Many restaurants are technically insovlent.
Some estimates are as high as 12%.
They will want to know about bankruptcy, and their own remedies.
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Recently in Lawsuits Category
Times are difficult right now, for both franchisors and franchisees. What with an economic lockdown which may last for 4 or 5 months.
Some franchisors are trying offer some inducements to their franchisees to hang in there.
But, Carmen Caruso warns that you might want to look this gift horse in the mouth.
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As most people know, in the US, jurisdiction over franchising is at both the State and Federal level.
A well-known franchise lawyer, Rochelle Spandorff, has proposed a radical change:
- The end of independent state jurisdiction over registration;
- A private cause of action for the violation of the FTC Franchise Rule.
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The Americans with Disabilities Act (ADA) is most frequently cited in reference to the employer-employee relationship; however, Title III of the ADA contains accessibility requirements for public buildings and facilities, including regulations related to signage, parking spaces, curbs, height of service counters, and size of restrooms. These regulations apply to anyone who owns, leases, or operates a place of public accommodation, which includes almost all businesses that serve the public.
Any public facility that is not ADA compliant is in violation of the law, and contrary to popular belief, there are no grandfather provisions in Title III of the ADA. Essentially, if you have an architectural barrier that prevents a disabled person from using your premises then you have to remove that barrier if removal is "readily achievable." Readily achievable means the removal may be accomplished without undue cost or effort.
The problem for franchisors and franchisees is that they may not know if they are ADA compliant until a lawsuit is filed.
With astounding frequency, lawsuits are being filed against businesses, restaurants, bars, and hotels that allege violations of Title III of the ADA. The rise in these lawsuits is attributed to the fact that Title III of the ADA permits a prevailing plaintiff to recover attorney fees.
Certain plaintiff's attorneys do little else other than filing Title III lawsuits. Some have even taken out advertisements seeking local attorneys to partner with them in jurisdictions in which they do not practice. Typically, the plaintiff's attorney will enlist the help of a disabled individual. In fact, some of these individuals file so many suits that when another attorney in our office advised me his client had been sued for an ADA violation, I immediately correctly guessed the identity of the plaintiff and his counsel.
The standard operating procedure is that the disabled individual, upon his own initiative or at counsel's direction, will travel to a business and assess whether or not it is ADA compliant. If the business is not in compliance, the disabled individual will report back to his or her attorney who will then file a lawsuit. In most cases, the business will not receive any advance warning, such as a demand letter, because the plaintiff's attorney does not receive any fees if the business voluntarily agrees to remedy any violations. The lawsuit will name either the business or the landowner -- the plaintiff's attorney really does not care which one he or she names because both may be liable for any violations.
The defense of these lawsuits can entail significant costs. As mentioned, a prevailing plaintiff generally is awarded attorney fees. Second, the determination of whether a business is ADA compliant and/or whether the removal of architectural barriers is "readily achievable" requires the testimony of an expert witness.
The best defense is to ensure your business is ADA compliant. Attorneys, consultants, and architects can assist in auditing your business for compliance. Additionally, determining whether any applicable insurance policies cover ADA violations can save a business owner from having to fight any claims itself. Likewise, reviewing lease provisions can assist a business owner in determining exactly who is liable for ADA violations as many lease agreements contain indemnification provisions.
If a lawsuit is filed, attacking the plaintiff's standing is also a viable defense. In order to have standing to bring a claim, an individual must be disabled and they must intend to return to the business. In some instances, lawsuits have been brought by individuals who live hundreds of miles away from the business. A little background research on the particular plaintiff can go a long way toward establishing a defense. In instances where the plaintiff does not reside in close proximity to the business, you can attack standing on the basis the individual does not legitimately intend to return to the business.
The volume of these lawsuits certainly has not gone unnoticed by the courts, nor has the fact that the same disabled individual may be the plaintiff in numerous lawsuits. Accordingly, another defense is to argue that attorney fees should not be available to the plaintiff as the business could have and would have remedied any violations without the filing of a lawsuit.
Another defense, albeit a potentially expensive one, is to argue that removal of architectural barriers is not readily achievable. A determination of what is "readily achievable" requires consideration of the expense of the proposed remedy and the business's overall financial resources. As such, what might be "ready achievable" for one business may not be for another business. Generally, this defense will require expert testimony.
Keep in mind, obtaining building permits and compliance with local zoning laws and ordinances does not mean your building complies with the ADA regulations and does not provide you with a defense to an ADA claim. If you have questions regarding your ADA compliance or provisions in your insurance policies or lease agreements it is recommend you consult with counsel to determine your potential exposure.
If you follow my blog, you know that one of the issues I've been writing about for a couple of years now is the problem that certain franchisors have faced in being deemed "employers" of their franchisees.
The most well-publicized of the "franchisees are really employees" cases is Awuah v. Coverall, a case I blogged about here,here, and here.
The trend that has seen franchisees filing lawsuits seeking a determination that they are actually employees of their franchisors has continued to grow.
The case discussed below, Roosevelt Kairy, v. Supershuttle International, Inc., Bus. Franchise Guide (CCH) (N.D. Cal. Sept. 20, 2012), is a good example of what these cases typically look like. The decision I report on does not deal directly with the "franchisees as employees" issue, which will likely be decided upon by an arbitrator (for the reasons discussed below). This decision in particular deals with a challenge by the franchisees to the arbitration clause that was in their respective franchise agreements, which they claimed were unconscionable.
Plaintiffs, individuals who drive passenger vehicles for SuperShuttle, were franchisees of the company. Plaintiffs sued to challenge SuperShuttle's "unlawful misclassification of its airport shuttle drivers as 'franchisees' and independent contractors," alleging that they had not been paid minimum wages and overtime compensation pursuant to the Fair Labor Standards Act ("FLSA") and under California law.
Each franchisee signed a franchise agreement with SuperShuttle that contained a mandatory arbitration clause." Most of the franchise agreements also provided that "[a]ny arbitration, suit, action or other legal proceeding shall be conducted and resolved on an individual basis only and not on a class-wide, multiple plaintiff or similar basis."
Supershuttle moved to compel arbitration and to stay the action pursuant to Section 3 of the Federal Arbitration Act. The only issue was whether the arbitration agreements were valid and enforceable. Plaintiffs made three challenges to arbitrability: (1) that Supershuttle waived arbitration by pursuing litigation; (2) that the arbitration agreements were unconscionable and therefore invalid; and (3) that Plaintiffs should not be compelled to arbitrate their statutory claims.
The Court began its analysis by discussing the Supreme Court's decision in AT&T v. Concepcion, 563 U.S. __, 131 S. Ct. 1740 (2011). Under Concepcion, the Court stated, agreements to arbitrate may be "invalidated by generally applicable contract defenses, such as fraud, duress, or unconscionability, but not by defenses that apply only to arbitration or derive their meaning from the fact that an agreement to arbitrate is at issue." (quotingConcepcion, 131 S. Ct. at 1742-43.
The Court first considered the waiver argument. In essence, the plaintiffs claimed that SuperShuttle waived its right to enforce arbitration because it did not seek to compel that process after plaintiffs first filed suit (which occurred prior to the ruling in Concepcion). In disposing of that argument, the Court found that it would have been futile for SuperShuttle to attempt to compel arbitration because, prior to Concepcion, California and Ninth Circuit law held that similar arbitration agreements with class action waivers were unconscionable and unenforceable.[1]
Because SuperShuttle had no right to waive prior to Concepcion, the Court held that no such waiver occurred. The Court also found that the plaintiffs had not been prejudiced by SuperShuttle's delay in seeking to compel arbitration.
The Court then turned to plaintiffs' argument that they should not be compelled to arbitrate their statutory claims. The Court observed the rule that, where statutory claims are involved and an arbitration agreement exists, the agreement should be enforced if the litigant can "effectively vindicate his or her statutory claim for relief in arbitration, unless Congress itself has evinced an intention to preclude waiver of judicial remedies for the statutory rights at issue." (internal citation omitted).
Finding that plaintiffs had not shown any such intention by Congress to preclude arbitration of claims under the FLSA, the Court disposed on plaintiffs' argument on statutory grounds as well.
Finally, the Court considered plaintiffs' argument that the arbitration provision was unconscionable. To demonstrate procedural unconscionability, the plaintiffs claimed that the arbitration provision was "hidden in a prolix of printed matter," and that SuperShuttle had failed to provide them with copies of the AAA's commercial arbitration rules before the plaintiffs signed the franchise agreement.
The Court found that there was no procedural unconscionability because the plaintiffs: (1) were given franchise disclosure documents that described the arbitration provisions; (2) had a fourteen-day period to review the franchise agreements and disclosure documents; and (3) were given copies of the franchise agreement with a table of contents that clearly identified the arbitration provision.
Interestingly, the Court did agree with plaintiffs that the fee-splitting provisions (providing that the parties would equally share the arbitrator's fees and costs) were substantively unconscionable.
In this regard, the Court observed that "fee splitting can be unconscionable where fees and costs are so prohibitively expensive as to deter arbitration" and that the Court should consider "whether the arbitral forum in a particular case is an adequate and accessible substitute to litigation."
The Court reasoned that, based on the plaintiffs' cost projections, it appeared that the individual plaintiffs would not be able to afford arbitration.
Instead of refusing to enforce the arbitration provision, however, the Court severed the fee-splitting provisions of the arbitration agreements as unenforceable.
[1] The Court observed Concepcion specifically found that the FAA preempts the rule announced by the California Supreme Court in Discover Bank v. Superior Court, 36 Cal. 4th 148, 1b62 (2005), aff'd Discover Bank, Laster v. AT&T Mobility LLC, 584 F.3d 849, 855 (2009), which found class action waivers in arbitration clauses to be unconscionable.
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Background
Billy Baxters is a coffee shop franchise system.
The case of Trans-It Freight Pty Ltd v Billy Baxters (Franchise) Pty Ltd [2012] VCA 71 involves the Billy Baxters' franchisor and its former Glenelg franchisee. The franchisee had terminated their franchise agreement after the business made losses and it was unable to pay the franchise fees. The franchisor sued the franchisee, seeking recovery of unpaid royalties and advertising fees under the franchise agreement.
In the first instance, the Supreme Court of Victoria found against the franchisee who had admitted that $250,000 worth of fees were unpaid. However, the franchisee had also issued a counter-claim, seeking compensation for its losses suggesting that the franchisor's representative had made misleading and deceptive statements before the franchisee signed up to the lease and franchise agreement.
The question to the Court was whether the statements of projected turnover and reasonableness of rent made by the franchisor's representative were misleading and deceptive under the Trade Practices Act 1974. The franchisee stated that the franchisor's representative had told it the anticipated turnover for the business was $1.3 million and that this would allow the franchisee to pay the rent and return a profit.
In finding against the franchisee, the Court found that the franchisor's representative had in fact provided a spread sheet template to the franchisees which allowed the franchisee to play around with figures for the business and determine viability themselves. The franchisee (who was an experienced franchisee itself) was also advised to enter its own information into the spread sheet and seek independent advice. The franchisee ignored this advice.
The Court found that the $1.3 million turnover claim was false. However, it was made on reasonable grounds so there had not been a breach by the franchisor.
The Appeal
On Appeal, a critical consideration for the Court was the set rent for the premises of $160,000 per annum which had been agreed between the franchisor and the landlord. The Court of Appeal found that the franchisor's representative would have told the franchisees that the ideal maximum rental was 15% of the turnover for the business.
The Court also found that the figure of $1.3 million was provided without reasonable grounds and that the turnover figure's only connection to the rent figure was that the business would need to make that amount of turnover as a minimum to make the rent affordable. The Court held that franchisor's representative had no foundation on which to base the representation that the franchisee could expect the turnover of the business would be $1.3 million and there was no evidence of any analysis that could back up that projection.
In a unanimous decision, the Court of Appeal agreed that the franchisor's representative's comments were not made on reasonable grounds and the decision of the Supreme Court was overturned with the franchisor ordered to pay the franchisees damages of $1.22 million.
Lessons for Franchisors
- Franchisors should make sure that they closely monitor and oversee the actions of their representatives in dealing with prospective franchisees. It is important that representatives are educated on the kinds of statements that should not be made to prospective franchisees and to be clear at all times that franchisees should conduct their own due diligence and draw their own conclusion from their research. Any statements made about turnover and profitability when franchisees are considering the business are likely to become an issue if the business subsequently fails.
- Franchisors should also review their documents and procedures surrounding site selection.
- Prospective franchisees should also be required to seek independent legal and financial advice before proceeding to enter into a franchise agreement.
- Prospective franchisees should also be encouraged to undertake their own demographic, analysis and feasibility studies for the site they are considering.
- Careful attention should also be paid to the information provided in the disclosure document. However, the greatest risk lies in the statements made by representatives of a franchisor in their attempt to make the business seem more attractive to prospective franchisees. Discussions around figures and potential or expected income for a particular site need to be approached very carefully to ensure franchisees are not entering into franchise agreements on any false or misleading information.
For more information contact:
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There are countless grounds for termination of a franchise agreement. Failure to pay royalties is most assuredly grounds of termination of the franchise agreement. Abandonment of the franchise business is another sure bet for termination of the franchise agreement. Not operating franchise business in compliance with franchise standards, transferring franchise assets without franchisor approval, under reporting gross revenues; these are all common grounds for terminating the franchise agreement.
What about not having enough money in the bank? Well that is what happened in one case. The case is 7-Eleven, Inc.et. al. v. Brinderjit Dhaliwal. Brinderjit Dhaliwal ("Dhaliwal") is a 7-Eleven franchisee. He owned and operated a successful 7-Eleven franchise from 1997 to 2010, more than a dozen years. The lease on his location expires. He is forced to close the location.
7-Eleven gives him the option to take over a number of available locations free of an initial franchise fee or transfer fee. The locations available, which do not carry a waiver of the initial franchise fee, don't work for Dhaliwal. He ends up buying a location in Rocklin, California. The initial franchise fee is $219,000.
Dhaliwal thinks it is going to be a great location! But, it does not work out that way. Projected sales don't hit the mark. Under the 7-Eleven franchise agreement, Dhaliwal is required to maintain a net worth of $15,000. The profits are just not what were expected. The net worth of the franchise business repeatedly falls below the $15,000 threshold. 7-Elven sends Dhaliwal repeated default notices and ultimately terminates Dhaliwal's Rocklin, California, franchise.
Why would a franchisor put a net worth requirement on the franchisees?
And make it a terminable offense. I can think of several reasons:
1. The franchisor is worried about creditors taking over the franchise assets.
2. Insufficient cash flow may impede inventory levels, advertising expenditures, and staffing levels.
That is not what the franchisor goes with. Get this. The franchisor argues: it has good cause to terminate a franchise if they fail to maintain a net worth of less than $15,000.
This is a quote from the court's decision: The reason for the net worth requirement, as clarified at hearing, was to ensure that the franchisee was fully invested in the operation of the store."
Guess what? The court goes for it. The court grants a preliminary injunction in favor of 7-Eleven, ordering Dhaliwal to surrender the franchise premise and cease using the 7-Eleven name.
Lesson from the Court: Always have a reason. It does not have to be a good reason. It does have to be the best one, the logical one, but you must have one.
Grounds for termination of the franchise must be disclosed in the franchise disclosure document and agreement, and there may be 7, 8 or more. Read your contract - together with an experienced franchise attorney.
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In Spina v. Shoppers Drug Mart Inc., 2012 ONSC 5563, Justice Perell for the Ontario Superior Court has given judgment in the first stage of a class action certification motion brought on behalf of franchisees of Shoppers Drug Mart. The decision addressed the threshold requirement for certification, namely whether the claim disclosed reasonable causes of action.
In the process, the Court reviewed and determined the legal validity of the varied and interrelated causes of action asserted by the representative plaintiffs.
While only a pleadings motion, Spina provides useful guidance to franchisors and franchisees in Ontario. Although the decision addressed numerous issues, this comment focuses on the following three lessons:
Franchisors should review their standard form franchise agreements to ensure that the key financial terms are absolutely clear and leave no doubt regarding the scope of the franchisor's rights to earn profits from the franchise system.
In Spina, the Court allowed the Franchisees' claim to proceed on the allegation that the Franchisor had improperly profited from certain services provided to the Franchisees. While the franchise agreement contained detailed provisions on these issues, it was not plain and obvious that the Franchisor could earn a profit on these services provided to the Franchisees.
The duty of good faith and fair dealing does not provide franchisees with the right to receive ongoing disclosure throughout the term of the franchise relationship. The Court struck the Franchisees' claim in this respect, rejecting the argument that such ongoing disclosure was necessary for the Franchisees to verify that the Franchisor was complying with its obligations under the franchise agreement. The Court held that imposing an ongoing disclosure obligation of this nature would be impossible to meet, would turn management of the franchise relationship over to the franchisees, and would encourage litigious fishing expeditions.
The Ontario Courts are demonstrating an increasing willingness to dispose of weak contractual arguments at the pleadings stage, even in class action proceedings. In Spina, the Franchisees -- ignoring an explicit clause that provided the Franchisor with the right to retain rebates earned from suppliers of merchandise -- asserted a contractual right to such rebates. The Franchisees relied on a general clause in the agreement that suggested they would benefit from the franchise system's use of "bulk purchasing". The Court struck the Franchisees' claim for rebates upholding the express language of the agreement over what Justice Perell deemed a "tortured interpretation of the contract".
The Franchisor's Ability to Profit on Fees Charged to Franchisees
The Plaintiffs in this case claimed that, contrary to the terms of the franchise agreement, the Franchisor had improperly earned profits in respect of certain services that it provided to the Franchisees.
The franchise agreement contained several, interrelated provisions that addressed the financial aspects of the franchisor-franchisee relationship. These included a profit-sharing provision, under which the Franchisor was entitled to receive a percentage of all of the Franchisees' gross sales. This, according to the Franchisees, was the sole mechanism through which the Franchisor was permitted to earn a profit from the Franchisees. In addition to this profit-sharing provision, there were additional clauses that obligated the Franchisees to contribute to a national advertising fund and marketing in initiatives, as well as additional fees for ancillary services provided by the Franchisor. The additional fees provision in the franchise agreement explicitly stated that the quantum of fees was to be set by the Franchisor "in the good faith exercise of its judgment".
The Franchisees claimed that the Franchisor had improperly earned a profit from the additional fees that it charged to Franchisees, and that this was a breach of the franchise agreement and contrary to the statutory and common law duties of good faith and fair dealing.
The Franchisor countered that it was perfectly entitled to include margin and return-on-investment in the additional fees it charged to its Franchisees, and that such fees were subject only to the obligation that it exercise good faith judgment.
