Bakery Distributorships Were Not “Franchises” Within the Washington Franchise Investment Protection Act

This posting was written by John W. Arden.

Pepperidge Farm bakery distributorships were not “franchises” within the Washington Franchise Investment Protection Act because Pepperidge Farm did not exercise the level of control over the distributors to satisfy the “marketing plan” requirement, the distributors were not substantially associated with the Pepperidge Farm trademarks, and the distributors did not pay a franchise fee, according to the federal district court in Richland, Washington (Atchley v. Pepperidge Farm, Incorporated, December 6, 2012, Shea, E.).

Since Pepperidge Farm was not a franchisor doing business within Washington, it was not required to register a franchise disclosure document or provide a disclosure document prior to entering a distributorship agreement.

Pepperidge Farm entered into consignment agreements with third-party independent contractors, granting them geographically exclusive distributorships. In 2003, Michael Gilroy purchased an existing distributorship from David Spangler for $299,550. In 2004, John Atchley purchased a distributorship from Jason Godwin for $225,000. For both purchases, payment was nominally made to Pepperidge Farm, which facilitated the transactions. Pepperidge Farm credited the payments to outstanding loans or other financial obligations owed by the selling distributors and then furnished all remaining monies directly to the selling distributors.

Each distributor voluntarily entered into a separate consignment agreement with Pepperidge Farm and received an exclusive right to distribute Pepperidge Farm products in retail stores within their territories. The distributors received commission payments for the sale of Pepperidge Farm goods or a percentage of the net proceeds, depending on the products. Despite the territorial exclusivity provision of the agreements, Pepperidge Farm retained the right to sell and deliver its products to customers in the distributors’ territories.

After business reversals, the distributors brought separate claims against Pepperidge Farm, alleging violation of the Washington Franchise Investment Protection Act and negligent misrepresentation. Both cases were eventually assigned to Senior Judge Fred Van Stickle, who granted partial summary judgment for Pepperidge Farm and then consolidated the cases. Judge Van Stickle granted summary judgment on the remaining negligent misrepresentation claims and held a trial on Pepperidge Farm’s counterclaim for Gilroy’s failure to repay the loan that enabled him to purchase the distributorship. The court found that factual issues regarding whether the forced sale of Gilroy’s distributorship was commercially reasonable precluded summary judgment.

After a three-day trial in February 2009, the court entered a finding that the sale of the distributorship was commercially reasonable. The distributors appealed to the Ninth Circuit, which largely affirmed the district court rulings, but reversed the decision with respect to the Franchise Investment Protection Act, concluding that there was a genuine issue of material fact about whether the distributors paid franchise fees. The appeals court remanded the case for further proceedings.

On remand, the district court dismissed the Franchise Investment Protection Act claims on the ground that the distributorships were not “franchises” within the meaning of the Act. Under the statute, a “franchise” is an agreement by which (i) a person is granted the right to engage in the business of offering, selling, or distributing goods or services under a marketing plan prescribed in substantial part by the grantor; (ii) the operation of the business is substantially associated with a trademark, trade name, or other commercial symbol owned by or licensed by the grantor; and (iii) the person pays or is required to pay a franchise fee.

Marketing Plan

Although Pepperidge Farm controlled pricing of products directly sold and provided pricing schedules for the purpose of calculating commissions, it did not exercise control over many other factors used to determine the existence of a marketing plan, the court found. These factors included: (1) hours and days of operations; (2) advertising; (3) retail environment; (4) employee uniforms; (5) trading stamps; (6) hiring; (7) sales quotas; and (8) management training. While Pepperidge Farm provided the distributors with financial support by guaranteeing the initial loan to finance purchases of the distributorships, it was not show to provide any other financial support.

Thus, the distributors failed to satisfy the marketing plan element of the “franchise” definition of the Washington Franchise Investment Protection Act.

Association with Trademark

To satisfy the “substantial association” element of the “franchise” definition, the distributors were required to show a substantial association with Pepperidge Farm trademarks or trade names beyond the act of distributing the Pepperidge Farm products. Although Atchley used the Pepperidge Farm logo on his business card and on one business form and his delivery trucks, such association was limited and incidental, the court ruled. The use of the Pepperidge Farm trademarks did not rise to the level of “substantial association.”

