Court Watch

The franchisor moved for a temporary restraining order (TRO) to halt the franchisees' competing business. The franchisor alleged that the franchisees' new business was competing in the same territory as the franchise had previously operated. Furthermore, the franchisor alleged that the former franchisees were able to compete unfairly with the franchisor given: a) the training they received; and b) their access to proprietary marketing materials. Despite these arguments, the district court refused injunctive relief, concluding Executive Care had not established it would suffer irreparable harm if a TRO were denied. Executive Care appealed.

The Third Circuit affirmed, approving the district court's conclusion regarding irreparable harm. The Third Circuit found it significant that counsel for Executive Care conceded that the former franchisees had returned all known information containing the franchisor's trademarks, and had returned other proprietary materials (such as the franchisor's operations manual). The Third Circuit also relied upon counsel's concession that the former franchisees were no longer operating out of the franchised location and were not using Executive Care's trademarks. (The concession regarding the new business's non-operation in the former franchised location was contrary to allegations detailed in the franchisor's appeal documents.) Largely based on these concessions, the Third Circuit upheld the district court's denial of injunctive relief.

Executive Home Care Franchising demonstrates how many courts are taking an increasingly circumspect view of requests for injunctive relief. Although Executive Care argued that injunctive relief was necessary to prevent harm to the system and to avoid a precedent that would encourage other franchisees to breach their franchise agreements, the federal courts analyzing the TRO motion closely considered the facts of the matter to determine that injunctive relief was unnecessary. The concessions made by counsel for the franchisor were important to the Third Circuit's decision and serve as another warning to counsel that statements made in oral argument can cause substantial damage. It is also significant that the Third Circuit affirmed the district court's denial of the TRO notwithstanding the presence of a provision in the franchise agreement expressly recognizing that injunctive relief should issue after a franchise agreement breach. Conscientious franchise counsel must inform their clients that such language in a franchise agreement, all other things being equal, may not be enough to secure injunctive relief.'

Fifth Circuit Issues Cautionary Note to Franchisees That Plead Their Claims Haphazardly

In Yumilicious Franchise, L.L.C. v. Barrie, No. 15-10508, 2016 WL 1375871 at 1 (5th Cir. Apr. 6, 2016), franchisees of Yumilicious Franchise, L.L.C. (Yumilicious), a Texas-based franchisor of frozen yogurt stores, appealed a district court's dismissal of their claims to the U.S. Court of Appeals for the Fifth Circuit. Yumilicious had sued first, after the franchisees closed one of their stores in South Carolina without permission claiming that supply chain issues prevented their successful operation of the store. The franchisees responded “with a countercomplaint liberally sprinkled with counterclaims,” including “breach of contract, fraud, fraudulent and negligent inducement, and violations of the Texas Deceptive Trade Practices Act, the Business Opportunity Act of Texas, and the Federal Trade Commission Act Disclosure Rules.” In a series of rulings, the district court dismissed the franchisees' breach of contract and statutory claims and entered summary judgment in favor of Yumilicious on the franchisees' tort claims. The franchisees only appealed the district court's denial of their statutory and tort claims.

The Fifth Circuit upheld the district court's dismissal of the franchisees' statutory claims based on a number of pleading defects. At the outset, the Fifth Circuit noted that the franchisees had failed to allege the essential elements of their statutory claims, including that Yumilicious's omissions were intentional, the franchisees relied upon the information provided by Yumilicious, and suffered an injury as a result of their reliance. The Fifth Circuit further explained that the franchisees' allegation that Yumilicious's CEO had falsely stated that Yumilicious was preparing “to go national and supply products to stores outside Texas” and “in the process of negotiating a contract with a national distributor” was not actionable because “[t]he failure of those negotiations does not make the prior statement false.” Ultimately, the Fifth Circuit held that it was within the district court's discretion to deny the franchisees leave to amend these claims “[w]hen, after more than a year of litigation, [the franchisees] assorted claims melted down.”

With respect to the franchisees' tort claims, the court observed that the franchisees had merely “reframed [their contract] claims as torts.” As a result, the Fifth Circuit applied Texas's economic loss rule, which “generally precludes recovery in tort for economic losses resulting from the failure of a party to perform under a contract.” The court held that “the economic loss rule dictates that any losses [the franchisees] suffered as a result of the franchise agreements give rise to claims sounding in contract, not tort.” Moreover, the court noted that the franchisees acknowledged in the franchise agreements that they had “conducted an independent investigation of the business venture” and disclaimed “reliance on any express or implied statements about potential volume, profits or success of the business.” The Fifth Circuit enforced these disclaimers, holding that “[u]nder Texas law, a statement disclaiming reliance is sufficient to waive fraud-based claims.” It also enforced the franchisees' waiver of punitive damages.

The court concluded by describing the lawsuit as “a large serving of claims and counterclaims piled precariously together,” cautioning that “[t]his saccharine swirl of counterclaims suggests that litigants, like fro-yo fans, should seek quality over quantity.” Franchisees can chose among a variety of legal theories when they decide to sue their franchisor. Nevertheless, as the Fifth Circuit counseled in Yumilicious, franchisees should select and plead these theories carefully to avoid early setbacks in their litigation strategy.

Bryan Huntington and co-author R. Henry Pfutzenreuter are franchise attorneys with Larkin Hoffman in Minneapolis, MN. Bryan can be reached at'[email protected]. Henry can be reached at [email protected].