Unlike other claims of improper profits raised by the Plaintiffs the Court was not prepared to strike this claim, holding that it had "sufficient traction" under the franchise agreement. As it was ambiguous whether the Franchisor's obligation to exercise good faith judgment permitted it to establish the fees at such a level that would allow it to derive a profit, it was not plain and obvious whether such claims would fail.
Although we do not know whether the Franchisees' claims will ultimately prevail, this holding should serve as a cautionary tale to franchisors. These financial aspects of the franchise relationship are foundational and lie at the heart of the business model. As such, financial clauses that address profit sharing should be explicit and drafted with clarity. Where they are absent or ambiguously crafted, franchisors may be vulnerable to the argument that their ability to make profits from certain aspects of the franchise system are limited by more general clauses in the franchise agreement or the duties of good faith and fair dealing.
The Right to Share in Rebates
Another element of the Franchisees' claim relied on a provision in the franchise agreement which obligated the Franchisor to provide each Franchisee with the "advantages of bulk purchasing". The Franchisees asserted that, pursuant to this provision, the Franchisor was obliged to provide them with any rebates that were received from product suppliers.
The Court held that it was plain and obvious that this claim would fail. The franchise agreement at issue contained a specific provision that expressly held that the Franchisor was "entitled to the benefit of any and all discounts, rebates, advertising or other allowances, concessions, or other similar advantages" received from a supplier of merchandise. Given this clear, specific provision, it was plain and obvious that the principles of contractual interpretation did not support the Franchisees' position. The Court also held that it was plain and obvious that the statutory and common law duty of good faith and fair dealing did not modify the contract by establishing a right for the Franchisees to share in the rebates.
By contrast, the Court was not willing to strike out a related claim by the Franchisees for "professional allowances" provided by pharmaceutical suppliers to pharmacists under the Ontario Drug Benefit Act. The Court held that it was ambiguous whether "professional allowances" fell within the definition of "rebate" in the franchise agreement and thus would not determine whether they were governed by this clause.
The Right to Continuous Disclosure Throughout the Franchise Relationship
In part related to their two previous claims regarding profit-sharing and access to rebates, the Franchisees also asserted that the common law and statutory duties of good faith and fair dealing obligated the Franchisor to provide ongoing disclosure of information that would permit the Franchisees to verify whether the Franchisor was complying with its financial obligations. For example, the Franchisees claimed that they had a right to disclosure of the costs that the Franchisor incurs for the programs it provides to Franchisees, in order for the Franchisees to know whether the Franchisee was improperly profiting from those programs.
The Court rejected this argument and held that it was plain and obvious that the duties of good faith and fair dealing did not impose an obligation for intra-term disclosure in this circumstance. Justice Perell distinguished the circumstances of this case from the situation where a Franchisor is in possession of material information that could reasonably influence a Franchisee's decision with regard to the franchise. The Court emphasized that imposing this obligation would effectively "turn over design, supervision, and management of the franchise system to each franchisee, who gets to fish for grounds to sue the franchisor".
You believe that your franchisor has intentionally, with little or no justification, inflicted serious economic harm on you and other franchisees.
A group of franchisees has formed The Fight Association, and wants to hire the biggest baddest franchisee trial lawyer to punish the franchisor. The Fight Association's trial lawyer fires a couple of strongly worded missives to the franchisor, with the message: Capitulate or be Sued.
Some other franchise owners, horrified by the damage to the relationships, to the brand, and their ability to resell their own units, want some form of negotiation, discussion or mediation with the franchisor. Even in face of the clear economic damage inflicted by those working at the franchisor's corporation.
Should you fight or negotiate?
There are three important lessons for franchisees and their associations to learn from Mnookin's research.
1. Fight your franchisor only when they have shown themselves to be an unreliable negotiating partner.
2. It is smart to start bargaining from outcomes that neither party can from either the litigation or arbitration process
3. The franchisee community as a whole needs to commit resources to continual training in interest based communication. If interest based negotiation is going succeed over the long haul, you need to commit funds to training.
Background- Managing Mental Traps
Robert Mnookin is the Director of Harvard's Program on Negotiation, and so it unsurprising that he frames the advice in his book as a way of managing two types of mental or intuitive traps, one set of traps which promotes fighting and the other which promotes cooperation.
(This is conceptually similar to one of the original themes from the Harvard Program on Negotiation: negotiation is the rational management of the inherent tension between claiming value and creating value, explored more throughly in The Manager as Negotiator, Lax and Sebenius.)
Mnookin identifies (6) mental traps in Chapter 1 of the book, and then goes on to evaluate (7) major confrontations in which one or both sides could reasonably see the other as the devil; someone who had intentionally inflicted serious harm with little or no justification. (Of particular interest to the franchise community is the chapter 8, "Disharmony in the Symphony".)
Here are Mnookin's traps, which shape the perceptions of the conflict
1. Tribalism involving an appeal to group identity, creating an in-group. It is us against them. Universalism is at the opposite end of the scale, the tendency to overlook important differences in culture, history and group identity. "Why it is just business, after all."
2. Demonization is the tendency to see the other party's action completely defined by being rotten or bad to the core. Contextual rationality is the impulse to find reasonable explanations for individual bad behavior.
3. Dehumanization is way of putting the other party outside normal moral concerns, treating them as a mere object. The other end of this spectrum is one of Redemption: everyone deserves a second chance.
4. Self-righteousness is the tendency to frame the problem in which you are blameless, but the other fellow is entirely to blame for this problem. The other extreme is to see parties always being Equally at Fault for a conflict.
5. Zero-sum trap in which my interests necessarily are in opposition to yours. At the other end is the view that there is always an Win/Win which makes both parties equally well off.
6. The Fight/Flight response, which for the franchisee community would be litigate or sell. At the other end of spectrum, we have Policy of Accommodation.
Finally, there is the call to battle in which the trial lawyer has to call out the franchisee troops for a battle with the franchisor in using the language of war, and the techniques of demonization, tribalism. and others.
The (3) Lessons: When to fight, How to Negotiate, and How to Follow Through.
(1) When to Fight - Only Fight as a Group with an Unreliable Business Partner.
In Chapter 5, Mnookin, relying upon recently declassified reports, examines Churchill's decision not to negotiate with Hitler. He does a remarkably good job of situating us in a world in which Hitler's manifest evil is not yet apparent and Churchill's War Cabinet is unmoved by Churchill's emotional appeals.
It is not known yet that Dunkirk will be a resounding success, that England will win the Battle of Britain, nor that Hitler will uncharacteristically hesitate for many months about deciding to cross the English channel.
A Britain that had insufficient resources to win a war on their own, seemingly without powerful allies, had to seriously consider whether a separate peace might be worth entering into.
Churchill was convinced that Germany was aiming at enslaving England, but his War Cabinet was more persuaded that Germany's goal was only more territory in Eastern Europe.
Since both England and Germany shared a hatred of Communism, it made sense to the War Cabinet that Germany would have to turn east and face down Russia.
What was critical, according to Mnookin, was that Churchill eventually framed the problem this way: if the negotiation was to fail, and this was likely given Hitler's total unsuitability as a bargaining partner, then British morale would be so undermined that they could not credibly commit a fight to the finish. The failed attempt at negotiations with Hitler would end in surrender.
This strikes me as correct. If the party you want to negotiate with has shown themselves to be utterly capricious, unable to be counted upon, then the very attempt at negotiation, should it fail, will undermine the group's commitment to prolonged litigation.
Fortunately, I don't believe that many franchise systems -although there are a few- have franchisors who have absolutely no credibility as a bargaining partner.
My own view, is that systemic challenges are not well suited to litigation, but the franchisor who owns little or no units will have always have trouble convincing the franchisee community to adopt systemic changes, when there has been a local history or either mistrust or bad decisions.
It will be hard for the franchisee community in these cases not to see the franchisor as acting intentionally to harm their own economic interests and misplaced litigation is the likely result.
(2) How to Negotiate out of Shadow of the Law
In 1983, after a bitter commercial fight, IBM and Fujitsu concluded an agreement over the extent to which Fujitsu could use, copy, or otherwise reverse engineer IBM's operating system. One year later, the agreement was in shambles - with each side reasonably convinced that the other had acted intentionally to inflict serious economic harm on the other with out justification. Devils!
For the next 10 years, Mnookin would play an important role both as arbitrator and mediator in both settling and assisting the parties to settle their dispute.
At one point, Mnookin and the other mediator, Jack Jones, had to convince each party of viability of IBM giving Fujitsu the right to inspect, in a very secure environment, IBM's source code. This was needed if Fujitsu was going to be able produce a compatible IBM OS, without infringing or copying on IBM's source code.
IBM could have rejected this deal by saying "Are you crazy, Fujitsu is a major competitor! The 1983 agreement doesn't give them the right to inspect our source code and they will never get that in arbitration. Screw them."
Fujitsu might have also rejected the deal because the restrictions placed on them by the secure environment were highly disruptive to their own programming practices.
But what both parties, even though intense rivals, came to see was that starting from a point which was not available through either litigation or arbitration produced an agreement superior to what any party could get through litigation or arbitration.
This is important advice: don't start bargaining from only those outcomes possible from litigation or arbitration. Both the franchisor and franchisee community need to focus on what would be the best outcome for all of them, and identify what steps need to be taken to get there - especially in the face of previous intractable conflict.
(3) Follow Through and Interest Based Negotiation Training
The last lesson is very important for the franchise community. In 1997, Mnookin was contacted after a bitter strike by San Francisco orchestra.
The orchestra's bargaining committee was itself bitterly divided, barely on speaking terms. Management's representative was seen as a destructive bully, intent on getting his own way.
"Moreover, the musician's relationships with one another were badly strained. They were traumatized. They had no authority structure, no strong leadership in collective bargaining."
Mnookin was able, in the short term, to introduce both sides to interest based negotiation, which involves both active listening and the management of creating value versus claiming value techniques. Both parties took part in the standard Harvard negotiation program, with some excellent short term results.
The parties spent, in 1998, six days in total to come to a new contract. However, they had spent almost 14 month in communication and in joint sessions prior to the bargaining at the table. "For complex negotiations, with critical conflicts behind the table, this is an appropriate ratio." says Mnookin.
However, 6 years later the symphony negotiating committee shunned additional training in interest based techniques, despite having new members who did not have these skills.
It's new attorney was suspicious of interest based negotiation and had argued in public that collective bargaining was essentially adversarial in nature and that the best deals could only be made when everyone was facing collective disaster.
Interestingly, the former management representative, Pastreich summarizes the value of interest based negotiation best:
"The greatest value of adversarial negotiation might be the opportunity it gives musicians to express anger and frustration accumulated during 3 years of doing a job that, by its very nature, allows them relatively little control over their working lives, while the greatest value of interest based bargaining might be the opportunity it gives musicians to work with managers and board members at solving problems in an atmosphere of teamwork and cooperation."
The parties did not make the necessary long term commitment to interest based negotiation, so reverted to the ordinary form of collective bargaining - a process which favours the ill prepared, but obstinate negotiator.
Conclusion
Franchise relations are not going to change overnight, but many franchisee associations, franchisors, and counsel can learn a great deal from Mnookin's book on negotiation.
Finally, the thoughtful exercises Mnookin prescribes in managing the (6) traps are worth reviewing to see which could be employed in your franchise system.
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Just back from the wars, so to speak, I found that most folks are too socially emasculated through the process of institutionalized position sensitivity to even have an inkling about what to do when a dominant position person goes off the deep end and his actions threaten to destroy businesses if not brought to a screeching halt. Such was the war just concluded, in which we represented numerous franchisees of a franchisor who's point person thought and acted like a white bread Benito Mussolini.
This was a renewal issue in which the franchisees had the right to renew on the same terms they currently enjoyed unless the franchisor was then selling new franchises, in which instance they would have to sign the then current franchise agreement in order to renew.
Obviously, new franchise agreements are historically upon worse terms for franchisees than expiring agreements. At least that is the predominant experience in the franchising business.
Money, restrictions, franchisor prerogatives and other matters that impact the relative economics of a franchise relationship tend to move in favor of the franchisor with each new iteration of the agreement.
This franchisor was a more than over the hill operation and had not sold new franchises for about twenty years. It had seen the attrition of most of its franchisee population and did not even have an operations manual.
Peter the Point Man decided that the value of being his franchisee was far above then current relative economics and that he was not going to be so foolish as to honor renewal terms, no matter how clearly they may be stated in the soon to expire current agreements of my clients. They were the best performing franchisees, historically, in the system and had been there for about forty years. Had Old Pete been possessed of any good sense, he would have paid them to show him how to operate the company owned units which lost money while theirs prospered every year more and more.
Any econometrician would tell you that in these circumstances the relative value of the relationship among the parties were indeed skewed, but in favor of the franchisees rather than the franchisor. Had Old Pete simply gifted these franchisees with the entire company, he would have come out far better off economically compared to facing years upon years of continuing losses eventuating in the bankruptcy of his company.
These franchisees had been clients of mine for over thirty five years, having once before been confronted by an earlier edition of delusional point person. I sued the franchisor on their behalf then, and the results of that litigation was the ultimate cause of their having favorable contract terms now.
My clients believed that when renewal time came around this Bozo had plans to try to rip them off, and so we had almost a year head start in setting Him up for his comeuppance.
Franchisors love discussions. Discussions leave no tracks. Writings are tracks, and thus are despised by franchisors, especially if they have an agenda to be predatory and need deniability in case there is strong push back by the franchisees. Peter the Point Man, however, failed to recognize that our insistence upon having email confirmations and exchanges to prevent negotiations from being nothing more than conversations was providing us with a plainly visible trail of the development of his entire program to rip us off.
His arrogant lack of subtlety even went so far as to acknowledge his obligation to negotiate terms with us and then insist that the negotiations be restricted to only those issues raised by the franchisor.
He even went to the trouble to have his lawyers send us a proposed contract amendment saying just that.
No one signed that, on advice of counsel.
He then told us that business requirements prevented him from being able to negotiate the renewal terms right now and offered a one year extension of the same terms to accommodate his claimed business needs. In fact, what he did during that extension period was to have his lawyers create a spurious FDD, which he registered in Virginia so that he could claim that he was in reality engaged in selling new franchises and therefore exonerated from having to negotiate new terms with us or to offer renewal upon the same terms as before. He then imperiously insisted that we sign his new franchise agreement, which was full of incredibly stupid positions that no competent franchisor would ever put into his agreement.
To be sure, he also changed the economics drastically in his own favor (as if that needed to be said). The State of Virginia took one look at his company financial reports and immediately slapped him with an initial fee impound.
My clients had been successful business operators for over forty years, and had been in only one real battle royal in their entire lives, the earlier litigation with this same franchisor under other "leadership". They found it very out of character for me to insist that they seriously do things to bring about the entrapment of the present franchisor management. I had constantly to explain to them that if they didn't handle the situation as a prelude to a main battle they were going to lose their businesses.
They, like most folks, erroneously believed that they had obvious rights and that that was all that was necessary for the correct result to ensue.
They were initially incredulous when I explained to them that there is no right on earth that is self-executing, not even those in the Constitution. If you don't stand and defend your rights, they can easily be taken from you, and this was an obvious situation in which that was exactly what would happen unless we succeeded in entrapping the franchisor into revealing his hand in an evidentiarily usable manner.
They had never heard of such a thing, and their regular lawyers had no inkling or experience with this sort of confrontation technique. They were always fearful of giving offense and messing up their negotiating posture. They refused at first to believe that there was in this instance no such thing as negotiations and accordingly no such thing as a proper negotiating posture. Fearful of burning bridges and self-destructing, it required a lot of tough love quasi-military training to get them to go along with my urgings.
Only as the unfolding of the fact pattern revealed that I had absolutely correctly assessed the risk and danger profile did they come to accept the ancient truth that the only way to deal with a bully is to whip his ass half to death - or at least until he came to terms.
Peter the Point Man had no experience in working with a company that was actively selling franchises. His overlord had once before been with a franchising company that had, under his leadership, gone into bankruptcy. Between them both, they were playing with far less than a full deck - were several bricks short of a load.
Accordingly, they compounded mistake upon mistake. They failed totally to do what every real franchisor always does to market a franchise program. They even sent us a letter half way through the litigation saying that they hoped soon to have an operations manual ready for review. The list of bozo mistakes would provide a standup comic with at least fifteen minutes of material.
They informed the court that their position was that the issuance of the spurious FDD was all they needed to prove that they were indeed engaged in selling new franchises. They could not have posited a more ridiculous strategy. This was the easiest possible position for us to defeat. Four days before we were to take their depositions in anticipation of an immediate preliminary injunction hearing, they had an epiphany, and about a week later the case was resolved upon very favorable terms for my clients.
The lesson here is that while it is nice to have polished manners and live by reasonable rules of commercial civilization, there comes the moment when those rules do not apply. If you continue to live by those rules you will simply be eaten alive. In times like that you need representation that understands and understands how to execute battle plans that level any playing field.
When someone decides that a business relationship is there to serve the terms of an agreement rather than the agreement being there to serve the quality of the business relationship, the result will be calamity if not immediately changed. Usually that change can only be brought about by aggressive confrontation.
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As always, you can call me, RIchard Solomon, at 281-584-0519.
A franchisee who sued his franchisor for fraud learned the hard way why it's important to read the Franchise Disclosure Document, cover to cover, before buying a franchise.
A California franchisee of Big O Tires sued the company in California court, alleging that Big O defrauded him when it sold him a franchise.
The California Court of Appeals ruled against him because the disclosure document Big O gave to the franchisee before he bought contradicted each and every one of his claims.
Mr. Hailemariam purchased his Big O Tires franchise in February 2008. Before he bought the franchise, he received Big O's Uniform Franchise Offering Circular ("UFOC"). The UFOC was similar in content and structure to the Franchise Disclosure Document that franchisors are now legally required to give prospective franchisees.
After operating a store for little more than a year, Mr. Hailemariam closed it down due to financial difficulties. 'In August 2009, Mr. Hailemariam sued Big O in California state court alleging that the franchisor fraudulently induced him into purchasing a franchise.
Specifically, the franchisee alleged that Big O:
(1) told him (falsely) that he did not need experience to operate a tire store;
(2) provided exaggerated earnings claims;
(3) concealed from him that many of its franchisees had failed;
(4) told him that it would sell him tires at competitive prices, when the same tires were often available for less money from other sources;
(5) falsely stated that it develops new products and services; and
(6) had expertise in locating and outfitting stores.
Big O moved for summary judgment on the franchisee's claims. Based on a Colorado choice-of-law provision in the franchise agreement, the trial court held that Colorado law (and not California law) applied.
