Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2013

And the saga continues . . .

In H.C. Duke & Son, LLC v. Prism Marketing Corp., No. 411CV04006SLDJAG, 2013 WL 5460209, at *1 (C.D. Ill. Sept. 30, 2013), a producer and distributor of a line of soft-serve ice cream machinery and equipment (“plaintiff”) filed suit against one of its distributors (“defendant”). The parties entered into an agreement whereby defendant agreed to distribute plaintiff’s equipment. Roughly eight years later, plaintiff notified defendant that it was terminating the agreement. After defendant disputed this termination, plaintiff filed suit seeking a declaration of the parties’ rights and duties under the agreement.

Defendant countered, arguing that it was labeled as a “franchisee” under their agreement and that plaintiff violated various provisions of both the Illinois Franchise Disclosure Act (“IFDA”) and California Franchise Relations Act (“CFRA”) during the course of their relationship. Plaintiff then sought dismissal on the grounds that no franchise existed because defendant never paid a franchise fee. As such, both the IFDA and CFRA were inapplicable.

  1. Illinois Franchise Disclosure Act

First, the court turned to the definition of a franchise fee under the IFDA. The IFDA defines a “franchise fee” as “any fee or charge that a franchisee is required to pay directly or indirectly for the right to enter into a business or sell, resell, or distribute goods, services or franchises under an agreement, including, but not limited to, any such payment for goods or services . . . .” In addition, “[a]ny payment(s) in excess of $500 that is required to be paid by a franchisee to the franchisor . . . constitutes a franchise fee unless specifically excluded by Section 3(14) of the Act.”

Second, the court turned to defendant’s specific allegations that it paid a franchise fee. Defendant argued that:

  • It was required to assume a prior distributor’s debt in order to enter the agreement;
  • It was required to purchase and carry an “ample stock” of plaintiff’s service and repair parts;
  • It paid plaintiff for advertising and promotional materials; and
  • It was required to pay a franchise fee of $500 or more.

Third, the court determined that “taken together, these allegations state a plausible claim that a franchise fee was paid, and therefore meet Rule 8(a)’s notice pleading standard.”

  1. California Franchise Relations Act

First, the court stated that the analysis for the existence of a franchise fee under the CFRA is similar to the analysis under the IFDA. The CFRA defines a “franchise fee” as “any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay for the right to enter into a business under a franchise agreement including, but not limited to, any payment for goods or services.” The provision also provides that “the payment must exceed $100 on an annual basis or it is not a ‘franchise fee.’”

Second, the court turned to defendant’s same allegations of the payment of a franchise fee under the IFDA and stated that these allegations “raise the reasonable inference that these putative franchise costs amounted to $100 or more annually.” Accordingly, defendant made sufficient pleadings under Rule 8(a).

Because defendant had sufficiently pleaded the existence of a franchise fee under both the IFDA and the CFRA, the court denied plaintiff’s motion to dismiss.

Takeaway: This case provides a great example of the interplay between different state statutes defining the “franchise fee” element. Although there were only relatively minor definitional differences, the largest difference was the portion on required payments. The IFDA required a one-time payment in excess of $500, whereas the CFRA required a payment in excess of $100 on an annual basis. Despite these differences, the court still found that defendant had sufficiently pleaded the payment of a franchise fee under both the IFDA and the CFRA. Another lesson of this case is that when you make a motion to dismiss, all allegations are deemed true. So, good pleading can win you your motion. If you are a defendant, you have to be careful about making a motion to dismiss if a franchise fee is properly pled.

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