DLA Piper IPT partners Barry Heller and John Verhey recently conducted a webinar reviewing 2011's top franchise cases, focusing on decisions providing guidance to franchisors in running their businesses, including cases dealing with noncompete provisions, disclosure issues, pricing controls and renewal rights.
Three of the most significant 2011 cases are summarized here.
1. In KFC Corp. v. Iowa Department of Revenue,1 the United States Supreme Court denied review of an Iowa Supreme Court decision that has caused concern among franchisors. KFC has no company-owned units in Iowa, only franchised units. The Iowa Department of Revenue issued a US$284,658 assessment against KFC for three years' worth of unpaid corporate income taxes plus penalties and interest. KFC challenged the assessment as unconstitutional because it had no "physical presence" in Iowa. The Iowa courts concluded it was sufficient for tax purposes that KFC licensed its intangible property (its trademark) to Iowa franchisees, generating income for KFC. Franchisors with franchisees in Iowa should be aware of the requirement to pay income taxes on revenue received from those franchisees. Franchisors should consider whether to take advantage of Iowa's "voluntary disclosure program," allowing certain taxpayers to report (and pay) income taxes for the prior five years.
2. In 7-Eleven, Inc. v. Spear,2 a rare but important case involving adequacy of financial performance representations (FPR) in franchise disclosure documents, a federal district court held that an FPR need not contain information that might be material to a prospective franchisee's investment decision. When 7-Eleven sought to terminate a defendant's franchise agreement, the defendant countersued, claiming 7-Eleven had violated the Illinois Franchise Disclosure Act and had committed common law fraud because it did not provide historical financial information about the store the defendant had bought.
The court dismissed the franchisee's claims, saying an FPR is optional and the nature of the financial information given to prospective franchisees is left to the franchisor, although its presentation must conform to disclosure guidelines. The court held that, in light of disclaimers in the FPR that the historical averages did not show either the store's actual performance or any store's prospective performance, failure to provide sales information for the acquired store was not misleading: the disclaimers explained the precise nature of the financial information and 7-Eleven was obligated to disclose only what the disclosure guidelines required.
This case highlights both the importance of including appropriate disclaimers in a franchise disclosure document and the limitations on proper use of that information.
3. In Doctors' Associates, Inc. v. Uninsured Employers' Fund,3 the Kentucky Supreme Court rendered an opinion important to the trend of claimants seeking to blur the line between franchise relationships and employment relationships. The Uninsured Employers' Fund sought indemnity from Doctors' Associates, franchisor of Subway, when an employee of an uninsured franchisee sustained work-related injuries and received payments from the Fund. After an Administrative Law Judge and the Workers Compensation Board found Doctors' Associates not liable for payments to the employee, the Kentucky Court of Appeals reversed and remanded, asking whether the franchisee's work was "a regular or recurrent part" of Doctors' Associates business. The Kentucky Supreme Court reversed and held Doctors' Associates should not be liable because Doctors' Associates did not control its franchisees' day-to-day activities; it was in the business of developing franchisees, not operating sandwich shops. The court also suggested agreement provisions franchisors might use to minimize the risk of having to pay workers' compensation benefits for employees of their franchisees.
Audio of the webinar and the PowerPoint presentation, including the list of all 11 cases, are available here.
For more information about franchise case decisions providing guidance to franchisors in running their businesses, please contact Barry Heller or John Verhey.
1 KFC Corp. v. Iowa Dep't of Revenue, 792 N.W.2d 308 (Iowa Dec. 30, 2010), cert. denied, 132 S. Ct. 97 (Oct. 3, 2011).
2 7-Eleven, Inc. v. Spear, 2011 WL 2516579, at *4-*7 (N.D. Ill. June 23, 2011).
3 Doctors' Assocs., Inc. v. Uninsured Emp'rs.' Fund, ___ S.W.3d ___, 2011 WL 5878145, at *3-*4 (Ky. Nov. 23, 2011).