PLANT MOOTY The GPMemorandum TO: OUR FRANCHISE AND DISTRIBUTION CLIENTS AND FRIENDS FROM: GRAY PLANT MOOTY'S FRANCHISE AND DISTRIBUTION PRACTICE GROUP Quentin R. Wittrock, Editor of The GPMemorandum Maisa Jean Frank, Assistant Editor DATE: November 5, 2014 No. 187 Below are summaries of recent legal developments of interest to franchisors. DAMAGES ATTORNEYS' FEES FRANCHISOR AWARDED MORE THAN $480,000 IN ATTORNEYS' FEES AND COSTS IN LITIGATION TO COLLECT AMOUNTS OWED AND TO ENFORCE POST-TERMINATION OBLIGATIONS The United States District Court for the Western District of Missouri awarded H&R Block Tax Services, which Gray Plant Mooty represented, $481,184.57 in attorneys' fees and costs incurred in connection with litigation arising out of Block's termination of its largest franchisee in Puerto Rico. H&R Block Tax Servs. LLC v. Acevedo-Lopez, 2014 U.S. Dist. LEXIS 139269 (W.D. Mo. Oct. 1, 2014). The court had previously awarded Block more than $1.3 million in damages and issued a permanent injunction enforcing the franchisee's posttermination obligations. The court found that the time spent by Block's counsel in connection with the district court proceedings was reasonable and that Block's billing records reflected "appropriate delegation of tasks to the level at which they could be handled most economically." It also found that the complexity of the litigation, the importance of the case in terms of the amount of money involved and the need to protect the integrity of the franchise system, and the results obtained (success on all claims and counterclaims in the case) warranted awarding the full amount requested by Block for attorneys fees' and costs incurred at the district court level. The court did, however, deny Block's request for fees in connection with an interlocutory appeal challenging the district court's denial of Block's motion at the beginning of
the case for a preliminary injunction. Although the court of appeals had vacated the order denying preliminary relief, Block was granted summary judgment, including for a permanent injunction, on the same day that the court of appeals issued its mandate. Lirtivimv L., I %., rryrun...111.,tt COURT FINDS TECHNICAL VIOLATIONS OF REGISTRATION AND DISCLOSURE LAWS, BUT REFUSES TO AWARD DAMAGES OR RESCISSION A federal court granted partial summary judgment in favor of a former franchisee after finding clear but technical violations of the Maryland and New York registration and disclosure laws, but refused to award damages. A Love of Food I v. Maoz Vegetarian USA, Inc., 2014 U.S. Dist. LEXIS 138962 (D.D.C. Sept. 30, 2014). After approximately two years of operations, franchisee A Love of Food's quick-service restaurant went out of business as a result of large operating losses and significantly higher than expected outof-pocket expenditures. A Love of Food brought suit against its franchisor, Maoz Vegetarian, alleging numerous violations of applicable registration and disclosure laws, including Maoz's failure to register the franchise offering with applicable state authorities and failure to timely provide disclosure. Because A Love of Food's principal place of business was in Maryland, and Maoz's offer to sell the franchise originated from New York, both Maryland and New York franchise laws applied. Maoz had prepared an offering prospectus and provided a copy to A Love of Food, but never registered the prospectus in Maryland. Although Maoz did apply for registration in New York, its application was not approved until after the franchise sale. As a result, the court concluded that Maoz violated both states' disclosure requirements. But it also found that the failure to register and timely disclose was not material to A Love of Food's investment decision. Further, the court held that the business losses sustained by A Love of Food were primarily attributable to its own conduct and not caused by Maoz's failure to register or timely disclose, as the franchisee had, among other things, expended significant amounts on developing the franchised restaurant at a location that was not approved by Maoz. Therefore, the court found that the plaintiff was not entitled to any award of damages or rescission of the franchise agreement. N...1-11..1..1 At. I I...1 I Y..) COURT ALLOWS CONSUMER CLASS ACTION AGAINST FRANCHISOR TO PROCEED A federal district court in California determined that a franchisor could be held liable for violation of the California Unfair Competition Law (UCL) based upon the content of form membership agreements it had originated and distributed to its franchisees for sale to the public. In Hahn v. Massage Envy Franchising, LLC, 2014 U.S. Dist. LEXIS 2
