Franchise 101: A Franchise Nondisclosure Document; and Franchisee’s Milkshake Brings All Claims to the Yard

Franchisor 101: A Franchise Nondisclosure Document

A California federal court denied a motion to dismiss a former franchisee’s complaint against a healthcare recruitment franchisor’s Chief Executive Officer.

The franchisee alleged Medical Search Consultants LLC’s Franchise Disclosure Document (“FDD”) contained incomplete and misleading information about the franchisor, the AllMed Search franchise system, and franchisor’s CEO/COO, Nadia Gruzd, who provided the FDD. The franchisee claimed that misleading statements in the FDD induced the purchase of the franchise in violation of the California Franchise Investment Law (“CFIL”).

Under the CFIL, it is unlawful for any person to offer or sell a franchise in this state by means of any written or oral communication not enumerated in Section 31200 which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. The franchisee’s CFIL claims raised several alleged violations.

First, the franchisee alleged that by making inaccurate disclosures of required information, Gruzd violated the CFIL’s requirement of truthful and non-misleading disclosure in connection with franchise sales. This includes the failure to disclose the existence of a previous entity Gruzd managed, Unlimited Med Search Franchise System, Inc. (“UMFS”), through which she sold AllMed Search franchises. The franchisee also alleged that UMFS was a predecessor to the franchisor. In moving to dismiss, Gruzd argued that UMFS was not a predecessor and did not need to be disclosed. The court disagreed with Gruzd and found that the franchisee adequately pled Gruzd’s failure to disclose required information about predecessor companies.

Second, the franchisee alleged the FDD failed to disclose litigation relating to Gruzd’s ownership of UMFS, under which she was “held liable,” thereby requiring disclosure in the FDD. The court was unpersuaded by Gruzd’s argument that ending litigation with a settlement agreement meant that she was not “held liable” in connection with the litigation.

And third, the franchisee alleged the FDD did not properly disclose Gruzd’s personal bankruptcies as well as UMFS’ bankruptcy, and that Gruzd made financial performance representations about the profitability of an AllMed Search franchised business, which were not included in the FDD. Gruzd invoked the one-year statute of limitations and argued these claims are time-barred. The court concluded the statute of limitation inapplicable at the motion to dismiss stage because it was not apparent from the face of the complaint that the franchisee would have sufficient knowledge or notice of falsity of the bankruptcy or financial performance information upon receipt of the FDD.

Any person who offers or sells a franchise in violation of the CFIL’s requirement of truthful and non-misleading disclosure in connection with franchise sales may be liable for damages. Franchisors should work with counsel to make sure their FDD contains complete and accurate disclosures.

Pasture Gate Holdings, Inc. v. Gruzd, Case No.: 3:24-CV-00886-L-BJC (S.D. Cal. May 19, 2025)

Franchisee 101: Franchisee’s Milkshake Brings All Claims to the Yard

A Texas federal court granted American Dairy Queen Corporation’s motion for partial summary judgment against a terminated franchisee, finding no dispute to the material facts establishing the franchisee’s material breach of the franchise agreement and trademark infringement.

The parties entered into a franchise agreement for the operation of a Dairy Queen restaurant in Texas. Dairy Queen later terminated the franchise agreement based on the franchisee’s violations of various covenants. Specifically, Dairy Queen alleged the franchisee breached the franchise agreement by selling shakes made using soft serve mix instead of milk, in direct violation of the franchise agreement, which unequivocally states that only fresh milk shall be used as the liquid parts of malts and shakes.

The franchisee conceded this breach, but claimed it was an “isolated and temporary ingredient substitution,” which is a nonmaterial breach and is insufficient to justify termination. The court disagreed and concluded the franchisee materially breached the agreement by failing to use fresh milk to make malts and shakes.

The court also found in favor of Dairy Queen on its trademark infringement and unfair competition claims. The franchisee disputed the timing of the use of the marks and claimed that any use of the “Dairy Queen” marks occurred prior to the franchisee’s receipt of written notice of termination. However, Dairy Queen offered evidence establishing that the franchisee displayed the Dairy Queen marks on multiple dates after the franchisee received the notice of termination.

The court found the franchisee had not shown a genuine dispute of material facts on this issue. Dairy Queen also established a likelihood of consumer confusion between licensed Dairy Queen brand restaurants and the franchised restaurant.

Franchisees should carefully read their franchise agreements to make sure they abide by all obligations and system standards. A franchise system is defined by the consistency of its franchised locations’ offerings. A franchisee’s decision to make a change or substitution in a core offering of the franchise can lead to disastrous results, up to and including termination of the franchise agreement.

American Dairy Queen Corp. v. UAM, LLC, No. 5:24-CV-01209-JKP (W.D. Tex. Apr. 25, 2025)