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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.

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

 

 

 

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2010

And the saga continues . . .

 

In Bye v. Nationwide Mutual Insurance Co., 733 F. Supp. 2d 805 (E.D. Mich. 2010), an insurance agent (“plaintiff”) brought suit against the insurer (“defendant”) alleging it violated the Michigan Franchise Investment Law (MFIL). There, plaintiff had been in defendant’s employ as an insurance agent for nine years. During such time, plaintiff had worked in various capacities, ranging from a Financed Community Agent to an Independent Contractor Agent.

 

Plaintiff expanded his business by acquiring existing agencies or opening new satellite offices, primarily in Michigan. Plaintiff took out considerable loans in order to fund such acquisitions. By 2006, however, plaintiff was continually operating at a loss. In an effort to “help with [their] future,” plaintiff’s wife opened an insurance business because it “would [have been] inappropriate based on [her] husband’s employment with [defendant] to start another company on his own.” After defendant learned of the business, defendant believed that plaintiff was referring its existing and potential customers to his wife’s insurance business. Defendant subsequently terminated plaintiff’s agency for breach of the exclusive representation agreement, and plaintiff filed suit.

 

On motion for summary judgment, plaintiff alleged defendant violated the MFIL by “employing devices, schemes and artifices to defraud in its sale or offer of a franchise.” Controlling on this issue was whether plaintiff paid a franchise fee. The MFIL defines a “franchise fee” as “a 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 payments for goods and services.” Mich. Comp. Laws § 445.1503(1).

 

In support of its argument that it paid a franchise fee, plaintiff alleged “[d]efendant churns agents. When the agent fails . . . [defendant] takes the enhanced book of business, sells it for more than it credits the defaulted former agent and then makes more money off the same book with the new agent. The fee is the profit from the book obtained by [defendant].”

 

The court found this argument unpersuasive. Because the “profit” would occur after the agent had been churned, the alleged profit could not be for the right to enter into a business. This, by definition, needed to be paid at the outset of the agreement. The court then reiterated that it is the circumstances existing at the time of the offer or sale which determines whether an agreement is a franchise under the MFIL. Accordingly, because plaintiff did not provide sufficient evidence that it paid a franchise fee, the court rendered the MFIL inapplicable and awarded defendant summary judgment.

 

Takeaway: A franchise fee needs to exist at the outset in order for it to be for the “right to enter into a business” under the MFIL.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2004

And the saga continues . . .

 

In Home Pest & Termite Control, Inc. v. Dow Agrosciences, LLC, No. 8:02CV406, 2004 WL 240556, at *1 (D. Neb. Feb. 6, 2004), a trained pest control operator (“plaintiff”) filed suit against the manufacturer of a termite elimination system (“defendant”) after the manufacturer terminated the agreement between the parties. After plaintiff alleged violations of the Nebraska Franchise Practices Act, defendant moved for summary judgment on the basis that the agreement between the parties was not a franchise agreement. In support of this, defendant pointed to the following section of the agreement “[t]his Agreement is not, nor is it to be construed as, a franchise agreement.”

 

Although the agreement contemplated “a community of interest in the marketing” of the pest control system, thereby seemingly satisfying part of the definition of a franchise under the statute, the court ultimately rendered the relationship not a franchise because the Agreement “nowhere required [plaintiff] to pay a franchise fee in exchange for a license to use the [defendant’s] name or mark. None of the fees mentioned in the agreement are for a surety bond or deposit or for security; rather, they are connected to the purchase of the termite system components.”

 

Takeaway: Payments primarily for the purchase of components, rather than for the license to use a name or mark, have not been found to satisfy the franchise fee element of the Nebraska Franchise Practices Act.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2009

And the saga continues . . .

 

In Coyne’s & Co. v. Enesco, LLC, 553 F.3d 1128 (8th Cir. 2009), a distributor (“plaintiff”) entered into an agreement with a company formed under the laws of England (“company”). The agreement provided for plaintiff’s exclusive right to sell, distribute, market and advertise all of the company’s products in the United States and Mexico from 2005 through December 2007. In exchange, plaintiff agreed to pay the company a 35–50% mark-up on the products.

