The Gpmemorandum, Issue 99

The GPMemorandum, Issue 99

July 1, 2007

To view a PDF copy of this newsletter, please click here. 1.) FRANCHISE TRANSACTIONS

Supreme Court Reverses Ban On Vertical Price Fixing 2.) RECENT CASES

■ Arbitration

■ Minnesota Federal Court Grants Order Staying Injunctive Claims And Compelling Arbitration

■ Michigan Court Confirms Arbitration Award In Favor Of Franchisor

■ Promissory Estoppel

■ Franchisor Not Liable For Agent's General Assurances That The Franchisee Would Be Given A Franchise

■ Jurisdiction/Venue/Choice Of Forum

■ Florida Court Holds That It Does Not Have Jurisdiction Over Indiana-Based Franchisee

■ New York Federal Court Holds That Franchisee's Parallel State Court Action Did Not Constitute Grounds To Abstain/Dismiss Franchisor's Federal Court Complaint

■ Trademark Infringement/Non-Compete Agreements

■ Tennessee Federal Court Enforces Post-Termination Non-Compete Agreement

■ Franchisee's Secured Creditor Not Permitted To Operate Business In Violation Of Non-Compete

■ Court Enjoins Former Franchisee's Continued Use Of Franchisor's Trademarks In Connection With Competitive Business

■ Federal Court Denies Franchisor's Motion For Preliminary Injunction Seeking Enforcement Of Post- Termination Covenant Not To Compete

■ Personal Injury

■ Court Dismisses Claims Alleging Health Problems Caused By Consumption Of Trans Fat In KFC Food

■ Damages/Attorneys' Fees

■ Minnesota Court Denies Request For Attorneys' Fees Under Minnesota Franchise Act

www.lathropgpm.com ■ Class Actions

■ Illinois Federal Court Partially Dismisses Class Action Lawsuit Against McDonald's For Alleged Misrepresentations Regarding Ingredients In French Fries And Hash Browns

■ Franchise Associations/Terminations

■ Colorado Federal Court Grants Preliminary Injunction Allowing Quiznos® Franchisees To Continue Operating After Receipt Of Notices Of Termination

FRANCHISE TRANSACTIONS

This section of The GPMemorandum addresses non-judicial developments, trends, and best practices of interest to franchisors. SUPREME COURT REVERSES BAN ON VERTICAL PRICE FIXING

For almost a century federal antitrust law has prohibited suppliers from setting minimum resale prices based on the 1911 decision in Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (U.S. 1911). Last week the United States Supreme Court, in Leegin v. Creative Leather Products, Inc., 2007 WL 1835892 (U.S. June 28, 2007), reversed that long-standing precedent, ruling that all such agreements are now subject to the "rule of reason," a method of analysis under which the claimant must make the difficult showing that the arrangement harms competition substantially in the market as a whole. This decision will expand the ability of franchisors to design flexible pricing programs.

Under Dr. Miles, it was per se illegal for a franchisor or supplier to enter into an agreement with a reseller over its minimum retail prices. Cases subsequent to Dr. Miles focused on whether the franchisor or other supplier met the technical requirements of reaching an "agreement." In order to avoid per se illegality, suppliers were permitted to "announce" their policy and decide to deal with those who complied with the policy. This created an artificial structure in which a supplier could establish a minimum price policy but could not reach or enforce agreements on the policy.

The Supreme Court's decision in Leegin means it is no longer necessary for suppliers to engage in the appearance of suggesting but not agreeing. Under federal law, companies now can direct specific resale prices to be charged, need not utilize agency or consignment arrangements in order to direct prices, need not adopt cumbersome "minimum advertised price programs," and no longer need to exercise extreme caution to avoid "agreements" with franchisees (as opposed to unilateral actions) on the prices to be charged.

Leegin was a typical minimum resale price case in which a discounting retailer was terminated for failing to abide with a resale price maintenance policy. In its 5-4 decision, the Supreme Court found resale price maintenance to be generally pro-competitive because: (1) it can help ensure that retail services that

www.lathropgpm.com enhance interbrand competition will not be underprovided (e.g., because of free riding); and (2) it may facilitate market entry for new companies and brands. As the Court noted, similar justifications have justified "rule of reason" analysis for non-price vertical agreements (such as exclusive territories) for decades.

