Court Watch

In finding Renee Everett was bound to the arbitration provision in the franchise agreement, and therefore the arbitration award, the Court of Appeals noted that ordinary principles of contract and agency may bind a non-signatory party to an arbitration agreement, including under the doctrine of direct benefits estoppel. Under this doctrine, a non-signatory is estopped from avoiding arbitration if she “knowingly seeks the benefits of the contract containing an arbitration clause.” Here, Renee Everett obtained the benefits of the franchise agreement, namely owning and operating the franchise and trading upon the name, goodwill, and reputation of the franchisor.

While the holding in Everett supports franchisor controls of brand reputation by supporting the enforcement of post-termination contractual provisions, franchisors are advised to take steps to ensure the proper persons are bound to covenants not to compete and other contractual provisions from the onset of the relationship. Requiring individual shareholders or members of a franchisee entity to execute personal guaranties, and including provisions that prohibit the unauthorized transfer of the franchise agreement, may be effective tools to ensure contractual terms can be enforced against the proper offenders. It is always easier to have all proper persons sign the franchise agreement and any ancillary documents at the onset of the franchise relationship than to have to rely on the doctrine of equitable estoppel afterwards in the event of a dispute.

No Damages Awarded to Franchisee Despite Technical Violations of Registration and Disclosure Requirements By the Franchisor

The Federal District Court for the District of Columbia has granted partial summary judgment to a plaintiff franchisee who complained of technical violations of New York and Maryland franchise registration and disclosure statutes. A Love of Food I v. Moaz Vegetarian USA, Inc., 2014 U.S. Dist. LEXIS 138962 (D.D.C. Sept. 30, 2014).

Moaz Vegetarian USA, Inc. (Moaz) is a franchisor of vegetarian quick-service restaurants. Plaintiff A Love of Food entered into a franchise relationship with Moaz in 2007 for the ownership and operation of a Moaz restaurant in the District of Columbia. Less than three years after opening, the franchise failed and A Love of Food filed a lawsuit seeking over $900,000 in damages and rescission based on Moaz's failure to register its franchise offering statement, failure to disclose the statement in a timely manner, statements projecting A Love of Food's future earnings, and alleged misrepresentations about initial start-up expenses. The parties filed cross motions for summary judgment on all of these claims.

In considering the registration and disclosure claims, the court found both the laws of Maryland, where A Love of Food had its principal place of business, and New York, where the offer to sell the franchise originated, were applicable. Interestingly, the court found that the offer to sell the franchise originated in New York, based on the simple fact that the franchisor sent the initial e-mail related to the sale from New York. The court was not bothered by the idea that e-mail could be sent from virtually any location, because in this case, the sender admitted that he actually was in New York at the time that he pushed the send button.

At the time the parties entered into the franchise agreement, Moaz had not begun the process of registering its offering prospectus in Maryland. Although it had applied for registration in New York, the application was not approved until 10 days after the sale of the franchise to A Love of Food. Therefore, the court concluded that Moaz was liable to A Love of Food for violating the statutory requirements of both states related to registration, and A Love of Food was entitled to seek damages. Accordingly, A Love of Food was granted partial summary judgment for the failure to register. The court found, however, that causation was missing because the franchisee must demonstrate that the failure to register caused harm to the franchisee in order to recover damages. A Love of Food had not pointed to any evidence to show that the failure to register had caused its business losses. Instead, the court found that the record suggested that any business losses were the result of A Love of Food's own conduct, related to difficulties with site selection, the landlord, and other issues.

The Maryland and New York franchise laws also provide for rescission if a franchisor violates the statutes. However, because the technical violation of the Maryland statute did not cause harm to A Love of Food, rescission could not be granted under Maryland law. With respect to the New York statute, rescission may be awarded only when the statutory violation is both willful and material. The court determined that the violation was willful, because Moaz knew it needed to register (as evidenced by its application for registration prior to the sale of the franchise), and knew it had not been approved at the time of the sale. The court did not find that the second requirement ' materiality ' had been met, however. It concluded that no reasonable jury could find that the failure to register was material to A Love of Food's decision to enter into the franchise agreement, and therefore rescission was not appropriate.

The court also granted summary judgment to A Love of Food for Moaz's technical violation of New York's disclosure statute. (Maryland's statute does not provide for a private right of action on a disclosure claim.) Moaz did not disclose its offering prospectus to A Love of Food at the first personal meeting, as required by New York law. Similar to the analysis for the registration violations, the court considered this a “technical violation” that required a finding of liability but resulted in no damages to A Love of Food. The court again concluded that A Love of Food could not prove the causation element of its claim. There was no evidence linking the untimely disclosure to A Love of Food's business losses, particularly in light of A Love of Food's admission that it relied on the content of the offering prospectus, regardless of when it was provided. The court further found that the timing violation was not material to A Love of Food's decision to enter into the franchise agreement and therefore denied rescission.

