Court Watch

Criminal Defendant's Knowledge of FTC Rule Showed His Criminal Intent

The U.S. Court of Appeals for the Eighth Circuit has ruled that evidence of a defendant's knowledge of the terms, provisions, and requirements of the FTC Franchise Rule ' even though the FTC Rule is strictly civil in nature ' regarding the scope, application, and requirements of that regulation were properly admitted and sufficient to establish the defendant's criminal intent. United States of America v. Parker, 364 F.3d 934 (8th Cir. 2004).

Parker was convicted of mail fraud. The government alleged that he fraudulently induced investors to purchase FCI automotive parts distributorships by making false statements. Parker appealed his conviction on the grounds that the trial court erred in admitting the expert testimony of Steven Toporoff, the Federal Trade Commission's expert on the FTC Rule, claiming that the testimony improperly invaded the province of the judge and jury by addressing legal standards and was irrelevant. Parker also asserted that even if Toporoff's testimony were relevant, its probative value was substantially outweighed by its prejudicial effect. The Eighth Circuit rejected these assertions and upheld the conviction.

At trial, the government sought to prove that Parker fraudulently induced investors to purchase FCI distributorships by making several false statements concerning the quality of the automotive parts sold under the FCI brand name, the quality of the distributorship accounts, FCI's business history, and the amount of actual and projected income that a distributor could expect to earn.

At trial, Toporoff testified regarding the FTC Franchise Rule's definition of the term “franchise” and the disclosure obligations required of franchisors under that Rule. However, Toporoff was not called upon, and did not offer any opinion as to whether or not FCI distributorships were actually “franchises” as defined by the Rule. Instead, Toporoff testified that under the Rule a franchisor must reveal in its disclosure document the total number of franchises that are open and the number that have closed; the franchisor's litigation history; and all bankruptcy proceedings in which the franchisor or its principals have been involved. He further testified that any disclosure concerning “financial performance information” must comply with generally accepted accounting principles, and that projections of revenues or income must have a reasonable basis.

The trial judge permitted this testimony as evidence concerning whether Parker knew of the obligations under the FTC Rule and failed to comply in order to hide things from investors and to deceive them into becoming distributors. The Eighth Circuit agreed with the trial court's determination that Toporoff's testimony was properly admissible to show Parker's intent to defraud. The Eighth Circuit found that the government presented sufficient evidence from which a reasonable jury could have found that FCI was subject to the FTC Rule, that Parker knew he was selling franchises, and that he was aware of the obligations of the Rule. Therefore, the court concluded, Toporoff's testimony concerning the scope and substance of the rule was relevant to show Parker's intent to deceive if he knowingly failed to comply with the Rule.

The court also ruled that the trial judge employed appropriate measures to prevent undue prejudice and jury confusion that otherwise could have resulted from evidence that Parker may have violated FTC civil regulations.

Maryland Franchisee Can Sue Under California Franchise Law

The U.S. District Court for the Southern District of California has ruled that a dating service franchisee located in Maryland could sue a California franchisor for violations of the California Franchise Investment Law, but could not sue under the Maryland Franchise Registration and Disclosure Law. It's Just Lunch International, LLC v. Polar Bear, Inc. et al., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,819 (S.D. Ca. 2004).

The franchisee raised claims under both the California Franchise Investment Law and the Maryland Franchise Registration and Disclosure Law. The franchisor argued that the California Franchise Investment Law did not apply because the franchisees did not reside in California. It contended that the statute was intended to protect California franchisees and thus does not cover nonresident franchisees.

The court disagreed. It pointed out that the California Franchise Investment Law provided that any person who offers or sells a franchise in violation of the statute would be liable to the franchisee, and that it is unlawful to offer or sell any franchise in this state unless the offer of the franchise has been registered or exempted. The statute also states that an offer or sale is made “in” California where “an offer to sell is made in this state, or an offer to buy is accepted in this state.” The owner of the franchise had substantial conversations with the franchisor's president in California, during which the franchise was offered for sale and the parties negotiated the franchise agreement. Furthermore, the franchise agreement was signed and the initial fee was paid in California. Thus, the court concluded, the franchise was offered for sale in California within the meaning of the statute.

