State Farm Agents Seek to Prove Franchisee Relationship with Insurer

Discovery will be completed this month in a lawsuit brought by the National Association of State Farm Agents (NASFA) for breach of contract and violation of franchise laws. The case, which is in the Superior Court for the District of Columbia, has already generated important rulings for franchisors and franchisees about whether the trade association has the standing to sue as a representative of its members, and whether the case should be heard in state or federal court.

In a response to the original lawsuit (which was filed in Baltimore County Court in Baltimore, MD, in December 2001), State Farm argued that: 1) the independent agents do not have standing to sue State Farm as a franchisor; and 2) the case, if it was to be heard, should be heard in federal court. Separate decisions went against State Farm on each issue.

The superior court ruled in October 2002 that NASFA has standing to bring suit for equitable relief and injunctive relief against State Farm (see Business Franchise Guide: CCH, paragraph 12,431). State Farm had moved to dismiss the case on the basis that NASFA, though an association, nevertheless could not fulfill the requirements to sue on behalf of its members; State Farm argued NASFA lacked “representational standing.”

“All parties had agreed that NASFA could not have standing to sue as a representative of the members to seek damages for the members, because that would require the participation of individual members in order to calculate what each agent's damages were,” said Allan Hillman, a Baltimore-based attorney with Neuberger, Quinn, one of two law firms representing NASFA. “But NASFA had not sued for damages. It sued for a declaration of its rights ' in other words, it sought a ruling that certain practices by State Farm were illegal, either as breaches of the Agents' agreements with State Farm, or as violations of the franchise laws of Illinois and other states.”

The major dispute on standing was whether members of an association must “all” support a suit, or whether the action of the Board was the determining factor. The court decided that it would harm the concept of association standing ' a valuable right ' by requiring that all members agree, especially in a situation in which the Board acted unanimously.

State Farm representatives would not return calls to comment for this article, citing the ongoing litigation.

Previously, in May 2002, Judge Cynthia Blake of the U.S. Federal District Court in Baltimore granted NASFA's motion and remanded the case back to Maryland state court (201 F.3d 525 (D. Md. 2002)), after State Farm sought to shift it to federal court. Judge Blake ruled that NASFA be treated as an unincorporated association (not as a corporation) for the purposes of diversity analysis, in determining where the case should be heard. “NASFA's members and not NASFA are the real parties in interest to this controversy,” she wrote. “It is thus the members' citizenship that should be considered for the purpose of determining diversity jurisdiction.”

NASFA is a Washington, D.C. corporation, and has its principal place of business in Maryland. State Farm is an Illinois corporation, and has its principal place of business in Illinois. If NASFA was treated like a typical corporation, there would have been a diversity of citizenship, and State Farm would have been justified in removing the case to federal court.

Encroachment of Agents' Businesses

With the two rulings in its favor, NASFA is now focused on proving its allegations that State Farm unfairly encroached on Agents' businesses by bringing in new representatives (which State Farm called “partners”) to sell additional financial products, such as investments, to clients who were already buying insurance from other State Farm agents.

The Agents charge that the partner program breached their contract with State Farm and could harm their client relationship.

The litigation also may help to clarify the issue of when an independent agent is a franchisee ' an issue that has vexed insurance companies and other corporations. “We are asking the court to declare that the State Farm-agent relationship is a franchise relationship,” said Hillman. “It would be a significant decision if the court finds that NASFA members are franchisees. Some court decisions seem to favor our position, but there has not been a flat-out decision; and there have been some cases that have been ruled adversely to our position. We will be trying to convince the court that those latter decisions were in error.”

State Farm Agents have argued that many of the things they are required to do are, in essence, a franchisee-franchisor relationship. Among other things, they pay to use the State Farm trademark in their advertising and in Yellow Pages ads; they cannot sell insurance products from competing firms; and they contribute to national advertising programs, according to Jerry Beauchamp, NASFA's director of government affairs.

State Farm Agents also receive lesser fees on certain business when they move from being a franchisee to an independent agent. “We're 'captive' agents, which means we get a lower commission than independent agents who can sell anyone's insurance,” said Beauchamp. “We consider this to be a franchise fee.”

For decades, State Farm referred to its agents as franchisees, Beauchamp added. “When I joined with State Farm 40 years ago, I was sold on the presumption that I was getting a franchise. I recently surveyed more than 200 other agents, and about half of them said the same thing … that we were told this was similar to McDonald's,” he said.

In 1997, State Farm modified its agreements with new agents, and began to refer to them exclusively as “independent contractors,” said Beauchamp. “Yes, State Farm has moved away from [using that word] franchise in recent years because, it seems to me, the franchise laws are pretty strict about what a franchisor can and cannot do,” he said. “They call us independent contractors, so we are employed at will; you can't fire a franchisee at will.”

The change that generated the strongest opposition, according to Beauchamp, was the “partnering” program described above that required long-term agents to either get the qualifications to sell investment products or to work with a partner who could sell them. State Farm has disputed NASFA's claim that its agents were required to sell the additional products, but the company has not abandoned the partnering requirement.

After discovery concludes in January, Hillman said that he anticipates that one or both parties will file for summary judgment. If summary judgment is denied, the parties will engage in mandatory mediation and then, if a resolution is not reached, a trial will be held late in 2004 or in 2005.

