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Two recent cases illustrate the ease with which fraud claims against franchisors survive motions to dismiss, but rarely survive summary judgment. In each case, groups of franchisees claim they were defrauded by the franchisor’s business plan. The complaint alleges that had the truth been known, the franchisees would not have purchased the franchise, or in the alternative, have acted to their detriment. The cases are typically determined by careful contract drafting and the difficult elements of common law fraud. In Kuligowska v. GNC Franchising Inc., pending in the U.S. District Court for the Western District of Pennsylvania, Arizona franchisees alleged their franchisor engaged in an unlawful scheme to induce prospective franchisees into purchasing GNC stores, and then intentionally drove the franchisees out of business. Plaintiffs allege that GNC makes oral misrepresentations as to profitability and significant affirmative misrepresentations and omission in its uniform franchise offering circular. The alleged scheme is that after a franchised location is established, the franchisor locates corporate stores nearby to “steal market share and customers” from the franchised locations. The franchisor causes the usurpation by allegedly selling inventory to the corporate locations at low cost, allowing the corporate stores to engage in predatory pricing. The claim arises from the purchase of a second location by the plaintiffs. GNC already established a corporate location in the same city, but promised 100 percent financing if plaintiffs would open another location in the same city. GNC also granted the franchisees a one-mile protected territory preventing establishment of another location within one mile of the plaintiffs’ intended location. GNC also obtained a release from the plaintiffs in connection with the offer of an “assistance package,” which promised reduced royalties and increased discounts on GNC products. The plaintiffs claim that the one-mile protected territory was illusory because it would not effectively protect against encroachment by corporate stores and that the releases were fraudulently induced, and therefore, ineffective. The court refused to grant GNC’s motion to dismiss the RICO claims and claim for breach of the implied duty of good faith and fair dealing. Plaintiffs alleged as predicate acts under RICO that over the Internet and through its Web site, GNC made fraudulent statements to its franchisees concerning price increases and also through telephone conference calls. GNC argued that plaintiffs did not detrimentally rely on the predicate acts of mail and wire fraud. However, the court was compelled to accept plaintiff’s allegations as true when considering a motion to dismiss. In a related claim for breach of the duty of good faith and fair dealing, the court recognized that such a duty exists under Pennsylvania law applicable only in the context of an attempt of a franchisor to terminate its relationship with a franchisee. The court nevertheless sustained such a cause of action as an “indirect termination” because of the allegation that the franchisor tried to drive the franchisees out of business, and then usurp the abandoned franchise. In order to prevail, the franchisees will be required to demonstrate a previous pattern of conduct by GNC in which franchisees were fraudulently induced to purchase franchises and then had their markets usurped by the GNC. Each instance that will be used to prove a pattern will require proof of justifiable reliance by each franchisee allegedly defrauded. Proof of such a pattern is a huge burden and rarely do we see franchisee RICO cases or group fraud cases survive until trial. One case in which a treble damage jury verdict was entered against the franchisor was ultimately reversed. The difficulty in proving these cases often is not apparent until discovery is issued. It should be noted that plaintiffs’ original counsel has filed a motion and has been granted leave to withdraw as counsel. In Brock v. Baskin Robbins, USA, Co., the Eastern District of Texas dismissed common law fraud claims brought by a group of 40 franchisees against Baskin’ Robbins claiming that Baskin’ knew certain store formats were not viable and intended to phase out certain “non-strategic locations.” Plaintiffs claim that Baskin’ had a duty to disclose this information to current and prospective franchisees. In discussing the duty of disclosure, the court for the purposes of analysis characterized the case as a breach of contract claim, rather than as a tort claim. The parties also stipulated that although the case arguably involved choice of law issues involving seven different jurisdictions, that the analysis under each state law would be identical. The court determined that plaintiff’s theory that Baskin’ breached a duty to disclose was based on an alleged fiduciary duty between franchisor and franchisee. The court found that no such fiduciary duty existed as a matter of contract between the parties and that none would be implied for the purpose of this analysis. The court also concluded that plaintiffs failed to demonstrate that Baskin’ had prior knowledge or intent to phase out locations that should have been disclosed. Plaintiffs also alleged that Baskin’ orally promised “perpetual” franchises; however, these claims were dismissed on summary judgment because of the merger and integration clause contained in each franchise agreement. The court concluded no detrimental reliance can occur where the parties disclaim unwritten representations outside of the written contracts actually signed. As can be seen from these two cases, individualized issues of detrimental reliance often create an obstacle to groups of franchisees claiming fraud. Individualized issues of damages also impede streamlined trial presentation of a damage theory. In Broussard v. Meineke, supra., the 4th U.S. Circuit Court of Appeals reversed and remanded a jury verdict based on a damage theory using a “composite” franchisee. This composite franchisee was deemed to have average revenues, cost structures and profits. Even though the alleged fraud was claimed to have occurred across the franchise system based on fraudulent misrepresentation concerning the administration of the advertising fund, the circuit court held that it was unfair to use a composite franchisee to estimate damages across the franchise system and required evidence of actual losses on remand. Franchisors can insulate themselves from fraud lawsuits by fully complying with the Federal Trade Commission rule on franchise disclosure and by engaging in reasonable business conduct consistent with the FTC rule. Franchisees can avoid being defrauded by having knowledgeable counsel and dealing with reputable franchisors. As can be seen, proving a fraud is exponentially more difficult than merely alleging a fraud. If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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