Tuesday, May 13, 2008

RICO Claims Based on Franchisor Misrepresentations About Sourcing Reinstated

This posting was written by Mark Engstrom, Editor of CCH RICO Business Disputes Guide.

Previously dismissed civil RICO claims against a sandwich shop franchisor were reinstated after the federal district court in Green Bay, Wisconsin, concluded that its original decision was in error.

Originally, the court held that the franchisor's use of express disclaimers and non-reliance clauses in its franchise agreement had fatally undermined the franchisees' allegations of fraudulent misrepresentations and concealment, offenses that provided the basis for plaintiffs' RICO claims. Upon closer examination, however, the court decided that this determination was erroneous.

Overcharging by Approved Vendors

Franchisees argued that the franchisor had knowingly caused them to be overcharged for essential goods and services by demanding kickbacks from approved vendors, even though the franchisor had induced franchisees, through contrary representations, to purchase their franchises.

The court had relied on three Seventh Circuit decisions to support its earlier conclusion that the terms of the franchise agreement were dispositive as a matter of law. That reliance demonstrated "manifest error" because none of the Seventh Circuit decisions had held that the terms of a contract could preclude the possibility of a fraud claim regardless of the facts alleged.

Case law suggested that the degree of sophistication of the plaintiffs should be considered. In this instance, the franchisees' complaint suggested that they had a greater degree of sophistication than the average consumer. However, not even the franchisor contended that the contracts at issue involved equally sophisticated commercial enterprises. These considerations, coupled with the uncertainty in federal law regarding the significance of reliance in a civil RICO claim, made it clear that dismissal of the franchisees' claims was "at best premature."

Negotiations for Benefit of Franchisees

Among other things, the franchisor's Uniform Franchise Offering Circular represented that "we and our affiliates negotiate purchase agreements with suppliers for the benefit of Franchisees." Initially, the term "benefit" was deemed "too vague and indefinite" to support a fraud claim. Upon reconsideration, however, the court concluded that this determination should be left for trial, or at least for a more complete development of the record.

Newly Discovered Evidence

An assertion that reconsideration was warranted by "newly discovered evidence," however, was rejected. According to the court, the evidence characterized as "new" was neither new nor fatal to the court's analysis of the plaintiffs' fraud claims. Nevertheless, the court's original judgment was vacated—because its original decision was based on an erroneous finding of law—and the franchisees' RICO and fraud claims were reinstated.

The April 16 decision in Westerfield v. The Quizno's Franchise Co., LLC appears at CCH RICO Business Disputes Guide ¶11,475.

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