A Love of Food also claimed that Moaz violated the franchise statutes by making misrepresentations related to initial start-up costs. The court considered these claims but found that genuine issues of material fact existed with respect to whether the statements were false and whether A Love of Food reasonably relied on the statements, and denied both parties' motions for summary judgment. The court looked in part to the disclaimers in the prospectus and A Love of Food's business acumen to determine that questions of fact existed with respect to reasonable reliance. Similarly, the court denied summary judgment for either party on the common law fraud claims related to start-up costs. Triable factual issues of falsity, reasonable reliance, and intent prevented summary judgment.

In summary, technical violations of the franchise statutes resulted in a finding of liability against the franchisor, but because the specific violations did not cause harm to the franchisee, the franchisee was denied any award of damages or rescission. The only claims remaining for trial related to alleged misrepresentations of start-up costs.

Cynthia M. Klaus is a shareholder, and Susan E. Tegt is an associate, with Larkin Hoffman. Ms. Klaus can be contacted at [email protected], and Ms. Tegt can be contacted at [email protected].

Franchise Owner-Operator Bound to Franchise Agreement As a Non-Signatory

In Everett v. Paul Davis Restoration, Inc., Nos. 12-3407, 13-1036, 2014 U.S. App. LEXIS 21059 (7th Cir. Nov. 3, 2014), the United States Court of Appeals for the Seventh Circuit held that an owner-operator of a property damage restoration services franchise was bound to a franchise agreement that she did not execute because she received a direct benefit from the franchise agreement. Everett is just one of many cases finding that a non-signatory to a contract may be bound by its terms under various theories ' in this case, direct benefits estoppel.

In Everett, the franchisor entered into a franchise agreement with Matthew Everett and EA Green Bay, LLC (EAGB). At the time the franchise agreement was executed, EAGB was owned, controlled, and operated by Matthew Everett and his wife, Renee Everett. Nonetheless, and in spite of the fact that Ms. Everett owned a 50% share of EAGB at the time of signing the franchise agreement, EAGB and Matthew Everett informed the franchisor that Mr. Everett was the 100% owner of EAGB and therefore Ms. Everett was not required to sign the franchise agreement. The franchise agreement required consent from the franchisor before ownership in EAGB could be transferred. Six years into the franchise relationship, the franchisor terminated the franchise agreement for cause. Matthew Everett then transferred his 50% ownership interest in EAGB to Renee Everett and an EAGB employee. Renee Everett then continued to operate EAGB under a new assumed name and continued to serve the same customers from the same location, in spite of a provision in the franchise agreement prohibiting the operation of a competitive business for a period of two years after the termination of the franchise. The franchisor responded by initiating arbitration to enforce its covenant not to compete, resulting in the issuance of a unanimous award against Renee Everett. The district court, however, vacated the arbitration award finding that Renee Everett could not be bound to the arbitration provision as a non-signatory under a theory of direct benefits estoppel. The Seventh Circuit Court of Appeals reversed.

In finding Renee Everett was bound to the arbitration provision in the franchise agreement, and therefore the arbitration award, the Court of Appeals noted that ordinary principles of contract and agency may bind a non-signatory party to an arbitration agreement, including under the doctrine of direct benefits estoppel. Under this doctrine, a non-signatory is estopped from avoiding arbitration if she “knowingly seeks the benefits of the contract containing an arbitration clause.” Here, Renee Everett obtained the benefits of the franchise agreement, namely owning and operating the franchise and trading upon the name, goodwill, and reputation of the franchisor.

While the holding in Everett supports franchisor controls of brand reputation by supporting the enforcement of post-termination contractual provisions, franchisors are advised to take steps to ensure the proper persons are bound to covenants not to compete and other contractual provisions from the onset of the relationship. Requiring individual shareholders or members of a franchisee entity to execute personal guaranties, and including provisions that prohibit the unauthorized transfer of the franchise agreement, may be effective tools to ensure contractual terms can be enforced against the proper offenders. It is always easier to have all proper persons sign the franchise agreement and any ancillary documents at the onset of the franchise relationship than to have to rely on the doctrine of equitable estoppel afterwards in the event of a dispute.

