The Long Arm of U.S. Law Grabs Canadian Executive

This posting was written by Michael Osborne, a partner with Affleck Greene McMurtry LLP of Toronto, Ontario, Canada.

Doing business in the U.S. can be very lucrative. But Canadian (and other foreign) companies and their executives that engage in corrupt practices there can expect to face serious penalties there.

Former Bennett Environmental, Inc. executive Robert Griffiths is a case in point. On September 12, 2011, he was sentenced to serve 50 months in a U.S. jail, after pleading guilty to participating in fraud and money-laundering conspiracies.

Bennett Environmental is an environmental soil remediation company. Beginning in 2001, it won a series of contracts to remediate soils at a major environmental cleanup in the U.S. known as the Federal Creosote site.

An investigation by the U.S. Justice Department’s Antitrust Division revealed that bidders on the project, including Bennett Environmental, had conspired in the bidding process, fraudulently inflated the price of certain subcontracts, and paid kickbacks.

To date, three companies and ten individuals have been charged. Bennett Environmental is one of the three companies: in 2008 it pleaded guilty to one count of conspiracy to defraud the U.S. Environmental Protection Agency and was fined $1 million.

Bennett Environmental’s woes in the U.S. are not over. Its founder, John Bennett, was indicted in 2009 and faces charges of conspiracy, fraud, and money laundering in relation to the Federal Creosote site. Mr. Bennett has recently succeeded in obtaining orders from Ontario courts that Bennett Environmental pay his legal bills.

Controversy over the Federal Creosote contracts has also led to trouble at home. An OSC investigation determined that Bennett Environmental failed to disclose disputes over Federal Creosote contracts in 2003 until about one year later.

In a series of settlements, Mr. Bennett was prohibited by the Ontario Securities Commission from acting as an officer or director of a public company for ten years, and ordered to pay an administrative monetary penalty (“AMP”) of $250,000.

Mr. Griffiths was barred from trading in securities or acting as a director or officer of a public company for 15 years, and ordered to pay an AMP of $150,000. Another Bennett Environmental executive, Rick Sterns, was prohibited from acting as an officer or director for five years and ordered to pay an AMP of $490,000.

Further information regarding the 2008 criminal charges against Bennett Envronmental, Inc. appears in an August 1, 2008 posting on Trade Regulation Talk.

Failure to Disclose Earnings of Franchised Store Was Not Fraud, Franchise Law Violation

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

A convenience store franchisor did not commit common law fraud or violate either the Illinois Franchise Disclosure Act (IFDA) or Illinois “little FTC Act” by failing to provide material information on the historical performance of a store to a prospective franchisee that had requested such information in connection with her consideration and purchase of the franchise for the store, according to a federal district court in Chicago.

After terminating the franchisee for failing to meet the franchise’s minimum net worth requirement, the franchisor brought suit seeking a preliminary injunction forcing the franchisee to surrender the store premises and meet her other post-termination obligations.

The franchisee counterclaimed, alleging that the franchisor was required to disclose financial information concerning the particular store she was considering and eventually purchased because the store’s financial performance was supposedly “below average” for the region. The franchisor had refused to provide the franchisee with sales figures for the store, which had been operating for less than one year.

The franchisor was not required by either the FTC Franchise Rule or the North American Securities Administrators Association’s Uniform Franchise Offering Circular (UFOC) Guidelines to disclose earnings information for any of its stores, let alone the store that the franchisee decided to purchase, the court determined.

Earnings Claim

Although the franchisor elected to include an earnings claim in its UFOC, that was a specific disclosure of “the most recently available annual averages of the actual sales, earnings and other financial performance” in each market area in the state, the court noted.

The franchisor specifically disclosed in its UFOC that it was not providing information related to stores that had been opened for less than 12 months, such as the store in question, and informed the franchisee that it would not provide such information, the court noted.

The franchisee argued that she should have been provided with information on the store’s “historical poor performance” in order to correct a misimpression created by the earnings claim. However, a logical fallacy of the franchisee’s argument was that the earnings claim was not offered as indicative of the actual performance of the store, the court reasoned.

Duty to Make Further Representations

While admitting that the information provided by the franchisor might not have been false, the franchisee maintained that the franchisor was under a duty to make further representations in order to prevent the provided information from being misleading. However, the earnings claim made by the franchisor was only “misleading” if the franchisee ignored the express terms of the earnings claim and made projections based upon her own assumptions concerning historical information of other stores, the court decided. The franchisee could not have done so consistent with the disclaimers in her franchise agreement and in the UFOC.

The franchisee contended that the disclaimers in the franchise agreement and UFOC were somehow inoperative because the information, or lack thereof, was material to her investment decision. However, the franchisor was not under an obligation to disclose every piece of information that could have been material to the franchisee’s investment decision, the court held.

Because the franchisor had no duty to disclose the historical financial performance of the store, the franchisee’s common law fraudulent omission claim, as well as her IFDA and “little FTC Act” claims, failed.

