Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Ill. App.: Franchise agreement properly rescinded for violation of franchise disclosure law, (May 19, 2015)

By Greg Hammond, J.D.

A pizza franchise agreement was correctly rescinded where a franchisor failed to comply with the requirements of the Illinois Franchise Disclosure Act of 1987 (IFDA) and the franchisor had an active and essential role in effectuating the sale of the franchise to plaintiffs. The Illinois Court of Appeals in Mount Vernon affirmed the Madison County Circuit Court’s decision, upholding an arbitrator’s finding that the sale of the pizza franchise did not come within an exclusion applicable to the transfer of an existing franchise by the franchisee if the sale is not affected by or through the franchisor (McGill v. Wortham, May 15, 2015, Chapman, T.).

In March 2011, Plaintiffs John and Susan McGill entered into discussions with defendant Eric Wortham to purchase a Pizza World restaurant owned and operated by Wood River Pizza, Inc.—a company under Wortham’s sole ownership and control. Defendant Pizza World USA Franchise Corp., which was also owned and controlled by Wortham, was not registered to sell franchises in Illinois at the time of the discussions. During negotiations, Wortham provided a franchise disclosure document to the McGills, but no franchise agreement for the restaurant existing at the time the disclosure document was dated. Pizza World eventually entered into a franchise agreement with Wood River Pizza, but Wood River failed to pay the franchise fee of $9,500 and did not comply with the requirement to provide a franchise disclosure document to Wood River Pizza at least 14 days prior to executing the franchise agreement.

The McGills subsequently entered into an asset purchase agreement with Wood River Pizza, which closed in May 2011. However, the McGills later learned that the defendants overstated the restaurant’s earnings, the defendants understated its labor costs, and some of the restaurant’s equipment did not function. The McGills requested that Wortham rescind the agreement and refund the money they paid for the purchase, but Wortham refused. After the plaintiffs closed the restaurant and went out of business, they filed suit against Wortham, Pizza World, and Wood River Pizza.

The arbitrator found in favor of the McGills, finding that there was no credible evidence of a franchise agreement; that Wortham used himself and his various entities interchangeably without distinction to purposefully evade the franchise disclosure laws; and that the exclusion in section 7 of the IFDA was not applicable. The circuit court confirmed the arbitrator’s award, finding that Pizza World’s failure to comply with the disclosure requirements and Wood River Pizza’s failure to pay the franchise fee supported the arbitrator’s finding that Wortham used these business entities interchangeably and her conclusion that the subsequent transfer of the franchise to the McGills was a transfer by or through the franchisor. The defendants appealed.

On appeal, the defendants raised three arguments: (1) a recent amendment to the Uniform Arbitration Act expands judicial review of arbitration awards; (2) the arbitrator’s finding that there was no existing franchise agreement to transfer to the plaintiffs was not correct; and (3) the arbitrator’s conclusion that Wortham used his entities interchangeably to evade the franchise disclosure requirements was supported by “zero evidence.”

The court rejected all three arguments, first finding that Illinois courts have not altered their interpretation of the Arbitration Act’s limited scope of review, and declining to depart from established precedent limiting the scope of judicial review of arbitration awards. Second, the court noted that the defendants did not explicitly argue that the arbitrator’s supposed errors were gross error of law or gross mistake of fact, which rendered their arguments beyond the purview of the court’s review. Nevertheless, the court still found no gross error of law or mistake of fact in the arbitrator’s award, because the defendants acknowledged that Wortham reregistered the Pizza World franchise company only after entering into discussions with the McGills to sell them the supposed franchise; the defendant companies—both of which were owned and controlled exclusively by Wortham—entered into a franchise agreement only six days after the registration; and Wood River did not pay the franchise fee required under the agreement. The franchisor consequently had an active and essential role in effectuating the sale of the franchise to the plaintiffs, the court concluded.

The case number is 5-13-0581.

Attorneys: David Duree (David M. Duree and Associates, PC) for John McGill and SJ McGill Inc. G. Edward Moorman (G. Edward Moorman Law Office) for Eric Wortham, Pizza World USA Franchise Corp., and Wood River Pizza, Inc.

Companies: SJ McGill, Inc.; Pizza World USA Franchise Corp.; Wood River Pizza, Inc.

Cases: FranchisingDistribution IllinoisNews