Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—W.D. Wis.: Real estate office franchisee’s tort counterclaims barred by New Jersey’s economic loss doctrine, (Aug 1, 2013)

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

In action brought by ERA Franchise Systems, LLC against a Wisconsin real estate office franchisee, Hoppens Realty, Inc., and its principal, Michael S. Hoppens, counterclaims for breach of contract, unjust enrichment, and for violation of the Wisconsin Fair Dealership Law withstood the franchisor’s efforts to have them dismissed. However, counterclaims for misrepresentation and conversion were barred by New Jersey’s economic loss doctrine, according to the federal district court in Madison, Wisconsin (ERA Franchise Systems, LLC v. Hoppens Realty, Inc., July 31, 2013, Crocker, S.).

Background. In 2008 the parties entered into a 10-year franchise agreement for the operation of a real estate office franchise in Wisconsin. According to the franchisee, it entered into the agreement because it relied upon untrue statements made by a representative of the franchisor about training and support the franchisor would provide. The alleged untrue statements were not included in the franchise agreement, which contained an integration clause.

As a result of the franchisor’s alleged failure to honor its promises, the franchisee stopped making payments under the agreement. The parties eventually reached a settlement agreement, but, when the franchisor allegedly again failed to provide the promised support, the franchisee refused to make the final two payments under the settlement. The franchisor then terminated the parties’ franchise agreement and brought suit. Before the court was the franchisor’s motion for judgment on the pleadings with respect to the franchisee’s counterclaims.

Breach of contract. The franchisee alleges that by failing to provide the training and support “as promised,” ERA breached the Franchise Agreement. The franchisor contends that the breach of contract claim must be dismissed because the franchisee’s principal admitted in the counterclaim that he stopped making payments under the parties’ franchise agreement. Citing New Jersey law, the franchisor argues that “[u]nder basic contract principles, the non-breaching party may either stop performance and assume the contract is avoided, or continue its performance and sue for damages,” but “[u]nder no circumstances may it stop performance and continue to take advantage of the contract’s benefits.”

Even assuming, arguendo, that New Jersey law applies, the cases cited by ERA did not sweep as broadly as it suggested, the court explained. In each of those cases, the question was whether an alleged pre-termination breach by the franchisor permitted the franchisee to continue using the franchisor’s marks after the franchisor had properly terminated the franchise agreement, so as to defeat a claim of trademark infringement. The courts held that although evidence of pretermination disputes was irrelevant to the question of trademark infringement because the franchisor’s right to terminate a franchise exists independently of any claims the franchisee might have against the franchisor, the franchisee still could maintain an action for damages on its breach of contract claim. Here, the franchisee was not raising the franchisor’s alleged breach as a defense to a claim of trademark infringement, but are asserting it as their own cause of action.

The breach of contract claim faced other problems, however. First, nowhere in the counterclaim did the franchisee identify any specific provision in the franchise agreement that the franchisor allegedly breached. Instead, it relied exclusively on alleged oral misrepresentations made to Michael Hoppens by an unnamed representative for the purpose of inducing him to enter into the contract. Thus, this claim was unlikely to survive application of the franchise agreement’s integration clause.

Second, although the franchisee did not directly request rescission of the franchise agreement (perhaps because it already has been terminated), it hinted at this remedy by requesting in their counterclaim that this court dismiss ERA’s claims with prejudice. Even where grounds might exist to set aside a contract, a party waives his right to rescind for fraud or mistake if he unreasonably delays asserting that right or affirms the agreement after learning of the fraud or mistake giving rise to the right of rescission. Here, the franchisee’s conduct suggested that it elected to affirm the contract: it continued its use of the ERA name and marks for nearly two years after it discovered that ERA had misrepresented the services it would provide, and it was claiming breach of contract in this lawsuit and it is not directly seeking rescission, according to the court. All of this being so, it would be improper to dismiss this claim at this time until all the relevant facts have been fully and fairly presented to the court.

