Tag: litigation

Enforcing Quality Standards in Hotel Franchise Agreements

August 6th, 2014
David Cahn

David Cahn

Take-away. A franchisor’s diligence in conducting and documenting quality assurance inspections is as important as ever, particularly if the franchisor seeks to exercise its ultimate weapon – termination of the franchise agreement. Prudent inspection and documentation practices are particularly crucial in the many U.S. states and territories that have statutes requiring a showing of “good cause” in order for a franchisor to terminate a franchise agreement. In such states, a franchisor must furnish evidence demonstrating that the franchisee failed to substantially comply with the material and reasonable franchise requirements; otherwise, a court may well restore the franchise rights and order money damages to the franchisee.

The Case.  Pooniwala v. Wyndham Worldwide Corp., a May 2014 decision by the U.S. District Court for the District of Minnesota, is an exemplary demonstration of how a franchisor establishes that one of its franchisees repeatedly violated quality assurance standards so that there was “good cause” to terminate the franchise agreement under state law. The franchisor’s in this case diligently conducted and documented regular quality assurance (“QA”) inspections.

The Facts. Minn. Stat. Section 80C.14, part of the Minnesota Franchise Act, allows a franchisor to terminate an agreement if the franchisor can show “good cause” for termination. Good cause means failure by the franchisee to substantially comply with the material and reasonable franchise requirements imposed by the franchisor, including “any act by or conduct of the franchisee which materially impairs the goodwill associated with the franchisor’s trademark, trade name, service mark, logotype or other commercial symbol.”

Pooniwala involved franchise agreements for two hotels, one a “Super 8,” and the other a “Travelodge.” The franchisee alleged that the franchisors, both of which are affiliated companies within the Wyndham Hotel Group, took retaliatory action against the franchisee because of a lawsuit between the franchisee and Ramada Worldwide Inc., its fellow Wyndham Group affiliate. The franchisors, for their side, argued that their attempts to terminate the franchise agreements were not retaliatory actions, but rather that the franchisee had repeatedly violated QA standards found in the respective franchise agreements, giving each franchisor good cause for termination.

The first attempted termination involved a Super 8 hotel facility in Roseville Minnesota. The franchise agreement for the Roseville Super 8 included quality assurance requirements, as well as provisions allowing Super 8 to inspect the facility to ensure that it was operating in compliance with Super 8’s system standards and QA requirements.  The franchisee had failed six consecutive QA inspections at the Roseville Super 8.  Each inspection was followed by a letter indicating that the franchisee had received a failing score on the QA inspections. The letters also gave the franchisee notice that it had sixty days to cure the QA deficiencies, the failure of which could result in termination of the franchise agreement. Finally in September 2013 Super 8 notified the franchisee that the franchise would terminate on December 29, 2013, unless the hotel passed a final QA inspection. The franchisee failed that final inspection, and shortly thereafter Super 8 informed the franchisee that termination would take effect on the originally scheduled termination date.

The second termination was for a Travelodge hotel facility in Burnsville, Minnesota. The Burnsville Travelodge agreement contained similar QA requirements, and the franchisee failed eight consecutive QA inspections, receiving letters documenting the failures following each inspection. Finally the franchisee received notice of termination for the Travelodge franchise. The notice described QA deficiencies, and stated that termination would take effect in ninety days, but that another inspection would be scheduled to determine whether the QA violations had been cured. The franchisee failed that inspection, and as a result Travelodge informed the franchisee that termination would take effect on the originally scheduled date.

Preliminary Injunction. It is not a wonder that motions for preliminary injunction are commonplace in hotel franchise termination cases. With the great potential for loss of good will among customers, employees and suppliers, franchisees will not want to give up their rights to franchise logos or their presence on a franchisor’s reservation system. In Pooniwala, the franchisee sought an order for preliminary injunction to stop the franchisors from terminating the franchise agreements before the court heard the case on its merits.

In deciding whether to grant a preliminary injunction, courts have to balance the harm to the two sides. They also consider the requesting party’s likelihood of success on the merits in the underlying claim–here, violation of the good cause requirement of the Minnesota Franchise Act.

