False Advertising: Eleventh Circuit Makes It Harder for Franchisees to Bring Cases Against Franchisors

Section 43(a) of the Lanham Act provides an action for 'false advertising':

[I]n commercial advertising or promotion, misrepresents that nature, characteristics, [or] qualities ' of his or her ' commercial activities, shall be liable in a civil action by any person who believes that he or she is likely to be damaged by such act ' 15 U.S.C. ' 1125(a).

The Act protects companies' ability to compete in the marketplace by allowing them to sue to enjoin and award damages for advertising that maliciously attacks their reputation or unfairly drives consumers to their competitor's product based on false or misleading claims.

Standing to Bring Suit for False Advertising

To bring suit for false advertising, a plaintiff must have standing to assert his or her claims. Standing has two components: 1) 'Article III standing,' which is the ability to show an injury that can be remedied by the court; and 2) 'prudential standing,' which is difficult to define but generally means that the plaintiff is the 'right party' to bring the lawsuit.

Article III standing is rooted in the Constitution, which limits federal courts to hearing 'cases and controversies.' In false advertising cases, Article III standing is satisfied if the plaintiff can show 'an injury in fact' (commonly, money damages) that is 'fairly traceable to the defendant's challenged conduct' (the false ad) and which is 'likely redressable by a favorable ruling' by the court, such as a monetary award, an order stopping further ads, or even corrective advertising.

'Prudential standing,' on the other hand, is based on judge-created rules for exercising federal jurisdiction over false advertising claims. The goal of prudential standing is not to determine whether the plaintiff was injured by false advertising, but rather whether the plaintiff is the 'right' plaintiff to bring the case. It requires the court to examine the lawsuit in a larger context so it can determine whether it should hear the case at all. If the lawsuit alleges claims 'of broad social import,' and if other parties might be in a better position to proceed with claims against the defendant, prudential standing might not be satisfied. It is inherently judgmental in nature, involves considerations of public policy, and is difficult to define.

Circuit Courts Split on How to Determine Prudential Standing

Although every circuit agrees that consumers do not have standing to challenge false advertising, courts have split on what is required to satisfy 'prudential standing' and whether a direct competitor always has standing to sue for false advertising.

The most rigid, yet in some ways most expansive, test for standing is employed by the Seventh, Ninth, and Tenth Circuits. These three courts apply a 'categorical' standard that generally requires, and grants standing to, 'actual' or 'direct' competitors that can 'assert a competitive injury' stemming from the false advertisement.

By contrast, in the First and Second Circuits direct competition between plaintiff and defendant is not required. Instead, these two courts require that a plaintiff have a ”reasonable interest' to be protected against the type of harm the Lanham Act is intended to prevent and a 'link or nexus' between the false ad and the plaintiff's Lanham Act injury, or a 'reasonable basis for believing' that the false or misleading advertisement is injuring the plaintiff.

The Third and Fifth Circuits employ a complex standing analysis involving the application of a five-factor balancing test. First developed by (now) Supreme Court Justice Alito in Conte Bros. Automotive, Inc. v. Quaker State Slick 50, Inc., 165 F.3d 2211 3d Cir. 1998), the test requires these courts to consider and weigh: 1) the nature of the plaintiff's alleged injury; 2) the directness or indirectness of the asserted injury; 3) the proximity or remoteness of the party to the alleged injurious conduct; 4) the speculativeness of the damages claim; and 5) the risk of duplicative damages or complexity in appropriating damages.

The Fourth, Sixth, and Eighth Circuits have recognized the split among the other circuit courts, but have not yet settled on a definitive test for standing in false advertising cases, other than to acknowledge that the plaintiff must be involved in commercial activity.

Eleventh Circuit Adopts Balancing Test

The Eleventh Circuit did not have a definitive test for determining prudential standing in false advertising cases until the June 2007 Phoenix decision. In Phoenix, the Eleventh Circuit adopted the Third Circuit's Conte Bros. test. The Eleventh Circuit's intent in adopting this multi-factor balancing test was to provide the 'appropriate flexibility in application to address factually disparate scenarios that may arise in the future, while at the same time supplying a principled means for addressing standing under ' '43(a).'

The Conte Bros. test differs from the approaches of other circuits by changing the focus of standing from the status of the plaintiff (Is he/she a competitor?) to instead placing the burden on plaintiffs to show that they have been directly damaged by false advertising in a way that impedes their ability to compete in the marketplace. The test is very favorable to defendants.

