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Latent but Potent; The Hidden Possibilities of Franchising Claims Under State Law

By: Kamil Ismail | 11.9.15 | Media Featured

The Situation

In marketing a franchise, Ms. Jones talks up the opportunity in glowing terms, using a spreadsheet that projects large profits after a minimal investment, and hands Mr. Brown a 75-page prospectus in small print.  Sold on the idea, Mr. Brown signs a franchise agreement.

Struggling to stay afloat a year later, Mr. Brown takes stock of the situation, and realizes that his outlays have been far larger and his revenues infinitesimally smaller than Ms. Jones had projected.  Worse, he learns from another angry franchisee that Ms. Jones had known all along that the projections were unrealistic.  He pulls out his agreement, where his eyes fall immediately on the following:

Franchisee acknowledges that he has not received, and is not relying upon, any representations from Franchisor as to the capital or operating costs needed to operate a franchise, or of the amount of revenues or profits that a franchise may generate.  Franchisee also acknowledges that he has received and read copies of this franchise agreement and the Franchise Disclosure Document.

It slowly dawns on Mr. Brown that he has probably signed away all recourse for the misleading projections from Ms. Jones.  Right?

The Implications

Not necessarily.  Whether a claim might be viable could depend on both factual issues and what law applies.  Maryland law, for example, states that:

As a condition of the sale of a franchise, a franchisor may not require a prospective franchisee to agree to a release, assignment, novation, waiver, or estoppel that would relieve a person from liability under [Maryland franchise law].[1]

This means that Ms. Jones could not require Mr. Brown to give up his rights under franchise law as a condition of entering into a franchise agreement.  This law has been held to trump contractual language in which a franchisee agreed that it had not received and was not relying on any representations or guarantees.[2]  The court held that the contractual language alone was not enough for dismissal of the case; instead, a jury would have to decide whether the franchisee had reasonably relied on the projections of outlays and revenues.[3]

Another court went even further, applying this statute to override a choice-of-law clause in an agreement that – on its face – was governed by Texas law, with all disputes to be resolved in Texas courts.[4]  The plaintiff characterized the parties’ agreement as a franchise, for which he had paid a franchise fee.  The defendants, on the other hand, argued that the arrangement was a distributorship, and that the payment was for merchandise ordered. Disregarding the venue provision, the plaintiff filed suit in Maryland.

Under Maryland law, the defendants’ failure to register franchise disclosure documents with state regulatory authorities was actionable.[5]  Texas law, by contrast, did not provide a comparable right of action.[6]  The court held that, “if enforced, the choice-of-law clause here would operate as precisely the type of waiver proscribed by the Maryland General Assembly.”[7]  It therefore rejected a motion to dismiss and a motion to transfer to Texas, holding that the choice-of-law provision was against Maryland public policy and unenforceable.[8]

Not all states, of course, have anti-waiver provisions governing franchise agreements.  Even where they do, courts don’t always apply them to trump choice-of-law clauses.[9]  In states that have such provisions, however, especially where they have been held to override choice-of-law clauses,[10]these laws require careful analysis of franchise rights and liabilities – by both franchisees evaluating potential claims and franchisors defending against them.

[1] Md. Code Ann. Bus. Reg. § 14-226.

[2]  Hanley v. Doctors Express Franchising, LLC, 2013 WL 690521 at *26-29 (D. Md. Feb. 25, 2013).

[3]  Id. at *27.  The disclaimer, thus, could still be relevant in the end; the question was whether the franchisee – as a factual matter – reasonably relied on the flawed projections while aware of the contractual language disclaiming them.

[4]  Three M Enter., Inc. v. Texas D.A.R Enter., Inc., 368 F. Supp. 2d 450 (D. Md. 2005).

[5]  Id. at 454, 457-60.

[6]  See id. at 458-59.

[7]  Id. at 459.

[8]  Id.

[9]  See, e.g., JRT, Inc. v. TCBY Systems, Inc., 52 F.3d 734 (8th Cir. 1995).

[10] E.g., Three M, 368 F. Supp. 2d 450; Dunkin Donuts, Inc. v. N.A.S.T. Inc., 428 F. Supp. 2d 761, 767 (N.D. Ill.  2005).  Non-waiver provisions were also enforced in Solanki v. 7-Eleven, Inc., 2014 WL 320236 (S.D.N.Y. Jan. 29, 2014); Randall v. Lady of Am. Franchise Corp., 532 F. Supp. 2d 1071 (D. Minn. 2007); Long John Silver’s, Inc. v. Nickleson, 923 F. Supp. 2d 1004 (W.D. Ky. 2013).  Note that the federal Petroleum Marketing Practices Act also prohibits the conditioning of a franchise agreement on the release or waiver of any protected right. 15 U.S.C. § 2805(f)(1)(B); see also Coast Village, Inc. v. Equilon Enter., LLC, 263 F. Supp.2d 1136, 1178 & n. 38   (C.D. Cal. 2001).