In Pooniwala, the court denied the franchisee’s motion for preliminary injunction and ordered it to go ahead with its post-termination obligations, such as removing the franchised brands’ signage. The court found that, given the many QA inspection failures at the two hotels, and the fact that the franchisees had continuing franchise relationships with Wyndham Hotel Group affiliates at other hotel properties, the franchisee did not demonstrate an adequate likelihood of success of proving that the termination was without good cause. Further, the court held that, while the franchisee would suffer obvious harm through loss of the franchise rights, the franchisors were also suffering continuing, irreparable harm as long as the franchisee’s hotels continued to operate under their trademarks while not maintaining brand quality standards.

Conclusion. Hotel franchise agreements typically provide for substantial liquidated damages if the franchisor terminates for cause, meaning that the Pooniwala franchisees are likely to owe hundreds of thousands of dollars. In other franchise cases, the terminated franchisee may be forced to cease operating a similar business due to a covenant not to compete.

The stakes are high, and franchisors can expect a fight. So if they decide to take the drastic step of terminating for cause, they had better have their “ducks in a row.” In Pooniwala, the Wyndham Hotel Group franchisors showed how this is done.

 Nicholas Cintron, a law clerk at the firm and a 2016 J.D. candidate at Wake Forest University Law School, contributed to the preparation of this article.

ABA Forum on Franchising’s “Wizard” proposals do not address arbitration issue

December 30th, 2013

At the October 2013 American Bar Association Forum on Franchising Convention, the keynote program was entitled “If I had a Wizards’s Wand” and concerned what each of the four presenters would change about franchising and the law, if they could. Rochelle “Shelley” Spandorf’s proposals as part of that program are summarized by reporter Janet Sparks in this BlueMauMau.com article . While Ms. Spandorf’s proposed changes are wonderful as far as they go (if not magical), unfortunately she did not clearly address one of the most important dispute resolution issues in the U.S. legal system, including franchising; the use of mandatory pre-dispute arbitration clauses to blunt weaker parties’ access to civil justice.

Aspects of Shelley’s proposals that seem particularly commendable are requiring all new franchisors to have some base of experience, creating a uniform national regisry of franchise sales registration, mandating the provision of a financial performance representation, and freeing states’ attorney generals to puruse enforcement rather than adminiistering a registration system. Moreover, while such legislation might appear to be substantially more burdensome to franchisors than the current legal regime of franchise sales regulation, the reality is that, even in the so-called “non-registration states” most franchisees do have the ability to pursue private civil actions for material violations of the FTC Franchise Rule; for example, see Final Cut, LLC v. Sharkey, 2012 Conn Super. LEXIS 98, 2012 WL 310752 (Conn. Superior Ct., Jan. 3, 2012) (franchisee prevails under Connecticut Unfair Trade Practices Act in claims that franchise sales were made in material violation of the FTC Franchise Rule).

However, on the issue of dispute resolution, it is unclear whether the proposal that U.S. federal courts have “exclusive jurisdiction” over U.S. franchise law claims would mean that franchisors could not require arbitration instead of court proceedings. This is particularly important with regard to the ability of franchisees to pursue group or class actions. Through many Supreme Court decisions authored by conservative justices, as well as legislation passed by Republican Congressional majorities, plaintiffs seeking class certification face a rigorous burden in U.S. courts. As many an attorney can attest, there are myriad difficulties (both ethical and practical) in representing substantial groups of franchisees pursuing common claims. However, in appropriate circumstances where common questions of fact predominate, particularly on liability, use of a group or class action is the most efficient (and sometimes the ony practical) way for parties who have suffered grievous financial losses to seek a remedy. Supreme Court decisions have made it extremely easy for parties to bar class or group actions by inserting an arbitration clause in their form contracts and refusing to remove them.