Payment of Franchise Fee

A “franchise fee” is a payment for the right to enter into a business under a franchise agreement and does not include “any payment for the mandatory purchase of goods or services or any payment for goods or services available only from the franchisee.” Also excluded from the definition are payments for purchases at a bona fide wholesale price. Ordinary business expenses are not “franchise fees” because they are paid during the regular course of business and not for the right to do business.

Thus, the distributors did not pay, agree to pay, or were required to pay a “franchise fee” within the meaning of the Washington Franchise Investment Protection Act, in the court’s view.

The case is No. CV-04-452-EFS.

Howard R. Morrill (Simburg Ketter Sheppard Purdy) for John R. Atchley. Forrest A. Hainline, III (Goodwin Procter LLP) for Pepperidge Farm Inc.

Distributors Could Have Paid “Franchise Fee” Under Washington Law

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

A genuine issue of material fact existed as to whether two purchasers of geographically exclusive baked goods distributorships paid a “franchise fee” under the meaning of the Washington Franchise Investment Protection Act to a baked goods manufacturer either through a $30 deduction from commissions the purchasers were paid for their participation in the manufacturer’s Pallet Delivery Program (PDP) or through any suspected fee, according to a federal district court in Spokane, Washington.

The issue had been remanded to the district court by the Eighth Circuit, which held that the district court had erred in an earlier ruling (CCH Business Franchise Guide ¶13,338) in granting summary judgment to the manufacturer after finding that the purchasers had not paid a franchise fee.

The purchasers did not argue that they paid a direct franchise fee to the manufacturer. Instead, they contended that the $30 deduction from the commissions they earned in the PDP, representing a portion of the costs the manufacturer incurred to shrink-wrap, palletize, and deliver the products to consumers’ warehouses, was a charge for the “mandatory purchase of goods or services, “available only from the franchisor,” under the meaning of the Washington Act and that none of the statutory exceptions applied.

Because the PDP was a fee-for-services agreement, it did not fall under the Franchise Investment Protection Act’s fair-market-value exception, the court determined. That statutory exception applied only to supplies, fixtures, and real property. Further, the Washington Supreme Court has not recognized a fair-market-value exception for the mandatory purchase of services.

The manufacturer cited to a law review article and two unpublished federal cases to argue that the deduction from commissions was not a franchise fee because it (1) was an ordinary business expense for services rendered and (2) lacked an unrecoverable capital investment. However, the manufacturer identified no binding precedent upon which the court could find that an ordinary business expense for services was exempted from Franchise Investment Protection’s Act’s definition of “franchise fee,” according to the court.

One of the cited cases did find that a payment of more than $6,000 for training was not a franchise fee but rather an ordinary business expense, but that case was unpublished, over 17 years old, and relied on nonbinding precedent from another Circuit. The other cited case similarly failed to persuade the court.

Although at least one Washington court considered an unrecoverable investment as one factor in determining whether a franchise fee was present, it was not a necessary component of a franchise fee. With no binding or persuasive authority on point, a genuine issue of material fact existed.

The decision in Atchley v. Pepperidge Farm, Inc. will appear at CCH Business Franchise Guide ¶ 14,793.

Washington Franchise Law Covers Out-of-State Franchisees

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

The “franchisee bill of rights” provision of the Washington Franchise Investment Protection Act (WFIPA)—requiring franchisors and franchisees to deal with each other in good faith and listing several prohibited acts, practices, and unfair methods of competition—applied to the relationship between a California hotel franchisee and a Washington franchisor, according to the U.S. Court of Appeals in San Francisco.

A ruling (CCH Business Franchise Guide ¶14,367) that the WFIPA did not apply to the termination of the franchise—because the franchisee's hotel operation did not occur "in this state"—was reversed.

The provision at issue (Wash. Rev. Code Section 19.100.180), commonly referred to as the “franchisee bill of rights,” did not contain language limiting its application to the relationship between a franchisor and a franchisee “in this state,” the appellate court noted.

