Court Watch

The trial court ruled in favor of all defendants. While it essentially found that there was fraudulent concealment of the losses of the franchised stores, it ruled that plaintiffs could not have reasonably relied because: 1) information about expenses of the stores was publicly available; and 2) the exculpatory clauses in the UFOC precluded reliance on the non-disclosure of store losses and the parent's financial condition.

The appellate court rejected arguments that the disclaimers at issue should be rejected, because they sought to relieve the defendants from their own fraud. While noting the FTC's position that integration clauses are not likely to protect franchisors from fraud claims, the court held that the disclaimers constituted an affirmative representation by the plaintiffs that they were not relying on the matters disclaimed.

The court affirmed the findings as to the company stores, since those disclaimers stated: 1) that the numbers were not indicative of how franchised stores would perform; 2) that no profitability representations were being made; and 3) that the “earnings” figures did not reflect expenses.

The court found that the disclaimers in the UFOC did not apply to the article's representations about the parent's profitability since that representation was not part of the UFOC. The UFOC disclaimers pertained only to representations regarding the franchisor and did not pertain to undisclosed but material information concerning the franchisor's parent.

The court also held that the FTC Act, which did not require disclosure of financial condition of the parent, did not mean that the parent was precluded by law from disclosing financial information about its losses, since that information was not deceptive or contrary to any information disclosed. The court also affirmed dismissal of the Colorado “little” FTC Act claims, drawing a dissenting opinion, because only 68 persons received packets, and that did not constitute a public impact as required by that law. It rejected arguments that the availability of the company's Web site constituted a public impact since it was available to the public. In coming to that conclusion, the court focused on the disclaimer on the Web site that its contents did not constitute the offer of a franchise.

The court upheld the contractual jury trial waiver mainly on the basis that the right to a jury trial in a civil case is not constitutionally guaranteed under Colorado law, and that the waiver was clearly set out. The court also allowed the franchisor's law firm, not a party to the contractual jury trial waiver, to enforce the waiver on the basis that it was an agent of the franchisor and, thus, under the agreement was allowed to do so.

An interesting side issue as to claims against the franchisor's law firm was the affirmance of a bifurcation order that the trial court issued, reasoning that in a joint trial the other defendants and/or the law firm would be prejudiced to the extent that the firm sought to use privileged communications in its own defense.

Existence of Enforceable In-term Covenant Not Enough for a MN Court
to Issue a TRO

The ability to enforce an in-term covenant against competition in a franchise agreement by use of extraordinary remedies was the issue in Anytime Fitness, Inc. v. Family Fitness of Royal, LLC, et al., Bus. Franchise Guide (CCH) ' 14,303 (USDC D.Minn., Jan. 8, 2010). The franchisor, Anytime Fitness, entered into an area development agreement with Delamater for the development of franchises in Kern County, CA. Pursuant to the ADA, Delameter signed franchise agreements for Anytime Fitness facilities in Oildale, Tehachapi, Westchester, and a yet-to-be-determined location. Each agreement contained an in-term covenant against competition in which the franchisee agreed not to “own, operate, lease, franchise, engage in, be connected with, have any interest in, or assist any person or entity engaged in any other fitness center.”

When the Oildale agreement expired, Delamater replaced the “Anytime Fitness” sign with “Oildale Fitness” and took other steps to “de-identify” the Oildale facility. He also transferred the Oildale Anytime Fitness memberships to his Anytime Fitness studio in nearby Westchester and informed Oildale members that Anytime Fitness memberships would not be honored in the re-branded Oildale facility.

Since post-term covenants against competition are not enforceable in California under California Business and Professions Code ' 16600, Anytime Fitness filed an action claiming a breach of the in-term covenant against competition in the remaining Delamater Anytime Fitness franchise agreements and sought a temporary restraining order (“TRO”) to enforce those provisions. The court stated that it had to consider four factors: 1) the threat of irreparable harm to the moving party; 2) the balance between the harm caused to the moving party, versus the harm that would be caused to the non-moving party if the TRO should issue; 3) the likelihood of the moving party's ultimate success on the merits; and 4) the public interest that would be affected by issuing the order.

Anytime Fitness argued that it would suffer irreparable harm since the Oildale facility would have access to its proprietary information, such as planned promotions and sales strategies. The court indicated that this type of harm was too speculative to serve as the basis for a TRO, especially since Delamater's other Anytime Fitness facilities would be the prime victims of that misuse. Anytime Fitness also argued that its goodwill would be harmed since former Oildale members would be confused by the change in the identity. The court pointed to the steps Delamater had taken to distinguish the Oildale facility from Anytime Fitness facilities, reducing the certainty of imminent harm. Lastly, Anytime Fitness argued that if Delamater was allowed to open independent fitness facilities, other franchisees would be similarly inspired. The court, again, found this type of harm speculative, since being affiliated with Anytime Fitness, a system with more than 1,200 facilities, provided its franchisees with many benefits not available to independents and that a win by Anytime Fitness on the merits would discourage breakaway franchisees.

