings, as is required by the HFIL upon termination or refusal to renew a franchise. Isuzu argued that JJCO was not a franchise under the HFIL definition, because it was not required to pay a franchise fee. On JJCO's motion for summary judgment, the Hawaii district court conducted a comprehensive analysis to determine if a franchise relationship existed in the business relationship between the dealer and the defendant in the case.

JJCO contended that several of its expenses were indirect franchise fees, including the purchase of tools, parts and service equipment from Isuzu, communications system licensing fees, marketing fees, the purchase of signs, training expenses, flooring arrangements and service pricing. This issue had not been interpreted by Hawaii courts prior to this case. Therefore, the court looked to other states with similar statutes for guidance, including Indiana, California, Michigan, Illinois, New York, and Washington.

Initial Tools and Equipment. Regarding payments for tools, parts, and service equipment, the court found that, consistent with other states' interpretations, the mere purchase of goods did not constitute a franchise fee. In so finding, it held that the general exception from the franchise fee definition for goods purchased at wholesale prices was applicable not only to goods purchased for resale, but also for supplies or fixtures necessary to enter into the business.

Communication Fee. JJCO was also required to pay a monthly fee to use Isuzu's computer network to transmit and receive information about vehicles, parts, and services. JJCO argued that there was no statutory exemption for the wholesale cost of “services” under the HFIL. Whether this was a franchise fee turned on whether JJCO would have had to incur a similar expense in the course of doing business outside of its agreement with Isuzu, or if the fee was incurred for the right to do business with Isuzu. Because Isuzu charged dealers less than it paid to maintain the communications system, the court found that JJCO would have incurred a communications system fee regardless of the nature of its agreement with Isuzu, and it was not a franchise fee.

Marketing Fees. JJCO was charged a direct fee for advertising and was required to purchase signs to display at its dealership. The court found that only advertising costs that are unreasonable or lack a valid business purpose, or that are a substantial and unrecoverable investment, should be considered franchise fees. The marketing expenses paid by JJCO did not rise to this level.

Training Expenses. JJCO argued that the cost of sending its employees to mandatory training sessions conducted by Isuzu constituted a franchise fee. Interestingly, “training fees” are expressly included in the HFIL's definition of a “franchise fee.” In considering whether the training fees and expenses that JJCO incurred fell into this definition, the court first found that any fees paid to third parties (such as travel expenses) cannot be considered a franchise fee. The court also decided that expenses paid for materials provided in training, such as manuals, publications, videos, reference guides, and magazines, can only constitute a franchise fee if they are provided at a premium cost. Only the payments for training sessions, ideas, and instruction themselves could be considered a franchise fee.

Fees Paid to Third Parties. JJCO argued that a requirement of Isuzu that it obtain flooring arrangements, or wholesale financing for such arrangements, constituted a franchise fee. Again, the court found that fees paid to third parties were not franchise fees as a matter of law.

Non-mandatory Fees. JJCO also argued that a fee charged by Isuzu to participate in a service pricing program constituted a franchise fee. JJCO's participation in the program was voluntary, however, and the court found that for a fee to be considered a franchise fee, it must be a condition of doing business with the franchisor. Accordingly, participation in and payment of fees related to non-mandatory programs did not meet this definition.

Inventory. The court noted that JJCO did not argue that the requirement of Isuzu that JJCO purchase a minimum level of inventory was an indirect franchise fee. Normally, sales quotas are not sufficient to create a fee for franchise relationship purposes because of the bona fide wholesale price exception. With regard to inventory, the quantity of goods required to be purchased would have to be so unreasonable as to be considered excess in order to constitute an indirect franchise fee.

In consideration of the above, the court found that JJCO did not meet its burden in showing a franchise fee existed, and the court denied JJCO's motion for partial summary judgment on its HFIL claim.