In contrast, several other of the WFIPA’s provisions contained an explicit statement that they applied only to actions “in this state.” Those provisions included requirements that the offer or sale of any franchise “in this state” must be registered in the state and that any franchise broker selling or offering a franchise “in this state” must register with the state.

Originally, the term “in this state” was not defined in WFIPA, the court observed. The statute was amended in 1991 to provide a definition of the term, largely in response to a law professor’s article recommending the clarification. However, that professor did not recommend that the legislature add a territorial limitation to the franchisee bill of rights. He recommended only that the legislature define the limitation where it already existed in the WFIPA. The Washington legislature did no more than what the professor recommended, the court determined.

By its terms, the definition of “in this state” provided by the 1991 amendments applied only to the specific provision making it unlawful to offer or sell a franchise “in this state” if it was unregistered or not exempt (Wash. Rev. Code Section 19.100.020).

The district court erred in concluding that the “overall statutory scheme,” as well as the 1991 amendments, evinced a legislative intent to confine the reach of the WFIPA to only those franchises operating “in this state,” the appellate court held.

As a matter of general principle, if a state law did not have limitations on its geographical scope, courts would apply it to a contract governed by that state’s law, even if parts of the contract were performed outside of the state. The fact that the WFIPA’s provisions relating to sales of franchises contained a territorial limitation did not lead to the conclusion that WFIPA’s bill of rights was similarly limited. Rather, the inclusion of explicit territorial limitations in the sale-related provision, and the failure to include such a limitation in the bill of rights, suggested the opposite conclusion.

The dispute was remanded to the federal district court for consideration of the merits of the franchisee’s WFIPA counterclaim and consideration of the availability of a remedy under the Washington “little FTC Act.”

The Ninth Circuit’s December 7 ruling in Red Lion Hotels Franchising, Inc. v. MAK, LLC, will appear in the CCH Business Franchise Guide.

Secret Partnership to Purchase McDonald’s Franchise Was Deceptive, Illegal

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

A partnership formed by two brothers to purchase a McDonald’s franchise and to conceal the existence of the partnership—in order to contravene McDonald’s policy against selling to partnerships—was deceptive conduct in violation of the Washington Franchise Investment Protection Act and a Washington securities statute that rendered the partnership agreement unlawful, a Washington appellate court has held. A ruling by a Washington state court that the partnership was illegal and unenforceable was affirmed.

The brothers decided to purchase a McDonald’s franchise and agreed that one of them would apply for the franchise and the other would supply a portion of money required for the purchase and for other initial operating costs. They were aware that McDonald’s sold franchises only to individuals who owned the entire equity interest in the franchise and not to partnerships. They agreed to conceal the existence of their partnership and the investor brother’s involvement,

More than one year after the franchise purchase, the franchisee brother died and his estate rejected the investor brother’s claim for an interest in the partnership. The investor brother filed suit against the estate, alleging that he was entitled to receive his share of the partnership interest from the estate.

Violation of Securities, Franchise Laws

The partnership violated a Washington securities statute that made it unlawful for any person—in connection with the offer, sale, or purchase of any security—to engage in any act that operated as a fraud on any person, the court determined. The partnership violated the statute because the brothers set out to deceive McDonald’s and did so with knowledge of the franchisor’s policy against selling to partnerships.

A contention that the partnership did not qualify as a security was without merit, the court held. However, even if the partnership did not qualify as a security, the brothers violated the Washington Franchise Investment Protection Act’s provisions making it unlawful for any person—in connection with the purchase of a franchise—to employ any scheme to defraud or engage in any act operating as a fraud upon any person.

Culpability

The investor brother was equally culpable as the franchisee brother in perpetrating the fraud on McDonald’s, the court ruled. Under Washington law, if parties to an illegal contract, such as the partnership, were not equally at fault, the less culpable party could bring an action based on the illegal contract, the court noted. In this case, the investor brother was equally active in pursuing the franchise purchase and provided the franchisee brother with knowledge and information concerning the advisability of purchasing a McDonald’s franchise in general and in various locations.

There was no evidence that the franchisee brother cheated the investor brother out of any profits or otherwise attempted to defraud him, unlike the facts of the case cited by the investor brother. It was the franchisee brother’s estate—not the franchisee brother—that refused to recognize the partnership and share the profits with the investor brother, the court observed.

