Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—DMd: Maryland Franchise Law Claims Proceed Against Medical Center Franchisor and Franchise Broker, (Feb 27, 2013)

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

A medical center franchisee may proceed with claims under the Maryland Franchise Registration and Disclosure Law against the franchisor and its franchise broker over alleged misrepresentations and omissions in the documents provided by the franchisor to the franchisee and an alleged attempt to condition the sale of the franchise on a waiver of the franchisee’s claims, the federal district court in Baltimore has ruled (Hanley v. Doctors Express Franchising, LLC, February 25, 2013, Hollander, E.).

Doctors Express Franchising, LLC offers medical center franchises. In January 2010, Raymond and Marsha Hanley began expressing interest in acquiring a medical center franchise, and Rhino 7 Consulting Co., as Doctors Express’s franchise broker, contacted the Hanleys and sent them a copy of Doctors Express’s Franchise Disclosure Document (FDD) and an Urgent Care Benchmarking Study describing aspects of medical centers, such as number of patients treated and average revenue per patient. The FRD was allegedly the same as the FRD Doctors Express had filed with the California Commissioner of Corporations.

The Hanleys then asked Rhino 7 to refer them to a Small Business Administration lender that could finance their franchise. A Rhino 7 representative forwarded them to First Financial, a lending institution apparently affiliated with Doctors Express, which provided the Hanleys with a Dcotors Express Business Model, allegedly prepared by Doctors Express. The Business Model “contained estimates of income, expenses, and patient volume for the first two years of operation of a [Doctors Express] franchise,” and a First Financial employee told the Hanleys it accurately represented the performance of a typical Doctors Express franchise.

The Hanleys, through their business entity Hanley Limited Partners, LLC, executed a franchise agreement, and later sent Doctors Express a business plan for their franchise. However, their franchise only lasted about six months before the Hanleys closed it, allegedly because it “operate[d] at a substantial financial loss each month.” Prior to closing the franchise, the Hanleys attempted to sell the franchise to Doctors Express’s “Master Franchisor,” but Doctors Express conditioned their purchase of the franchise on the Hanleys agreeing to a release of their claims against Doctors Express. The Master Franchisor later withdrew his offer due to delay in obtaining approval from Doctors Express.

The Hanleys filed suit against Doctors Express and Rhino 7, asserting claims under the Maryland Franchise Registration and Disclosure Law (“FRD Law”), common law fraud, and common law constructive fraud. The Hanleys alleged that the defendants had made numerous misrepresentations with regard to “(a) the required initial investment; (b) the initial operating capital requirements; (c) the physician credentialing and health insurance reimbursement contracting process; and (d) the projected earnings and financial performance of the [Doctors Express] franchise.” The Hanleys also claimed that Doctors Express’s attempt to get the Hanleys to agree to a waiver of their claims also constituted a violation of the Maryland franchise law. Rhino 7 and Doctors Express moved to dismiss.

The court began its discussion of the FRD Law claims by noting that neither party disputed that the law applied to the Doctors Express franchise offer. Under the Franchise Law, a franchisee can have a private right of action against a franchisor for offering a franchise “by means of an untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading, if the person who buys or is granted a franchise does not know of the untruth or omission.” Moreover, the FRD Law also provides that “[a]s a condition of the sale of a franchise, a franchisor may not require a prospective franchisee to agree to a release assignment, novation, waiver, or estoppel that would relieve a person from liability under [the FRD Law].”

Doctors Express first argued that it had not made any misrepresentations, because all of the representations in the FDD and the franchise agreement “were expressly labeled as estimates or projections, which are not statements of fact and are therefore not actionable.” Since Doctors Express based its projections on the performance of a facility owned by an affiliate, and did not misrepresent that performance, and since it “warned prospective franchisees that the projections and estimates could not be relied upon to predict accurately the future performance of a franchise,” it had not engaged in any misrepresentations, it contended.

The court rejected this argument. Although the court agreed that “[e]stimates or projections of future profits are statements of opinion,” the court observed that “inaccurate projections of future profitability and inaccurate planning volumes could be considered fraudulent if there was evidence that the [defendant] knew they were inaccurate at the time they were made.”

Here, the Hanleys alleged that Doctors Express’s projections constituted “untrue statement[s] of material fact” or “omission[s] to state a material fact” under the FRD Law, and that they “constituted knowingly false misrepresentations or concealment of material facts.” They also provided allegations regarding the alleged misrepresentations or omissions that satisfied the Federal Rule of Civil Procedure 9(b) standard. The court concluded that the Hanleys had stated a claim at the motion to dismiss stage.

