Focused on Franchise Law - January 2014

Hardware store franchisor, Ace Hardware Corporation, recently prevailed in several fraud claims brought by two former Indiana franchisees in Avon Hardware Co., v. Ace Hardware Corporation. However, the outcome would likely have been different in other jurisdictions, which is one reason why franchisors must ensure the accuracy of financial performance representations they make to potential franchisees.

In 2006 and 2007, Ace provided Avon with a pre-sale "pro forma" document containing sales and cash flow forecasts in connection with Avon's purchase of Ace franchises. The "pro forma" document provided, among other things, anticipated annual sales, profit projections and estimates of first year revenues. Ace also provided Avon with a pre-sale Uniform Franchise Offering Circular (UFOC) that contained an Item 19 disclosure of historical financial performance data for a small percentage of existing Ace stores.

Avon's stores failed to achieve the revenues included in the "pro-forma" document and soon failed. Avon sued Ace claiming Ace committed common law fraud and violated the Indiana Franchise Disclosure Act and Illinois Consumer Fraud and Deceptive Practices Act by (1) providing the "pro forma" document with projections and estimates Ace knew or should have known Avon could not achieve, and (2) purposely reporting inflated historical financial performance data in Item 19 of its UFOC.

To win its case, Avon had to prove Ace made a false statement of material fact that Avon relied on when entering Ace's franchise agreements, but Avon failed to do so. The court found that the projected sales figures and financial data in the "pro forma" document were not actionable statements of fact under Indiana law. But, it ruled, "[R]epresentations as to past income of a business [do] constitute statements of fact," so Ace could be liable for false historical performance data in its Item 19. After analyzing Ace's Item 19, however, the court found that the historical data were not false. The court pointed to Ace's Item 19 footnotes that stated the data came from a small fraction of all Ace Stores and warned that Ace had not independently verified any of the financial information. The court went on to reject Avon's claim that Ace knowingly concealed material information and made false statements of material facts by "failing to account for failed or failing Ace stores" in its Item 19 since other sections of the UFOC contained information about Ace stores that had closed in the preceding 3 years. Finally, the court found that the UFOC, along with other documents provided to Avon, were replete with warnings advising Avon not to rely upon the projections or past performance data to predict the future performance of any store. These warnings, the court held, rendered Avon's reliance upon any misrepresentations in the historical data unreasonable.  To read the entire case, click here.

The U. S. Court of Appeals for the Fourth Circuit recently ruled in Hamden v. Total Car Franchising Corporation that the words "termination" and "expiration" had different meanings in a franchise agreement between Total Car Franchising and Hamden, its franchisee, and that TCF could not enforce post-termination, non-competition and non-solicitation covenants against Hamden after the natural expiration of the term of the franchise agreement.

Hamden signed a franchise agreement in May 1996 that prohibited Hamden from participating in a paint restoration business for "2 years following the termination of this Agreement" and signed a Non-Competition and Confidentiality Agreement that contained 1) a non-compete covenant, which barred Hamden from engaging in a similar business for two years following the termination or transfer of the franchise agreement; 2) a non-disclosure covenant, which barred Hamden from disclosing any of TCF's trade secrets during the term of the franchise agreement and thereafter; and 3) a non-solicitation covenant, which barred Hamden from soliciting any customers in his former territory for two years following the termination or transfer of the franchise agreement. Even though Hamden's franchisee status ended in December 2011, he continued operating a paint-restoration business at his former franchised location.

TCF sued Hamden for breach of the post termination covenants, and the district court, applying Virginia law, held in favor of Hamden, ruling that the term "termination," as used in the franchise agreement, did not encompass the natural expiration of the franchise agreement at the end of its term, and thus, none of the restrictive covenants were binding on Hamden. The Court of Appeals agreed that "termination," as used in the franchise agreement, connoted an end to the agreement distinct from its expiration. The court held that the two terms were not used interchangeably and that a termination of the franchise agreement only occurred upon the occurrence of certain events specifically listed in the franchise agreement, not passively upon the expiration of the franchise agreement's natural term. Because of this, the non-compete and non-solicitation provisions were not enforceable against Hamden. The appellate court held, however, that TCF could enforce the non-disclosure provision of the Confidentiality Agreement against Hamden because, unlike the other clauses, it applied "during the term of the franchise agreement and thereafter."

A franchisee planning to not renew a franchise agreement at the natural expiration of its term should review the franchise agreement's post-term covenants to determine if they will apply after the expiration of the agreement. To read the entire case, click here.