While reforms freeing state attorneys’ general to focus on claims enforcement might help improve failed franchisees’ access to justice, experience shows that attorney generals tend to focus on relief for large number of consumers rather than smaller numbers of small business owners. Unless a federal franchise law contains an express exemption from the Federal Arbitration Act for disputes between franchisors and franchisees, its benefits for franchisees may prove to be illusory.

Another Court Ruling Shows Franchisors the Value of Providing an Item 19 FPR

May 10th, 2013
David Cahn

David Cahn

Takeaway: Franchisors cannot rely on disclaimers in the contracts and FDD to protect against claims of providing false financial information.

The Case: In a recent decision, Long John Silver’s Inc. v. Nickleson, decided February 12, 2013, the U.S. District Court for the Western District of Kentucky once again showed the danger of a franchisor relying on disclaimers in its contracts and the Franchise Disclosure Document (“FDD”) to defeat claims that it provided false financial performance information in selling a franchise. The court denied summary judgment for the franchisor of A&W Restaurants, Inc. (“A&W”) and will allow the franchisee’s claims of fraud and violation of franchise sales laws to be decided at trial. The case is particularly noteworthy because the franchise purchased was the claimant’s fourth from the same franchisor.

A&W’s FDD had what is known a “negative disclosure” in Item 19 concerning the provision of information about the sales or profits at existing franchises, specifically saying “[w]e do not make any representations about a franchisee’s future financial performance or past financial performance of company-owned or franchised outlets.” The Minnesota-based franchisee alleged that, in connection with considering purchase of a franchise to open a new “drive in” model A&W restaurant, the franchisor provided “information, including financial projections, which was laden with false data.” These allegations, if true, would mean that A & W provided a financial performance representation (“FPR”) outside of its FDD, in violation of federal and state franchise sales laws.

A&W followed the usual route of trying to get the franchisee’s claims thrown out before trial on the argument that, in light of the disclaimers in Item 19 of the FDD and in various parts of the franchise agreement, as a matter of law the franchisee could not “reasonably rely” on the information provided. The court rejected the argument that the disclaimers could be used to flatly bar the franchisee’s claim that A&W provided misleading information in violation of the Minnesota Franchise Act, because that law (like the Maryland Franchise Registration & Disclosure Law) contains a provision making “void” any waivers of conduct contrary to the franchise sales law. Instead, the franchisor will be permitted to use the disclaimers at trial as evidence to persuade the jury that the franchisee could not have reasonably relied on the “projections.”

The court also ruled that the disclaimers could not be used to deny the franchisee a trial on its claim of common law fraud (under Kentucky law) with regard to its allegation that the projections were based on false data about other locations’ sales or earnings. In the words of the court, “A broadly-worded, strategically placed disclaimer should not negate reliance as a matter of law where A&W allegedly shared objectively false data to induce Defendant to enter into the Franchise Agreement.” Therefore summary judgment was denied and the franchisee’s fraud claim will proceed to trial, with A&W potentially liable for punitive damages if the franchisee prevails on that claim.

Further thoughts: Given that the franchisee in this case already owned three other A&W restaurants at the time it purchased the franchise at issue, it would hardly be surprising if it demanded and received specific financial performance information about the other “drive-in” models. A logical question is, if A&W had included sales and earnings data in Item 19 of the FDD that it provided to this franchisee, would it have been less likely to have faced the allegations made in this case? In this author’s opinion, based on more than 15 years of representing franchisors and franchisees, A&W would have been in a better position to defend itself if it had included such data in Item 19. The reason is that the data would have been reviewed by A&W’s attorneys and probably by upper management, who would have been more likely to make sure that the presentation was accurate and not misleading. Once the presentation is in the FDD, most franchise salespeople will be less likely to “go off script” and provide information that is more optimistic than Item 19.

However, even if the franchise seller did provide information beyond the written FPR, at trial the franchisor would have been able to point to the data provided in Item 19 and say, “Look, we gave the franchisee the data in the FDD and made it easy for him to investigate further, so it is ridiculous to believe he relied on something are franchise salesperson said.” In that situation it may be more likely than not that the jury would agree with the franchisor. By contrast, by denying its franchise seller use of an Item 19 FPR, A&W made it difficult to both comply with the law and convince qualified candidates to purchase the franchise – setting up a scenario where a jury may believe that the franchise seller “went over the line.”