Franchisors and system suppliers have worked under the limitations of the per se restriction on resale prices for years. Typically that has meant that franchisors have established some form of pricing policy while working through the convoluted legal environment to avoid any suggestion of an agreement between franchisor and franchisee. The Leegin decision may provide franchisors with a significant new tool for success in the marketplace. Greater freedom to establish resale prices may improve franchise operations by facilitating a greater level of service, enhancing brand value, and encouraging promotion efforts by franchisees. As the Court observed, these pricing policies may "encourage retailers to invest in tangible or intangible services or promotional efforts that aid the manufacturer's position as against manufacturers." Resale price restraints may prevent free-riding by those franchisors that may underprovide services. These price restraints may also facilitate entry into the marketplace by "induc[ing] competent and aggressive retailers to make the kind of investment of capital and labor that is often required in the distribution of products unknown to the consumer."

Franchisors should be cautioned, however. Minimum resale prices can still be challenged under the "rule of reason." In those situations in which price limitations clearly harm consumers and the franchisor has market power, there may be competitive concerns raised. Moreover, while many state laws typically follow federal antitrust decisions, such as the Leegin decision, it remains to be seen whether states will continue to apply the per se rule to resale price maintenance. Finally, as the Court cautioned, resale price maintenance can be used as a tool to facilitate collusion among retailers or suppliers. The majority opinion cautioned lower courts "to be diligent in eliminating [the] anticompetitive uses" of resale price maintenance from the market. Thus, careful guidance in establishing resale price policies is prudent; collusion with competitors must be avoided.

The decision in Leegin will, no doubt, help franchisors in many sectors and it provides an opportunity to reexamine distribution practices in light of this substantial change in the law. RECENT CASES

Here are some of the most recent judicial developments of interest to franchisors: ARBITRATION MINNESOTA FEDERAL COURT GRANTS ORDER STAYING INJUNCTIVE CLAIMS AND COMPELLING ARBITRATION

In Eco Water Systems LLC v. KRIS, Inc., 2007 WL 1321851 (D. Minn. May 4, 2007), the United States District Court for the District of Minnesota denied, without prejudice, a manufacturer's request for injunctive

www.lathropgpm.com relief to enforce various post-term covenants, including removal of trademarks, against its former dealer. In reaching its decision, and granting a stay as to the manufacturer's claims for injunctive relief, the court found that the parties had agreed to arbitrate certain core issues that predominate over the non-arbitrable issues in the case.

The underlying dispute arose out of a June 2006, letter in which Eco Water Systems ("Eco") terminated the parties' 17-year business relationship, citing unethical conduct by the dealer that "may impair the goodwill of [Eco's trademarks or trade name]." Following the termination, Eco demanded that the dealer comply with all post-termination obligations, including immediate de-identification of the business. When the dealer failed to act accordingly, Eco filed an action for trademark infringement, violations of fair trade practices, breach of contract, unjust enrichment, and unfair competition. The dealer countered with its own claims for breach of contract, unjust enrichment, and violation of state franchise laws.

Contending that the provisions of the parties' Dealer Agreement required mandatory arbitration of the disputed issues, other than Eco's claims for injunctive relief, the dealer argued for a stay of the non- arbitrable, injunctive claims. In accepting the dealer's argument, the court found that the arbitrable issues predominated over the non-arbitrable issues and that the outcome of the non-arbitrable issues largely depended upon the decisions of the arbitrator. The court also found that the parties' Dealer Agreement did not include any qualifying language affording Eco a right to automatic injunctive relief without first addressing the merits of the underlying arbitrable claims. Accordingly, the court stayed the court proceedings pending completion of the arbitration. MICHIGAN COURT CONFIRMS ARBITRATION AWARD IN FAVOR OF FRANCHISOR

In The Coffee Beanery Ltd. v. WW L.L.C., 2007 WL 1500533 (E.D. Mich. May 23, 2007), the underlying arbitration centered around the franchisees' ("the Welshans") allegations that The Coffee Beanery made false representations and failed to disclose material information concerning the earnings potential of its franchises. Shortly before the arbitration, the Maryland Securities Commissioner brought an administrative action against The Coffee Beanery. The franchisor subsequently entered into a Consent Order that specifically stated The Coffee Beanery violated the Maryland Franchise Law by making material misrepresentations and failing to give prospective franchisees a prospectus. As a sanction, the Consent Order required The Coffee Beanery to make a rescission offer to the Welshans. The Welshans never accepted the offer to rescind. Following the arbitration hearing, the arbitrator found in favor of The Coffee Beanery and concluded that the Welshans waived their right to rescission by failing to timely accept The Coffee Beanery's rescission offer.

