Court Watch

Jury Finds Independent Insurance Agent a 'Franchisee'

On Dec. 13, 2004, a federal jury in the U.S. District Court of Connecticut awarded $2.3 million in damages to a terminated independent insurance agent, in the case of Charts v. Nationwide Mutual Insurance Company, Civil Action No. 3:97 01621 (CFD). Among the findings of the jury were that agent Charts operated pursuant to a franchise agreement, that the franchise was terminated without good cause as required by the Connecticut Franchise Act, that Nationwide violated the implied covenant of good faith and fair dealing, and that Nationwide's conduct violated the Connecticut Unfair Trade Practices Act.

Note that at press time, the court had not yet ruled on Nationwide's post-verdict motion for judgment as a matter of law and/or for new trial. Among the several grounds for its post-trial motion, Nationwide has asserted that it had good cause to terminate; that the evidence did not prove that Charts was a franchisee because there was no proof that he was engaged in the sale, offering, or distribution of Nationwide's products; that the sale, offering, and distribution of Nationwide's insurance policies were vested solely in Nationwide; and that Charts was merely an agent/conduit with no authority to vary the terms for Nationwide's insurance products. The post-trial motion further contends that no marketing plan was imposed by Nationwide, that Charts was an independent contractor who had the sole discretion and responsibility for operating the agency, and that Nationwide's control was limited to its obligations under Connecticut's insurance statutes and to preserving its trademark.

Although insurance agencies may be considered franchises in the context of some state relationship laws, for the reasons noted below, it appears that insurance agency arrangements can be structured to avoid the necessity of complying with presale disclosure requirements, at least in those states where disclosure requirements are governed solely by the Federal Trade Commission's Franchise Rule.

The Nationwide decision was based on the Connecticut Franchise Act. In order to constitute a franchise under Connecticut law, only two elements are necessary: 1) the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor; and 2) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark. Notably absent is the “fee” or “required payment” element present in most, but not all, state definitions and the FTC's definition of a franchise. Since Connecticut does not have a franchise disclosure law, disclosure obligations in that jurisdiction are based solely on the FTC Franchise Rule.

The FTC Interpretative Guides specifically address the “required payment” element in the context of insurance agents and states, “Agency relationships in which independent agents, compensated by commission, sell goods or services (e.g. insurance salespersons) are excluded, since there is no 'required payment.'” The Statement of Basis and Purpose of the FTC Franchise Rule, in a footnote explaining the “required payment” element, bolsters this analysis and states: “Under this provision, most distributors who do not take title to goods and who receive commissions, will not be making 'payments' to the producer within the meaning of this provision. This would include, for example, insurance agents … ”

This position was adapted in an early FTC Interpretative Opinion, Highland Petroleum, Inc., Bus. Franchise Guide (CCH) '6434 (Dec. 9, 1982), which, although not involving an insurance agency relationship, noted that the conclusion in the FTC's Statement of Basis and Purpose was reached because in a commission arrangement where a producer or supplier retains title to the goods sold, the retailer ordinarily does not pay any of its own money to the producer, and sales commissions are paid by the supplier to the retailer. The Interpretative Opinion goes on to note that the fact that the retailer may act on the supplier's behalf to collect from consumers for the goods sold does not alter this conclusion, because the money collected is the property of the supplier, not the retailer.

A highly regarded treatise on franchise law, Garner's Franchise and Distribution Law and Practice (1990) section 1.31, pages 30-31, which has been quoted in several cases, also notes that “'Manufacturer's representatives are independent sales representatives … They generally are paid on a commission basis … These representatives usually make no investment in the business of distribution of the product, carry no inventory and have no warehouse or employees. Typically they cannot alter the terms on which the manufacturer offers the products for sale, and they do not have authority to close sales. … They do not pay a fee for the right to sell the manufacturer's product and are not usually held to constitute franchises or dealerships.'”

Furthermore, in Vitauskas v. State Farm Mutual Automobile Insurance Co., Bus. Franchise Guide (CCH) '8899 (July 28, 1987), the Illinois court found that no franchise relationship existed because the plaintiff was not required to a pay a franchise fee. The court noted, “A payment alleged to be a franchise fee must fit precisely within the statutory definition.”

If independent insurance agency contracts are carefully drafted and in practice there are no fees ' as well as no hidden or indirect fees ' payable to the insurance company or its affiliates, insurance companies stand a good chance of not being subject to the presale disclosure requirements applicable to franchises under the FTC Franchise Rule. On the other hand, if insurance agents make any required payments to the insurance company or its affiliates in excess of $500 during the first 6 months of business operations, and if they otherwise satisfy the elements of a franchise under the FTC Franchise Rule, they may fall within the grasp of the Rule, as well as certain state statutes, some of which have more expansive franchise definitions. Furthermore, some states may not adapt the FTC's position regarding commission payments.

