Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—CalCtApp: Big O Tires Did Not Breach Agreement with Franchisee, (May 28, 2013)

By Tobias J. Gillett, J.D., LL.M.

Big O Tires, LLC did not breach its agreement with a franchisee whose business failed, or fraudulently induce the franchisee to enter into the agreement, a California appellate court has ruled (Ayu’s Global Tire, LLC v. Big O Tires, LLC, May 24, 2013, Manella, N.). A decision granting summary judgment to Big O was affirmed.

Ayu Global Tires, LLC purchased a tire store franchise from Big O, but the business soon failed. Ayu filed suit against Big O, asserting claims for breach of contract, breach of the implied covenant of good faith and fair dealing, and fraud in the inducement, among other claims. The trial court granted summary judgment to Big O, and Ayu appealed.

According to Ayu’s complaint, Ayu’s owner had no experience in the tire industry, but Big O representatives falsely claimed experience was unnecessary to succeed in that business, and that it would provide adequate training. Big O also allegedly exaggerated the estimated profits Ayu would earn, and concealed the facts that many Big O franchises had failed and that the tires Big O offered could be obtained from other suppliers at lower prices. Big O provided Ayu’s owner with a demographic study of the area where the store would be located, and claimed that it would acquire five to six percent of the market share in the area. Ayu’s owner based his pro forma financial statement he provided to his lender and Big O on this information, but it proved to be “grossly inaccurate.” Big O’s own “internal use only” pro forma statement estimated that Ayu would earn approximately $70,000 less per year than listed in Ayu’s statement. Big O also chose an unsuitable inventory for the store and required Ayu to buy unnecessary equipment.

However, the court concluded that Big O had made a sufficient showing to shift the burden to Ayu “to raise triable issues of fact.” The cover page of Big O’s offering circular told prospective franchisees not to “rely on it alone,” and recommended showing the franchise agreement to an advisor, such as an attorney, but Ayu’s owner admitted he neither read the circular carefully nor asked his attorney to review it. Ayu’s owner also signed an acknowledgment stating that he had not relied on any promises not in the franchise agreement. In addition, the circular “described the competitive nature of the tire market,” observed that a franchisee’s success would be dependent on a variety of factors, and stated that Big O did not guarantee the success of a store.

Moreover, Big O proffered evidence that franchisees had been successful without experience, and that it offered “an extensive training program.” The offering circular contained data from 211 Big O stores allegedly supporting Big O’s sales estimates, and included a list of transferred, cancelled, and terminated franchises. The franchise agreement did not guarantee a specific supply of tires, did not oblige Big O to supply tires at competitive prices, and did not require Big O to develop new products or services. Big O also submitted evidence that it had provided competitively priced tires, and matched its prices with its competitors.

Furthermore, although Big O assisted Ayu with finding a location for the store, Ayu’s owner made the final decision. Big O never told Ayu’s owner that the business would be profitable, and instead merely provided some of the information from which the owner made his own pro forma statement. Ayu negotiated the purchase of a Firestone store and its equipment for the store’s location, and rejected a proposal from Big O’s preferred contractor to remodel it, instead using a different contractor to make modifications that Big O advised him would be unnecessary and expensive. Ayu also selected a more expensive equipment package than Big O recommended.

Fraud in the inducement. Applicable Colorado law required a plaintiff bringing a claim for fraud in the inducement to “show that he or she relied on the misrepresentation, and was justified in doing so.” Colorado applied the doctrine of inquiry notice, under which “whatever is enough to excite attention, and put the party upon his guard, and call for inquiry, is notice of everything to which such inquiry might have led.”

Here, Ayu’s owner had received multiple copies of the offering circular, and the warnings on it suggesting careful study and professional advice, combined with the large financial investment, were enough to “excite [his] attention.” As the owner did not engage in that study or seek advice, and since he had to “be charged with full knowledge of the terms and disclosures in” the franchise documents, his “fraud claim fail[ed] for want of triable issues regarding reasonable reliance.”