Sylvan Learning, Inc. Fighting Franchise Act Claim

April 24th, 2012

David Cahn

During 2012 Sylvan Learning, Inc. and its corporate affiliates are fighting a claim of violating of the Maryland Franchise Registration & Disclosure Law and fraudulent conduct in its sale of tutoring center franchise rights, after having its motions to dismiss the fraud claims denied by the U.S. District Court in Baltimore.

In Next Generation Group, LLC v. Sylvan Learning Centers, LLC, Case CCB-11-0986 (decided Jan. 5, 2012), the plaintiff franchisee alleged that he agreed to develop and operate a new Sylvan Learning Center in Irving, Texas, in reliance upon representations from Sylvan that it would sell the plaintiff two existing Centers in nearby Arlington and Allen, Texas. According to the Amended Complaint, those representations were made orally by Sylvan’s agent to plaintiff’s principal both before and after the plaintiff signed the franchise agreement for Irving, but several weeks before the Irving location opened, Sylvan’s agent advised plaintiff’s principal “in writing that Sylvan had approved his acquisition of the Arlington and Allen Learning centers, respectively.” The parties executed letters of intent for the sale of both sites about two weeks before the Irving Center opened. However, about three weeks after the Irving Center opened, Sylvan’s same agent “informed [plaintiff] that Sylvan would not sell him the license and assets for any more franchises.” According to the Amended Complaint, Sylvan provided no explanation of its reversal of course. The franchisee claimed that Sylvan fraudulently induced it to develop and open the Irving location.

Sylvan argued for dismissal of the claims on the basis that the Irving franchise agreement contained an “integration clause” that prevented the plaintiff from relying on promises made outside that written agreement. The court rejected this, by quoting a prior court decision stating, “[T]he law in Maryland … is that a plaintiff can successfully bring a tort action for fraud that is based on false pre-contract promises by the defendant even if (1) the written contract contains an integration clause and even if (2) the pre-contractual promises that constitute the fraud are not mentioned in the written contract. Most of our sister states apply a similar rule. Greenfield v. Heckenbach, 144 Md. App. 108, 130, 797 A.2d 63, 76 (2002).” Sylvan’s problem is that the contractual “integration clause” did not disclaim any specific oral representations, and certainly not any concerning Sylvan’s willingness to sell the plaintiff additional existing franchised businesses. Without specific disclaimers as to representations made on that specific topic, the integration clause did not prevent pursuit of the claim.

While Sylvan could use the presence of the integration clause at trial to challenge whether the plaintiff reasonably relied on promises made outside of the Irving franchise agreement, based on the facts alleged the court stated, “there is reason to believe [plaintiff] could reasonably have relied on Sylvan’s representations” concerning the sale of the existing locations. Therefore, the court held that permitting the plaintiff to file a second amended complaint would not be “futile” and granted the plaintiff’s motion to do so.

After the plaintiff filed its Second Amended Complaint, Sylvan immediately moved to dismiss it on essentially the same grounds as asserted previously, and the court once again refused to dismiss the claims for fraud and violation of the Maryland Franchise Registration & Disclosure Law. Accordingly, the parties are now conducting discovery that may take most of 2012 to complete.

It is important to recognize that the proceedings in this case to date solely concern the sufficiency of the plaintiff’s factual allegations as a matter of law, and in later proceedings Sylvan’s representatives will provide information on what occurred with regard to this franchise sale. Nevertheless, the decision reiterates an important point for all Maryland business people – even if promises and statements are excluded from a particular written agreement, they may have legal consequences if the subsequent business relationship fails to meet the other party’s expectations.

Talking to Your Competitors Can Be Risky

September 13th, 2011

Talking to your competitors can be risky

Criminal Price-Fixing Conspiracy Convictions Highlight Dangers

Two recent guilty pleas announced by the U.S. Department of Justice’s Antitrust Division highlight an underappreciated area of serious legal liability – price coordination in violation of the Sherman Act.