The decision in Marte v. Hernandez will appear at CCH Business Franchise Guide ¶14,622.

Further information about CCH Business Franchise Guide appears here.

California Court Applies Washington Franchise Law to California Franchise

This posting was written by John W. Arden.

A California garbage removal franchisee, bringing a wrongful termination action against its Canadian franchisor, was entitled to enforce a contractual choice of law in order to bring the action under the Washington Franchise Investment Protection Act rather than under the California Franchise Relations Act, according to a California court of appeals.

In 2003, the franchisee entered into an agreement to operate a franchise in the Los Angeles area with 1-800 Got Junk?, a franchisor headquartered in Vancouver, British Columbia.

The franchise agreement expressly provided that the contract be “construed and interpreted according to the laws of the state of Washington.” The franchisor’s Uniform Franchise Offering Circular stated that “Washington law governs this agreement, and this law may not provide the same protections and benefits as local law . . . ”

In May 2007, the franchisor terminated the franchise for failure to report some jobs and the gross revenues derived from such jobs and failure to pay a percentage of revenues to the franchisor. The franchisor maintained that the franchisee’s falsifying of reports was a material default of the franchise agreement, justifying termination of the franchise without an opportunity to cure.

The franchisee denied any wrongdoing, alleging that its drivers pocketed money from at least three jobs without reporting the payments to the franchisee or the franchisor.

The franchisee filed suit against the franchisor in Los Angeles County, charging that the franchisor terminated the agreement without cause, in violation of Section 19.100.180 of the Washington Franchise Investment Protection Act, which limits the circumstances in which a franchisor can terminate a franchise without providing notice or an opportunity to cure.

The franchisee also alleged breach of contract, breach of the implied covenant of good faith and fair dealing, tortuous interference with prospective economic advantage, defamation, and acting with a discriminatory motive under the California Fair Dealership Law.

Choice of Washington Law

In an unusual twist, the California franchisee pled application of Washington law, while the franchisor asked the California trial court to avoid its contractual choice of law in order to apply California law. The franchisor argued that the choice of law provision in its franchise agreement was unenforceable because there was no reasonable basis for application of Washington law.

Nevertheless, the trial court enforced the contractual provision, stating that there was a reasonable basis for the franchisor to designate Washington as the law governing the agreement, since Washington is the state closest to the franchisor’s Vancouver headquarters. The trial court found it puzzling that the franchisor’s founder and president said he did not know why Washington law was selected, since he was in a position to know.

“The objective facts are that it is reasonable for a company doing business in many states to designate the laws of one state in a contract that will be used in many states,” the trial court judge said. “If the company’s lawyers are already familiar with the laws of that one state and find them favorable, they will not have to spend so much time and energy learning the law of remaining states . . . “

The franchisor then sought a writ of mandate to vacate the trial court ruling.

The court of appeal found that there were two issues presented: (1) whether a reasonable basis existed for the parties’ choice of Washington law and (2) whether enforcement of the choice of law is barred by the California Franchise Relations Act.

Under California law, a contractual choice of law is enforceable unless either (a) the chosen state has no substantial relationship to the to the parties or the transaction and there is no other reasonable basis for the parties’ choice or (b) application of the law of the chose state would be contrary to a fundamental policy of a state that has a materially greater interest than the chosen state.

Reasonable Basis

Even though there was no substantial relationship between the franchisee or the transaction and the State of Washington, the franchisee satisfied the alternative prong of the test—that there was a reasonable basis for the selection of Washington law.

There is a benefit to a franchisor and franchise system in having a single set of rules to apply to all franchisees—a benefit that has been recognized by many courts examining choice of law issues, the court found. Further, the State of Washington is the closest U.S. jurisdiction to the franchisor’s headquarters in Vancouver.

Fundamental Public Policy

Moreover, the franchisor failed to establish that the application of Washington law contravened the fundamental public policy embodied in the California Franchise Relations Act.

