Court Watch

With respect to the labor code claims, franchisees asserted that Jani-King's policies and practices tightly controlled the franchisees' actions to create an employer-employee relationship. They accused Jani-King, acting as an employer, of failing to pay overtime wages, failing to pay minimum wage for all hours worked, failing to provide itemized wage statements, failing to indemnify employees for expenses, deducting wages unlawfully, and compelling employees to patronize their employer. Jani-King maintained that the franchisees were independent contractors rather than employees.

In California, generally, the principal test of any employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the desired result. However, the court noted that in the context of franchising, in order to establish that an employer-employee relationship exists, the franchisee must show that the franchisor exercised “control beyond that necessary to protect and maintain its trademark, trade name, and good will.”

The court concluded that the plaintiffs were independent contractors, as expressly provided in their franchise agreements. The court noted that the plaintiffs controlled hiring and firing decisions for their employees, purchasing decisions related to their cleaning supplies and equipment, and decisions relating to servicing and bidding on accounts. Unlike in an employer-employee relationship, Jani-King could not terminate the relationship at will. Moreover, the fact that Jani-King managed billings and distributed to the franchisees their gross revenues minus fees payable to Jani-King did not make the payments equivalent to wages. In addition, the court concluded that the controls that Jani-King imposed on the franchisees were no more than necessary to protect its trademark, trade name, and good will. For example, Jani-King's practice of retaining ownership of all contracts with its cleaning clients was deemed by the court to be important to protect its customer relationships. Similarly, the court reasoned that Jani-King was able to protect its good will by reserving the right to terminate a franchisee's right to service particular clients if it failed to follow Jani-King's policies and procedures. By managing billing and accounting for its franchisees, Jani-King was able to maintain consistency throughout the franchise system. Taken together, the court granted Jani-King's motion for summary judgment on all of the labor code claims.

The plaintiffs asserted a variety of fraud and CFIL claims based on allegations that Jani-King made false earnings promises, misrepresented the amount of work and accounts available, failed to disclose all fees and costs, and failed to make a number of other required disclosures in the disclosure document. The court granted Jani-King summary judgment on these claims because they were barred by the applicable statutes of limitation and were barred by the parol evidence rule, since the alleged omissions and oral misrepresentations were directly contradicted by the written agreements. The court also rejected a related claim that Jani-King's failure to provide Spanish-language translations of the agreements constituted a fraudulent practice under the UCL, as there was no such requirement under the CFIL.

However, the plaintiffs succeeded with claims that Jani-King breached the implied covenant of good faith and fair dealing and the UCL in its practice of bidding for client accounts for its franchisees to service. The plaintiffs alleged that Jani-King regularly underbid for accounts and underestimated the amount of time necessary to service accounts. As a result, the franchisees claimed that accounts often were not profitable, which interfered with their ability to operate profitable businesses. Because the implied covenant prohibits one party from injuring the other party's ability to receive the benefits of the agreement, the court denied Jani-King's motion for summary judgment.

The court also denied summary judgment on a handful of other claims, including a breach of contract claim over the reimbursement of certain monies owed under the contract and three claims that Jani-King committed unfair business practices in violation of the UCL. With respect to the UCL claims, the court held that the plaintiffs had shown that triable issues of fact exist as to whether Jani-King provided insufficient information and used high-pressure sales tactics to lead franchisees to purchase illusory contracts, whether Jani-King used unfair tactics to keep plaintiffs from leaving their employment, and whether Jani-King's agreements included unconscionable terms such as an overly restrictive noncompetition provision.

Jani-King counterclaimed that some of the plaintiffs violated the noncompetition provisions of their franchise agreements by operating a separate cleaning company (while operating their Jani-King franchise) that serviced at least three clients that Jani-King had previously bid on or served. Rather than contesting the allegations, the plaintiffs asserted that the noncompetition clause was not enforceable. The court noted that in California, contracts that restrain individuals from engaging in a lawful business, trade, or profession are typically found to be void, unless the noncompetition covenant is necessary to protect a franchisor's trade secrets or proprietary information. The court was uncertain why it was necessary for Jani-King to prevent the plaintiffs from having any financial interest in or employment in any contract cleaning business anywhere in order to protect its trade secrets. As a result, the court denied Jani-King's motion for summary judgment on its counterclaim, allowing the enforceability of the noncompete to be determined at trial.

