Court Watch

Heartlein alleged that Tires Plus violated the IFDA requirement that a franchisor disclose rebates that it receives from suppliers as a result of required purchases or leases. The court found for Tires Plus because Heartlein was not required to purchase from the suppliers who gave Tires Plus rebates. For the same reason, the non-disclosure did not constitute common law fraud by omission since Heartlein presented no evidence that it relied on the non-disclosure of the rebates to his detriment or that the vendor payments resulted in any price differential to Tire Plus franchisees.

The court was more troubled by the earnings claims Heartlein received. For each of Heartlein's two franchises, Tires Plus provided Heartlein with a detailed 3-year pro forma with costs, sales, and earnings information about the market in which the franchise was to be located. The pro formas did not contain any disclaimers or admonitions. Along with the pro formas, Tires Plus provided Heartlein with a detailed demographic breakdown that included data prepared by Equifax, which the court described as “an objective, third party source of demographic information.” But the demographic reports also included a “multiplier factor” that increased projected sales volume for Heartlein's proposed market by 25% above that presented by Equifax. The “multiplier factor” was not labeled as being supplied by Tires Plus and was in the same typeface as the rest of the documents, giving the appearance of having been part of the Equifax report. A Tires Plus representative testified that the multiplier was inserted by Tires Plus into the Equifax documents to bring projected sales results for potential new stores into line with the actual results of existing Tires Plus stores.

Tires Plus gave the pro formas and demographic reports to Heartlein after the franchise agreements had been signed, but during a period before approval of the store sites or the signing of leases for the sites. Heartlein contended that during this period, he still had the right to rescind the agreements. The UFOC provided for the right to cancel “before signing documents that legally obligate [franchisee] to develop the property for the Franchised Service Center.”

According to the court, Minnesota courts define the elements of fraud as: 1) a false representation pertaining to a material past or present fact susceptible of human knowledge; 2) knowledge by the one making the representation of its falsity, or assertion of it without knowledge of its truth or falsity; 3) an intention that the other person act on it, or circumstances justifying the other person in so acting; 4) reasonable reliance by the other person on the representation; and 5) damage attributable to the misrepresentation.

The court found that Heartlein established the first element of fraud through the Equifax reports altered by Tires Plus without notification to the franchisee. The evidence also established the second element of fraud, the court ruled, because Tires Plus knew that the documents were not generated wholly from Equifax, and therefore knew the representations were false. Construing the evidence in Heartlein's favor, as the court is required to do when deciding a motion for summary judgment, the court found that, under the circumstances, Heartlein was justified in believing the false representations and that it could not find as a matter of law that Heartlein had lost the right to rescind. Therefore, the court determined for purposes of summary judgment that Heartlein reasonably relied on the altered Equifax reports in choosing to forego the right to cancel until Tires Plus had formally approved of the sites. Finally, the court ruled that the fifth element of fraud was met because Heartlein showed damage attributable to the misrepresentations ' the franchises operated at a loss.

The court also rejected Tires Plus' motion for summary judgment against Heartlein's assertion that the franchisor violated the IFDA through its pro formas. The court ruled that Heartlein made out a prima facie case for fraudulent practices under the IFDA. The evidence viewed in the light most favorable to Heartlein showed that Tires Plus employed a scheme to defraud by omitting statements of material fact necessary to make the statements not misleading under the circumstances and by omitting information from the pro formas that would have revealed that the report labeled as originating from Equifax also contained numbers inserted by Tires Plus. The court also held that this evidence, when construed in favor of Heartlein, showed that this practice or course of business by Tires Plus operated as a fraud or deceit. Additionally, the court found that the pro formas would qualify as earnings statements under the regulations to the IFDA, which meant that they should have included a description of the factual basis and material assumptions underlying the reports' preparation and presentation.

Tires Plus argued that these claims were barred because the general anti-fraud provision and the earnings-claim regulations of the IFDA are limited to statements made in the offer or sale of a franchise, and that Heartlein's allegations stemmed from the time after Heartlein had signed the franchise agreements. However, the court refused to find as a matter of law that Heartlein was bound to the franchise agreements before site approval. Before then, he could not “hang the proverbial sign” or “operate as Tires Plus franchises.” The court therefore ruled that a jury question existed as to whether Heartlein was a prospective franchisee at the crucial times.

Dunkin' Donuts' Refusal of Consent to Transfer Was Reasonable

The U.S. District Court for the District of New Mexico has granted partial summary judgment to Dunkin' Donuts against claims by a former franchisee that the refusal of Dunkin' Donuts to grant consent to transfer his franchise was in bad faith and in violation of the franchise agreement. Dunkin' Donuts Incorporated, et al., v. Sharif, Inc., et al., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,842 (D.N.M. 2004).