The Coffee Beanery thereafter moved the federal district to confirm the arbitration award. In response, the Welshans sought to vacate the award. In support of their motion to vacate, the Welshans argued that they

www.lathropgpm.com were led to believe they would be able to litigate all claims that arose under the Maryland Franchise Laws. The court rejected that argument, noting that the Franchise Agreement clearly disclosed that all claims were subject to arbitration. The Welshans further alleged that the arbitrator was biased because she used the same accounting firm as The Coffee Beanery, which the court rejected summarily.

The Welshans also claimed that the arbitrator engaged in manifest disregard of the law. They claimed that the Maryland Franchise Law allowed them to rescind the Franchise Agreement within three years of the receipt of the UFOC if The Coffee Beanery failed to disclose certain information before the Welshans executed their Franchise Agreement. The court held that the Consent Order provided the Welshans their opportunity to rescind the agreement, which they waived by failing to respond within the 30 days called for under the offer. PROMISSORY ESTOPPEL FRANCHISOR NOT LIABLE FOR AGENT'S GENERAL ASSURANCES THAT THE FRANCHISEE WOULD BE GIVEN A FRANCHISE

In Knauf Realty, LLC v. Prudential Real Estate Affiliates, Inc., 2007 WL 1502198 (W.D. Wis. May 23, 2007), a would-be franchisee ("Knauf Realty") sued franchisor Prudential Real Estate Affiliates, alleging breach of a promise to grant it a franchise. Knauf Realty had taken the preliminary steps towards obtaining a franchise in Madison, Wisconsin, which would have been the first franchise for Prudential in the area. Prudential's agent explained to Knauf Realty that there were two steps in the application process: (1) preliminary approval; and (2) final approval. Knauf Realty was preliminarily approved, but never obtained final approval from Prudential.

A representative of Knauf Realty falsely stated on his franchise application that he had no prior convictions when, in fact, he had a few misdemeanor convictions on his record. In addition, Knauf Realty's application was incomplete in several other respects. Prudential asked that Knauf Realty explain the discrepancies and provide the necessary information to supplement its earlier response. Although Knauf Realty provided some supplemental information, it never explained the discrepancy or provided all of the necessary information to Prudential. Without waiting for final approval, Knauf Realty entered into a lease and other contractual obligations based on vague representations by Prudential's agent that approval was imminent. Knauf Realty never received final approval from Prudential, however, and later learned that Prudential had offered the same franchise to another company. Knauf Realty sued, claiming that Prudential's agent "promised" final approval and that it relied on the promise to its detriment.

The court stated that in order to establish promissory estoppel, Knauf Realty had to prove: "that (1) there was ‘[a] promise that the promisor should reasonably have expect[ed] to induce action or forbearance of a definite and substantial character on the part of the promisee; (2) the promise ‘induce[d] such action or forbearance'; and (3) the ‘injustice can be avoided only by enforcement of the promise.'" The court found

www.lathropgpm.com that Knauf Realty's evidence was insufficient as a matter of law to prove these elements because the evidence consisted of general oral statements by Prudential's agent concerning the granting of a franchise. The court held that there must be a degree of specificity to the promise. Moreover, it was unreasonable for Knauf Realty to rely on the general statements of Prudential's agent because the written evidence Knauf Realty had received prior to entering into the lease with the landlord clearly stated that Prudential would not be legally bound or liable until final approval was granted. The court found that Knauf Realty knew that it had not submitted all the materials for final approval and that final approval had not been obtained. Therefore, the court granted Prudential's motion for summary judgment. JURISDICTION/VENUE/CHOICE OF FORUM FLORIDA COURT HOLDS THAT IT DOES NOT HAVE JURISDICTION OVER INDIANA-BASED FRANCHISEE

In Lee's Famous Recipes, Inc. v. Fam-Res, Inc., 2007 WL 1451808 (N.D. Fla. May 15, 2007), the Florida Federal District Court held that it did not have personal jurisdiction over a franchisee based in Indiana who was the subject of a lawsuit commenced by Lee's Famous Recipes, Inc. ("LFRI"), a Florida-based franchisor. The franchisee was an Indiana based company that had entered into a Franchise Agreement with Shoney's Inc., a Tennessee corporation, to operate a LEE'S FAMOUS RECIPE® franchise. The Franchise Agreement contained a choice of law provision stating that Tennessee was the controlling law and identifying Tennessee as the site for any legal action related to the Franchise Agreement. LFRI became the franchisor of the LEE'S FAMOUS RECIPE® franchise system after it purchased all of the assets from the former franchisor, Shoney's Inc.

