Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—N.D. Ind.: Buying club could have breached franchise agreement by overcharging fees, (Nov 21, 2013)

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

Members-only buying club franchisor DirectBuy, Inc., and its affiliate Trivest Partners, LP, could have breached a franchise agreement with two franchisees by charging the franchisees more for advertising and marketing than the agreement allowed, the federal district court in South Bend, Indiana, has decided (Arcangelo, Inc. v. DirectBuy, Inc., November 20, 2013, Simon, P.).

However, the franchisee’s breach of an implied duty of good faith and fair dealing was dismissed on the ground that Indiana law provided no basis for an implied duty of good faith attached to the parties’ franchise agreements. In addition, the franchisees’ claims for tortious interference, criminal conversion, unjust enrichment, breach of fiduciary duty, and for a declaratory judgment were dismissed.

Background. The franchisees brought suit against the franchisor, believing that over a period of years they were charged more for advertising and marketing than their franchise agreements allowed. Trivest, LP was alleged to control Trivest Fund IV, LP, the company that acquired a controlling interest in DirectBuy in late 2007.

Breach of contract. The franchisees alleged that “Paragraph 3.03 of the DirectBuy Franchise Agreements limits DirectBuy’s right to charge Franchisees for national marketing and advertising to a maximum of3% of annual gross new membership sales (the ‘3% Cap’).” However, at this stage of the case, the court was unable to make a definitive interpretation of the interrelated provisions in the franchise agreement concerning marketing and advertising.

The fundamental question to be answered in this case was whether the charges that the franchisees complained of were assessed as contributions to the Marketing and Legislative Fund, as charges for marketing materials, or whether they were imposed as fees of some other kind altogether. What the franchisees characterized as charges for national marketing and advertising programs subject to the 3% cap, the franchisor characterized as charges for “sales leads” that were not subject to any cap (except for reasonableness). To get to the bottom of the disagreement about the disputed charges, a number of subsidiary questions needed to be resolved. These involved factual determinations that could not be made at this time, the court held. The complaint’s allegations were sufficient to permit a reasonable inference that DirectBuy was liable for breach of the franchise agreement.

DirectBuy also suggested that the franchisees’ reading of the agreement was defeated by the contrary determination of a Pennsylvania bankruptcy court. See In re Trinity Innovative Enterprises, LLC, Case No. 09-20579-REF (Bankr.E.D.Penn. 2009). Trinity was cited as persuasive authority, but had no preclusive effect because neither of the plaintiffs in this case were parties to that proceeding.

But more importantly, the bankruptcy judge’s determinations in Trinity involved factual findings based on an evidentiary hearing and a record that included evidence concerning the history of the Marketing and Legislative Fund, the practices and methods for DirectBuy’s assessment of fees to its franchisees generally, and its history with the franchisee in that case.

The procedural posture of the Trinity case demonstrated why the court must deny DirectBuy’s motion to dismiss. The bankruptcy judge in Pennsylvania had the benefit of full factual record before him. When and if this case reached a similar stage, the court would give the analysis in Trinity the consideration appropriate for such non-controlling authority.

Breach of duty of good faith. Under Indiana law, a duty of good faith and fair dealing is implied only in certain kinds of contracts, such as insurance contracts, employment contracts, contracts under the Uniform Commercial Code as adopted in Indiana, and contracts that are “ambiguous as to the application of the covenants.” Coates v. Heat Wagons, Inc., 942 N.E.2d 905, 918 (Ind. App. 2011). Only the last of these four possibilities could apply here.

But even if the court considered Indiana law to imply an overall duty of good faith in a contract that was ambiguous as to whether it contains such a duty, it would not find such an implied duty here. This was because the DirectBuy franchise agreement states the exact opposite in §18.10: “If applicable law shall imply a covenant of good faith and fair dealing in this Agreement, the parties agree that such covenant shall not imply any rights or obligations that are inconsistent with a fair construction of the terms of this Agreement.” The clause goes on to express four further attempts to limit the impact of any such implied duty. The language of §18.10 is clearly inconsistent with any express assumption of a duty of good faith, and is not ambiguous about whether such a duty is to apply, the court explained.

Because Indiana law provided no basis for an implied duty of good faith attaching to the parties’ agreements, the claim was dismissed.

Constructive termination. Both parties treated Count 1 of the complaint as if it also contained a claim of constructive termination of the franchises, based on the allegation that the fees in excess of the applicable 3% cap so significantly impacted the franchises’ net income as to result in a de facto termination of the franchises. Count I’s heading does not identify it in that manner, referencing only breach of contract and breach of the duty of good faith.

As just discussed, the latter claim was dismissed. To the extent the constructive termination was alleged to constitute a breach of the franchise agreements, it survived this motion to dismiss for the reasons already explained. To the extent the constructive termination was intended as a separate cause of action, DirectBuy’s challenge to that theory was not articulated until its reply. The issue whether Indiana law recognized such a claim was not adequately briefed and the court would not decide it here.