 

In August 2007, the company was placed into receivership and its receivers entered into an asset sale agreement with an Illinois corporation (“defendant”). A few days later, the company’s receivers sent plaintiff a termination letter pursuant to Section 5.4 of the agreement, allowing for any party to terminate if the other becomes insolvent. Plaintiff responded that the termination was without legal effect because Section 5.4 did not allow an insolvent party to use its own insolvency to justify termination.

 

One month later, defendant announced that it would be distributing the products—which plaintiff had an exclusive right to distribute in the United States and Mexico—in the United States. Plaintiff subsequently filed suit and sought a TRO and preliminary injunction to prevent defendant from moving forward with its plan to distribute the products in the United States.

 

The district court denied plaintiff’s motion and rejected plaintiff’s claim for unlawful termination in violation of the Minnesota Franchise Act. The court reasoned that plaintiff was unable to demonstrate a likelihood of success on its claims if the agreement was not still in effect. Plaintiff appealed on the basis that it paid a franchise fee. As such, the failure to comply with the termination requirements under the Minnesota Franchise Act rendered both the termination invalid and the agreement still in effect. In support, plaintiff argued that the minimum purchase requirement and 35–50% mark-up on the products constituted an indirect franchise fee.

 

Minimum Purchase

 

A minimum purchase requirement can satisfy the franchise fee element of the Minnesota Franchise Act “if the distributors were required to purchase amounts or items that they would not purchase otherwise.” To determine this, the court asks “whether the [minimum purchase] requirements were unreasonable.” Because plaintiff did not put forth the argument at the district court or before the court on appeal that the minimum purchase requirement was unreasonable, the district court’s finding that the minimum purchase requirement was not an indirect franchise fee was not clearly erroneous.

 

Price Mark-up

 

Whether a price mark-up on goods above a bona fide wholesale price constitutes an indirect franchise fee is a fact-specific inquiry. The district court found that the mark-up was not an indirect franchise fee, as the mark-up represented the profits on the products. On appeal, plaintiff argued that this was incorrect “because it is illogical to assume that all of the rights granted to [plaintiff] under the Agreement . . . are merely in consideration for [plaintiff’s] payment of a bona fide wholesale price for [the] products.” The court on appeal, without much (or any) elaboration, responded that plaintiff’s argument was insufficient to demonstrate that the district court’s finding was clearly erroneous. As a result, the court affirmed the district court’s holding.

 

Takeaway: Under the Minnesota Franchise Act, a minimum purchase requirement can be a franchise fee and a price mark-up on goods above a bona fide wholesale price can be an indirect franchise fee. However, be aware that different trial court judges may demand different standards of proof to establish a “franchise fee” and a decision of a trial court judge may not receive a great deal of scrutiny on appeal.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

 

 

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2008

And the saga continues . . .

 

In Boeve v. Nationwide Mut. Ins. Co., No. 08-CV-12213, 2008 WL 3915011, at *1 (E.D. Mich. Aug. 20, 2008), plaintiff entered into an Independent Contractor Agent’s Agreement (“ICAA”) with defendant in 2003 to sell defendant’s financial products and insurance. In order to secure her bonus, plaintiff alleged she was “encouraged” to take out loans to open new offices and hire additional staff. After plaintiff’s ICAA was terminated in 2007, however, plaintiff owed defendant approximately $65,000 on the defaulted loans. Plaintiff filed suit shortly thereafter alleging violations of the Michigan Franchise Investment Law (“MFIL”), and defendant moved for dismissal or summary judgment.

 

The MFIL defines a “franchise fee” as “a fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay for the right to enter a business under a franchise agreement, including but not limited to payments for goods or services.” In support of her argument that she paid a franchise fee, plaintiff contended that her payment of interest on the loans she took out under the ICAA, in addition to her payments for training, represented an indirect franchise fee.

