A Tennessee federal district court granted a franchisee’s request for a preliminary injunction to prevent the franchisor from enforcing noncompete restrictions under the franchise agreement while the franchisee litigated its fraud claims against the franchisor.
Frost Shades Franchising, LLC, the franchisor of a window tinting and frosting business, granted a franchise for the operation of a South Carolina location. Shortly after entering into the franchise agreement, the parties’ relationship broke down. The franchisee learned that some of the franchisor’s members were involved in litigation not disclosed in the Frost Shades’ Franchise Disclosure Document (FDD) provided prior to entering the franchise agreement.
The franchisee alleged Frost Shades fraudulently induced the franchisee to enter into a franchise agreement by failing to disclose material litigation. Though the litigation was not against Frost Shades, Frost Shades’ members were personally named with a different franchisor in proceedings filed by franchise enforcement divisions in Minnesota and New York. In Minnesota, the members entered a consent order, in which they acknowledged they violated the Minnesota Franchise Act agreed to pay a civil penalty, and not sell franchises in Minnesota until the franchisor is registered. In New York, one of the individual members had not disclosed a felony conviction for credit card fraud.
The franchisee claimed the prior enforcement matters were required to be disclosed in Frost Shades’ FDD, but were not. As part of the litigation, the franchisee sought a preliminary injunction to enjoin Frost Shades’ enforcement of noncompete provisions in the franchise agreement pending resolution of the fraud claims. Frost Shades moved to dismiss the complaint and compel arbitration.
The court concluded the franchisee was likely to succeed on the merits of its fraud claims, authorizing the injunctive relief sought. Frost Shades admitted it inadvertently omitted from the FDD one of the cases that was still pending at the time the franchisee executed the franchise agreement. However, Frost Shades argued the error was negligible because that litigation was filed after the two members sold their ownership interests in the other franchisor. The court held that the members’ sale of their ownership interests did not excuse the Frost Shades’ failure to disclose the litigation against the two members.
The court likewise rejected Frost Shades’ argument that the franchisee was unlikely to establish that the FDD contained materially false or misleading statements on which the franchisee reasonably relied to his detriment. The court found sufficient the franchisee’s claim that, had the litigation been disclosed, the franchisee would not have entered into the franchise agreement.
FDDs must be updated annually. Franchisors should work with franchise counsel to investigate and evaluate past and pending litigation to determine whether, and the manner in which, proceedings against the franchisor or its principals are properly disclosed.
Lunt v. Frost Shades Franchising, LLC 2023 U.S. Dist. LEXIS 85389 (M.D. Tenn., May 16, 2023)