The parties' franchise agreement contained a Nevada choice-of-law clause, but a rider to the agreement provided that the franchisee could bring suit in Maryland for any claims arising under the Maryland Franchise Registration and Disclosure Law. Because the lawsuit was brought in federal court in California, the court ruled, the franchisee could not rely on the rider to bring a claim under the Maryland Franchise Registration and Disclosure Law.

Interestingly, the court makes no reference to the anti-waiver provisions of the Maryland Franchise Registration and Disclosure Law, which may have led it to reach a different conclusion if they had been considered.

Franchisee Who Was in Default Cannot Recover for Franchisor's Breach of Contract

A Texas appellate court has upheld a lower court ruling refusing to permit a cosmetics franchisee to sue her franchisor for breach of contract, on the grounds that the franchisee was herself in violation of the franchise agreement, and there was no evidence that the franchisor breached the agreement. Patti Hildreth v. Merle Norman Cosmetics, Inc., 2004 WL 736991 (Tex.App.20043).

Patti Hildreth asked Merle Norman, the franchisor, for approval to relocate because the building in which she was operating her “studio” had been sold. She was told she needed to “clear her account” prior to moving. She sent a check to Merle Norman, and when Merle Norman claimed the check was not received, she mailed a second check. Merle Norman again claimed it did not receive the check, so Hildreth sent a check by overnight courier. However, she never received written approval to relocate her business and was forced to close her business. She sued Merle Norman for breach of contract and breach of the implied covenant of good faith and fair dealing.

The lower court ruled that Hildreth could not bring suit for breach of contract because she herself was in breach of the franchise agreement. Merle Norman alleged that Hildreth did not perform under the agreement because she only operated her store 1 day per week rather than 5 days per week. Merle Norman alleged that the franchisee failed to operate the studio in a businesslike manner, “keeping the Studio open at all hours regularly kept by other retail establishments in your neighborhood or area,” as required by her agreement. The evidence produced for summary judgment indicated that Hildreth admitted that she had failed to keep regular business hours and only opened 1 day per week most of the time.

Hildreth claimed, however, Merle Norman was aware of and consented to her hours. The court ruled that, under Texas law, a course of performance accepted or acquiesced in without objection was relevant to determine the meaning of the agreement, but only when the agreement was ambiguous. It ruled that Hildreth's assertion that Merle Norman consented to her irregular business hours by failing to object is irrelevant because the contract was unambiguous.

Furthermore, according to the court, there was no concrete evidence, other than Hildreth's assertion, that Merle Norman “knew” that she was only operating 1 day per week. The court therefore reasoned that while Hildreth presented evidence proving she breached the contract requirements, she failed to provide evidence showing Merle Norman knew of, and consented to, her breach. This also led the court to reject another of Hildreth's claims: that Merle Norman breached the contract by failing to provide her with notice to cure any contract violations as specified by the agreement. Hildreth failed, the court concluded, to produce “more than a scintilla of evidence” that Merle Norman had breached the franchise agreement.

Distributor Not Entitled to Extended Cure Period

The U.S. Court of Appeals for the Second Circuit has upheld a district court ruling that a terminated cold and allergy product distributor was not entitled to the extended cure period provided under the distributorship agreement for defaults which by their nature could not be cured within 60 days, on the grounds that there was no evidence that the cure could not be effected within the 60-day period. Innomed Labs, LLC v. Alza Corporation, 98 Fed. Appx. 51 (not reported in F.3d.), CCH Bus. Fran. Guide Par. 12,825 (2nd Circuit 2004).

The court ruled that the distributor presented no evidence that its breach ' as opposed to its chosen method of curing that breach ' was of such a nature that it could not be cured in 60 days through diligent efforts, so that it was entitled to the longer period reasonably necessary to cure such breach using diligent efforts. It therefore failed to raise an issue of fact as to its entitlement to the extended cure period. (It seems from the court's language that the breach was monetary in nature. This implies that the “chosen method” of curing the breach was paying the amount owed over an extended period of time, presumably in installments. Unfortunately, the court does not make either point clear.)

