Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—Mich. Ct. App.: Jury verdict of silent fraud in violation of Michigan Franchise Investment Law reinstated, (Feb 5, 2014)

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

The Michigan Court of Appeals has reinstated a jury verdict, finding that Wireless Toyz Franchise engaged in silent fraud towards a franchisee in violation of the Michigan Franchise Investment Law and awarding more than $200,000 to the franchisee (Abbo v. Wireless Toyz Franchise, L.L.C., February 4, 2014, Per Curiam). The decision overturned the trial court’s entry of judgment notwithstanding the verdict and its ruling that the merger clause in the franchise agreements precluded the franchisor’s liability for silent fraud, the evidence did not support a claim for silent fraud, and the franchisee failed to establish the reasonable reliance element of silent fraud.

Wireless Toyz is a franchisor of retail stores that sell electronic communication devices and initiate cellular telephone services with various providers. Franchisees can earn commissions by selling third-party service contracts and profit from marketing cell phones and related merchandise. David Abbo is an entrepreneur who became interested in Wireless Toyz as a business opportunity. In discussions with Abbo, the vice president of franchise development for Wireless Toyz made factual representations regarding subjects relevant to a franchisee’s success. He extolled the great relationship that Wireless Toyz had with cellular carriers, noted the low inventory costs franchisees had due to reduced bulk pricing, mentioned a “formidable” training program for incoming franchisees, and said that franchisees earned the best commissions because of the franchisor’s national presence.

Abbo reviewed the franchisor’s Uniform Franchise Offering Circular (UFOC), which presented a chart detailing average monthly gross revenues for stores and noting monthly post-paid activations per location. The UFOC itself said that a franchisee’s commissions could be subject to chargebacks but did not include any data on the way chargebacks operated to decrease the gross profit number represented by the “average commissions” figure.

In August 2004, Abbo’s business entity, Wireless Phones, entered into a franchise agreement with Wireless Toyz. Abbo paid a $20,000 franchise fee and opened a store in Colorado. Shortly thereafter, another of Abbo’s business entities agreed to become a development agent and paid $180,000 for the exclusive right to market and sell franchises in Colorado. By the fall of 2006, Abbo’s store ranked in the top third of the franchises nationwide, but he deemed his profits insufficient. His store experienced a chargeback rate of 40 percent each month and absorbed hits of $75 to $100 on almost every phone sold. Abbo discovered that Verizon did not participate directly with Wireless Toyz franchises and that cellular service activations were brokered through a middleman who received a cut of the profits. He also discovered that Wireless Toyz had no relationship with Cingular. Despite the franchisor’s claim that Wireless Toyz enjoyed low inventory costs, Abbo determined that it was actually cheaper for him to purchase items at a big box store. He later testified that the franchisor provided no training on how to manage chargeback disputes, how to conduct commission audits, or how to control inventory. He sought to end his relationship with Wireless Toyz and to sell the franchise back to the franchisor. Wireless Toyz refused the offer. By 2009, Abbo’s franchise had closed.

Abbo filed suit against Wireless Toyz, charging violations of the Michigan Franchise Investment Law and breach of contract and raising claims for rescission, fraudulent and innocent misrepresentation, concert of action, and silent fraud. A subset of the breach of contract claims were dismissed before trial, and Abbo withdrew the rescission claims with prejudice. Wireless Toyz sought a directed verdict after Abbo presented his case-in-chief, but the trial judge denied that motion except to one defendant.

The jury determined that the franchisor violated the disclosure provision of the Michigan Franchise Investment Law, but that the franchisor had established an estoppel defense. The jury concluded that the franchisor breached the contract, but accepted the affirmative defense that Abbo committed the first substantial breach. It found that the franchisor did not make any actionable affirmative fraudulent statements, but was liable for silent fraud, awarding $20,000, representing the franchise fee, and $180,000, representing the development agent fee.