On August 24, 2011,the Justice Department announcedthe guilty plea of Great Lakes Concrete, one of four Iowa companies that sell “ready-mix concrete” for construction projects and have plead guilty to reaching agreements regarding their respective price lists and project bids and then accepting payment for those sales at prices artificially increased due to collusion. The press releaseemphasizes the maximum fine that may be imposed for the conviction, which is the greater of $100 million, twice the gain derived from the crime or twice the loss suffered by the victims of the crime. In addition, the president of Great Lakes Concrete was sentenced to serve a year and a day in prison.

On August 31, 2011, the Justice Department announced a guilty plea by a California company, Sabry Lee (U.S.A.) Inc., in “a global conspiracy to fix the prices of aftermarket auto lights.”The company is the U.S. distributor for a Taiwan producer of the auto lights, which are most commonly installed in vehicles after collisions. The alleged conspiracy was apparently between several Taiwan based manufacturers of auto lights and their U.S. distributors, who “met and agreed to charge prices of aftermarket auto lights at certain predetermined levels” and “issued price announcements and price lists in accordance with the agreements reached, and collected and exchanged information on prices and sales of aftermarket auto lights for the purpose of monitoring and enforcing adherence to the agreed-upon prices.” Executives of two of the U.S. distributor companies have pled guilty to price-fixing charges, and the second ranking officer of one of the Taiwan manufacturers was arrested in the U.S. and has been indicted.

While the press release leads one to believe that the executives in these cases knowingly intended to fix prices at artificially high levels, it is quite possible that at least some of them were not completely aware of the legal implications of their conversations. However, any communications between competing companies concerning prices are legally risky.

The Takeaway: Business people should seek pricing intelligence from customers, service providers, or independent websites — but not from direct communications with their competitors. This is particularly true for industries in which formal competitive bidding is common or in which a relatively small number of companies make a large percentage of the total sales.

Beyond that basic rule, certain types of communications and collaborationsbetween competitors are permitted and even encouraged by U.S. antitrust law. Each situation needs to be analyzed based on the particular facts and reasons for your collaborative effort.

Holiday Inn case shows danger of deception

May 13th, 2011

A recent case with compelling facts shows that, despite attempts through written agreements and disclosure documents to shield franchisors from liability, deceptive conduct within the franchise relationship can still result in substantial liability for franchisors.

In Holiday Inn Franchising, Inc. v. Hotel Associates, Inc., 2011 Ark.App. 147 (Ark. Ct. Apps. 2011), the franchisee Hotel Associates, Inc. (“HAI”), is owned by J.O. “Buddy” House, one of the early Holiday Inn franchisees who was close friends with the chain’s founder.  The court found that, over the course of decades, House had developed a relationship with the executives of Holiday Inn Franchising, Inc. (“Holiday Inn”) founded in “honesty, trust and the free flow of pertinent information”, thereby creating a “special relationship” imposing a duty on Holiday Inn to disclose facts material to the ongoing relationship. 

In 1994, HAI, at the suggestion of a Holiday Inn executive, considered purchase of a rundown hotel in Wichita Falls, Texas to convert to a Holiday Inn.  House realized that the property would need expensive renovations and requested a 15 or 20 year term in the Holiday Inn franchise agreement.  Holiday Inn declined, but its Vice President of Franchising  “stated that, if House operated the hotel appropriately, there was no reason to think that he would not receive a license extension at the end of the ten years.” 

HAI signed a ten year franchise agreement in early 1995 and made extensive renovations before opening.  The hotel was successful and HAI received offers to sell for up to $15 million, but declined based on its belief that the franchise would be extended.  Meanwhile, Holiday Inn’s commission franchise salesperson was pursuing conversion of a nearby Radisson hotel at the end of HAI’s term and  prepared a business plan for that conversion in 1999.