Summary Judgment Reversed in Mail Boxes Etc. Case

The conversion of franchises from the Mail Boxes Etc. (“MBE”) brand to The UPS Store (“UPS”) brand led a class of franchisees to assert claims of negligent and intentional misrepresentation and violations of the CFIL against their franchisor and various affiliates (collectively, “the defendants”) in D.T. Woodard, Inc. v. Mail Boxes Etc., Inc. et al., Bus. Fran. Guide (CCH) ' 14,786 (Cal. Ct. App. Jan 1, 2012).

After acquiring the MBE brand and franchise agreements in 2001, Mail Boxes Etc., Inc., a subsidiary of United Parcel Service, began offering MBE franchisees the opportunity to sign a Gold Shield Amendment and convert their stores to the UPS brand and business model. In exchange, the UPS Stores received discounted UPS rates, but were limited in their ability to charge prices over certain maximum rates.

Soon after converting in 2003, franchisees began filing complaints against the defendants, culminating in the certification of a class of franchisees that had converted to the UPS model. In 2010, a trial court granted summary judgment to the defendants against the class represented by Woodard, prompting this appeal.

Woodard asserted that in the process of presenting the Gold Shield Amendment option to franchisees, the defendants made negligent and intentional misrepresentations and violated a number of provisions of the CFIL. The defendants represented to franchisees that they had conducted “more than a full year of research and analysis” on how the merger could be optimized to the benefit of all parties. The defendants claimed that they used a field test on a small but reliable scale to establish that stores that converted to the UPS model outperformed MBE stores and dual-branded stores in average daily shipping volume, growth rates, customer counts, and net profit. The defendants also emphasized that they had taken steps to ensure the reliability of the data collected from stores participating in the test.

Woodard claimed it relied on the Gold Shield test results and the defendants' assertions in deciding whether to sign the Gold Shield Amendment, but subsequently learned that the defendants had omitted material information regarding the past performance of the tested stores and misrepresented facts concerning the reliability of the test methods. The plaintiffs presented expert evidence that the Gold Shield tests contained numerous flaws that invalidated their outcome.

In designing the test, the defendants compared UPS outlets in St. Louis and Seattle against MBE stores in Phoenix and San Antonio and dual-branded stores in Greenville, SC, and Harrisburg, PA. Woodard's expert noted that the tested markets and stores were not comparable before the test began: They were not balanced in size or geography and had experienced materially different market conditions. Moreover, there was evidence that, before the test began, the tested MBE stores had lower average UPS package volume, and the UPS outlets had higher average revenues than the other stores included in the test. Because most of the testing was conducted in only the fourth quarter when holiday shipping represents a higher percentage of store sales, the MBE stores were disadvantaged.

Woodard asserted that in conducting the test, the defendant failed to eliminate other variables that could affect the results. For example, the franchisor allowed MBE stores to reduce their prices more than the other tested concepts, compared the different concepts based on test results taken from different periods of the year, and allowed advertising for the different concepts to vary in timing and amounts. Further, inconsistent data were collected from franchisees, with some providing gross profit information and others providing net profit data. Notably, outside consultants were not employed to ensure that the test results would be statistically reliable.

As a result of these testing flaws, Woodard's expert opined that the test results could not be valid for determining the likely performance of the different branding scenarios in the rest of the franchise system over a full calendar year. The court concluded that there was a triable issue of fact about whether the defendants made misrepresentations and factual omissions regarding the Gold Shield tests, the accuracy and reliability of those tests, and the performance of The UPS Store business model.

Next, because reliance was a necessary element of each of Woodard's causes of action, the court considered whether the defendants had proven that Woodard did not actually rely on their representations. The court noted that the defendants did not present any evidence to counter Woodard's assertions of actual reliance. The defendants did, however, argue that Woodard could not have relied on their representations because they never represented that the franchisees could predict future profits based on the results of the Gold Shield test.

The defendants' data were accompanied by disclaimers indicating that they were not making any forecast, projection, or representation that the franchisees' stores would achieve increases in revenue, profits, or expenses if they converted to the UPS model. The disclaimer, which was similar to those that would be contained in an FDD financial performance representation, warned the franchisees that their performance would likely differ substantially than the test results for a number of factors and that by accepting the figures presented, the franchisees were accepting the risk of not performing as well.

