Court Watch

Failure to Register Franchise in Illinois Renders Franchise Agreement Invalid

The Appellate Court of Illinois has affirmed a lower court decision ruling that a franchise agreement including its arbitration provisions was not binding on the franchisee because the franchisor sold the franchise in Illinois without registering its UFOC with the Illinois Attorney General's Office. The arbitration provision of the franchise agreement was therefore unenforceable. Jensen v. Quik International, 801 N.E.2d 1124 (Ill. App. Ct. 2003).

On July 3, 2002, Jensen entered into a franchise agreement with Quik International (“Quik”) that granted Jensen the right to operate a franchise in Illinois. The franchise agreement provided that all disputes between the parties would be submitted to binding arbitration. Sometime after the agreement was signed, Quik advised Jensen that its sale of the franchise to him was in violation of the Illinois Franchise Disclosure Act (“IFDA”) because Quik's franchise registration had expired at the time of the sale. Quik advised Jensen that he had the right to rescind the franchise agreement and/or sue for damages.

On April 24, 2003, Jensen filed a complaint against Quik and its CEO and president, alleging various violations of the IFDA. Quik filed a motion to stay the case pending arbitration in accordance with the arbitration provision in the franchise agreement. It also filed a separate arbitration demand pursuant to the Federal Arbitration Act (“FAA”). Jensen then filed a cross-motion to stay the arbitration.

In support of its motion to stay the case and compel arbitration, Quik admitted that it violated the IFDA. However, it maintained that the parties were still required to arbitrate their dispute pursuant to the FAA. Jensen, on the other hand, relying on the Illinois Appellate Court's earlier decision in Barter Exchange, Inc. of Chicago v. Barter Exchange, Inc., 606 N.E.2d 186 (Ill. App. 3d 1992), claimed that because the franchisor failed to register to sell its franchises in the state of Illinois, the franchise agreement and its arbitration provision was not binding on him. Quik countered that Barter Exchange was decided under Illinois' Uniform Arbitration Act and not the FAA. According to Quik, the FAA supersedes state law, including the IFDA. The trial court ruled in Jensen's favor.

On appeal, the appellate court affirmed the trial court's decision. It found that Quik's attempts to distinguish Barter were “misguided.” It noted that Quik's registration was a condition precedent to the contract that was never satisfied. Therefore, according to the appellate court, the franchise agreement and its arbitration provision were unenforceable. Interestingly, the Third District Appellate Court noted that the Fourth and Fifth District Illinois Appellate Courts have rejected the Third District's decision in Barter Exchange. But the court stated that, despite the fact that two other appellate courts in Illinois have rejected the Barter Exchange decision, it was “well-founded.” Accordingly, the appellate court affirmed the decision of the trial court.

Franchisor May be Liable for Negligent Misrepresentation in UFOC

The Texas Court of Appeals has reversed the decision of a trial court granting a directed verdict in favor of a franchisor on a franchisee's claim that the franchisor made negligent misrepresentations in its UFOC. Carousel's Creamery, LLC v. Marble Slab Creamery, Inc. 2004 WL 63936 (Tex. Ct. App. 2004).

In the mid-1990s, Marble Slab Creamery distributed a UFOC to prospective franchisees containing earnings claims based on the operating results at its two company-owned locations. Carousel's Creamery LLC (“Carousel's”) received a UFOC and purchased a Marble Slab Creamery franchise. Over time, Carousel's operated several Marble Slab Creamery franchises. Carousel's sustained financial losses and eventually closed its shops.

Carousel's brought a claim against Marble Slab alleging that the UFOC that it received misrepresented the value of the franchise because the earnings of one of the company-owned locations reported in the UFOC were not typical of Marble Slab franchises. Specifically, Carousel's claimed that the company-owned location's labor costs did not reflect a franchisee's costs because it was operated by company employees. Also, the company-owned store catered corporate events, which generated more profits than in-store sales. According to Carousel's, the profits at the company-owned store were artificially inflated by approximately 30%.

