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Franchise Law

Gentis v. Safeguard Business Systems, Inc. Liberal Construction of Remedial Statutes: What Is a Franchise?

By Steven D. Wiener

California’s Franchise Investment Law (the CFIL) requires franchisors offering and selling franchises in the state to register their offering circulars and agreements with the Commissioner of Corporations and to make disclosures to prospective franchisees. It makes punishable, and provides a private right of action for private parties aggrieved by untrue statements of material facts or the omission to state material facts in the required documents and in other oral and written communications between franchisor and franchisee.

In a rare case interpreting the CFIL, the court of appeals decided Kim v. Servosnax, Inc., in which Kim had obtained a license agreement from Servo to operate a lunch counter in an office building and later filed a lawsuit alleging violation of the provisions of the CFIL and seeking damages for fraud. Servo argued that it was not subject to the CFIL because the license agreement had not created a franchise and Servo was not a franchisor. The court of appeals, turning to the provision of the statute declaring the "Need for Disclosures," declared that trial courts must liberally interpret the portion of the CFIL defining franchises. The CFIL defines a franchise as a marketing plan or system "substantially associated with the franchisor’s trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate."

In Servosnax, Servo contracted with owners and managers of office complexes and other buildings to operate food dispensing facilities, typically cafeterias, on site. Servo would build out the cafeteria space, purchase and install the equipment, open the cafeteria for business, and operate it for a period of four to eight weeks. Servo would then license the right to operate the cafeteria to an individual operator pursuant to a license agreement. Although (1) there was no name, logo or symbol identifying the cafeteria with Servo, (2) licensees were not permitted to use Servo’s name or any derivative thereof in the operation of the cafeteria, and (3) Servo did not register its license agreements as franchises under the Franchise Investment Law, the court held that the business was a franchise because the host office building knew the name of the licensor, and that Kim could sue Servo under the CFIL for fraud. Specifically, the court concluded that host companies that own the buildings where the cafeterias are built are customers of the licensees to whom the name of the franchisor is communicated, such that the licensee’s operation of the cafeteria or other food service enterprise was substantially associated with Servo’s name.

In so ruling, the court referred to the legislative intent expressed in the CFIL which acknowledged that California franchisees had suffered substantial losses where the franchisor or his or her representative had not provided full and complete information regarding the franchisor-franchisee relationship, the details of the contract between franchisor and franchisee, and the prior business experience of the franchisor. The statute provided that the intent of the law is to provide each prospective franchisee with the information necessary to make an intelligent decision regarding franchises being offered, to prohibit the sale of franchises where such sale would lead to fraud or a likelihood that the franchisor’s promises would not be fulfilled, and to protect the franchisor by providing a better understanding of the relationship between the franchisor and franchisee with regard to their business relationship.

In Gentis v. Safeguard Business Systems, Inc., the court of appeals affirmed a judgment against an alleged franchisor, Safeguard Business Systems. As in Servosnax, the issue in Gentis was whether the distributorship arrangement was a franchise subject to the CFIL. Relying on the language in Servosnax, mandating liberal application of the statute, the court of appeals held that the use of the word "or" in the statutory definition of a franchise among the words, "offering, selling or distributing goods or services," meant that "offering" alone was enough to bring a marketing plan within the definition of a franchise. Significantly, the statutory language at issue is stated in the disjunctive: "offering, selling or distributing goods or services." The court reasoned that by using the word "or," the legislature intentionally broadened the scope of the statute. Applying a liberal construction, the court concluded that the meaning of the word "offering" included what Safeguard’s sales representatives had been doing. Specifically, the court found that plaintiffs offered Safeguard’s goods for sale to customers by: contacting existing customers and recruiting new business; calling on customers; demonstrating products; installing Safeguard systems; solving customer problems; providing ongoing service; and soliciting orders for goods subject to Safeguard’s approval. By presenting and demonstrating its products, installing its systems, and providing ongoing service, plaintiffs ensured the distribution and sale of Safeguard’s goods.

The results in other courts are not so uniformly liberal. Though many have found similar statutes to be remedial in nature and designed to "combat abuses," few, if any, have expressed the need for liberal interpretation of the statutes with such force. In Petereit v. S.B. Thomas, construing the Connecticut Franchise Act, Thomas, the manufacturer of the famous English muffins of the same name, argued that its distributors were not franchisees because they did not operate pursuant to a marketing plan. The district court made detailed findings with respect to the amount of control Thomas exerted under its marketing plan over plaintiffs. The court pointed to price control—the dealers were prohibited from selling to local outlets at prices less than Thomas sold to chain food stores—as a primary indicium of control. Ultimately, the court of appeals agreed with the trial court that there was sufficient control to indicate a marketing plan and that the distributorship was a franchise.

In two cases under the Illinois Franchise Disclosure Act, the court found that business arrangements were not franchises under a definition substantially identical to that in California. In Rolscreen Co. v. Pella Products of St. Louis, Inc., a distributor claimed that Rolscreen had terminated its distributorship agreement in violation of the Illinois Franchise Disclosure Act. The court held that to qualify as a franchisee during the period in question the distributor would have had to pay at least one hundred dollars in franchise fees. The district court properly decided as a matter of law that the price of structural windows could not be considered a franchisee fee because in the Illinois Administrative Code only required indirect payments are considered franchisee fees. In the case before it, P0

roducts was not required to buy Rolscreen windows. Similarly, in Digital Equipment Corp. v. Uniq Digital Technologies, Inc., the court held that a requirement that a dealer purchase computers for sale in advance of sales was not an indirect franchise fee.

In Wright-Moore Corp. v. Ricoh Corp., the court noted that the general policy behind franchise laws is particularly helpful in delineating the scope of the franchise fee requirement. The purpose of most franchise laws is to protect franchisees who have unequal bargaining power once they have made a firm-specific investment in the franchisor. Remanding the case for retrial, the court noted that excess inventory requirements can constitute an indirect franchise fee. It found uniformity of interpretation in other Midwestern state decisions, noting that the Illinois franchise statute contained regulations interpreting the Illinois definition of franchise fees. These regulations explicitly include excess inventory, providing that an indirect franchise fee is present despite the bona fide wholesale price exceptions if the buyer is required to purchase a quantity of goods so unreasonably large that such goods may not be resold within a reasonable time.

Steven D. Wiener is an attorney practicing in Los Angeles, California.


- This article is an abridged and edited version of one that originally appeared on page 115 in Franchise Law Journal, Spring 1998 (17:4).

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