Franchise 101: A Sticky Situation; and Expo Is No Excuse

Franchisor 101: A Sticky Situation

A federal court in Maryland entered default judgment and a permanent injunction in favor of an ice cream franchisor against a franchisee that continued operating its ice cream shop after termination.

A franchisor of Thai ice cream roll shops terminated its Yuma, Arizona franchisee for failing to pay required fees. The franchisee continued operating the ice cream shop, offering the same rolled ice cream. The franchise agreement had a non-competition clause prohibiting operation of a dessert business selling ice cream or frozen desserts within five-miles of the franchised location.

The franchisor sued, claiming breach of contract, trademark infringement, and unfair competition due to the terminated franchisee’s noncompliance with post-termination restrictions. The franchisee appeared at the first hearing, but then failed to appear at further hearings, including the preliminary injunction hearing. The court entered a default judgment, permanent injunction and award of attorney fees against the franchisee.

Franchisors should review their franchise agreement with counsel to make sure the non-competition provisions are adequate, reasonable and offer protections to ensure, where permitted by law, that former franchisees do not harm the brand by operating a competing business. After terminating a franchisee, the best interest for the franchisor, the brand, the system and the public, is usually to make sure the franchisee de-identifies and follows the franchise agreement’s post-termination provisions. If the franchisee is not complying, legal action can be considered to enforce the provisions and protect the brand and proprietary information from being used by the terminated franchisee.

ICENY USA, LLC v. M&M’s LLC,  TDC-19-2418 (D. Md. Apr. 16, 2020)

Franchisee 101: Expo is No Excuse

A federal court in Missouri ruled that a franchisee’s fraud claim cannot be based on the franchisor’s prediction at a franchise expo of future success in the franchised business.

The franchise was for a virtual care platform, enabling hospitals, doctors and other practitioners to connect with other medical professionals and provide care to patients. The franchisee attended a franchise expo, a trade show where various franchisors can exhibit and present information about their programs.

At the expo, the franchisee met several franchisor representatives. The franchisee claimed the representatives misrepresented how much the franchisee would make in the first two years of operation.

Based on the alleged representations, the franchisee entered into the franchise agreement and began operations. The franchisee claimed the franchisor failed to support the franchisee, which forced the franchisee to stop operating, and that he was fraudulently induced to enter into the franchise agreement due to false, misleading and fraudulent representations, including unsupported statements about potential earning capacity.

Fraud requires proving misrepresentation of past or existing fact. Statements of opinion, expectation or predictions for the future are insufficient to recover for fraudulent misrepresentation. The court dismissed the fraud claims arising from the franchise expo statements, finding the statements, if made, were only puffery and were insufficient to win a claim of fraud. Since franchisor representatives made the profit representations without knowledge of the franchisee’s business plans, experience and expected level of investment, their representations did not rise to the level of fraud.

Fraud also requires proof of reasonable reliance on the misrepresentations. The court found no reasonable reliance due to the franchisee’s experience in the telehealth business, due diligence performed by the franchisee, and the franchisee’s participation in negotiating the franchise agreement. These negated reasonable reliance on anything the franchisee was told.

Some statements, opinions or predictions made by a franchisor outside the Franchise Disclosure Document, regarding future performance, may support a claim for relief. Success depends on a variety of factors, such as applicable state law, the franchisee’s background and whether the franchisee reasonably relied on the statements in entering into the franchise agreement.

Fabius v. Medinexo USA, LLC, No. 4:19CV2526 JCH (E.D. Mo. Apr. 3, 2020)