Carousel's sued Marble for alleged violation of the Texas Deceptive Trade Practices Act (“DTPA”), negligent misrepresentation, and fraud. The case was tried to a jury. But at the close of the evidence, the trial court granted Marble's motion for a directed verdict on Carousel's negligent misrepresentation claim. The court denied Marble's motion for a directed verdict on Carousel's claims for violation of the DTPA and fraud. However, the jury found in Marble's favor on both the DTPA and fraud claims. Carousel's appealed the court's decision granting Marble's motion for a directed verdict on the negligent misrepresentation claim as well as the jury verdict in Marble's favor on the DTPA and fraud claims.

The appellate court denied Carousel's appeal of the jury verdict. However, it ruled in favor of Carousel's on the negligent misrepresentation claim, finding that the trial court erred when it directed a verdict in Marble's favor and dismissed the negligent misrepresentation claim.

Marble's motion for directed verdict was based on two grounds, neither of which was dispositive, according to the appellate court. Marble's first argument was that Carousel's failed to establish that it suffered an injury independent of the contract and therefore could not assert a claim for negligent misrepresentation. In the alternative, Marble argued that even if there was an independent injury, the parol evidence rule and the franchise agreement's disclaimer and merger and integration clauses barred Carousel's negligent misrepresentation claim.

The appellate court observed that in order for Carousel's to prevail on its negligent misrepresentation claim, it had to prove that: 1) a representation was made by Marble in the course of its business; 2) Marble supplied “false information” for the guidance of others in its business; 3) Marble did not exercise reasonable care or competence in obtaining or communicating the information; and 4) Carousel's suffered a monetary loss as a result of its justifiable reliance on Marble's misrepresentation.

With respect to Marble's claim that Carousel's failed to prove that it suffered an injury independent of the contract claim, the appellate court observed that it is well-settled Texas law that in order to proceed on a claim for negligent misrepresentation the party must establish that it sustained an injury independent of its contract claim. But the appellate court noted that Carousel's had abandoned its breach of contract claim. In other words, Carousel's was not claiming that Marble breached the franchise agreement. Rather, it was claiming that Marble misrepresented what it sold to Carousel's. According to the appellate court, since Carousel's had abandoned its breach of contract claim, Texas law did not require it to prove an injury independent of the breach of contract. Thus, held the court, even though the nature of the parties' dispute emanated from the franchise agreement, Carousel's was allowed to advance its tort claim.

Marble also argued, in the alternative, that the parol evidence rule and the franchise agreement's disclaimer and merger and integration clause rendered Carousel's reliance on the alleged misrepresentations in the UFOC unjustified as a matter of law. In the franchise agreement, Carousel's acknowledged that the financial results from the company-owned store upon which the earnings claim was based could vary from other Marble Slab Creamery locations and that there was no guarantee that Carousel's Marble Slab Creamery franchise would perform as well as the company-owned location. Carousel's also agreed in the merger and integration clause that the franchise agreement (which did not contain the earnings claim information) was the entire agreement between the parties and that Carousel's was not relying on any additional representations, promises, or inducements in entering into the franchise agreement. According to Marble, both the merger and integration clause and the disclaimer negated the justifiable reliance prong of the negligent misrepresentation claim.

However, the appellate court disagreed. The appellate court observed that there was evidence in the record supporting every element of the negligent misrepresentation claim. A Marble employee had even testified that “if information is included in Marble Slab's UFOC, a prospective franchisee may rely on it.” The court held that the disclaimer clause was not an integral part of the franchise agreement and therefore, it did not preclude the negligent misrepresentation claim as a matter of law. The court further noted that the merger and integration clause did not automatically render Carousel's reliance on the UFOC's earnings claim information unjustified because the integration clause contemplated only contractual liability and not liability for misrepresentation ' a tort. Thus, the court reversed the trial court's decision and remanded the case back to the trial court with respect to the negligent misrepresentation claim. The appellate court did affirm the jury's verdict in favor Marble on the fraud and DTPA claims.

