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February 12, 2019 in 75-1.1 Exemptions by

No Hot-Dogging: The Intersection of Section 75-1.1 and Federal Franchise Law

Thomas H. Segars thumbnail photo

Thomas H. Segars

This post examines two new decisions that apply N.C. Gen. Stat. § 75-1.1 to a specific factual context: the relationship between franchisors and franchisees.

The decisions—Trident Atlanta, LLC v. Charlie Graingers Franchising, LLC and Sanghrajka v. Family Fare, LLC—parallel one another in important ways, but reach different results.

This post summarizes and attempts to reconcile these decisions. We will also keep our blog’s discussion of hot-dog-related jurisprudence rolling.

Trident Atlanta

Charlie Grangers is a “hot dog restaurant.” In Trident Atlanta, the plaintiffs alleged that they were fraudulently induced by franchisors to purchase franchises to operate these restaurants in Georgia, Alabama, and Florida. Their claims included a 75-1.1 claim.

The franchisors moved to dismiss.

The franchisors’ first line of defense depended on a prospective “General Release” of claims included in the franchise agreements. The court rejected the franchisors’ argument for two reasons.

First, the General Release could not bar the claims, because the release was contained in the very document that the franchisees contended was induced by fraud.

Second, the General Release was “void” because it violated a federal law known as the Franchise Rule.  (The Franchise Rule is actually a collection of rules established by the Federal Trade Commission to    “give[] prospective purchasers of franchises the material information they need in order to weigh the risks and benefits of such an investment.”) In particular, the General Release violated 16 C.F.R. 436.9(h), which makes it “an unfair or deceptive act or practice” to “[d]isclaim or require a prospective franchisee to waive reliance on” certain representations about the business.

With the General Release out of the way, the Trident Atlanta court analyzed the claims in turn. By the time it reached the 75-1.1 claim, the court had concluded already that fraud was adequately pleaded. The court held that the fraud was “in or affecting commerce,” which would have been sufficient to deny the motion as to the 75-1.1 claim.

The court, however, went a step further, noting that “defendant’s alleged violation of the FTC’s Franchise Rule is enough on its own to establish a claim under the UDTPA.”  For this proposition, the court cited an earlier decision from the U.S. District Court for the Eastern District of North Carolina, Hometown Publishing LLC v. Kidsville News!, Inc.

Neither Trident Atlanta nor Hometown Publishing expressly recognized a per se violation of section 75-1.1. (A per se rule would have been in tension with Ken-Mar Finance v. Harvey. In Ken-Mar, the North Carolina Court of Appeals held that violation of a similar FTC regulation (the Credit Practices Rule) would not constitute a per se 75-1.1 violation.) But, the Franchise Rule violation was a basis for concluding that the 75-1.1 pleadings were sufficient in both cases.

Ultimately, the court allowed several of the plaintiffs’ claims—including the 75-1.1 claim—to proceed.

Sanghrajka

From 2006 until 2013, Purnima Sanghrajka ran a convenience store as a “contract operator.” Family Fare owned and controlled the store. (We will take blogger’s notice of the fact that most convenience stores sell hot dogs—usually from a roller cooker.)

In 2013, Family Fare decided to convert its “contract operators” into franchisees. Family Fare provided information required by the Franchise Rule, including a form franchise agreement, to Ms. Sanghrajka in late 2013. Unlike other “contract operators,” Ms. Sanghrajka was told that she could continue operating her store only if she agreed to operate a second, under-performing store, too.

Two provisions of the form agreement became important. First, any franchisee desiring to transfer her interest was required to pay a “transfer fee” of 10%. Second, the form reduced the time for commencing actions “arising out of or relating to” the agreement to one year.