The trial court had found these disclaimers, in conjunction with an integration clause in the Gold Shield Amendment, to be sufficient to show that Woodard could not have reasonably relied on the defendants' representations. But the appellate court disagreed, accepting Woodard's argument that it relied on misrepresentations and omissions of fact about past test results rather than about future profitability and success of UPS franchises. The court noted that the “disclaimers did not advise or warn franchisees to disregard test results, and elsewhere defendants reported test results in such a way to emphasize their reliability.” As a result, the disclaimers were insufficient to preclude Woodard's reliance. Moreover, the court noted that fraud in the inducement renders an integration clause voidable and that parties may not contract away their liability for fraud or deceit based on intentional misrepresentation. As a result, the court reversed the grant of summary judgment in favor of the defendants.

Finally, the court reconsidered the trial court's grant of summary judgment in favor of the defendants, with respect to Woodard's alleged inability to prove damages. In order to establish any of Woodard's claims, Woodard needed to show that it had sustained damages as a result of the defendants' misrepresentations or CFIL violations. The court noted that Woodard had provided evidence that since converting to a UPS outlet, the store had shipped fewer packages, earned less money for each shipment, and lost a significant number of FedEx customers ' resulting in an overall decline in profit. Based on this evidence, the court concluded that there was a triable issue of material fact concerning the damages Woodard may have sustained as a result of the conversion, reversing the trial court's grant of summary judgment.

Alexander G. Tuneski is a counsel at Kilpatrick Townsend & Stockton LLP and can be reached at 202-508-5814 and [email protected].

CA Courts Agree with Franchisees' Assertions of Triable Facts

In two recent California cases, dissatisfied franchisees commenced actions against their franchisors, asserting a variety of causes of action ranging from labor code violations to claims of negligent and intentional misrepresentation. Unlike many such cases, in both, the franchisees asserted triable issues of fact that were sufficient to survive motions for summary judgment by their franchisors.

In Juarez, et al. v. Jani-King of California, Inc., et al., Bus. Fran. Guide (CCH) ' 14,764 (U.S.D.C. ND Calif, Jan. 23, 2012), the owners of four janitorial services franchises sued their franchisor, Jani-King, asserting 14 causes of action, including breach of contract, breach of the implied covenant of good faith and fair dealing, violations of the California Franchise Investment Law (“CFIL”), violations of California's Unfair Competition Law (“UCL”), and a number of labor code claims. Jani-King sought summary judgment on the plaintiffs' claims, while counterclaiming that the plaintiffs breached their contract and tortiously interfered with contracts.

With respect to the labor code claims, franchisees asserted that Jani-King's policies and practices tightly controlled the franchisees' actions to create an employer-employee relationship. They accused Jani-King, acting as an employer, of failing to pay overtime wages, failing to pay minimum wage for all hours worked, failing to provide itemized wage statements, failing to indemnify employees for expenses, deducting wages unlawfully, and compelling employees to patronize their employer. Jani-King maintained that the franchisees were independent contractors rather than employees.

In California, generally, the principal test of any employment relationship is whether the person to whom service is rendered has the right to control the manner and means of accomplishing the desired result. However, the court noted that in the context of franchising, in order to establish that an employer-employee relationship exists, the franchisee must show that the franchisor exercised “control beyond that necessary to protect and maintain its trademark, trade name, and good will.”

The court concluded that the plaintiffs were independent contractors, as expressly provided in their franchise agreements. The court noted that the plaintiffs controlled hiring and firing decisions for their employees, purchasing decisions related to their cleaning supplies and equipment, and decisions relating to servicing and bidding on accounts. Unlike in an employer-employee relationship, Jani-King could not terminate the relationship at will. Moreover, the fact that Jani-King managed billings and distributed to the franchisees their gross revenues minus fees payable to Jani-King did not make the payments equivalent to wages. In addition, the court concluded that the controls that Jani-King imposed on the franchisees were no more than necessary to protect its trademark, trade name, and good will. For example, Jani-King's practice of retaining ownership of all contracts with its cleaning clients was deemed by the court to be important to protect its customer relationships. Similarly, the court reasoned that Jani-King was able to protect its good will by reserving the right to terminate a franchisee's right to service particular clients if it failed to follow Jani-King's policies and procedures. By managing billing and accounting for its franchisees, Jani-King was able to maintain consistency throughout the franchise system. Taken together, the court granted Jani-King's motion for summary judgment on all of the labor code claims.