Disgruntled Franchisee Compelled to Arbitrate Claims Against Franchisor

The U.S. District Court for the Southern District of New York has ruled that a former Prudential Real Estate Affiliates, Inc. (“PREA”) franchisee improperly sued PREA in a New York federal court and ordered the franchisee to submit his claim to mediation, and if necessary, to file suit in California as required by the franchisee agreement's forum selection clause. M.L.B. Kaye International Realty, Inc. v. The Prudential Real Estate Affiliates, Inc. and Prudential Insurance Company of America, 2004 WL 385034 (S.D.N.Y. 2004).

In March 1994, M.L.B. Kaye International Realty, Inc. (“Kaye”) entered into a franchise agreement with PREA pursuant to which Kaye was granted the right to operate a PREA franchise. By all indications, Kaye fully performed his obligations under the franchise agreement. When the initial term of the franchise agreement expired in 2001, Kaye declined to exercise the option to renew. Instead, approximately 2 years after the agreement expired, Kaye brought suit against PREA in a New York State court, alleging that: 1) Kaye was fraudulently induced to enter into the franchise agreement; 2) Prudential Insurance Company of America tortiously interfered with Kaye's franchise agreement with PREA; 3) the defendants tortiously interfered with prospective economic advantage; and 4) the defendants violated various provisions of the New York Franchise Sales Act.

The defendants immediately removed the case to federal court in New York based on the parties' diversity of citizenship. Shortly thereafter, the defendants moved to dismiss the case based on a mandatory mediation agreement in the franchise agreement. In the alternative, the defendants moved to transfer venue to the U.S. District Court for the Central District of California in accordance with the venue selection provision in the parties' expired franchise agreement.

Kaye opposed the defendants' motion to transfer venue because, according to Kaye, enforcement of the venue selection provision would be unreasonable and unjust. Kaye argued that: 1) all of Kaye's business contacts, relationships, and records were located in New York; 2) Kaye would be forced to hire California counsel and to litigate in an unfamiliar jurisdiction; 3) all the facts and circumstances associated with the action were based in New York; 4) “requiring Kaye to transfer all the data, testimony, and facts necessary to achieve a meaningful day in court in California … is likely to be impossible”; and 5) “compulsory transfer of the case to California for prosecution is … likely to be tantamount to the entry of a final judgment for the defendant.”

The court observed that forum selection clauses are prima facie valid and enforceable unless the party opposing it can make a strong showing that the application of the clause would be unreasonable under the circumstances. According to the court, Kaye failed to meet his heavy burden of proof because he failed to show why the enforcement of the clause would be unreasonable. In fact, observed the court, the record supported the conclusion that the parties' selection of California for any litigation was in fact reasonable under the circumstances. It showed that Kaye made a substantial amount of money while he was a PREA franchisee and therefore, he has the financial ability to litigate the case in California. Further, said the court, the fact that PREA has its principal place of business in California demonstrated that it was reasonable for the parties to choose California as the forum to resolve any and all disputes between the parties. The court noted that “mere inconvenience” is not, standing alone, a valid reason to disturb the parties' contractual choice of venue.

The court also addressed PREA's argument that Kaye was bound by the alternative dispute resolution provision in the franchise agreement. The franchise agreement provided that before a party could bring an action against the other party, the aggrieved must tender a “Notification of Dispute” to the other party and afford the non-aggrieved party an opportunity to file a written response. Therefore, according to the franchise agreement, “the parties must endeavor in good faith to resolve the disputes outlined in the Notification.”

Kaye claimed that the ADR provision did not apply to him because it only applied to current PREA franchisees. And even if it did apply to former franchisees, application of the ADR provisions would be unreasonable because the process was onerous, unduly time consuming, and expensive.

The court rejected Kaye's arguments. According to the court, Kaye failed to demonstrate his inability to proceed with his claims in California. In addition, said the court, the franchise agreement specifically provides that Kaye's obligation to submit any disputes to ADR before bringing suit for any claims arising out of the parties' franchise relationship clearly survives the expiration of the franchise agreement.

Accordingly, the court dismissed the case without prejudice and ordered Kaye to comply with the ADR procedure outlined in the parties' franchise agreement and, if necessary, to file his complaint in the U.S. District Court for the Central District of California.