The result can be counter-intuitive: In some cases, such as Phoenix, a direct competitor will not have standing to sue for ads that are injuring it; in other cases, a non-competitor may have standing if the ads are injuring the good will associated with and reputation of a product in which it has an interest. The Phoenix decision is a good case study of the former.

Conte Bros. Test in Action: The Phoenix Decision

In Phoenix, a Burger King franchisee operating a single Burger King restaurant in Florida filed a class-action false advertising lawsuit against McDonald's Corp. based on the 'Monopoly' and similar games it had in effect from 1995 through 2001. In a national advertising campaign promoting these games, McDonald's claimed that customers had a 'fair and equal' chance to win low-, mid- and high-value prizes. McDonald's believed the advertisement to be true when it ran, but in reality a high-level McDonald's employee embezzled at least $20 million of the 'high-value' prizes and distributed them to his own network of 'winners' (his friends). Federal authorities discovered and then publicly disclosed the illegal scheme, stating that it 'denied McDonald's customers a fair and equal chance of winning.' Thereafter, McDonald's settled multiple class-action suits alleging fraud, negligence, and unjust enrichment.

The Florida Burger King franchisee did not file suit until several years after the campaign had been disclosed as being rigged. In its lawsuit, the franchisee alleged that it and other Burger King franchisees were damaged by the advertising because McDonald's experienced an 'unnatural spike' in sales during the promotion, Burger King suffered a decrease in sales while the promotion was run, and the franchisee sought to recoup its sales losses. Thus, Article III standing was satisfied because the Burger King franchisee had alleged that he was injured by the false promotion (lost sales) and asked that the court make him whole with money damages.

The Eleventh Circuit, however, dismissed the complaint on prudential standing grounds, ruling that: 1) the franchisee's assumption that customers would have eaten at Burger King (and not other restaurants) 'but for' the false promotion was 'tenuous, to say the least'; 2) the franchisee's damages were too 'speculative' because it would be hard to determine what, if any, lost sales could be traced to McDonald's false claim that consumers had a 'fair and equal' chance to win high-value prizes; and 3) there was a high risk of duplicative damages because every non-Burger King franchisee could assert similar claims if the Burger King franchisees were granted standing in the case. The court, however, was careful to limit the holding to its precise facts, citing the 'flexibility' of the Conte Bros. test.

Underlying the decision was the Eleventh Circuit's clear reluctance to allow a sole local franchisee to sue a franchisor based on that franchisor's national advertising campaign. Although the court stated that its fear was that apportionment of damages would be difficult, it is clear that the court saw the possibility for a Pandora's Box of piecemeal litigation for a national franchisor if the local franchisee's false advertising claim were allowed to continue. As a matter of public policy, the court dismissed the case because the number of potential claimants would substantially affect federal courts and risk duplicative damage awards. Thus the Phoenix decision appears to insulate franchisors from franchisee-filed false advertising claims in the future if the franchisor can show that it has multiple competitors and the franchisor has not identified or 'singled out' any competitor in the challenged advertising such that a local franchisee can claim that it has been uniquely damaged.

Aggressively Monitor Damages When Faced with False Advertising

One important lesson to be learned from Phoenix is that the Burger King franchisees were denied standing despite being direct competitors of McDonald's. This is reason for despair for victims of false advertising ' as victims potentially have no remedy for an illegal ad even when they are damaged, if they cannot show they were 'damaged enough.' However, defendants will likely litigate when questions of prudential standing arise in the future because Phoenix gives defendants an opportunity to dismiss a false ad case early in the litigation.

Phoenix places an onerous burden on plaintiffs to quantify and qualify their damages in detail and 'tell the story' with hard facts about how a false advertisement has injured their business. Given the Eleventh Circuit's focus on the type and quality of damages when determining prudential standing in false advertising cases, companies are advised to aggressively document any damages that they may see in loss of sales and customers that may be due to competitors' advertising if they believe it is false or misleading and that litigation may be the only solution.

Eric Schroeder is a partner with Powell Goldstein LLP in Atlanta. He can be contacted at 404-572-6894 or [email protected].

In a battle of fast food restaurants, a local Florida Burger King franchisee sued McDonald's for false advertising, only to have the Eleventh Circuit Court of Appeals rule that the franchisee could not show that it had standing to bring its claim, despite the fact that the franchisee directly competed against McDonald's restaurants. The ruling, Phoenix of Broward Inc. v. McDonald's Corp., 489 F.3d 1156 (11 th Cir. 2007), states that even direct competitors who allege they have been damaged by false advertisements must also show their damages are not speculative and their claims are unique, before they will be allowed to proceed with their lawsuit. The ruling highlights a split in the circuit courts that may have to be resolved by the Supreme Court, as the ruling differs from the law of other circuits that generally have allowed 'direct competitors' of the advertiser to sue for false advertising as long as they allege they have been injured by the ad.

