Must A False Statement To A Franchisee Be Made “In this state”?

by Allen Matkins

The list of instruments and interests included within the definition of a “security” in California Corporations Code Section 25019 is long.  A franchise, however, is not to be found amongst the named.  In fact, the statute specifically excludes a franchise subject to registration under the California Franchise Investment Law (Corporations Code Section 31000 et seq.) or exempt from registration under the CFIL by Section 31100 or Section 31101 .

The CFIL roughly parallels the Corporate Securities Law in structure.  The CFIL, like the CSL, imposes a registration requirement on offers and sales of franchises “in this state” unless exempt, and creates a private right of action for certain violations.  A recent federal court ruling illustrates the interplay of these provisions.  G.P.P., Inc. v. Guardian Prot. Prods., 2017 U.S. Dist. LEXIS 7056 (E.D. Cal. Jan. 18, 2017).  The ruling is quite long and addresses many different issues.  Today’s post focuses on only one of these – whether a plaintiff under the CFIL must allege that misrepresentations and omissions were made “in this state” by an exempt franchisor.

Corporations Code Section 31202 provides:

It is unlawful for any person willfully to make any untrue statement of a material fact in any statement required to be disclosed in writing pursuant to Section 31101, or willfully to omit to state in any such statement any material fact which is required to be stated therein.

Noticeably absent from the statute are the words “in this state”.  The phrase itself is found in other provisions of the CFIL, including Sections and 31110 and 31201.  Section 31202 itself does not create a private right of action, this is established by Sections 31300 and 31302.  It is important to note that Section 31202 does not make all misstatements unlawful, the statement must be a statement required to be disclosed in writing pursuant to Section 31101.  That statute exempts from registration the offer and sale of franchises subject to registration pursuant to Section 31110 provided the franchisor meets specific net worth, experience and disclosure requirements.  It is not surprising that Section 31101 does not mention “in this state” because Section 31110 expressly applies only to offers and sales of franchises “in this state”.  If the offer and sale are not made “in this state”, there is no need of an exemption.

U.S. Magistrate Judge Sheila K. Oberto, however, focused only on the fact that none of Sections 31101, 31202 and 31300 includes the phrase “in this state”.  Thus, she found that the plaintiff’s claim was not subject to dismissal because there was no evidence that the defendants ever sold a franchise in California.  I disagree with this conclusion because, as explained above, a statement is required to be disclosed pursuant to Section 31101 only when the offer and sale are made “in this state”.  Perhaps, some of confusion is traceable to the characterization of Section 31101 as exempting the franchisor rather than the offer and sale of a franchise in California:

Section 31101 of the CFIL requires a franchisor, in order to be exempt from the requirements of Part 2 of the CFIL, to disclose certain enumerated information to a prospective franchisee.

Section 31013 describes when an offer or sale is made “in this state” with all of the painful detail of Section 25008.  See Citizenship And The California Securities Laws.

Judge Gorsuch, the SEC and a pachyderm named “Chevron”

A little of two years ago, I posed the question the following question:  Should judicial deference to the SEC be strong, weak or non-existent?  The federal courts generally apply a strong form of deference to regulations adopted by federal agencies through notice-and-comment rulemaking.  The Supreme Court adopted this deference in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).  If Judge Neil Gorsuch takes a seat on the Supreme Court, he may cast a chary eye on Chevron deference.  In Gutierrez-Brizuela v. Lynch, 834 F.3d 1142 (2016), Judge Gorsuch wrote in concurrence:

There’s an elephant in the room with us today. We have studiously attempted to work our way around it and even left it unremarked. But the fact is Chevron and Brand X permit executive bureaucracies to swallow huge amounts of core judicial and legislative power and concentrate federal power in a way that seems more than a little difficult to square with the Constitution of the framers’ design. Maybe the time has come to face the behemoth.

The reference to Brand X is to Nat’l Cable & Telecomms. Ass’n v. Brand X Internet Servs., 545 U.S. 967 (2005).

What would a world with Chevron deference look like?  For the answer, see Chevron Deference in California.

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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