Failure to Register Franchise in Illinois Renders Franchise Agreement Invalid

The Appellate Court of Illinois has affirmed a lower court decision ruling that a franchise agreement including its arbitration provisions was not binding on the franchisee because the franchisor sold the franchise in Illinois without registering its UFOC with the Illinois Attorney General's Office. The arbitration provision of the franchise agreement was therefore unenforceable. Jensen v. Quik International , 801 N.E.2d 1124 (Ill. App. Ct. 2003).

On July 3, 2002, Jensen entered into a franchise agreement with Quik International (“Quik”) that granted Jensen the right to operate a franchise in Illinois. The franchise agreement provided that all disputes between the parties would be submitted to binding arbitration. Sometime after the agreement was signed, Quik advised Jensen that its sale of the franchise to him was in violation of the Illinois Franchise Disclosure Act (“IFDA”) because Quik's franchise registration had expired at the time of the sale. Quik advised Jensen that he had the right to rescind the franchise agreement and/or sue for damages.

On April 24, 2003, Jensen filed a complaint against Quik and its CEO and president, alleging various violations of the IFDA. Quik filed a motion to stay the case pending arbitration in accordance with the arbitration provision in the franchise agreement. It also filed a separate arbitration demand pursuant to the Federal Arbitration Act (“FAA”). Jensen then filed a cross-motion to stay the arbitration.

In support of its motion to stay the case and compel arbitration, Quik admitted that it violated the IFDA. However, it maintained that the parties were still required to arbitrate their dispute pursuant to the FAA. Jensen, on the other hand, relying on the Illinois Appellate Court's earlier decision in Barter Exchange, Inc. of Chicago v. Barter Exchange, Inc., 606 N.E.2d 186 (Ill. App. 3d 1992), claimed that because the franchisor failed to register to sell its franchises in the state of Illinois, the franchise agreement and its arbitration provision was not binding on him. Quik countered that Barter Exchange was decided under Illinois' Uniform Arbitration Act and not the FAA. According to Quik, the FAA supersedes state law, including the IFDA. The trial court ruled in Jensen's favor.

On appeal, the appellate court affirmed the trial court's decision. It found that Quik's attempts to distinguish Barter were “misguided.” It noted that Quik's registration was a condition precedent to the contract that was never satisfied. Therefore, according to the appellate court, the franchise agreement and its arbitration provision were unenforceable. Interestingly, the Third District Appellate Court noted that the Fourth and Fifth District Illinois Appellate Courts have rejected the Third District's decision in Barter Exchange. But the court stated that, despite the fact that two other appellate courts in Illinois have rejected the Barter Exchange decision, it was “well-founded.” Accordingly, the appellate court affirmed the decision of the trial court.

Franchisor May be Liable for Negligent Misrepresentation in UFOC

The Texas Court of Appeals has reversed the decision of a trial court granting a directed verdict in favor of a franchisor on a franchisee's claim that the franchisor made negligent misrepresentations in its UFOC. Carousel's Creamery, LLC v. Marble Slab Creamery, Inc. 2004 WL 63936 (Tex. Ct. App. 2004).

In the mid-1990s, Marble Slab Creamery distributed a UFOC to prospective franchisees containing earnings claims based on the operating results at its two company-owned locations. Carousel's Creamery LLC (“Carousel's”) received a UFOC and purchased a Marble Slab Creamery franchise. Over time, Carousel's operated several Marble Slab Creamery franchises. Carousel's sustained financial losses and eventually closed its shops.

Carousel's brought a claim against Marble Slab alleging that the UFOC that it received misrepresented the value of the franchise because the earnings of one of the company-owned locations reported in the UFOC were not typical of Marble Slab franchises. Specifically, Carousel's claimed that the company-owned location's labor costs did not reflect a franchisee's costs because it was operated by company employees. Also, the company-owned store catered corporate events, which generated more profits than in-store sales. According to Carousel's, the profits at the company-owned store were artificially inflated by approximately 30%.

