Court Watch

Federal Court Rejects PA Choice-of-Law Provisions

Franchisors likely realize that choice-of-law provisions may not immunize them from the franchise laws of their franchisees' various states, but, as happened in Cottman Transmission Systems, LLC, et. al. v. Dale Kershner, et. al., CCH ' 13,641 (E.D. Pa. 2007), a franchisor likely would not anticipate that it would have to defend itself against the disclosure laws of multiple states in a single lawsuit.

Cottman Transmission Systems, LLC is a Pennsylvania franchisor of stores that service and repair automobile transmissions. Several of Cottman's franchisees from various jurisdictions brought an action in federal court in Pennsylvania, claiming that Cottman misrepresented its franchise system to induce them to enter into franchise agreements. They alleged, among other things, that Cottman under-represented the initial investment and failed to provide the support it promised under the franchise agreement.

The franchisees later sought to amend their complaint to assert claims individually against Todd P. Leff, Cottman's president and chief executive officer, under franchise disclosure statutes in California, Wisconsin, and New York. Cottman objected because the franchise agreements specified that Pennsylvania law would govern any dispute.

Under Pennsylvania choice-of-law rules, the plaintiffs could overcome the choice-of-law clause if: 1) the chosen state has no substantial relationship to the parties or the transaction, or 2) if application of the law of the chosen state would be contrary to a policy of a state with a materially greater interest than the chosen state in the determination of the particular issue.

The court determined that Pennsylvania had a substantial relationship to the parties and the transaction in this case. Cottman's corporate headquarters are located in Pennsylvania, the franchise agreements were negotiated in Pennsylvania, and the franchise agreements required new franchisees to travel to Pennsylvania to attend training.

With respect to the second factor, however, the court concluded that applying Pennsylvania law would violate the respective policies established by California, New York, and Wisconsin in enacting their respective franchise disclosure statutes. The court reasoned that the standards and remedies available under those franchise disclosure statutes provided substantially more protection to the franchisees than the application of the common law claims available under Pennsylvania law. Under the California, New York, and Wisconsin franchise statutes, persons who directly or indirectly control others who are liable under the states' franchise acts are themselves liable, without the need to pierce the corporate veil. Thus, the franchise disclosure statutes enabled the franchisees to assert claims against Leff individually without having to pierce the Cottman corporate veil.

Further, when common law fraud is asserted under Pennsylvania law, the franchisor has the defense that its statements were not misrepresentations because they were factual. Under the particular franchise disclosure statutes, however, the franchisor would have to establish that it provided information in a non-misleading manner.

The court also considered it important that each of the California, New York, and Wisconsin franchise statutes contained anti-waiver provisions.

Finally, under the New York statute, the franchisees could recover their reasonable attorneys' fees and costs.

For those reasons, the court decided that the laws of California, New York, and Wisconsin would apply to the appropriate franchisees in the case. As a result, Cottman will have to defend its practices under the laws of each of the respective states in which its franchisees operate.

Summary Judgment for Dunkin' Donuts Reversed in Pork Products Case

Franchisors must ensure that they enforce the obligations in their franchise agreements fairly and not in a racially discriminatory manner. The Seventh Circuit has held that a franchisee stated a prima facie case for racial discrimination where the franchisor refused to allow him to relocate or renew his franchisee agreements based on noncompliance with the franchise agreement. Elkhatib v. Dunkin Donuts, Inc., __ F.3d __, 2007 WL 1976126 (7th Cir. 2007).

Elkhatib purchased his first Dunkin' Donuts franchise in 1979. One of the reasons he chose Dunkin' Donuts is that, at the time, it did not require him to handle pork products, which he testified was forbidden to him as an Arab. (Note: The lower court apparently based at least part of its decision on religious discrimination, reflecting Elkhatib's Moslem religion; but that was not the argument he made in court.)

In 1984, Dunkin' Donuts began selling breakfast sandwiches which contained pork. Dunkin' Donuts did not object to Elkhatib's refusal to sell the sandwiches and, later, to sell the sandwiches without any meat. In fact, Dunkin' Donuts supplied Elkhatib with a sign that stated 'Meat Products Not Available.' In 1995, Elkhatib opened a second store, and in 1998, he opened a third store. At no point did Dunkin' Donuts object to Elkhatib's continued refusal to sell pork products.

In 2002, Elkhatib sought approval to relocate one of his stores. Dunkin' Donuts refused to approve the relocation and later informed him that it would not renew his franchise agreements due to his refusal to sell the full line of breakfast sandwiches. Elkhatib commenced an action in the U.S. District Court for the Northern District of Illinois, alleging racial discrimination under 42 U.S.C. ”1981 and 1982. The trial court granted summary judgment in favor of Dunkin' Donuts, and Elkhatib appealed.

