Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D.N.H.: Stratford Insurance may have to indemnify franchisor in franchise dispute, (Nov 7, 2024)

By Wendy Biddle, J.D.

Violations of CFIL predated the existence of franchise agreement.

After a restaurant franchisor alleged that its insurance company, Stratford Insurance Company, breached the terms of their policy when it refused to defend and indemnify the franchisor in an arbitration with a franchisee, the district court in New Hampshire partially granted the franchisor’s motion for summary judgment. The court found that two of the three exclusions in the contract did not apply to the case, but did find that one of the exclusions, the prior notice exclusion, could apply. The court also denied Stratford’s motion for summary judgment in full because liability for that franchisees’ claim was attributable to MRFranchise’s misrepresentation in the required disclosure document and did not flow from the franchise agreement. Therefore, the court found that the contract exclusion too narrow to include statutory liability that has only an incidental nexus to a contract (MRFranchise, Inc. v. Stratford Insurance Co., No. 1:22-cv-00572-LM (D.N.H. Nov. 1, 2024)).

MRFranchise is the franchisor of the Panini Kabob Grill restaurant chain in Southern California. In 2016, three individuals (franchisees) inquired about opening a Panini Kabob Grill in California.

Both federal and California state law require franchisors to provide formal disclosures in writing before entering into a franchise agreement. The Federal Trade Commission has a set of disclosure requirements, and the California Franchise Investment Law (CFIL) is the state’s analog to the FTC rules. One of the items that is required to be disclosed is if any of the franchisor’s officers have been held liable in (or settled) a civil case involving allegations of fraud or deceptive acts.

MRFranchise provided the franchisees with the required disclosures (the MRF Disclosure). In the disclosure, MRFranchise answered the question on prior litigation with “No litigation is required to be disclosed.” Afterwards, the parties executed the franchise agreement.

The franchise relationship broke down when one of the franchisees would not complete the necessary management training. The parties began negotiating a buy-back arrangement but could not come to an agreement. In February 2020, the franchisees filed a complaint against the principal at MRFranchise as well as the company who was doing the renovations on the franchise. The renovation company was also solely owned by the principal of MRFranchise.

In May 2020, MRFranchise sent the franchisees a notice it was terminating the franchise agreement. Later that month, MRFranchise initiated arbitration proceedings against the franchisees. The franchisees filed an arbitral counter-complaint alleging sixteen claims, including a statutory claim alleging that MRFranchise and its principal violated the CFIL by failing to disclose prior fraud cases.

In March 2022, the arbitrator found in favor of MRFranchise on all counterclaims, except for the statutory claim. On that claim, the arbitrator found that MRFranchise’s failure to disclose its prior litigation constituted a misrepresentation under the CFIL. The arbitrator rescinded the franchise agreement and awarded the franchisees about $1 million in damages.

MRFranchise relationship with Stratford. Close to the same time the franchisees filed suit against MRFranchise, MRFranchise purchased liability insurance from Stratford. The insurance has a defense of claim provision that states it will defend any claim, other than a wage and hour claim, and guaranteed that the insurance company would pay all defense expenses incurred in the defense of a claim that is covered under the policy. The policy contained a prior notice exclusion, intentional acts exclusion, as well as seven other exclusions.

In February 2021, Stratford notified MRFranchise that it was denying coverage and disclaimed any duty to defend based on the prior notice exclusion because MRFranchise knew of a likely claim prior to the policy’s start date; the professional services exclusion; and the contract exclusion, because the claims are premised on liability under the franchise agreement.

After the arbitrator awarded $1M to the franchisees, MRFranchise again asked Stratford to cover them. Again, Stratford denied the request. MRFranchise then brought this suit claiming breach of contract for failure to pay defense costs, breach of contract for failure to indemnify, and tortious breach of the implied covenant of good faith and fair dealing.

Summary judgment motions. Each party filed a motion for summary judgment. Stratford moved for summary judgment on all claims, arguing that the policy’s contract exclusion bars coverage for the entire counter-complaint because the claims stem from the franchise agreement.