Insurance companies are certainly not alone in their vulnerability to being classified as franchisors, and they must, in any event be cognizant of the state relationship laws. As one court noted, “Legal terms often have specialized meanings that can surprise even a sophisticated party. The term 'franchise,' or its derivative 'franchisee,' is one of those words.” To-Am Equipment Company, Inc v. Mitsubishi Caterpillar Forklift America, Inc., 152 F.3d 658 (7th Cir. 1998).

Although there is no universal definition of a “franchise,” a wide array of cases and administrative opinions have declared certain arrangements to be so-called “hidden franchises.” Many of these have been found in cases involving various types of business arrangements, including: an air conditioner dealer, appliance dealer, basketball team, cafeteria in office building, computer training system, copy machine distributor, furniture dealer, Internet provider, law firm branch office, magazine distributorship, office products dealer, sales representative, slot machine manufacturer, snack distributorship, sports information service provider, and a sublease agreement for pet shop. To the untrained eye, many of these situations do not appear to be franchises because they are not the traditional types of arrangements normally associated with franchises.

Although many of these arrangements would not be subject to presale disclosure requirements, they were still found to be subject to the state relationship laws that often govern termination, transfer, cancellation, and non-renewal. Arkansas, California, Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Indiana, Iowa, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, South Dakota, Virginia, Washington, and Wisconsin have enacted some form of state relationship law. Absent a statutory exclusion, if a business relationship contains the elements of a franchise in any of those states, state law will apply, regardless of contractual language to the contrary, and even if there is no state registration requirement. For example, a state franchise law that requires a notice and opportunity to cure before a termination will generally trump a contractual provision that permits termination without an opportunity to cure. In addition, many states have “business opportunity” and “sales representative” laws, which may be applicable under certain circumstances.

Each state law is different, so it is important to carefully examine the applicable statute. Manufacturers and suppliers, as well as insurance companies, must analyze the appropriate statutes, regulations, interpretative guides, and court decisions to determine if there is a way to structure their relationship in order to avoid the unintended or inadvertent applicability of the franchise laws. Even if they can avoid the disclosure requirements, the safest course may be to comply with the state relationship laws if there is any doubt as to their applicability. As Charts demonstrates, failure to do so poses a great risk to those who are arguably franchisors. Even if the putative franchisor ultimately prevails in court, the costs of defense are likely to be substantial.

Jury Finds Independent Insurance Agent a 'Franchisee'

On Dec. 13, 2004, a federal jury in the U.S. District Court of Connecticut awarded $2.3 million in damages to a terminated independent insurance agent, in the case of Charts v. Nationwide Mutual Insurance Company, Civil Action No. 3:97 01621 (CFD). Among the findings of the jury were that agent Charts operated pursuant to a franchise agreement, that the franchise was terminated without good cause as required by the Connecticut Franchise Act, that Nationwide violated the implied covenant of good faith and fair dealing, and that Nationwide's conduct violated the Connecticut Unfair Trade Practices Act.

Note that at press time, the court had not yet ruled on Nationwide's post-verdict motion for judgment as a matter of law and/or for new trial. Among the several grounds for its post-trial motion, Nationwide has asserted that it had good cause to terminate; that the evidence did not prove that Charts was a franchisee because there was no proof that he was engaged in the sale, offering, or distribution of Nationwide's products; that the sale, offering, and distribution of Nationwide's insurance policies were vested solely in Nationwide; and that Charts was merely an agent/conduit with no authority to vary the terms for Nationwide's insurance products. The post-trial motion further contends that no marketing plan was imposed by Nationwide, that Charts was an independent contractor who had the sole discretion and responsibility for operating the agency, and that Nationwide's control was limited to its obligations under Connecticut's insurance statutes and to preserving its trademark.

Although insurance agencies may be considered franchises in the context of some state relationship laws, for the reasons noted below, it appears that insurance agency arrangements can be structured to avoid the necessity of complying with presale disclosure requirements, at least in those states where disclosure requirements are governed solely by the Federal Trade Commission's Franchise Rule.

The Nationwide decision was based on the Connecticut Franchise Act. In order to constitute a franchise under Connecticut law, only two elements are necessary: 1) the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor; and 2) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark. Notably absent is the “fee” or “required payment” element present in most, but not all, state definitions and the FTC's definition of a franchise. Since Connecticut does not have a franchise disclosure law, disclosure obligations in that jurisdiction are based solely on the FTC Franchise Rule.

