Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—CalCtApp: Liberty Tax Service Was Liable for Franchisees’ Advertising Due to Agency Relationship, (Jan 18, 2013)

By Tobias J. Gillett, J.D., LLM.

A tax and loan services franchisor was liable for its franchisees’ allegedly misleading advertising under California’s Unfair Competition Law (UCL) and Fair Advertising Law (FAL) because the franchisor exercised the a high degree of control over its franchisees and because the franchisor did not satisfy an alleged exception to agency theory under those circumstances, the California Court of Appeal in San Francisco has ruled (The People v. JTH Tax, Inc., January 17, 2013, Lambden, J.).

The franchisor, JTH Tax, Inc., doing business as Liberty Tax Service (Liberty), offers tax preparation services, e-filing, refund anticipation loans (RAL), and electronic refund checks (ERC) through a network of company-owned and franchise stores. In February 2007, the Attorney General of California filed a complaint against Liberty, alleging that it had violated the UCL and the FAL.

The trial court concluded that a handling fee charged to Liberty’s ERC customers violated the federal Truth in Lending Act, that its failure to disclose the fee violated the UCL and the FAL, and that certain “cross-collection” practices employed by Liberty violated federal and state law. In addition, the court found Liberty liable for advertisements it found were “likely to deceive,” including those produced by the company and those produced by its franchisees.

The trial court ordered monetary penalties of approximately $1.17 million, restitution of approximately $135,000, and a permanent injunction requiring Liberty to cease disseminating advertisements that represented that an RAL represented a customer’s actual refund and requiring Liberty to monitor its employees and franchisees to prevent future violations. Liberty appealed.

Liability for Franchisee Advertising

Liberty argued that the trial court erred in concluding that Liberty had violated California law through its franchisees’ advertising. The trial court had found that Liberty could be held liable for its franchisees’ advertising on an agency theory, that Liberty exercised a degree of control over its franchisees in excess of the necessary to police its trademarks, and hence that Liberty was liable under that theory.

Agency Relationship. Liberty first contended it could not be held liable on a theory of vicarious liability for the actions of its franchisees. Liberty argued that liability would require “actual control over the day-to-day operations of the franchisee,” not merely a right to control the “uniformity and the standardization of products and services.” As Liberty’s franchisees had responsibility over management of employees, outfitting offices, complying with laws, choosing how many offices to operate, selecting marketing methods, designing advertising subject to Liberty’s approval, choosing publications in which to advertise, controlling “discretionary elements outlined in the advertising and marketing sections of the operations manual,” and deciding how much to spend on advertising, it did not have the “day-to-day operational control” that would subject it to liability on an agency theory, Liberty contended.

The appellate court disagreed, citing the California Supreme Court’s 1982 decision in Ford Dealers Assn. v. Department of Motor Vehicles, 32 Cal.3d 347, which had found that the FAL “incorporates the concept of principal-agent liability.” Since the UCL stated that “unfair, deceptive, untrue or misleading advertising and any act prohibited by [the FAL]” constituted a violation of the UCL, Liberty could be held liable for its franchisees’ advertising “under normal agency theory.” Therefore, the determination of whether an agency relationship existed would turn on whether Liberty retained “the right to control the means and manner” in which its franchisees achieved their results.

The court acknowledged that application of agency theory to the franchisor-franchisee relationship would have to recognize the franchisor’s interest in maintaining the reputation of its trademarks. The court therefore determined that “a franchisor may exercise a right of control over such activities as advertising to protect its marks and goodwill,” but an agency relationship could nonetheless exist “if the franchisor exercise a right of control that goes beyond its interests in its marks and goodwill.”

Liberty’s Vicarious Liability. Liberty next contended that, even if agency theory did apply to its relationship with its franchisees, it did not exercise a sufficient right of control over its franchisees to subject it to liability under that theory. It argued that, to the extent that it did control its franchisees’ advertising, it did so to protect its trademarks and public image.

The appellate court upheld the trial court’s determination that Liberty did exercise sufficient control over its franchisees to hold it liable for their advertising activities, and that it exceeded the control necessary to protect its goodwill. Liberty had provided “step-by-step instructions” to its franchisees in its operating manuals regarding their advertising. The franchisees were obligated to comply with the manuals’ provisions, and Liberty had the right to unilaterally modify the manuals at any time. The franchisees could not offer products or services without Liberty’s written consent, and Liberty controlled the pricing of the products and services, the number of free tax returns they could offer, and the discounts they could offer in coupons.

