Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—C.D. Ill.: Terminated distributor’s California franchise law claims proceed, Illinois franchise law claims dismissed, (Oct 3, 2013)

By John W. Arden, J.D., LL.M.

A terminated machinery distributor’s counterclaims that its supplier violated the California Franchise Relations Act and breached the distributorship agreement were not subject to dismissal, according to the federal district court in Rock Island, Illinois (H.C. Duke & Son, LLC v. Prism Marketing Corp., September 30, 2013, Darrow, S.). However, the distributor’s Illinois Franchise Disclosure Act, fraud, and Illinois Consumer Fraud Act counterclaims were dismissed.

The distributor’s California Franchise Relations Act counterclaims withstood the supplier’s contentions that the claim was time-barred and that the parties’ relationship was not a “franchise” under the Act because the distributor did not pay the required franchise fee. However, the Illinois Franchise Disclosure Act counterclaims were dismissed on the grounds that an out-of-state purported franchisee was not within a class protected by the law and the fraud-based claims were not pleaded with requisite specificity.

Background. H.C. Duke & Son, a producer of soft-serve ice cream machinery and equipment under the Electro Freeze trademark, entered into a distributorship agreement with Prism Marketing Corp. on August 25, 2003. Under the agreement, Duke would ship machinery and equipment from Illinois to Prism in California and Nevada. The agreement expressly prohibited modifications of its terms except in writing and signed by both parties. Prism maintained that Duke waived this requirement through an oral modification correcting or crediting Prism for supplying defective equipment.

On January 18, 2011, Duke notified Prism that it was invoking the termination provision of the agreement. Prism contested this termination. In response, Duke filed a complaint, seeking a declaration of the parties’ rights and duties under the agreement.

Prism filed an answer and a nine-count counterclaim against Duke, alleging breach of contract, fraud, violation of the Illinois Consumer Fraud Act, fraudulent concealment, tortious interference with contractual relations, violation of the Illinois Franchise Disclosure Act, and violation of the California Franchise Relations Act. Duke filed a motion to dismiss the counterclaims.

Breach of contract. Prism claimed that Duke breached modified provisions of the distributorship agreement, establishing “an unwritten understanding” that Prism was to be credited for its expenses to repair or replace defective equipment supplied by Duke and increasing Duke’s credit line to Prism. It further claimed that it performed its duties under the written understanding, with Duke’s knowledge and acquiescence, but that Duke failed to provide the agreed-upon credit.

Prism made allegations that, accepted as true, made out a plausible claim that Duke waived the written modification requirement of the distributorship agreement and that Prism reasonably relied on this waiver, the court found. Thus, Duke’s motion to dismiss was denied.

Fraud and related claims. Counterclaims alleging fraud, violation of the Illinois Consumer Fraud Act, and fraudulent concealment failed to meet the heighted pleading standard required by the Federal Rules of Civil Procedure.

The fraud counterclaim charged Duke’s representative with making misrepresentations in 2009, 2010, and 2011. However, the “representative” label did not sufficiently identify the person making the alleged misrepresentations. The 25-month time range alleged in the counterclaim was overly broad and did not establish the “when” needed in pleading with particularity. The counterclaim omitted any place, particular mode of communication, or other details regarding the alleged fraudulent communications that would grant Duke adequate notice of its individual representatives’ particular conduct at issue. Thus, the fraud counterclaim lacked the specificity required by Rule 9(b).

The Illinois Consumer Fraud and Deceptive Business Practices Act claim was based on a series of misrepresentations upon which Prism detrimentally relied. However, Prism alleged the same unspecified 25-month period and omitted any particular details regarding the allegedly deceptive communications. Thus, the statutory deceptive practices claim also lacked the required specificity.

In order to state a fraudulent concealment claim, a plaintiff must allege that a defendant intentionally omitted or concealed a material fact that it was under a duty to disclose. Such a duty arises either if the parties are in a fiduciary or confidential relationship or in a situation in which the plaintiff places trust and confidence in the defendant, which may arise from friendship, agency, or experience. While Prism alleged that it had a confidential or fiduciary relationship with Duke, it made no allegations that it was heavily dependent on Duke’s advice or even that the parties were more closely related than arm’s length dealers in a business transaction. Even if the parties’ relationship were considered a franchise, such a relationship is not necessarily a confidential or fiduciary one. Thus, Prism failed to make factual allegations sufficient to state a claim of fraudulent concealment by Duke.