The Franchise Relations Act serves to protect California franchisees from abuses by franchisors in connection with the termination and nonrenewal of franchises. The statutory scheme generally prohibits termination of a franchise prior to the expiration of its term except for good cause, which is defined as the failure to comply with any lawful requirement of the franchise agreement after being given at least 30 days notice and a reasonable opportunity to cure the failure. There are specific grounds for immediate notice of termination.

The Act includes an antiwaiver provision that “{a]ny condition, stipulation or provision purporting to bind any person to waive compliance with any provision of this law is contrary to public policy and void.”

Waiver of Compliance

The antiwaiver provision does not categorically prohibit choice of law provisions, the court held. It only voids choice of law provisions that require a franchisee to waive compliance with the protections of the Franchise Relations Act. Thus, the critical inequity is whether the enforcement of the choice of law provision in this case would diminish the franchisee’s rights under the Franchise Relations Act.

“A comparison of the CFRA and the WFIPA shows that Washington affords a franchisee far greater protection from summary termination of a franchise,” the court ruled.

While the California statute contained 11 grounds for immediate termination, without notice or right to cure, the Washington statute authorized such termination in only four situations: (1) the franchisee’s bankruptcy or insolvency, (2) the franchisee’s assignment for the benefit of creditors, (3) the franchisee’s voluntary abandonment of the franchise, and (4) the franchisee’s conviction or plea of no contest to a charge of violating any law relating to the franchise business.

Providing superior protection from summary termination is not a waiver of compliance with the California Franchise Relations Act, in the court’s view. “California public policy is not offended if the franchisor contractually obligates itself to give notice and an opportunity to cure in situations where the CFRA would permit immediate termination of a franchise.”

Accordingly, the enforcement of the choice of law provision was not barred by the antiwaiver provision of the California Franchise Relations Act, the court concluded.

The decision is 1-800-Got Junk? LLC v. Superior Court of Los Angeles County, B221636, filed October 21, 2010. It will appear in the CCH Business Franchise Guide.

Failure to Disclose Business Plans to Prospective Franchisee Did Not Violate Washington Law

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

A pizza restaurant franchisor did not violate the Washington Franchise Investment Protection Act (WFIPA) by failing to disclose to a prospective franchisee that the franchisor was planning to discontinue its outlet franchises at the time that the franchisee purchased its franchise, according to a Washington appellate court.

Thus, a Washington trial court’s dismissal of the franchisee’s claim that the franchisor’s silence as to its plans was a “material omission” under the WFIPA was affirmed.

The franchisor sold two different models of franchises: an outlet model that sold only “take-and-bake” pizzas and a restaurant model that sold both "take-and-bake" pizzas and “ready-to-eat” pizzas that could be consumed at the store.

The proposed franchise agreement between the parties did not require the franchisee to specify which model they would follow and provided that the franchisor could change store operating methods in the future.

Material Omission

Case law held that nondisclosure of a fact would qualify as a material omission under the WFIPA if a reasonable person would consider that fact important in determining what action to take with respect to the transaction in question, the appellate court observed.

The franchisor presented evidence demonstrating that it had not discontinued its outlet stores after the franchise purchase. In fact, it continued to support outlet store franchisees in several locations throughout the country.

In response, the franchisee pointed to evidence that approximately seven months after its franchise purchase, the franchisor announced a plan to require new franchises to offer some dining facilities. However, under this plan, existing outlet stores were not required to change their operations and they continued to receive support from the franchisor.

The franchisee failed to offer any evidence that this prospective policy affected existing outlet stores such as its franchise, the court determined. At most, it showed that the franchisor was considering a shift in its mix of stores going forward. Moreover, the franchisor disclosed in both its offering circular and the franchise agreement that such a shift could occur if the franchisor decided to change its store operating methods.

Materiality

As to materiality, the franchisor’s mix of outlet and restaurant models was not a key feature of the franchise agreement, the court ruled. Indeed, the number of outlet versus restaurant stores was not mentioned in the franchise agreement. Further, the agreement did not require franchisees to specify which model they would follow or limit their ability to change methods. Thus, there was no reason to expect that the mixture of store models would remain static.

Even assuming that the franchisor was considering a change to the way new stores could operate in the future, the franchisee failed to show that disclosure of this fact would have been necessary to make the franchise offering not misleading, according to the court.

