Franchise 101: Poked in the Eye; and Transaction Totaled

Franchisor 101: Poked in the Eye

A poke restaurant franchisee in Ohio sued the franchisor for violation of the California Franchise Investment Law (CFIL) and other claims. The franchisor defendants moved to dismiss the claims. A California federal court granted the motion and dismissed the claims.

The franchisee claimed the Franchise Disclosure Documents (FDDs) received in the sale process understated the total investment needed to establish the restaurants. The franchisee claimed the franchisor knew the costs were higher. As evidence, the franchisee pointed to other FDDs the franchisor filed in California three months after the franchise agreements were signed.

The franchisor argued that under the CFIL, only two kinds of claims could be made based on FDD misrepresentations before a franchise sale, and that here, neither was available to the franchisee. The court agreed.

The first CFIL claim was based on a statute that allows rescission of franchise agreements for violations listed in the statute. These include failure to register the FDD with the state and failure to disclose the FDD. The franchisor identified an exemption for out-of-state franchised businesses. Here, the franchisee’s restaurants were outside California. This made the CFIL registration and disclosure requirements inapplicable. The exemption precluded liability for each kind of listed violation except one. The one kind of claim not covered by the exemption was a misleading misrepresentation or omission made in any document filed with the state.

On this alleged violation, the franchisor showed that the FDDs given to the franchisee were not “filed” FDDs. Based on the exemption, and the franchisee being located in Ohio, the FDDs given to the franchisee were not the FDD that the franchisor had registered (filed) in California. The court agreed that the franchisee relied exclusively on FDDs that were not filed in California. 

The second CFIL claim was based on misleading representations or omissions in anything other than a document filed with the state. But this claim was subject to a two-year statute of limitations. The court found that the two-year time started to run when the franchise agreements were signed in February 2020. That meant a claim on this basis had to be brought by February 2022. The franchisee had filed the action in May 2022.

The court dismissed the CFIL claims. Dismissal of the CFIL claims resulted in dismissal of all claims that could be brought only under the CFIL.

The court noted that the CFIL preempts allegations of fraud based on CFIL violations, while ensuring that any claims beyond the CFIL’s coverage may be brought independently. The franchisee alleged that statements made “outside the FDD and Franchise Agreement” were not preempted. The franchisor countered, and the court agreed, that all alleged statements were made before the franchise agreements were signed, and allegedly to induce the franchise purchase. Accordingly, claims for common law fraud, negligent misrepresentation and unfair competition claims were also dismissed.

A provision stating that the CFIL is a franchisee’s exclusive remedy is about to be removed from the statute, effective January 2023. It will abrogate case law relied on by the court that recognized the exclusive remedy and preemptive effect of the CFIL. Franchisors defending cases involving CFIL claims next year can expect to defend additional common law claims based on the same conduct.

Range 2 Poke, LLC v. LemonShark Franchising, LLC, No. 8:22-cv-00949-SPG-ADS (Oct. 21, 2022) (Full disclosure: Lewitt Hackman represented the franchisor in this action).

Franchisee 101: Transaction Totaled

Franchisee Cipercen, LLC operated several Meineke Car Care Centers. By 2017, Cipercen owed $550,000 in unpaid franchise fees to Meineke and decided to sell the franchises. Cipercen believed Meineke offered to waive the unpaid fees if Cipercen sold to a preferred buyer, Morningside. Cipercen and Morningside entered into an Asset Purchase Agreement (APA). Cipercen transferred control of the franchises to Morningside, with the understanding that Morningside would pay the purchase price into an escrow.

Morningside did not pay and the sale failed to close. Cipercen and Morningside sued each other in state court. Cipercen also sued Meineke, claiming Meineke fraudulently induced it to enter into the APA and for interference. Meineke counterclaimed for payment of the $550,000. 

The fraudulent inducement claim against Meineke failed for lack of any false statement. Cipercen alleged a Meineke representative said Meineke would write-off the outstanding fees if Cipercen sold to Morningside. But the write-off was conditioned on a series of events that did not occur, including closing of the APA.

The franchisee and franchisor made claims that the court held were time-barred. Cipercen sued Meineke in March 2021. Meineke contended the interference claim accrued no later than October 2017 when all its claimed misconduct was complete. Cipercen argued the statute of limitations period of three years, began to run later, when Morningside failed to perform the APA. The court sided with Meineke. By October 2017, Cipercen declined other offers for the franchises and stopped soliciting new offers, due to Meineke’s alleged inducement to sign the APA. Therefore, the court found the date of the alleged injury was October 2017. That made October 2020 the time limit to bring a claim.

On Meineke’s counterclaim for breach of franchise agreements, Cipercen argued the claim accrued no later than the APA closing date. Meineke conceded that mutual releases set the same date for payment of the outstanding franchise fees. The court determined Cipercen was in breach when the closing date arrived and conditions of Meineke’s release of Cipercen failed to materialize. That was the latest date the claim could have accrued and Meineke filed its counterclaim more than three years later.

Preferred buyers arranged by franchisors can be a franchisee’s solution when financial strain forces a franchisee to find a way out. Franchisees and their counsel should perform due diligence into the buyer’s ability to complete a purchase and review the transaction documents for adequate protections and pathways for recourse in case the buyer cannot perform. 

Cipercen, LLC v. Morningside Texas Holdings, LLC, Del. Super., No. N19C-12-074 EMD CCLD (Sept. 14, 2022)




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