Franchise Fraud and the Wizard of Oz

Franchise Fraud and the Wizard of Oz

By: Jeffrey M. Goldstein

Goldstein Law Firm, PLLC

Washington, DC

(202) 293-3947

 In Moxie Venture L.L.C., et al. v. The UPS Store, Inc., 2016 U.S. Dist. LEXIS 3603, (January 12, 2016), the United States District Court for the District of Minnesota stridently and emphatically rejected the franchisee’s fraud claims under the Minnesota Franchise Act (“MFA” or “Franchise Act”). Although Minnesota federal courts have generally been antagonistic to fraud claims under the MFA, the Moxie decision, in particular, could be the straw that finally breaks the camel’s back regarding the practical viability of franchise fraud and related waiver claims under the MFA.

On the whole, a franchisee or dealer may recover for fraud if it is successful in showing a material misrepresentation or omission of fact known to be false by the defendant, made by the defendant for the purpose of inducing plaintiff’s reliance, and upon which plaintiff reasonably relied, causing it injury. Although the prima facie elements for showing fraud differ among states based on the particular state’s common law and franchise-specific legislation, very many fraud-based claims encompass these essential factors. In practice, nowadays, it is not an easy task for a franchisee to prove a fraud claim, even when armed with a naked misrepresentation claim. Not only must the successful plaintiff prove each and every identified element, but it must also adequately fend off myriad legal defenses that have been recently reinvigorated by conservative courts.

Most frequently, in the franchise context, the ‘get out of jail free card’ for the franchisor or manufacturer is of one of four types, including the following: (1) the misrepresentations are predictions of the future and not of past or existing facts; (2) the misrepresentations are not significantly momentous, or material; (3) the franchisee has not in fact reasonably relied upon the misrepresentations; or (4) the franchisee cannot as a matter of law reasonably rely upon the misrepresentations since the franchise agreement contains an integration or disclaimer clause under which the franchisee, at the time it signs the franchise agreement, agrees that it has not been provided with any fraudulent misrepresentations. (Similar disclaimer language habitually is included in all Franchise Disclosure Documents).

Of these four prototypical situations, the first three are primarily fact-based defenses, while the fourth is chiefly a legal one.  Also, since the third and fourth situations both involve the reliance element, they provide the defendant franchisor two bites at the same non-reliance apple. In this regard, a defendant can win on the reliance element by showing either that the plaintiff did not in fact rely upon the misrepresentations, or that the plaintiff simply legally is not ‘allowed’ to argue that it relied on the misrepresentations. The conceptual problem from the franchisee’s point of view is that the latter is beginning to swallow-up the former. This means that, in many courts, to the extent disclaimer language has been strategically jammed in either the franchise agreement or the FDD, or both, the franchisee will not be permitted to testify that it relied upon the misrepresentations in purchasing the franchise.

The Moxie case involved a dispute regarding a franchise agreement between Plaintiff Moxie Venture L.L.C. ("Moxie") and Defendant The UPS Store, Inc. ("TUPSS"). TUPSS operates the UPS store franchise system, and TUPSS franchisees provide retail shipping, postal, printing, and business services. The Franchise Agreement had granted Moxie the exclusive right to own and operate a UPS Store franchise in Bloomington, Minnesota; however, the Franchisee was unable to operate profitably at the location. In turn, Moxie sued the franchisor claiming that TUPSS fraudulently induced it to enter into the Franchise Agreement. The Franchisor moved to dismiss the MFA claims and transfer the remaining claims to a court in California.

Moxie alleged that its UPS Store had not performed as promised since opening in August 2013, that Moxie "never reached the break-even point, let alone made a profit," and that the Franchisor had made numerous misrepresentations (regarding a profitable location for Moxie's UPS Store, the franchise's anticipated revenue, cash flow, and operating profits), in order to induce Moxie to enter into the Franchise Agreement.  The Franchisee alleged that the Franchisor’s conduct had violated the Minnesota Franchise Act, as well as common-law claims for fraud.

Faced squarely with the Franchisee’s allegations that it had failed in business ‘because the Franchisor lied about the franchise opportunity at the time of purchase’, the Court appeared to have a déjà vu moment, and quickly scoured the franchise documents to locate traditional ‘disclaimer’ provisions; these clauses, which had been liberally interspersed in the prolific text of the UPS Franchise Agreement by the Franchisor’s franchise lawyers, included the following:

• “NO REPRESENTATIONS OF EARNINGS OR PROFITS.” (This section stated in capital letters that “YOU UNDERSTAND AND ACKNOWLEDGE THAT NEITHER TUPSS, NOR ANY OF ITS OFFICERS, AGENTS, EMPLOYEES OR REPRESENTATIVES, NOR ANY TUPSS AREA FRANCHISEE, HAS MADE ANY CLAIMS OR REPRESENTATIONS WHATSOEVER REGARDING POTENTIAL REVENUES, EARNINGS, OR PROFITS THAT YOU MAY ACHIEVE AS THE OWNER OF A THE UPS STORE FRANCHISE, AND THAT YOU HAVE NOT MADE A DECISION TO PURCHASE YOUR FRANCHISE BASED ON ANY SUCH REPRESENTATIONS),
• "Establishment of a New Business" (This section stated in capital letters that “YOU UNDERSTAND THAT THE CREATION AND OPERATION OF A NEW BUSINESS INVOLVE A NUMBER OF RISKS, WHICH MEANS THAT IF YOU ARE NEVER ABLE TO OPERATE THE BUSINESS PROFITABLY, YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT, PLUS ANY ADDITIONAL FUNDS THAT YOU CONTRIBUTE TO THE BUSINESS. YOU UNDERSTAND AND ACKNOWLEDGE THAT TUPSS CANNOT GUARANTEE THAT YOUR BUSINESS WILL EVER ACHIEVE PROFITABILITY, AND BY YOUR SIGNATURE ON THIS DOCUMENT YOU ARE AGREEING TO PURCHASE A THE UPS STORE FRANCHISE WITH FULL KNOWLEDGE OF THE RISKS DESCRIBED HEREIN).