Discovery will be completed this month in a lawsuit brought by the National Association of State Farm Agents (NASFA) for breach of contract and violation of franchise laws. The case, which is in the Superior Court for the District of Columbia, has already generated important rulings for franchisors and franchisees about whether the trade association has the standing to sue as a representative of its members, and whether the case should be heard in state or federal court.

In a response to the original lawsuit (which was filed in Baltimore County Court in Baltimore, MD, in December 2001), State Farm argued that: 1) the independent agents do not have standing to sue State Farm as a franchisor; and 2) the case, if it was to be heard, should be heard in federal court. Separate decisions went against State Farm on each issue.

The superior court ruled in October 2002 that NASFA has standing to bring suit for equitable relief and injunctive relief against State Farm (see Business Franchise Guide: CCH, paragraph 12,431). State Farm had moved to dismiss the case on the basis that NASFA, though an association, nevertheless could not fulfill the requirements to sue on behalf of its members; State Farm argued NASFA lacked “representational standing.”

“All parties had agreed that NASFA could not have standing to sue as a representative of the members to seek damages for the members, because that would require the participation of individual members in order to calculate what each agent's damages were,” said Allan Hillman, a Baltimore-based attorney with Neuberger, Quinn, one of two law firms representing NASFA. “But NASFA had not sued for damages. It sued for a declaration of its rights ' in other words, it sought a ruling that certain practices by State Farm were illegal, either as breaches of the Agents' agreements with State Farm, or as violations of the franchise laws of Illinois and other states.”

The major dispute on standing was whether members of an association must “all” support a suit, or whether the action of the Board was the determining factor. The court decided that it would harm the concept of association standing ' a valuable right ' by requiring that all members agree, especially in a situation in which the Board acted unanimously.

State Farm representatives would not return calls to comment for this article, citing the ongoing litigation.

Previously, in May 2002, Judge Cynthia Blake of the U.S. Federal District Court in Baltimore granted NASFA's motion and remanded the case back to Maryland state court (201 F.3d 525 (D. Md. 2002)), after State Farm sought to shift it to federal court. Judge Blake ruled that NASFA be treated as an unincorporated association (not as a corporation) for the purposes of diversity analysis, in determining where the case should be heard. “NASFA's members and not NASFA are the real parties in interest to this controversy,” she wrote. “It is thus the members' citizenship that should be considered for the purpose of determining diversity jurisdiction.”

NASFA is a Washington, D.C. corporation, and has its principal place of business in Maryland. State Farm is an Illinois corporation, and has its principal place of business in Illinois. If NASFA was treated like a typical corporation, there would have been a diversity of citizenship, and State Farm would have been justified in removing the case to federal court.

Encroachment of Agents' Businesses

With the two rulings in its favor, NASFA is now focused on proving its allegations that State Farm unfairly encroached on Agents' businesses by bringing in new representatives (which State Farm called “partners”) to sell additional financial products, such as investments, to clients who were already buying insurance from other State Farm agents.

The Agents charge that the partner program breached their contract with State Farm and could harm their client relationship.

The litigation also may help to clarify the issue of when an independent agent is a franchisee ' an issue that has vexed insurance companies and other corporations. “We are asking the court to declare that the State Farm-agent relationship is a franchise relationship,” said Hillman. “It would be a significant decision if the court finds that NASFA members are franchisees. Some court decisions seem to favor our position, but there has not been a flat-out decision; and there have been some cases that have been ruled adversely to our position. We will be trying to convince the court that those latter decisions were in error.”

State Farm Agents have argued that many of the things they are required to do are, in essence, a franchisee-franchisor relationship. Among other things, they pay to use the State Farm trademark in their advertising and in Yellow Pages ads; they cannot sell insurance products from competing firms; and they contribute to national advertising programs, according to Jerry Beauchamp, NASFA's director of government affairs.

State Farm Agents also receive lesser fees on certain business when they move from being a franchisee to an independent agent. “We're 'captive' agents, which means we get a lower commission than independent agents who can sell anyone's insurance,” said Beauchamp. “We consider this to be a franchise fee.”

For decades, State Farm referred to its agents as franchisees, Beauchamp added. “When I joined with State Farm 40 years ago, I was sold on the presumption that I was getting a franchise. I recently surveyed more than 200 other agents, and about half of them said the same thing … that we were told this was similar to McDonald's,” he said.

In 1997, State Farm modified its agreements with new agents, and began to refer to them exclusively as “independent contractors,” said Beauchamp. “Yes, State Farm has moved away from [using that word] franchise in recent years because, it seems to me, the franchise laws are pretty strict about what a franchisor can and cannot do,” he said. “They call us independent contractors, so we are employed at will; you can't fire a franchisee at will.”

The change that generated the strongest opposition, according to Beauchamp, was the “partnering” program described above that required long-term agents to either get the qualifications to sell investment products or to work with a partner who could sell them. State Farm has disputed NASFA's claim that its agents were required to sell the additional products, but the company has not abandoned the partnering requirement.

After discovery concludes in January, Hillman said that he anticipates that one or both parties will file for summary judgment. If summary judgment is denied, the parties will engage in mandatory mediation and then, if a resolution is not reached, a trial will be held late in 2004 or in 2005.