The decision in 7-Eleven, Inc. v. Spear appears at CCH Business Franchise Guide ¶14,644.

Startup Cost Projection in UFOC Might Constitute Fraud, Franchise Law Violations

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

A vegetarian restaurant franchisee adequately alleged common law fraud and violations of the Maryland Franchise Disclosure Law against a franchisor, based on the franchise startup cost projections in the franchisor’s Uniform Franchise Offering Circular (UFOC), a federal district court in Greenbelt, Maryland, has decided. Thus, the franchisor’s motion to dismiss the claims was denied.

The franchisor’s motion to dismiss claims alleging violation of the New York Franchise Sales Law—on the ground that the New York statute did not apply to the parties’ relationship—was also denied.

Fraud Allegations

The allegations of fraud in the franchisee’s complaint were sufficiently detailed to satisfy particularity in pleading requirements, the court held. The franchisee was consistently specific regarding time, date, place, and contents of the allegedly fraudulent cost projections made by the franchisor.

The franchisee alleged that the startup cost estimates in the franchisor’s UFOC dramatically underestimated the actual startup costs for its franchise and that the franchisor knew that the representations were inaccurate at the time it made them. The franchisee’s factual averments about the franchisor’s knowledge were less specific, but heightened pleading was not required for the scienter element of fraud, according to the court.

The facts in this case made the franchisee’s claims even stronger than they were in an earlier case, Motor City Bagels, LLC v. American Bagel Co., (CCH Business Franchise Guide ¶11,654), in which the court held that a franchisor could have committed fraud by misrepresenting the initial investment costs in its UFOC, the court reasoned.

In this case, the alleged discrepancy between the UFOC and the actual startup costs was much greater than in Motor City, suggesting a potential miscalculation of 85 percent or more.

The UFOC specifically encouraged the franchisee to rely on the startup cost estimates in two ways. First, the UFOC specifically itemized various cost categories and provided sub-estimates for each category. Second, the UFOC pointed out that the estimates were based on the franchisor’s “15 years of combined industry experience and experience in establishing and assisting our franchisees in establishing and operating 23 [vegetarian restaurants] which are similar in nature to the Franchised Unit you will operate.”

The franchisor argued that cost projections were statements of opinion and could not constitute fraud because they were not susceptible to exact knowledge at the time they are made. However, erroneous projections could supply a basis for fraud under Maryland law in some cases, the court held.

Whether projections were sufficiently concrete and material to qualify as statements of fact required a context-sensitive inquiry that could not be reduced to a single formula. An assessment of relevant factors—including the extent of the alleged discrepancy, whether the projection was based on mere speculation or on facts, and whether the projection was contrary to any facts in the franchisor’s possession—supported the conclusion that the franchisee stated a claim for fraud.

New York Franchise Sales Law Claims

The New York Franchise Sales Act applied to the relationship between the Delaware franchisor, with its principal place of business in New York, and the franchisee’s operation of a restaurant in Washington, D.C. because the franchisor’s offer to sell the franchise originated from New York, the court ruled.

Important aspects of the franchise transaction occurred in New York. The initial in-person discussions regarding the franchisee’s potential purchase of a franchise took place there, the court noted. Both of the documents central to the parties’ franchise transaction—the franchisor’s UFOC and the franchise agreement—were mailed by the franchisor from its principal place of business in New York to the franchisee’s Maryland address.

Although neither the franchisee nor the franchised restaurant were located in New York, those facts alone were not dispositive because the New York Franchise Sales Act attempted to protect franchisees in other states where offer and/or acceptance took place in New York, according to the court.

The rationale for extending the statute to situations such as this was to protect and enhance the commercial reputation of New York by regulating not only franchise offers directed at New York from other states, but also those originating in New York, from New York-based franchisors, in the court’s view.

The July 7 opinion in A Love of Food I, LLC v. Maoz Vegetarian USA, Inc. will appear at CCH Business Franchise Guide ¶14,633.

$12 Million Punitive Damage Award to Hotel Franchisee Upheld

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

There was no due process violation in an Arkansas state court jury’s award of $12 million in punitive damages to a hotel franchisee in its dispute with a franchisor, an Arkansas appellate court has determined. Thus, the trial court erred in reducing the punitive damages awarded to $1 million, and its ruling was reversed.

The jury found that the franchisor committed fraud by failing to disclose a report prepared by one of its executives that he would oppose the franchisor’s re-licensing of a franchisee’s hotel and instead would advocate the licensure of a competing hotel in the franchisee’s area.

Amount of Punitive Damage Award

Three guideposts are considered in determining whether a punitive damages award was excessive under federal law:

(1) The degree of reprehensibility of the defendant’s conduct;

(2) The disparity between the harm or potential harm suffered by the plaintiff and the punitive damages award, also expressed as the ratio between compensatory and punitive
damages; and

(3) The difference between the punitive award and comparable civil penalties authorized or imposed in comparable cases.