MEI 147899 (S.D. Cal. Sept. 25, 2014), the plaintiffs represented a class of customers who had signed membership agreements at one of Massage Envy's franchised clinics. They argued that a provision in the agreements that required customers to forfeit unused prepaid massage services when they cancelled their memberships or failed to make timely payments violated the UCL. In moving for summary judgment, Massage Envy argued that it could not be held liable because it was not a party to the membership agreements and that the plaintiffs' claims could be asserted only against its franchisees. The court held that Massage Envy failed to raise a genuine issue of material fact as to its potential liability for the business practices it had originated and denied summary judgment on that issue. The evidence demonstrated Massage Envy required its clinics to use the form membership agreements and exercised "wide-reaching control" over its franchisees' day-to-day operations beyond what was necessary to protect its brand and goodwill. The court distinguished this case from Patterson v. Domino's Pizza, LLC, 60 Cal. 4th 474 (2014), in which the California Supreme Court recently ruled a franchisor could not be held liable for sexual harassment committed by a franchisee's employee against a co-worker. The court reasoned that the franchisor in Patterson did not have control over the franchisee's employment practices, whereas Massage Envy prepared the content of the membership agreements that formed the basis of the plaintiffs' claims. The court also rejected Massage Envy's argument that its franchisees made modifications to the agreements during performance, reasoning that post-formation conduct was irrelevant to liability. PROCEDURE COURT BARS GUARANTOR'S AFFIRMATIVE DEFENSES RAISED IN BANKRUPTCY A federal court recently determined that a franchisee's affirmative defenses were barred by the doctrine of res judicata. In KFC Corp. v. Kazi, 2014 U.S. Dist. LEXIS 138278 (W.D. Ky. Sept. 30, 2014), KFC sought to recover past-due money from Kazi, the guarantor and sole shareholder of four franchisees that operated 142 terminated KFC units. Kazi asserted affirmative defenses attacking the franchisees' liability to KFC. The franchisor argued Kazi's defenses were barred because they were, or should have been, litigated during prior bankruptcy proceedings involving the franchisees. For the doctrine of res judicata to apply, there must have been (1) a final decision on the merits; (2) a subsequent action between the same parties; (3) an issue in the subsequent action that was litigated or should have been litigated in the prior action; and (4) a similar core of operative facts or transactions. The court held, first, that the order of a sale in the bankruptcy proceedings constituted a final decision on the merits. Second, the case at bar involved the same parties from the prior bankruptcy proceedings KFC as a creditor of the franchisees and Kazi as the sole shareholder of 3
MOOTti the franchisees and guarantor of their debts. Regarding the third prong, the court found that Kazi had unsuccessfully raised, or should have raised, the affirmative defenses attacking KFC's pre-bankruptcy conduct in the bankruptcy proceedings because "those claims would have a direct effect on the assets in the bankruptcy proceeding." Finally, the court had no doubt that the defenses arose from the same transactions giving rise to Kazi's liability under the guaranties. ARBITRATION COURT CONFIRMS ARBITRATION AWARD AGAINST FRANCHISEE AND ALTER EGO A federal court in New Jersey recently granted a franchisor default judgment confirming an arbitration award against a former franchisee. Doctor's Assocs. Inc. v. Singh-Loodu, 2014 U.S. Dist. LEXIS 142208 (D.N.J. Oct. 6, 2014). Doctor's Associates prevailed in arbitration proceedings against Singh-Loodu, which terminated his Subway franchise, enjoined him from continuing to use its marks, and awarded monetary damages for each day he continued to operate the store. After arbitration, Doctor's Associates sought to confirm the award in federal court against both Singh-Loodu and his company Amie, LLC, under an alter ego theory. Neither Singh-Loodu nor Amie, LLC appeared or answered in court, so Doctor's Associates moved for default judgment. After initially denying relief because the franchisor had styled the action as a complaint rather than a petition to confirm, the court reconsidered its decision and concluded there was no evidence that the arbitrator exceeded his powers in awarding Doctor's Associates relief. The court also concluded that, although an action for confirming an arbitration award is generally not the proper time to determine a claim to pierce the corporate veil, concerns about the adequacy of proof were not present in the default motion because the facts alleged by a plaintiff must be taken as true. Because Doctor's Associates had alleged that Amie, LLC was the de facto operator of the franchise and made all or most of the payments, the court concluded that an alter ego finding was appropriate and confirmed against both. FRAUD NEW JERSEY FEDERAL COURT DISMISSES CLAIMS ALLEGING THAT HOTEL FRANCHISOR SOLD A FRANCHISE KNOWING THAT IT WOULD FAIL In Robinson v. Wingate Inns International, the United States District Court for the District of New Jersey granted in part and denied in part the hotel franchisors' motion to dismiss a former franchisee's claims relating to two failed hotel franchises. 2014 U.S. Dist. LEXIS 139758 (D.N.J. Sept. 24, 2014). Robinson, the franchisee, brought claims against Wingate for breach of contract, breach of the covenant of good faith and fair 4