The Eleventh Circuit ruling illustrates the difficulties franchisees or franchisors may experience in the future when asserting false advertising claims; they will be held to a high standard in order to demonstrate that they have been injured competitively by the ad in question. Further, the decision indicates strong reluctance by courts to have local franchisees sue franchisors for national advertising campaigns. As a practical matter, if franchisees and franchisors suspect that their competitor's ads are false and damaging, they must be proactive in documenting loss of sales and customers, or else they may be denied the right to be made whole, maintain their ability to compete, and protect their reputation.

False Advertising Claims Under the Lanham Act

Section 43(a) of the Lanham Act provides an action for 'false advertising':

[I]n commercial advertising or promotion, misrepresents that nature, characteristics, [or] qualities ' of his or her ' commercial activities, shall be liable in a civil action by any person who believes that he or she is likely to be damaged by such act ' 15 U.S.C. ' 1125(a).

The Act protects companies' ability to compete in the marketplace by allowing them to sue to enjoin and award damages for advertising that maliciously attacks their reputation or unfairly drives consumers to their competitor's product based on false or misleading claims.

Standing to Bring Suit for False Advertising

To bring suit for false advertising, a plaintiff must have standing to assert his or her claims. Standing has two components: 1) 'Article III standing,' which is the ability to show an injury that can be remedied by the court; and 2) 'prudential standing,' which is difficult to define but generally means that the plaintiff is the 'right party' to bring the lawsuit.

Article III standing is rooted in the Constitution, which limits federal courts to hearing 'cases and controversies.' In false advertising cases, Article III standing is satisfied if the plaintiff can show 'an injury in fact' (commonly, money damages) that is 'fairly traceable to the defendant's challenged conduct' (the false ad) and which is 'likely redressable by a favorable ruling' by the court, such as a monetary award, an order stopping further ads, or even corrective advertising.

'Prudential standing,' on the other hand, is based on judge-created rules for exercising federal jurisdiction over false advertising claims. The goal of prudential standing is not to determine whether the plaintiff was injured by false advertising, but rather whether the plaintiff is the 'right' plaintiff to bring the case. It requires the court to examine the lawsuit in a larger context so it can determine whether it should hear the case at all. If the lawsuit alleges claims 'of broad social import,' and if other parties might be in a better position to proceed with claims against the defendant, prudential standing might not be satisfied. It is inherently judgmental in nature, involves considerations of public policy, and is difficult to define.

Circuit Courts Split on How to Determine Prudential Standing

Although every circuit agrees that consumers do not have standing to challenge false advertising, courts have split on what is required to satisfy 'prudential standing' and whether a direct competitor always has standing to sue for false advertising.

The most rigid, yet in some ways most expansive, test for standing is employed by the Seventh, Ninth, and Tenth Circuits. These three courts apply a 'categorical' standard that generally requires, and grants standing to, 'actual' or 'direct' competitors that can 'assert a competitive injury' stemming from the false advertisement.

By contrast, in the First and Second Circuits direct competition between plaintiff and defendant is not required. Instead, these two courts require that a plaintiff have a ”reasonable interest' to be protected against the type of harm the Lanham Act is intended to prevent and a 'link or nexus' between the false ad and the plaintiff's Lanham Act injury, or a 'reasonable basis for believing' that the false or misleading advertisement is injuring the plaintiff.

The Third and Fifth Circuits employ a complex standing analysis involving the application of a five-factor balancing test. First developed by (now) Supreme Court Justice Alito in Conte Bros. Automotive, Inc. v. Quaker State Slick 50, Inc., 165 F.3d 2211 3d Cir. 1998), the test requires these courts to consider and weigh: 1) the nature of the plaintiff's alleged injury; 2) the directness or indirectness of the asserted injury; 3) the proximity or remoteness of the party to the alleged injurious conduct; 4) the speculativeness of the damages claim; and 5) the risk of duplicative damages or complexity in appropriating damages.

The Fourth, Sixth, and Eighth Circuits have recognized the split among the other circuit courts, but have not yet settled on a definitive test for standing in false advertising cases, other than to acknowledge that the plaintiff must be involved in commercial activity.

Eleventh Circuit Adopts Balancing Test

The Eleventh Circuit did not have a definitive test for determining prudential standing in false advertising cases until the June 2007 Phoenix decision. In Phoenix, the Eleventh Circuit adopted the Third Circuit's Conte Bros. test. The Eleventh Circuit's intent in adopting this multi-factor balancing test was to provide the 'appropriate flexibility in application to address factually disparate scenarios that may arise in the future, while at the same time supplying a principled means for addressing standing under ' '43(a).'