Disclaimers, 'Disclosure Acknowledgement Statement' Do Not Preclude Claim of Fraud

It is common practice for franchisors to obtain various signed statements from franchisees providing that in entering into the franchise agreement, the franchisee is not relying on any representations outside of those contained in the franchise agreement or the franchise disclosure document. Such disclaimers come in a variety of forms and are commonly included as a provision in the franchise agreement itself, and sometimes as a separate document in the form of a questionnaire or acknowledgment.

A recent case, Martrano v. Quizno's Franchise Co., LLC, et. al., Bus. Franchise Guide (CCH) 14,161 (June 15, 2009), involving a putative class of Quiznos franchisees, examined the legality of these disclaimers and their effect on future claims by franchisees. In Martrano, franchisees in Pennsylvania filed a statewide class action suit against Quiznos alleging, among other claims, fraudulent inducement to purchase a Quiznos franchise based on misrepresentations, omissions, and illegal, deceptive and exploitative practices. The defendants moved to dismiss the claims.

Plaintiffs alleged that the UFOC they received from Quiznos contained at least one express misrepresentation and that several misrepresentations were made in the sales process by sales representatives. The claimed misrepresentation in the UFOC stated that the franchisor and its affiliates would “negotiate purchase arrangements with the supplier for the benefit of Franchisees, which often include volume discounts,” a statement which was refuted by the franchisees in this case. The franchisees also asserted that sales representatives represented to them that Quiznos would use the aggregate buying power of the system to obtain volume discounts, which would then be passed on to franchisees. Other alleged misrepresentations and claims of omission related to trade areas, market over-saturation, and information concerning above-market markups on required supplies.

In support of its motion to dismiss, Quiznos argued that: The franchisees signed extensive non-reliance and disclaimer provisions as part of the franchise agreement; disclaimers were also included in the UFOC; and each franchisee signed a “Disclosure Acknowledgment Statement.” This statement provided that: 1) the franchisee was aware of business risks; 2) the franchisee had reviewed and consulted with legal counsel regarding the franchise investment; 3) the franchisee's decision was not predicated on oral representations, assurances, warranties, guarantees, or promises made by the franchisor or its officers, employees, or agents (including sales brokers) as to the likelihood of success of the franchise; and 4) that except as set forth in the UFOC, the franchisee had not received any information from the franchisor or its officers, employees, or agents (including sales brokers) concerning actual, average, projected, or forecasted franchise sales, profits, or earnings. The Disclosure Acknowledgment Statement then provided a space for the franchisee to write in any such information it had received in the sales process. Each putative plaintiff had answered “None” in the space provided. Quiznos argued that it was unreasonable for franchisees to claim to have relied on representations after acknowledging in writing that they were not relying on such representations.

The federal district court in Pennsylvania dismissed the fraudulent inducement claims because the express statement in the UFOC was explicitly exempted from the disclaimer. As this was enough to allow the claim to go forward, the court did not expressly rule on the effect of the disclaimers. Nonetheless, the court noted that contractual waivers applicable to intentional misconduct, such as fraud, are unenforceable as a matter of public policy. As an additional reason for finding them unenforceable, the court considered that a party cannot waive the right to sue for fraud in the inducement in a waiver provision included in the very contract that is being challenged by the party.

Additionally, the court examined the franchisor's practices surrounding the execution of the Disclosure Acknowledgment Statement. The franchisees submitted evidence that they were required, in order to purchase the franchise, to answer “None” to the written request for any representations that were made outside of the UFOC. The court stated that if this practice were true, then the disclaimer amounts to a “sham” with a purpose to mislead.

As a result, the franchisees were allowed to go forward with their misrepresentation claims. The disclaimer contained in the franchise agreement and the execution of the Disclosure Acknowledgment Statement were not sufficient to bar claims of fraudulent inducement and misrepresentation.

Cynthia M. Klaus is a shareholder at Larkin Hoffman in Minneapolis. She can be contacted at [email protected] or 952-896-3392. Meredith A. Bauer is an associate in the firm's Minneapolis office. She can be contacted at [email protected] or 952-896-3263.