Choice of Florida Law Barred Minnesota Franchise Act Claims

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

Minnesota Franchise Act claims asserted by a Florida franchisee of two hockey-training businesses and its principal against a Minnesota franchisor and several of its officers were barred by the valid and enforceable choice of Florida law provision in the parties’ agreements, the federal district court in St. Paul, Minnesota, has decided.

After hearing about the franchise opportunity, the corporate franchisee’s principal traveled to Minnesota and met with three officers of the franchisor there. Provided with a Uniform Franchise Offering Circular, the franchisee and principal entered into two franchises for territories in Florida. The franchisee opened only one of the franchises, closing it after one year due to financial losses.

The franchisee and principal filed suit, alleging that the franchisor violated the Minnesota Franchise Act by failing to register the franchise and making several false representations that induced them to purchase the franchises. As a result of these violations, the franchisee and principal lost more than $800,000.

Specifically, the plaintiffs alleged that, contrary to the franchisor’s representations:

(1) The franchises did not generate anywhere near the gross total sales that the franchisor claimed they could;

(2) It was imperative that a franchise be located in or near a hockey rink;

(3) It was highly unlikely that all of the hockey facilities of the franchisor were financially successful;

(4) The owner of the franchise needed to have significant hockey experience to operate profitably; and

(5) The franchisor did not experience the growth that had been represented or have an established business plan for running hockey facilities.

Waiver of Rights

The franchisee and principal argued that, despite the choice of law provision, the franchisor was liable for violations under the Minnesota Franchise Act (MFA) because Minnesota law did not permit the waiver of any rights secured by the Act.

However, the statute’s anti-waiver provision prohibited the waiver of rights secured by the MFA through a choice of law provisions only if the waiver purported to bind (1) a person who was a Minnesota resident (or Minnesota corporation) at the time the that person or organization acquired a franchise or (2) a person (regardless of residence) who was acquiring a franchise that would operate in Minnesota.

In this case, the principal was not a resident of Minnesota, the franchisee was not was not organized or incorporated in Minnesota, and the franchises at issue were to be operated in Florida, not Minnesota, the court found. Accordingly, the Minnesota Franchise Act’s anti-waiver provision did not void the parties’ choice of law provision.

Although the statutory anti-waiver provision was to be construed broadly, it was also to be construed in favor of protecting Minnesota franchisees, the court observed.

Fraud, negligent misrepresentation, and Florida Franchise Act claims brought by the franchisee and its principal withstood a motion for dismissal. The court held that the issues could not be decided at such an early stage of litigation.

The January 10 decision is Hockey Enterprises, Inc. v. Total Hockey Worldwide, LLC, CCH Business Franchise Guide ¶14,531.

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.

Franchise Agreements’ Arbitration Clause Was Unenforceable Under California Law

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

The arbitration clause in franchise agreements between a Texas payday loan franchisor and two California payday loan franchisees was neither severable nor enforceable under California law, according to the U.S. Court of Appeals in San Francisco.

A federal district court did not err in declining to sever the unconscionable portions and refusing to enforce the entire arbitration clause (CCH Business Franchise Guide ¶13,966).

The dispute centered on the franchisees' claims that the franchisor made material misrepresentations and omissions regarding its franchises and that the franchisor's business model did not comply with California law.

The franchisees alleged violations of the California Franchise Investment Law, unfair trade practices, fraud, and breach of contract, among other things. The franchisor filed a motion to dismiss or, alternatively, to stay the action pending arbitration. After the district court held the arbitration clause unconscionable and unseverable, the franchisor appealed.

Abitrability of Claims

On appeal, the franchisor argued that, under the “crux of the complaint rule,” the question of arbitrability should be determined by an arbitrator because the franchisees’ complaint did not contain a specific challenge to the arbitration clause. However, the Ninth Circuit did not create a rule under which a plaintiff must plead a separate and distinct challenge to the arbitration clause in order to have a court determine arbitrability, the court reasoned.

In most cases in which the validity of the arbitration clause was distinct from contract claims, a court would not expect the plaintiff to raise claims against the arbitration clause in the complaint because such claims would be unrelated to the plaintiff’s principle prayer for relief.

An independent challenge to the arbitration clause would become relevant only when the plaintiff was required to oppose a motion to compel arbitration. In such a case—and in this one—the challenge to the arbitration clause would come in the pleadings resulting from a motion to compel. Thus, to determine arbitrability, it was necessary to look at the franchisees’ complaint and motion papers to determine if the franchisees’ objections to the arbitration clause were severable from the challenge to the validity of the franchise agreement as a whole.

Unconscionability of Clause

The franchisees contended that the arbitration clause was both procedurally and substantively unconscionable, because it:

(1) Was not mutually entered into;

(2) Improperly limited the franchisee’s damages;

(3) Impermissibly shortened the statute of limitations;

(4) Contained invalid place and manner restrictions;

(5) Sought to negate the franchisee’s unwaiveable rights under the California Franchise Investment Law; and

(6) Wrongly banned class and consolidated actions.

These contentions were clearly attacks on the arbitration clause alone and separate from the franchisees’ claims that the franchisor’s misrepresentations fraudulently induced them into purchasing franchises, the appellate court held. Thus, the question of arbitrability of the parties’ dispute was properly decided by the district court.

Choice of Law

California law governed the question of the unconscionability of the arbitration clause, and the district court’s decision to apply California law to determine that the arbitration clause was unconscionable was affirmed.

On appeal, the franchisor argued that Texas law should govern because the agreements contained a choice of Texas law clause. California’s choice of law rules applied to determine which state’s law governed the unconscionability issue, the appellate court observed.

It was undisputed that Texas had a substantial relationship to the parties and the transaction because the franchisor’s principle place of business was there and the agreements were executed there. However, enforcement of the arbitration clause would contravene the fundamental California public policy in favor of protecting franchisees from unfair and deceptive business practices, as established by the California Franchise Investment Law (CFIL).

Case law demonstrated California’s established public policy against arbitration clauses that forced franchisees to waive the limitations period, bar class actions, or limit punitive and consequential damages in violation of the CFIL’s anti-waiver provisions, the appellate court noted.

Under Texas law, the arbitration clause in the parties’ agreement would be enforceable. Thus, Texas law was in conflict with that of California on the issue. The question came down to which state had a materially greater interest in having its law regarding unconscionability of arbitration agreements applied in the dispute, according to the court.

Of the two, California’s interest was greater. Texas had a significant general interest in enforcing contracts executed there and by its citizens, and in protecting its franchisors from significant liabilities. However, California had a substantial, case-specific interest in protecting its resident franchisees from losing statutory protections against fraud and unfair business practices. Because the franchises were operated in California by California citizens, California would suffer a significant impairment of its public policy if the arbitration clause was enforced against its citizens.

Severability

The district court did not abuse its discretion by declining to sever the unconscionable portions of the arbitration clause and refusing to enforce the arbitration clause in its entirety, the court ruled. Four of the five paragraphs of the arbitration clause were unconscionable, or at least unenforceable, under California law.

After determining that the majority of the arbitration clause was substantively unconscionable and imposed on the franchisees without any opportunity to negotiate, the district court ruled that unconscionability “permeated” the entire arbitration clause and was “overwhelming.” This ruling was not an abuse of discretion, the appellate court held.

The September 16 decision in Bridge Capital Fund Corp. v. Fastbucks Franchise Corp. will appear in the CCH Business Franchise Guide.