The Conte Bros. test differs from the approaches of other circuits by changing the focus of standing from the status of the plaintiff (Is he/she a competitor?) to instead placing the burden on plaintiffs to show that they have been directly damaged by false advertising in a way that impedes their ability to compete in the marketplace. The test is very favorable to defendants.

The result can be counter-intuitive: In some cases, such as Phoenix, a direct competitor will not have standing to sue for ads that are injuring it; in other cases, a non-competitor may have standing if the ads are injuring the good will associated with and reputation of a product in which it has an interest. The Phoenix decision is a good case study of the former.

Conte Bros. Test in Action: The Phoenix Decision

In Phoenix, a Burger King franchisee operating a single Burger King restaurant in Florida filed a class-action false advertising lawsuit against McDonald's Corp. based on the 'Monopoly' and similar games it had in effect from 1995 through 2001. In a national advertising campaign promoting these games, McDonald's claimed that customers had a 'fair and equal' chance to win low-, mid- and high-value prizes. McDonald's believed the advertisement to be true when it ran, but in reality a high-level McDonald's employee embezzled at least $20 million of the 'high-value' prizes and distributed them to his own network of 'winners' (his friends). Federal authorities discovered and then publicly disclosed the illegal scheme, stating that it 'denied McDonald's customers a fair and equal chance of winning.' Thereafter, McDonald's settled multiple class-action suits alleging fraud, negligence, and unjust enrichment.

The Florida Burger King franchisee did not file suit until several years after the campaign had been disclosed as being rigged. In its lawsuit, the franchisee alleged that it and other Burger King franchisees were damaged by the advertising because McDonald's experienced an 'unnatural spike' in sales during the promotion, Burger King suffered a decrease in sales while the promotion was run, and the franchisee sought to recoup its sales losses. Thus, Article III standing was satisfied because the Burger King franchisee had alleged that he was injured by the false promotion (lost sales) and asked that the court make him whole with money damages.

The Eleventh Circuit, however, dismissed the complaint on prudential standing grounds, ruling that: 1) the franchisee's assumption that customers would have eaten at Burger King (and not other restaurants) 'but for' the false promotion was 'tenuous, to say the least'; 2) the franchisee's damages were too 'speculative' because it would be hard to determine what, if any, lost sales could be traced to McDonald's false claim that consumers had a 'fair and equal' chance to win high-value prizes; and 3) there was a high risk of duplicative damages because every non-Burger King franchisee could assert similar claims if the Burger King franchisees were granted standing in the case. The court, however, was careful to limit the holding to its precise facts, citing the 'flexibility' of the Conte Bros. test.

Underlying the decision was the Eleventh Circuit's clear reluctance to allow a sole local franchisee to sue a franchisor based on that franchisor's national advertising campaign. Although the court stated that its fear was that apportionment of damages would be difficult, it is clear that the court saw the possibility for a Pandora's Box of piecemeal litigation for a national franchisor if the local franchisee's false advertising claim were allowed to continue. As a matter of public policy, the court dismissed the case because the number of potential claimants would substantially affect federal courts and risk duplicative damage awards. Thus the Phoenix decision appears to insulate franchisors from franchisee-filed false advertising claims in the future if the franchisor can show that it has multiple competitors and the franchisor has not identified or 'singled out' any competitor in the challenged advertising such that a local franchisee can claim that it has been uniquely damaged.

Aggressively Monitor Damages When Faced with False Advertising

One important lesson to be learned from Phoenix is that the Burger King franchisees were denied standing despite being direct competitors of McDonald's. This is reason for despair for victims of false advertising ' as victims potentially have no remedy for an illegal ad even when they are damaged, if they cannot show they were 'damaged enough.' However, defendants will likely litigate when questions of prudential standing arise in the future because Phoenix gives defendants an opportunity to dismiss a false ad case early in the litigation.

Phoenix places an onerous burden on plaintiffs to quantify and qualify their damages in detail and 'tell the story' with hard facts about how a false advertisement has injured their business. Given the Eleventh Circuit's focus on the type and quality of damages when determining prudential standing in false advertising cases, companies are advised to aggressively document any damages that they may see in loss of sales and customers that may be due to competitors' advertising if they believe it is false or misleading and that litigation may be the only solution.

Eric Schroeder is a partner with Powell Goldstein LLP in Atlanta. He can be contacted at 404-572-6894 or [email protected].