Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Ill. App. Ct.: Allegations of presale fraud did not state common law, franchise law, deceptive practices claims, (Oct 29, 2013)

By John W. Arden, J.D., LL.M.

Claims that Ace Hardware Corp. provided misleading historical financial data regarding the performance of existing Ace hardware stores in a Uniform Franchise Offering Circular and made fraudulent sales and revenue forecasts failed to allege fraud or violations of the Indiana Franchise Disclosure Act or the Illinois Consumer Fraud and Deceptive Business Practices Act, according to the Illinois appellate court (Avon Hardware Co. v. Ace Hardware Corp., October 28, 2013).

Three franchisees brought suit in the Circuit Court of Cook County, alleging that Ace Hardware fraudulently induced them to enter a franchise agreement based on misleading historical financial data and fraudulent sales and revenue forecasts. The franchisees’ stores never approached the forecasted sales and revenues and eventually failed. Their amended complaint alleged that Ace Hardware (1) violated the Indiana Franchise Disclosure Act by providing pro forma and Uniform Franchising Offering Circular (UFOC) documents that did not comply with legal guidelines and reported inflated financial data; (2) violated the Illinois Consumer Fraud and Deceptive Business Practices Act by providing fraudulent financial information, and (3) committed fraud, fraudulent inducement, and negligent misrepresentations.

Ace moved to dismiss the complaint, arguing that the claims were barred by statements in the franchise agreements in which the plaintiffs affirmatively represented that they had not received or relied on any guarantee of sales, revenues, profits, or success of Ace stores. Ace further argued that the financial statements in the documents were mere projections, which are considered statements of opinions and not actionable, and that the information in the documents was not false because it warned that the financial data was based on only a small percentage of Ace stores. The franchisor also asserted that the plaintiffs failed to allege the necessary elements of fraud—namely, that Ace made false statements of material facts and that the plaintiffs reasonably relied on the information.

The circuit court dismissed the plaintiffs’ complaint, stating that cautionary language, if sufficiently substantive and tailored to the projections and opinions in the offering statement, may render the alleged misrepresentations and omissions immaterial as a matter of law. The court determined that the “bespeaks caution” doctrine applied to this case and that the cautionary language of the pro forma and UFOC documents rendered reliance on the statements in the document immaterial as a matter of law. Thus, the court dismissed the complaint with prejudice.

Fraud, negligent misrepresentation. The appellate court first took up the fraudulent inducement, fraud, and negligent misrepresentation claims. To state an action for common law fraud, a plaintiff must plead: (1) a false statement of material fact, (2) knowledge or belief by the defendant that the statement was false, (3) an intention to induce the plaintiff to act, (4) reasonable reliance on the truth of the statement by the plaintiff, and (5) damage to the plaintiff resulting from this reliance. Fraud claims must be pleaded with sufficient specificity, particularity, and certainty to apprise the opposing party of what he or she is called upon to answer, the court observed.

Negligent misrepresentation has essentially the same elements, except that the defendant need not know that the statement is false. Rather, his own carelessness or negligence in ascertaining the truth will suffice.

Regarding these claims, Ace argued that the financial data in the pro forma and UFOC were future projections, which do not constitute facts. The plaintiffs contended that their allegations relate to the historical financial facts, which are actionable. Both parties were correct in part, the court found.

“We agree with Ace that the plaintiffs’ allegations related to projected sales figures or other projected financial data, such as those contained in the pro forma document, are not actionable,” the appellate court held. “Thus, the circuit court properly dismissed the plaintiffs’ complaint as to the claims involving statements of future performance. However, some of the plaintiffs’ allegations were based on false representations of historical financial data of Ace stores. Historical financial data, such as the past store performance averages included in the UFOC, is factual in nature and actionable, and we continue our analysis of those claims.”

The plaintiffs argued that Ace could not shield its statements from liability under the “bespeaks caution” doctrine where it knew it had misrepresented material facts regarding the stores’ past performance in order to entice new investors. The court agreed that the doctrine applied to cautionary statements relating to future projections, not present facts or current conditions. “However, we still analyze statements in context and consider whether all elements of the plaintiffs’ claims have been properly pleaded.” In doing so, the court agreed with Ace that its documents did not contain the alleged false statements of material facts and that any reliance on the historical data as evidence of all Ace stores or future Ace stores was unreasonable.

In this case, the language of the UFOC sufficiently demonstrated that Ace neither made false statements of material fact nor concealed material facts regarding the historical financial data of its stores, the court observed. The UFOC clearly stated that the financial data was based on only a small fraction of all Ace stores (37 percent for 2004 and 41 percent for 2005). The form stated that the data came only from stores that reported their numbers and warned that Ace did not independently verify any of the information submitted by the stores.

“Thus, contrary to the plaintiffs’ allegations, the documents provided to them did not conceal the fact that the historical financial data was not representative of the performance of all Ace stores and did not fail to account for failed Ace stores.”

To the extent that the plaintiffs alleged that they relied on the data as a representation of the performance of all Ace stores, the cautionary language in the documents rendered any reliance on the alleged misrepresentations unreasonable, in the court’s view.

Because the plaintiffs failed to state the necessary elements of a reasonable reliance and materiality of their common law fraud claims, the appellate court ruled that the dismissal of the fraud and negligent misrepresentation claims was proper.

Statutory claims. The appellate court affirmed the dismissal of the Indiana Franchise Disclosure Act and Illinois Consumer Fraud and Deceptive Business Practices Act for similar reasons that supported dismissal of the fraud claims.

The Indiana franchise law creates a private right of action only for acts that constitute fraud, deceit, or misrepresentation. Such claims require reasonable reliance and materiality. In this case, the plaintiffs failed to state these elements as a matter of law.

Although the Illinois consumer fraud statute does not require reliance, it does require materiality, the court explained. As concluded in the fraud analysis, the documents provided by Ace did not make any false statements of material fact or conceal any material facts.

The case is No. 1-13-0750.

Attorneys: Kenneth A. Wexler (Wexler Wallace LLP) and J. Gordon Rudd, Jr. (Zimmerman Reed, PLLP) for Avon Hardware. DLA Piper LLP and Leon & Hughes for Ace Hardware Corp.

Companies: Avon Hardware Co.; Ace Hardware Corp.

Cases: FranchisingDistribution IllinoisNews