Sometime after LFRI purchased the franchise, LFRI alleges that the franchisee committed numerous breaches of the Franchise Agreement, which ultimately led to termination of the franchisee's franchise rights. In response to LFRI's lawsuit seeking to collect damages related to the franchisee's alleged breaches, the franchisee brought a motion claiming that the Florida Federal District Court lacked personal jurisdiction.

In response to the motion, LFRI argued that the franchisee had sufficient "minimum contacts" with Florida and, therefore, was subject to the court's jurisdiction, because the franchisee sent payments and sales reports to the franchisor's corporate office in Florida, made one inventory purchase from the franchisor in Florida, and the franchisee's president attended a conference in Florida. In rejecting LFRI's argument, the court held that the contacts were merely random and fortuitous and that the franchisee did not make any purposeful contact with Florida. The court determined that simply because the franchisee was a party to a contract with a Florida-based company, and was obligated to send payments to Florida, the "minimum contacts" requirement was not satisfied. Further, the applicable Franchise Agreement was negotiated and entered into in Tennessee and specified Tennessee as the proper venue for any litigation. Accordingly, the

www.lathropgpm.com franchise was not subject to the Florida court's jurisdiction. NEW YORK FEDERAL COURT HOLDS THAT FRANCHISEE'S PARALLEL STATE COURT ACTION DID NOT CONSTITUTE GROUNDS TO ABSTAIN/DISMISS FRANCHISOR'S FEDERAL COURT COMPLAINT

In Dunkin' Donuts Franchised Restaurants LLC, et al. v. Rijay, Inc., et al, 2007 WL 1459289 (S.D.N.Y. May 16, 2007), a case handled by Gray Plant Mooty, the United States District Court for the Southern District of New York denied a DUNKIN' DONUTS® franchisee's motion for abstention under the Colorado River Doctrine and retained jurisdiction over the lawsuit filed by Dunkin' Donuts in federal court. The franchisee argued that the parallel state court action it filed against Dunkin' just prior to Dunkin's commencement of the federal case constituted "exceptional circumstances" and warranted a departure from the federal court's "virtually unflagging obligation" to exercise jurisdiction for all matters properly before it. Rejecting the franchisee's arguments, the court held that the two cases were parallel and that all six of the Colorado River factors weighed in favor of its obligation to exercise jurisdiction.

The franchisee initially filed a lawsuit against Dunkin' in state court seeking a determination that it had not breached its Franchise Agreements and asking for an order enjoining Dunkin' from terminating the Agreements. Following the filing of the state court action, Dunkin' terminated the franchisee's franchise rights based upon the franchisee's violation of various federal employment and tax laws. Despite the termination, the franchisee continued to operate its stores as if it were a licensed DUNKIN'® franchisee. Thus, Dunkin' filed its federal lawsuit for breach of contract and trademark infringement. Dunkin' also moved to stay or dismiss the state court action. In response, the franchisee moved for abstention or dismissal of Dunkin's federal court case.

Finding that the two cases were essentially the same in the identity of the parties, the issues, and the relief sought, the court held that the cases were "concurrent" and "parallel" and thus subject to the Colorado River Doctrine. The court explained that the presumption heavily favors exercising jurisdiction. In its opinion denying the franchisee's motion for abstention, the court examined the six Colorado River factors and determined that each weighed decisively in Dunkin's favor. TRADEMARK INFRINGEMENT/NON-COMPETE AGREEMENTS TENNESSEE FEDERAL COURT ENFORCES POST-TERMINATION NON-COMPETE AGREEMENT

In ServiceMaster Residential/Commercial Services, LP v. Asaad, et al., Case File No. 07-2253 (W.D. Tenn. June 18, 2007), a case that was handled by Gray Plant Mooty, the franchisee signed two Franchise Agreements to operate a SERVICEMASTER® cleaning business in Tampa, Florida. The franchisor learned that the franchisee had registered numerous fictitious names with the state of Florida, including "Stanli Steemer," "SteamMaster Clean," and "Sun State Carpet Cleaning." The franchisor also learned that the franchisee was operating one or more of these competitive businesses simultaneously with his

www.lathropgpm.com SERVICEMASTER® franchise. Thus, the franchisor gave the franchisee a 24-hour notice to cure by cancelling the fictitious name registrations and ceasing all competitive activity. When the franchisee failed to comply, the franchisor terminated the Franchise Agreements. The franchisee continued to operate using ServiceMaster's trademarks in association with a new business called "StainMaster Clean." The franchisor moved for injunctive relief to prevent trademark infringement and to enforce the one year post-termination non-compete agreement.

