Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—D.N.J.: Urgent care franchisees could not state constructive termination claims, (Mar 6, 2014)

By Peter Reap, J.D., LL.M.

Two still-operating New Jersey urgent care center franchisees could not state valid claims for constructive termination against their franchisor in violation of the New Jersey Franchise Practices Act (NJFPA) because the franchisor’s allegedly wrongful conduct had not compelled the franchisees to abandon their businesses, the federal district court in Trenton, New Jersey, has decided (Pai v. DRX Urgent Care, LLC, March 4, 2014, Pisano, J.). In addition, the franchisees’ other claims, including breach of contract, fraud, and violation of the Maryland Franchise Registration and Disclosure Law, were without merit.

Background. The two franchisees were members of the Doctors Express franchise system, of which defendant American Family Care is the current franchisor. The franchisees filed nearly identical complaints against the franchisor, its predecessor-in-interest, an affiliated entity, and other individuals and entities (collectively, the “franchisor”).

Essentially, the franchisees complained that the franchisor constructively terminated their franchises, misrepresented costs and operating expenses of a franchise in its Franchise Disclosure Document (FDD), initiated material and system-wide changes after they entered into their franchise agreements, and breached their agreements when Dr. John Shufeldt, an individual who had been investigated by the U.S. Department of Justice for fraudulent medical billing, became the CEO of the franchise system. Before the court was the franchisor’s motion to dismiss.

Constructive termination. The franchisees alleged that the franchisor constructively terminated their franchise without good cause in violation of the NJFPA and sought to “[p]reliminarily and permanently enjoin[]Defendants termination of Plaintiff’s franchised business… .”

The franchisees admitted that they both continue to operate as franchisees, and there has been no steps taken by the franchisor to terminate their franchise agreements. The franchisees alleged, however, that the franchisor constructively terminated the franchise agreements by: (1) involving Shufeldt with the Doctors Express system at a time when he was implicated in the investigation of NextCare, his earlier employer; (2) “grossly understating” the initial investment and working capital required to start and operate a Doctors Express franchise, including failing to include the cost of a Medical Director salary; (3) failing to account for the collection of franchise advertising monies; and (4) failing to “understand the law surrounding regulatory matters and its inducement of franchisees to abrogate the law.”

The Supreme Court recently made clear that a claim for constructive termination by a franchisee requires that a franchisee no longer be in operation, according to the court. In Mac’s Shell Service v. Shell Oil Prods. Co., 559 U.S. 175, 178 (2010), the Court found that a franchisee failed to state a claim for constructive termination under the Petroleum Marketing Practices Act (PMPA)—a federal statute that protects gas station franchisees—when “the franchisor’s allegedly wrongful conduct did not compel the franchisee to abandon its franchise.” The Court reasoned that requiring franchisees to abandon their franchise before claiming constructive termination was consistent with the general understanding of the doctrine of constructive termination, where “a plaintiff must actually sever a particular legal relationship” in order to state a claim.

Both franchisees are still continuing to operate their respective Doctors Express franchise at the same location, are still using the Doctors Express marks and system, and are continuing to generate revenue. The franchisees tried to overcome this hurdle by arguing that Mac’s Shell should not apply at all here, essentially because it involved the PMPA rather than the NJFPA. This argument was rejected. The franchisees asserted no reason why the statutes should be interpreted or applied differently, particularly where both statutes shared the same purpose of protecting franchisees from termination without cause, the court explained. Indeed, at least one other federal court has held that the reasoning of Mac’s Shell applies to a state statute, almost identical to the NJFPA, aiming to protect franchises, the court noted.

There were no allegations that any of the defendants engaged in engaged in the sort of conduct that would render either franchisee’s situation so intolerable that they would be effectively forced to stop operating their franchise. There has been no termination, and therefore, there was nothing to enjoin. Therefore, the claim was dismissed.

Breach of contract. The franchisees sought rescission of the franchise agreements for breach of certain express terms. Specifically, the franchisees alleged that “Defendants have grossly understated the original start-up investment and operating costs required to own and operate a DEF franchise location.” This was not a cognizable claim for a breach of the franchise agreement, according to the court. The estimate of the initial investment was contained in the FDD, which the franchisees “reviewed prior to executing a franchise contract with DEF.”

While the franchisees alleged that their start-up and operating costs have far exceeded the amounts estimated within the FDD, the FDD unequivocally stated that the costs included within it are estimates, and not to be considered a projection or promise of the actual costs of the franchise. The FDD also clearly states that there are no currently operating franchised units, and the estimates are based only upon the single Doctors Express center that was in existence at the time, which was owned by an affiliate of the franchisor. Consequently, because the allegedly understated estimated costs for start-up and operation of the franchises were not contained or otherwise incorporated within the franchise agreements, the franchisees could not validly state a claim for breach of contract premised on that basis.

However, even if they could state a claim, the claim would be time-barred, the court reasoned. The agreement between the parties establishes that all claims between them “must be brought or asserted” within the earlier of one year of the discovery of the claim or two years after “the first act or omission giving rise to an alleged claim,” there is nothing improper with a contractual limitation period. Under either New Jersey or Maryland law, parties to a contract could shorten the applicable statutory limitations period provided the shortened period is reasonable and does not violate public policy.