MRFranchise moved for summary judgment on its first two claims, arguing that coverage of the franchisee’s counter-complaint is not barred by any exclusion and that Stratford breached its duty to pay defense costs and its duty to indemnify.

Stratford’s motion. The court first looked at the contract exclusion, which according to Stratford, bars coverage because the franchisees’ counterclaims are related to the conduct that formed the basis for the franchisees’ breach of contract counterclaim. However the court found that reading the contract exclusion in the context of the other exclusions, the contract exclusion requires a closer relationship between the insured’s liability and the circumstance barring coverage. If Stratford wanted the contract exclusion to apply broadly, the court noted, it could have written it that way, like with the other exclusions.

While most of the counterclaims sounded in breach of contract and torts regarding the franchise agreement, the claim that MRFranchise was found liable stemmed from a statutory violation of the CFIL. That claim was premised on the misrepresentations in the MRF disclosures. The liability for that claim was based upon or attributable to MRFranchise misrepresentation in the document and did not flow from the franchise agreement. Therefore, the court found that the contract exclusion too narrow to encompass statutory liability that has only an incidental nexus to a contract.

The court noted that even if Stratford could show that the contract exclusion applied, it could not show that one of its exceptions did not apply. The exception to the contract exclusion stated that “this exclusion shall not be applicable to the Insured’s alleged liability that exists in the absence of such contract or agreement…” So, the exclusion did not apply to liability that existed independent of a contract. Again, MRFranchise’s liability flowed from the statute and is based on the disclosure document that was separate and distinct from any contract and predated the franchise agreement. Therefore, the court found that the CFIL claim falls “squarely within the exception to the Contract Exclusion.” The court denied Stratford’s motion for summary judgment.

MRFranchise’s motion. MRFranchise argued they are entitled to summary judgment because no exclusion bars coverage under the insurance policy. Stratford had argued that there were three other exclusions, besides the contract exclusion, that precluded coverage.

Professional services exclusion. Stratford argued that MRFranchise was not entitled to summary judgment because the professional services exception applied. The exception bars coverage for any claim arising out of the performance of any professional service. The term “professional service” is not defined. The court concluded that the exclusion did not appear to apply to the conduct of MRFranchise in their role as franchisors. MRFranchise’s liability under the CFIL is not related to its alleged failure to provide training and resources to the franchisees.

Prior notice exclusion. Next Stratford argued that the prior notice exclusion bars coverage for claims the insured knew or should have known of before obtaining insurance. MRFranchise must show that there was no genuine dispute if they knew of an act or omission that could give rise to a claim. However, the court questioned the timing, since MRFranchise had already issued a notice of default to the franchisees and attempted to enter into a buy-back agreement prior to applying for coverage. Six days after the policy went into effect, the franchisees filed suit for claims related to the franchise relationship. The court concluded a reasonable jury could conclude that MRFranchise knew before they purchased the policy, that a lawsuit could ensue. The court therefore declined the motion for summary judgment because the prior notice exclusion could bar coverage.

Intentional acts exclusion. The intentional acts exclusion bars claims that are brought about by committing any intentional criminal or fraudulent acts. Stratford argued that this exclusion bars them from defending the claims against MRFranchise because MRFranchise willfully violated the CFIL. The arbitrator found the MRFranchise, the corporate entity, willfully violated the CFIL, but also found that there was insufficient evidence to find the principal himself intentionally omitted the information in the disclosure. MRFranchise argued that the exclusion did not preclude coverage for the principal because the arbitrator did not find that he had committed an intentional act. The court agreed. Because the arbitrator did not find that the principal committed intentional misconduct, there is no genuine issue as to whether coverage of the principal’s liability is precluded. The court found that MRFranchise was entitled to summary judgment as to the applicability of the intentional act exclusion to the principal.

The Case is No. 1:22-cv-00572-LM.

Judge: McCafferty, L.

Attorneys: Cheryl Dunn Soto (Franklin Soto Leeds LLP) for Mr. Franchise Inc. Lincoln A. Rose (Peabody & Arnold LLP) for Stratford Insurance Co.

Companies: Mr. Franchise Inc.; Stratford Insurance Co.

Cases: FranchisingDistribution NewHampshireNews GCNNews