Court Watch

California Court Shows Rare Hostility Toward Franchisee's Claims

California courts are known for being what many franchisors might describe as being friendlier to franchisees than the courts in many other jurisdictions. There is a reason the California judicial system is often referred to as being “Left Coast.”

Notwithstanding this perceived bias, a recent California decision suggests that even that state's courts will only tolerate so much when it comes to weakly pleaded claims.

In Passport Health, Inc. v. Travel Med., Inc., (CCH) Bus. Franchise Guide '14,272 (E.D. Cal. Nov. 13, 2009), a federal district court threw out a F.R.C.P. 12(b)(6) motion to dismiss various claims filed by a traveler immunization clinic franchisee against its franchisor. The claims included: 1) beach of contract; 2) breach of the implied covenant of good faith and fair dealing; 3) breach of fiduciary duty; 4) intentional interference with prospective business advantage; 5) trade libel; and 6) unfair business practices under the Cal. Bus. & Prof. Code ' 17200. The breach of fiduciary duty claim was dismissed with prejudice. The other claims were dismissed without prejudice and with leave to amend.

In essence, the franchisee's complaint was long on theory but short on facts. For the contract claim, the franchisee asserted that the franchisor failed to correct several flaws in the franchise system after they were called to the franchisor's attention by the plaintiff, and also failed to supply sufficient supervision and support to the franchisee. The court, however, found nothing specific in the contract that required the franchisor to correct flaws in the system or to supply post-signing support. Thus, the franchisee's contractual claims were dismissed.

Similarly, the implied covenant of good faith and fair dealing claim was rejected, with the court following the generally accepted principle that the implied covenant cannot be used to enhance a party's rights or obligations. The court also found that the breach of fiduciary duty claim failed because the precedents in California law made clear that a franchisor does not owe a fiduciary duty to a franchisee, thus following the national trend that was established after the Broussard decision was rendered in 1998 (Broussard v. Meineke Discount Muffler Shops, Inc., 155 F.3d 331 (4th cir. 1998)).

As to the intentional interference claim, the court simply found that the allegations about lost customer relations were too speculative, but allowed the franchisee the opportunity to amend its complaint to correct this deficiency. As for the trade libel claim, the court found the franchisee's complaint was missing relevant facts to fend off a motion to dismiss as well. And finally, as to the unfair business practices act, the court concluded that the franchisor's failure in its advertising to note the flaws in the franchise system could constitute an unfair business practice, but the franchisee had failed to plead that damages had actually been incurred, and instead simply said that damages were “unknown at this time.” Thus the court dismissed this claim, too.

While it has been many decades since the U.S. judicial system adopted the concept of notice pleading, the California court in Passport implicitly drew a line as to how non-specific a franchisee's complaint may be.

Since the Federal Trade Commission's Franchise Rule does not provide for a private right of action, and because of the FTC's limited resources in the area of enforcement, rare are the occasions when courts have the opportunity to give insights into how the FTC Rule, and particularly its definition sections, will be judicially interpreted. Englert, Inc. v. LeafGuard USA, Inc., (CCH) Bus Franchise Guide '14,297 (D.S.C. Dec. 14, 2009) is one of those rare cases.

Although there were several issues before the court, including patent and trademark infringement, there were two questions before the court specifically relevant to franchising. First, was the gutter fabricating machine purchased by the licensee and the related business model a “franchise” under the FTC Franchise Rule; and second, if so, was the failure by the defendant to provide the prescribed offering document a violation of the FTC Franchise Rule and, as a result, a violation of South Carolina's “little FTC Act”?

Looking at the three-prong definition of a “franchise” in the FTC Franchise Rule (i.e., in generic terms: 1) trademark association; 2) substantial assistance or control; and 3) payment of a franchise fee), the court concluded that both the “control” test and the “franchise fee” test had not been met. As for control, the court emphasized that the business which was the subject of the license arrangement between the licensor and licensee did not give the licensor the necessary control over the licensee's entire business to meet this prong of the franchise definition test. The fact that the licensee had other lines of business certainly did not help the licensee's case.

As for the franchise fee test, the court found that the purchase of the equipment necessary to operate this aspect of the licensee's business was not a payment necessary to operate a franchise; rather, it was simply the purchase of business machinery. The fact that the machinery was subject to a patent controlled by the licensor did not seem significant to the court.

Thus, the court concluded that no franchise arrangement had been created that would make the FTC Franchise Rule applicable to this situation.