The post-trial court granted the franchisor’s motion for judgment notwithstanding the verdict, ruling that (1) the merger clauses in the agreements precluded the franchisor’s liability for silent fraud, (2) the trial evidence did not support a claim for silent fraud; and (3) Abbo failed to establish the reasonable reliance element of the silent fraud claim. On appeal, Abbo challenged only the entry of judgment notwithstanding the verdict on the silent fraud claim.

Silent fraud. To prove silent fraud, Abbo had to establish that Wireless Toyz (1) suppressed or concealed the truth by employing false and misleading words (2) with the intent to defraud or deceive (3) while having a duty to disclose factually accurate information. Abbo’s silent fraud claim focused on the franchisor’s failure to disclose the truth regarding hits, chargebacks, the nature of the franchisor’s relationship with cell phone carriers, the hidden costs of purchasing inventory from the franchisor, and the number of sales necessary to make a profit.

Merger clauses. While the post-trial court determined that merger clauses in the franchise and development agreement barred the silent fraud claim, the appellate court disagreed. “Merger clauses bar evidence of earlier agreements because the law presumes that a contract represents the final expression of the parties’ bargaining,” the appellate court observed. “Silent fraud, however, involves information that has been deliberately and deceptively withheld by one of the contracting parties. Undisclosed material facts that were never the subjects of precontractual negotiations are not absorbed by a contract.”

Moreover, merger clauses do not mechanically eliminate from consideration all precontractual statements or representations. A party may present evidence that deceit induced a contract, thereby rendering the agreement void, according to the court. Parol evidence substantiating that Wireless Toyz fraudulently concealed the true effects of hits and chargebacks, poor relationships with cellular carriers, high inventory costs, and ineffective training programs neither contradicted nor varied any contractual terms. Thus, the post-trial court erred in concluding that the merger clauses immunized the franchisor from the silent fraud claim.

Duty to disclose. The post-trial ruling that Abbo’s evidence failed to establish that Wireless Toyz committed silent fraud was reversed. Contrary to the ruling, Abbo clearly and convincingly demonstrated that the franchisor had a duty to disclose information that it suppressed or misrepresented with the intent to defraud. The Michigan Franchise Investment Law imposes a statutory duty on franchisors to refrain from making material misrepresentations and omitting pertinent information from any disclosures. When the franchisor’s representatives made statements about chargebacks, hits, inventory costs, and training programs, they had a statutory duty to speak the truth, the court of appeals held. “As a matter of law defendants owed Abbo a duty to disclose truthful, non-misleading information in the UFOC and to avoid concealing or misrepresenting material facts when responding to further inquiries.”

Evidence of silent fraud. The trial evidence substantiated that hits and chargebacks figured prominently in the investment calculus of cellular telephone retail business. Viewed in the light most favorable to Abbo, the evidence substantiated that the franchisor’s representative knowingly eased Abbo’s concerns about hits and chargebacks by providing falsely deflated figures, asserting that chargebacks affected only five to seven percent of total commissions “and that a good operator could keep the percentage much lower than that.” Other representations about the costs of inventory and the training program proved false as well. The post-trial court erred in determining that judgment notwithstanding the verdict was proper, based on Abbo’s failure to establish the reliance element of silent fraud.

Damages. Finally, the grant of judgment notwithstanding the verdict on the jury’s award of rescissionary damages was improper. There was nothing in the Michigan Franchise Investment Law requiring a plaintiff to select between rescissionary and actual damages. Further, there was overlap between rescissionary and actual damages in this case, rendering the jury’s award proper, even if there were such a requirement.

Dissent. A dissent, filed by Judge Michael Riordan, maintained that the trial court judgment should be affirmed because the evidence, viewed in a light most favorable to Abbo, failed to establish a claim of fraud as a matter of law. He argued that the merger clauses did in fact bar a claim for silent fraud.

The case is No. 304185.

Attorneys: John Hermann (John T. Hermann Law Offices) for David Abbo. Brian Witus for Wireless Toyz Franchise, L.L.C.

Companies: Colorado Toyz Inc.; Wireless Phones LLC; Wireless Toyz Franchise LLC; JSB Enterprizes Inc.

Cases: FranchisingDistribution MichiganNews