The June 1 unpublished decision is Something Sweet v. Nick-N-Willy’s Franchise Co. It will appear at CCH Business Franchise Guide ¶14,398.

Inventory Requirement, Control of Supplies Might Be “Franchise Fee” Under Washington Law

This posting was written by John W. Arden.

A supplier’s requirement that distributors maintain a particular level of inventory and its control over the supplies sent to the distributors might constitute a “franchise fee” within the Washington Franchise Investment Protection Act, according to the U.S. Court of Appeals in San Francisco.

Summary dismissal of the distributors' franchise law claims (CCH Business Franchise Guide ¶13,338 and ¶13,437)—based on its failure to establish that it paid a “franchise fee”—was reversed, and the claim was remanded to the federal district court in Spokane, Washington.

Mandatory Purchases

Payments for “the mandatory purchase of goods or services” are considered franchise fees under the Washington Franchise Investment Protection Act’s definition of “franchise.” (Wash. Rev. Code §19.100.010 (12)), the appeals court held.

The complaining distributors claimed that their supplier (Pepperidge Farm) effectively required them to purchase goods by mandating inventory levels and controlling pallet shipments “and then requiring [them] to pay for some product that went stale prior to sale.”

While the district court ruled that the distributors were never required to purchase a set quantity of Pepperidge Farm products, the distributors “submitted evidence to support their claim to the contrary,” the appeals court said, finding a genuine dispute of material fact that precluded summary judgment.

Business Opportunity Law

The appellate court upheld the summary dismissal of other claims brought by the distributors—including claims brought under the Washington Business Opportunity Fraud Act and negligent misrepresentation. It was not apparent that a distributorship was a “business opportunity” under the statute, and the distributors offered no counter argument, the court held.

The negligent misrepresentation claim was rejected on the ground that the distribution agreement specifically required the distributor to remove stale Pepperidge Farm products from store shelves and provided that Pepperidge Farm had no obligation to accept stale goods.

Commercially Reasonable Sale

The district court’s finding that Pepperidge Farm’s sale of the distributorship to the complaining distributor was commercially reasonable under the Washington Uniform Commercial Code (CCH Business Franchise Guide ¶14,145) was upheld on appeal.

“Pepperidge Farm undertook efforts in excess of ordinary procedures for marketing a distributorship, easily satisfying the standard for a commercially reasonable sale,” the Ninth Circuit ruled.

The May 14 not-for-publication opinion is Atchley v. Pepperidge Farm Inc., No. 09-35275. Text of the decision will appear in the CCH Business Franchise Guide.

Insurance Agent Not Protected “Franchisee” Under Washington Law

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

An insurance agent was not a “franchisee” of an insurance company within the meaning of the Washington Franchise Investment Protection Act because the agent did not pay the company a “franchise fee,” according to the federal district court in Tacoma, Washington.

Thus, the company could not have violated the Franchise Investment Protection Act by committing fraud and breaching the duty of good faith and fair dealing in threatening the agent’s retirement benefits if he did not immediately retire.

The agent filed suit after a representative of the company allegedly improperly threatened his retirement benefits in a meeting to discuss employees’ claims of sexual harassment against the agent. The agent argued that, but for his allegedly forced retirement, he would have worked for an additional seven years.

Franchise Fee

The agent admitted that he did not pay any money to the insurance company for the agency. Instead, he argued that he paid an indirect franchise fee by exclusively selling the company’s insurance and allowing his customers and their information to become trade secrets of the company.

However, case law indicated that indirect franchise fees had been found only in situations when some money had changed hands, such as required purchases of products above the fair market value. Because the agent paid no money to the company—either directly or indirectly—he could not satisfy the Franchise Investment Protection Act’s franchise fee requirement, the court ruled.

Exemption for Insurance

In any event, insurance actions and transactions regulated under the insurance code were expressly exempted from the Franchise Investment Protection Act. Because the action of terminating an insurance agent is generally regulated by the insurance code, the agent’s complaint was specifically exempted from the protections of the Franchise Investment Protection Act.

The decision is Noyes v. State Farm General Insurance Co., CCH Business Franchise Guide ¶14,133.