Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—S.D. Cal.: California Franchise Investment Law claim fails, (Sep 27, 2013)

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

A claim under the California Franchise Investment Law (CFIL) brought by Frederick Stocco, Kathleen Stocco, and GIA Florence SRL (“GIA Italy”) against the Gemological Institute of America, Inc. (“GIA”) failed on both statute of limitations and geographic exemption grounds, the federal district court in Los Angeles has decided (Stocco v. Gemological Institute of America, Inc., September 24, 2013, Hayes, W.). However, the plaintiffs did plausibly assert a claim against GIA for breach of contract. Thus, GIA’s motion to dismiss the CFIL and contract claims was granted in part and denied in part.

Background. GIA represents itself as a nonprofit institute, whose mission is to ensure the public trust in gems and jewelry by upholding the highest standard of integrity, academics, science, and professionalism through education, research, laboratory services, and instrument development, the court noted. A GIA gem grading certificate is claimed to significantly increase the value of a gem across the world. The GIA gem grading certificates can only be issued by gem grading labs authorized by GIA to issue GIA gem grading certificates.

In 2005, Donna Baker, GIA’s President, on behalf of GIA, entered into a written agreement with the Florence Chamber of Commerce to move GIA Italy (which was then owned by GIA and located in Vicenza, Italy) to Florence, and open a GIA school and a GIA gem drop-off location authorized to issue GIA gem grading certificates. The 2005 “agreement,” entitled the “Articles of Incorporation” of the “Firenze Scienze Gemmologiche Foundation,” was referred to by the plaintiffs as “the Firgem Agreement.” In 2007 GIA Italy was transferred to the Stoccos via the parties’ first franchise agreement, which was later replaced and renewed in 2009.

Breach of contract. In its claim for breach of written contract, GIA Italy alleged that GIA breached the “Firgem Agreement,” i.e., the Articles of Incorporation to the Firgem Foundation, by (1) “resigning from and withdrawing support for the Firgem Agreement and then declining to provide any support to GIA Italy for the purpose of opening a gem drop-off window in Florence that was authorized to issue GIA gem grading certificates”; and (2) “failing to comply with the terms of the Firgem Agreement and failing to provide any support to GIA Italy for the purpose of opening a gem grading drop-off window authorized to issue GIA grading certificates.”

Under California law, a third party could enforce a contract if the contract was made expressly for the benefit of a third person, the court observed. Reading the agreement as a whole and drawing all reasonable inferences from the nonconclusory factual content of the Complaint, it was plausible that the parties to the Articles of Incorporation intended for “the Foundation [to] provide economic and financial support” to GIA Italy (at that time the wholly owned subsidiary of GIA) in exchange for the issuance of GIA-authorized certificates at a gem lab or drop-off location, the court determined.

Assuming, without deciding, that the parties to the Articles of Incorporation did intend to confer rights or benefits on GIA Italy, the factual allegations of the Complaint plausibly suggested that such rights or benefits had been transferred to, and could be enforced by, plaintiff GIA Italy (the entity currently owned by Frederick and Kathleen Stocco). Thus, GIA Italy alleged sufficient facts to support a cognizable legal theory as to the breach of contract claim.

CFIL. In their CFIL claim, the plaintiffs alleged that GIA failed to “disclose,” failed to “register,” and failed to “provide the Plaintiffs [with] a copy of the franchise offering circular pursuant to California Corporations Code [§] 31119 and other applicable law.” They alleged that, as a result of GIA’s “willful” “breach of duties and failure to disclose and provide the Plaintiffs a copy of the franchise offering circular,” they had been damaged “in an amount not less than $850,000” and were entitled to rescind the franchise agreement pursuant to California Corporations Code § 31119.

Documents attached to the Complaint showed that a GIA Authorized Education Agreement (the first franchise agreement between the parties) was entered into on December 20, 2007, roughly four years and five months before the plaintiffs initiated this action on May 19, 2012, the court noted. Accordingly, to the extent the CFIL claim alleged that the 2007 Agreement violated the CFIL, it was barred by the four-year statute of limitations.

The Complaint alleged that the 2007 Agreement “was replaced and superseded by a 2009 agreement.” However, Frederick and Kathleen Stocco acknowledged that they resided in Italy, not California, at the time the 2009 Agreement was formed. Any “offer, sale, or other transfer of a franchise” to the plaintiffs that occurred pursuant to the 2009 Agreement was exempt from California Corporations Code § 31119, so long as “all locations from which sales, leases or other transactions between [GIA Italy] and its customers are made, or goods or services are distributed, are physically located outside [California].” Cal. Corp. Code § 31105. While the Complaint alleged that “Italian students worked in and visited California … while earning GIA gemologist degrees,” it contained no allegations suggesting that GIA Italy conducted any transactions or distributed any goods or services from a location physically within California, the court noted. Moreover, the 2009 Agreement appeared to explicitly prohibit any otherwise authorized business activities from occurring outside of GIA Italy’s “Facility” located in Firenze, Italy.

Therefore, the plaintiffs failed to allege that any “sales, leases, or other transactions between” GIA Italy and its customers were made from a location physically within California, or that GIA Italy distributed any “goods or services” from a location physically within California. Cal. Corp. Code § 31105. Thus, any transfer of a franchise or interest in a franchise that resulted from the 2009 Agreement was “exempted from the provisions of” California Corporations Code § 31110, et seq, the court ruled. The motion to dismiss the CFIL claim was granted.

The case is No. 12-CV-1291 WQH.

Attorneys: Dennis Patrick Hickman (Hickman & Robinson LLP) for Frederick Stocco. Amanda Catherine Fitzsimmons (DLA Piper LLP) for Gemological Institute of America Inc.

Companies: Gemological Institute of America Inc.; GIA Florence SRL

Cases: FranchisingDistribution CaliforniaNews