Comparison of the Trilogy: Common Law Fraud, Franchise Investment Laws, and

Little FTC Laws Remedies for Misrepresentations and Omissions in the

Offer and Sale of Franchises

Lord of the Rings

Fellowship of the Ring

The Trilogy

• Common Law Fraud

• Franchise Disclosure Laws

• Little FTC Acts

Gandalf and the Federal Trade Commission Act

Section 5 of the FTC Act prohibits “unfair

and deceptive acts or practices” and “unfair

methods of competition.”

The Breadth of the FTC Act and Purpose of the

FTC Franchise Disclosure Rule • Showing of capacity to deceive

sufficient. No showing of actual deception required.

• The FTC Franchise Disclosure Rule’s Statement of Basis and Purpose found the following landscape at original enactment:– rampant misrepresentations– false earnings claims by

franchisors– “informational disparity” – “economic disparity” between

franchisors and franchisees.

State Franchise Disclosure Laws

• California Franchise Investment Law addresses “numerous problems from an investment and business point of view …”

• In enacting the New York Franchise Sales Act, the New York Legislature found “franchise sales fraud was endemic … [S]ince 1972 alone, an estimated 14,000 New Yorkers had been victimized by fly-by-night and unethical franchisors …”

State Little FTC Acts

• “With the enactment of the Tennessee Consumer Protection Act (“TCPA”) in 1977, Tennessee joined the growing number of states that had passed so called ‘little FTC Acts.”

• Consumers or businesses covered?• Goods or services limitations?• State geographic limitations?

ACTIONABLE MISREPRESENTATIONS

Actionable Misrepresentations

Misrepresentations of Fact

• Intentional

• False statement about a past or present material fact

• Knowledge of falsity or recklessly made

• Defendant intended that plaintiff would rely

• Plaintiff did rely to his or her detriment

Actionable Misrepresentations

Misrepresentations of Fact

• Negligent

• Defendant supplied false information

• Plaintiff was justified in relying

• Defendant did not exercise reasonable care

• Special relationship?

Actionable Misrepresentations

Half-Truths

“To tell half a truth only is to conceal the other half.”

Rochester Methodist Hospital v. Travelers Ins. Co., 728 F.2d 1006, 1017-1018 (8th Cir. 1984).

Actionable Misrepresentations

Material Omissions

• Concealment of a fact material to a transaction

• Duty to disclose?

Actionable Misrepresentations

Earnings Claims and Projections

• Representations pertaining to past or present facts?

or

• Predictions or opinions as to possible future events?

Actionable Misrepresentations

False Opinions

• “Actual language used and the context in which the comment is made”

Cal. Bagel Co., LLC v. Am. Bagel Co., No. 97-8863, 2000 U.S. Dist. LEXIS 22898, *28 (C.D. Cal. June 9, 2000).

• Superior knowledge?

Actionable Misrepresentations

False Promises• Positive intent not to perform

• Promise made without present intent to perform

• Past or present material fact

• Superior knowledge?

Proving Fraud Against Lord Sauron: Scienter and Intent to Deceive

Reliance

Causation / Reliance

• Some state franchise disclosure laws use the word reliance in remedy provisions.

• Some state franchise disclosure laws use causation or a derivative in remedy provisions.

• Some Little FTC Acts do not require proof of reliance, others do.

Justified Reliance

• A number of judicial decisions have added a justified reliance requirement under several state franchise disclosure statutes though those statutes do not use the words justified or reasonable in their remedy provisions.

• Justified reliance is likely not required under the Minnesota Franchise Act. Randall v. Lady of America Franchise Corp.

Remedies • Actual Damages• Statutory Damages• Non-Economic Damages• Punitive and Exemplary

Damages• Rescission• Injunctive Relief• Declaratory Relief• Attorney’s Fees

Sauron’s Forces Attack With Integration, No

Representation, and No Reliance Clauses • Important to distinguish

integration, no representation and no reliance clause.

• Fraud vitiates all versus enforcement of contract terms at common law

• Anti-waiver provisions of statutes

Choice of Law and Venue Clauses

• Enforceability:– At common law– Under state

disclosure laws– Under Little FTC

Acts

Select Defenses • Statutes of

Limitations• Waivers and

Releases• Could Not Have

Known Defense• Claim Sounds In

Contract Rather Than Tort

PERSONAL LIABILITY OF OFFICERS,

DIRECTORS AND SALESPERSONS

Personal Liability of Officers, Directors and Salespersons

•Common Law

•Direct Liability

•Piercing the Corporate

Veil

Personal Liability of Officers, Directors and Salespersons

• Common Law

•Direct Liability

•Direct personal involvement•Establish each element of common law fraud claim

Personal Liability of Officers, Directors and Salespersons

• Common Law

•Piercing the Corporate Veil

•Individual exercised significant

control

•Use of control for improper purpose

•Fact-specific inquiry

Personal Liability, Officers of Directors and Salespersons

• State Franchise Statutes

•14 states expressly

extend liability

•Typically directors, officers,

& employees

Personal Liability of Officers, Directors and Salespersons

• State Franchise Statutes

•“Materially aid”

•Defense: did not know or could

not have reasonably known of

the wrongful conduct

Personal Liability of Officers, Directors and Salespersons

• Little FTC Acts

•Individual’s direct, active

participation in the

wrongful conduct of the

corporate entity

Personal Liability of Officers, Directors and Salespersons

• Little FTC Acts

•Broad definition of

“person”

•“Knowing acquiescence”

may be enough

DRAFTING AND PLANNING CONSIDERATIONS

Drafting and Planning Considerations

• Elements of Claims• Common Law• State Franchise Investment Law• Little FTC Act

• Reliance• Scienter• Remedies• Choice of Law/Venue• Waiver/Release• Integration, No Reliance, and No

Representation