Reasonable Reliance
Under Colorado law, the Court said that a plaintiff claiming that he was defrauded must be able to show that he reasonably relied on the defendant's misrepresentation (or on the material facts that the defendant purposefully concealed).
Courts in Colorado apply the concept of "inquiry notice" when considering whether a plaintiff's reliance on alleged fraudulent statements was reasonable.
Quoting the Colorado Supreme Court, the Court summarized the doctrine as follows:
[W]hatever is notice enough to excite attention, and put the party upon his guard, and call for inquiry, is notice of everything to which such inquiry might have led. . . .
When a person has sufficient information to lead him to a fact, he shall be deemed conversant of it. . . . . The presumption is that, if the party affected by any fraudulent transaction or management might, with ordinary care and attention, have reasonably detected it, he reasonably had actual knowledge of it.
[As a result] [w]here the means of knowledge are at hand and equally available to both parties, and the subject of purchase is alike open to their inspection, if the purchaser does not avail himself of these means and opportunities, he will not be heard to say that he has been deceived by the vendor's representations.
Quoting Cherrington v. Woods 290 P.2d 226, 228 (Colo. 1955).
In other words, a person who receives a franchise disclosure document is supposed to read it. If he doesn't read the document, he can't later complain that he didn't know what was in it when he signed the franchise agreement. Moreover, if there was enough information in the disclosure document to allow the person to investigate the truth of the other party's claims, he can't later complain if he failed to do so.
The Franchisee's Fraud Claims
The Court held that statements made in the UFOC received by Mr. Hailemariam before he bought his Big O Tires franchise should be considered when determining whether he had access to those facts. Applying Colorado law to the facts, the Court examined each of the franchisee's fraud claims.
1. Exaggerated Earnings Claims
Regarding Mr. Hailemariam's claim that Big O exaggerated earnings claims in Item 19 of the UFOC, the Court examined Big O's UFOC, which stated: "BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER."
Big O also pointed to the actual language of Item 19, which included data from 211 stores. The data from the 211 stores supported Big O's own estimate of the average sales per store.
In Item 19 of the UFOC, Big O stated that it would provide substantiation for the data upon the franchisee's request, and stated that a franchisee should conduct an independent investigation of the information by contacting existing and former franchisees of the system that were listed in Item 20 of the UFOC.
But Mr. Hailemariam did neither of those things, and the Court found it significant that he failed to make those inquiries.
2. Concealing Failed Franchises
Regarding the franchisee's claim that Big O concealed from him the failure rate of its franchisees, Big O again pointed out that Item 20 of the UFOC contradicted Mr. Hailemariam's claim.
Specifically, Big O showed that the UFOC specifically listed the number of transferred, cancelled, and terminated franchises during the periods specified in the UFOC - and that if Mr. Hailemariam had bothered to read the UFOC, he would have known exactly what the failure rate was.
3. Tire Sale Prices
Turning to the allegation that Big O misrepresented to Mr. Hailemariam that it would sell him tires at competitive prices, Big O again referred to the UFOC. Big O argued, and the Court found it significant that, Big O did not guarantee any specific supply of tires, and the franchise agreement did not contain any provision obligating Big O to supply tires to franchisees at competitive prices.
What the franchise agreement did say is that Big O was only required to provide tires to franchisees "to the extent available," and that Big O could set the recommended prices for the tires.
So again, the clear language of the UFOC rebutted Mr. Hailemariam's claims.
4. Store Location
Mr. Hailemariam claimed that Big O misrepresented that it had certain expertise in locating and outfitting stores, when in actuality the site he selected with Big O was not a profitable or good location. In response, Big O noted that the UFOC specifically told Mr. Hailemariam that the "final decision" regarding a store's location was left to him, and that Big O disclaimed any liability for that decision.
Because the UFOC stated that selection of a location was entirely the franchisee's responsibility, and not Big O's, the Court gave no credence to that claim, either.
5. Need For Experience
Considering Mr. Hailemariam's claim that Big O (falsely) told him that a franchisee did not need experience in the tire business, the Court found it significant that the UFOC contained this disclaimer:
BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER.
Mr. Hailemariam acknowledged this disclaimer in his Franchise Agreement, which the Court found significant in overcoming the fraud claim.
Failure To Read The UFOC
With regard to all of the franchisee's fraud claims, the Court found it significant that, on the cover page of the UFOC, Mr. Hailemariam was admonished to read the circular carefully and show it to an accountant. The franchisee admitted that he did neither.
The franchisee's failure to read the UFOC was especially significant because he negotiated with Big O for three years (since 2005) before executing the franchise agreement and consulted with an attorney in obtaining the lease for his store.
Despite this long period of time - and his having sought legal counsel to obtain a lease -- he paid little attention to Big O's franchise offering circular and franchise agreement, and never sought legal advice regarding them.
Under the doctrine of inquiry notice, the Court found that Mr. Hailemariam should be charged with knowing all of the information in those franchise documents.
Last, the Court gave considerable weight to an integration clause in the franchise agreement, where the franchisee acknowledged that he was "not relying on any promises of Big O which are not contained in the Big O franchise agreement . . . [or the] accompanying Franchise Offering Circular."
Based on the disclosures, statements, and disclaimers made in Big O's franchise offering circular and franchise agreement, the Court held that Mr. Hailemariam could not have reasonably relied on any of Big O's alleged misrepresentations or concealed material facts. As a result, the Court granted summary judgment in favor of Big O and against the franchisee. The Court of Appeals affirmed the trial Court's judgment in all respects.
Lessons For Franchisees and Franchisors
If you are considering buying a franchise, this case is a warning of the importance of actually reading your Franchise Disclosure Document before you sign on the dotted line. It also illustrates the importance of hiring an experienced franchise attorney to help you understand your legal obligations before committing to a franchise.
If you are a franchisor, this case shows why it's important to have a well-written and legally compliant Franchise Disclosure Document. Big O was able to win this lawsuit because its UFOC specifically contradicted each one of the franchisee's claims.
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To read more of Matthew's articles on Franchising Law, please click here.
There are exceptions to Blaise Pascal's suggestion that the more things change the more they are really the same - Le plus ca change le plus c'est la meme chose. Franchise branding is one of those situations from the perspective of many legal doctrines.
This case study is somewhat dear to my heart because it involves a company that in years past I used to represent from time to time until it decided to hire its own in house general counsel, a man who's entrepreneurial spirit caused him to think it was just fine to demand a kickback/referral fee from outside law firms he hired to represent the company in lawsuits.
When I declined to pay him for the company's legal business, for reasons just about anyone can appreciate, the company and I parted ways.
To be sure, there were other ways in which the gentleman derived extraneous income from his client's business, and it might be a good story scenario for Saturday Night Live, but not here.
Fortunately, there were other firms that also declined his blandishments that in desperation were hired anyway because the company's situation was rather desperate and the firms were ethical enough to just say no.
In these desperate situations the large firms did not produce victories and charged a bloody fortune to obtain settlements that were hardly favorable, in one instance charging $16,000,000 before fessing up that they were unable to present a plausible case.
The latest of these exceptional situations came to a bad end recently and represents a good case study about a company's management believing it could simply spend its way to victory no matter what.
It happened eventually to General Motors, so for a privately owned franchise company to convince itself that a litigation budget was the road to invincibility is an exceptional case study in arrogance and one worth discussing.
There is a doctrine in intellectual property law known as "secondary meaning". Secondary meaning imputes to a "look" the value and power of a trade or service mark when that "look" becomes so identified in the public mind with the company that the look alone becomes an automatic source identifier. Imagine that the Golden Arches were not registered intellectual property of McDonalds. Even without that statutory protection they so speak to McDonalds in the mind of the public that one would say with confidence that they had secondary meaning.
Not all things that could eventually have secondary meaning as source identifiers attain that status, and some that do eventually lose it because the "look" becomes generic to that segment of trade, mainly through its functionality aspects.
Functionality is a secondary meaning killer because serving a function common to most companies in that business inherently means that all will adopt it. In the beginning, however, for a fleeting moment something functional could be a source identifier in that interim before others start using it throughout the industry. Think of the "serpentine" line up of customers waiting for service back in the early days of Wendy's when Wendy's was the only company using it. There was actually a case on that subject in Tennessee back in the day (Judy's Hamburgers).
In normal circumstances functional features do not achieve secondary meaning status. This case study involves the assertion of an incredibly ridiculous claim that the interior appearance of this brand of restaurant was itself a brand identifier. Impossible and absurd on its face in all but the most exceptional situation (which this was not), but insisted upon as the product of arrogance and stupidity by company management and by the large nationally known law firm it hired to make that assertion in court. The legal expenses were outrageously huge.
One could posit that they were not outrageous on the theory that the firm had to know it was a balls out loser and would only make the assertion if it could find a client dumb enough to pay a fortune to finance the effort. It would be difficult to find a competent trade dress lawyer to give an opinion that the functional aspects of the interior of any chain restaurant had secondary meaning.
Face it, the interior contains tables, chairs, counters, maybe a bar, and any kind of "back of the house" configuration you like. Paint and decor could be extremely distinctive, but that could be fixed by an accused infringer with a cheap paint job on a weekend.
No one litigates over something curable by a cheap paint job.
Where it is a paint job resolution the accused infringer has to be a fool for refusing to redecorate and the franchisor has to be a fool for not being able to resolve it short of the cost of full blown litigation to a verdict. That is a total failure of relationship management as well as dispute resolution management. But this company and its former franchisee did exactly that.
Moreover, the company hired one of the country's major franchise litigating firms to handle it. No large firm can afford to turn down a big fee with all that overhead, no matter how stupid the position it has to take in a public forum.
Let's take a second look at this and give someone the benefit of the doubt by suggesting that the decor infringement claims were really just the manure spread across a field planted with the seeds of a post termination covenant not to compete. If that is the case, then the franchisor is doubly stupid. If the covenant is enforceable, why screw it up with BS? And if the covenant claims are worthless, is the BS decor infringement claim going to put lipstick on this pig? This is wall to wall stupidity no matter how you slice it.
Something tells me that maybe this client went through a number of competent firms with self respect who turned it down before it came upon a firm who, for the right money, would represent anyone on any claim regardless of the merits. There's a song about a girl who just can't say no, and this is that kind of firm. I know this company's regular firm - went to school with one of its partners, and he is smart enough to know better than to do this to a regular client. I also know the trial firm who took the case, and this is the kind of trash they will roast in a slow oven for a long time and tell you it's good brisket. If you are a spoilt child client who will pay anything to have someone tell you that you can have your way, I guess you really deserve this kind of result. Intelligent folks don't shoot themselves in the foot (or elsewhere on their anatomy) like this.
One could posit that the usefulness of this court's ruling to other departing franchisees represents an enormous impact loss. Almost all franchise contracts and disclosure documents claim great value in distinctive decor. Will their next step be to try to force franchisee investment in a new decor that is distinctive, an investment that at this stage if its life cycle holds no promise of generating ROI. When arrogance trumps analysis the result is always to ignore realities.
Certain kinds of relationships - franchising is one of them - tend to imbue the lead player with a sense of entitlement that simply won't work all the time. The passage of time - the impact of history - changes in technology, market and company life cycle changes all coalesce to erode balances of power. What once may have been a reliable option may, even with the same contract language over time become less useful and even dangerous. That's called reality. Refusal to take hard looks at your situation when trouble arises often leads to unnecessary expenses of large magnitudes and to serious structural damage to your future potentialities. The insights borne of crisis management experience transfer well from industry to industry and company to company. Don't let your access to this resource go unused. It may save your company, your distributive systems and your future.
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Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
Noise reduction consists of purging the witness' speech patterns of habits of expression that are irrelevant and potentially harmful. It is important to re-emphasize here that you are not coaching him to speak untruthfully, but to speak truthfully in the most effectively communicative manner.
Most of us are not conscious of how others hear us when we say things. We think we are doing just fine when misimpressions are sometimes occurring.
One of the worst things that people do is self justify. The answer to 'Did you do that?' is not 'I would never do such a thing.' The answer is a yes or a no.
Many who hear self-justification and not direct testimony come away with the impression that the witness has just tried to duck the question for the purpose of concealment.
Teach the witness to listen to the question and to answer the question that is being asked and not some other imagined question.
The questioner is not asking him to give a speech about his rectitude and integrity. He is asking if something happened; was the witness involved; how was the witness involved; and what was the purpose of doing whatever it was that was done. These will be asked in separate questions and need to be responded to directly.
The witness needs to know that he will not be entrapped by this response pattern. If you are calling the witness and are on direct examination, he will be asked these questions in a manner that will give him the opportunity to say what needs to be said.
If he is being called by the opposition and roughly examined, you will be there to resurrect his opportunity to say the proper things immediately after the opponents have concluded their questioning. He can feel comfortable that he will not be left hanging from some limb.
Long-winded statements of company policy, mission statements (the single most horrid language usage in the universe), and rectitude do as much damage to credibility as false testimony.
When you aren't sticking directly to the point and answering questions forthrightly, the perception is that you are being evasive for purposes of concealment and false testimony. If the answers from the witness are direct and forthright, the impression left with judge, jury or arbitrator will be that you are being truthful.
This includes direct answers about the good and the bad. You shouldn't be there in the first place if the bad outweighs the good. You should have settled and taken your medicine in private.
There is a tendency to speak ill of the opposition. If the opponents' acts are blameworthy, a straightforward statement of what they have done ought to suffice and leave the desired impression of what miscreants the opposition truly are.
Name-calling and undue rancor leave a bad impression. Let their conduct speak to the issue of what they deserve, not your opprobrium and epithets.
Hopefully, they will not be so gracious when it is their turn to speak, and they will by contrast show that you are being direct and that they are not.
Many lawyers make the mistake of thinking that accusations, often repeated, are a substitute for evidence. It is not and will elicit proper objections and rulings from the bench that confirm your view of the negative value of name calling as a 'filler' for evidentiary voids.
You should teach the witness his proper role and show him how attempts to confuse his role with yours can get him into big trouble. His role is to provide truthful information and to be a gentleperson.
Yours is to be the advocate.
It is your function to be concerned about where your opponent is going with a line of questioning. If the witness deems that to be his function, he is not concentrating on simply giving accurate answers. If he gets into that mode, he will not be convincing.
Constantly coach him to simply answer the question that is being asked and leave the advocacy to you.
Role-playing in this and in every other phase of witness preparation is an indispensable tool.
Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
(Here is Part 4 This is Part 5 of 6 on How to Win Franchise Trials. Here is Final Part)
You simply must prepare the witness about the story told in the written documents. There are two ways to approach this.
One is to simply talk to him about the events that are at the core of the dispute. It should be as much a conversation as you can make it. Save the tough questioning for another round.
The other is to have first given him a set of the relevant documents to study to refresh his recollection, and then have the initial conversation about the events.
I think most people will appreciate having been given the documents first rather than having been allowed to misspeak and then perhaps be embarrassed when the documented history does not agree. If embarrassment raises its ugly head, it will either be a positive learning experience or you will have to go back and rebuild part of the relationship with him.
Keep reminding him that there is no agenda to tell the 'story' in a particular direction. At this point the object is to get him to appreciate what really happened and sort out any incorrect recollections he may have had. In this manner you are consolidating the truth in his mind and eliminating unreliable recollections.
It may be that some documentation does not mean what it seems to mean, and this round will help you sort that out also.
People do not always say things in an unambiguous manner.
Sometimes it is useful for the witness to know what others have said about the events if their statements seem to conflict with his. If there is genuine conflict, it needs to get sorted out. If not, telling him what others had to say may not be productive. It would be helpful in this phase to know whether he and others who were involved have had conversations amongst themselves about the events, and what those conversations were. It is now a distillation process for the witness and for the documentation.
It is important to discuss the completeness of the documents.
- Are all the files there?
- Is anything missing?
- Have documents been removed from any files?
If so, what happened to them?
- File searchers and those involved in the operative events have been known to remove and destroy files.
- In-house lawyers, seeking to impress their only client with their loyalty will do that also.
Witnesses will be asked about records retention/destruction when they are deposed.
Find out the truth before you are on a public record and under oath.
Once the distillation process is complete, and the witness and you are both confident that the essential truth is clear to both of you, and you are still comfortable with your case, it is time for round two -- noise reduction.
Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
(Here is Part 3. This is Part 4 of 6 on How to Win Franchise Trials. Here is Part 5)
Our thoughts, so far, presuppose that you will be candid with a client or potential client once you have evaluated his position based on the available evidence.
If you will continue to tell folks that they are on the side of the angels when it is clear that the other side has something significant supporting it's position, and don't aggressively promote amicable resolution, then you need not read any further.
When Arthur Anderson accounting shredded documents regarding Enron's business, in the face of an obviously oncoming SEC and grand jury investigation, some fool concocted a position that they weren't doing that to conceal evidence or obstruct justice, but they were 'just' complying with their records retention policy. If you are at that level of stupidity, you are counting upon a jury of idiots, which, of course, Arthur Anderson didn't get.
And, amusingly, it was some dumb lawyer who concocted that scenario for the company. Delusional lawyers and desperate clients concoct fanciful stories that are not worthy of belief and try to sell them to a room full of ordinary folk with ordinary common sense. Most of the time it bites em in the ass. This article is not for such people.
We are now at the point at which our investigation about our client's position is telling us that we have a sound evidential and legal position, and we are not getting anywhere with initial efforts at reasonable settlement.
People will have to be deposed.
Now is when you prepare for trial -- not prepare for a deposition -- prepare for trial.
To me the deposition is the trial. I want my people to be as good in the deposition as they will be expected to be at trial. If that can be accomplished, the deposition transcript will not be useful in the witness' cross examination, for there will be no prior testimony inconsistent with his trial testimony. The deposition will serve to enhance chances of settlement.
Witness preparation begins with reassurance.
Tell the witness what you think about the case.
Tell the witness that the only thing he can do to hurt you is to be untruthful.
Tell the witness that if you have made a mistake and he spots it, the greatest favor he can do for you and for the company is tell you what that mistake is.
If his perception differs from yours, remember that he was there when it happened. You weren't.
Tell the witness that the plainer and simpler the telling of the truth is, the more believable a witness he will be.
Tell the witness that it is easy to remember the truth and difficult to tell untrue stories the same way more than once.
Tell the witness that what you are going to help him do is to tell the truth in the plainest and simplest and most direct form, eliminating extraneous noise that everyone has when they speak of events and their participation in them.
Tell the witness that not every fact in any case is going to be one hundred percent in support of your side of the case, and that the negatives have to be dealt with in equally straight forward a manner as the positives.
A witness who will, without hesitation, own up to a mistake is a believable witness. Having been up front about the bad stuff, what he says about the good stuff will be pure gold credibility.