In 2001, an employee of HAI spoke to a Holiday Inn representative about early relicensure, and was convinced to send Holiday Inn a $2,500 fee to obtain a Property Improvement Plan (“PIP”) for changes needed for relicensure.  The PIP required changes costing  $2 million dollars, and after going through 2 rounds of Holiday Inn PIPs, HAI spent about $3,000,000 — without ever being informed of  the business plan for the Radisson, which continued to be pursued.

In October 2002, when the hotel was fully renovated pursuant to the PIP and received a quality score of 96.05 (out of 100),  Holiday Inn informed HAI that the Radisson had applied for a license and was being considered as a possible “partial replacement” for HAI’s facility “if it left the system.”  After HAI protested, Holiday Inn stated that the Radisson application had been denied.  However, after several more twists and turns, the new franchise development team “prevailed” over the relationship managers, the Radisson was licensed and HAI’s facility was denied relicensure.  HAI sold it in 2007 for $5 million, before the real estate crash.

After a jury trial, HAI prevailed on claims against Holiday Inn of fraud and promissory estoppel, which means detrimental reliance on promises.  After appeal, HAI’s judgment was for over $10 million in compensatory damages and $12 million in punitive damages.  The case is notable because (a) HAI had no right to relicensure under the parties’ written agreement, but (b) the court found a “special relationship” that imposed a duty to disclose to the franchisee material information about the future of the business relationship, and (c) the court found that Holiday Inn’s course of conduct supported a punitive damages award.

Lessons for Both Sides of the Table from the Recent Jackson Hewitt Franchisor Liability Cases

June 16th, 2010

Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees’ business operations. Where a franchisor imposes and exercises substantial controls over its franchisees’ operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor’s exercise of control makes it liable for its franchisees’ negligence or misconduct.

Two recent cases involving employee and customer claims against Jackson Hewitt shed light on this issue. In one case, a customer of a Jackson Hewitt franchised tax center in Louisiana filed suit against the franchisor based upon a privacy breach committed by the franchisee. In the other, an employee of a Jackson Hewitt franchise in Pennsylvania sued the franchisor for sexual harassment based upon the alleged actions of certain owners and managers of the franchise. In asserting their claims against the franchisor, both plaintiffs relied heavily upon language in Jackson Hewitt’s franchise operations manual and other documentation, and also the direct involvement of Jackson Hewitt representatives in the operations of its franchisees. The courts in both cases were willing to consider the plaintiffs’ claims against Jackson Hewitt despite clear admonitions in the Franchise Agreement and Operations Manual that the franchisee and its employees “shall not be considered or represented [by the franchisee] as [Jackson Hewitt’s] employees or agents” and that franchisee has exclusive responsibility over hiring and matters relating to personnel.

Jackson Hewitt provided its franchisees with detailed mandatory policies and procedures for center operations. It required all franchisees to provide customers with a copy of the “Jackson Hewitt Privacy Policy” promising that the confidentiality of personally identifying information (e.g., social security numbers) would be safeguarded. It also provided franchisees’ employees with a Code of Conduct, which made no reference to the existence of franchises, and which included numerous references to the reader as an “employee” of Jackson Hewitt. Jackson Hewitt also operated an Intranet site through which franchise employees could apply for employment positions with other Jackson Hewitt offices, could obtain Jackson Hewitt policies, and could communicate with Jackson Hewitt representatives. In addition, franchise employees were directed to call Jackson Hewitt’s corporate office to resolve issues with tax returns. All of these factors weighed in favor of establishing a sufficient level of control over franchisees’ operations to impose liability on Jackson Hewitt. The court also found significant control in the Jackson Hewitt system relating to training and termination of employees of the franchises.

The conclusion to be drawn from the Jackson Hewitt litigation is that franchisors are essentially presented with two options when drafting their franchise agreements and operations manuals. The first option is to impose significant operational controls over their franchisees’ operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates. The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications.

The first approach allows franchisors to impose greater control over, and have more say in, their franchisees’ operations—which is an attractive proposition for many franchisors. In addition, franchisees may perceive greater value in a franchise system that provides strict operating standards and procedures, which may help to distinguish the franchisor from competing brands. If the franchisor chooses this approach, it should consider increasing the minimum policy limits required for franchisees’ insurance policies and the types of required policies. It may also want to explore direct insurance coverage for the franchisor for all claims arising from franchised operations.

