Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION —N.D. Ga.: Restaurant franchisor avoids claims over disclosure of its CEO’s financial stake in supplier, (Feb 5, 2015)

By Linda O’Brien, J.D., LL.M.

Franchisees of Mexican food restaurant Moe’s Southwest Grill failed to prove at trial fraud, misrepresentation, and state civil RICO claims against the franchisor in their suit to recover allegedly illegal undisclosed "kickbacks" provided by Moe's suppliers to Moe’s CEO, the federal district court in Atlanta has decided. A revised offering circular provided to existing franchisees made no representations regarding the franchisor not deriving income from franchisee food purchases, and the merger clauses in the marketing development and franchise agreements precluded their RICO and consumer protection claims (Massey, Inc. v. Moe’s Southwest Grill, LLC, February 3, 2015, Story, R.).

Prior to joining the Moe’s franchise, prospective franchisees received a Uniform Franchise Offering Circular (UFOC). Franchisees were required to execute both a market development agreement and franchise agreement, which set forth the franchisee’s obligations as a developer of the franchise and included the UFOC as an exhibit.

The UFOCs that these franchisees received prior to entering into their franchise agreements in 2002 and 2003 obligated them to purchase certain products from Moe's-approved suppliers. At that time, the UFOCs stated that the required suppliers were not affiliated with the franchisor and that “neither we nor any of our affiliates” would derive any income from the required purchases. The UFOCs were revised in 2005 to disclose that Moe's CEO Martin Sprock had an ownership interest in one of Moe's suppliers, as well as other suppliers. The statement within the UFOC was revised to explain that the franchisor did not “derive revenue, directly or indirectly, from any of these suppliers in connection with the services or products they provide to our franchisees.” The reference to “affiliates” of the franchisor was deleted.

Subsequently, 39 franchisees, brought fraud, misrepresentation, and state civil RICO claims against the franchisor to recover allegedly illegal undisclosed “kickbacks” provided by Moe's suppliers to Moe CEO Martin Sprock. The case was before the court for a bench trial.

Fraud claim. The court determined that the complaining franchisees failed to sustain a claim for fraud based on the supply requirement and disclosure in the UFOC. The plaintiffs’ argument that the provision was a false representation since it failed to disclose that Spock and the supplier in which he had an ownership interest were affiliates of Moe’s was rejected. The court noted that the UFOC made no representations regarding Moe’s or its affiliates derived any income from the purchases by franchisees of food, paper products, hardware, or software. Even if Sprock and the supplier were affiliates of Moe’s, the UFOC made no false representation as to the fact of their receipt of income derived from food purchases by franchisees. Furthermore, the merger and integration clauses of the market development and franchise agreements precluded the plaintiffs’ claims based on the pre-contractual statements made by Sprock that Moe’s did not derive income from the purchases by franchisees in the supply chain.

RICO claim. Since the plaintiffs failed to establish a false misrepresentation of material fact in the UFOCs, the court found that the plaintiffs also failed to show the type of fraudulent activities that would support a finding of mail or wire fraud as a racketeering activity for a RICO claim. Under the state RICO act, it is unlawful for anyone to require an interest in or control of money or property through a pattern of racketeering activity. According to the court, the merger and integration clauses of the market development and franchise agreements precluded the plaintiffs’ RICO claim of deceit by prior representations.

Moreover, in those agreements, the plaintiffs waived any reliance on representations made the defendants and agreed that they conducted an independent investigation of the merits of the business venture. Thus, they could not show that their damages were caused by the alleged predicate acts.

Consumer protection claim. The Tennessee Consumer Protection Act (TCPA) grants a private right of action to consumers who suffer a loss due to unfair and deceptive acts or practices. FTC regulations require that the franchisor disclose whether it or its affiliates will or may derive revenue from required purchases or leases by franchises. In this case, disclosure of the business arrangement between Sprock and the supplier was required under FTC regulations, and Moe’s failure to provide that disclosure was an unfair and deceptive act under the TCPA, the court explained. However, the plaintiffs failed to show an ascertainable loss they suffered as a result of the TCPA violation.

The court noted that the plaintiffs failed to prove they suffered any loss as result of commissions paid to Sprock and the supplier or caused by business relationship between the CEO and the supplier. On the contrary, the evidence showed that it was likely that the relationship resulted in net savings to the franchisees from the increased buying power. Thus, judgment was entered in favor of the defendant.

The case is No. 1:07-CV-0741-RWS.

Attorneys: K. Brian Roller (Zarco, Einhorn, Salkowski & Brito, PA), Leon Hirzel (Hirzel & Dreyfuss, PA), and Robert M. Einhorn (Zarco, Einhorn, Salkowski & Brito, PA) for Barco Grills, LLC, Parde Roswell, LLC, Parde, LLC, and Gryphmore Foodservices of Kentucky, Inc. Blakely Holloway Frye (Hill Kertscher & Wharton) for Moe's Southwest Grill, LLC, Raving Brand Holdings, Inc., Raving Brands, Inc., and Moe's Southwest Holding, LLC.

Companies: Barco Grills, LLC; Parde Roswell, LLC; Parde, LLC; Gryphmore Foodservices of Kentucky, Inc.; Moe's Southwest Grill, LLC; Raving Brand Holdings, Inc.; Raving Brands, Inc.; Moe's Southwest Holding, LLC

Cases: FranchisingDistribution RICO StateUnfairTradePractices GeorgiaNews