Tuesday, January 20, 2009

Franchisees’ Deception Claims Adequately Pled RICO Violations by Franchisor's Finance Company

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

Three tanning salon franchisees adequately alleged that deceptive leasing practices by a franchisor's affiliated finance company constituted a pattern of racketeeering activity in support of their federal RICO claims, the federal district court in Camden, New Jersey, has ruled.

According to the franchisees’ complaint and RICO case statement, the finance company, together with the franchisor (1) induced them to enter into "deceptively vague leasing agreements" that contained little or no description of the equipment being leased and (2) mailed and faxed misleading invoices that charged the franchisees for what they did not receive and for new equipment when they received used equipment.

Because the franchisees identified the specific dates on which some of the allegedly fraudulent invoices were received—and identified specific pieces of equipment that were billed but never received—their "representative" allegations were "more than adequate" to put the defendants on notice of the particular conduct that was at issue. Therefore, the franchisees’ complaint was sufficiently pled under the Federal Rule of Civil Procedure's heightened pleading standards for fraud.

Pattern of Racketeering

In order to establish a pattern of racketeering activity, a RICO plaintiff must assert that the acts of racketeering at issue: (1) were related and (2) amounted to, or posed a threat of, continued criminal activity. In this case, allegations that the defendants sent similarly fraudulent billings to different franchisees satisfied the relatedness requirement. Allegations that the defendants repeatedly mailed fraudulent invoices to multiple franchises over a period of 15 months were sufficient, at this stage of the litigation, to satisfy closed-ended continuity.

Charges that three unrelated franchisees in three different states were subjected to the same fraudulent leasing practices supported the franchisees' assertions that the alleged misconduct was consistent with the defendants' "regular way of operating." Therefore, open-ended continuity was sufficiently pled.


The franchisees asserted an association-in-fact enterprise that included the franchisor; its agents, officers, and employees; the assignee; and the assignee's agents, officers, and employees. The franchisees sufficiently alleged that these associates functioned as a unit in furtherance of an alleged scheme to deceive and overcharge the franchisees.

Moreover, the franchisees' allegations sufficiently specified the distinct role that each of the corporate associates had played in the alleged enterprise: the franchisor allegedly required new franchisees to use the finance company's leasing and financing services; the finance company utilized deceptive and inaccurate invoices and leasing agreements to overcharge the franchisees; and both entities collaborated to keep the franchisees at a distance from the finance company in an effort to prevent them from acquiring complete information about the nature of their loans. These allegations were more than sufficient to support a RICO enterprise.

Motives and Objectives

The franchisees alleged that the franchisor and the finance company had agreed to send fraudulent invoices to three of the franchisees, and that the defendants' motive in conspiring to operate the finance company was to fraudulently obtain, through a pattern of racketeering activity, illegal profits. The latter allegation sufficiently provided the requisite mens rea: the knowing furtherance of the enterprise's affairs.

In addition, the franchisees' assertions regarding the objectives and composition of the conspiracy—and the finance company's conduct in advancing those objectives—contained sufficient information to enable the defendants to prepare an adequate responsive pleading.

Fraud, Unjust Enrichment

Claims that the defendants fraudulently induced the franchisees into entering unconscionable franchise agreements and sent deceptive and inflated invoices were allowed to proceed. Contentions that the fraud claims were not pled with particularity and were barred by the economic loss doctrine were rejected by the court. When read together with the RICO claims, the fraud claims were pled with sufficient particularity. The economic loss rule applied only to some tort claims based on negligence, not to intentional torts such as common law fraud.

However, the franchisees’ unjust enrichment claims against the finance company were dismissed on the ground that a party cannot recover under a quasi-contractual theory where there is an express contract between the parties. In this case, express contracts government the franchisees’ relationships with the finance company.

The decision is HT of Highlands Ranch, Inc. v. Hollywood Tanning Systems, Inc., CCH RICO Business Disputes Guide ¶11,603. It also will appear at CCH Business Franchise Guide ¶14,036.

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