Tort claims: misrepresentation and conversion. In Count II of the counterclaim, the franchisee alleges that the franchisor committed the tort of conversion when it accepted a settlement payment, failed to perform under the settlement agreement and then “refused to return” the settlement payment. In Count IV, the franchisee alleges that the franchisor committed intentional or strict liability misrepresentation when its representative told Hoppens that his employees would receive training and support if Hoppens entered into a franchise agreement, knowing this was untrue or not caring if it was false, and that Hoppens relied on these representations to his detriment.

The economic loss doctrine, which is recognized by courts in both Wisconsin and New Jersey, precludes contracting parties from pursuing tort remedies for purely economic or commercial losses associated with the contract relationship. While New Jersey applies the doctrine to contracts for services, Wisconsin does not. Thus, because the parties agreed that the Franchise Agreement in this case is a contract for services, the economic loss doctrine comes into play only if New Jersey law applies. Answering this question required the court to delve into the parties’ choice of law dispute.

The parties’ agreement contains two choice-of-law provisions: a general choice of New Jersey law provision in § 22.6, and, in § 24.6, a provision stating that if the franchisee is a citizen of Wisconsin, the Wisconsin Fair Dealership Act applies and supersedes any provision to the contrary. The franchisee contended that § 24.6 “supersedes” the New Jersey choice-of-law provision found at § 22.6, while ERA contended that § 24.6 simply adds the additional requirements that the Wisconsin Fair Dealership law imposes on franchises located in Wisconsin.

ERA had the better argument, the court ruled. Section 24.6 did not indicate that Wisconsin law “supersedes” § 22.6 or that it displaces New Jersey law entirely. Rather, § 24.6 provided only that the Wisconsin Fair Dealership Law applies to the parties’ agreement. Thus, New Jersey law applied, except to the extent that it is inconsistent with Wisconsin’s Fair Dealership Law. Accordingly, the franchisee’s tort claims were dismissed on the ground that they are barred by New Jersey’s economic loss doctrine.

Unjust enrichment. In Count III, the franchisee alleges that ERA has been “unjustly enriched” by accepting at least $23,808 in franchise payments without providing the support or training in return as promised and by accepting $1,000 in settlement funds and then failing to honor the terms of the settlement.

In urging the court to dismiss the unjust enrichment claim, ERA made the same arguments raised as to why the breach of contract claim must be dismissed, namely, that the franchisee was not entitled to sue for unjust enrichment because it continued to use the ERA name after ERA allegedly breached the contract. The court already rejected this argument, it explained. Thus, in the absence of a cognizable argument to dismiss the unjust enrichment claim, ERA’s motion to dismiss this claim was denied.

Wisconsin Fair Dealership Law. The franchisee alleges that ERA violated the Wisconsin Fair Dealership Law when it “terminated, cancelled, and/or substantially changed the competitive circumstances of the Franchise Agreement” without good cause and without providing adequate notice.

ERA argued that this claim must be dismissed because exhibits to its own complaint show that the franchisee was provided with the 90 days pre-termination notice required by the statute and because the franchisee’s admitted cessation of franchise payments constituted “good cause” for termination. However, the April 6, 2012 letter to which ERA referred in support of its argument regarding notice was not properly before the court because the franchisee did not refer to it in its counterclaim, the court observed.

As for good cause, although it was true that the franchisee admitted to stopping franchise payments, it contended that it had a right to “suspend performance” under the agreement in light of ERA’s failure to provide the promised services and support. Although this argument stood on shaky ground for reasons discussed above, at this initial pleading stage the franchisee’s allegations sufficiently stated a facially plausible claim for violation of the franchise statute, the court held.

The case is No. 12-cv-594-slc.

Attorneys: Patrick Frasor Moran (Gordon & Rees LLP) for ERA Franchise Systems, LLC. Stephen O. Murray (Coyne, Schultz, Becker & Bauer, S.C.) for Hoppens Realty, Inc.

Companies: ERA Franchise Systems, LLC.; Hoppens Realty, Inc.

Cases: FranchisingDistribution WisconsinNews