No Damages Awarded to Franchisee Despite Technical Violations of Registration and Disclosure Requirements By the Franchisor

The Federal District Court for the District of Columbia has granted partial summary judgment to a plaintiff franchisee who complained of technical violations of New York and Maryland franchise registration and disclosure statutes. A Love of Food I v. Moaz Vegetarian USA, Inc., 2014 U.S. Dist. LEXIS 138962 (D.D.C. Sept. 30, 2014).

Moaz Vegetarian USA, Inc. (Moaz) is a franchisor of vegetarian quick-service restaurants. Plaintiff A Love of Food entered into a franchise relationship with Moaz in 2007 for the ownership and operation of a Moaz restaurant in the District of Columbia. Less than three years after opening, the franchise failed and A Love of Food filed a lawsuit seeking over $900,000 in damages and rescission based on Moaz's failure to register its franchise offering statement, failure to disclose the statement in a timely manner, statements projecting A Love of Food's future earnings, and alleged misrepresentations about initial start-up expenses. The parties filed cross motions for summary judgment on all of these claims.

In considering the registration and disclosure claims, the court found both the laws of Maryland, where A Love of Food had its principal place of business, and New York, where the offer to sell the franchise originated, were applicable. Interestingly, the court found that the offer to sell the franchise originated in New York, based on the simple fact that the franchisor sent the initial e-mail related to the sale from New York. The court was not bothered by the idea that e-mail could be sent from virtually any location, because in this case, the sender admitted that he actually was in New York at the time that he pushed the send button.

At the time the parties entered into the franchise agreement, Moaz had not begun the process of registering its offering prospectus in Maryland. Although it had applied for registration in New York, the application was not approved until 10 days after the sale of the franchise to A Love of Food. Therefore, the court concluded that Moaz was liable to A Love of Food for violating the statutory requirements of both states related to registration, and A Love of Food was entitled to seek damages. Accordingly, A Love of Food was granted partial summary judgment for the failure to register. The court found, however, that causation was missing because the franchisee must demonstrate that the failure to register caused harm to the franchisee in order to recover damages. A Love of Food had not pointed to any evidence to show that the failure to register had caused its business losses. Instead, the court found that the record suggested that any business losses were the result of A Love of Food's own conduct, related to difficulties with site selection, the landlord, and other issues.

The Maryland and New York franchise laws also provide for rescission if a franchisor violates the statutes. However, because the technical violation of the Maryland statute did not cause harm to A Love of Food, rescission could not be granted under Maryland law. With respect to the New York statute, rescission may be awarded only when the statutory violation is both willful and material. The court determined that the violation was willful, because Moaz knew it needed to register (as evidenced by its application for registration prior to the sale of the franchise), and knew it had not been approved at the time of the sale. The court did not find that the second requirement ' materiality ' had been met, however. It concluded that no reasonable jury could find that the failure to register was material to A Love of Food's decision to enter into the franchise agreement, and therefore rescission was not appropriate.

The court also granted summary judgment to A Love of Food for Moaz's technical violation of New York's disclosure statute. (Maryland's statute does not provide for a private right of action on a disclosure claim.) Moaz did not disclose its offering prospectus to A Love of Food at the first personal meeting, as required by New York law. Similar to the analysis for the registration violations, the court considered this a “technical violation” that required a finding of liability but resulted in no damages to A Love of Food. The court again concluded that A Love of Food could not prove the causation element of its claim. There was no evidence linking the untimely disclosure to A Love of Food's business losses, particularly in light of A Love of Food's admission that it relied on the content of the offering prospectus, regardless of when it was provided. The court further found that the timing violation was not material to A Love of Food's decision to enter into the franchise agreement and therefore denied rescission.

A Love of Food also claimed that Moaz violated the franchise statutes by making misrepresentations related to initial start-up costs. The court considered these claims but found that genuine issues of material fact existed with respect to whether the statements were false and whether A Love of Food reasonably relied on the statements, and denied both parties' motions for summary judgment. The court looked in part to the disclaimers in the prospectus and A Love of Food's business acumen to determine that questions of fact existed with respect to reasonable reliance. Similarly, the court denied summary judgment for either party on the common law fraud claims related to start-up costs. Triable factual issues of falsity, reasonable reliance, and intent prevented summary judgment.

In summary, technical violations of the franchise statutes resulted in a finding of liability against the franchisor, but because the specific violations did not cause harm to the franchisee, the franchisee was denied any award of damages or rescission. The only claims remaining for trial related to alleged misrepresentations of start-up costs.

Cynthia M. Klaus is a shareholder, and Susan E. Tegt is an associate, with Larkin Hoffman. Ms. Klaus can be contacted at [email protected], and Ms. Tegt can be contacted at [email protected].