The franchisor’s failure to disclose valuable information to the franchisee, who had worked with and trusted the franchisor for over half a century, showed a degree of reprehensibility that supported a significant punitive damages award, the court held.

Ratio of Punitive to Compensatory Damages

The ratio of punitive damages to compensatory damages was 1.19-to-1 ($12 million to $10.056), a ratio that was well within constitutional territory. Such a ratio was a far cry from the 145-to-1 or 500-to-1 ratios found constitutionally wanting in other cases. The ratio of 1.19-to-1 also fell easily within the range of generally accepted ratios that Arkansas courts approved in other punitive damages cases.

As for comparable civil penalties, the Arkansas “little FTC Act” imposed a $10,000 penalty for unconscionable trade practices and the Arkansas Civil Justice Reform Act, which was not in effect at the time this cause of action arose, limited punitive damages to $1 million in many circumstances, the court observed.

Those statutes militated in favor of reducing the jury’s award but they were not dispositive, in the court’s view. When balanced against the reprehensibility of the franchisor’s conduct and a punitive to compensatory ratio of 1.19 to 1, the analysis compelled a net result in favor of the jury’s full punitive damages award, the court ruled.

Evidence of Fraud

Substantial evidence supported the jury’s finding of fraud, the appellate court held. On appeal, the franchisor argued that because it had no fiduciary or other confidential or special relationship with the franchisee, it had no duty to disclose the existence of its executive’s report.

However, the franchisee had a long-term relationship with the franchisor, characterized by honesty, trust, and the free-flow of pertinent information, the court noted.

In light of the parties’ history and the assurances he had received, the franchisee was justified in assuming that there were no obstacles to his re-licensure, according to the court.

The decision is Holiday Inn Franchising, Inc. v. Hotel Associates, Inc. It will be reported at CCH Business Franchise Guide ¶14,563.

Snapple Purchasers’ “All Natural” Claims Meet Fraud Pleading Standards

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

Purchasers of Snapple drink products pleaded with particularity that “all natural” labeling of beverages containing high fructose corn syrup (HFCS) was deceptive and fraudulent under California consumer protection laws, the federal district court in Sacramento has ruled.

The purchasers' broader allegations regarding unspecified “commercial advertisements” and “other promotional materials” were dismissed.

Labeling Claims

The purchasers alleged that between March 4, 2005 and March 4, 2009, Snapple used “All Natural” and other similar terms in labeling its drink products. The purchasers submitted examples of the labels from bottles of each of the sixty drink products, all of which contain the term “All Natural” or “100% Natural.”

The purchasers alleged that this labeling deceived consumers because the drink products contained HFCS, which they asserted is not a natural product. The purchasers further alleged that if they had not been deceived by the labels on the products, they would not have purchased the products, but would have purchased alternative drink products.

These allegations satisfied the heightened standard for specifying the who, what, where, and how of fraud, under Rule 9(b) of the Federal Rules of Civil Procedure, the court held.

Advertisements, Promotional Materials

The purchasers' allegations regarding unspecified “commercial advertisements” and “other promotional materials” were dismissed because they failed to (1) identify any specific advertisements or promotional materials; (2) allege when plaintiffs were exposed to each advertisements or materials; or (3) explain how such advertisements or materials were false or misleading, according to the court.

The January 6 opinion in Von Koenig v. Snapple Beverage Corp. will be reported at CCH Advertising Law Guide ¶64,116.

Costco Faces False Patent Marking Claims

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

In a qui tam complaint filed on behalf of the United States, a plaintiff stated false patent marking claims by alleging that Costco marked its premium Kirkland Signature brand diapers with two expired United States patent numbers, knowing that the patents had expired, with intent to deceive the public, the federal district court in Chicago has ruled.

The false patent marking statute (35 U.S.C. §292) provides that “[w]hoever marks upon, or affixes to, or uses in advertising in connection with any unpatented article, the word `patent’ . . . for the purpose of deceiving the public” will be fined up to $500 for each offense.”

Knowledge

Costco allegedly marked its Kirkland diaper products with the expired patents that did not cover the items within the packaging. One patent allegedly had expired in October 2007 and the other in September 2009. The complaint also contained facts that could support a reasonable inference that Costco had knowledge that its Kirkland diapers were no longer covered by the patents at issue at the time of marking, the court found.

Costco allegedly had experienced in-house counsel, retained outside intellectual property legal counsel, an internal compliance officer, and a long history of patent litigation. Costco had publicly affirmed its commitment to investing in protecting its intellectual property of its Kirkland brand products.

Fraud Pleading

The claims identified the entity responsible for the alleged fraud, the conduct through which the fraud was accomplished (false patent marking), the item falsely marked, and a temporal and geographical frame of reference for the conduct at issue, according to the court.

The allegations of fraud were pleaded with the particularity required to pass muster under Rule 9(b) of the Federal Rules of Civil Procedure, the court determined.

The November 22 opinion in Englehardt v. Costco Wholesale Corp. will be reported in CCH Advertising Law Guide.