False Financial Representation Slams Franchisor
bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
April 2014
Craft Brewers Conference 2014
Barry Kurtz and Bryan H. Clements were invited to speak at the annual Craft Brewers Conference and BrewExpo America, the largest brewer’s trade show in the country. The three day event was held in Denver. Lewitt Hackman represents craft brewers in distribution and related transactions. Barry and Bryan’s presentation focused on the federal three-tier system of beer distribution law, and its similarities and contrasts with franchise and distribution law.
David Gurnick in Valley Lawyer Re Non-Compete Clauses
Generally, California Courts will not enforce a restrictive covenant. But there are several circumstances in which such covenants can be enforced. Read, Enforcement of Non-Compete Clauses in California by David Gurnick for details.
FRANCHISOR 101:
False Financial Representation Slams Franchisor
In Rogers Hospitality, LLC v. Choice Hotels International, Inc., a panel of arbitrators found that the franchisor of Choice Hotels violated Minnesota franchise laws by making false financial performance representations to its franchisee.
The franchisee proved that in a 2008 investor conference, the franchisor’s Director endorsed financial projections for a potential Sleep-Inn and Suites Hotel in Minnesota. The projections were adopted into a pro-forma that identified average daily rates the hotel could expect.
At the conference, Choice Hotels’ Director claimed the pro forma numbers were “attainable, conservative, and/or spot-on.” The statements were made outside Item 19 of the Franchise Disclosure Document. Therefore they were unlawful.
The arbitration panel also found the information was false because only 2.3% of Choice’s Sleep-Inn and Suite hotels achieved such performance, and Choice’s Director failed to disclose this low percentage. The arbitrators concluded that some of the franchisee’s representatives at the conference relied on the statements in electing to purchase the franchise. Accordingly, the panel ruled against Choice Hotels and in favor of the franchisee.
For franchisors, the Choice Hotels case is a reminder of the importance not to give financial performance information to franchisees or endorse pro formas prepared by franchisees, if not included in the Franchise Disclosure Document, Item 19.
This case should also remind franchisees to tread carefully when given earnings information outside Item 19. The information may be inaccurate, false or misleading.
FRANCHISEE 101:
Terminated Franchisee Can Pursue Fraudulent Disclosure Claims
In Solanki v. 7-Eleven, Inc., a U. S. District Court in New York ruled that a terminated 7-Eleven franchisee who decided to purchase a third location before receiving the Franchise Disclosure Document (FDD) could proceed with claims that 7-Eleven made false presale revenue and earnings claims in violation of the New York Franchise Sales Act.
The franchisee owned two 7-Elevens and contacted the franchisor to buy a third. At that time, he received the New York version of the 7-Eleven FDD, which contained unaudited financial statements showing averages of actual sales, earnings, and other financial performance of franchised 7-Eleven stores.
In a deposition, the franchisee testified he decided to buy the third store before receiving the FDD. Later, he explained that he committed to the purchase only after seeing the FDD.
Prior to signing the franchise agreement, he provided a business plan to 7-Eleven for approval. When he was approved, he was told the projections in his business plan were consistent and in line with 7-Eleven’s estimates.
However, 7-Eleven never provided its revenue projections for the store he purchased. In the first year of operation, the store never achieved the sales projected in the business plan. Later he was unable to make payroll. At the franchisee’s request, 7-Eleven terminated the Agreement.
The franchisee brought an action claiming 7-Eleven’s representation that the revenue projections in his business plan “were consistent with and in line with 7-Eleven’s estimates” violated New York’s Franchise Sales Act because:
- 7-Eleven’s revenue estimates and their basis were not in the FDD, as required by the Franchise Sales Act, and
- 7-Eleven’s earnings estimates were false, misleading and lacked any reasonable basis.
Though the franchisee testified he decided to purchase a third franchise before receiving the FDD, the court rejected 7-Eleven’s defense. The court explained that making up one’s mind to buy a particular store and committing to go through with the purchase based on information received from 7-Eleven were two different actions. The court also held that any disclaimers reviewed, acknowledged, or agreed to by the franchisee in the franchise agreement could not bar his claims.
For franchisees the 7-Eleven case shows that claims for damages and fraud against franchisors can be won, even though it is not clear how much a franchisee relied on an FDD when deciding to purchase the franchise and even though a franchise agreement contains customary disclaimers.
For more information regarding this case, click Jimmy Solanki v. 7-Eleven, Inc.