No Infringement Without Termination Notice

The U.S. District Court for the Western District of Kentucky has refused to permit a pizza franchisor to sue a former franchisee for trademark infringement because the franchisor did not send the franchisee a notice of termination. However, it also rejected the franchisee's claim for fraud based on alleged misrepresentations made both before and after the execution of a development agreement because the agreement contained a merger and integration clause. Papa John's International, Inc. v. Dynamic Pizza, Inc., __ F.Supp.2d __, 2004 WL 1048222 (W.D.Ky. 2004).

Under the terms of the parties' franchise agreements, Papa John's had the discretion to immediately terminate the agreements after giving the franchisee three notices of default within 12 months, even if the franchisee cured the defaults. Papa John's claimed that this provision allowed for the agreement to be terminated without Papa John's giving notice. The franchisee did not contest that it received three notices of default within a 12-month period, but disagreed with Papa John's interpretation of the franchise agreement. It argued that Papa John's was required to serve a formal notice of termination.

The disputed provision was headed “Without Notice,” but read as follows: “…You [Defendants] shall be in default, and we may, at our option, terminate the Franchise and all rights granted in this Agreement, without affording you any opportunity to cure the default, effective upon the earlier of receipt of notice of termination by you, or five days after mailing of such notice by us, upon the occurrence of any of the following events …” One of the events listed was the franchisee's receipt of three notices of default within a 12-month period. The court held that this provision did require notice for the termination to become effective.

Papa John's also moved for summary judgment on the franchisee's counterclaims of fraudulent inducement and negligent misrepresentation both before and after the signing of a development agreement. The court granted summary judgment against the fraudulent inducement claim, on the grounds that the agreement's merger and integration clause barred claims for misrepresentations before the signing of the development agreement. According to the court, as a matter of law, the franchisee could not have reasonably relied on any representations outside the agreement.

The franchisee also claimed that Papa John's continued to make negligent misrepresentations concerning the profits that the franchisee would make after the signing of the development agreement. The court rejected these claims as well because the parties continued to sign a series of franchise agreements with merger and integration clauses after each of the alleged misrepresentations. The court also held that no cause of action existed for the alleged misrepresentations concerning profits because they were unfulfilled promises or statements as to future events and thus could not be the basis for a fraud action.

Criminal Defendant's Knowledge of FTC Rule Showed His Criminal Intent

The U.S. Court of Appeals for the Eighth Circuit has ruled that evidence of a defendant's knowledge of the terms, provisions, and requirements of the FTC Franchise Rule ' even though the FTC Rule is strictly civil in nature ' regarding the scope, application, and requirements of that regulation were properly admitted and sufficient to establish the defendant's criminal intent. United States of America v. Parker , 364 F.3d 934 (8th Cir. 2004).

Parker was convicted of mail fraud. The government alleged that he fraudulently induced investors to purchase FCI automotive parts distributorships by making false statements. Parker appealed his conviction on the grounds that the trial court erred in admitting the expert testimony of Steven Toporoff, the Federal Trade Commission's expert on the FTC Rule, claiming that the testimony improperly invaded the province of the judge and jury by addressing legal standards and was irrelevant. Parker also asserted that even if Toporoff's testimony were relevant, its probative value was substantially outweighed by its prejudicial effect. The Eighth Circuit rejected these assertions and upheld the conviction.

At trial, the government sought to prove that Parker fraudulently induced investors to purchase FCI distributorships by making several false statements concerning the quality of the automotive parts sold under the FCI brand name, the quality of the distributorship accounts, FCI's business history, and the amount of actual and projected income that a distributor could expect to earn.

At trial, Toporoff testified regarding the FTC Franchise Rule's definition of the term “franchise” and the disclosure obligations required of franchisors under that Rule. However, Toporoff was not called upon, and did not offer any opinion as to whether or not FCI distributorships were actually “franchises” as defined by the Rule. Instead, Toporoff testified that under the Rule a franchisor must reveal in its disclosure document the total number of franchises that are open and the number that have closed; the franchisor's litigation history; and all bankruptcy proceedings in which the franchisor or its principals have been involved. He further testified that any disclosure concerning “financial performance information” must comply with generally accepted accounting principles, and that projections of revenues or income must have a reasonable basis.