In granting the franchisor's motion, the court found a significant risk of confusion because customers who called the former franchisee's SERVICEMASTER® telephone number reached the terminated franchisee who offers the same services as ServiceMaster "under the strikingly similar name of StainMaster." The court enjoined the former franchisee from any further infringement, including any names or marks that are confusingly similar to SERVICEMASTER®.

With respect to the post-termination non-compete agreement, the court found that the franchisor had a strong likelihood of success on the merits based on the franchisee's failure to comply with the non-compete provisions of the Franchise Agreements. The court found that the franchisor's good will was likely to be harmed by the former franchisee's continued operation in his former territory. The court enjoined the franchisee from operating any competitive business within a 75 mile radius of his former territory for a period of one year from the date of the court's Order. FRANCHISEE'S SECURED CREDITOR NOT PERMITTED TO OPERATE BUSINESS IN VIOLATION OF NON-COMPETE

The United States District Court for the Western District of Michigan granted a preliminary injunction in favor of a franchisor seeking to enforce a non-compete against a defunct franchisee's secured creditor. In Tanfran, Inc. v. Aron Alan, LLC, 2007 U.S. Dist. LEXIS 44544 (W.D. Mich. June 20, 2007), a multi-unit tanning salon franchisee entity borrowed $1 million from a trust belonging to the franchisee principal owner's mother. The loan was secured by all of the assets of the franchisee, including customer lists and telephone numbers of the franchised salons. The franchisee subsequently fell behind in both its royalty payments to the franchisor and in its loan payments to the trust. The franchisor sent a written notice of default to the franchisee, stating that the franchisee's continued failure to pay all overdue royalties would result in termination of the franchises. Within one month of the default notice, the franchisee voluntarily surrendered all of its business assets to the trust, ostensibly in compliance with the security agreement. The trust then assigned the business assets to a newly-formed company, Miracle Tanning, LLC, which continued the operations of the tanning salons uninterrupted.

Thereafter, the franchisor sought a preliminary injunction to enforce the two-year non-compete against both the trust and Miracle Tanning, asserting claims of breach of contract and tortious interference with contract. The trust and Miracle tanning argued that the non-compete could not be applied to them because they were

www.lathropgpm.com not parties to the franchise agreement. In support of its motion, the franchisor cited Federal Rule of Civil Procedure 65(d), which provides that a preliminary injunction is binding on "those persons in active concert or participation" with the party to be enjoined. The franchisor also cited several cases in which non- competes, in the franchise setting, have been enforced against non-signatories who sought to operate competing businesses using the terminated franchisees' assets and/or business location.

The court granted the franchisor's preliminary injunction motion, finding, among other things, that the transfer of business assets from the franchisee to the trust and then from the trust to Miracle Tanning suggested that the defendants' goal was "not of furthering the Trust's collection of the outstanding debt, but rather of avoiding the effects of Tanfran's notice of termination and the non-compete agreements while preserving [the] ongoing tanning business." This collusion interfered not only with the franchisor's enforcement of the non-compete, but also with the franchisor's right of first refusal to purchase the assets of the franchised business. A preliminary injunction preventing the trust and Miracle Tanning from operating tanning salons in violation of the two-year non-compete was, therefore, granted. COURT ENJOINS FORMER FRANCHISEE'S CONTINUED USE OF FRANCHISOR'S TRADEMARKS IN CONNECTION WITH COMPETITIVE BUSINESS

In a decision notable for its scathing criticism of a number of former franchisees, the United States District Court for the District of Maryland recently granted a franchisor's motion for preliminary injunction. In NaturaLawn of America, Inc. v. West Group, LLC, 2007 WL 1191131 (D. Md. April 22, 2007), the defendant franchisees chose to permit their Franchise Agreements to expire. Those franchisees then began operating a competing lawn care business in violation of a covenant against competition contained in their Franchise Agreements, using the franchisor's confidential business information, trade secrets, trademarks, and customer lists. The court found that the franchisees had notified their former customers that their business had merely undergone a name change when the Franchise Agreements expired and had represented that the newly named company would continue servicing their accounts. The court further found that the franchisees had informed the franchisor's customers that New Jersey law prohibited the franchisor from doing business in the state and urged such customers not to make payments to the franchisor.