The FTC Interpretative Guides specifically address the “required payment” element in the context of insurance agents and states, “Agency relationships in which independent agents, compensated by commission, sell goods or services (e.g. insurance salespersons) are excluded, since there is no 'required payment.'” The Statement of Basis and Purpose of the FTC Franchise Rule, in a footnote explaining the “required payment” element, bolsters this analysis and states: “Under this provision, most distributors who do not take title to goods and who receive commissions, will not be making 'payments' to the producer within the meaning of this provision. This would include, for example, insurance agents … ”

This position was adapted in an early FTC Interpretative Opinion, Highland Petroleum, Inc., Bus. Franchise Guide (CCH) '6434 (Dec. 9, 1982), which, although not involving an insurance agency relationship, noted that the conclusion in the FTC's Statement of Basis and Purpose was reached because in a commission arrangement where a producer or supplier retains title to the goods sold, the retailer ordinarily does not pay any of its own money to the producer, and sales commissions are paid by the supplier to the retailer. The Interpretative Opinion goes on to note that the fact that the retailer may act on the supplier's behalf to collect from consumers for the goods sold does not alter this conclusion, because the money collected is the property of the supplier, not the retailer.

A highly regarded treatise on franchise law, Garner's Franchise and Distribution Law and Practice (1990) section 1.31, pages 30-31, which has been quoted in several cases, also notes that “'Manufacturer's representatives are independent sales representatives … They generally are paid on a commission basis … These representatives usually make no investment in the business of distribution of the product, carry no inventory and have no warehouse or employees. Typically they cannot alter the terms on which the manufacturer offers the products for sale, and they do not have authority to close sales. … They do not pay a fee for the right to sell the manufacturer's product and are not usually held to constitute franchises or dealerships.'”

Furthermore, in Vitauskas v. State Farm Mutual Automobile Insurance Co., Bus. Franchise Guide (CCH) '8899 (July 28, 1987), the Illinois court found that no franchise relationship existed because the plaintiff was not required to a pay a franchise fee. The court noted, “A payment alleged to be a franchise fee must fit precisely within the statutory definition.”

If independent insurance agency contracts are carefully drafted and in practice there are no fees ' as well as no hidden or indirect fees ' payable to the insurance company or its affiliates, insurance companies stand a good chance of not being subject to the presale disclosure requirements applicable to franchises under the FTC Franchise Rule. On the other hand, if insurance agents make any required payments to the insurance company or its affiliates in excess of $500 during the first 6 months of business operations, and if they otherwise satisfy the elements of a franchise under the FTC Franchise Rule, they may fall within the grasp of the Rule, as well as certain state statutes, some of which have more expansive franchise definitions. Furthermore, some states may not adapt the FTC's position regarding commission payments.

Insurance companies are certainly not alone in their vulnerability to being classified as franchisors, and they must, in any event be cognizant of the state relationship laws. As one court noted, “Legal terms often have specialized meanings that can surprise even a sophisticated party. The term 'franchise,' or its derivative 'franchisee,' is one of those words.” To-Am Equipment Company, Inc v. Mitsubishi Caterpillar Forklift America, Inc., 152 F.3d 658 (7th Cir. 1998).

Although there is no universal definition of a “franchise,” a wide array of cases and administrative opinions have declared certain arrangements to be so-called “hidden franchises.” Many of these have been found in cases involving various types of business arrangements, including: an air conditioner dealer, appliance dealer, basketball team, cafeteria in office building, computer training system, copy machine distributor, furniture dealer, Internet provider, law firm branch office, magazine distributorship, office products dealer, sales representative, slot machine manufacturer, snack distributorship, sports information service provider, and a sublease agreement for pet shop. To the untrained eye, many of these situations do not appear to be franchises because they are not the traditional types of arrangements normally associated with franchises.

Although many of these arrangements would not be subject to presale disclosure requirements, they were still found to be subject to the state relationship laws that often govern termination, transfer, cancellation, and non-renewal. Arkansas, California, Connecticut, Delaware, District of Columbia, Hawaii, Illinois, Indiana, Iowa, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, South Dakota, Virginia, Washington, and Wisconsin have enacted some form of state relationship law. Absent a statutory exclusion, if a business relationship contains the elements of a franchise in any of those states, state law will apply, regardless of contractual language to the contrary, and even if there is no state registration requirement. For example, a state franchise law that requires a notice and opportunity to cure before a termination will generally trump a contractual provision that permits termination without an opportunity to cure. In addition, many states have “business opportunity” and “sales representative” laws, which may be applicable under certain circumstances.

Each state law is different, so it is important to carefully examine the applicable statute. Manufacturers and suppliers, as well as insurance companies, must analyze the appropriate statutes, regulations, interpretative guides, and court decisions to determine if there is a way to structure their relationship in order to avoid the unintended or inadvertent applicability of the franchise laws. Even if they can avoid the disclosure requirements, the safest course may be to comply with the state relationship laws if there is any doubt as to their applicability. As Charts demonstrates, failure to do so poses a great risk to those who are arguably franchisors. Even if the putative franchisor ultimately prevails in court, the costs of defense are likely to be substantial.