The court found that the balancing of harms and public interest tests came out more or less even.

In discussing whether California or Minnesota law should apply to the matter, the court found that the law of both states supported the enforcement of in-term covenants against competition where needed in order to protect a franchisor's trademark and goodwill. As such, it did not engage in a choice-of-law analysis to determine which state's law should apply.

While the court stated that the final factor, the likelihood of success on the merits, is the most significant test, and opined that Anytime Fitness was likely to prevail on the merits, the court refused to grant the TRO.

The result in this case is troubling. While forcing a business to close is a serious, sometimes irreversible, action, not issuing a TRO when there is a clear violation of an enforceable in-term covenant against competition may be worse than allowing the business to continue to operate. It further confuses customers of the franchised business and exacerbates any actual harm. While the delay may be only until a ruling on a motion for a preliminary injunction or trial on a permanent injunction, that could take weeks or months to be heard, briefed, and resolved. Even if the nearest franchised outlet is owned by the former franchisee, the protections of the contract should be enforced, unless doing so would result in a clear injustice.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller, a member of this newsletter's Board of Editors, is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.

New CO Appellate Case Has Something for Everyone

In a closely watched case in which the International Franchise Association (“IFA”) and the American Association of Franchisees and Dealers (“AAFD”) filed amicus briefs, the Colorado Court of Appeal had occasion to deal with a number of issues that often come up in franchise litigation, including the impact of exculpatory clauses, waiver of jury trial, effect of the FTC Rule on disclosure, and liability of attorneys for aiding and abetting disclosure violations. Colorado Coffee Bean, LLC v. Peaberry Coffee, Inc. 2010 WL 547633 (Colo. App. Feb. 18, 1010) involved Peaberry Coffee franchises in Colorado. Defendants were the franchisor, its parent, the law firm that assisted in drafting the UFOC, and certain officers or shareholders of the franchisor and its parent. The case was tried before a judge because of a jury trial waiver in the franchise agreement.

The crux of the case was that the defendants failed to disclose that the parent company had significant losses and that most of the company-owned stores were unprofitable. The UFOC (written prior to the 2007 development of the new FDD) only disclosed gross sales of the company stores, and the defendants argued that it complied with the FTC Rule. The franchisees also had been given a news article that stated that the parent was profitable “now,” which they claimed was false. The franchisees admitted they understood the UFOC or had it reviewed by an attorney. The UFOC and franchise agreements had a number of disclaimers and acknowledgements by the franchisees regarding the risks and profitability of the business.

The trial court ruled in favor of all defendants. While it essentially found that there was fraudulent concealment of the losses of the franchised stores, it ruled that plaintiffs could not have reasonably relied because: 1) information about expenses of the stores was publicly available; and 2) the exculpatory clauses in the UFOC precluded reliance on the non-disclosure of store losses and the parent's financial condition.

The appellate court rejected arguments that the disclaimers at issue should be rejected, because they sought to relieve the defendants from their own fraud. While noting the FTC's position that integration clauses are not likely to protect franchisors from fraud claims, the court held that the disclaimers constituted an affirmative representation by the plaintiffs that they were not relying on the matters disclaimed.

The court affirmed the findings as to the company stores, since those disclaimers stated: 1) that the numbers were not indicative of how franchised stores would perform; 2) that no profitability representations were being made; and 3) that the “earnings” figures did not reflect expenses.

The court found that the disclaimers in the UFOC did not apply to the article's representations about the parent's profitability since that representation was not part of the UFOC. The UFOC disclaimers pertained only to representations regarding the franchisor and did not pertain to undisclosed but material information concerning the franchisor's parent.

The court also held that the FTC Act, which did not require disclosure of financial condition of the parent, did not mean that the parent was precluded by law from disclosing financial information about its losses, since that information was not deceptive or contrary to any information disclosed. The court also affirmed dismissal of the Colorado “little” FTC Act claims, drawing a dissenting opinion, because only 68 persons received packets, and that did not constitute a public impact as required by that law. It rejected arguments that the availability of the company's Web site constituted a public impact since it was available to the public. In coming to that conclusion, the court focused on the disclaimer on the Web site that its contents did not constitute the offer of a franchise.