The trial judge permitted this testimony as evidence concerning whether Parker knew of the obligations under the FTC Rule and failed to comply in order to hide things from investors and to deceive them into becoming distributors. The Eighth Circuit agreed with the trial court's determination that Toporoff's testimony was properly admissible to show Parker's intent to defraud. The Eighth Circuit found that the government presented sufficient evidence from which a reasonable jury could have found that FCI was subject to the FTC Rule, that Parker knew he was selling franchises, and that he was aware of the obligations of the Rule. Therefore, the court concluded, Toporoff's testimony concerning the scope and substance of the rule was relevant to show Parker's intent to deceive if he knowingly failed to comply with the Rule.

The court also ruled that the trial judge employed appropriate measures to prevent undue prejudice and jury confusion that otherwise could have resulted from evidence that Parker may have violated FTC civil regulations.

Maryland Franchisee Can Sue Under California Franchise Law

The U.S. District Court for the Southern District of California has ruled that a dating service franchisee located in Maryland could sue a California franchisor for violations of the California Franchise Investment Law, but could not sue under the Maryland Franchise Registration and Disclosure Law. It's Just Lunch International, LLC v. Polar Bear, Inc. et al., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,819 (S.D. Ca. 2004).

The franchisee raised claims under both the California Franchise Investment Law and the Maryland Franchise Registration and Disclosure Law. The franchisor argued that the California Franchise Investment Law did not apply because the franchisees did not reside in California. It contended that the statute was intended to protect California franchisees and thus does not cover nonresident franchisees.

The court disagreed. It pointed out that the California Franchise Investment Law provided that any person who offers or sells a franchise in violation of the statute would be liable to the franchisee, and that it is unlawful to offer or sell any franchise in this state unless the offer of the franchise has been registered or exempted. The statute also states that an offer or sale is made “in” California where “an offer to sell is made in this state, or an offer to buy is accepted in this state.” The owner of the franchise had substantial conversations with the franchisor's president in California, during which the franchise was offered for sale and the parties negotiated the franchise agreement. Furthermore, the franchise agreement was signed and the initial fee was paid in California. Thus, the court concluded, the franchise was offered for sale in California within the meaning of the statute.

The parties' franchise agreement contained a Nevada choice-of-law clause, but a rider to the agreement provided that the franchisee could bring suit in Maryland for any claims arising under the Maryland Franchise Registration and Disclosure Law. Because the lawsuit was brought in federal court in California, the court ruled, the franchisee could not rely on the rider to bring a claim under the Maryland Franchise Registration and Disclosure Law.

Interestingly, the court makes no reference to the anti-waiver provisions of the Maryland Franchise Registration and Disclosure Law, which may have led it to reach a different conclusion if they had been considered.

Franchisee Who Was in Default Cannot Recover for Franchisor's Breach of Contract

A Texas appellate court has upheld a lower court ruling refusing to permit a cosmetics franchisee to sue her franchisor for breach of contract, on the grounds that the franchisee was herself in violation of the franchise agreement, and there was no evidence that the franchisor breached the agreement. Patti Hildreth v. Merle Norman Cosmetics, Inc., 2004 WL 736991 (Tex.App.20043).

Patti Hildreth asked Merle Norman, the franchisor, for approval to relocate because the building in which she was operating her “studio” had been sold. She was told she needed to “clear her account” prior to moving. She sent a check to Merle Norman, and when Merle Norman claimed the check was not received, she mailed a second check. Merle Norman again claimed it did not receive the check, so Hildreth sent a check by overnight courier. However, she never received written approval to relocate her business and was forced to close her business. She sued Merle Norman for breach of contract and breach of the implied covenant of good faith and fair dealing.

The lower court ruled that Hildreth could not bring suit for breach of contract because she herself was in breach of the franchise agreement. Merle Norman alleged that Hildreth did not perform under the agreement because she only operated her store 1 day per week rather than 5 days per week. Merle Norman alleged that the franchisee failed to operate the studio in a businesslike manner, “keeping the Studio open at all hours regularly kept by other retail establishments in your neighborhood or area,” as required by her agreement. The evidence produced for summary judgment indicated that Hildreth admitted that she had failed to keep regular business hours and only opened 1 day per week most of the time.