If you have no confidence in your case because of the presence of negative facts, then you probably don't have a case and ought to settle it as soon as possible. Negative facts abound in every business dispute There are always mistakes in every single business project. Perfection is impossible, and pretense about never being wrong is a hallmark of a liar.
Now that you have had the conversations with the witness that have provided him with the requisite comfort level, and trust has been established between you, it is time to 'work' the documents and hear what he has to say -- round one.
Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
(Here is Part 2. This is Part 3 of 6 on How to Win Franchise Trials. Here is Part 4)
If we have a good case, and the opposition cannot be convinced of that, then we do have to go to trial, and we have to have our people testify in a way that makes them practically immune to effective cross-examination.
How you go about doing that is the lesson of this tutorial.
People come in all varieties of personality. The most scrupulously honest person may be the most boring, confused, frightened individual who, though he would only tell the truth, would tell it so badly that his testimony is worthless or worse.
Among the sentiments at work in the mind of a potential witness are, in addition to an inclination to truthfulness, fear of being embarrassed; for embarrassing others and his company; for not being able to provide affirmative support for his side of the case; for his position in the company should he be seen not to have been helpful; for his financial future; for his references, promotions; for his being included in significant projects; for his dignity; for his family; for his masculinity; for ... the list could go on and on.
- Is he boring?
- Is he a smartass?
- Does he have nervous tics that can be interpreted adversely?
- Does he get quickly to the point or wander around it forever?
- Is he into self-justification?
- Is he ostentatiously religious?
- Does he have his own agenda?
- Is he intelligent?
- What are his language skills?
- What are his reasoning skills?
- Does he try too hard to please, either you or, when the time comes, opposing counsel?
- Will your time spent trying to help him be simply truthful be seen as an inappropriate attempt to coach your client's agenda?
Does he fear you are trying to make him someone other than who he really is, and that he won't be able to do it the way you want.
If the witness is the high panjandrum who is always treated with deference to an extreme -- used to having his own way - there is another cart full of baggage to be accounted for.
All these and many more fears and attitudes are strongly present in the mind of a potential witness. They will have a physical effect upon him. They must be recognized and addressed in an effective relationship-building manner, so that in the end you have built confidence and trust, not fear and loathing.
The central goal of all you do to prepare a witness to testify has to be to show him how to tell the truth in a way that is obviously truthful. One by one you must help him overcome each of his fears and each of his adverse tendencies. You must spend time with a witness. You must show him how to do his homework.
And you must do it before he testifies in his first deposition, as changes in testimony later on may be used to impeach credibility, comparisons of his trial statements against his prior, seemingly or actual, inconsistent statements. It is not an issue of rote memorization. That is almost as bad as ineptitude. The goal is that he knows what the truth is and how best he can state it with the least fear of confusion or of being ambushed on cross-examination.
In my experience, even if they superficially portray an air of modest pliability, just beneath the surface is a thick layer of 'How dare you?' With this person the relationship building is tougher, because he can fire you and find a 'real' lawyer who appreciates who this person really is and how he is to be treated.
His ego is engaged far more than any other witness in the company. He expects to appear for a deposition and at trial and have the judge, jury and opposing counsel rise when he enters the room, and that he will be able to control the questioning, not the lawyers or the judge. If you have never seen such a person on the witness stand, you have missed a spectacle.
When his side loses, his analysis is that the company's lawyer would have won if he had just 'put me back up on the stand'. Yeah right!
Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
(Here is Part 1. This is Part 2 of 6 on How to Win Franchise Trials. Here is Part 3)
Dispute resolution management requires realism and maturity.
People, and their lawyers who think that they can prevail despite the facts, despite the law, and that all they have to do is tell the story a certain way, usually fail. Sometimes they get away with murder, but it is very rare.
Justice usually works the way the justice system is intended to work. And that is even more reliable in business disputes where the burden of proof is simply that your side of the case is more appealing that that of the opponent.
More appealing in this context is not just a sympathy contest. More appealing really means that what you are telling the judge, jury or arbitrators is corroborated by extrinsic evidence that was created when there was no dispute, usually in the normal course of business -- what you honestly wrote about what was happening at the time it was actually happening.
True, there are companies that have such a bad reputation that even the truth won't help them, and it is a delight to sue them in their own home towns where everyone knows them and their prospect of picking an unbiased jury is slim.
But that usually isn't the case. Nor is it usually the case that 'home cooking' spoils the prospects for the correct result. Sometimes that happens. Usually it does not.
Where does that leave us? It usually leaves us with a level playing field in which the correct result is the most likely result.
The purpose of this article is to suggest that it is probably not going to be possible to change that by concocting fanciful stories contrary to the true facts.
On the criminal side, executives can rob a company and its shareholders and employees blind and get away with 'I did nothing wrong!' or, if they are 'society criminals', a light sentence in a country club prison.
On the civil side it is a different story.
One critical reason is the difference in the burden of proof.
Another critical reason is that on the civil side they are confronted by a better class of opposing counsel -- one who probably can expect compensation only if he wins -- an arena in which razor sharp cross examination is the rule, not the exception.
Arrogant executives to whom everyone has always been afraid to tell the unvarnished truth without polishing it to reflect positively upon their ego often get their comeuppance because they can't imagine anyone having the unmitigated gall to challenge their veracity and shove their own paperwork up their ass in a public forum.
But, as they learn too late (and for which they blame their lawyers, not themselves), shoving your corporate records up your ass in broad daylight in front of a crowd of people is what a good trial lawyer does for a living.
In over fifty years of trying business cases, I have so often seen disputes that should have been resolved reasonably and properly long before trial, go to trial because someone who did something wrong, mistakenly or intentionally, was insisting that the facts be found and the result be rendered in his favor no matter what.
And since that kind of person will pay anything to 'have his way', he is fair game for any lawyer who will pretend to agree with him for the purpose of generating a big fee.
Later, when everything has come a cropper, the lawyer will simply say that the judge ruled incorrectly and we should appeal (also stupid in almost every instance); the witnesses against us were lying; the jury was crooked; opposing counsel rigged the result; and any number of other stupid excuses. Then, of course, the fractured executive will go find another lawyer and tell him to sue the first lawyer for malpractice. And the cycle may go on and on. It just depends on the degree to which ego rules over intellect.
I have my own way to evaluate a case and to prepare a witness.
I am absolutely brutal on my own side of the case. If it can pass my sniff test, it will probably pass that of any judge, jury or arbitrator. And if it can't pass my sniff test, I tell the client about my concerns.
The client can then consider my advice and seek a reasonable resolution, or look elsewhere for less challenging counsel.
In my experience, if you are forthright about the situation early on, and have not called everyone on the other side a no good son of a bitch, rational resolutions are readily available and, in the long run, much less costly.
Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop. Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.
(This is Part 1 of 6 on Franchise Trials. Here is Part 2)
Another interesting decision has come down regarding the use of exculpatory clauses in franchise agreements -- and this time, the decision went in favor of the franchisee.
Exculpatory clauses are provisions that parties use to disclaim the making of any promises, representations, or statements outside of the contract.
Such provisions are commonly used by franchisors in franchise agreements to give the franchisor the assurance that their franchisees are not relying on any promise, statement, or representation that was made before signing -- many of which the franchisors may not even be aware (for example, those that were made by salespeople speaking beyond the limits of their authority).
The most common form of exculpatory clause is an integration clause, which in most contracts goes by the title "Entire Agreement." An example of an integration clause (taken from the franchise agreement in this case) is below. Often, a franchisor will be able to rely on an integration clause and other exculpatory provisions to avoid liability in court for promises that were allegedly made to a franchisee that are not reflected in the terms of the franchise agreement.
But other times, a badly-written or otherwise non-comprehensive exclupatory clause will not provide a sufficient shield to a franchisor to avoid liability. The C&M v. True Value case, from the Wisconsin Court of Appeals, provides a good example of how courts can sometimes find that a franchisor's exculpatory clause is insufficient to protect it from liability for an alleged misrepresentation.
In this case, C&M was a True Value hardware store franchisee for a short time, having only operated the store for less than a year before closing it due to financial reasons. Shortly after closing the doors, C&M sued True Value, claiming that (among other things) that True Value misrepresented the possible performance of the franchise business.
The franchise agreement in question, called a "Retail Member Agreement" (the "Agreement") was signed by C&M and contained two different exculpatory clauses that said:
[True Value] has not represented to [C&M] that a "minimum," "guaranteed," or "certain" income can be expected or realized. Success depends, in part, on [C&M] devoting dedicated personal efforts to the business and exercising good business judgment in dealings with customers, suppliers, and employees. [C&M] also acknowledges that neither [True Value] nor any of its employees or agents has represented that [C&M] can expect to attain any specific sales, profits, or earnings. If [True Value] has provided estimates to [C&M], such estimates are for informational purposes only and do not represent any guarantee of performance by [True Value] to [C&M]. [TRUE VALUE] MAKES NO REPRESENTATIONS OR WARRANTIES EITHER EXPRESS OR IMPLIED REGARDING THE PERFORMANCE OF [C&M'S] BUSINESS.
And
This Agreement, and any other agreement which [C&M] signs with [True Value], is the entire and complete Agreement between [C&M] and [True Value] and there are no prior agreements, representations, promises, or commitments, oral or written, which are not specifically contained in this Agreement or any other agreement which [C&M] signs with [True Value]. The current form of the Company Member Agreement shall govern all past and present relations, actions or claims arising between [True Value] and [C&M].
Based on these two exculpatory clauses, the trial Court determined that C&M was placed on notice that anything True Value said could and did not constitute representations or warranties about the possible performance of the business. Based on this holding, the trial Court dismissed C&M's misrepresentation claims.
C&M appealed. The Court of Appeals of Wisconsin first stated the general rule that exculpatory contracts are disfavored in the law. Because of this general rule, the Court said that exculpatory contracts should be carefully reviewed by a trial court to determine whether they violate public policy.
Moreover, the Court advised that any such provisions should be strictly construed against the party seeking to rely on them.
The Wisconsin Court of Appeals stated that, to enforce an exculpatory provision in Wisconsin, the contract must specifically inform the signer of the types of risks being waived.
The Court found that the Agreement failed to notify C&M that it was intended to operate as a "waiver of True Value's liability for misrepresentation" and that it did not make any "mention of disclaiming liability let alone specifying any specific tort." Because the two exculpatory provisions in question failed to "clearly, unmistakably, and unambiguously" inform C&M of these types of liability being waived, the Court held that the provisions failed to protect True Value.
The Wisconsin Court of Appeals also determined that the exculpatory provisions were not sufficiently conspicuous in the Agreement because they "did not stand out from the rest of the form in any manner and did not require a separate signature."
The Court particularly noted that the exculpatory provisions were not placed together, did not have to be specifically initialed or signed by C&M, were not in a conspicuous location, were not surrounded by an attention-grabbing box, and were not emphasized by a heading.
The provisions were in the same typeface as the rest of the contract, and, "although the last sentence in the first provision is in capital letters, it is neither a title nor a warning to C&M."
Because the provisions were not remarkable or notable on the face of the Agreement, the Court held that they could not be enforced against C&M.
In light of the above findings, the Court of Appeals reversed the trial Court's dismissal of C&M's misrepresentation claims, holding the exculpatory provisions void because: "(1) [they] failed to clearly, unambiguously, and unmistakably explain to C&M that they were accepting the risk of True Value's negligence; and (2) the form, looked at in its entirety, failed to alert the signer to the nature and significance of the document being signed."
The lesson for franchisors (at least under Wisconsin law) in C&M is twofold: first, make sure that your exculpatory clauses are reasonably specific, addressing the types of statements that you do not authorize your salespeople to make and upon which your prospective franchisees should not rely.
Second, your exculpatory clauses should in some way stand out from the rest of your franchise agreement -- by separating them from the agreement itself, or by using capital letters, bold, or a text box to call the reader's attention to them. Many franchisors have successfully relied on a separate "disclosure questionnaire" containing exculpatory clauses for this purpose.
For franchisees, the lesson is to carefully read your franchise disclosure document, franchise agreement and other related contracts before you sign them!
If a promise, statement, or representation was made to you by the franchisor or its salespeople and you're relying on it, make sure it's in the franchise agreement or in an addendum before you sign.
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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A federal court in Hawaii recently issued an opinion finding that a distribution agreement is not a franchise under Hawaii's Franchise Investment Law. The defendant in the case, Pace-O-Matic ("Pace") is the manufacturer of gaming devices, which include "skill stop" gambling machines.
The plaintiff, Prim, LLC entered into a distribution agreement with Pace to become the exclusive distributor for Pace's "amusement devices" in an area that included Hawaii.
In October 2010, Pace sent Prim a notice of default, and terminated the exclusivity portion of the agreement between the parties. Prim sued in the U.S. District Court for the District of Hawaii. Among other things, Prim asserted that Pace violated Hawaii's Franchise Investment Law (Haw. Rev. Stat. §480-2 et seq.) by failing to deal with Prim in good faith and by terminating Prim's franchise without good cause.
Pace sought summary judgment on that claim, arguing that there was never a franchise between Prim and Pace, and that Prim never paid Pace a franchise fee.
The Court noted that, under Hawaii law, a franchise consists of an agreement "in which a person grants to another person, a license to use a trade name, service mark, trademark, logotype or related characteristic... and in which the franchisee is required to pay, directly or indirectly, a franchise fee." Haw. Rev. Stat. §482E-2.
Examining the Distribution Agreement, the Court found that the contract did not provide that Prim could use Pace's name, trademarks, or proprietary software, and that instead Prim's role under the contract was to "purchase games" from Pace and "exercise its best efforts to develop markets for the games and distribute" them.
Citing the U.S. Court of Appeals for the Ninth Circuit's decision in Gabana Gulf Distribution, Ltd. v. Gap Int'l Sales, Inc., 343 Fed. App'x 258, 259 (9th Cir. 2009), the Court noted that a distributorship is "not the same thing as a franchise relationship." In this regard, the Court noted that "[t]he very essence of a franchise relationship is that the franchisee represents the franchise to the public; a franchise is not created whenever one company purchases and distributes another company's products."
Considering that the Distribution Agreement only allowed Prim to purchase Pace's products, and did not permit Prim to "substantially associate" with Pace's trademarks, the Court found that the Distribution Agreement did not create a franchise.
The Court also found that Prim did not pay Pace a franchise fee. Under Hawaii law, a franchise fee is "any fee or charge that a franchisee . . . is required to pay or agrees to pay for the right to enter into a business or to continue a business under a franchise agreement," but does not include "the purchase or agreement to purchase goods at a bona fide wholesale price." Haw. Rev. Stat. §482E-2.
The Court cited its previous opinion in JJCO, Inc. v. Isuzu Motors America, Inc., 2009 WL 1444103, at *4 (D. Haw. 2009), aff'd, 2012 WL 2584294 (9th Cir. July 5, 2012) for the "guiding principle is that, unless the expenses result in an unrecoverable investment in the franchisor, they should not normally be considered a fee." The Court found no evidence suggesting that the money paid by Prim to Pace for products was anything other than a bona fide wholesale price, or that it constituted an "unrecoverable investment" in Pace.
Based on its finding that the Distribution Agreement did not create a "franchise" within the meaning of Hawaii law, the Court granted summary judgment for Pace on that claim.
The case is validation for companies that operate through networks of independent distributors. Where the distributor: (1) is not permitted to "substantially associate" its business with the manufacturer; and/or (2) pays only the bona fide wholesale price for its merchandise (and no other form of compensation) to the manufacturer, the relationship will typically not be considered a franchise under state laws.
That being said, the "hidden franchise" problem can exist any time a business wishes to structure its model to avoid being considered a franchise. There are many traps for unwary business owners in this area of the law; as a result, it's critically important for a distribution business seeking to avoid being labeled as a franchise to consult with an attorney experienced in franchising before using any particular business model.
It should be obvious to anyone reading these words that it is never a good idea to lie to a court of law. That's a pretty basic concept, right? Lying in court documents is called "perjury," and it's a crime in every State in the union.
So it's always interesting to hear a story about someone who failed to grasp this fairly simple concept -- and how they got caught doing it. This time it was the Husains, longtime McDonald's franchisees, who lied to a court in Northern California in litigation against their franchisor.
The decision in Husain v. McDonald's Corp. was handed down by the California Court of Appeals on March 28, 2013. The story goes something like this:
The Husains are longtime McDonald's franchisees, having owned up to five different McDonald's franchises located in northern California since the early 1980s. In June 2005, the Husains entered into an agreement with a third party to purchase an additional 7 restaurants. Of those, 3 of the franchise agreements were nearing the end of their 20-year franchise terms.
As part of the purchase, the Husains asked McDonald's whether it would agree to provide them with new 20-year franchise agreements when the 3 expiring agreements came to the end of their respective terms.
McDonald's offered to extend the Husains' expiring terms by letter, which offer had to be countersigned and agreed to by the Husains to become effective. McDonald's claimed the offer was never accepted and expired on its own terms, leaving the Husains without renewal franchise agreements for the 3 expiring restaurants. The Husains sued to enforce McDonald's alleged promise to them. McDonald's filed a cross-complaint to compel the Husains to relinquish the 3 restaurants to the company.
To "prove" that they had, indeed, accepted McDonald's offer to extend the expiring franchise terms, the Husains produced a certificate of mailing with a United States Postal Service postmark dated before the offer expired, alleging that the agreement had been properly accepted. McDonald's countered by producing evidence that the post office that had supposedly provided the certificate of mailing was closed on the date bearing the postmark, and that the postmark stamp on the certificate was not in use until 2008.
Based on this evidence, McDonald's claimed that the Husains had committed perjury and fabricated evidence, and sought terminating sanctions -- in other words, McDonald's asked the Court to sanction the Husains by not permitting them to continue litigating their case.
The trial court denied the motion, finding that at most McDonald's would be entitled only to dismissal of a cause of action the Husains had already dismissed, and that there was a factual dispute regarding the fabrication charges that could not be determined at the motion stage.
Renewed Motion for Terminating Sanctions
Four weeks into the trial and after the Husains had presented their case-in-chief, McDonald's filed a renewed motion for terminating sanctions. The motion was based on McDonald's contentions that Mr. Husain:
(1) presented falsified invoice information to overstate his investment in the franchise;
(2) falsified the certificate of mailing; and
(3) repeatedly mentioned his wife's recurring breast cancer in violation of a court order on a motion in limine on that subject.
McDonald's argued that the sanctions were required under California Code of Civil Procedure Sec. 2023.030 and pursuant to the inherent power of the court.
The trial court found the Husains committed perjury, provided false evidence in discovery, and willfully and repeatedly violated its order on McDonald's motion in limine regarding the mention of Mrs. Husain's breast cancer.
