Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Ga. App.: Negligence, misrepresentation damage awards to daycare center franchisees reversed, (Jun 13, 2016)

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

Because the former franchisees of a daycare center failed to prove that they suffered any out-of-pocket damages as a result of alleged misrepresentations made by their franchisor Legacy Academy, a Georgia state trial court erred in denying the franchisor’s motions for directed verdict and judgment notwithstanding the verdict ("JNOV") on the franchisee’s claims for negligent misrepresentation and negligence under Georgia law, a Georgia appellate court has ruled. However, the trial court did not err in denying the franchisor’s motion for a directed verdict on its counterclaim for attorney fees or in denying the franchisee’s motions for directed verdict and JNOV on the franchisor’s counterclaims for lost royalties and advertising fees (Legacy Academy, Inc. v. Doles-Smith Enterprises, Inc., June 9, 2016, Barnes, A.).

The parties entered into a franchise agreement that incorporated the representations made in the franchisor’s Uniform Franchise Offering Circular ("UFOC") in 2006. The franchise opened for business in 2008. As a result of financial troubles—including net losses in 2009, 2010, and 2011—the franchisee stopped paying monthly royalties and advertising fees to the franchisor after March 2011. In 2012, the franchisee notified the franchisor that it was terminating the franchise upon discovering false and misleading information in the UFOC. The franchisee removed all indicia of Legacy affiliation from the center and began operating under a different name. After the termination, the franchisee turned a net profit in 2012, the court noted.

The franchisee (together with its individual owners) filed suit, alleging that the representations in the UFOC about Legacy’s litigation history and the projected cash flow of its franchises were materially false and misleading and violated the FTC’s Franchise Rule. Based on the alleged misrepresentations in the UFOC, the franchisee asserted, among other things, claims for negligent misrepresentation and for negligence under OCGA § 51-1-6 for the breach of duties imposed by the FTC Franchise Rule. The franchisor asserted counterclaims for breach of the franchise agreement, seeking recovery of lost royalties and advertising fees, and for attorney fees.

The jury found in favor of the franchisee on the claims of negligent misrepresentation (awarding $350,000 in damages) and negligence under OCGA § 51-1-6 (awarding $40,000 in damages).The jury also found in favor of Legacy on its breach of contract counterclaim for lost royalties and lost advertising fees (awarding $46,300 in damages). The jury declined to award attorney fees to Legacy. The trial court entered final judgment on the jury’s verdict, and both parties appealed.

Negligent misrepresentation. The franchisor argued that the trial court erred in denying its motions for directed verdict and JNOV on the franchisee’s negligent misrepresentation claim because the franchisee failed to prove any out-of-pocket economic damages proximately resulting from the alleged misrepresentations contained in the UFOC. The appellate court agreed.

Proof of actual economic loss, proximately resulting from the defendants’ negligent misrepresentation, is an essential element of a negligent misrepresentation claim, the court explained. Notably, as it conceded on appeal, the franchisee did not introduce any evidence at trial, expert or otherwise, of the difference between the purchase price that it paid for the Legacy franchise and the value of the franchise actually sold to them in light of the alleged misrepresentations in the UFOC. In other words, the franchisee presented no evidence of any out-of-pocket direct damages resulting from the franchisor’s alleged misrepresentations. Instead, it sought only to prove consequential damages proximately resulting from the alleged misrepresentations.

The $40,000 franchise fee and $200,000 in personal debt obligations, however, were not recoverable as consequential damages for the alleged negligent misrepresentations contained in the UFOC, the court determined. Consequential damages are defined as losses that do not flow directly and immediately from the injurious act but that result indirectly from the act. Indeed, awarding consequential damages in the amount of the purchase price and other costs inherent in the underlying purchase of a franchise "would be tantamount to putting [a franchisee] into the position [it] would be in if the transaction with [the franchisor] had never taken place." Massey, Inc. v. Moe’s Southwest Grill, LLC, Business Franchise Guide ¶15,454 (N.D. Ga. Feb. 3, 2015).

Furthermore, testimony regarding the loss of the franchise owners’ savings was simply too vague and would have required the jury to resort to speculation and guesswork in awarding damages, according to the court. This testimony thus did not provide a basis for the recovery of consequential damages in this case. Finally, neither the franchisee’s bus expense nor salary losses of the individual owners proximately resulted from the alleged misrepresentations in the UFOC and thus could not be recovered as consequential damages under subsection (b) of Restatement § 552B, the court held. The trial court therefore erred in denying the franchisor’s motions for directed verdict and JNOV on the negligent misrepresentation claim.

Negligence. The franchisor also contended that the trial court erred in denying its motions for directed verdict and JNOV on the franchisee’s negligence claim under OCGA § 51-1-6 for the violation of duties imposed by the FTC Franchise Rule because the franchisee failed to prove any economic damages. For the same reasons discussed above, the franchisee failed as a matter of law to establish any economic damages to support their claim for negligence under OCGA § 51-1-6, and thus the trial court should have granted the franchisor’s motions for directed verdict and JNOV on this claim as well, the appellate court explained.

Attorney fees. Legacy argued that the trial court erred in denying its motion for directed verdict on its counterclaim for contractual attorney fees. The determination of the reasonableness and value of attorney fees is for the trier of fact, the court said. The trier of fact is not bound to the opinion of an attorney regarding the reasonableness and value of his own fees. It followed that the trial court committed no error in declining to direct a verdict in the amount of $32,170 on Legacy’s counterclaim for contractual attorney fees.

Lost royalties and advertising fees. The franchisee asserted that the trial court erred in denying its motions for directed verdict and JNOV on Legacy’s breach of contract counterclaim seeking to recover lost royalties. According to the franchisee, Legacy failed to come forward with sufficient evidence of its lost profits from royalties to allow the jury to calculate damages without resorting to speculation and guesswork. The appellate court disagreed. Testimony provided at least some evidence of avoided costs and expenses and authorized the jury, as the trier of fact, to calculate the amount of lost profits from royalties with reasonable certainty.

Additionally, the franchisee’s contention that the trial court erred in denying their motions for directed verdict and JNOV on Legacy’s breach of contract counterclaim seeking to recover lost advertising fees was rejected. Contrary to the franchisee’s position, Legacy was not required to calculate how much the loss of the fees diminished its brand, but instead could rely on the value assigned to the fees by the parties themselves – one percent of the franchisee’s gross monthly revenue – as a basis for its damages. Consequently, the trial court committed no error in denying the franchisee’s motions for directed verdict and JNOV on Legacy’s counterclaim to recover lost advertising fees, the court held.

The case is Nos. A16A0174 and A16A0175.

Attorneys: Cary Ichter (Ichter Thomas LLC) for Doles-Smith Enterprises Inc. Charles L. Bachman Jr. (Gregory, Doyle, Calhoun & Rogers, LLC) for Legacy Academy, Inc.

Companies: Doles-Smith Enterprises Inc.; Legacy Academy, Inc.

Cases: FranchisingDistribution GeorgiaNews