On December 19, 2013, Ms. Sanghrajka met with Family Fare. For the first time—and before Ms. Sanghrajka signed anything—Family Fare presented Ms. Sanghrajka with an addendum to the franchise agreement that increased her transfer fee from 10% to 50%. Family Fare presented this as a “take-it-or-leave-it” offer. If Ms. Sanghrajka did not sign that day, she would be required to immediately cease operating and vacate the store she had run for seven years. (Family Fare forecast that it would dispute this version of events, but recognized that it was taken as true on a pleadings-stage motion.) Ms. Sanghrajka signed the papers and operated the two stores.

In 2016, Ms. Sanghrajka sold her franchise, and the parties disagreed about whether the 10% or 50% transfer fee should apply.

In May 2017, Ms. Sanghrajka sued Family Fare. She sought rescission of her franchise agreement and brought misrepresentation-based claims, including a claim under section 75-1.1. Family Fare obtained a pleadings-stage dismissal, and Ms. Sanghrajka appealed.

The North Carolina Court of Appeals began its analysis with the statute of limitations. It concluded that Ms. Sanghrajka’s claims accrued when she signed her franchise agreement on December 19, 2013, and that the agreement’s one-year limitations provision barred all of her common-law claims. Even if the provision were not enforceable, the court explained, Ms. Sanghrajka’s failure to bring those claims within three years of December 19, 2013, was dispositive.

Interestingly, the Sanghrajka court’s statute-of-limitations discussion did not address the 75-1.1 claim. Ms. Sanghrajka did bring that claim within four years of December 19, 2013, but not within the one-year contractual limitations period that the court deemed enforceable.

Instead, the court disposed of the 75-1.1 claim by concluding that Ms. Sanghrajka’s allegations were insufficient. The court supported this reasoning with Bumpers v. Community Bank of Northern Virginia’s holding that “there is nothing unfair or deceptive about freely entering a transaction on the open market.” It affirmed dismissal of the claim.

The court’s emphasis on Ms. Sanghrajka’s freedom of contract is curious, given the circumstances of the “take-it-or-leave-it” offer alleged. According to Ms. Sanghrajka, Family Fare gave her no time to review and consider the 50% transfer fee, a material change to the franchise agreement. And, its alleged insistence that she either sign or immediately vacate her business of seven years undoubtedly put Ms. Sanghrajka “on the spot,” if not in outright duress.

The Franchise Rule addresses Ms. Sanghrajka’s situation. It requires franchisors to give prospective franchisees a review period of several days before requiring them to sign any franchise agreement or material modification. Failure to comply is deemed an unfair or deceptive practice. In her complaint, Ms. Sanghrajka alleged a per se 75-1.1 violation based on this provision, contending that she was not given sufficient time to consider the 50% transfer fee. And, the parties touched on the issue in their briefs to the court. The court, however, never addressed this aspect of the Franchise Rule.

The Takeaway

Both Trident Atlanta and Sanghrajka involved affirmative, franchise-agreement-based defenses—a General Release and a contractual limitations provision, respectively.

Both cases involved alleged violations of Franchise Rule provisions that were designed to protect franchisees.

Only one case, however, permitted a 75-1.1 claim based on an alleged Franchise Rule violation to proceed past the pleadings.

One possible explanation for these divergent results comes to mind. The Sanghrajka court may have concluded sub silentio that the 75-1.1 claim was barred by the one-year contractual limitations period.  (This was the trial court’s reason for dismissing the claim. At least one previous court-of-appeals decision has held that parties can contract to shorten section 75-16.2’s four-year statute of limitations.)  Arguably, that provision was not tainted by the alleged Franchise Rule violation. It was contained in the form franchise agreement, which had been provided well in advance of the December 19, 2013 meeting.

Of course, if the Court had concluded that the claim was barred, then no analysis of the complaint’s sufficiency would have been needed. For example, a statute-of-limitations bar allowed the North Carolina Business Court to make short work of a Franchise-Rule-based 75-1.1 theory in Haigh v. Superior Insurance Management Group, Inc.

No matter the explanation, Trident Atlanta and Sanghrajka are essential reading for anyone litigating a 75-1.1 claim that arises from a franchise relationship.

Author: Tom Segars