Dunkin' Donuts terminated Sharif's franchise for nonpayment of various current and back fees and non-reporting. Sharif continued to operate his shop, however, and Dunkin' Donuts brought suit against Sharif for violations of the Lanham Act, breach of contract, and other claims. In the motion before the court, Sharif argued that he should not have to pay Dunkin' Donuts anything. He claimed that another Dunkin' Donuts franchisee, Razzak Gauba, had agreed to purchase the franchise before the termination and to assume Sharif's debts. Sharif alleged that if Dunkin' Donuts had fulfilled its contractual duty to consent to the transfer reasonably, Sharif would owe Dunkin' Donuts nothing, and the obligations would be Gauba's.

The partial summary judgment ruling focused on the issue of whether Dunkin' Donuts acted unreasonably and in bad faith in refusing consent to the transfer. The court ruled that Dunkin' Donuts acted reasonably. It was reasonable, the court found, for Dunkin' Donuts to deny consent for Sharif to transfer his franchise when he was in continuing material default under the franchise agreement and had not met all his financial obligations to the franchisor, because those were conditions for transfer approval under the terms of the franchise agreement. Furthermore, the proposed transferee himself, Gauba, was in default at that time under his own Dunkin' Donuts franchise agreement, so the court concluded that it was reasonable for Dunkin' Donuts to deny consent for Sharif to transfer the franchise to Gauba.

Franchisor's Supermarket Sales Permitted Under Franchise Agreement

The New York State Supreme Court, Appellate Division, has recently upheld the decision of a trial court granting a franchisor's motion to dismiss claims for breach of contract and tortious interference with existing and prospective business relationships as a result of the franchisor's sale of its product to supermarkets and convenience stores for resale to the general public. Silverman v. Carvel Corporation, 778 N.Y.S. 515 (2nd Dept. 2004).

This case involved a dispute between ice cream franchisor Carvel and its former franchisee. The franchisee asserted claims against Carvel for breach of contract and tortious interference with existing and prospective business relationships as a result of Carvel's sales of its products in supermarkets and convenience stores. Carvel filed a motion to dismiss, claiming that Silverman's claims were barred by the statute of limitations and, in the alternative, that the complaint failed to state a claim upon which relief could be granted because nothing in the parties' franchise agreement precluded Carvel's sale of products through alternative channels of distribution such as supermarkets or convenience stores.

The trial court granted Carvel's motion to dismiss because the court believed that the claims were time barred. Silverman appealed, and the appellate court agreed that the claims were not time barred. The appellate court then turned to the substantive issues in the case and found that the complaint should still be dismissed because Silverman's complaint failed to state a claim upon which relief could be granted. Specifically, the court held that Silverman could point to no provision in his franchise agreement that would prohibit Carvel's sale of its products to supermarkets or convenience stores. The court noted that while the agreement prohibited Carvel from opening another store within one-quarter mile of Silverman's store, Silverman failed to allege in his complaint the existence of a Carvel store, or any store, selling Carvel products, within the protected territory. As a result, the appellate court affirmed the trial court's decision and dismissed Silverman's case against Carvel.

This is another in a long line of cases brought by Carvel franchisees against Carvel as a result of Carvel's sales of products in supermarkets and convenience stores. Generally, cases alleging this type of “encroachment” fail if the franchisor in question has drafted the franchise agreement to adequately protect its right to sell through alternative distribution channels. But there have been adverse judgments as well as reported opinions in which the court has found that a franchisor's sale of its product through alternative channels of distribution in close proximity to the franchisee's business could violate the covenant of good faith and fair dealing. (See, e.g., Carvel Corporation v. Baker, et. al., 79 F.Supp.2d 53 (D. Conn. 1997).

Concealing Rebates from Franchisee No Violation, But Minnesota Court Rules Earnings Claims Might Be Fraudulent

The U.S. District Court for the District of Minnesota has ruled that a tire and oil-change franchisor's failure to disclose rebates that it received from suppliers did not violate the Illinois Franchise Disclosure Act (IFDA) or constitute fraud by omission, but it may have committed fraud under the IFDA and common law by making sales projections that were false and not included in the UFOC as earnings claims. In a separate opinion, the court permitted the franchisee to amend the counterclaim to request punitive damages. Team Tires Plus, Ltd. v. Mark Heartlein, et al., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,820 and __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,821 (D.Minn. 2004).