The court upheld the contractual jury trial waiver mainly on the basis that the right to a jury trial in a civil case is not constitutionally guaranteed under Colorado law, and that the waiver was clearly set out. The court also allowed the franchisor's law firm, not a party to the contractual jury trial waiver, to enforce the waiver on the basis that it was an agent of the franchisor and, thus, under the agreement was allowed to do so.

An interesting side issue as to claims against the franchisor's law firm was the affirmance of a bifurcation order that the trial court issued, reasoning that in a joint trial the other defendants and/or the law firm would be prejudiced to the extent that the firm sought to use privileged communications in its own defense.

Existence of Enforceable In-term Covenant Not Enough for a MN Court
to Issue a TRO

The ability to enforce an in-term covenant against competition in a franchise agreement by use of extraordinary remedies was the issue in Anytime Fitness, Inc. v. Family Fitness of Royal, LLC, et al., Bus. Franchise Guide (CCH) ' 14,303 (USDC D.Minn., Jan. 8, 2010). The franchisor, Anytime Fitness, entered into an area development agreement with Delamater for the development of franchises in Kern County, CA. Pursuant to the ADA, Delameter signed franchise agreements for Anytime Fitness facilities in Oildale, Tehachapi, Westchester, and a yet-to-be-determined location. Each agreement contained an in-term covenant against competition in which the franchisee agreed not to “own, operate, lease, franchise, engage in, be connected with, have any interest in, or assist any person or entity engaged in any other fitness center.”

When the Oildale agreement expired, Delamater replaced the “Anytime Fitness” sign with “Oildale Fitness” and took other steps to “de-identify” the Oildale facility. He also transferred the Oildale Anytime Fitness memberships to his Anytime Fitness studio in nearby Westchester and informed Oildale members that Anytime Fitness memberships would not be honored in the re-branded Oildale facility.

Since post-term covenants against competition are not enforceable in California under California Business and Professions Code ' 16600, Anytime Fitness filed an action claiming a breach of the in-term covenant against competition in the remaining Delamater Anytime Fitness franchise agreements and sought a temporary restraining order (“TRO”) to enforce those provisions. The court stated that it had to consider four factors: 1) the threat of irreparable harm to the moving party; 2) the balance between the harm caused to the moving party, versus the harm that would be caused to the non-moving party if the TRO should issue; 3) the likelihood of the moving party's ultimate success on the merits; and 4) the public interest that would be affected by issuing the order.

Anytime Fitness argued that it would suffer irreparable harm since the Oildale facility would have access to its proprietary information, such as planned promotions and sales strategies. The court indicated that this type of harm was too speculative to serve as the basis for a TRO, especially since Delamater's other Anytime Fitness facilities would be the prime victims of that misuse. Anytime Fitness also argued that its goodwill would be harmed since former Oildale members would be confused by the change in the identity. The court pointed to the steps Delamater had taken to distinguish the Oildale facility from Anytime Fitness facilities, reducing the certainty of imminent harm. Lastly, Anytime Fitness argued that if Delamater was allowed to open independent fitness facilities, other franchisees would be similarly inspired. The court, again, found this type of harm speculative, since being affiliated with Anytime Fitness, a system with more than 1,200 facilities, provided its franchisees with many benefits not available to independents and that a win by Anytime Fitness on the merits would discourage breakaway franchisees.

The court found that the balancing of harms and public interest tests came out more or less even.

In discussing whether California or Minnesota law should apply to the matter, the court found that the law of both states supported the enforcement of in-term covenants against competition where needed in order to protect a franchisor's trademark and goodwill. As such, it did not engage in a choice-of-law analysis to determine which state's law should apply.

While the court stated that the final factor, the likelihood of success on the merits, is the most significant test, and opined that Anytime Fitness was likely to prevail on the merits, the court refused to grant the TRO.

The result in this case is troubling. While forcing a business to close is a serious, sometimes irreversible, action, not issuing a TRO when there is a clear violation of an enforceable in-term covenant against competition may be worse than allowing the business to continue to operate. It further confuses customers of the franchised business and exacerbates any actual harm. While the delay may be only until a ruling on a motion for a preliminary injunction or trial on a permanent injunction, that could take weeks or months to be heard, briefed, and resolved. Even if the nearest franchised outlet is owned by the former franchisee, the protections of the contract should be enforced, unless doing so would result in a clear injustice.

Darryl A. Hart is an attorney with Bartko, Zankel, Tarrant & Miller in San Francisco. Charles G. Miller, a member of this newsletter's Board of Editors, is a shareholder and director of the firm. Hart and Miller can be reached by phone at 415-956-1900.