Tortious interference. Prism’s claims of tortious interference with contractual relations and tortious interference with prospective economic advantage were dismissed with regard to allegations based on false representation, but not with regard to allegations based on non-fraud conduct.

Illinois Franchise Disclosure Act. Prism claimed that it was a franchisee within the Illinois Franchise Disclosure Act and that Duke violated multiple provisions of the statute in its dealings with Prism. Duke sought dismissal of the franchise law claim because (1) the claim was time-barred, (2) the relationship was not a franchise because Duke did not require a franchise fee and (3) Prism was not within the class protected by the franchise statute.

The court found that the claim could not be dismissed as time-barred at this stage of the litigation because Illinois law allows a defendant to bring an otherwise time-barred counterclaim as long as the plaintiff’s claim arose before the cause of action brought as a counterclaim became time-barred. “Because factual scenarios are possible where either or both of Duke’s causes of action accrued before the IPDA statutes of limitations had run on Prism, Prism has not pleaded itself out of court,” it was held.

Contrary to Duke’s contention, Prism made a plausible claim that it was required to pay a franchise fee of $500 or more, based on allegations that it had to assume the debt of a prior distributor as a condition precedent to entering the distributorship agreement; made other payments for required inventory; and paid Duke for advertising and promotional materials.

Duke’s motion to dismiss was granted on the claim that Prism was not within a class protected by the Illinois Franchise Disclosure Act, which only covered franchisees located in Illinois. Prism claimed to be incorporated in Nevada and to have its principal place of business in Washington, and the agreement contemplated Prism distributing Duke’s products in Nevada and California. Prism argued that the agreement was entered in Illinois and was to be performed in Illinois to the extent of Duke receiving orders and payment and shipping items from the state. However, the court found that these allegations did not give rise to a reasonable inference that Prism was a franchisee located in Illinois. Accordingly, Duke’s motion to dismiss was granted as to Prism’s claims under the Illinois Franchise Disclosure Act.

Other claims brought under Section 6 of the Act—which prohibits fraudulent practices in the offer or sale of a franchise—were dismissed for failure to satisfy the heightened pleading standard for fraud under Rule 9(b), just as the fraud and deceptive practices claims were dismissed.

California Franchise Relations Act. Prism’s counterclaim that Duke violated the California Franchise Relations Act could not be dismissed either for being time-barred or for a failure to demonstrate the existence of a franchise fee as required to invoke the protection of the Act, according to the court.

Duke asserted that Prism’s counterclaim under the California statute had to be brought within the limitations period contained in the California Franchise Investment Law. However, that limitations period applied only to actions for violation of the Franchise Investment Law. Prism’s counterclaim alleged only violations of the Franchise Relations Act, the court observed.

The franchise fee requirement of the California Franchise Relations Act parallels that of the Illinois Franchise Disclosure Act. To qualify as a franchise, the franchisee must be required to pay a franchise fee exceeding $100 “directly or indirectly.” A franchise fee is “any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay for the right to enter a business under a franchise agreement including, but not limited to, any payment for goods or services.” A payment may be a franchise fee “regardless of the designation given to, or the form of, such payment.”

As with the counterclaim under the Illinois Franchise Disclosure Act, Prism pleaded that it was required to pay a franchise fee, alleging multiple payments and obligations to Duke that could constitute a requisite fee, such as assuming the debt of a prior Duke distributor or paying Duke for advertising materials. Prism’s allegation that it was required to purchase and carry “ample stock” of Duke products raised the reasonable inference that these putative franchise costs amounted to $100 or more annually. Thus, Prism sufficiently pleaded the existence of a franchise fee.

The case is No. 4:11-cv-04006-SLD-JAG.

Attorneys: James S. Zmuda (Califf & Harper PC) for H.C. Duke & Son, LLC. Janaki Hannah Nair (Elias Meginnes Riffle & Seghetti) for Prism Marketing Corp.

Companies: H.C. Duke & Son, LLC; Prism Marketing Corp.

Cases: FranchisingDistribution StateUnfairTradePractices IllinoisNews