Scrutinizing Franchise Legal Claims
For the Legal Intelligencer
by Craig R. Tractenberg
Franchisees need to carefully consider their actions when faced with a
franchisor that is seeking claims and recourse for violations under the terms of
the franchise agreement.
Judges are charged with performing justice among the litigants. Members
of the bar benefit when the judiciary writes not only for the litigants, but to
explain its reasoning for others. The decision in the Eastern District of
Pennsylvania in AAMCO Transmission v. Wirth expounds on what franchisees need to
allege in order to succeed in overcoming a motion to dismiss for failure to
state a claim under Pennsylvania law.
The case was brought by AAMCO to enforce a settlement agreement with its
franchisee Wirth. The settlement agreement provided for catch up payments by
Wirth for economic defaults and upon default, the franchise agreement could be
terminated. Upon termination, Wirth was to stop operating, observe a
post-termination non-compete agreement and pay the back money. AAMCO terminated
the franchise and filed a complaint to enforce the settlement agreement. AAMCO
claimed that Wirth continued to operate after effective termination under the
settlement agreement. AAMCO moved for a preliminary injunction, which was
resolved by stipulation and Wirth filed a counterclaim.
The counterclaim alleged that AAMCO represented it had a proven formula and
system for success for its franchisees and that its business model contained
cost containment provisions for labor and parts that would allow Wirth to make a
profit. Wirth further alleged that the model was profitable only for rebuilding
transmissions and not for other services offered, such as general automobile
repairs, installing remanufactured or used transmissions, which are facts AAMCO
should have known and disclosed. Wirth further alleged that AAMCO should not
have removed Wirth from its internal website and external Center Locator merely
because it could not pay for its adverting costs. Wirth claimed that it could
not pay the advertising contributions because the model failed, and Wirth could
not make catch up payments under the settlement agreement because of the flawed
model. The counterclaim asserted breaches of the franchise agreement, breach of
good faith and fair dealing and for fraudulent misrepresentation.
AAMCO filed a motion to dismiss, which requires the court to review the
allegations with every factual inference interpreted in favor of Wirth. In
addition, the Court noted that the claims will be dismissed unless a plausible
claim for relief is asserted, reviewed as a context-specific task that requires
to the court to draw on its judicial experience and common sense. The Court
reviewed each of the claims against this standard.
With respect to the fraud counterclaim, the Court found the claim alleged two
components, fraud in the inducement and fraud in the performance. Fraud in the
inducement requires a false statement which induced the signing of the franchise
agreement. The parol evidence rule, however, could bar admission of the false
statement if the contract contains terms which directly deal with the subject
matter of the representations and the contract contains an integration clause.
In this case, the franchise agreement was found to explicitly disclaim any prior
representation as to the potential profitability of operating an AAMCO and
nothing in the remainder of the franchise agreement implied that adherence to
the business model would guarantee any level of profitability. The Court
further found the integration clause unequivocally represented that the entire
agreement of the parties was contained in the franchise agreement. The Court
rejected Wirth’s argument that the narrow exception to the parol evidence rule
under Pennsylvania law for “real estate inspection cases” could relieve the
harsh result of the parol evidence rule. The rationale of the exception is that
like a real estate buyer, a franchisee cannot assess the true condition of what
is being bought. The Court refused to extend the narrow exception.
The Court also dismissed the fraud in performance claim based on the gist of
the action doctrine. The gravamen of the claim is that AAMCO told Wirth that his
profits would improve the business model were followed. The gist of the
action doctrine allows a tort claim only if the contract is collateral to
conduct that is primarily tortuous. Here the Court found that the tort claim was
barred because it was grounded on a duty to perform under a contract.
The Court then turned to the two breaches of contract claims. The first claim
is the removal of Wirth from the website and Center locator. The second is the
licensing of two other franchisees within ten miles. On the website and
Center locator claim, the Court found that Wirth failed to identify a duty
within the franchise agreement that required such a performance. To the extent
such a performance did exist, it was an obligation only to assist in
advertising. Assuming arguendo that an actual duty did exist to advertise,
and then Wirth concedes that he failed to pay the pooled advertising
contribution. The Court refused to grant Wirth a free ride for advertising.
The Court similarly could not find a provision in the contract that prevented
the licensing of two franchisees within a ten mile radius. The contract
contained a population density metric, but not a ten mile radius prohibition,
and the complaint failed to explain how one related to the other. Moreover, the
contract states “Franchisee agrees that he does not have and is not being
granted a protected trading area, specifically without limitation, in regard to
placement of other AAMCO Centers. “
Finally, the Court addressed the good faith and fair dealing claim and
explained that not every contract applying Pennsylvania law imposes the duty of
good faith and fair dealing, and that the doctrine is limited in franchise
settings to issues of termination. To the extent that the doctrine of good
faith and fair dealing did apply to this setting, the doctrine could not
override an express contractual term which disclaimed a protected trading area.
Although Wirth had creative arguments with some basis in the contract, the
Court explained the limits of Pennsylvania law and its obligation not to extend
those limits. The case is a very good summary of the current law regarding the
pleading of claims of fraud and breach of contract by franchisees.
Craig Tractenberg is the leader of the franchise and
distribution group, and a partner in the business litigation and bankruptcy
teams in the New York and Philadelphia offices of Nixon Peabody LLP. His
practice focuses on complex litigation and counseling requiring expertise with
franchise and distribution, insolvency or intellectual property issues.
Our Philadelphia Office is located at Two Penn Center, Suite
200, 1500 JFK Blvd, Philadelphia, PA 19102. Phone: 215-246-3525 • Fax: