Thursday, April 17, 2008

Nondisclosure of Franchisor Supplier Contracts Was Not Fraudulent Inducement of Franchisees

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A sandwich shop franchisor's failure to disclose facts about its contracts with franchise suppliers did not constitute fraud or fraud by omission in inducing a putative class of Illinois sandwich shop franchisees to enter into franchise agreements, the federal district court in Chicago has decided.

There was no tenable argument that the franchisor had a duty to disclose certain facts about its contracts with suppliers or that the franchisees reasonably relied upon alleged misrepresentations and omissions made by the franchisor. Thus, the franchisees’ claims for fraudulent inducement and for violation of the federal RICO statute were dismissed.

Duty to Disclose

The franchisees alleged that the franchisor committed fraud by, among other things, failing to disclose certain key facts to them about its contracts with franchise suppliers. However, absent a duty to disclose, the franchisor could not be held liable for a failure to make disclosures. No duty to disclose existed in the present circumstances because it was well established under Illinois law that parties to a contract, including franchise contracts, did not owe a fiduciary duty to one another, the court held.

Specifically, the franchisees claimed: (1) that the franchisor required its franchisees to pay prices it knew to be higher than those the franchisees could get from third-party vendors for goods of equal or better quality; and (2) that the prices the franchisees paid were deliberately inflated by kickbacks from approved vendors to the franchisor. This conduct directly contradicted representations made in the franchisor's Uniform Franchise Offering Circular (UFOC) that contracts with suppliers would be made for the benefit of franchisees, according to the franchisees.

Importantly, however, the UFOC did not say that the supplier contracts would be made for the sole benefit of franchisees, the court reasoned. Instead, the agreement explicitly warned the franchisees that the franchisor could “receive payments from suppliers on account of such suppliers' dealings with Franchisee and other franchisees and may use all amounts so received without restriction and for any purpose Franchisor and its affiliates deem appropriate.”

The UFOC similarly warned the franchisees that the franchisor had the right to receive payments from suppliers. In light of such explicit contractual provisions, the court reached the same conclusion reached in an almost identical case (Westerfield v. Quizno’s Franchise Co., Inc., CCH Business Franchise Guide ¶13,734)—that it would be unreasonable for the franchisees to have assumed that the franchisor would not negotiate contracts with suppliers that would benefit the franchisor. Thus, even if the franchisor owed the franchisees a duty to disclose, the provisions in the franchise agreement and the UFOC clearly satisfied that duty, according to the court.

Contractual Disclaimers

The franchisees’ claims that the franchisor fraudulently induced them to enter into their franchise agreements through misrepresentations and omissions were without merit because, faced with unambiguous disclaimers and non-reliance clauses in the UFOC and franchise agreement, the franchisees could not have reasonably relied on any oral statements concerning likely profits and expenses, the court ruled.

The franchisees’ suggestion that the franchise agreement was unconscionable—and therefore could not be used to defeat their claims—was rejected. In assessing whether a contractual provision should be disregarded as unconscionable, Illinois courts looked to the circumstances at the time of the contract's formation, including the relative bargaining positions of the parties and whether the provision's operation would result in unfair surprise.

However, none of the clauses contained within the UFOC or the franchise agreement could be seen as creating an unfair surprise, the court determined. Before signing the franchise agreement, each franchisee was provided with the UFOC, which clearly disclosed the vendor rebates. Nor were the franchisees vulnerable consumers or helpless workers. Rather, they were business people who bought a franchise.

The decision is March 31, 2008 decision in Siemer v. Quizno's Franchise Co., Inc. appears at CCH Business Franchise Guide ¶13,869.

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