The court granted the franchisor's motion for a preliminary injunction to restrain the franchisees' unlawful conduct. After considering the conduct, the court concluded that "defendants' inexcusable behavior presents as blatant and unjustified a repudiation of subsisting contractual obligations in a commercial context as has been known to or encountered by this court." The court found that the franchisees' continued use of the franchisor's trademark, combined with their representation that their customers would continue to be serviced by the same entity, with only a change in name, constituted trademark infringement due to the potential for customer confusion as to franchisees' continued affiliation with the franchisor. The court also found that the franchisees' continued operation of a competitive business violated the terms of the Franchise

www.lathropgpm.com Agreements' covenant against competition, the terms of which the court found reasonable as a matter of law.

The franchisees attempted to argue that the noncompete provision of the Franchise Agreements applied only if the Agreements were terminated, not if they expired on their own terms. The court rejected that interpretation of the parties' Agreement, finding that expiration of the Agreements merely constituted one specific means by which those Agreements could be terminated. Finding that the franchisor would be irreparably harmed in the absence of injunctive relief, the court granted the motion for preliminary injunction. FEDERAL COURT DENIES FRANCHISOR'S MOTION FOR PRELIMINARY INJUNCTION SEEKING ENFORCEMENT OF POST-TERMINATION COVENANT NOT TO COMPETE

In Certified Restoration Dry Cleaning Network, LLC v. Tenke Corp., 2007 WL 1343682 (E.D. Mich. May 8, 2007), the federal court denied a franchisor's motion for preliminary injunction seeking to enforce a post- termination covenant not to compete on the ground that it lacked enough facts to allow it to determine the reasonableness of the geographic restrictions on a former franchisee's business activities.

The Franchise Agreement between the parties provided that if the contract were terminated, the franchisee would be prohibited from engaging in a restoration dry cleaning business for a period of two years. The geographic limitations set forth in the covenant included: (1) the franchisee's territory; (2) an area extending 25 miles out from the borders of the franchisee's territory; and (3) within the territory of any other franchisee operating as of the date of termination. In addition, the covenant prevented the franchisee from contacting any of its former restoration dry cleaning customers.

After several years in business, the franchisor terminated the Franchise Agreement because of the franchisee's failure to make required payments. The former franchisee filed suit in state court in Ohio challenging the termination. At about the same time, the franchisor filed its own case in federal court to enforce the post-termination covenant not to compete and filed a motion for preliminary injunction shortly thereafter. In response, the franchisee filed a motion for summary judgment arguing that the covenant not to compete was not enforceable because it contained inconsistent terms that should be construed against the franchisor.

The federal district court denied both motions. With respect to the franchisor's motion for a preliminary injunction, the court concluded that the franchisor had failed to address whether the covenant's geographic restrictions were reasonable under Michigan law, which requires a showing that the covenant supported legitimate business interests and was not merely aimed at preventing competition from the former franchisee. The court concluded that the reasonableness of the geographic restriction was "inherently fact specific" and that discovery was needed to determine whether the covenant was reasonable. The court also denied the franchisee's motion for summary judgment, holding that the question of whether a contract

www.lathropgpm.com provision was ambiguous and capable of two conflicting interpretations was an issue of fact. As such, it concluded that it would be "premature" to decide the issue prior to the completion of discovery. PERSONAL INJURY COURT DISMISSES CLAIMS ALLEGING HEALTH PROBLEMS CAUSED BY CONSUMPTION OF TRANS FAT IN KFC FOOD

In an important decision for those franchisors engaged in the quick serve food business, a federal court in the District of Columbia dismissed the claims of a plaintiff who alleged that the Yum! Brands restaurant group failed to disclose that its KFC food products contained trans fat and misled the public about the content of its KFC food. In Hoyte v. Yum Brands, Inc. d/b/a KFC, 2007 WL 1302590 (D.D.C. May 2, 2007), the court granted the franchisor's motion to dismiss the complaint due to the lack of specificity in the plaintiff's claims.