Moreover, the franchisees had to submit all advertising to Liberty for its approval. The court concluded substantial evidence supported the determination that Liberty had used this approval process “not only to protect its marks and goodwill, but also to control the business strategies and tactics of its franchisees.” The court therefore upheld the trial court’s finding that “[e]ven if Liberty’s franchisees are not its agents for all purposes, they are its agents at a minimum for purposes of advertising.”

Ford Dealers Exception. Liberty’s final attempt to avoid liability for its franchisees’ advertising focused on an exception to agency liability identified in the California Supreme Court’s Ford Dealers decision. The appellate court explained that the opinion contained a footnote with dictum stating that an automobile dealer might be able to avoid liability for the misleading statements of its sales people by “demonstrating that it made every effort to discourage misrepresentations; had no knowledge of salespeople’s misleading statements; and, when so informed, refused to accept the benefits of any sales based on misrepresentations and took action to prevent a reoccurrence.”

Liberty argued that it had “made every effort” to prevent misleading advertising by its franchisees, had no knowledge of the advertising at issue, and worked to prevent a reoccurrence once it learned of the advertising, and therefore that it satisfied the exception. The court disagreed, finding under the first element of the exception that, to the extent the exception existed, Liberty had not “made every effort to discourage misrepresentations.”

The court observed that Liberty, despite knowing of the franchisees’ advertising and its potential “legal problems” as early as January 2006, had not instituted a monitoring system or seriously attempted to work with the publication to halt the advertising until July 2008, “six months after the Attorney General found the illegal ads and two months before trial.” Although Liberty contended that other evidence demonstrated that it did take “reasonable steps” to prevent misleading evidence, the court concluded that it would not “reweigh the evidence” under the substantial evidence standard of review.

Unfair Competition Law

The court also upheld the trial court’s determination that “Liberty’s cross-collection practices violated the ‘fraudulent’ and ‘unfair’ prongs of California’s UCL and FAL.” Liberty had argued that it did not have to address those prongs in its reply brief because the trial court “offered no elaboration beyond its extended discussion of” federal and state debt collection and consumer protection statutes.

The court agreed, noting that the “fraudulent” and “unfair” prongs of the statute did not require a finding of unlawful activity, and therefore Liberty’s arguments that the court erred in its conclusions concerning Liberty’s liability under the debt collection and consumer protection statutes missed the mark. As the court found that Liberty had not addressed the trial court’s “independent UCL and FAL bases for its rulings about Liberty’s cross-collection practices,” the court found that Liberty had waived its appellate claims regarding those rulings. Moreover, the court granted the People’s motion to strike those portions of Liberty’s reply brief that addressed the trial court’s UCL ruling because they were “tardily made without good reason for doing so being shown.”

The court affirmed the trial court’s awards of civil penalties pursuant to the UCL and FAL, finding that its penalties of over $400,000 for a television advertisement and $50,000 for print advertisements were reasonable and in line with California case precedent.

Furthermore, the court approved the trial court’s permanent injunction requiring Liberty “to discipline its employees and franchisees who did not comply with policies and procedures that required Liberty to review all franchisee advertisements prior to their dissemination in California,” to audit at least ten California franchisees each year to determine their compliance with its procedures and the court order, and to obtain and inspect franchisees’ advertising. The court noted that the trial court had found the advertising to be a “serious violation” and “persistent,” and that Liberty knew of it and took little corrective action. Moreover, Liberty had the ability to seek modifications to or termination of the order in future.

The court also upheld the trial court’s conclusions regarding Liberty’s liability under the Truth in Lending Act. Therefore, the court affirmed the judgment of the trial court, and awarded the costs of the appeal to the People.

The case is No. A125474.

Attorneys: Robert J. Stumpf, Jr. (Sheppard, Mullin, Richter & Hampton LLP) for JTH Tax, Inc. Kamala D. Harris for State of California.

Companies: JTH Tax, Inc.

Cases: Advertising ConsumerProtection FranchisingDistribution StateUnfairTradePractices CaliforniaNews