Executive Summary:
In an unpublished decision, Judge Staton of the United States District Court for the Central District of California denied a plaintiff franchisee’s motion or summary judgment regarding fraud actions asserted against a franchisor consultant.
Citation:
Shaw v. Ultimate Franchises, Inc., 2021 WL 678687 (C.D. Cal. Jan. 15, 2021).
Relevant Background:
Ultimate Franchises, Inc. (“Franchisor”) operated a beauty salon related franchise. Plaintiffs John K. Shaw, Midori G. Shaw, and Shipshape Collective of Fitchburg, LLC (collectively, “Franchisees”) purchased the right to operate a franchise. Plaintiffs claim that when deciding to purchase the franchise, one of Franchisor’s sales team members–Love (“Consultant”)–made financial representations to Franchisees and failed to disclose whether stylists at sites that they were visiting were independent contractors or employees and how this would impact the profitability of locations they were visiting during Discovery Day. Thereafter, Franchisees closed the franchise and sued franchisor and all persons associated with the sale of the franchise–including Consultant–for (1) fraud, (2) fraud by omission, (3) violation of the California Franchise Investment Law (“CFIL”), and (4) violation of the California Unfair Practices Act. After discovery, Franchisees moved for summary judgment against Love on their fraud, fraud by omission, and CFIL claims.
Decision:
The majority of the Court’s analysis concerns disputes of material facts and how such disputes prevent it from granting summary judgment on any of Franchisees claims against Love. With that said, the Court made several nuanced findings related to each claim. Specifically, on the fraud claim, the Court found as follows:
“As an initial matter, even if the facts proffered by Plaintiffs were undisputed, the Court cannot conclude that any reasonable fact finder presented with these facts would conclude that Love made a misrepresentation. That is, it is not clear that presenting data about salon profitability based on franchisor-owned salons constitutes a material misrepresentation about the profitability of franchisee-owned salons. Whether this is a misrepresentation depends on the context and details of the presentation, and the disparity between the revenues of franchisor-owned and franchisee-owned salons. But Plaintiffs present no details about the content of Love’s presentations. And they have provided no evidence to show the difference in profitability of the two kinds of salons.”
On the fraud by omission claim, the Court found as follows:
“… Love’s general discussion of salon and their revenues would not create a duty for him to disclose the stylist pay-structures specific to franchisee or franchisor owned salons. And Plaintiffs offer no other evidence in support of their assertion that Love had a duty to disclose that franchisor-owned salons treated some stylists as independent contractors. For example, they offer no details about statements that Love made at the presentation to show that failing to disclose that franchisor-owned salons treated stylists as independent contractors rendered his presentation incomplete and misleading given the context.”
Last, on the California Franchise Invest claim, the Court noted the following:
“… Plaintiffs have adduced no independent evidence to show that, contrary to his testimony, Love had a senior role in the company and helped prepare the FDD. Therefore, even assuming the FDD contains a material misrepresentation or omission–which the Court does not decide–there exists an issue of material fact about whether Love can be held liable for any statements in the FDD.
Looking Forward:
While the most critical finding of the Court in denying Franchisees Motion for Summary Judgment was that a dispute of material facts exists, the Court’s notes regarding the manner in which a representative of a franchisor can be held liable for misstatements or omissions demonstrates two important points:
- Not all franchisees succeed. When franchisees fail, they inevitably sue the franchisor and have 20/20 hindsight on what the franchisor should or should not have said to warn them that they would fail. It is, unfortunately, the nature of the industry. With this in mind, the best way to protect against and/or defend against such a backwards looking lawsuit is a thorough and accurate Franchise Disclosure Document that the franchisor’s sales team consistently references throughout its sales presentation.
- Directly relevant here, prospective franchisees almost always ask questions to the franchisor’s sales team about the potential profitability of their investment. This topic has become one of the most common–if not the most common–basis for lawsuits against franchisors by failed franchisees. Rather than take any chances with this information, franchisors should work closely with their legal counsel on their Item 19 disclosures and scripts for their sales representatives that include how to gently inform a prospective franchisee that the information they are requesting goes beyond the scope of what a franchisor can provide under state or federal law. As noted in the Court’s decision multiple times, context for these representations are critical and having a script–particularly a written exemplar script–can be what makes or breaks a case.
This article was originally published on the California Franchise Network.
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Thomas O’Connell – Tom O’Connell is a Shareholder at Buchalter APC, where he serves as Chair of the firm’s Franchise Law Practice and Chair of Litigation for the firm’s San Diego office.
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