Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D.D.C.: Maoz Vegetarian’s failure to register, untimely disclosure did not harm franchisees, (Oct 3, 2014)

By Greg Hammond, J.D.

Franchisor Maoz Vegetarian USA, Inc. technically violated Maryland and New York franchise law by failing to register its franchise offering statement with state authorities, and failing to offer the statement to a potential franchisee in a timely manner. The federal district court in Washington, D.C. therefore partially granted summary judgment in favor of the franchisee but did not award monetary damages or rescission of the franchise agreement, because no harm was caused by the violations (A Love of Food I v. Maoz Vegetarian USA, Inc., September 30, 2014, Jackson, K.).

A Love of Food I, LLC (ALOF) entered into a franchise agreement with Maoz, authorizing ALOF to open a vegetarian quick-service restaurant in Washington, D.C. However, after sustaining operating losses of $271,633 and total out-of-pocket expenditures on their venture of over $900,000, the franchise closed after a little more than two years in operation. ALOF filed suit against Maoz, seeking rescission of the franchise agreement, $900,000 in compensatory damages, and $1.8 million in punitive damages.

The suit claimed: (1) Maoz violated the Maryland Franchise Registration and Disclosure Law by failing to register its offering prospectus with state authorities, failing to disclose its offering prospectus to ALOF in a timely fashion, and making statements in the offering prospectus that misrepresented start-up costs and disclaimed any earning s statements; (2) Maoz violated the New York Franchise Sales Act for the same reasons; and (3) the start-up costs estimates and disclaimer of earnings statements constituted common law fraud. The companies filed cross-motions for summary judgment.

Failure to register the offering prospectus. Under both Maryland and New York state law, a franchisor is required to register its offering prospectus with the state before the franchisor offers to sell or sells a franchise in that state. However, New York provides an “isolated sales” exception to the registration requirement if a single franchise is sold in response to an offer that was made to two or fewer people.

According to the court, there was no dispute that ALOF was in existence when the parties actually executed the Franchise Agreement. Therefore, Maoz violated both states’ registration requirements by selling a franchise to ALOF without having registered its offering prospectus in either state. Further, the isolated sales exemption under New York law—which permits the owners of a store to grant a single franchise of that retail establishment without registration—was deemed inapplicable, as Maoz’s planned franchise expansion could not render the ALOF franchise an “isolated” occurrence.

Consequently, Maoz was liable to ALOF for its failure to register prior to selling the franchise. However, there was no evidence that connected Maoz’s failure to register its offering prospectus in either state to ALOF’s business losses. Rather, the court found that ALOF’s losses were mostly attributable to its own conduct, in which the company expended substantial sums on historic building permit problems, issues with its landlord, and architectural problems when converting its space to a restaurant layout. The company was therefore precluded from recovering both compensatory and punitive damages.

Rescission of the franchise agreement was also denied in this case. Specifically, the court found that although the technical violation of the registration requirement could be found willful, no reasonable jury could find that the violation was material to ALOF’s investment decision. The court reasoned that neither of ALOF’s owners testified that they would not have moved forward with the sale had they known Maoz had not yet registered its offering prospectus, and the owners had previously and repeatedly initiated a number of meetings with Maoz to further franchise negotiations, knowing that the delay was attributable to the fact that the franchisor had not yet registered the prospectus with relevant authorities.

Untimely disclosures. Under Maryland law, franchisors are required to provide prospective franchisees with a copy of the offering prospectus and proposed franchise agreement “at the earlier of”: (1) 14 calendar days prior to the execution by the prospective franchisee of any binding agreement with the franchisor; (2) 14 calendar days prior to payment of any consideration that relates to the franchise relationship; or (3) a reasonable request by a prospective franchisee to receive a copy of the offering prospectus. The court concluded that Maoz’s disclosure of the prospectus was timely under Maryland’s statute, and dismissed the untimely disclosure claim in Count I of ALOF’s complaint.

New York law, on the other hand, requires a franchisor to disclose the offering prospectus and proposed franchise agreement to the franchisee at the earlier of: (1) the first personal meeting between the franchisor or its agent and the prospective franchisee; (2) at least ten business days prior to the execution of a binding franchise or other agreement; or (3) at least ten business days prior to the receipt of any consideration in connection with the sale or proposed sale of a franchise. The court found that Maoz clearly violated the New York disclosure requirement, and awarded ALOF summary judgment on Count II of its complaint. However, once again, damages were not appropriate, as there was no evidence that the technical violation caused any harm to ALOF. Moreover, rescission was inappropriate, because there was no proof that the failure to timely disclose the offering prospectus was material to ALOF’s decision to purchase the franchise months later.

Misrepresentations. ALOF’s state law and common law misrepresentation claims survived the cross-motions for summary judgment. The court determined that there were genuine issues of material fact regarding: (1) whether the initial start-up cost estimates listed in the offering prospectus were false, and (2) whether ALOF was entitled to claim reasonable reliance on those cost estimates.

The case number is 12-CV-1117 (KBJ).

Attorneys: Steven K. Fedder (Fedder & Janofsky LLC) for A Love of Food I, LLC. Raymond Thomas McKenzie, Jr. (Law Office of Raymond T. McKenzie) for Maoz Vegetarian U.S.A., Inc.

Companies: A Love of Food I, LLC; Maoz Vegetarian U.S.A., Inc.

Cases: FranchisingDistribution DistrictofColumbiaNews