The court ordered terminating sanctions, finding that "[n]o lesser sanction would be appropriate or would ensure compliance and a fair trial."
The court dismissed the Husains' complaint with prejudice, and struck their answer to McDonald's cross-complaint. The court also dissolved the preliminary injunction in the Husains' favor and granted McDonald's an injunction preventing the Husains from continuing to occupy the restaurants and use its trademarks.
The Husains appealed.
Appeal
The appellate court began by observing that "[b]ecause a terminating sanction is a drastic measure that denies a party the right to a trial on the merits, our courts have limited its use to only the rarest and most extreme cases of litigation misconduct when no lesser sanction can preserve the fairness of the trial and restore balance to the adversary system."
The Court found the Husain's conduct reprehensible, but that it did not necessarily justify terminating sanctions.
Examining the Husains' conduct, the appellate court reasoned that the discovery statutes relating to document production, depositions, and interrogatories do not authorize terminating sanctions unless a party refuses to obey a court order relating to that discovery.
The court found that the Husains had not in fact disobeyed any discovery order by doctoring evidence, and that the end result of their tampering was "of little or no consequence to the litigation." Based on this, the court found that the discovery statutes did not authorize terminating sanctions.
The appellate court also found that the trial court's inherent powers did not justify terminating sanctions because McDonald's failed to show that "the Husains' misconduct deprived it of a fair adversary trial in any sense." McDonald's, the appellate court reasoned, had the opportunity to effectively cross-examine Mr. Husain and place his credibility at doubt.
In other words, McDonald's had the opportunity at trial to use Mr. Husain's actions against him. The court also found that Mr. Husain's violations of the trial court's orders on McDonald's motions in limine "could not have so impaired McDonald's ability to defend itself as to throw the fairness of the trial into question." The court reasoned that some lesser sanctions would have fully protected McDonald's right to a fair trial.
Because it found that terminating sanctions were not justified, the court of appeals set aside the terminating sanctions and ordered the trial court to schedule a new trial date -- in effect, permitting the Husains to continue litigating their case against McDonalds.
Presumably, the serious issues of the franchisees' credibility, along with any lesser sanctions the trial court enters due to their perjury, will be a significant enough consequence to them to ensure that they are not able to benefit from their fraud on the court.
Under the FTC's Franchise Rule, a franchisor is permitted, but not required, to answer that all-important question asked by would-be franchise buyers: "How much Money Can I Make?"
A franchisor that chooses to make a "financial performance representation" ("FPR") must put the representation in its Franchise Disclosure Document ("FDD").
The representation can take one of two forms. It can be: (1) an earnings claim based on historical performance of operating units; or (2) a projection of possible future performance.
Allowing franchisors to make FPRs based on projections of future performance is still fairly new to franchising; the allowance of "future projections" was added when the Franchise Rule was amended in 2007.
In either case, the touchstone requirement for an FPR is whether the franchisor has a reasonable basis for making it. As a related requirement, the franchise company must also be able to produce written substantiation for any claim to prove the "reasonable basis."
Since the Franchise Rule was amended in 2007, there hasn't been much litigation over financial performance representations. Cases regarding representations of future performance are even more rare, which makes a recent Maryland court decision on the topic, Hanley v. Doctors Express Franchising, LLC, all the more noteworthy.
Doctors Express Franchising, LLC ("DRX") is a Maryland-based franchisor of urgent medical care centers.[1] Hanley is a former franchisee that owned a DRX franchise in Des Peres, Missouri.
Hanley sued DRX alleging (among other things) violations of Maryland Franchise Registration and Disclosure Law[2], as well as common law fraud through both active misrepresentation and intentional failure to disclose material facts. Hanley also named several of DRX officers individually, contending that they are joint and severally liable for DRX's violations of Maryland law. The decision is on a Rule 12(b)(6) Motion to Dismiss brought by DRX.
The Alleged Misrepresentations
Hanley alleged that DRX made misrepresentations in its 2009 Franchise Disclosure Document ("FDD"), which Hanley received from DRX in January 2010, as well as in other pre-sale documents given to Hanley by DRX. These included a document entitled "Doctors Express Financial Data and Operating Assumptions" given to Hanley by his lender, First Financial, a lending institution apparently affiliated with DRX. Hanley alleged that he relied on the representations when he signed his franchise agreement in March 2010.
The allegedly fraudulent statements included FPRs made both in Item 19 of DRX's FDD and in the "Operating Assumptions" document he received from First Financial. The FPRs were based on the experience and data of DRX's affiliate, which had been operating since 2006, and provided information for its performance in 2007 and 2008. The allegedly false statements included:
- FPRs stating that DRX franchisees would open with and sustain average per-patient revenue of $125, with a volume of 45 patients per day.
- Hanley alleged that DRX knew that, because medical service providers must be credentialed and contract with third-party (insurance / Medicare) payers, franchisees average per-patient revenues were "far below" $100, and that even its highest-performing franchisee treated an average of 27 patients per day.
- An estimated initial investment range of between $466,220 and $602,720.
- Hanley alleged that DRX knew this number to be too low, and that in DRX's 2010 FDD (filed with the California Department of Corporations 2 weeks after Hanley executed his agreement), the number was stated to be between $508,500 and $693,000. Hanley alleged his actual investment to be more than $1 million.
- An "additional funds" / working capital line item as part of the initial investment Item 7, estimated by DRX to be between $50,000 and $90,000 for the first 3 months of operation.
- Hanley alleged that DRX knew these numbers to be low because (due to 2009 changes in Medicare law) franchisees were not able to become fully credentialed / contracted with insurance payers by the time they opened, and that while waiting for credentials, franchisees were forced to accept substantial reductions in fees. Hanley alleged that the approval of many insurance company contracts are delayed far past the opening date, a fact that DRX knew and concealed from him.
Hanley alleged that DRX knew that using the experience and data of its affiliate for its FPRs and advertising was materially misleading to prospective franchisees because the affiliate was not representative of the experience of new franchisees. This is because the affiliate opened in 2006, several years before major changes to Medicare enrollment procedures made it difficult or impossible to open fully credentialed and contracted, and the affiliate was not required to use expensive vendors.
DRX's Motion to Dismiss
DRX moved to dismiss the fraud claims by arguing: (1) the representations in the FDD were labeled as estimates and projections, not statements of fact, and therefore were not actionable; and (2) Hanley expressly disclaimed his reliance on statements outside of the FDD and Franchise Agreement, and as a result could not claim that his reliance on them was reasonable.
1. Estimates and Projections Can Be Actionable
As to the first argument, DRX argued that its FDD warned prospective franchisees that the projections and estimates could not be relied upon to accurately predict future performance. In essence, DRX argued that its statements based on the affiliate's performance were not misrepresented, and therefore, could not be fraudulent.
Quoting Jaguar Land Rover North America, LLC. v. Manhattan Imported Cars, Inc., 738 F.Supp.2d 640 (D. Md. 2010), Hanley responded by arguing that "inaccurate projections of . . . future profitability and inaccurate planning volumes could . . . be considered fraudulent if there was evidence that the [defendant] knew they were inaccurate at the time they were made."
The Court agreed with Hanley and refused to dismiss the fraud claim, citing Motor City Bagels, LLC v. American Bagel Co., 50 F.Supp.2d 460 (D. Md. 1999) (by providing estimate of projected startup costs, "the defendants thus also made a representation of a present fact -- that they knew of no information that would make the projection in the UFOC improbable"). The Court also found that Maryland law specifically prohibits "[a] disclosure that is knowingly inaccurate because it omits material information known to the franchisor." Md. Code. Bus. Reg. §14-227(a)(1)(ii).
2. Disclaimers Do Not Make Reliance by Franchisee Unreasonable
In support of its second argument, DRX pointed to disclaimers in Item 19 of DRX's FDD that warned prospective franchisees that actual expenses would vary from business to business, and that prospects should make their own independent investigation prior to buying a franchise. Similarly, DRX argued that Item 7 of the FDD warned prospects that it was an estimate only. DRX also argued that the Franchise Agreement's: (a) integration clause; and (b) contractual acknowledgement that Hanley was not relying on any representations outside of the FDD or Franchise Agreement defeated any claim by Hanley that his reliance was reasonable.
The Court disagreed, finding that Maryland law prohibits a franchisor "from requiring a prospective franchisee to agree to a release, assignment, novation, waiver, or estoppel that would relieve a person from liability" under Maryland franchise law. Md. Code. Bus. Reg. §14-226. As such, the Court found the disclaimer void.[3]
Based on the findings summarized above, the Court refused to dismiss Hanley's fraud claims. Hanley will be permitted to take discovery and continue pursuing his claims against DRX.
The Hanley case serves as a reminder to franchisors of the importance of ensuring that they have a reasonable basis for each of their financial representations and cost projections. When basing FPRs or cost projections on the results of company-owned operations, it is critical to ensure that significant variations between the franchise business model and company-owned businesses are both accounted for and adequately explained to prospective franchisees.
[1] Franchisees for Doctors Express are not necessarily physicians. Franchisees in the system handle the administration, marketing, facilities and equipment, and file maintenance aspects of the urgent care business, and contract with physicians, nurses, and medical technicians employed by a separate entity to provide medical services to patients.
[2] Md. Code. Bus. Reg. §14-201 et seq. Although Hanley lives, and operated the franchise, in Missouri, the parties did not dispute the application of Maryland's franchise law because DRX made the offer to sell in that state. See Md. Code. Bus. Reg. §14-203(a)(1).
[3] The Court did note its agreement with the decision in Long John Silver's, Inc. v. Nickleson, ___ F.Supp.2d ___, 2013 WL 557258, *9 (W.D. Ky. Feb. 12, 2013). In that case, the Kentucky court found that, while disclaimers could not be used to defeat the franchisee's fraud claims (under Minnesota law), "[t]he disclaimers will no doubt influence a jury's determination of whether [the franchisee's] reliance on the alleged untrue statements was reasonable."
You have a business dispute. Either the seller of the business you bought is directly competing against you after the closing or an ex-employee has gone to work for the competition taking trade secrets with him. First, hopefully you have a signed a Non-Compete Agreement.
Now you have to evaluate certain risks in asking for a preliminary injunction.
One of the first things I am asked as part of bringing suit in such situations is how fast I can get emergency injunctive relief. An injunction is a court order which, in this case, prohibits the competition against you that is breaching the Non-Compete Agreement.
But you'll also be suing for damages. And that is where you have to be careful. The arguments for your damages claim and for your injunction typically will not be that different. As a result, if you lose your emergency motion for temporary injunction, you may be giving the other side a victory if the court finds the likelihood of you prevailing is not high enough to grant you the injunction.
So the down side is that since you are also suing for damages, you have to really think about whether a court order on an injunction will help in the long run. If the acts the defendant is engaging in don't really extend the harm significantly or threaten to put you out of business, then the risk of an adverse temporary injunction hearing may not be worth it.
Even worse, this scenario may occur after you win a temporary injunction. If the defendant thinks the injunction order is unfair, the defendant can take it up on appeal and if successful, you have the same problem and the possibility of paying for their legal fees after your own fees spent on the appeal. Just as a Non-Compete Agreement can't be overbroad (such as being for an unreasonable number of years or a geographic region that is too large), so too can a trial court's order be overbroad.
The elements you must prove to win a preliminary injunction are:
1) you will suffer irreparable harm unless the order is granted;
2) there is no adequate remedy at law (money damages can't pay for the harm being done);
3) you have a substantial likelihood of winning your underlying damages claim; and
4) public interest supports granting the temporary injunction.
Appellate courts have reversed entry of temporary injunctions where they are vague and overbroad. A business was sued that provided orthopedic physicians and their practices with administrative support for worker's compensation prescription claims receivables.
The temporary injunction was reversed since it had no time restriction and prohibited "soliciting any [physician] practices which are current or prospective clients" of the plaintiff. Anyone could be a prospective client so you can see the problem. The case is 4UORTHO, LLC v. Practice partners, Inc., Physician Wellness Products, LLC, et. al., 18 So.3d 41 (Fla. 4th DCA 2009).
In Zupnik v. All Fla. Paper, Inc., 997 So. 2d 1234 (Fla. 3d DCA 2008), All Florida Paper sued Zupnik, an ex-employee and his new employer Dade Paper, to stop them from breaching his non-competition agreement and to prevent them from misappropriation of trade secrets. This case is important because it shows that the appellate court can render its own opinion of a Non-Compete Agreement and doesn't have to rely on what the trial court found.
All Paper Florida lost on the Non-Compete enforcement against Zupnik. Though he remained employed by All Paper Florida for an additional two years after his employment contract of two years expired, the appellate court ruled he was only an at-will employee. As such no new employment agreement was created. Meanwhile, the non-competition period was only for 12 months after the initial two year period expired.
All Paper Florida further lost on their misappropriation of trade secrets claim against Dade Paper. The appeals court found that All Florida Paper did not prove Dade Paper misappropriated any specific trade secret information related to any All Florida Paper customer. As such, All Florida Paper failed to establish the third element, a likelihood of success on the merits.
For All Paper Florida, it seems winning their temporary injunction was all in all a disaster. It is hard to say if the case would have settled before such devastating rulings would have affected their case. Make sure you think through the pros and cons of a preliminary injunction before going after one.
When you finally figure out that you have been had, that you bought a bozo franchise and that you are going to be cheated even more by the scoundrels who sold you the deal, the first things that you will do will be the wrong things. It never fails.
People who won't spend money to obtain competent help on deal due diligence before they invest, who only want to spend a few hundred bucks to have some bozo lawyer "read the contract", usually - in fact almost always in the case of the newer franchises these days - wake up one morning realizing that they have been royally screwed.
Before continuing, I think I need to explain the term "bozo lawyer", as I know I will get a lot of angry feedback from certain circles in the legal profession if I don't explain it.
A bozo lawyer is a lawyer who wants so much to make a few hundred dollars doing something inadequately and incompetently, that a small fee will be accepted rather than honestly saying to the client that the scope of the project is beyond their ability and helping the client find a resource who knows what to do.
A bozo lawyer will take the small "read 'em the contract" fee rather than tell the client that the project requires business and financial and franchise, as well as legal due diligence and experience with how representations are skewed in the franchise industry.
Any lawyer who will "read you the contract" and not do the other things I have suggested in the Franchise Fraud Symposium Tutorial articles is a bozo lawyer. And, as I have said in those Tutorials, even that is sometimes not enough.
Fraud is sometimes blatant and often subtle. If you don't have the training or experience to do the job right, you have a fiduciary duty to the client to direct them elsewhere and help them get what is needed to do the job competently.
If you don't do this you are a bozo lawyer and deserve to be sued for malpractice.
It breaks my heart when I realize that almost everyone who comes to me after they have already been cheated hired a lawyer before they bought the franchise who only told them that the franchise contract is very one sided and that usually there is no opportunity to negotiate individual terms, and maybe also that it looks like a good deal if all the claims are true.
I just want to scream that there are not militant seminars to teach so-called business lawyers about how to do franchise purchase due diligence in a hot zone of intense franchise investment fraud.
The due diligence on a new franchise has to be as intense, if not more so, than the due diligence on the acquisition of an up and operating business. There is less actual information available on the new franchise proposition, because there is no actual operating history for the store that the client will operate.
This makes it easier to fabricate the appearance of financially positive prospects. Ferreting out that scenario's warts calls for more intense cynicism.
Because the work is more complex and costs substantially more to do it properly, prospective clients are often reluctant to spring for The Full Monty. The client is presold and, at the moment of your first meeting, the job will be to disabuse him of the enthusiasm for the proposal.
But if, after you have told him the risks of skullduggery, there is still unwillingness to pay for doing the job right, taking the smaller version of counseling is simply an invitation to disaster.
If the client won't pay for doing the job right, the only intelligent course is to show him the door. Oh, you can write a fee agreement that limits what you will do for the small fee, but if you have ever heard that kind of fee agreement dealt with in trial of a malpractice case, you probably will never do it that way.
You're not a professional if you lack the ethical substance to tell a prospective client that you can't help them. Usually those resources have to be multi disciplined.
They have to be capable of spotting fraud, spotting "tricks" always used by franchise sales people, knowing where to look for the "stuff" that isn't obvious on the surface, parsing the financial substance of how the proposed business relationship will really work, and differentiating between what is communicated in the sales and marketing process and how - if at all - that is reflected in the franchise agreement and accompanying disclosure documents.
You have to be capable of graphic portrayals of the defects that the client has no idea are hidden within the documents provided by the franchisor. The client believes that the people that are on the opposite side of the proposed transaction are really trying to help out rather than fleece him.
If the prospective client doesn't want to pay for that level of assistance, the only smart thing to do is to decline the retention and let the victim go take his lumps. That way the victim won't have you to blame/sue when the worst happens after the sale is closed.
Filled with anger, loathing and hatred, these victimized franchisees initiate a campaign of name calling, send emails and letters and make telephone calls whining about something that they thought they had a right to that is not being performed by your franchisor, or about something the franchisor is doing that they said they would never do in the sales pitch - but not in the franchise agreement itself.
They also get on the phone and discuss it angrily with their fellow franchisees, some of whom will - of course - report to the franchisor that you are calling around bad mouthing the organization, hoping that by ratting you out they can suck up and maybe avoid the same treatment.
Then the victim will spend the next two years whining and complaining, and usually making no money or far less than he was led to believe - almost no one makes the projections - even if they make the sales they don't make the profit numbers.
All this time the victim will be miserable. His net worth will decrease. His ability to handle financial obligations will get steadily worse.
And the statute of limitations will be running toward the extinction of any fraud and misrepresentation claims that he may have and does not assert in a proper forum.
Since he wouldn't spend money to get competent help with the due diligence before he bought the franchise, he resists spending money to get competent assistance on what to do about the situation now.
If he is really stupid, he will wait until his financial condition is so bad that he can't afford competent help anyway.
One thing is certain. If the franchise he bought is a fraud, one of the franchisor's goals is that when he figures out what happened to him, he will be too poor to do anything about it. He may already be beyond help. If he delays further, his chances of being beyond help increase rapidly and dramatically.
That's what most folks do in this situation.
There are two rational solutions to having just learnt that you've been had. And the earlier on that you chose one and get on with its execution, the better off you will be. Life is tough. You have to be tough or it will devour you.
The ability to sue the lawyer who failed to provide competent guidance in counseling you about doing the deal in the first place is probably subject to a two year statute of limitations.
The statute of limitations on any franchise fraud claim is probably going to run out in three or at the most four years from the date you signed the franchise agreement. There may be an even shorter contract limitations period.