The plaintiffs asserted a variety of fraud and CFIL claims based on allegations that Jani-King made false earnings promises, misrepresented the amount of work and accounts available, failed to disclose all fees and costs, and failed to make a number of other required disclosures in the disclosure document. The court granted Jani-King summary judgment on these claims because they were barred by the applicable statutes of limitation and were barred by the parol evidence rule, since the alleged omissions and oral misrepresentations were directly contradicted by the written agreements. The court also rejected a related claim that Jani-King's failure to provide Spanish-language translations of the agreements constituted a fraudulent practice under the UCL, as there was no such requirement under the CFIL.

However, the plaintiffs succeeded with claims that Jani-King breached the implied covenant of good faith and fair dealing and the UCL in its practice of bidding for client accounts for its franchisees to service. The plaintiffs alleged that Jani-King regularly underbid for accounts and underestimated the amount of time necessary to service accounts. As a result, the franchisees claimed that accounts often were not profitable, which interfered with their ability to operate profitable businesses. Because the implied covenant prohibits one party from injuring the other party's ability to receive the benefits of the agreement, the court denied Jani-King's motion for summary judgment.

The court also denied summary judgment on a handful of other claims, including a breach of contract claim over the reimbursement of certain monies owed under the contract and three claims that Jani-King committed unfair business practices in violation of the UCL. With respect to the UCL claims, the court held that the plaintiffs had shown that triable issues of fact exist as to whether Jani-King provided insufficient information and used high-pressure sales tactics to lead franchisees to purchase illusory contracts, whether Jani-King used unfair tactics to keep plaintiffs from leaving their employment, and whether Jani-King's agreements included unconscionable terms such as an overly restrictive noncompetition provision.

Jani-King counterclaimed that some of the plaintiffs violated the noncompetition provisions of their franchise agreements by operating a separate cleaning company (while operating their Jani-King franchise) that serviced at least three clients that Jani-King had previously bid on or served. Rather than contesting the allegations, the plaintiffs asserted that the noncompetition clause was not enforceable. The court noted that in California, contracts that restrain individuals from engaging in a lawful business, trade, or profession are typically found to be void, unless the noncompetition covenant is necessary to protect a franchisor's trade secrets or proprietary information. The court was uncertain why it was necessary for Jani-King to prevent the plaintiffs from having any financial interest in or employment in any contract cleaning business anywhere in order to protect its trade secrets. As a result, the court denied Jani-King's motion for summary judgment on its counterclaim, allowing the enforceability of the noncompete to be determined at trial.

Summary Judgment Reversed in Mail Boxes Etc. Case

The conversion of franchises from the Mail Boxes Etc. (“MBE”) brand to The UPS Store (“UPS”) brand led a class of franchisees to assert claims of negligent and intentional misrepresentation and violations of the CFIL against their franchisor and various affiliates (collectively, “the defendants”) in D.T. Woodard, Inc. v. Mail Boxes Etc., Inc. et al., Bus. Fran. Guide (CCH) ' 14,786 (Cal. Ct. App. Jan 1, 2012).

After acquiring the MBE brand and franchise agreements in 2001, Mail Boxes Etc., Inc., a subsidiary of United Parcel Service, began offering MBE franchisees the opportunity to sign a Gold Shield Amendment and convert their stores to the UPS brand and business model. In exchange, the UPS Stores received discounted UPS rates, but were limited in their ability to charge prices over certain maximum rates.

Soon after converting in 2003, franchisees began filing complaints against the defendants, culminating in the certification of a class of franchisees that had converted to the UPS model. In 2010, a trial court granted summary judgment to the defendants against the class represented by Woodard, prompting this appeal.

Woodard asserted that in the process of presenting the Gold Shield Amendment option to franchisees, the defendants made negligent and intentional misrepresentations and violated a number of provisions of the CFIL. The defendants represented to franchisees that they had conducted “more than a full year of research and analysis” on how the merger could be optimized to the benefit of all parties. The defendants claimed that they used a field test on a small but reliable scale to establish that stores that converted to the UPS model outperformed MBE stores and dual-branded stores in average daily shipping volume, growth rates, customer counts, and net profit. The defendants also emphasized that they had taken steps to ensure the reliability of the data collected from stores participating in the test.