The court also found that the South Carolina little FTC Act would not have made the license agreement voidable even if the FTC Franchise Rule had been applicable. The court concluded that the licensee had failed to provide persuasive authority that a South Carolina court would have construed violation of the FTC Franchise Rule as being a per se violation of the South Carolina act, and thus refused to grant summary judgment in favor of the licensee on this point.

In a somewhat below-the-radar screen decision ' at least for the moment ' the Missouri Court of Appeals has demonstrated how good contract drafting can lead to good decisions, and bad drafting can lead to disasters. In the same decision, the court paved the way for deciding what might lead to a significant precedent on what constitutes the unlawful practice of law in the franchise environment.

In Jitterswing, Inc. v. Francorp, Inc. No. ED93045, 2010 WL 933763 (Mo. Ct. App. Mar. 16, 2010), the dispute centered upon plaintiff franchisor's suit against its franchise consultant for the unlawful practice of law ' a tort under Missouri law. The contract, drafted by the consultant, provided that disputes “under the Agreement” must be brought in an Illinois federal or state court. The franchisor, however, brought suit in Missouri.

The Missouri trial court dismissed the complaint, deciding that the contract with Francorp should be enforced as written. However, the appellate court disagreed, stating that the franchisor's tort claim did not result in a proceeding brought “under the agreement,” but, instead, was a proceeding to enforce a statutory claim under the laws of Missouri. In reaching this decision, the court also noted that because this was a Missouri statutory claim, an Illinois court would not have jurisdiction to adjudicate the claim, thus leaving the Missouri-based franchisor without a remedy.

The more interesting issue lurking in this proceeding, however, has yet to be considered by this court in this proceeding, and that is whether Francorp's conduct constituted the practice of law. The facts showed that Francorp would prepare the relevant franchise documents, and then suggest that its client present them to the client's attorney for review. If the case goes forward, perhaps it will shed some light on what franchise consultants can, and cannot do, without crossing the line into the practice of law.

The decision, it should be noted, currently appears with the following Notice: “This opinion has not been released for publication in the permanent law reports. It may be subject to a motion for rehearing or transfer. It may be modified, superseded or withdrawn.”

California Court Shows Rare Hostility Toward Franchisee's Claims

California courts are known for being what many franchisors might describe as being friendlier to franchisees than the courts in many other jurisdictions. There is a reason the California judicial system is often referred to as being “Left Coast.”

Notwithstanding this perceived bias, a recent California decision suggests that even that state's courts will only tolerate so much when it comes to weakly pleaded claims.

In Passport Health, Inc. v. Travel Med., Inc., (CCH) Bus. Franchise Guide '14,272 (E.D. Cal. Nov. 13, 2009), a federal district court threw out a F.R.C.P. 12(b)(6) motion to dismiss various claims filed by a traveler immunization clinic franchisee against its franchisor. The claims included: 1) beach of contract; 2) breach of the implied covenant of good faith and fair dealing; 3) breach of fiduciary duty; 4) intentional interference with prospective business advantage; 5) trade libel; and 6) unfair business practices under the Cal. Bus. & Prof. Code ' 17200. The breach of fiduciary duty claim was dismissed with prejudice. The other claims were dismissed without prejudice and with leave to amend.

In essence, the franchisee's complaint was long on theory but short on facts. For the contract claim, the franchisee asserted that the franchisor failed to correct several flaws in the franchise system after they were called to the franchisor's attention by the plaintiff, and also failed to supply sufficient supervision and support to the franchisee. The court, however, found nothing specific in the contract that required the franchisor to correct flaws in the system or to supply post-signing support. Thus, the franchisee's contractual claims were dismissed.

Similarly, the implied covenant of good faith and fair dealing claim was rejected, with the court following the generally accepted principle that the implied covenant cannot be used to enhance a party's rights or obligations. The court also found that the breach of fiduciary duty claim failed because the precedents in California law made clear that a franchisor does not owe a fiduciary duty to a franchisee, thus following the national trend that was established after the Broussard decision was rendered in 1998 ( Broussard v. Meineke Discount Muffler Shops, Inc. , 155 F.3d 331 (4th cir. 1998)).