Carousel's sued Marble for alleged violation of the Texas Deceptive Trade Practices Act (“DTPA”), negligent misrepresentation, and fraud. The case was tried to a jury. But at the close of the evidence, the trial court granted Marble's motion for a directed verdict on Carousel's negligent misrepresentation claim. The court denied Marble's motion for a directed verdict on Carousel's claims for violation of the DTPA and fraud. However, the jury found in Marble's favor on both the DTPA and fraud claims. Carousel's appealed the court's decision granting Marble's motion for a directed verdict on the negligent misrepresentation claim as well as the jury verdict in Marble's favor on the DTPA and fraud claims.

The appellate court denied Carousel's appeal of the jury verdict. However, it ruled in favor of Carousel's on the negligent misrepresentation claim, finding that the trial court erred when it directed a verdict in Marble's favor and dismissed the negligent misrepresentation claim.

Marble's motion for directed verdict was based on two grounds, neither of which was dispositive, according to the appellate court. Marble's first argument was that Carousel's failed to establish that it suffered an injury independent of the contract and therefore could not assert a claim for negligent misrepresentation. In the alternative, Marble argued that even if there was an independent injury, the parol evidence rule and the franchise agreement's disclaimer and merger and integration clauses barred Carousel's negligent misrepresentation claim.

The appellate court observed that in order for Carousel's to prevail on its negligent misrepresentation claim, it had to prove that: 1) a representation was made by Marble in the course of its business; 2) Marble supplied “false information” for the guidance of others in its business; 3) Marble did not exercise reasonable care or competence in obtaining or communicating the information; and 4) Carousel's suffered a monetary loss as a result of its justifiable reliance on Marble's misrepresentation.

With respect to Marble's claim that Carousel's failed to prove that it suffered an injury independent of the contract claim, the appellate court observed that it is well-settled Texas law that in order to proceed on a claim for negligent misrepresentation the party must establish that it sustained an injury independent of its contract claim. But the appellate court noted that Carousel's had abandoned its breach of contract claim. In other words, Carousel's was not claiming that Marble breached the franchise agreement. Rather, it was claiming that Marble misrepresented what it sold to Carousel's. According to the appellate court, since Carousel's had abandoned its breach of contract claim, Texas law did not require it to prove an injury independent of the breach of contract. Thus, held the court, even though the nature of the parties' dispute emanated from the franchise agreement, Carousel's was allowed to advance its tort claim.

Marble also argued, in the alternative, that the parol evidence rule and the franchise agreement's disclaimer and merger and integration clause rendered Carousel's reliance on the alleged misrepresentations in the UFOC unjustified as a matter of law. In the franchise agreement, Carousel's acknowledged that the financial results from the company-owned store upon which the earnings claim was based could vary from other Marble Slab Creamery locations and that there was no guarantee that Carousel's Marble Slab Creamery franchise would perform as well as the company-owned location. Carousel's also agreed in the merger and integration clause that the franchise agreement (which did not contain the earnings claim information) was the entire agreement between the parties and that Carousel's was not relying on any additional representations, promises, or inducements in entering into the franchise agreement. According to Marble, both the merger and integration clause and the disclaimer negated the justifiable reliance prong of the negligent misrepresentation claim.

However, the appellate court disagreed. The appellate court observed that there was evidence in the record supporting every element of the negligent misrepresentation claim. A Marble employee had even testified that “if information is included in Marble Slab's UFOC, a prospective franchisee may rely on it.” The court held that the disclaimer clause was not an integral part of the franchise agreement and therefore, it did not preclude the negligent misrepresentation claim as a matter of law. The court further noted that the merger and integration clause did not automatically render Carousel's reliance on the UFOC's earnings claim information unjustified because the integration clause contemplated only contractual liability and not liability for misrepresentation ' a tort. Thus, the court reversed the trial court's decision and remanded the case back to the trial court with respect to the negligent misrepresentation claim. The appellate court did affirm the jury's verdict in favor Marble on the fraud and DTPA claims.