Woodard claimed it relied on the Gold Shield test results and the defendants' assertions in deciding whether to sign the Gold Shield Amendment, but subsequently learned that the defendants had omitted material information regarding the past performance of the tested stores and misrepresented facts concerning the reliability of the test methods. The plaintiffs presented expert evidence that the Gold Shield tests contained numerous flaws that invalidated their outcome.

In designing the test, the defendants compared UPS outlets in St. Louis and Seattle against MBE stores in Phoenix and San Antonio and dual-branded stores in Greenville, SC, and Harrisburg, PA. Woodard's expert noted that the tested markets and stores were not comparable before the test began: They were not balanced in size or geography and had experienced materially different market conditions. Moreover, there was evidence that, before the test began, the tested MBE stores had lower average UPS package volume, and the UPS outlets had higher average revenues than the other stores included in the test. Because most of the testing was conducted in only the fourth quarter when holiday shipping represents a higher percentage of store sales, the MBE stores were disadvantaged.

Woodard asserted that in conducting the test, the defendant failed to eliminate other variables that could affect the results. For example, the franchisor allowed MBE stores to reduce their prices more than the other tested concepts, compared the different concepts based on test results taken from different periods of the year, and allowed advertising for the different concepts to vary in timing and amounts. Further, inconsistent data were collected from franchisees, with some providing gross profit information and others providing net profit data. Notably, outside consultants were not employed to ensure that the test results would be statistically reliable.

As a result of these testing flaws, Woodard's expert opined that the test results could not be valid for determining the likely performance of the different branding scenarios in the rest of the franchise system over a full calendar year. The court concluded that there was a triable issue of fact about whether the defendants made misrepresentations and factual omissions regarding the Gold Shield tests, the accuracy and reliability of those tests, and the performance of The UPS Store business model.

Next, because reliance was a necessary element of each of Woodard's causes of action, the court considered whether the defendants had proven that Woodard did not actually rely on their representations. The court noted that the defendants did not present any evidence to counter Woodard's assertions of actual reliance. The defendants did, however, argue that Woodard could not have relied on their representations because they never represented that the franchisees could predict future profits based on the results of the Gold Shield test.

The defendants' data were accompanied by disclaimers indicating that they were not making any forecast, projection, or representation that the franchisees' stores would achieve increases in revenue, profits, or expenses if they converted to the UPS model. The disclaimer, which was similar to those that would be contained in an FDD financial performance representation, warned the franchisees that their performance would likely differ substantially than the test results for a number of factors and that by accepting the figures presented, the franchisees were accepting the risk of not performing as well.

The trial court had found these disclaimers, in conjunction with an integration clause in the Gold Shield Amendment, to be sufficient to show that Woodard could not have reasonably relied on the defendants' representations. But the appellate court disagreed, accepting Woodard's argument that it relied on misrepresentations and omissions of fact about past test results rather than about future profitability and success of UPS franchises. The court noted that the “disclaimers did not advise or warn franchisees to disregard test results, and elsewhere defendants reported test results in such a way to emphasize their reliability.” As a result, the disclaimers were insufficient to preclude Woodard's reliance. Moreover, the court noted that fraud in the inducement renders an integration clause voidable and that parties may not contract away their liability for fraud or deceit based on intentional misrepresentation. As a result, the court reversed the grant of summary judgment in favor of the defendants.

Finally, the court reconsidered the trial court's grant of summary judgment in favor of the defendants, with respect to Woodard's alleged inability to prove damages. In order to establish any of Woodard's claims, Woodard needed to show that it had sustained damages as a result of the defendants' misrepresentations or CFIL violations. The court noted that Woodard had provided evidence that since converting to a UPS outlet, the store had shipped fewer packages, earned less money for each shipment, and lost a significant number of FedEx customers ' resulting in an overall decline in profit. Based on this evidence, the court concluded that there was a triable issue of material fact concerning the damages Woodard may have sustained as a result of the conversion, reversing the trial court's grant of summary judgment.

Alexander G. Tuneski is a counsel at Kilpatrick Townsend & Stockton LLP and can be reached at 202-508-5814 and [email protected].