Moreover, the court observed that the evidence indicated that Big O’s statement regarding the experience necessary to operate a franchise did not constitute fraud. Although an internal e-mail showed Big O knew inexperienced franchisees failed at a high rate, Big O provided evidence of 41 successful franchisees with no prior experience. Big O’s offering circular also “described the competitive nature of the tire market,” disclaimed any guarantee of success, and disclosed previous transferred, cancelled, and terminated franchises.

Big O also did not commit fraud by failing to disclose its own internal pro forma financial statement, according to the court. The court explained that Colorado law required a party to a transaction to disclose “facts basic to the transaction, if he knows that the other is about to enter into it under a mistake as to them, and that the other, because of the relationship between them, the customs of the trade or other objective circumstances, would reasonably expect a disclosure of those facts.” However, “[i]f the parties expressly or impliedly place the risk as to the existence of a fact on one party . . . the other party has no duty of disclosure.”

Here, Big O’s offering circular stated that Big O employees were not authorized to disclose information regarding “a specific level or range of actual or potential sales, costs, income or profits of a Big O store or franchise,” and therefore “place[d] the risk as to the existence” of such facts on Ayu, in the court’s view. Moreover, no evidence indicated “that the existence of Big O’s pro forma went to the basis, or essence, of the transaction for purposes of a duty to disclose.” Although the pro forma statements created by Ayu and Big O differed regarding levels of sales and profits, both statements projected that the franchise would be viable. No evidence suggested that attaining the level of profits in Ayu’s pro forma was critical to the transaction, or “an important part of the substance of what [Ayu] bargained for.”

Finally, language in the offering circular stating that Big O’s approval of a store site “does not constitute a representation or warranty of any kind as to the suitability of the site for a Big O store” precluded “reasonable reliance on any oral representations that Big O would choose a successful store location,” in the court’s view. Further, although the offering circular and the franchise agreement did not disclaim Big O’s liability as to the equipment packages it proposed, the documents only required Big O to provide “prototype” equipment packages, and did not guarantee the success of the store, and therefore Ayu “could not have reasonably relied on any oral representation that Big O would propose equipment that assured the success of their store.”

Big O also fulfilled any obligation it might have had to select a manager for the store, since the manager only left after the store opened, and no evidence indicated that “Big O lacked the intention to fulfill the promise when it was made.” In addition, Big O listed previously transferred, cancelled, or terminated franchises, and therefore no evidence suggested “that Big O failed to disclose information regarding failed or terminated franchises material to [Ayu’s owner’s] decision to go forward.”

Breach of contract. The court also rejected Ayu’s breach of contract claim. The franchise agreement’s integration clause stated that it “terminate[d] and supersede[d] any prior agreement between the parties concerning the same subject matter and any oral or written representations which are inconsistent with the terms of this instrument and its accompanying Franchise Offering Circular,” and therefore incorporated the offering circular within the franchise agreement.

Further, the agreement did not impose an obligation on Big O to strengthen Ayu’s “competitive posture,” and a recital stating that Big O has acted “to enhance the competitive posture of its franchisees” did not alter this conclusion because, under Colorado law, recitals could not “enlarge the duties imposed in a contract.” The agreement also did not require Big O to supply tires to Ayu at the same price it sold tires to other franchisees, guarantee that Big O would provide adequate inventory, or require Big O to provide products and services distinct from those offered by its competitors.

Finally, the agreement authorized Big O to require Ayu to buy equipment it approved, and “stated that the cost of appropriate equipment and fixtures ordinarily ranged from $100,000 to $220,000.” Ayu’s owner chose an equipment package valued at $177,906, and later bought more equipment. The court found “no breach of the agreement” in these facts.

The case is No. B236930.

Attorneys: Nicholas W. Hornberger for Ayu’s Global Tire, LLC. Jonathan Solish (Bryan Cave) for Big O Tires, LLC.

Companies: Ayu’s Global Tire, LLC; Big O Tires, LLC

Cases: FranchisingDistribution CaliforniaNews