Tires Plus brought suit in Minnesota, its home state, against Heartlein, a franchisee based in Illinois with stores in both Illinois and Iowa. The suit alleged breach of contract for failure to pay fees. Heartlein then raised several counterclaims, against which Tires Plus moved for summary judgment. The parties agreed that Illinois law governed the counterclaims under the IFDA, but Minnesota law governed the other counterclaims. The court granted summary judgment for Tires Plus on the counterclaim involving non-disclosure of supplier rebates, but it denied summary judgment on the others, and it granted Heartlein leave to amend fraud counterclaims to request punitive damages.

Heartlein alleged that Tires Plus violated the IFDA requirement that a franchisor disclose rebates that it receives from suppliers as a result of required purchases or leases. The court found for Tires Plus because Heartlein was not required to purchase from the suppliers who gave Tires Plus rebates. For the same reason, the non-disclosure did not constitute common law fraud by omission since Heartlein presented no evidence that it relied on the non-disclosure of the rebates to his detriment or that the vendor payments resulted in any price differential to Tire Plus franchisees.

The court was more troubled by the earnings claims Heartlein received. For each of Heartlein's two franchises, Tires Plus provided Heartlein with a detailed 3-year pro forma with costs, sales, and earnings information about the market in which the franchise was to be located. The pro formas did not contain any disclaimers or admonitions. Along with the pro formas, Tires Plus provided Heartlein with a detailed demographic breakdown that included data prepared by Equifax, which the court described as “an objective, third party source of demographic information.” But the demographic reports also included a “multiplier factor” that increased projected sales volume for Heartlein's proposed market by 25% above that presented by Equifax. The “multiplier factor” was not labeled as being supplied by Tires Plus and was in the same typeface as the rest of the documents, giving the appearance of having been part of the Equifax report. A Tires Plus representative testified that the multiplier was inserted by Tires Plus into the Equifax documents to bring projected sales results for potential new stores into line with the actual results of existing Tires Plus stores.

Tires Plus gave the pro formas and demographic reports to Heartlein after the franchise agreements had been signed, but during a period before approval of the store sites or the signing of leases for the sites. Heartlein contended that during this period, he still had the right to rescind the agreements. The UFOC provided for the right to cancel “before signing documents that legally obligate [franchisee] to develop the property for the Franchised Service Center.”

According to the court, Minnesota courts define the elements of fraud as: 1) a false representation pertaining to a material past or present fact susceptible of human knowledge; 2) knowledge by the one making the representation of its falsity, or assertion of it without knowledge of its truth or falsity; 3) an intention that the other person act on it, or circumstances justifying the other person in so acting; 4) reasonable reliance by the other person on the representation; and 5) damage attributable to the misrepresentation.

The court found that Heartlein established the first element of fraud through the Equifax reports altered by Tires Plus without notification to the franchisee. The evidence also established the second element of fraud, the court ruled, because Tires Plus knew that the documents were not generated wholly from Equifax, and therefore knew the representations were false. Construing the evidence in Heartlein's favor, as the court is required to do when deciding a motion for summary judgment, the court found that, under the circumstances, Heartlein was justified in believing the false representations and that it could not find as a matter of law that Heartlein had lost the right to rescind. Therefore, the court determined for purposes of summary judgment that Heartlein reasonably relied on the altered Equifax reports in choosing to forego the right to cancel until Tires Plus had formally approved of the sites. Finally, the court ruled that the fifth element of fraud was met because Heartlein showed damage attributable to the misrepresentations ' the franchises operated at a loss.

The court also rejected Tires Plus' motion for summary judgment against Heartlein's assertion that the franchisor violated the IFDA through its pro formas. The court ruled that Heartlein made out a prima facie case for fraudulent practices under the IFDA. The evidence viewed in the light most favorable to Heartlein showed that Tires Plus employed a scheme to defraud by omitting statements of material fact necessary to make the statements not misleading under the circumstances and by omitting information from the pro formas that would have revealed that the report labeled as originating from Equifax also contained numbers inserted by Tires Plus. The court also held that this evidence, when construed in favor of Heartlein, showed that this practice or course of business by Tires Plus operated as a fraud or deceit. Additionally, the court found that the pro formas would qualify as earnings statements under the regulations to the IFDA, which meant that they should have included a description of the factual basis and material assumptions underlying the reports' preparation and presentation.