YOU CAN NEVER ASSUME THAT STATUTES OF LIMITATIONS GIVE YOU THE AMOUNT OF TIME THAT I HAVE JUST SUGGESTED. YOU HAVE TO CHECK THE SPECIFIC STATE STATUTE FOR YOUR PARTICULAR SITUATION IN EVERY INSTANCE. YOU MAY NOT HAVE AS MUCH TIME IN YOUR SITUATION FOR ANY NUMBER OF REASONS.
You may stupidly have given away your right to jury trial and your right to collect most categories of damages when you singed the franchise agreement, and damn few courts are going to be willing to give those rights back to you under any kind of unconscionability rationale.
You need to get yourself into the hands of a competent business fraud trial lawyer as soon as you believe you have been cheated. You need also to avoid any communication whatsoever about your situation until you and your new lawyer have sorted out what you options are and in what priority you are going to exercise them.
Don't send the angry emails and letters. Don't make the angry phone calls. Don't talk about the situation with other franchisees. Shut up until you have a battle plan. Everything you say or write before you get the battle plan sorted out is more likely to hurt your real interests than help.
One of the first and most important options you will have is simply to get out of the business by putting your franchised business up for sale. It probably has some market value. If you think you would rather just sell the business than spend money fighting your franchisor and/or your original lawyer, you will need not to have created a difficult situation by bad mouthing anyone or anything.
You will have to deal within yourself with the question of how you will feel about dumping the deal you wish you had never bought onto someone else. That's your call, but the option is there and you need to consider it.
You may well not realize total recovery of your investment. What you can get has to be measured against what you would have to spend and to risk in order to go to war over having been cheated.
Contingent fee lawyers only get paid if they win something, so if you insist on a contingent fee arrangement for your new lawyer, expect a recommendation to fight.
Solutions that don't produce cash recoveries don't provide funds to pay contingent fees. If the contingent fee agreement states that it will apply to any sums you receive, expect the lawyer to claim a percentage of the price you get from selling your business.
Business brokers are cheaper in percentage of sales price than anything you will find in a contingent fee agreement. Contingent fee agreements frequently take 30 - 50 % of the recovery from any and all sources. Do you want to go that way? Probably not. If you want competent legal assistance and don't want to pay that kind of fee, you have to pay the lawyer by the hour and not on a contingency. If you pay by the hour you will also get more attention paid to alternatives that do not involve having to fight for a litigated recovery. There is no free lunch!
Do not expect that your fellow franchisees are going to come to your aid. They almost certainly will not. They will in all likelihood gossip amongst themselves about what you tell them.
Promises of confidentiality are totally useless. Some of these folks will tell the franchisor everything that is said in hopes of getting some favorable treatment for themselves.
Even if what happened to you also happened to them, do not expect assistance. They would rather lie in the weeds and see what you get on your own than stand with you and assist in the attainment of a better result for everyone. That's how the world works and how it has always worked.
See the Tutorial entitled "WHO DO I NEED? WHEN DO I NEED HIM? GETTING THE RIGHT LAWYER AT THE RIGHT TIME" in the roster of Specialized Tutorials on my web site.
Ask the tough questions of the lawyer you are thinking of hiring for due diligence work. How many of these proposed transactions have you vetted? Have you followed up on any of them regarding how well or poorly they did? What were the main problems that contributed to the difficulties of those franchisees who had difficulties? Can you identify the point at which the due diligence work may require the participation of a financial advisor in addition to a legal advisor? If so, do you have someone who is available to assist with that work, and what should I expect that to cost?
And don't forget that a reality mode appreciation of the terms of the franchise agreement is also part of the mix. You really do have to understand what the contract says and, more importantly, how that works when it comes into play and why it is configured the way it is.
If you the lawyer can't appreciate the intertwining of Integration and Acknowledgement clauses, and the intertwining of covenants not to compete and liquidated damages clauses, and you are unable to portray to the prospective client how those work together and why they are in the contract, you aren't ready for this work at any level.
If you lack sensitivity for the differences between the sales and marketing brochures and the substance of the Duties Of The Franchisor provisions of the franchise contract, and how to go about accounting for them, plus the oral statements made by franchisor representatives, you may be a RedNeck, as Jeff Foxworthy says, but you aren't ready for prime time when it comes to counseling about franchise purchases.
Nothing lasts forever. That includes the right to sue for franchise disclosure violations. If a franchisor does not comply with franchise disclosure laws, the franchisee has only a finite time to file a complaint.
This is referred to as the statute of limitation in the legal world. The statute of the limitations is the set period of time that claim must be filed. If the time period the complaining party has lapses, they cannot sue. There may be no remedy. No liability. No recovery - even for a great case.
So goes the case of Stocco v. Gemological Institute of America, Inc., Gemological Institute". Frederick Stocco and Kathleen Stocco, collectively "Stoccos" entered into a license agreement with the Gemological Institute in 2007. The license agreement was a franchise to be operated in California. In 2012, the Stoccos sued Gemological Institute. In one count, the Stoccos alleged Gemological Institute violated California franchise disclosure laws.
California's disclosure law states:
No action shall be maintained to enforce any liability created ..... unless brought before ..... [4] four years after .........the violation, [or] the expiration of [1] one year after the discovery........
That means the Stoccos could not claim a violation of the California franchise disclosure laws past 4 years. Do the math. The violation occurred in 2007 and the Stoccos did not bring their compliant until 2012. That is 5 years. The court disregarded the discovery issue. Four years was absolute. The Stoccos did not bring the claim within the 4 year window, the claim was dismissed!
Now, that is not the end of the story. The Stoccos had numerous other claims against Gemological Institute. So, don't assume a franchisor is off the hook after 4 years. In this case there were 5 other claims against the franchisor that will have to be defended.
Business Take Away: Disclosure violations have a finite life, but there are other counts to consider.
If you have an issue regarding a franchise disclosure violation, we want to hear about it. Contact us to discuss your specific case!
Plaintiffs filed a class action lawsuit against Papa John's, arguing that a text message campaign conducted by the company's franchises violated the Telephone Consumer Protection Act.
According to the complaint, the franchisees sent text messages to customers without their consent, in violation of the TCPA. Under the law, a plaintiff can recover between $500 to $1,500 for each message sent without consent, depending on whether the violation is willful.
As we've noted in previous posts, the number of lawsuits involving text message campaigns has increased dramatically in recent years.
Part of the increase is because many companies aren't paying attention to legal requirements.
But the increase is also largely because class action attorneys have come to see these cases as an easy way to make money.
For example, a recent case involving text messages sent by Jiffy Lube settled for $47 million.
These attorneys will seize on any violation -- no matter how minor -- as an opportunity to force a settlement.
Most of the recent lawsuits could have been avoided if the text message campaigns if the campaigns had been carefully reviewed prior to launch.
Sometimes, there's a tendency to try to skip that step in order to cut costs and launch quickly, but the recent string of multi-million dollar settlements demonstrates that's a very short-sighted approach.
It will cost exponentially less time and money to do things right from the start.
If you're planning a new campaign, get your legal team involved early in the process.
In March, the Ontario Superior Court of Justice released its decision on a motion for summary judgment in Dodd v. Prime Restaurants of Canada (Prime).
The decision offers further insight into how the courts will apply the new summary judgment rules in the franchise context and raises some interesting issues regarding the interaction between Section 11 of the Arthur Wishart Act (Franchise Disclosure) (AWA) and a mutual release agreement executed by a franchisor and a franchisee in the context of a failed franchise.
The dispute in this case arose between the owner of East Side Mario's and two of its franchisees. In 2003, the parties entered into an agreement to open a new East Side Mario's franchise in Toronto. Almost immediately after opening its doors, the venture began losing money and the franchisees fell behind on rent, royalty and financing payments.
After one year, the franchisees made a voluntary assignment in bankruptcy and the franchisor took over operation of the restaurant. Concurrently, the parties entered into a mutual release under which they released each other from any debts, claims or actions. The franchisor also agreed to pay the interest on the financing debt owed to GE Canada Equipment Financing G.P. (GE) and to use reasonable efforts to find a buyer for the restaurant that would assume the debt to GE.
Shortly after executing the release, however, the franchisees issued a Notice of Rescission (Notice) on the basis that they had received inadequate pre-sale disclosure contrary to Ontario franchise legislation. The franchisor responded to the Notice, advising the franchisees that the Notice was unenforceable due to the mutual release and stated its intention to meet its obligations under the mutual release.
For nearly two years thereafter, the franchisor did precisely that: it operated the restaurant, paid interest on the financing debt and found a buyer for the restaurant. The restaurant was sold and the debt to GE settled with the proceeds and some further contribution from the franchisor. But, two years after serving its Notice, the franchisees commenced an action against the franchisor claiming, inter alia, damages for breach of contract, negligence, misrepresentation and rescission of the franchise agreement. The franchisor brought a motion for summary judgement on the basis that the action was barred by the mutual release. In response to the summary judgment motion, the franchisees claimed that a trial was necessary to determine the validity of the mutual release which the franchisees' argued was not enforceable since it was both unconscionable and void pursuant to Section 11 of the AWA.
The Court refused to grant the franchisor's motion for summary judgment.
Enforceability of the Release: Unconscionability and Section 11 of the AWA
The franchisees argued that the release was not enforceable because it was barred by Section 11 of the AWA, which voids any "purported waiver or release by a franchisee of any right given under [the] Act." They also argued that it was an unconscionable agreement and therefore unenforceable at law.
With respect to the latter, the franchisees argued that the mutual release contained all four of the essential elements of unconscionability: a grossly unfair and improvident transaction, the absence of independent legal advice, overwhelming imbalance in bargaining power and intentional exploitation of this vulnerability. In response, the franchisor maintained that there was insufficient evidence before the court to establish all of these requirements and the onus was on the franchisees to do so.
The Court concluded that the conflicting evidence in relation to the value of the benefits realized and rights forgone by entering into the mutual release, whether the franchisees had legal advice at the time they executed the mutual release and whether there was in fact an imbalance of power were all matters that should be resolved at trial, with the benefit of oral evidence.
The franchisor also argued that Section 11 of the AWA cannot be used as a bar to render ineffective an agreement between the parties to a franchise agreement that was intended to settle claims arising out of an alleged breach of that statute. In support of its argument they cited the Court's decision in 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC (Tutor Time). In the Tutor Time case, the franchisor had provided a prospective franchisee with a disclosure document that failed to meet Ontario disclosure regulations.
Subsequently, in order to settle the ongoing dispute and with the advice of independent legal counsel the parties entered into a settlement agreement that included a mutual release of all rights and claims. Some time later, the franchisee delivered to the franchisor a notice of rescission of the franchise agreement. On a motion for partial summary judgment, the Court held that the mutual release was effective notwithstanding Section 11 stating:
s. 11 does not have application to a release given (with the advice of counsel) by a franchisee in the settlement of a dispute for existing, known breaches of the Act by the franchiser in respect of its disclosure obligations, which would otherwise entitle the franchisee to a statutory rescission.
The Court, however, declined to follow the decision in Tutor Time in this case. It distinguished the dispute before it from the Tutor Time decision on two bases. First, unlike the franchisee in Tutor Time, it was not clear to what extent the franchisees were aware of potential rescission claims at the time the release was executed. Second, there was conflicting evidence regarding the extent to which the franchisees had independent legal advice before executing the mutual release.
On this basis, the Court concluded that the extent to which Section 11 of the AWA may render ineffective the mutual release as a bar to the franchisees' action was a matter for determination at trial.
Lessons From the Decision
The decision provides some useful guidance on the way in which a court will consider a mutual release in the franchise context.
First, it should be noted that the Court appeared to accept the franchisor's argument that even if Section 11 of the AWA rendered ineffective any waiver of rights under the AWA, the release would still be effective to prevent parties to the waiver from claiming common law or equitable relief such as breach of contract, misrepresentation and negligence. In the case at bar, the franchisees made numerous common law and equitable claims that will be barred unless the mutual release is found at trial to be unconscionable. Thus, there is a clear benefit from continuing with the practice of obtaining releases from franchisees despite Section 11 of the AWA.
Second, the case provides an additional reminder to franchisors that mutual releases should only be finalized with franchisees who have received independent legal advice. The Court's refusal to summarily enforce the release in Prime flowed from the factual uncertainty as to the franchisees' access to legal advice at the time the release was executed. Had the franchisee obtained legal advice prior to signing the release, it would have been very difficult for it to assert that it was unaware of the potential rescission claim.
Any reasonable lawyer advising a franchisee in the context of a mutual release would need to review the previous disclosure document that had been provided by the franchisor to ensure that the franchisee is not inadvertently waiving a meritorious rescission claim without fair compensation.
In most cases, careful review of a disclosure document would allow counsel advising the franchisee to identify arguable deficiencies which could ground a claim for rescission under the two-year limitations period. If the franchisee insists that it only "discovered" a rescission claim after signing the release, it would need to prove this late "discovery" with clear and convincing evidence. Franchisors should therefore encourage their franchisees to obtain legal advice and request written confirmation that such advice was received prior to entering into any agreement to resolve a dispute.
Third, franchisors must be wary of entering into agreements with franchisees at a time when the franchisees are in desperate circumstances because it leaves them vulnerable to a claim of unconscionability. Moreover, simply because a franchisor has seemingly extended itself to "bail" its franchisee out by, for example, taking over rent or debt interest payments or relieving the franchisee of royalty back payments, does not mean that the release was mutually favourable.
The argument made by the franchisees in this case was innovative but not unreasonable: the franchisor stepped in to protect its brand and would have done these things whether or not the franchisees released them. Moreover, it also made the point that the franchisor would not likely have pursued the franchisees personally. As such, while the franchisees gave up the right to seek rescission and make other claims, it "received little of real value in return." While there are certainly strong arguments to counter this effort to claim that a mutual release is overwhelmingly favourable to the franchisor and not the franchisee, these arguments should be considered when approaching a franchisee to negotiate an agreement to resolve a dispute.
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This post was originally published on McCarthy Tétrault's website and written by Jane A. Langford, Tyler McAuley and Adam Ship
The Federal Trade Commission Franchise Rule, 16 C.F.R. 436.1 et seq., governs, at a federal level, disclosures which a "franchisor" must provide to each prospective franchise. There are also numerous state laws which may apply in any given situation. The discussion in this article will be limited to the requirements under the Franchise Rule.
Several types of continuing commercial relationships are governed under the Franchise Rule. Two specific types of relationships are: 1) package franchises: in which the franchisee adopts the business format established by the franchisor and is identified by the franchisor's trademark; and 2) product franchises: in which the franchisee distributes goods that are produced by the franchisor and which bear the franchisor's trademark, or are manufactured by the franchisee according to the franchisor's specifications. (See, Federal Trade Commission, Informal Staff Advisory Opinion 03-2.)
Whether a continuing commercial relationship is a "franchise" under the Franchise Rule, is determined by whether the business relationship contains the three definitional elements of a "franchise" set forth in the Franchise Rule, and it does not matter what name the parties choose to assign to the relationship. 44 Fed. Reg. 49,966 (August 24, 1979). In other words, if it walks like a duck and quacks like a duck . . . .
Under the Franchise Rule, where the parties are in a continuing commercial relationship there are three definitional elements of a "franchise." The franchisor must:
1. promise to provide a trademark or other commercial symbol;
2. promise to exercise significant control or provide significant assistance in the
operation of the business; and
3. require a minimum payment of at least $500 during the first six months of operations.
(16 C.F.R. Parts 436.2(a)(1)(i) and (2); 436.2(a)(iii)).)
TRADEMARK
According to the FTC, a franchise entails "the right to operate a business that is "identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark." The term "trademark" is intended to be read broadly to cover not only trademarks, but any service mark, trade name, or other advertising or commercial symbol. This is generally referred to as the "trademark" or "mark" element. The franchisor need not own the mark itself, but at the very least must have the right to license the use of the mark to others. Indeed, the right to use the franchisor's mark in the operation of the business - either by selling goods or performing services identified with the mark or by using the mark, in whole or in part, in the business' name - is an integral part of franchising. In fact, a supplier can avoid Rule coverage of a particular distribution arrangement by expressly prohibiting the distributor from using its mark." (FTC Franchise Rule Compliance Guide, May 2008.)
SIGNIFICANT CONTROL OR ASSISTANCE
The Franchise Rule covers business arrangements where the franchisor "will exert or has the authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation."
When Is Control or Assistance Significant? The more franchisees reasonably rely upon the franchisor's control or assistance, the more likely the control or assistance will be considered "significant." Franchisees' reliance is likely to be great when they are relatively inexperienced in the business being offered for sale or when they undertake a large financial risk. Similarly, franchisees are likely to reasonably rely on the franchisor's control or assistance if the control or assistance is unique to that specific franchisor, as opposed to a typical practice employed by all businesses in the same industry. Further, to be deemed "significant," the control or assistance must relate to the franchisee's overall method of operation - not a small part of the franchisee's business. Control or assistance involving the sale of a specific product that has, at most, a marginal effect on a franchisee's method of operating the overall business will not be considered in determining whether control or assistance is "significant."
Significant types of control include:
+ site approval for unestablished businesses;
+ site design or appearance requirements;
+ hours of operation;
+ production techniques;
+ accounting practices;
+ personnel policies;
+ promotional campaigns requiring franchisee participation or financial contribution;
+ restrictions on customers; and
+ locale or area of operation.
Significant types of assistance include:
+ formal sales, repair, or business training programs;
+ establishing accounting systems;
+ furnishing management, marketing, or personnel advice;
+ selecting site locations;
+ furnishing systemwide networks and website; and
+ furnishing a detailed operating manual.
To a lesser extent, the following factors will be considered when determining whether "significant control or assistance" is present in a relationship: a requirement that a franchisee service or repair a product (except warranty work); inventory controls; required displays of goods; and on-the-job assistance with sales or repairs.
REQUIRED PAYMENT
The FTC interprets the term "payment" broadly, capturing all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to associate with the franchisor, market its goods or services, and begin operation of the business. Often, required payments go beyond a simple franchisee fee, entailing other payments that the franchisee must pay to the franchisor or an affiliate by contract - including the franchise agreement or any companion contract. Required payments may include:
+ initial franchise fee;
+ rent;
+ advertising assistance;
+ equipment and supplies (including such purchases from third parties if the
franchisor or its affiliate receives payment as a result of the purchase);
+ training;
+ security deposits;
+ escrow deposits;
+ non-refundable bookkeeping charges;
+ promotional literature;
+ equipment rental; and
+ continuing royalties on sales.
Payments which, by practical necessity, a franchisee must make to the franchisor or affiliate also count toward the required payment. A common example of a payment made by practical necessity is a charge for equipment that can only be obtained from the franchisor or its affiliate and no other source.