The advantages of the second option are demonstrated by a recent court decision from Illinois, Braucher v. Swagat Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,355 (Mar. 19, 2010), in which Choice Hotels International, Inc. avoided liability in a wrongful death claim for the alleged negligence of one of its franchisees in maintaining its indoor swimming pool and whirlpool. Choice provided very limited operational guidance and controls with regard to swimming areas, and this approach allows a franchisor to avoid potential liability associated with imposing mandatory operational controls over franchises. However, it also carries the potentially negative business implications of allowing franchisees a measured level of discretion in running their businesses under the franchised brand. The term “measured” is important, because the franchise agreement should still include rights of termination or other remedies for acts or omissions that have the potential to cause material detriment to the franchise system’s goodwill. In addition, franchisees may view a franchisor that employs this approach as providing very little in terms of affirmative guidance and support, not acknowledging that the information and non-binding recommendations of a franchisor can provide value in and of themselves, irrespective of whether compliance is deemed mandatory.

A prospective franchisee can also glean guidance from the information provided above. When evaluating a franchise opportunity, a prospective franchisee should seek to review the franchisor’s operations manual, even if its table of contents is provided in the Franchise Disclosure Document (“FDD”). It is acceptable for a franchisor to require the prospect to sign a non-disclosure agreement with regard to the Manual. If the operations manual provides detailed mandatory specifications and procedures, the prospective franchisee should be wary of the likelihood that the franchisor will pursue rigorous enforcement, to account for the assumption of the significant liability risks described above. While the “deep pocket” franchisor’s potential “joint and several” liability for third-party claims may seem like a benefit to the franchisee, the prospect should be aware that indemnification and contribution provisions in the franchise agreement is likely to shift the ultimate financial burden back to the franchisee, unless it can prove that the franchisor’s actions caused the third party’s claim.

If the operations manual provides only examples and recommendations for franchisee policies and operational procedures, as opposed to detailed mandates, the franchisor may be attempting to avoid any direct performance obligations to its franchisees, or it may simply be attempting to limit its exposure. In performing its due diligence, a prospective franchisee should attempt to gain as much information as possible from the franchisor and its active franchisees to discern the quality and operational support the franchisor actually offers.

The operations manual and other forms and operational materials can be valuable tools for franchisors and franchisees alike. But, depending on how they are written, they can expose the franchisor to liability and raise serious questions in the minds of franchisees as to the benefit to be derived from subscribing to a particular franchise. Parties on both sides of the table should be sure to carefully evaluate these documents to ensure that they serve and meet their needs and expectations.

Minimum Contacts in the Digital Age: Using Online Resources Can Subject You to Foreign Jurisdiction

October 9th, 2009

The United States District Court for the District of Maryland recently held that use of a company’s website can be sufficient to subject the user to jurisdiction in the state where the company resides. In CoStar Realty Information, Inc. v. Mark Field d/b/a Alliance Valuation Group, Case No. 08-00663, the Court held that the defendants, who resided in California, Florida and Texas, were subject to jurisdiction in Maryland based on their use of CoStar’s website (CoStar’s principal place of business is in Bethesda, Maryland). This means that, to avoid having a court judgment entered against them, they had to defend against the claim in Maryland.

A court may exercise jurisdiction over a defendant only if requiring the defendant to appear before the court will not infringe the defendant’s due process rights under the Fourteenth Amendment of the U.S. Constitution. The U.S. Supreme Court has held that the requirements of due process are satisfied where: (1) exercise of jurisdiction will not “offend traditional notions of fair play and substantial justice”; and (2) the defendant, as a result of its actions, “should reasonably anticipate being hailed [before the court].” State “long-arm” laws can further define specific actions or conduct that will satisfy these constitutional requirements.

