Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—WDPenn: Claim of Franchise Agreement Invalidity Due to Breach of FTC Franchise Rule Did Not Confer Federal Court Jurisdiction, (Jan 25, 2013)

By Tobias J. Gillett, J.D., LLM.

A claim by an alleged franchisee, seeking a declaratory judgment that a gelato company violated the Federal Trade Commission’s Franchise Rule by failing to provide a pre-sale disclosure document, did not confer federal jurisdiction over the alleged franchisee’s case, the federal district court in Pittsburgh has ruled in dismissing the case sua sponte (Palermo Gelato, LLC v. Pino Gelato, Inc., January 24, 2013, Hornak, M.).

Palermo Gelato, LLC had entered an agreement with Pino Gelato, LLC under which Pino licensed Palermo to exclusively sell its gelato, claimed to be based on a “unique” Sicilian recipe, in a region of Pennsylvania. Palermo allegedly later discovered that the gelato was manufactured in bulk by a Florida company and sold wholesale for a price much lower than that charged by Pino.

Palermo filed suit the federal district court in Pittsburgh, alleging, among other claims, that the agreement had created a franchise relationship and that Pino had violated the FTC’s Franchise Rule by failing to provide a pre-sale disclosure document. Palermo asserted that federal jurisdiction existed under 28 USC § 1337, granting the federal courts jurisdiction over “any civil action or proceeding arising under any Act of Congress regulating commerce,” and that supplemental jurisdiction existed under 28 USC § 1367 over state law claims for unjust enrichment and fraud in the inducement.

The court dismissed the case sua sponte, concluding that it did not have jurisdiction over the action as pled. The court explained that a case “arises under federal law” under 28 USC § 1331 “if a well-pleaded complaint establishes either [1] that federal law creates the cause of action or [2] that the plaintiff’s right to relief necessarily depends on resolution of a substantial question of federal law,” citing the Supreme Court’s 2006 opinion in Empire Healthchoice Assur., Inc. v. McVeigh, 547 U.S. 677. The court observed that the FTC Act, and thus the FTC’s Franchise Rule, does not create a private cause of action.

The court determined that Palermo’s complaint could be interpreted as either (1) claiming that the agreement between the companies was “invalid due to its federal illegality” or (2) pleading that the violation of the Franchise Rule invalidated the agreement, and hence no “valid written contract” existed, a necessary element for Palermo’s state law unjust enrichment claim. The court chose to address both interpretations, concluding that neither supported federal jurisdiction.

Well-Pleaded Complaint Rule

With regard to the first interpretation, the court explained that the “well-pleaded complaint rule” required that “the application of federal law must arise in the plaintiff’s original cause of action.” It cited the Supreme Court’s 1950 decision in Skelly Oil Co. v. Phillips Petroleum Co., 339 U.S. 667, for the proposition that “if but for the availability of the declaratory judgment procedure, the federal claim would arise only as a defense to a state created action, jurisdiction is lacking.”

The court concluded that here, without the declaratory judgment procedure, “the claim that Pino could have brought against Palermo would have been a purely state law claim for breach of contract, which Palermo would have defended based on the invalidity of the contract, citing federal law.” Therefore, since the declaratory judgment procedure provided the only basis for federal jurisdiction, the court concluded it did not have jurisdiction based on the first interpretation of the complaint.

Substantial Federal Issue

With regard to the second interpretation, the court explained that the Supreme Court’s 2005 decision in Grable & Sons Metal Prods., Inc. v. Darue Eng’g & Mfg., 545 U.S. 308, had concluded that federal jurisdiction could exist over a “special and small category” of cases involving “state law causes of action predicated on federal laws that do not themselves create private rights of action.” The court observed that such an action would have to involve an “actually disputed and substantial” federal issue that a federal court could “entertain without disturbing any congressionally approved balance of federal and state judicial responsibilities.”

Applying these principles to the facts in the present case, the court concluded that it did not have jurisdiction under the second interpretation of the complaint. The court noted that the Federal Trade Commission Act did not contain a private cause of action, which weighed against a finding of federal jurisdiction. Moreover, no federal agencies or other entities were parties to the case, “also highlighting the lack of an important federal interest” in the case.

Even though the parties had actively litigated the question of the applicability of the Franchise Rule to their agreement and “recognize[d] that issue as central to the lawsuit,” the court concluded that the issue was “far from ‘substantial.’” The court observed that every federal court that had addressed the issue had concluded that a violation of the Franchise Rule’s disclosure requirements did not invalidate a subsequent agreement as illegal or contrary to public policy. The court determined that the real issue in the case involved Palermo’s allegations that Pino had “duped” Palermo regarding the source of the gelato it sold, not whether Pino had complied with the FTC’s disclosure requirements.

Finally, the court noted that disputes concerning agreements like the one at issue in the present case were common and ordinarily treated as “plain vanilla contract claims.” In declining to create a private cause of action under the FTC Act, Congress had indicated that it did not intend to take such franchise-related contract disputes out of state court and into federal jurisdiction. Therefore, the court determined that it did not have jurisdiction under the second interpretation of the complaint.

Since Palermo was a Pennsylvania corporation and Pino was a South Carolina corporation, federal diversity jurisdiction might exist under 28 U.S.C. § 1332, the court noted. Palermo’s allegations were too vague to determine whether the amount in controversy exceeded the $75,000 threshold for federal jurisdiction. Therefore, the court dismissed Palermo’s complaint, but with leave to amend it if Palermo could assert that the amount in controversy was greater than $75,000.

The case is No. 2:12-cv-00931.

Attorneys: Brad N. Sommer (Sommer Law Group, PC) for Palermo Gelato, LLC. Carolyn Batz McGee (Eckert Seamans Cherin & Mellott) for Pino Gelato, Inc.

Companies: Palermo Gelato, LLC; Pino Gelato, Inc.

Cases: FranchisingDistribution PennsylvaniaNews