Top franchise cases of 2013

by DLA Piper

DLA Piper lawyers Barry Heller, John Hughes and John Dwyer are conducting a webinar reviewing 2013’s top franchise decisions. Three significant 2013 cases from their webinar are summarized below.

1.  In Hanley v. Doctors Express Franchising, LLC, a former franchisee of the Doctors Express franchise system sued Doctors Express, the franchisor, and Rhino 7, a broker involved in the franchise sale, asserting that the disclosure documents contained misrepresentations and nondisclosures regarding required initial investment, initial operating capital requirements, physician credentialing/health insurance reimbursement process and projected earnings.

In their motion to dismiss, Doctors Express argued numerous disclaimers barred the former franchisee from relying on any statements outside of the documents and that its reliance was thus unreasonable. The former franchisee argued that the Maryland Franchise Law voided such disclaimers by prohibiting a franchisor from conditioning a franchise sale on the prospective franchisee’s release of any persons from liability. The district court agreed, but recognized the disclaimers could eventually establish that reliance on the alleged statements was unreasonable.

Rhino 7 moved to dismiss arguing that Maryland Franchise Law imposed liability only on a franchisor, defined as “a person who grants a franchise.” Because Rhino 7 was merely a broker, it claimed it did not “grant” the franchise. Rejecting this argument, the court interpreted the law as applying to agents involved in the franchise sales process, but noted Rhino 7 would have available to it the defense that it “did not know and, in the exercise of reasonable care, could not have known of the untruth[s] or omission[s].”

2.  An Illinois appellate court affirmed dismissal of two former Ace franchisees’ statutory and common law fraud claims because, in light of cautionary language in the disclaimers, the former franchisees could not have reasonably relied on the alleged misrepresentations and could not establish materiality.

In Avon Hardware Co. v. Ace Hardware Corp., former Ace franchisees alleged that Ace manipulated projected sales and revenue figures in pro forma documents and manipulated historical sales figures in disclosure documents. After the trial court dismissed all of the former franchisees’ claims, they appealed.

In affirming the trial court’s dismissal, the appellate court agreed with Ace’s argument that the former franchisees could not pursue any claim based on the pro formas because the financial projections were statements of opinion, not fact, and therefore not actionable. Regarding the historical financial data in Ace’s disclosure documents, the appellate court concluded the documents did not contain false statements because the documents clearly said the historical financial data was not representative of all Ace stores. The appellate court further held that the former franchisees could not have reasonably relied on that information to predict future performance because of the documents’ cautionary language.

3.  Courts have consistently enjoined terminated franchisees from continuing to use their former franchisors’ trademarks if the termination is based on a failure to pay ongoing royalties. But can a franchisee use the franchisor’s pre-existing breach to defeat a claim for non-payment of royalties, even if the franchisee continues to operate its business under the franchisor’s trademarks? In Wyndham Hotels & Resorts, LLC v. Northstar Mt. Olive, LLC, the court sided with the franchisor.

The franchisee hotel operator negotiated a provision under which the franchisor, Wyndham Hotels, guaranteed a certain level of revenue if the franchisee converted a hotel meeting room into a corporate training facility. The franchisee eventually stopped paying royalties, citing Wyndham’s failure to fulfill its obligations under this provision. Wyndham terminated the franchise agreement and brought suit to enjoin use of Wyndham’s trademarks and to recover unpaid royalties. The franchisee did not challenge liability under the Lanham Act, but argued that Wyndham’s breach of the revenue guaranty clause excused it from making royalty payments. Wyndham invoked the Third Circuit’s holding in S&R Corp. v. Jiffy Lube, which held a franchisor’s right to terminate a franchise agreement based on a franchisee’s breach and enforce its post-termination Lanham Act rights exists independently of any claim the franchisee might have against the franchisor.

The district court found that by continuing to operate the hotel using Wyndham’s trademarks with knowledge of the franchisor’s breach, the franchisee continued to reap the benefits of the franchise relationship and therefore could no longer use the franchisor’s pre-existing breach as an affirmative defense. The court thus granted summary judgment to Wyndham on its claim for unpaid royalties, but noted that the former franchisee could still maintain a claim against Wyndham based on the pre-existing breach of the revenue guaranty provision.



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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