Hildreth claimed, however, Merle Norman was aware of and consented to her hours. The court ruled that, under Texas law, a course of performance accepted or acquiesced in without objection was relevant to determine the meaning of the agreement, but only when the agreement was ambiguous. It ruled that Hildreth's assertion that Merle Norman consented to her irregular business hours by failing to object is irrelevant because the contract was unambiguous.

Furthermore, according to the court, there was no concrete evidence, other than Hildreth's assertion, that Merle Norman “knew” that she was only operating 1 day per week. The court therefore reasoned that while Hildreth presented evidence proving she breached the contract requirements, she failed to provide evidence showing Merle Norman knew of, and consented to, her breach. This also led the court to reject another of Hildreth's claims: that Merle Norman breached the contract by failing to provide her with notice to cure any contract violations as specified by the agreement. Hildreth failed, the court concluded, to produce “more than a scintilla of evidence” that Merle Norman had breached the franchise agreement.

Distributor Not Entitled to Extended Cure Period

The U.S. Court of Appeals for the Second Circuit has upheld a district court ruling that a terminated cold and allergy product distributor was not entitled to the extended cure period provided under the distributorship agreement for defaults which by their nature could not be cured within 60 days, on the grounds that there was no evidence that the cure could not be effected within the 60-day period. Innomed Labs, LLC v. Alza Corporation, 98 Fed. Appx. 51 (not reported in F.3d.), CCH Bus. Fran. Guide Par. 12,825 (2nd Circuit 2004).

The court ruled that the distributor presented no evidence that its breach ' as opposed to its chosen method of curing that breach ' was of such a nature that it could not be cured in 60 days through diligent efforts, so that it was entitled to the longer period reasonably necessary to cure such breach using diligent efforts. It therefore failed to raise an issue of fact as to its entitlement to the extended cure period. (It seems from the court's language that the breach was monetary in nature. This implies that the “chosen method” of curing the breach was paying the amount owed over an extended period of time, presumably in installments. Unfortunately, the court does not make either point clear.)

No Infringement Without Termination Notice

The U.S. District Court for the Western District of Kentucky has refused to permit a pizza franchisor to sue a former franchisee for trademark infringement because the franchisor did not send the franchisee a notice of termination. However, it also rejected the franchisee's claim for fraud based on alleged misrepresentations made both before and after the execution of a development agreement because the agreement contained a merger and integration clause. Papa John's International, Inc. v. Dynamic Pizza, Inc., __ F.Supp.2d __, 2004 WL 1048222 (W.D.Ky. 2004).

Under the terms of the parties' franchise agreements, Papa John's had the discretion to immediately terminate the agreements after giving the franchisee three notices of default within 12 months, even if the franchisee cured the defaults. Papa John's claimed that this provision allowed for the agreement to be terminated without Papa John's giving notice. The franchisee did not contest that it received three notices of default within a 12-month period, but disagreed with Papa John's interpretation of the franchise agreement. It argued that Papa John's was required to serve a formal notice of termination.

The disputed provision was headed “Without Notice,” but read as follows: “…You [Defendants] shall be in default, and we may, at our option, terminate the Franchise and all rights granted in this Agreement, without affording you any opportunity to cure the default, effective upon the earlier of receipt of notice of termination by you, or five days after mailing of such notice by us, upon the occurrence of any of the following events …” One of the events listed was the franchisee's receipt of three notices of default within a 12-month period. The court held that this provision did require notice for the termination to become effective.

Papa John's also moved for summary judgment on the franchisee's counterclaims of fraudulent inducement and negligent misrepresentation both before and after the signing of a development agreement. The court granted summary judgment against the fraudulent inducement claim, on the grounds that the agreement's merger and integration clause barred claims for misrepresentations before the signing of the development agreement. According to the court, as a matter of law, the franchisee could not have reasonably relied on any representations outside the agreement.

The franchisee also claimed that Papa John's continued to make negligent misrepresentations concerning the profits that the franchisee would make after the signing of the development agreement. The court rejected these claims as well because the parties continued to sign a series of franchise agreements with merger and integration clauses after each of the alleged misrepresentations. The court also held that no cause of action existed for the alleged misrepresentations concerning profits because they were unfulfilled promises or statements as to future events and thus could not be the basis for a fraud action.