Franchisee 101: The (Ice Cream) Cart Before the Rescission

Lewitt HackmanA federal court in Cleveland rejected a California franchisee’s claim that an Ohio-based ice cream franchisor violated the California Franchise Investment Law (CFIL). The claim failed because the franchisee could not show it suffered damages from the CFIL violations. The court further held that rescission of a franchise agreement is an additional remedy, available only if the franchisee first establishes that the CFIL violation caused damages.

At a meeting in October 2015, the franchisor (Handel’s) disclosed its registered FDD to the franchisee (Schulenberg). In December 2015, Schulenberg paid Handel’s a deposit toward the initial franchise fee. They entered into a franchise agreement in January 2016, granting Schulenburg a franchise in Encinitas, California, and the option to open a second location in San Diego. Handel’s applied ten days earlier to amend the FDD that was previously disclosed to Schulenberg in October 2015. The Department of Business Oversight approved the amendment two days before Schulenberg wired the balance of the franchise fee. The amended FDD was not shown to Schulenberg prior to signing the franchise agreement or paying the fee balance.

This violated the CFIL’s provisions requiring delivery of a registered FDD, and prohibiting the franchisor from receiving payment or signing a franchise agreement until at least 14 days after the disclosure date. Handel’s admitted it failed to provide correct disclosure documents in the required time. Handel’s argued that it should still prevail because the franchisee did not allege any damage resulting from the CFIL violations.

Under the CFIL, a person who violates certain CFIL requirements “shall be liable to the franchisee or subfranchisor, who may sue for damages caused thereby, and if the violation is willful, the franchisee may also sue for rescission.” Relying on an unpublished California case, the court interpreted this statute to mean rescission—a more expansive remedy which includes restitution of benefits conferred by the contract—is illogical and drastic to award without a showing that the statutory violation damaged the franchisee in any way.

Schulenberg claimed the franchise fee, royalties and costs of designing and opening the business were his damages. But according to the court, he did not show these were linked to the CFIL violations. The differences between the disclosure documents he received and the amended documents related to SBA funding, which did not impact the franchisee.

The differences between damages and rescission remedies for the same CFIL violation can be significant. If a technical violation occurred, a court could easily determine that the franchisee suffered no damages from the violation. On the other hand, California decisions hold that a “willful” CFIL violation that permits rescission need only be knowing and intentional, without requiring a showing of malicious intent by the franchisor. Aggrieved franchisees should consult franchise counsel on potential remedies for a franchisor’s CFIL violations, and the legal grounds and arguments to support recovery.

Read: Handel's Enterprises, Inc. v. Schulenburg, N.D. Ohio (Jan. 6, 2020)

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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