Two Appeals Court Victories for PK Clients – Plus Another Important Decision

Three appeals court rulings in April will help franchisors enforce their franchise agreements and system standards. We are pleased that Plave Koch litigators brought home two of those victories.

Fabbro v. DRX Urgent Care, LLC, No. 14-1734 
2015 WL 1453537 (3d Cir. April 1, 2015)

Our litigation team, led by Jim Rubinger, represented the franchisor in claims brought by two “Doctors Express” franchisees. The franchisees made several allegations, principally that their startup costs were higher than projected in the FDD and that the franchisor made several changes to the “Doctors Express” system that the franchisees did not believe to be beneficial. The franchisees alleged breach of contract, fraud, and constructive termination under the New Jersey Franchise Practices Act (“NJFPA”).

In April, the U.S. Court of Appeals for the Third Circuit affirmed the federal district court, which had granted the franchisor’s motion to dismiss the franchisees’ claims. The Court of Appeals reached three key conclusions:

 First, the Third Circuit agreed that no provision of the franchise agreement was breached.

Second, the Item 7 estimate of start-up costs was just that: an estimate. The court agreed with the franchisor that there was no claim that the estimates were inaccurate when the FDD was issued, and that the data in Item 7 was based on the franchisor’s actual experience.

Third, the court rejected the franchisees’ claim of “constructive termination” because there was neither a breach of contract nor any allegation that the franchisor had the intent to terminate the franchises (both of which were still operating). The Third Circuit discussed the U.S. Supreme Court’s decision in Mac’s Shell Service, Inc. v. Shell Oil Products, 559 U.S. 175 (2010), which held that there could be no claim for constructive termination under the Petroleum Marketing Practices Act when the franchise was continuing to operate. While the court found Mac’s Shell “not controlling” in reviewing a NJFPA claim, the court held that the “the distinction … is without a difference.” The court also held that even under a New Jersey lower court decision, which contained a more expansive interpretation of constructive termination under the NJFPA, the plaintiffs still did not state a valid claim.

 HLT Existing Franchise Holding LLC v. Worcester Hospitality Group, LLC No. 14-593, 2015 WL 1566858 (2d Cir. April 9, 2015)

 Ben Reed led our litigation team in seeking to uphold the termination of a “Hilton” brand franchise (a “Hampton Inn” in Worcester, Massachusetts) for repeated non-compliance with system standards, and also to recover liquidated damages. The federal district court granted the franchisor’s motion for summary judgment. In April, the U.S. Court of Appeals for the Second Circuit fully affirmed the trial court ruling.

The Court of Appeals’ decision included some key points.

 First, the Second Circuit held that guest survey responses, which were part of the franchisor’s evaluation process, were admissible over the franchisee’s hearsay objection. The court ruled that the statements were not hearsay because they were admitted for the purpose of showing their effect on the franchisor’s decision to terminate, rather than for proving the truth of the underlying statements.

 Second, the court rejected the franchisee’s argument that the franchisor’s on-site inspections were conducted in an arbitrary and irrational manner. The court noted that because the franchisor proved that the franchisee repeatedly failed contractually-permitted, rational, and non-arbitrary guest surveys, there was a valid independent basis for termination.

 Third, the court upheld the liquidated damages clause in the franchise agreement. Under that clause, the franchisee was required to pay a sum equal to three years’ worth of future royalties, based on the average royalty for the past two years. The court concluded that the contractual liquidated damages clause was a reasonable approximation of the losses that the franchisor would sustain, and affirmed the judgment of $702,355, plus attorneys’ fees and costs.

 Legacy Academy, Inc. v. Mamilove, Inc., No. S14G1891 
2015 WL 1773755 (Georgia Supreme Court, April 20, 2015)

 This case attracted attention when the intermediate court of appeals held that a franchisee could state a claim under the Georgia Little FTC Act for the violation of a disclosure obligation arising under the FTC Rule. The Georgia Supreme Court reversed the lower court’s opinion, and remanded for further proceedings. The Court noted several important points:

First, the Court concluded that franchisees’ failure to read their contract doomed their claim to have been deceived as to the terms of the agreement. The franchisees’ claim that they relied on statements (allegedly regarding anticipated income) ran directly counter to their acknowledgement in the contract that no such representations were made.

Second, the court ruled that the “merger” clause in the franchise agreement (sometimes referred to as the “entire agreement” clause) precluded the franchisee from suing on alleged pre-contract statements, which as a matter of law could not be relied upon as the basis for claims of fraud, negligent misrepresentation, or violation of the Georgia RICO statute, all of which were dismissed. The Court remanded the case for further determination of the continuing validity of the Little FTC Act claim.