 

First, the court stated that the repayment of a loan cannot be a franchise fee unless the loan was a “condition of entering into the business.” Similarly, interest payments “might arguably” be an indirect franchise fee “if the interest rate exceeded a fair market loan rate.”

 

Second, the court stated that the payment of ordinary business expenses cannot be an indirect franchise fee. Accordingly, plaintiff’s training costs could only be a franchise fee if they were “substantial and unrecoverable, locking the franchise[e] into the franchisor.”

 

Third, because the complaint did not specify any payment which could constitute a franchise fee, the court rendered plaintiff’s allegations insufficient to raise a right to relief under the MFIL “above a speculative level.”  As such, plaintiff failed to state a claim on which relief may be granted, and the court dismissed plaintiff’s MFIL claim. The court did, however, dismiss this claim without prejudice as there was still the possibility of uncovering facts during discovery to support a MFIL claim.

 

Takeaway: Although both of plaintiff’s franchise fee arguments fell short, the court gave helpful hints for future plaintiffs as to the type of arguments that could satisfy the franchise fee requirement under the MFIL.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2006

And the saga continues . . .

In Smith v. Molly Maid, Inc., 415 F. Supp. 2d 905 (N.D. Ill. 2006), a prospective Molly Maid franchisee (“plaintiff”) brought suit against the Molly Maid, Inc. franchisor (“defendant”) alleging, among other things, violation of the Illinois Franchise Disclosure Act and breach of the Franchise Agreement. In 2001, plaintiff telephoned defendant to inquire about the franchise opportunities it offered. During the course of conversations between the parties, plaintiff made several misrepresentations in order to better her chances of becoming a franchisee. Defendant later sent plaintiff a Uniform Offering Circular, indicating plaintiff would be required to pay: “(a) a fixed Franchise Fee of $6,900; (b) a fixed Initial Package Fee of $8,000; and (c) a Territory Fee of $1.00 for every qualified household, typically from $15,000 to $60,000.”

 

After intermittent conversations over the next couple of months, defendant approved plaintiff as a Molly Maid franchisee based on the false information that plaintiff submitted to defendant. Defendant later sent plaintiff a congratulatory letter, enclosing two copies of a franchise agreement (“agreement”), and informing plaintiff that the agreement would become effective on the date that defendant signed it.

 

Plaintiff signed both copies of the agreement and returned them to defendant, along with a $6,900 check for the franchise fee. Defendant then instructed plaintiff that defendant would sign the agreement once plaintiff completed the required training. Because plaintiff never completed the required training, however, defendant never signed the agreement. Accordingly, defendant subsequently sent plaintiff a letter refunding the initial $6,900 fee.

 

The Illinois Franchise Disclosure Act provides:

 

(1) “Franchise” means a contract or agreement, either expressed or implied, whether oral or written, between two or more persons by which:

(a) a franchisee is granted the right to engage in the business of offering, selling, or distributing goods or services, under a marketing plan or system prescribed or suggested in substantial part by a franchisor; and

(b) the operation of the franchisee’s business pursuant to such plan or system is substantially associated with the franchisor’s trademark, service mark, trade name, logotype, advertising, or other commercial symbol designating the franchisor or its affiliate; and

(c) the person granted the right to engage in such business is required to pay, directly or indirectly, a franchise fee of $500 or more.

 

815 Ill. Comp. Stat. 705/3(1). In order to establish that the parties entered into a franchise agreement, the court stated that plaintiff must prove, among other things, that plaintiff paid a “franchise fee exceeding $500 for the right to enter into the business.” Although plaintiff paid $6,900—an amount far exceeding $500—this amount was paid “towards the franchise fee, [but] the entire fee required for the right to enter into the business was $43,351.” Because plaintiff only paid part of the amount required to enter into the business, and not all of it, the court determined that the franchise fee element was not satisfied.

 

Takeaway: Payments towards the franchise fee, but equaling less than the full amount required for the right to enter into the business, have not been found to satisfy the franchise fee element of the Illinois Franchise Disclosure Act.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.