The court also rejected Doctors Express’s argument that it was not obligated under the FRD Law to update its FDD any more than annually, and therefore that the Hanleys could not “identify a duty of disclosure to support a claim for fraudulent concealment.” The court observed that “fraudulent concealment is actionable even in the absence of a duty to disclose,” and that such concealment “is in effect a representation that what is disclosed is the whole truth.” Although Doctors Express was not obligated to represent the financial performance of a franchise in its FDD, having done so it “was required to make a representation that was supportable based on what it knew at the time it made the representation.”

The court dispensed with an argument that Doctors Express did not conceal the fact that its projection were based on 2007-2008 data, and that the Hanleys “should have known that financial data from 2009 was going to be available in the near future” when they signed the franchise agreement. Whether or not that argument would convince a fact finder, the argument did not “undermine the sufficiency of plaintiffs’ claims at the pleading stage.”

Doctors Express also claimed that various disclaimers in the FDD and the franchise agreement meant that it was unreasonable for the Hanleys to rely on the alleged representations and projections from Doctors Express. Even if it had made misrepresentations, Doctors Express argued, “the misrepresentations were not ‘material,’ because a ‘material’ fact is one on which a reasonable person would rely.”

The court concluded that the FRD Law foreclosed that argument. Under that law, “[a]s a condition of the sale of a franchise, a franchisor may not require a prospective franchisee to agree to a release assignment, novation, waiver, or estoppel that would relieve a person from liability under [the FRD Law].” The court determined that this provision “preclude[d] Doctors Express’s reliance on the disclaimers and integration clause to defeat liability.”

Although the court noted that court were divided on the issue of whether similar disclaimers precluded reasonable reliance on a franchisor’s representations, the court chose to follow courts that had decided that such disclaimers were inoperative to the extent that they would operate as the kind of waiver proscribed by the FRD Law. However, the court noted that “the disclaimers remain factually relevant, and might be persuasive to a fact finder with respect to the materiality of the alleged misrepresentations and omissions and the reasonableness of plaintiffs’ reliance on them.”

The court also declined to dismiss the Hanleys’ claim that Doctors Express violated the FRD Law and related regulations by attempting to condition the sale of their franchise on the execution of a release of Doctors Express’s liability, allegedly as required under a provision of the franchise agreement. Although Doctors Express contended that the provision “applie[d] only to a ‘sale, renewal, or assignment of a franchise’ between the franchisor and the franchisee,” the court noted that it did not support this proposition with any authority, and the provision’s text did not indicate that limitation.

The court also rejected Doctors Express’s argument that the Hanleys’ claims should have been dismissed to the extent they were based on the credentialing and insurance reimbursement contracting process. Doctors Express had pointed to an e-mail in which Raymond Hanley had stated that “all damages stemming from credentialing and contracting are linked exclusively to [a third party’s] misconduct.”

The court found it could not consider that e-mail on a motion to dismiss, but even if it could, it would not have had the effect Doctors Express attributed to it. It was not a claim in litigation that could be subject to judicial estoppel. Moreover, the Hanleys may have had other reasons for making the statement, such as that the Hanleys made it before discovering Doctors Express’s fault, that Doctors Express might be vicariously liable for the third party’s misrepresentations, or that the Hanleys merely wanted to spur Doctors Express into resolving their complaints, even though the Hanleys knew Doctors Express was partly at fault.

Rhino 7 argued that the FRD Law was significantly narrower than the FTC’s Franchise Rule, because the Franchise Rule applied to entities that “arrange for the sale of a franchise,” while the FRD Law only referred to those who “sell or grant” franchises. The court rejected this argument, noting that the FRD Law defined a franchisor as “a person who grants a franchise.” If the legislature had wanted to limit the statute to just franchisors, it would not have included the “sells” language as well, the court found. Moreover, the court observed that the language of the statute indicated that it was to be applied broadly.

Furthermore, the court observed that the FRD Law differed from the common law in the key respect that the “defendant’s lack of scienter is an affirmative defense” under the FRD law, while the plaintiff had to prove the defendant’s knowledge under the common law. Under the FRD Law, the Hanleys did not have to demonstrate Rhino 7’s knowledge of the falsity of Doctors Express’s statements. Although Rhino 7 might be able to prove that affirmative defense, it could not be resolved on a motion to dismiss. Therefore, the court declined to dismiss the claim.

The case is Civil Action No. ELH-12-795.

Attorneys: Russell James Gaspar (Cohen Mohr LLP) for Raymond V. Hanley. Jeffrey W. Bredeck (Eccleston and Wolf PC) for Doctors Express Franchising, LLC. Ian Cameron Taylor (DLA Piper US LLP) for Rhino 7 Consulting Co.

Companies: Doctors Express Franchising, LLC; Hanley Limited Partners, LLC; Rhino 7 Consulting Co.

Cases: FranchisingDistribution MarylandNews