As to the intentional interference claim, the court simply found that the allegations about lost customer relations were too speculative, but allowed the franchisee the opportunity to amend its complaint to correct this deficiency. As for the trade libel claim, the court found the franchisee's complaint was missing relevant facts to fend off a motion to dismiss as well. And finally, as to the unfair business practices act, the court concluded that the franchisor's failure in its advertising to note the flaws in the franchise system could constitute an unfair business practice, but the franchisee had failed to plead that damages had actually been incurred, and instead simply said that damages were “unknown at this time.” Thus the court dismissed this claim, too.

While it has been many decades since the U.S. judicial system adopted the concept of notice pleading, the California court in Passport implicitly drew a line as to how non-specific a franchisee's complaint may be.

Since the Federal Trade Commission's Franchise Rule does not provide for a private right of action, and because of the FTC's limited resources in the area of enforcement, rare are the occasions when courts have the opportunity to give insights into how the FTC Rule, and particularly its definition sections, will be judicially interpreted. Englert, Inc. v. LeafGuard USA, Inc., (CCH) Bus Franchise Guide '14,297 (D.S.C. Dec. 14, 2009) is one of those rare cases.

Although there were several issues before the court, including patent and trademark infringement, there were two questions before the court specifically relevant to franchising. First, was the gutter fabricating machine purchased by the licensee and the related business model a “franchise” under the FTC Franchise Rule; and second, if so, was the failure by the defendant to provide the prescribed offering document a violation of the FTC Franchise Rule and, as a result, a violation of South Carolina's “little FTC Act”?

Looking at the three-prong definition of a “franchise” in the FTC Franchise Rule (i.e., in generic terms: 1) trademark association; 2) substantial assistance or control; and 3) payment of a franchise fee), the court concluded that both the “control” test and the “franchise fee” test had not been met. As for control, the court emphasized that the business which was the subject of the license arrangement between the licensor and licensee did not give the licensor the necessary control over the licensee's entire business to meet this prong of the franchise definition test. The fact that the licensee had other lines of business certainly did not help the licensee's case.

As for the franchise fee test, the court found that the purchase of the equipment necessary to operate this aspect of the licensee's business was not a payment necessary to operate a franchise; rather, it was simply the purchase of business machinery. The fact that the machinery was subject to a patent controlled by the licensor did not seem significant to the court.

Thus, the court concluded that no franchise arrangement had been created that would make the FTC Franchise Rule applicable to this situation.

The court also found that the South Carolina little FTC Act would not have made the license agreement voidable even if the FTC Franchise Rule had been applicable. The court concluded that the licensee had failed to provide persuasive authority that a South Carolina court would have construed violation of the FTC Franchise Rule as being a per se violation of the South Carolina act, and thus refused to grant summary judgment in favor of the licensee on this point.

In a somewhat below-the-radar screen decision ' at least for the moment ' the Missouri Court of Appeals has demonstrated how good contract drafting can lead to good decisions, and bad drafting can lead to disasters. In the same decision, the court paved the way for deciding what might lead to a significant precedent on what constitutes the unlawful practice of law in the franchise environment.

In Jitterswing, Inc. v. Francorp, Inc. No. ED93045, 2010 WL 933763 (Mo. Ct. App. Mar. 16, 2010), the dispute centered upon plaintiff franchisor's suit against its franchise consultant for the unlawful practice of law ' a tort under Missouri law. The contract, drafted by the consultant, provided that disputes “under the Agreement” must be brought in an Illinois federal or state court. The franchisor, however, brought suit in Missouri.

The Missouri trial court dismissed the complaint, deciding that the contract with Francorp should be enforced as written. However, the appellate court disagreed, stating that the franchisor's tort claim did not result in a proceeding brought “under the agreement,” but, instead, was a proceeding to enforce a statutory claim under the laws of Missouri. In reaching this decision, the court also noted that because this was a Missouri statutory claim, an Illinois court would not have jurisdiction to adjudicate the claim, thus leaving the Missouri-based franchisor without a remedy.

The more interesting issue lurking in this proceeding, however, has yet to be considered by this court in this proceeding, and that is whether Francorp's conduct constituted the practice of law. The facts showed that Francorp would prepare the relevant franchise documents, and then suggest that its client present them to the client's attorney for review. If the case goes forward, perhaps it will shed some light on what franchise consultants can, and cannot do, without crossing the line into the practice of law.

The decision, it should be noted, currently appears with the following Notice: “This opinion has not been released for publication in the permanent law reports. It may be subject to a motion for rehearing or transfer. It may be modified, superseded or withdrawn.”