Wholesale Inventory Exemption
The "payment" element of the franchise definition does not include "payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease." "Reasonable amounts" means amounts not in excess of those that a reasonable businessperson normally would purchase for a starting inventory or supply, or to maintain an ongoing inventory or supply. The inventory exemption, however, does not include goods that a franchisee must purchase for its own use in the operation of the business, such as equipment or ordinary business supplies.
REMEDIES AVAILABLE TO PURCHASERS OF DISGUISED FRANCHISES
Courts have held that the Franchise Rule does not provide a direct remedy to franchisees. However, actions have been brought against franchisors for violations of the Franchise Rule under state "little FTC acts," or unfair trade or business practices acts which incorporate the Federal Trade Commission Act. The remedies available under these acts vary from state to state. Some are limited to rescission and restitution, while others allow a plaintiff to be awarded damages, and in some cases the trebling of damages, costs and attorneys' fees. Additionally, it is important to remember that franchisees or persons who entered into license agreements without proper disclosure, may have remedies under their respective states' franchise laws. Such remedies can include rescission, actual damages, the trebling of damages, attorney's fees, and costs of litigation.
Please consult a seasoned Franchise Law Attorney or lawyer to determine if your "license" arrangement, is, in fact, a disguised franchise (i.e., a "duck").
Steve Lubet kindly sent me his new book entitled "Lawyers' Poker: 52 Lessons that Lawyers Can Learn from Card Players", after we had a lively exchange about the:
a) the value of slow play at poker, and;
b) what trial advocacy lessons can be learned from a sophisticated analysis of poker play.
I was pleasantly surprised with well how this book worked.
My concern was that I would find two interesting books: a) one on trial advocacy, and b) another on poker analysis; and that the two parts would wear out each other like sandpaper and wood, contributing only a fine dust.
Prior to reading the book, I thought it unlikely that an analysis of poker strategies would provide insightful analogies to trial advocacy skills, skills that could not be obtained direct inspection.
What do poker players have in common with trial lawyers, anyways?
Succinctly, each has to solve the game theoretic question:
"if he knows, that I know that he knows ...".
The poker player has to solve this problem in connection with what the other players believe they know about his hand, what he believes they know about what he believes about their hands, and other various permutations.
(You could try your luck here, playing Texas Hold 'Em
)
The trial lawyer has to solve this problem in connection with what the cross-examination witness believes what the lawyer knows about the facts, what the lawyer believes the cross-examination witness knows about the facts, and what the cross-examination witness believes about what the lawyer believes that the cross-examination witness knows about the facts, and other various permutations.
The poker player is at advantage since there is a set of facts which will soon be revealed: at trial, there are no sets of facts to be revealed until the Judge determines what facts there were.
If analogical explanations work, as a opposed to direct explanations, then the analogy must provide a quicker access to the problem.
One might complain, and this would be a superficial complaint, that the trial examples must be easier to understand than the poker examples because we are all potential jurors, but few of us are potential poker champions.
For example, in the beginning of the chapter on "Controlling the Opposition", Lubet describes the Johnny Cochrane gambit at the O.J. trial and the infamous glove scene and compares it with an example of "slow play".
After reading the two together, I was intially puzzled.
I understood Cochrane's move, but I really had to work hard at understanding the poker gambit.
How as a lawyer could I learn a trial advocacy point from a difficult poker problem, when I comprehended the trial example directly?
But, after working through the poker example, I realized that I had only superficially understood the trial advocacy gambit, and not appreciated all of the elements and what Christopher Draden should have been wary of.
Let me first review the poker example on slow play on pages 86 to 87, hardcover version.
WARNING- THIS NEXT BIT IS HARD.
Lubet recounts the story of Monty, a player who played hands only on their expected value, against a fellow named Solcum, a wealthy banker's son.
They were playing 5 card draw, one hidden card and four exposed cards, with four rounds of betting.
Round 1: M: Shows 7 S: Shows 7
M bets $5
Round 2: M: Shows 7 7 S: Shows 7 A
M bets $10, S raises $20,
and M calls.
Round 3: M: Shows 7 7 5 S: Shows 7 A 10
M checks, S bets $50, and
M calls.
Round 4: M: Shows 7 7 5 Q S: Shows 7 A 10 10
S bets $100, but M raises $1500.
What would you think that if you were S and your hidden or hole card was an A, giving you the highest possible two pair?
How would you analyze what M's bet was telling you? Assume that M and S know that it is not possible for S's hole card to be a 10, since the two other tens had shown.
Think carefully.
Well, I would react, and not think, that M had picked up his queen and had queens and sevens, which would lose to my aces and tens.
I would rationalize that M bet small and didn't raise because he feared but didn't know I had an Ace, but when M hit his big cards, he beat big.
I would call the raise and rake in the pot.
And, I would lose, because M had the last 7.
I lost because I looked only at the last round of betting to see what "information" it revealed.
I probably heavily discounted the possibility that M had the last 7, and so "knew" I had a lock. (In case it isn't obvious, I am dead poor average player in a good game.)
What did the betting in round 2 show, given that M only plays on with hands that he has an advantage with?
If S knew that M knew that S's hole card was an A, should S believe that M would fold? Yes.
And M didn't fold or bark in the night.
Therefore, M had a hand that beat a pair of Aces, in round 2.
The only hand possible was three sevens.
But would you have been disciplined enough to fold your hidden pair of Aces? Not me.
Turn to the trial problem. Should have Christopher Draden known that Johnny Cochrane knew that glove wasn't going to fit?
Don't know - but the point of the poker example, having worked it through, is this: did Christopher Draden ever stop to question whether Johnny Cochrane could know that the glove wasn't going to fit?
Not such a stretch, when you ask the question. What did Cochran know about the glove, given his daily interactions with accused? Darden should have stopped to think about the relative asymmetry in knowledge, made a few deductions, before forcing the play on.
That knowledge is worth the price of buying the book, Lawyers' Poker: 52 Lessons that Lawyers Can Learn from Card Players
CITATION: Quizno's Canada Restaurant Corporation v. 2038724 Ontario Ltd., 2010 ONCA 466 |
DATE: 20100624 |
DOCKET: C51028 |
COURT OF APPEAL FOR ONTARIO |
Armstrong, Blair and Juriansz JJ.A. |
BETWEEN |
Quizno's Canada Restaurant Corporation, Quiz-Can LLC, The Quizno's Master LLC, Gordon Food Service, Inc. and GFS Canada Company Inc. |
Appellants (Defendants) |
and |
2038724 Ontario Ltd. and 2036250 Ontario Inc. |
Respondents (Plaintiffs) |
Proceedings under the Class Proceedings Act, 1992 |
J. D. Timothy Pinos, Geoffrey B. Shaw and Eunice Machado, for the appellant Quizno's Canada Restaurant Corporation, Quiz-Can LLC and The Quizno's Master LLC |
Katherine L. Kay and Mark E. Walli, for the appellant Gordon Food Service, Inc. and GFS Canada Company Inc. |
David Sterns, Allan D. J. Dick and Sam O. Hall, for the respondent 2038724 Ontario Ltd. and 2036250 Ontario Inc. |
Heard: January 27, 2010 |
On appeal from the Order of Justices K. Swinton, P. Hennessy and A. Karakatsanis of the Superior Court of Justice, sitting as the Divisional Court, dated April 27, 2009. |
ARMSTRONG J.A.:
INTRODUCTION
[1] Quizno's Canada Restaurant Corporation, Quiz-Can LLC, The Quizno's Master LLC (collectively "Quiznos"), Gordon Food Service, Inc. and GFS Canada Company Inc. (collectively "GFS") appeal from the order of the Divisional Court dated April 27, 2009, which conditionally certified the within action as a class proceeding.
[2] Quiznos is the franchisor of a chain of some 427 fast food restaurants located across Canada. GFS is the distributor of food and other supplies to Quiznos restaurants. GFS operates through five affiliated companies, which distribute products to Quiznos restaurants through eight distribution centres across the country.
[3] The respondents are two former Quiznos franchisees in Ontario, who seek to represent a class of all Canadian Quiznos franchisees in business on or after May 12, 2006.
[4] The essence of the dispute between Quiznos and the franchisees is that the franchisees allege that they have been charged exorbitant prices for food and other supplies they purchase for use in their restaurants. Against GFS, it is alleged that they have engaged in a civil conspiracy with Quiznos in which they aided and abetted a price maintenance scheme.
[5] In the Superior Court, Perell J. dismissed the motion for an order certifying the action as a class proceeding. The Divisional Court reversed the motion court judge.
THE FACTS
[6] The Quiznos franchise system was established in the United States 25 years ago and commenced operation in Canada in 2001. The relationship between Quiznos and the franchisees is governed by a standard form franchise agreement.
[7] The Quiznos system requires the franchisees to offer common menu items made from uniform supplies. There is a common operating manual and common advertising. The franchisees may not sell at prices which exceed prices mandated by Quiznos. Franchisees pay royalties of 7 per cent on gross sales.
[8] The franchisees are required to purchase all equipment, products, services, supplies and materials from common sources or from sources with common ownership, which are designated by Quiznos. Quiznos has designated GFS to sell and distribute a full line of products including meats, produce, frozen foods, dairy goods, paper and cleaning chemicals to the franchisees in Ontario. Quiznos has designated four companies affiliated with GFS to sell and distribute supplies to franchisees in the rest of Canada.
[9] The franchisees allege that Quiznos, aided by GFS, has established a price maintenance scheme in which large sums of money are extracted from the franchisees from the sale of supplies. It is alleged that prices paid by the franchisees pursuant to this scheme are inflated and commercially unreasonable.
[10] As a result of the alleged price maintenance scheme, the franchisees further allege:
(a) They have been denied the ability to negotiate lower prices of supplies with the GFS defendants and other suppliers.
(b) They have been hindered, prevented or denied the opportunity to source identical supplies from other suppliers.
(c) They have been hindered, prevented or denied the opportunity to compete equitably with competitors whose prices are not unlawfully enhanced, fixed and maintained.
(d) They have experienced declining profitability, or are suffering losses, including unsustainable losses, which, if unabated, will result in irreparable harm including, inter alia, loss of total investment by some Class Members.
[11] The franchisees assert three causes of action:
(i) breach of the price maintenance provisions of the Competition Act, R.S.C. 1985, c. C-34;
(ii) conspiracy among the defendants (appellants) to fix prices; and
(iii) breach of contract
[12] Section 61(1)(a) of the Competition Act provides:
(1) No person who is engaged in the business of producing or supplying a product...shall, directly or indirectly...
(a) by agreement, threat, promise or any like means, attempt to influence upward, or to discourage the reduction of, the price at which any other person engaged in business in Canada supplies or offers to supply or advertises a product within Canada...
[13] The franchisees claim against the Quiznos defendants:
(a) compensation and damages in the amount of $75 million for conduct that is contrary to s. 61(1) of theCompetition Act;
(b) an interim, interlocutory and permanent injunction preventing Quiznos and GFS from engaging in the price maintenance scheme;
(c) $75 million for breach of contract including breach of the common law duty of good faith; and
(d) an amount equal to the full investigative costs of the plaintiffs and the plaintiff class, pursuant to s. 36 of theCompetition Act.
[14] The franchisees claim against Quiznos and GFS:
(a) damages in the amount of $75 million for civil con-spiracy;
(b) punitive, exemplary and/or aggravated damages in an amount to be determined by the court.
THE MOTION COURT DECISION
[15] There were two motions before the motion court: a motion by the franchisees to certify the action as a class proceeding pursuant to theClass Proceedings Act, 1992, S.O. 1992, c. 6 and a motion by Quiznos to stay the action. Only the certification motion is in issue in this appeal.
[16] Section 5(1) of the Class Proceedings Act provides:
5. (1) The Court shall certify a class proceeding on a motion under section 2, 3 or 4 if,
(a) the pleadings or the notice of application discloses a cause of action;
(b) there is an identifiable class of two or more persons that would be represented by the representative plaintiff or defendant;
(c) the claims or defences of the class members raise common issues;
(d) a class proceeding would be the preferable proce-dure for the resolution of the common issues; and
(e) there is a representative plaintiff or defendant who,
(i) would fairly and adequately represent the interests of the class,
(ii) has produced a plan for the proceeding that sets out a workable method of advancing the proceeding on behalf of the class and of notifying class members of the proceeding, and
(iii) does not have, on the common issues for the class, an interest in conflict with the interests of other class members.
[17] In respect of s. 5(1)(a) of the Class Proceedings Act the motion judge concluded that the statement of claim disclosed causes of action for breach of s. 61 of the Competition Act, breach of contract and civil conspiracy. The motion judge also found that "all persons, including firms and corporations, carrying on business in Canada under a Quiznos franchise agreement on or after May 12, 2006" with a slight alteration (the date for closure of the class membership) was an identifiable class as required by s. 5(1)(b) of the Class Proceedings Act.
[18] The motion judge's refusal to certify this case as a class proceeding turned on his analysis of the proposed common issues pursuant to s. 5(1)(c) of the Class Proceedings Act. The franchisees proposed the following common issues before the motion judge:
(a) Have the Quiznos defendants, or any of them, engaged in conduct contrary to Section 61(1) of theCompetition Act?
(b) Have the defendants, or any of them, engaged in conduct that amounts to civil conspiracy?
(c) (Issue deferred)
(d) Have the Quiznos defendants, or any of them, engaged in conduct which constitutes a breach of their contractual obligations to the Class Members?
(e) Have the Class Members suffered loss or damage as a result of any of the conduct referred to in issues a, b, c, or d? If so, what is the appropriate measure or amount of such loss or damages?
(f) Should the court award an aggregate assessment of monetary relief on behalf of some or all class members? If so, what is the amount of the aggregate assessment and how should the class members share in the award?
(g) Should the defendants pay punitive, exemplary or aggravated damages to the Class Members? Should such damages be assessed in the aggregate? If so, what is the amount of such damages including pre- and post-judgment interest thereon?
(h) Are the Class Members entitled to recover from the Quiznos defendants the full costs of their investigations and the full costs of this proceeding, including contingent legal fees on a complete indemnity basis, under section 36(1) of the Competition Act?
[19] As is often the case in certification motions, the problem for the franchisees before the motion judge was the issue of damages. The appellants argued that because damages constitute an individual issue for each franchisee it was not appropriate to be treat them as a common issue.
[20] The franchisees tendered the evidence of an economist, Dr. Andy Baziliauskas, in respect of the damages issue. Dr. Baziliauskas testified that the quantum of the over-charge from the alleged price maintenance conspiracy could be calculated by taking the difference between the prices paid by the franchisees and the prices they would have paid but for the price maintenance conspiracy. The economist testified that actual prices would be available from the financial records of the parties and the "but for" prices could be taken from industry data. Thus, the difference between actual prices and "but for" prices could be applied on a class wide basis to prove damages.
[21] The appellants argued that actual prices would vary on a class wide basis because of a number of variables including: whether the supplies are purchased outside of the authorized distribution system, whether the franchisee qualifies for a rebate, individual credit terms, waste, employee theft and sharing among franchisees.
[22] The appellants also argued that "but for" prices would vary on a class wide basis because of circumstances particular to individual franchisees such as location, financial capacity and purchasing power.
[23] The appellants relied on their own expert economist, Dr. Roger Ware, who testified that the impact of the alleged price maintenance scheme would have to be assessed on an individual franchise and product by product basis across the country. The motion judge summarized the expert opinions as follows:
[112] Thus, relying on the critique of Dr. Ware, the Defendants disputed Dr. Baziliauskas' opinion that that (sic) there were three methodologies for extrapolating "but for" prices on a class-wide basis; namely: (1) by using "benchmark prices," which are prices paid for substantially similar products purchased by a comparator coalition of buyers where there is no price maintenance agreement between the franchisor and its distributor; (2) by using a "servicing fee" analysis, which is to take the difference between the sourcing and mark-ups charged under the distribution agreement under which GFS-Canada supplied goods and the fees charged by other franchisors in similar circumstances but where there is no price maintenance; and (3) by using a "before and after comparison," which is to compare the prices charged to the Quiznos franchises before and after the purported price maintenance began.
[113] I agree with the criticism of the Defendants that: (a) Dr. Baziliauskas has not shown that a comparator group of franchisees or a comparator franchisor can be identified; (b) he has not explained how it could be determined that a comparator group of franchisees was paying for product free of price maintenance by its franchisor; and (c) with respect to the before and after methodology, he has not shown that there was or that it could be determined that there was a time before price maintenance began. In my opinion, these omissions make his three methodologies conceptually unsound and not feasible to measure a class-wide impact of price maintenance.
[24] On the basis of the above, the motion judge concluded that it was not shown by the franchisees that their damages, if any, could be proven in the aggregate on a class wide basis.
[25] Having disposed of damages, the motion judge turned to the other common issues advanced by the franchisees in para. 115 of his reasons:
This conclusion removes proposed common issue (f) [aggregate assessment of damages] as a common issue and has the effect of an avalanche that buries the proposed common issues with an absence of commonality and a proliferation of individual issues. Thus, for instance, pro-posed common issues (a) and (b) above (namely: (a) Have the Quiznos Defendants, or any of them, engaged in conduct contrary to section 61(1) of the Competition Act? And (b) Have the Defendants, or any of them, engaged in conduct that amounts to civil conspiracy?) depend upon showing: individual instances of price maintenance; individual instances of suffering loss in the "but for" world in order to measure the impact of losses; and individual claims of damages for the tort of conspiracy. Similarly, proposed common issues (d), and (e) are individual not common issues. Proposed common issues (g) and (h) have commonality but, standing alone, they would not sufficiently advance the litigation to qualify as common issues.
[26] The franchisees relied on ss. 23(1) and 24(1) of the Class Proceedings Act, which they claimed assisted them in establishing a common issue in respect of damages. Sections 23(1) and 24(1) provide:
Statistical evidence
23.(1) For the purposes of determining issues relating to the amount or distribution of a monetary award under this Act, the court may admit as evidence statistical information that would not otherwise be admissible as evidence, including information derived from sampling, if the information was compiled in accordance with principles that are generally accepted by experts in the field of statistics.
Aggregate assessment of monetary relief
24. (1) The court may determine the aggregate or a part of a defendant's liability to class members and give judgment accordingly where,
(a) monetary relief is claimed on behalf of some or all class members;
(b) no questions of fact or law other than those relating to the assessment of monetary relief remain to be determined in order to establish the amount of the defendant's monetary liability; and
(c) the aggregate or a part of the defendant's liability to some or all class members can reasonably be determined without proof by individual class members.
[27] The motion judge found that neither section was of any help to the franchisees. He was of the view that s. 23(1) related to the distribution of damages and had nothing to do with the determination of the entitlement to damages. He further concluded that s. 24(1) "provides a method to assess the quantum of damages on a global or aggregate basis, but not the fact of damage".