In CoStar Realty, the defendants were alleged to have improperly shared a user ID and passcode for accessing CoStar’s subscription-based website, which had been authorized for use only by a limited number of individuals. The defendants regularly accessed CoStar’s website, and also used Co-Star’s live telephone support, representing themselves as valid customers. Otherwise, the Court did not cite any relationship between the defendants and the State of Maryland for purposes of the due process analysis. However, based on these actions alone, the defendants were found to have availed themselves of the privileges of doing business in Maryland and therefore were held subject to the Court’s jurisdiction.

The Court also noted that, even though the defendants were not valid CoStar customers, by using CoStar’s website they implicitly agreed to the website’s Terms of Use, which included, among other things, the user’s consent to jurisdiction in Maryland.

While jurisdiction in this case was based specifically on the defendants’ alleged wrongful actions, so-called “general jurisdiction” can be based on systematic and continuous contacts with the forum state, whether or not they relate directly to a plaintiff’s claims. With the rapid growth of Internet-based commerce, your online activities may subject you to potentially being sued in more states than you expect.

Copyright 2009

The “Litigation Hold” and the Importance of Electronic Document Retention

October 1st, 2009

The “Litigation Hold” and the Importance of Electronic Document Retention

As email and text-messaging have become standard means of communication in the business world, issues relating to document retention are more and more complex. When you become aware of a lawsuit filed against your company, or when you are exchanging heated telephone calls or e-mails and think a lawsuit might occur, it is critical for you to take measured steps to ensure that all relevant electronic documents and communications are preserved. Failure to preserve documents, and to comprehensively and timely comply with an opposing party’s discovery requests, can lead to both monetary and non-monetary sanctions. Non-monetary sanctions, which may include an instruction to the jury to make an adverse presumption based on your improper failure to produce requested documents, can have a substantial and devastating impact on your ability to pursue or defend against a lawsuit.

A 2004 case issued by the United States District Court for the Southern District of New York provides guidance on the steps that need to be taken in order to adequately preserve electronic data and avoid these types of sanctions. Zubulake v. UBS Warburg, LLC started out as a simple employment discrimination case that ballooned into a three-year battle over UBS’s failure to preserve emails relating to the employee’s termination. Through evidence obtained from depositions and re-depositions (at UBS’s expense), and inferences drawn from emails that were produced, the plaintiff was able to show that UBS had at least negligently, and perhaps intentionally, permanently erased relevant emails and discarded backup tapes, which would have preserved the emails even after their deletion from UBS employees’ active computer systems. As a result, the Court ordered UBS to pay the costs of the plaintiff’s motion, and also to pay for additional depositions and re-depositions of its employees so that the plaintiff could ascertain the contents of the deleted emails. The Court also held that, as to the emails that were lost or deleted, the jury would be instructed to infer that they contained information that was damaging to UBS.

To avoid sanctions like those imposed on UBS in Zublake, parties facing pending or likely litigation or arbitration must institute a “litigation hold” in order to put officers, employees and representatives on notice that documents and data relevant to the suit must be preserved. This should be done with the cooperation and advice of an attorney in order to ensure that all affected individuals receive proper notice regarding the documents that need to be maintained. In addition to emails and active documents, deleted and archived files must be preserved, and potentially relevant backup tapes from servers may need to be segregated in order to ensure they are not recycled. While “key players” and information technology personnel certainly need to be actively addressed, all employees who could potentially have relevant information must be contacted as well. Document retention policies will also need to be preserved and likely produced, though mere reliance on an internal retention policy without affirmatively enforcing the litigation hold will be insufficient to protect against sanctions. Moreover, the litigation hold will need to be consistently reinforced and updated throughout the duration of the lawsuit.

Document retention is a serious matter that weighs heavily in the outcome of litigation. While the temptation to hit “delete” on damaging emails might be strong, the force of sanctions, and perhaps even contempt of court proceedings, should be stronger. Compliance with the “litigation hold” requirements will help to ensure that you are in the best position possible to protect the interests of your company in a dispute. For specific advice regarding document retention and “litigation hold” matters, please contact us by telephone or e-mail.

Copyright Franchise and Business Law Group, 2009