Tires Plus argued that these claims were barred because the general anti-fraud provision and the earnings-claim regulations of the IFDA are limited to statements made in the offer or sale of a franchise, and that Heartlein's allegations stemmed from the time after Heartlein had signed the franchise agreements. However, the court refused to find as a matter of law that Heartlein was bound to the franchise agreements before site approval. Before then, he could not “hang the proverbial sign” or “operate as Tires Plus franchises.” The court therefore ruled that a jury question existed as to whether Heartlein was a prospective franchisee at the crucial times.

Dunkin' Donuts' Refusal of Consent to Transfer Was Reasonable

The U.S. District Court for the District of New Mexico has granted partial summary judgment to Dunkin' Donuts against claims by a former franchisee that the refusal of Dunkin' Donuts to grant consent to transfer his franchise was in bad faith and in violation of the franchise agreement. Dunkin' Donuts Incorporated, et al., v. Sharif, Inc., et al., __ F.Supp.2d __, CCH Bus. Fran. Guide Par. 12,842 (D.N.M. 2004).

Dunkin' Donuts terminated Sharif's franchise for nonpayment of various current and back fees and non-reporting. Sharif continued to operate his shop, however, and Dunkin' Donuts brought suit against Sharif for violations of the Lanham Act, breach of contract, and other claims. In the motion before the court, Sharif argued that he should not have to pay Dunkin' Donuts anything. He claimed that another Dunkin' Donuts franchisee, Razzak Gauba, had agreed to purchase the franchise before the termination and to assume Sharif's debts. Sharif alleged that if Dunkin' Donuts had fulfilled its contractual duty to consent to the transfer reasonably, Sharif would owe Dunkin' Donuts nothing, and the obligations would be Gauba's.

The partial summary judgment ruling focused on the issue of whether Dunkin' Donuts acted unreasonably and in bad faith in refusing consent to the transfer. The court ruled that Dunkin' Donuts acted reasonably. It was reasonable, the court found, for Dunkin' Donuts to deny consent for Sharif to transfer his franchise when he was in continuing material default under the franchise agreement and had not met all his financial obligations to the franchisor, because those were conditions for transfer approval under the terms of the franchise agreement. Furthermore, the proposed transferee himself, Gauba, was in default at that time under his own Dunkin' Donuts franchise agreement, so the court concluded that it was reasonable for Dunkin' Donuts to deny consent for Sharif to transfer the franchise to Gauba.

Franchisor's Supermarket Sales Permitted Under Franchise Agreement

The New York State Supreme Court, Appellate Division, has recently upheld the decision of a trial court granting a franchisor's motion to dismiss claims for breach of contract and tortious interference with existing and prospective business relationships as a result of the franchisor's sale of its product to supermarkets and convenience stores for resale to the general public. Silverman v. Carvel Corporation , 778 N.Y.S. 515 (2nd Dept. 2004).

This case involved a dispute between ice cream franchisor Carvel and its former franchisee. The franchisee asserted claims against Carvel for breach of contract and tortious interference with existing and prospective business relationships as a result of Carvel's sales of its products in supermarkets and convenience stores. Carvel filed a motion to dismiss, claiming that Silverman's claims were barred by the statute of limitations and, in the alternative, that the complaint failed to state a claim upon which relief could be granted because nothing in the parties' franchise agreement precluded Carvel's sale of products through alternative channels of distribution such as supermarkets or convenience stores.

The trial court granted Carvel's motion to dismiss because the court believed that the claims were time barred. Silverman appealed, and the appellate court agreed that the claims were not time barred. The appellate court then turned to the substantive issues in the case and found that the complaint should still be dismissed because Silverman's complaint failed to state a claim upon which relief could be granted. Specifically, the court held that Silverman could point to no provision in his franchise agreement that would prohibit Carvel's sale of its products to supermarkets or convenience stores. The court noted that while the agreement prohibited Carvel from opening another store within one-quarter mile of Silverman's store, Silverman failed to allege in his complaint the existence of a Carvel store, or any store, selling Carvel products, within the protected territory. As a result, the appellate court affirmed the trial court's decision and dismissed Silverman's case against Carvel.

This is another in a long line of cases brought by Carvel franchisees against Carvel as a result of Carvel's sales of products in supermarkets and convenience stores. Generally, cases alleging this type of “encroachment” fail if the franchisor in question has drafted the franchise agreement to adequately protect its right to sell through alternative distribution channels. But there have been adverse judgments as well as reported opinions in which the court has found that a franchisor's sale of its product through alternative channels of distribution in close proximity to the franchisee's business could violate the covenant of good faith and fair dealing. (See, e.g., Carvel Corporation v. Baker, et. al., 79 F.Supp.2d 53 (D. Conn. 1997).