[28] Following from the above analysis, the motion judge concluded that a class proceeding would not be the preferable procedure for the resolution of the proposed common issues as required by s. 5(1)(d) of the Class Proceedings Act.
[29] Finally, the motion judge concluded, in accordance with s. 5(1)(e) of the Class Proceedings Act, that the two named franchisees are satisfactory representative plaintiffs subject to the filing of a better litigation plan.
[30] In the result, the motion for certification was dismissed.
THE DIVISIONAL COURT DECISION
[31] Hennessy and Karakatsanis J.J., for the majority, would have allowed the appeal from the decision of the motion judge. Swinton J., in dissent, would have dismissed the appeal.
[32] The majority concluded that the motion judge erred in focusing solely on the damages issue and failed to consider the other proposed common issues. The majority said at paragraph 45 of their reasons:
In our view, whether one of the proposed common issues is overwhelmed or buried by the individual issues is part of the analysis for the preferable procedure criterion, but is not necessarily determinative of the common issues requirement. The remaining proposed common issues ought to have been analysed.
The majority stated further at para. 47 of their reasons:
We are satisfied that the motions judge erred in principle by focusing on proof of damages and failing to consider and identify other common issues. Even if the motions judge made no reversible error with respect to his assessment that the expert evidence provided no basis in fact to prove damages on a class wide basis, he erred in failing to consider whether there was some other basis in fact to find that breach of s. 61 of the Competition Act, breach of contract, and the existence of loss on a class wide basis were common issues.
[33] The majority proceeded to a detailed analysis of the proposed common issues, (a), (b), (d), (e) and (f). The majority concluded that these issues had a sufficient number of common elements to provide the basis for the certification of the class proceeding.
[34] The majority also concluded that the motion judge erred in finding that s. 24 of the Class Proceedings Act would not be available to determine aggregate damages at trial and he erred in finding that a class proceeding would not be the preferable procedure for the resolution of the common issues.
[35] The dissenting judge concluded that the motion judge came to the right result. In her overview of the case she said at paras. 155 and 156:
[155] I agree with the majority that a motions judge hearing a certification motion must ask whether there are any common issues, and then determine whether they are a substantial part of each class member's claims. In my view, that is what the motions judge did here, although his reasons might have been more detailed in order to illustrate his reasoning process more clearly.
[156] However, even if he erred in the way in which he approached the common issues as the majority finds, I see no basis to interfere with his conclusion that a class proceeding is not the preferable procedure. He applied the correct legal principles, made no palpable and overriding errors of fact, and exercised his discretion based on the pleadings and evidence before him. Therefore, I would dismiss the appeal.
THIS APPEAL
[36] The appellants raise the following grounds of appeal:
(i) The Divisional Court majority applied the wrong standard of review.
(ii) The majority erred in finding that s. 61(1) of the Competition Act is a common issue.
(iii) The majority erred in finding that the conspiracy claim is a common issue.
(iv) The majority erred in finding that the breach of contract claim is a common issue.
(v) The majority erred in finding that ss. 23 and 24 of the Class Proceedings Act can be used to determine the damages.
(vi) The majority erred in interfering with the motion judge's discretionary decision that a class action is not the preferable procedure for this case.
ANALYSIS
(i) The Standard of Review
[37] It is clear from the majority's reasons that they understood their role as an appellate court. The majority recognized that a decision of a motion judge on certification is entitled to considerable deference. See Anderson v. Wilson (1999), 44 O.R. (3d) 673 (C.A.) at 677 andCassano v. The Toronto Dominion Bank (2007), 87 O.R. (3d) 401 (C.A.). However, as stated by Winkler C.J.O. in Cassano at para 23, "[L]egal errors by the motion judge on matters central to a proper application of s. 5 of the CPA displace the deference usually owed to the certification motion decision..."
[38] The appellants submit that the Divisional Court majority erred in concluding that the motion judge failed to consider all the proposed common issues and then further erred in assuming original jurisdiction to decide those issues. I disagree. In my view, the majority correctly concluded that the focus of the motion judge's reasons was on the issue of damages, which he found overwhelmed the remaining proposed common issues. While he referred to the other issues in passing, there was effectively no independent analysis of those issues by the motion judge, which constitutes the kind of error that attracts the intervention of an appellate court.
(ii) The Competition Act Claim
[39] The relevant sections of the Competition Act are:
Section 36
(1) Any person who has suffered loss or damage as a result of
(a) conduct that is contrary to any provision of Part VI, or
(b) the failure of any person to comply with an order of the Tribunal or another court under this Act,
may, in any court of competent jurisdiction, sue for and recover from the person who engaged in the conduct or failed to comply with the order an amount equal to the loss or damage proved to have been suffered by him, together with any additional amount that the court may allow not exceeding the full cost to him of any investigation in connection with the matter and of proceedings under this section.
Section 61
(1) No person who is engaged in the business of producing or supplying a product, who extends credit by way of credit cards or is otherwise engaged in a business that relates to credit cards, or who has the exclusive rights and privileges conferred by a patent, trade-mark, copyright, registered industrial design or registered integrated circuit topography, shall, directly or indirectly,
(a) By agreement, threat, promise or any like means, attempt to influence upward, or to discourage the reduction of, the price at which any other person engaged in business in Canada supplies or offers to supply or advertises a product within Canada; or
(b) Refuse to supply a product to or otherwise discriminate against any other person engaged in business in Canada because of the low pricing policy of that other person.
I should note that s. 61 of the Competition Act was repealed on July 13, 2009.
[40] As indicated, the majority in the Divisional Court was critical of the motion judge for his focus on the problems associated with the proof of damages. The majority concluded that the appropriate common issue was the breach of s. 61(1) of the Competition Act and that such breach "may be approached in a number of ways".
[41] The majority's detailed analysis of s. 61(1) of the Competition Act issue is found at paras. 51 - 75 of their reasons. I find it unnecessary to repeat that analysis here.
[42] The Divisional Court correctly concluded that breach of s. 61(1) of the Competition Act does not require proof of loss or damage. Likewise it does not, as alleged by the appellants, require detailed analysis of the prices paid for each product by each franchisee and the prices each franchisee would have paid but for the alleged maintenance agreements. The section is aimed at attempts to maintain prices. Loss of profit or damages is not a constituent element.
[43] I accept the submission of the appellants that for the franchisees to succeed in their Competition Act claim, s. 61(1) must operate in combination with s. 36(1) of the act, which requires proof of loss or damage. That said, it does not detract from the conclusion that a breach of s. 61 is itself an appropriate common issue, which advances the litigation.
[44] I am in agreement with the majority's conclusions in the following paragraphs from their reasons for judgment:
[67] We agree with the appellants' submission that a 'top down' approach focusing on the arrangement between the franchisor, the distributor and the suppliers, and the nature and amounts of the sourcing fees and mark-ups, may allow the court to determine whether the mark-ups and sourcing fees resulted in maintaining prices contrary to s. 61(1). This may ultimately allow the court to determine whether s. 61(1) was breached without the need to establish what each individual franchisee, acting alone, would pay for each product from an alternate supplier.
[68] Whether or not evidence is available of prices before and after the distribution agreement or comparable industry practices need not be shown at the certification stage. The requirement that there be some basis in fact to support the common issues does not require the plaintiffs to indicate the evidence to be advanced at the certification stage, nor does it determine the admissibility of evidence.
[70] If the court is satisfied that the Quiznos respondents imposed sourcing fees and mark-ups by way of the distribution agreement in an attempt to influence upwards the prices paid by the appellant franchisees, and that the pricing scheme resulted in a breach of s. 61(1), a substantial ingredient of liability under s. 36 of the Competition Actcan be proven on a class wide basis. This will advance the claim of each member of the class, and avoids the duplication of the legal analysis involved in determining this question. Alternatively, a finding that the distribution agreement did not amount to price maintenance will resolve the litigation relating to both the Competition Act and the civil conspiracy claim.
[Emphasis in the original.]
[45] To the above, I would add that it is unnecessary at this stage to engage in the debate about the relative strengths and weaknesses of the expert evidence.
(iii) The Conspiracy Claim
[46] As already noted, apart from the claims for punitive and exemplary damages, the conspiracy claim is the only claim that includes GFS. The franchisees allege that price maintenance agreements pleaded in respect of the claim advanced under s. 61(1) and 36(1) of the Competition Actsupport a claim for the tort of civil conspiracy. Paragraphs 62 and 63 of the Amended Amended Statement of Claim provide:
62. By entering into the Price Maintenance Agreements, and acting in furtherance of such agreements, each of the defendants entered into unlawful and tortious conspiracies to use unlawful means directed at the Class Members, knowing fully that their agreements and actions would cause injury to the Class Members, which injury has in fact resulted to the Class Members.
63. Furthermore, pursuant to the Price Maintenance Agreements and the acts particularized in paragraphs 31 to 42 hereof, the GFS companies have knowingly aided, abetted and counselled the Quiznos defendants in maintaining the prices at which the GFS companies have supplied or offered to supply products and supplies to the Class Members, which price maintenance is contrary to section 61(1) of the Competition Act and which aiding, abetting and counselling is contrary to sections 21 and 22 of the Criminal Code, R.S.C. 1985, c. C-46.
[47] As in the case of the s. 61(1) claim, the motion judge dismissed the conspiracy claim as a proposed common issue on the basis that it would be overwhelmed by the damages issue, which could not be established on a class wide basis.
[48] The Divisional Court in its analysis held that to succeed on the conspiracy claim, the appellants must prove the following elements:
1. that the respondents entered into an agreement (to permit the Quiznos respondents to enhance, fix and maintain prices to be paid by the class members contrary to s. 61 of the Competition Act);
2. that the GFS respondents' conduct (aiding and abetting price maintenance by the Quiznos respondents) is unlaw-ful;
3. that the respondents acted in furtherance of the agree-ment;
4. that the respondents should have known that the conspiracy would likely cause serious harm to the class members by forcing them to pay inflated prices for the goods; and
5. that the conspiracy has caused damage to the class members.
[49] The Divisional Court majority concluded at para. 81 of their reasons:
Given our conclusion that the fact of loss on a class wide basis is a common issue, we are satisfied that whether the respondents engaged in a civil conspiracy is a common issue. However, even in the absence of proof of the fact of loss, the first four constituent elements of conspiracy are common issues that would advance each franchisee's claim and avoid duplication of fact finding and legal analysis.
I agree with the Divisional Court's conclusion.
(iv) The Breach of Contract Claim
[50] The motion judge also disposed of the breach of contract claim as a proposed common issue on the basis that the claim for damages of $75 million arising from the breach would not permit the claim to proceed on a class wide basis.
[51] The Divisional Court majority concluded that the Quiznos appellants "are alleged to have breached certain sections of the franchise agreements by failing to ensure that its franchisees are obtaining 'commercially reasonable prices' for supplies".
[52] The Divisional Court majority was of the view that there were a number of contractual issues for determination on a class wide basis, which would advance the litigation including:
(a) the meaning of the contract provisions;
(b) the existence and nature of any common law duty of fairness; and
(c) whether the Quiznos respondents have breached a contract provision in failing to provide specifications.
[53] As in respect of the Competition Act claim and the conspiracy claim, the appellants argue that the contract claims are highly individualistic and are not conducive to a determination on a class wide basis. I am not persuaded. I accept the Divisional Court majority's conclusion at para. 93:
Based on the foregoing, we find that a significant number of factual and legal issues, integral to the breach of contract claim, are common issues. These represent substantial ingredients of the breach of contract claim that could advance the claim of each class member and will avoid duplication of fact-finding or legal analysis.
(v) Sections 23 and 24 of the Class Proceedings Act
[54] The appellants submit that the Divisional Court majority employed s. 23 to alter the constituent elements of the alleged causes of action by permitting the franchisees to establish damages on statistical probabilities or percentages. The appellants further submit that the court's right to make an aggregate assessment under s. 24(1) is only available after some liability and some entitlement are established - s. 24 merely provides a method to assess the quantum of damages on an aggregate basis.
[55] In my view, the appellants have mischaracterized the approach that the majority of the Divisional Court took in the application of ss. 23 and 24. The majority clearly recognized that s. 24 is procedural and cannot be used in proving liability. However, they observe that a breach of s. 61(1) of the Competition Act and liability for breach of contract can be established without proof of loss. The majority concluded at para. 123:
In this case, the appellants seek declaratory relief. We have found that liability for breach of the Competition Act and liability for breach of contract are common issues. Given our conclusions, ss. 23 and 24 of the CPA may be available at the common issues trial to determine damages on an aggregate basis.
[56] The judgment of this court in Cassano is supportive of the approach taken by the majority. Cassano involved an action against the TD Bank by the proposed class action plaintiff for alleged manipulation of exchange rates on charges to the plaintiff's Visa bill. At para. 38, Winkler C.J.O., writing for the court, said:
In my view, this is a case where the common issues trial judge could find, based on a review of the evidence, that it is appropriate to conduct an aggregate assessment of monetary relief under s. 24 of the CPA, as was contemplated by this court in Markson, supra. Alternatively, even if the trial judge were to conclude that an aggregate assessment of damages is inappropriate, the nature of the claim asserted is such that the provisions of the CPA might well be utilized so as to make a class proceeding under the statute the "preferable procedure for the resolution of the class members' claims": see Hollick v. Metropolitan Toronto (Municipality), [2001] 3 S.C.R. 158 at para. 29.
The expert evidence before the motion judge goes to the issue of whether the damages can be aggregated as indicated in the above passage, which is an issue to be decided by the common issues trial judge.
[57] Winkler C.J.O. adopted the approach taken by Cullity J. in Vezina v. Loblaw Companies Ltd., [2005] O.J. No. 197 at para. 25 (S.C.J.) and cited by Rosenberg J.A. in Markson v. MBNA Canada Bank (2007), 85 O.R. (3d) 321 (C.A.) at para. 44 to the effect that on a certification motion, a plaintiff is only required to establish that "there is a reasonable likelihood that the preconditions in s. 24(1) of the CPA would be satisfied and an aggregate assessment made if the plaintiffs are otherwise successful at a trial for common issues."
[58] Finally, Winkler C.J.O. at para. 52 of Cassano recognized that the ultimate decision of whether ss. 23 and 24 would be available rested with the trial judge:
Even in the event that a trial judge were not prepared to rely on ss. 24(2) and (3) to fashion a remedial order in this case, I note that the combined operation of ss. 24(4), (5) and (6) of the CPA authorize the court to require that class members submit individual claims in order to give effect to an aggregate award of damages.
[59] I would add to the above that s. 25 of the Class Proceedings Act provides a procedural code for the determination of individual issues as an adjunct to a class proceeding. It is clear that the intent of the act is to accommodate both common issues and individual issues that may arise in a class proceeding.
(vi) The Preferable Procedure
[60] The appellants rely on the reasoning of the motion judge that the proposed class proceeding would not be fair, efficient or manageable because the individual issues "overwhelm" the common issues and the resolution of the common issues would not significantly advance the litigation. I do not agree. If one accepts, as I do, that the motion judge erred in his treatment of the common issues then the rationale for his conclusion that a class proceeding is not the preferable procedure disappears.
[61] In my view, the trial of the common issues in this case will significantly advance the litigation. I agree with the conclusion of the Divisional Court majority that this is the case even if the damages issues cannot be dealt with on a class wide basis.
[62] I am also of the view that a class proceeding in this case will satisfy at least two of the objectives of the Class Proceedings Act of judicial economy and access to justice. It seems to me that this case involving a dispute between a franchisor and several hundred franchisees is exactly the kind of case for a class proceeding.
DISPOSITION
[63] For the above reasons, I would dismiss the appeal.
[64] If the parties cannot agree on costs, we will receive written submissions from counsel for the respondents within 15 days of the release of these reasons limited to 5 pages double spaced. Counsel for the appellants may respond with written submissions within 10 days of the receipt of the respondents' submissions limited to 5 pages double spaced.
RELEASED:
"RPA" "Robert P. Armstrong J.A."
"JUN 24 2010" "I agree R. A. Blair J.A."
"I agree R. G. Juriansz J.A."
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Automobile Cordiale Ltd v. DaimlerChrysler Canada Inc., J.E. 2010?164
From Fraser Milner Casgrain Focus on Franchising
In 1994, Automobile Cordiale Ltd. (the "Franchisee") and DaimlerChrysler Canada Inc. (the "Franchisor") signed a contract relating to the sale and service of Eagle and Jeep vehicles (the "Contract"). The Franchisee was granted the exclusive right to sell and lease Jeep and Eagle vehicles in the city of St-J�r�me.
However, between 1996 and 2003, three automobile dealerships located in or near the city of St?J�r�me, being Giraldeau Inter?Auto Inc., Impact Dodge DaimlerChrysler Inc. and DaimlerChrysler Plymouth de Blainville Ltd. (collectively, the "Dealerships"), sold and leased a significant quantity of Jeep vehicles, although they had no rights with respect to the Jeep banner.
The Dealerships also made warranty repairs on many Jeep vehicles and benefited from the Franchisor's discounts. Although the Franchisee had advised the Franchisor and filed several complaints since 1996 regarding the Dealerships' conduct, no corrective measures were taken by the Franchisor.
During the same period of time, the Franchisor sought to regroup all of its vehicle brands (Dodge, DaimlerChrysler and Jeep) under a single DaimlerChrysler banner. The Franchisee refused to accept this initiative named "Plan Canada 2000" and continued to operate a Jeep Eagle banner dealership with the Franchisor's permission. It must be noted that the Franchisor discontinued Eagle vehicles, thus the Franchisee's claim only concerned Jeep vehicles.
The Franchisor was not bound to protect its brands or to prevent its dealerships from competing with one another, directly or indirectly, under any explicit obligations of the Contract.
The Franchisor was nevertheless bound by implicit contractual obligations resulting from the nature of the Contract, equity, custom and law, to act with loyalty and in good faith at the time the contract was formed, as well as throughout its performance.
The Court concluded that the Franchisor deliberately chose to abandon the Franchisee and left it to face alone the unfair and illegal competition of the Dealerships.
The Franchisor's behaviour can be explained by the implementation of "Plan Canada 2000", which was drawn up in order to eliminate the single banner dealerships, such as the dealership of the Franchisee. The Court further concluded that the prohibited sales and leases made by the Dealerships could not be separated from the warranty repairs from which they benefited.
Therefore, the Franchisor could not on the one hand grant the Franchisee the exclusive right to use a brand in a given territory, and on the other hand, deprive same by omitting to prevent other dealerships from using said brand in an unfair and illegal manner.
The Franchisor was, therefore, in default of its implicit contractual obligations of loyalty and good faith.