Elkhatib presented very little direct evidence of racial discrimination, which the Seventh Circuit readily held to be insufficient. But where there is not sufficient direct evidence of discrimination under '1981, it may be shown through an indirect, burden-shifting test. Under that method, Elkhatib had to first establish a prima facie case of discrimination by showing that: 1) he belongs to a protected class; 2) he met Dunkin' Donuts' legitimate expectations with regard to the franchise agreement; 3) he suffered an adverse action; and 4) similarly situated non-protected individuals were treated more favorably.If Elkhatib made that showing, Dunkin' Donuts must provide a legitimate, non-discriminatory reason for its actions. Then, the burden would shift back to Elkhatib to show that Dunkin' Donuts' reasons were merely pretextual.

The first and third prongs of the test, belonging to a protected class and suffering an adverse action, were clearly shown by Elkhatib. With respect to the second element of the four-part test, Dunkin' Donuts argued that Elkhatib did not comply with the franchise agreement, which required franchisees to carry Dunkin' Donuts' full product line. Elkhatib argued that Dunkin' Donuts never required franchisees to comply with that provision and, in fact, assisted them by providing the 'No Meat Products Available' signs. Elkhatib further argued that the decision to enforce the provision was applied against him in a racially discriminatory manner. The Seventh Circuit reasoned that in this situation, the second and fourth prongs of the four-part test merge, and the inquiry becomes whether there were similarly situated franchisees not in the protected class that were treated differently.

The evidence in the record showed that three other franchisees in the Chicago area, none of which were Arab, refused to carry the breakfast sandwiches. One of these franchisees did not carry the sandwiches based on restrictions in its lease, one of them claimed he did not have space for the sandwich-making equipment, and the third stated that there was neighborhood demand for a kosher establishment. The court determined that despite the different reasons for not carrying the sandwiches, Elkhatib and these three franchisees were similarly situated. Because they were similarly situated, and Dunkin' Donuts had not refused to renew the franchise agreements of these other three franchisees, the Seventh Circuit held that Elkhatib had met his burden of proving a prima facie case.

Dunkin' Donuts then had the burden of proving a legitimate non-discriminatory reason for its actions. The evidence showed that the carrying of the breakfast sandwiches was not of any real importance to Dunkin' Donuts. It allowed other franchisees to refuse to carry them, it failed to raise this issue with Elkhatib for nearly 20 years, and it provided 'Meat Products Not Available' signs to franchisees. In addition, breakfast sandwich sales accounted for a very small percentage of total sales. The appellate court held that Dunkin' Donuts' reasons for its actions were pretextual, reversed the grant of summary judgment, and remanded the case for further proceedings before the trial court.

Cynthia M. Klaus and Sejal Desai Winkelman are attorneys at Larkin Hoffman in Minneapolis. Klaus can be contacted at [email protected], and Winkelman can be contacted at [email protected].

Federal Court Rejects PA Choice-of-Law Provisions

Franchisors likely realize that choice-of-law provisions may not immunize them from the franchise laws of their franchisees' various states, but, as happened in Cottman Transmission Systems, LLC, et. al. v. Dale Kershner, et. al., CCH ' 13,641 (E.D. Pa. 2007), a franchisor likely would not anticipate that it would have to defend itself against the disclosure laws of multiple states in a single lawsuit.

Cottman Transmission Systems, LLC is a Pennsylvania franchisor of stores that service and repair automobile transmissions. Several of Cottman's franchisees from various jurisdictions brought an action in federal court in Pennsylvania, claiming that Cottman misrepresented its franchise system to induce them to enter into franchise agreements. They alleged, among other things, that Cottman under-represented the initial investment and failed to provide the support it promised under the franchise agreement.

The franchisees later sought to amend their complaint to assert claims individually against Todd P. Leff, Cottman's president and chief executive officer, under franchise disclosure statutes in California, Wisconsin, and New York. Cottman objected because the franchise agreements specified that Pennsylvania law would govern any dispute.

Under Pennsylvania choice-of-law rules, the plaintiffs could overcome the choice-of-law clause if: 1) the chosen state has no substantial relationship to the parties or the transaction, or 2) if application of the law of the chosen state would be contrary to a policy of a state with a materially greater interest than the chosen state in the determination of the particular issue.

The court determined that Pennsylvania had a substantial relationship to the parties and the transaction in this case. Cottman's corporate headquarters are located in Pennsylvania, the franchise agreements were negotiated in Pennsylvania, and the franchise agreements required new franchisees to travel to Pennsylvania to attend training.

With respect to the second factor, however, the court concluded that applying Pennsylvania law would violate the respective policies established by California, New York, and Wisconsin in enacting their respective franchise disclosure statutes. The court reasoned that the standards and remedies available under those franchise disclosure statutes provided substantially more protection to the franchisees than the application of the common law claims available under Pennsylvania law. Under the California, New York, and Wisconsin franchise statutes, persons who directly or indirectly control others who are liable under the states' franchise acts are themselves liable, without the need to pierce the corporate veil. Thus, the franchise disclosure statutes enabled the franchisees to assert claims against Leff individually without having to pierce the Cottman corporate veil.

Further, when common law fraud is asserted under Pennsylvania law, the franchisor has the defense that its statements were not misrepresentations because they were factual. Under the particular franchise disclosure statutes, however, the franchisor would have to establish that it provided information in a non-misleading manner.

