A recent decision from a federal court in California addresses the enforceability of a general release of claims signed by former franchisees. Quick tutorial: a "general release" is a document where the signing party (releasor) agrees to relinquish the right to enforce or pursue any and all legal claims against the non-signing party (releasee). While general releases in the franchise context are usually unilateral (given by the franchisee, or former franchisee, to the franchisor), they can be and sometimes are mutual.
The court decision deals with Grayson and McKenzie, who are former franchisees of 7-Eleven, Inc. Grayson and McKenzie are also the name plaintiffs in a class action lawsuit they filed against 7-Eleven relating to 7-Eleven's collection of a federal excise tax on pre-paid telephone cards they and other franchisees sold at their respective stores.
When those cards were sold, 7-Eleven collected excise taxes from the plaintiffs, and paid those taxes to the federal government.
In 2006, the federal government stopped collecting excise taxes on pre-paid phone cards. The government authorized a one-time refund of the tax for payments made between March 2003 and July 2006.
The federal government made refund payments to 7-Eleven for millions of dollars, but the franchisees in the lawsuit alleged that 7-Eleven did not return any portion of the payments to them, even though those franchisees believed they were entitled to a 50% share of the refunded money.
The reason the franchisees believed they were entitled to a portion of the tax refunds was because of the way the 7-Eleven system is structured. While most franchise systems are designed so that the franchisee will pay the franchisor a royalty fee (as well as other fees) based on the franchisee's gross sales, 7-Eleven's system is built differently.
In the 7-Eleven system, 7-Eleven and the franchisee will split the store's gross profit as well as the operating expenses.
Based on the "share and share alike" operating structure, the plaintiffs in the lawsuit alleged that they were entitled to a 50% pro rata share of the excise tax refunds received by 7-Eleven. The franchisees sued 7-Eleven for: (1) conversion; (2) money had and received; and (3) breach of implied contract.
7-Eleven moved for summary judgment on Grayson and McKenzie's claims, asking the court to dispose of the franchisees' claims. 7-Eleven based its request on general releases that the franchisees had each signed in 2004 and 2005, respectively, when they terminated their franchise agreements with the company.
In response, Plaintiffs argued that California Civil Code Sec. 1668 prevents the releases from excusing 7-Eleven from liability. That section states:
All contracts which have for their object, directly or indirectly, to exempt any one from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.
In essence, the franchisees argued that their general releases could not be used to dispose of their legal claims because 7-Eleven had engaged in intentional wrongdoing, and that California law does not permit 7-Eleven to obtain a release of those types of claims from the franchisees.
The Court began its analysis by recognizing the rule that "generally, California Civil Code Section 1668 invalidates contracts that purport to exempt an individual or entity from liability for future intentional wrongs, gross negligence, and violations of the law."
As to the franchisees' conversion claim, the Court stated that "[a]bsent a public interest, section 1668 does not invalidate a release from simple negligence or strict liability claims." The Court found that conversion is a strict liability tort, and because there is no "public interest" involved in a franchisee-franchisor relationship, the conversion claim was released by the franchisees.
As to the second claim, money had and received, the Court found that the essence of the claim does not require a plaintiff to show that the other party engaged in either gross negligence or intentional wrongdoing. As a result, the Court found that claim to be released as well.
Turning to the final claim, breach of implied contract, the Court found that the claim did not involve an intentional tort (which is the type of action that California law protects against), and that it was therefore also released by the franchisees.
Based on the foregoing, the Court held that the releases signed by Grayson and McKenzie released 7-Eleven from each of the claims asserted by them, and entered summary judgment in favor of 7-Eleven.
This case is a good reminder to franchisors of the value of obtaining a general release from a franchisee when it is possible (and legally permissible) to do so. A typical franchise agreement will require a franchisee to provide a general release upon the franchisee's sale of the business, or upon renewal. A prudent franchisor will be sure to collect a general release upon the occurrence of either event.
To franchisees, the decision is instructive. General releases, legitimately obtained, are enforceable in most circumstances and will usually result in nullifying any legal claims that may exist against the franchisor.
As a result, it's important to understand these documents -- and the requirement in most franchise agreements that they be signed under certain circumstances -- before entering into a franchise relationship.
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