Disgruntled Franchisee Compelled to Arbitrate Claims Against Franchisor

The U.S. District Court for the Southern District of New York has ruled that a former Prudential Real Estate Affiliates, Inc. (“PREA”) franchisee improperly sued PREA in a New York federal court and ordered the franchisee to submit his claim to mediation, and if necessary, to file suit in California as required by the franchisee agreement's forum selection clause. M.L.B. Kaye International Realty, Inc. v. The Prudential Real Estate Affiliates, Inc. and Prudential Insurance Company of America, 2004 WL 385034 (S.D.N.Y. 2004).

In March 1994, M.L.B. Kaye International Realty, Inc. (“Kaye”) entered into a franchise agreement with PREA pursuant to which Kaye was granted the right to operate a PREA franchise. By all indications, Kaye fully performed his obligations under the franchise agreement. When the initial term of the franchise agreement expired in 2001, Kaye declined to exercise the option to renew. Instead, approximately 2 years after the agreement expired, Kaye brought suit against PREA in a New York State court, alleging that: 1) Kaye was fraudulently induced to enter into the franchise agreement; 2) Prudential Insurance Company of America tortiously interfered with Kaye's franchise agreement with PREA; 3) the defendants tortiously interfered with prospective economic advantage; and 4) the defendants violated various provisions of the New York Franchise Sales Act.

The defendants immediately removed the case to federal court in New York based on the parties' diversity of citizenship. Shortly thereafter, the defendants moved to dismiss the case based on a mandatory mediation agreement in the franchise agreement. In the alternative, the defendants moved to transfer venue to the U.S. District Court for the Central District of California in accordance with the venue selection provision in the parties' expired franchise agreement.

Kaye opposed the defendants' motion to transfer venue because, according to Kaye, enforcement of the venue selection provision would be unreasonable and unjust. Kaye argued that: 1) all of Kaye's business contacts, relationships, and records were located in New York; 2) Kaye would be forced to hire California counsel and to litigate in an unfamiliar jurisdiction; 3) all the facts and circumstances associated with the action were based in New York; 4) “requiring Kaye to transfer all the data, testimony, and facts necessary to achieve a meaningful day in court in California … is likely to be impossible”; and 5) “compulsory transfer of the case to California for prosecution is … likely to be tantamount to the entry of a final judgment for the defendant.”

The court observed that forum selection clauses are prima facie valid and enforceable unless the party opposing it can make a strong showing that the application of the clause would be unreasonable under the circumstances. According to the court, Kaye failed to meet his heavy burden of proof because he failed to show why the enforcement of the clause would be unreasonable. In fact, observed the court, the record supported the conclusion that the parties' selection of California for any litigation was in fact reasonable under the circumstances. It showed that Kaye made a substantial amount of money while he was a PREA franchisee and therefore, he has the financial ability to litigate the case in California. Further, said the court, the fact that PREA has its principal place of business in California demonstrated that it was reasonable for the parties to choose California as the forum to resolve any and all disputes between the parties. The court noted that “mere inconvenience” is not, standing alone, a valid reason to disturb the parties' contractual choice of venue.

The court also addressed PREA's argument that Kaye was bound by the alternative dispute resolution provision in the franchise agreement. The franchise agreement provided that before a party could bring an action against the other party, the aggrieved must tender a “Notification of Dispute” to the other party and afford the non-aggrieved party an opportunity to file a written response. Therefore, according to the franchise agreement, “the parties must endeavor in good faith to resolve the disputes outlined in the Notification.”

Kaye claimed that the ADR provision did not apply to him because it only applied to current PREA franchisees. And even if it did apply to former franchisees, application of the ADR provisions would be unreasonable because the process was onerous, unduly time consuming, and expensive.

The court rejected Kaye's arguments. According to the court, Kaye failed to demonstrate his inability to proceed with his claims in California. In addition, said the court, the franchise agreement specifically provides that Kaye's obligation to submit any disputes to ADR before bringing suit for any claims arising out of the parties' franchise relationship clearly survives the expiration of the franchise agreement.

Accordingly, the court dismissed the case without prejudice and ordered Kaye to comply with the ADR procedure outlined in the parties' franchise agreement and, if necessary, to file his complaint in the U.S. District Court for the Central District of California.