MEI dealing, and fraud, all based on his inability to obtain financing described in the FDD. Robinson also brought good faith and fair dealing and fraud claims against Wyndham, alleging that it sold him a franchise that it knew would fail. The court dismissed the good faith and fair dealing claim against Wyndham because Robinson alleged the breach occurred to entice plaintiff to form the contract, but the duty only extends to the performance and enforcement of the contract. The fraud claim also was dismissed because Robinson failed to specifically allege the misrepresentations made by Wyndham. Similarly, Robinson's fraud claim against Wingate was dismissed because he failed to plead that the applicable FDD misrepresented the availability of financing; instead, he pled only that he did not receive financing. The court held that Robinson had stated a breach of contract claim but ordered him to identify specifically the franchise agreement provisions allegedly breached. The court likewise held that Robinson sufficiently pled breach of the covenant of good faith and fair dealing by alleging that Wingate had represented that it would assist him in obtaining financing. The court provided Robinson with additional time to replead all of the dismissed claims. STATE FRANCHISE LAWS FRANCHISOR'S REFUSAL TO GRANT ADDITIONAL FRANCHISES TO AN EXISTING FRANCHISEE IS NOT AN UNFAIR OR DECEPTIVE TRADE PRACTICE A Louisiana Court of Appeal recently upheld dismissal of a franchisee's complaint, which alleged that a franchisor's refusal to grant development rights and to approve the transfer of additional franchises to the existing franchisee violated the Louisiana Unfair Trade Practices Act (LUTPA). LeCompte v. AFC Enters., Inc., Bus. Franchise Guide (CCH)1 15,386 (La. Ct. App. Oct. 1, 2014). LeCompte was a franchisee for AFC Enterprises' Popeye's restaurants. He requested development rights after AFC announced its intent to expand in his local market. LeCompte's requests for development rights and to acquire additional franchises from another franchisee were rejected by AFC on the grounds that it did not want to "grow with" LeCompte. AFC responded to his lawsuit with a motion for summary judgment, which was granted by the district court. The Louisiana Court of Appeal affirmed the lower court's ruling, finding that, absent a development agreement, AFC had no obligation to grant additional franchises to LeCompte. The appellate court unequivocally stated that the grant of a franchise is a privilege and not a right, and that franchisors have the unilateral right to select those with whom they choose to do business. AFC's motivation for rejecting LeCompte was irrelevant so long as there was also a sound business reason for the decision. Absent fraud, misrepresentation, deception, or other unethical conduct, which was wholly absent from the record, LeCompte's LUTPA claim must fail. 5
ME Minneapolis, MN Office * John W. Fitzgerald, co-chair (612.632.3064) Megan L. Anderson (612.632.3004) Sandy Y. Bodeau (612.632.3211) Phillip W. Bohl (612.632.3019) Jennifer C. Debrow (612.632.3357) Danell Olson Caron (612.632.3383) Elizabeth S. Dillon (612.632.3284) Ashley Bennett Ewald (612.632.3449) * Michael R. Gray (612.632.3078) Kelly W. Hoversten (612.632.3203) Franklin C. Jesse, Jr. (612.632.3205) Jeremy L. Johnson (612.632.3035) * Richard C. Landon (612.632.3429) Gaylen L. Knack (612.632.3217) * Kirk W. Reilly, co-chair (612.632.3305) * Craig P. Miller (612.632.3258) Bruce W. Mooty (612.632.3333) John W. Mooty (612.632.3200) Kevin J. Moran (612.632.3269) Kate G. Nilan (612.632.3419) * Karli B. Peterson (612.632.3278) * Daniel J. Ringquist (612.632.3299) Max J. Schott II (612.632.3327) Michael P. Sullivan, Jr. (612.632.3350) Michael P. Sullivan, Sr. (612.632.3351) Henry T. Wang (612.632.3370) Lori L. Wiese-Parks (612.632.3375) * Quentin R. Wittrock (612.632.3382) Washington, DC Office Robert L. Zisk, co-chair (202.295.2202) * Janaki J. Parmar (202.295.2235) * Julia C. Colarusso (202.295.2217) Iris F. Rosario (202.295.2204) * Maisa Jean Frank (202.295.2209) * Justin L. Sallis (202.295.2223) Jan S. Gilbert (202.295.2230) * Stephen J. Vaughan (202.295.2208) Jeffrey L. Karlin (202.295.2207) * David E. Worthen (202.295.2203) Mark A. Kirsch (202.295.2229) Eric L. Yaffe (202.295.2222) * Peter J. Klarfeld (202.295.2226) Carl E. Zwisler (202.295.2225) Sheldon H. Klein (202.295.2215) * Wrote or edited articles for this issue. For more information on our Franchise and Distribution practice and for recent back issues of this publication, visit the Franchise and Distribution Practice Group at http://www.gpmlaw.com/practices/franchise-distribution. GRAY PLANT MOOTY 500 IDS Center Suite 700, The Watergate 80 South Eighth Street 600 New Hampshire Avenue, N.W. Minneapolis, MN 55402-3796 Washington, DC 20037-1905 Phone: 612.632.3000 Phone: 202.295.2200 franchise@gpmlaw.com The GPMemorandum is a periodic publication of Gray, Plant, Mooty, Mooty & Bennett, P.A., and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult your own franchise lawyer concerning your own situation and any specific legal questions you may have. GP:3821309 v1 6