The court also considered it important that each of the California, New York, and Wisconsin franchise statutes contained anti-waiver provisions.

Finally, under the New York statute, the franchisees could recover their reasonable attorneys' fees and costs.

For those reasons, the court decided that the laws of California, New York, and Wisconsin would apply to the appropriate franchisees in the case. As a result, Cottman will have to defend its practices under the laws of each of the respective states in which its franchisees operate.

Summary Judgment for Dunkin' Donuts Reversed in Pork Products Case

Franchisors must ensure that they enforce the obligations in their franchise agreements fairly and not in a racially discriminatory manner. The Seventh Circuit has held that a franchisee stated a prima facie case for racial discrimination where the franchisor refused to allow him to relocate or renew his franchisee agreements based on noncompliance with the franchise agreement. Elkhatib v. Dunkin Donuts, Inc. , __ F.3d __, 2007 WL 1976126 (7th Cir. 2007).

Elkhatib purchased his first Dunkin' Donuts franchise in 1979. One of the reasons he chose Dunkin' Donuts is that, at the time, it did not require him to handle pork products, which he testified was forbidden to him as an Arab. (Note: The lower court apparently based at least part of its decision on religious discrimination, reflecting Elkhatib's Moslem religion; but that was not the argument he made in court.)

In 1984, Dunkin' Donuts began selling breakfast sandwiches which contained pork. Dunkin' Donuts did not object to Elkhatib's refusal to sell the sandwiches and, later, to sell the sandwiches without any meat. In fact, Dunkin' Donuts supplied Elkhatib with a sign that stated 'Meat Products Not Available.' In 1995, Elkhatib opened a second store, and in 1998, he opened a third store. At no point did Dunkin' Donuts object to Elkhatib's continued refusal to sell pork products.

In 2002, Elkhatib sought approval to relocate one of his stores. Dunkin' Donuts refused to approve the relocation and later informed him that it would not renew his franchise agreements due to his refusal to sell the full line of breakfast sandwiches. Elkhatib commenced an action in the U.S. District Court for the Northern District of Illinois, alleging racial discrimination under 42 U.S.C. ”1981 and 1982. The trial court granted summary judgment in favor of Dunkin' Donuts, and Elkhatib appealed.

Elkhatib presented very little direct evidence of racial discrimination, which the Seventh Circuit readily held to be insufficient. But where there is not sufficient direct evidence of discrimination under '1981, it may be shown through an indirect, burden-shifting test. Under that method, Elkhatib had to first establish a prima facie case of discrimination by showing that: 1) he belongs to a protected class; 2) he met Dunkin' Donuts' legitimate expectations with regard to the franchise agreement; 3) he suffered an adverse action; and 4) similarly situated non-protected individuals were treated more favorably.If Elkhatib made that showing, Dunkin' Donuts must provide a legitimate, non-discriminatory reason for its actions. Then, the burden would shift back to Elkhatib to show that Dunkin' Donuts' reasons were merely pretextual.

The first and third prongs of the test, belonging to a protected class and suffering an adverse action, were clearly shown by Elkhatib. With respect to the second element of the four-part test, Dunkin' Donuts argued that Elkhatib did not comply with the franchise agreement, which required franchisees to carry Dunkin' Donuts' full product line. Elkhatib argued that Dunkin' Donuts never required franchisees to comply with that provision and, in fact, assisted them by providing the 'No Meat Products Available' signs. Elkhatib further argued that the decision to enforce the provision was applied against him in a racially discriminatory manner. The Seventh Circuit reasoned that in this situation, the second and fourth prongs of the four-part test merge, and the inquiry becomes whether there were similarly situated franchisees not in the protected class that were treated differently.

The evidence in the record showed that three other franchisees in the Chicago area, none of which were Arab, refused to carry the breakfast sandwiches. One of these franchisees did not carry the sandwiches based on restrictions in its lease, one of them claimed he did not have space for the sandwich-making equipment, and the third stated that there was neighborhood demand for a kosher establishment. The court determined that despite the different reasons for not carrying the sandwiches, Elkhatib and these three franchisees were similarly situated. Because they were similarly situated, and Dunkin' Donuts had not refused to renew the franchise agreements of these other three franchisees, the Seventh Circuit held that Elkhatib had met his burden of proving a prima facie case.

Dunkin' Donuts then had the burden of proving a legitimate non-discriminatory reason for its actions. The evidence showed that the carrying of the breakfast sandwiches was not of any real importance to Dunkin' Donuts. It allowed other franchisees to refuse to carry them, it failed to raise this issue with Elkhatib for nearly 20 years, and it provided 'Meat Products Not Available' signs to franchisees. In addition, breakfast sandwich sales accounted for a very small percentage of total sales. The appellate court held that Dunkin' Donuts' reasons for its actions were pretextual, reversed the grant of summary judgment, and remanded the case for further proceedings before the trial court.

Cynthia M. Klaus and Sejal Desai Winkelman are attorneys at Larkin Hoffman in Minneapolis. Klaus can be contacted at [email protected], and Winkelman can be contacted at [email protected].