Tortious interference. The theory behind the claim against Trivest for tortious interference with contract was that after Trivest’s acquisition of a controlling interest in DirectBuy’s parent corporation in 2007, Trivest principals placed on DirectBuy’s Board of Directors intentionally induced or directed the aggressive and expensive national marketing and advertising strategy that triggered the imposition of fees on DirectBuy franchisees in excess of the 3% cap.

The franchisees’ allegations did not identify an illegitimate business purpose or a malicious intent exclusively directed to the harm of the franchisees, the court noted. To the extent the case reflected a disagreement between the franchisees and the franchisor as to the wisdom of expensive marketing efforts and their impact on the overall business model, that disagreement could not be viably shoe-horned into a tortious interference claim, according to the court. Thus, the claim was dismissed.

Criminal conversion. The franchisees alleged that by causing DirectBuy to charge franchisees far in excess of the applicable 3% cap, the defendants took “unauthorized control” over the property of the franchisees, constituting a criminal conversion under Indiana law.

DirectBuy’s best challenge to the criminal conversion count was that such a claim could apply only in circumstances involving a determinate sum that the defendant was entrusted to apply to a certain purpose. The franchisees argued that the challenged sums at issue in this case were supposed to be separately held and accounted for in the Marketing and Legislative Fund, circumstances sufficient for a criminal conversion claim.

However, even if the Marketing and Legislative Fund existed and was the basis for the assessment of the disputed fees as the franchisees alleged, the fees assessed were not money that continued to belong to the plaintiffs but was merely held and accounted for separately by the franchisor, subject to contingent future events. Instead, the assessed fees were paid to DirectBuy to be used for the development of marketing programs and not subject to return to the franchisees in certain circumstances. If fees for advertising were over-charged in excess of applicable limits, it merely constituted an overcharge to be repaid and not an appropriation of a separate, identifiable chattel, the court ruled.

The franchisees did not claim a possessory interest in any definite and identifiable sum of money that they retained ownership of but entrusted to the franchisor, who later wrongfully appropriated it. Because the facts alleged did not plausibly support a claim for criminal conversion as that claim has been interpreted by the courts of Indiana, the claim was dismissed.

Unjust enrichment. DirectBuy challenged the unjust enrichment claim of the franchisees, contending that Indiana law foreclosed such a claim “where an express contract controls the parties’ rights.” The franchisees responded that the equitable claim of unjust enrichment was pled as an alternative to the breach of contract claim, invoking an exception to the general rule should there be a determination that the franchise agreement did not fully address the subject of the parties’ dispute.

Here, a breach of contract claim was pleaded and the parties advocated competing interpretations of several different provisions of the franchise agreement that they contended govern the charges now disputed. There was no serious contention, much less agreement, that the franchise agreement would not ultimately be found to govern the question of whether the franchisor was authorized to impose the disputed charges in the manner it did. In this context, the parties’ contractual relationship provided a remedy at law and precluded a claim for unjust enrichment. Thus, the claim was dismissed.

Breach of fiduciary duty. The franchisor contended that the fiduciary duty claim must be dismissed because it had no such fiduciary duty, citing §17.01 of the franchise agreement, disclaiming such a relationship and citing Indiana law “that arms-length contractual agreements do not give rise to a fiduciary relationship creating a duty.”

Indiana cases repeatedly observe that ordinary business relationships based on arms-length contracts do not establish fiduciary relationships between the parties, the court noted. The franchisees could not overcome this legal principle which, augmented here by the express disclaimers in the parties’ agreement, defeated a claim for breach of fiduciary duty, the court reasoned.

Declaratory judgment. The franchisees sought a declaratory judgment that provisions of the franchise agreement depriving the franchisees of their right to a jury trial and prohibiting the recovery of punitive damages were void and unenforceable under Indiana law as against public policy.

Indiana law recognized that the constitutional right to a jury trial could be waived, and that a freely-bargained agreement waiving the right was enforceable. The Indiana Supreme Court has also upheld the enforceability of exculpatory clauses that limit damages liability, the court observed.

The franchisees were unable to overcome the force of these precedents contrary to their claim. The franchisee cited a case in which the federal court in Indianapolis held that a distribution agreement’s waiver of jury trial was unenforceable because it violated the Indiana Deceptive Franchise Practices Act (“IDFPA”), which prohibits franchise contract provisions “[l]imiting litigation brought for breach of the agreement in any manner whatsoever.” Ind.Code §23-2-2.7-1(10).

But the franchisor pointed out that the IDFPA applies to agreements involving “a franchisee who is either a resident of Indiana or a nonresident who will be operating a franchise in Indiana.” Ind.Code §23-2-2.7-1. The plaintiff franchisees are not Indiana residents, and their franchises are not operated in the State. So the IDFPA was not applicable, which could explain why it was not cited as a basis for the claim of unenforceability, the court noted.

The case is No. 3:13CV104-PPS/CAN.

Attorneys: Barbara A. Bagdon PHV (Dady & Gardner PA) for Arcangelo Inc. and Buying Power United LLC. C. Joseph Yast (Law Office of C. Joseph Yast) for DirectBuy Inc. and Trivest Partners LP.

Companies: Arcangelo Inc.; Buying Power United LLC.; Trivest Partners LP.

Cases: FranchisingDistribution IndianaNews