Sylvan Learning, Inc. Fighting Franchise Act Claim

April 24th, 2012

During 2012 Sylvan Learning, Inc. and its corporate affiliates are fighting a claim of violating of the Maryland Franchise Registration & Disclosure Law and fraudulent conduct in its sale of tutoring center franchise rights, after having its motions to dismiss the fraud claims denied by the U.S. District Court in Baltimore.

In Next Generation Group, LLC v. Sylvan Learning Centers, LLC, Case CCB-11-0986 (decided Jan. 5, 2012), the plaintiff franchisee alleged that he agreed to develop and operate a new Sylvan Learning Center in Irving, Texas, in reliance upon representations from Sylvan that it would sell the plaintiff two existing Centers in nearby Arlington and Allen, Texas. According to the Amended Complaint, those representations were made orally by Sylvan’s agent to plaintiff’s principal both before and after the plaintiff signed the franchise agreement for Irving, but several weeks before the Irving location opened, Sylvan’s agent advised plaintiff’s principal “in writing that Sylvan had approved his acquisition of the Arlington and Allen Learning centers, respectively.” The parties executed letters of intent for the sale of both sites about two weeks before the Irving Center opened. However, about three weeks after the Irving Center opened, Sylvan’s same agent “informed [plaintiff] that Sylvan would not sell him the license and assets for any more franchises.” According to the Amended Complaint, Sylvan provided no explanation of its reversal of course. The franchisee claimed that Sylvan fraudulently induced it to develop and open the Irving location.

Sylvan argued for dismissal of the claims on the basis that the Irving franchise agreement contained an “integration clause” that prevented the plaintiff from relying on promises made outside that written agreement. The court rejected this, by quoting a prior court decision stating, “[T]he law in Maryland … is that a plaintiff can successfully bring a tort action for fraud that is based on false pre-contract promises by the defendant even if (1) the written contract contains an integration clause and even if (2) the pre-contractual promises that constitute the fraud are not mentioned in the written contract. Most of our sister states apply a similar rule. Greenfield v. Heckenbach, 144 Md. App. 108, 130, 797 A.2d 63, 76 (2002).” Sylvan’s problem is that the contractual “integration clause” did not disclaim any specific oral representations, and certainly not any concerning Sylvan’s willingness to sell the plaintiff additional existing franchised businesses. Without specific disclaimers as to representations made on that specific topic, the integration clause did not prevent pursuit of the claim.

While Sylvan could use the presence of the integration clause at trial to challenge whether the plaintiff reasonably relied on promises made outside of the Irving franchise agreement, based on the facts alleged the court stated, “there is reason to believe [plaintiff] could reasonably have relied on Sylvan’s representations” concerning the sale of the existing locations. Therefore, the court held that permitting the plaintiff to file a second amended complaint would not be “futile” and granted the plaintiff’s motion to do so.

After the plaintiff filed its Second Amended Complaint, Sylvan immediately moved to dismiss it on essentially the same grounds as asserted previously, and the court once again refused to dismiss the claims for fraud and violation of the Maryland Franchise Registration & Disclosure Law. Accordingly, the parties are now conducting discovery that may take most of 2012 to complete.

It is important to recognize that the proceedings in this case to date solely concern the sufficiency of the plaintiff’s factual allegations as a matter of law, and in later proceedings Sylvan’s representatives will provide information on what occurred with regard to this franchise sale. Nevertheless, the decision reiterates an important point for all Maryland business people – even if promises and statements are excluded from a particular written agreement, they may have legal consequences if the subsequent business relationship fails to meet the other party’s expectations.

Litigating Waivers and Disclaimers in Franchise Disputes

October 5th, 2009

A recent case out of the Federal District Court for the Western District of Pennsylvania demonstrates what appears to be a movement by the courts away from their traditional franchisor-friendly view of franchisee waivers and disclaimers.

In the past, a franchisee’s willingness to sign a franchise agreement has generally bound them to the waivers and disclaimers included therein, regardless of any related fraud or misrepresentation on the part of their franchisor. Courts have typically been unsympathetic to franchisees’ claims of fraudulent inducement where the franchise agreements themselves and other documents, such as “franchisee disclosure questionnaires,” expressly stated that the franchisees were not relying on any statements made by the franchisor’s representatives other than those in the Franchise Disclosure Document (or “UFOC”), and that the franchisees understood that the parties’ entire agreement was contained in the franchise agreement. Most courts have held that franchisors are entitled to rely on their franchisees’ express affirmations, and that franchisees are bound by the statements and agreements they sign.

However, the federal district court in Martrano v. The Quizno’s Franchise Co. denied Quizno’s’ motion to dismiss a class of franchisees’ claims for fraudulent inducement based on waivers and disclaimers included in the Quizno’s franchise documents. The franchisees’ primary claim was that a statement in the UFOC that Quizno’s negotiated volume discounts for the benefit of its franchise system was misleading, and the court held that the franchise agreement and disclosure questionnaire did not disclaim any of Quizno’s’ assertions contained in the UFOC itself.

Importantly, the court also allowed the franchisees to pursue additional fraudulent misrepresentation claims for statements made outside of the UFOC based on the franchisees’ assertion that Quizno’s required all prospects to provide “correct” responses to the disclosure questionnaire in order to be awarded a franchise. The court also cited previous cases holding that disclaimers of intentional misconduct are void as against public policy, and that parties cannot waive the right to sue for fraudulent inducement in the very contract they wish to challenge. Finally, the court noted that Quizno’s may be liable for violating its general duties of good faith and fair dealing by taking actions detrimental to its franchisees for its own benefit.

While the court’s acceptance of the franchisees’ claim based on the misrepresentation included in the UFOC was clearly in line with established precedent and current franchising regulations, its willingness to allow the franchisees to pursue other claims that Quizno’s argued were barred by express waivers and disclaimers represents a separation from established precedent. This case suggests that courts may in the future accord less weight to defenses asserted by franchisors based solely on a franchisees’ execution of form contracts and other documents.

Also of note, the court also denied Quizno’s claim for enforcement of the franchise agreements’ class action waiver provision. The court held that class action certification is a matter of federal procedural law, and therefore remains within the federal courts’ discretion regardless of any agreement between the private litigants.

By: Jeffrey S. Fabian