Further, with regard to the location of the Franchisee’s UPS Store, the Franchise Agreement provided that the "ultimate decision and final responsibility on whether to accept the [proposed] site and the lease" was Moxie's. Last, the Franchise Agreement provided that it constituted the entire agreement between the parties and that San Diego, California, was the "exclusive" venue for disputes.

TUPSS moved to dismiss Moxie's MFA claim, and also to transfer the remaining claims under the Franchise Agreement's forum-selection clause to a California court. As discussed below, the Court strongly disagreed with the Franchisee’s arguments, and granted all the relief requested by TUPSS.

With regard to the MFA fraud claim, which was based upon the alleged financial misrepresentations of TUPSS, the Court, in essence, found that the claim was not viable because Moxie could not demonstrate that it reasonably relied upon the alleged misrepresentations by TUPSS. The Court pointed out that its view on this legal issue had clearly been set forth in a prior cased decided by the same Judge in 2011 -- Ellering v. Sellstate Realty System Network, Inc., 801 F. Supp. 2d 834 (D. Minn. 2011) (Kyle, J.).

According to the Court, like the plaintiffs in Ellering, “the plaintiffs [in Moxie] alleged the defendant franchisor had made misrepresentations, in violation of the MFA, about the amount of future income that would be generated if the plaintiff entered into a franchise agreement.” And, as in this case, the agreement in Ellering “expressly disclaimed any reliance on the defendant's representations about projected future income.” Specifically, in Ellering, the franchisees’ agreement had language stating that they had "acknowledge[d] that [they] have not relied upon any guarantee, warranty, projection, forecast or earnings claim . . . in entering into this Agreement". In dismissing the franchisees’ MFA claims in Ellering, the Court concluded that “the disclaimer scuttled such a claim and any purported reliance on the franchisor's ‘misrepresentations.’" The Court equated the Moxie franchisee’s MFA fraud claims with those claims rejected by the Court in Ellering:

The Court perceives no reason to reach a different result here. Simply put, the Franchise Agreement firmly establishes that even if TUPSS made misrepresentations in connection with the sale of Moxie's franchise, Moxie did not rely upon any of them and, if it did (contrary to the express terms of the Franchise Agreement), such reliance was unreasonable as a matter of law.

Expecting that the Judge might rely upon his prior franchise ruling to defeat the Franchisee’s claims in this case, Moxie’s franchise lawyers argued that Ellering was “wrongly decided”; the Court, not surprisingly, stated straightforwardly that “the Court disagrees”. In attempting to undercut the Ellering case, Moxie argued that Ellering was in conflict with another case involving franchise fraud that had been decided by the Minnesota federal court in 2007 -- Randall v. Lady of America Franchise Corp., 532 F. Supp. 2d 1071 (D. Minn. 2007). (Interestingly, although the Randall case was decided by the same District Court in Minnesota, it was decided by a different Judge.)

The Moxie Judge met Moxie’s attack by pointing out that in deciding the Ellering case, he had already “discussed and declined to follow Randall.” The Court further stated that “nothing in Moxie's argument persuades the Court that it reached an incorrect result in Ellering - a result that has been consistently followed in this District.”

After the court dismissed Moxie's MFA claim, it turned to Moxie’s remaining common law fraud claims, which it held should be ruled upon not by it, but by a court in California, in light of the forum selection clause in the Franchise Agreement. The Court pointed out that, in the past, Minnesota federal courts had transferred common-law claims based upon a forum-selection clause in a franchise agreement after an MFA claim had been dismissed. Despite this law, the Franchisee in Moxie argued that the forum-selection clause was invalid in toto, and not just as applied to the MFA claim, because it violated the MFA's anti-waiver provision. In this regard, the MFA, like some other state franchise acts, invalidates contract provisions that purport to waive a franchisee's rights under the Franchise Act.

In rejecting the Franchisee’s argument, the Court in Moxie focused very explicitly on the words of the anti-waiver provision: “the statute and the rules promulgated thereunder only invalidate clauses that ‘require a franchisee to waive his or her rights to any . . . forum . . . provided for by the laws of the jurisdiction.’" The Court concluded that “Moxie does not cite, and the Court is not aware of, any provision of Minnesota law requiring a common-law claim for fraud, breach of contract, or the like to be litigated in Minnesota - particularly where, as the parties acknowledge here, such claims are governed by California law (due to the Franchise Agreement's choice-of-law clause).” Accordingly, in the Court’s view, the anti-waiver provision did not invalidate the forum-selection clause as applied to Moxie's common-law claims.

The Moxie case is one of many recent decisions throughout the country tending to strip franchisees of their ability to maintain a fraud suit. Given the Moxie Judge’s prior publicly-known views on the MFA, as soon as the Moxie case was assigned to the specific Judge, the Franchisee’s lawyer probably muttered “Toto I have a feeling we’re not in Kansas anymore.” He would have been more accurate, however, had he then added: “And, Toto, I have a feeling we’re in court in Minnesota.”

Jeffrey M. Goldstein

Goldstein Law Firm, PLLC

Washington, DC

(202) 293-3947

[email protected]

www.goldlawgroup.com

*/Thanks to Noah Adam Goldstein for his valuable editorial assistance