The franchisees also alleged that the agreements were breached when Shufeldt acquired and/or became the CEO of the Doctors Express system. The franchise agreement, however, expressly reserves the right of the franchisor to “change our ownership or form and/or assign [the] Agreement and any other agreement to a third party without restriction” and establishes the right to change officers or other personnel of the Doctors Express system, the court noted. Finally, the franchisees attempted to state a claim for breach of the franchise agreement with their allegation that the franchisor breached it when it changed certain third-party vendors and changed the system standards. Once again, the agreement soundly establishes the right of the franchisor to change required vendors. Overall, the express terms of the franchise agreement were not breached by any of the franchisees’ allegations.

Breach of the implied covenant of good faith and fair dealing. Count Three of the complaints requested a rescission of the contract based upon a breach of the implied covenant of good faith and fair dealing. The franchisees alleged that the covenant was breached when the franchisor was affiliated with Shufeldt and when it changed the system standards. Under either New Jersey or Maryland law, this claim was meritless, the court ruled.

Significantly, while the franchisees cited to Maryland law, Maryland did not recognize a separate cause of action for breach of the implied duty of good faith and fair dealing. While New Jersey did recognize a cause of action for breaching the covenant, the duty of good faith and fair dealing could not be used to supersede the express terms of a valid contract, the court held.

Moreover, a claim for a breach of the implied covenant of good faith and fair dealing required proof of bad motive or intention because contract law does not require parties to act altruistically towards each other, and decisions that happen to result in economic disadvantage to the other party are of no legal significance. The complaints were void of any allegations of bad motive or intention.

Noncompete covenant. The franchisees requested the court to declare the post-termination covenant not to compete in their franchise agreements void and unenforceable. Because this claim was not yet ripe, it was dismissed, the court held. The franchisees did not allege any plan to compete, nevertheless a plan to compete in a way that would violate the covenant.

Audited accounting. The franchisees demanded a formal audited accounting from the franchisor, claiming that they were entitled to an audited accounting under Section 9.2 of the franchise agreement. Despite this allegation, the franchise agreement clearly stated that the franchisor has an obligation to provide an unaudited report, the court noted. Therefore, the franchisees’ demand for an audited accounting per the terms of the agreement was meritless and was dismissed.

Misrepresentation. The franchisees brought two claims for damages based upon alleged misrepresentations arising out of the projections of the initial costs and working capital in the FDD. As a threshold issue, these claims were time-barred under the contractually agreed upon limitations period. Both franchisees agreed in the franchise agreement to bring or assert “any and all claims and actions arising out of or relating to this Agreement” within the earlier of one year of the discovery of the claim or two years after the act giving rise to the claim. This contractual limitations period made no distinction between tort and contract claims, but rather applied to “all” claims relating to the agreement.

The allegations asserted by the first of the two franchisees occurred prior to signing the franchise agreement on or about February 12, 2010 and were not asserted until May 20, 2013. Likewise, the second franchisee’s allegations occurred prior to signing the franchise agreement on or about April 9, 2009, and were not asserted until more than two years later. These claims were therefore barred.

Further, neither the 2008 nor 2009 FDD were prepared or distributed by the franchisor defendant. Rather, each FDD was prepared by a predecessor franchisor that was not a defendant in this action. Any alleged misrepresentations contained within the FDD could not, therefore, be attributed to any of the defendants.

Even if the claims were otherwise cognizable, the claims for either fraud or negligent misrepresentation failed because, under both New Jersey and Maryland law, an action for either common law fraud or negligent misrepresentation must be predicated on a statement of present or past fact. Predictions of future events are not actionable. In this case, the franchisees’ claims for misrepresentations were based upon the estimates made in the FDD of the future initial costs and working capital. The franchisees also alleged that certain oral representations were made to them regarding start-up costs in addition to those in the FDD. Such estimates were not actionable because they related to future events, the court ruled.

Finally, the franchisees could not have reasonably relied on these estimates that were based on a company-owned unit in Maryland, particularly when the FDD disclosed that the estimates were not necessarily the costs that the individual franchisee would incur.

Maryland Franchise Registration and Disclosure Law. The franchisees also alleged a violation of the Maryland Franchise Registration and Disclosure Law. The terms of that statute creates civil liability to “[a] person who sells or grants a franchise.” In their complaint, the franchisees alleged that the franchisor made untrue statements of material fact “[i]n connection with the sale of a Doctor’s Express franchise to Plaintiffs.” However, the defendant-franchisor did not sell or grant the Doctors Express franchise to the franchisees. None of the defendants did, the court observed. Rather, it was a non-party predecessor-in-interest to the franchisor that sold the franchises to the franchisees.

Finally, this claim was time-barred. The statute provides that “[a]ny action under this section must be brought within 3 years after the grant of the franchise.” The franchisees did not file their actions within that timeframe, the court held.

The case is No. 13-4333 (JAP) (TJB).

Attorneys: Gerald Allen Marks (Marks & Klein, LLP) for Surendra Pai, Nexdrxi LLC and Nexetra Corp. Andrew James Hughes (Blank Rome LLP) for DRX Urgent Care, LLC and American Family Care.

Companies: Nexdrxi LLC; Nexetra Corp.; DRX Urgent Care, LLC; American Family Care

Cases: FranchisingDistribution NewJerseyNews