Antitrust Law Daily Ice cream parlor franchisee failed to show damages linked to CFIL violation
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Thursday, January 9, 2020

Ice cream parlor franchisee failed to show damages linked to CFIL violation

By Nicole D. Prysby, J.D.

A franchisee’s California Franchise Investment Law claims failed because the franchisee could show no injury linked to the violation.

Although an ice cream parlor franchisor admitted that it violated the California Franchise Investment Law (CFIL) by failing to provide the correct disclosure documents, the franchisee’s CFIL claims failed because it could not show that it suffered any damages from the CFIL violation, the federal district court in Cleveland has decided. The franchisor sued the franchisee and obtained a preliminary injunction preventing the franchisee from opening a competing store in violation of the parties’ agreement. The franchisee then brought CFIL claims in a separate litigation, later consolidated with the franchisor’s suit, in an attempt to rescind the agreement, but the court rejected the claims. The court held that the statutory language of the CFIL should be interpreted to mean that rescission is an additional remedy that is available only if the plaintiff first establishes that the violation damaged the plaintiff. Although the franchisee claimed damages (such as the payment of the franchise fee), he did not show that those damages were in any way linked to the CFIL violations. The court also held that the preliminary injunction should not be dissolved, but also denied the franchisor’s request to extend it to the end date for the parties’ franchise agreement (Handel's Enterprises, Inc. v. Schulenburg, January 6, 2020, Barker, P.).

Handel’s Enterprises, an ice cream parlor franchisor, which used products, equipment, methods, and recipes exclusive to itself entered into a five-year franchise agreement with the franchisee in 2016. Pursuant to that agreement, the franchisee agreed not to compete with the franchisor in any way for the initial term of the agreement and during the two years following the expiration or termination of the agreement. The noncompete clauses covered a three-mile radius and an additional neighborhood. The agreement also stated that the franchisor was providing proprietary and confidential trade secret information and that the franchisee would not use that information unless the franchisor approved.

In 2017, the parties had discussions about developing a second franchise, but the franchisee stated that he did not want to pay a separate fee for the second franchise, did not want to sign another franchise agreement, and declined to provide a final lease for the proposed location. Instead, he opened a competing ice cream parlor and filed suit in state court to rescind the parties’ existing franchise agreement. The franchisor filed suit and obtained a preliminary injunction barring the franchisee from setting up a competing ice cream parlor. The district court’s finding that the franchisor was likely to succeed on the merits of its claim for misappropriation of trade secrets and breach of the noncompete clause was affirmed by the Sixth Circuit. Before the court were parties’ cross-motions for partial summary judgment.

CFIL claim. The franchisee claimed that the franchisor failed to provide the correct disclosure documents required by the CFIL, within the required time period. The franchisor largely admitted that it violated the CFIL, but argued that it should prevail on the claim because the franchisee did not allege any damages resulting from the CFIL violations. The CFIL provides that any person who violates certain provisions of the CFIL "shall be liable to the franchisee or subfranchisor, who may sue for damages caused thereby, and if the violation is willful, the franchisee may also sue for rescission." Cal. Corp. Code § 31300. The court held that the statutory language should be interpreted to mean that rescission is an additional remedy that is available only if the plaintiff first establishes that the violation damaged the plaintiff. Although the franchisee claimed damages, such as the franchise fee, royalties, and the costs of designing and opening the franchise, he did not show that those damages were in any way linked to the CFIL violations. The differences between the disclosure documents he received and the correct documents related to Small Business Administration funding, which did not impact the franchisee.

Preliminary injunction. The franchisee sought to have the preliminary injunction dissolved. The court denied the request, after concluding that the franchisee failed to describe any new evidence with regard to the trade secrets or non-compete provisions or any changes in the law. The court also rejected the franchisee’s argument that the preliminary injunction should be dissolved because the franchisor acted in bad faith by opening two locations near the franchisee’s store. The stores are outside of the noncompete radius and because the franchisor acted within its contractual rights, it was not acting in bad faith.

The franchisor moved to correct the expiration date of the preliminary injunction to January 22, 2021 (rather than 2020), when the initial franchisee agreement term expires, asserting that the judge misunderstood the relevant dates. The court rejected that argument because the franchisor’s proposed order for the preliminary injunction requested that it remain in effect "no longer than the term of the parties’ franchise relationship, which expires January 22, 2021." Therefore, the judge was aware that January 22, 2021 was the end date for the franchise agreement. The judge modified the proposed order to change the end date to January 22, 2020 and the court would not assume that the judge was unaware of the significance of the 2021 date. The court also denied the franchisor’s request to extend the preliminary injunction.

This case is No. 4:18-cv-00508-PAB.

Attorneys: Warren T. McClurg, II (Benesch, Friedlander, Coplan & Aronoff LLP) for Handel's Enterprises, Inc. d/b/a Handel's Homemade Ice Cream & Yogurt. R. Michael Ghilezan (Global Legal Law Firm) for Kenneth S. Schulenburg.

Companies: Handel's Enterprises, Inc. d/b/a Handel's Homemade Ice Cream & Yogurt

MainStory: TopStory FranchisingDistribution OhioNews

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