The plaintiff, a medical physician, purchased food at a KFC® restaurant unaware that some of it was prepared with trans fat. The plaintiff claimed that trans fat is a major cause of heart disease and that all KFC® locations in the District of Columbia unnecessarily used partially hydrogenated oil, which contains a high amount of trans fat. The plaintiff also alleged that, due to KFC's advertisements that it sells the "best food" and is part of a nutritionally healthy lifestyle, ordinary customers are misled as to the true characteristics of KFC's food products. The plaintiff's allegations against the franchisor included violations of the implied warranty of merchantability, the D.C. Consumer Protection Procedures Act (DCCPPA), and negligent misrepresentation.

In dismissing the plaintiff's claims, the court first determined that it did not need to reach the issue of whether a consumer of fast food could reasonably expect to consume trans fat, simply because the plaintiff in this case failed to allege any injury from eating KFC's food products. The court noted that the plaintiff's argument that purchasing KFC food placed him in a "zone of physical danger" would only apply to a claim of serious and verifiable emotional distress, which the plaintiff did not allege. The court held that a franchisor could not be held liable for an implied warranty of merchantability claim where a consumer fails to specify his economic injury, alleges no immediate harm, pain, or suffering, and pleads facts which evince no injury.

The court also found that the plaintiff did not have standing to raise a DCCPPA claim because he failed to specify any actual or threatened injury. The court further expressed skepticism as to the underlying basis of the plaintiff's claim. The court noted that the plaintiff's allegation that KFC intentionally deceived or misled consumers into believing that its products did not contain harmful trans fat by not disclosing that the oil it used had trans fat was questionable.

Finally, the court rejected the plaintiff's negligent misrepresentation claim. The court found that KFC's statements that it serves the "best food" was nothing more than a bald statement of superiority that amounts

www.lathropgpm.com to non-actionable puffery. The court also found that KFC's statements that its food could be part of a healthy lifestyle were non-actionable because those statements alone do not suggest that trans fats are healthy or that a person should eat KFC as part of a healthy lifestyle. The court further noted that, although irrelevant to the motion to dismiss, KFC announced plans to use zero trans fat cooking oil for some of its menu items. DAMAGES/ATTORNEYS' FEES MINNESOTA COURT DENIES REQUEST FOR ATTORNEYS' FEES UNDER MINNESOTA FRANCHISE ACT

In Dunn v. National Beverage Corp., 729 N.W.2d 637 (Minn. Ct. App. April 3, 2007), Twin City Home Juice Co. ("Twin City") - the distributor of fruit juice drinks - entered into a franchise agreement with Home Juice Co. ("Home Juice"), which gave Twin City the right to sell and distribute Home Juice's products within a specified territory. As part of the Franchise Agreement, Home Juice agreed not to sell the products it manufactured within Twin City's territory without written consent from Twin City.

Sometime after the parties executed the Franchise Agreement, National Beverage Corp. purchased the assets of Home Juice, including its various franchise agreements. National Beverage then sent a letter to Twin City and other franchisees stating that the franchisees could continue operating on a year-to-year basis as long as they continued to meet certain standards.

A few years after National Beverage acquired Home Juice's assets, National Beverage began selling its products to another distributor in Twin City's territory. In response, Twin City commenced a lawsuit alleging that National Beverage breached the Franchise Agreement by selling products within Twin City's territory without written consent and violated the Minnesota Franchise Act ("MFA") by terminating Twin City's Franchise Agreement without good cause.

At trial, the jury found that National Beverage and Twin City's were parties to a Franchise Agreement under the MFA, that National Beverage had breached the Agreement by selling products within Twin City's territory, and that National Beverage terminated that Agreement without good cause in violation of the MFA. Although the jury awarded damages related to National Beverage's breach of the Agreement, it held that Twin City did not suffer any damages as a result of the unlawful termination claim under the MFA.

Following trial, Twin City made a motion for attorneys' fees and costs pursuant to the MFA. The court denied Twin City's request for fees and costs. On appeal, the appellate court affirmed the trial court's denial of fees on the ground that the jury awarded damages related to National Beverage's breach of the Franchise Agreement and not for a violation of the MFA. Accordingly, the court of appeals held that Twin City was not entitled to an award of attorneys' fees and costs pursuant to the MFA. CLASS ACTIONS

www.lathropgpm.com ILLINOIS FEDERAL COURT PARTIALLY DISMISSES CLASS ACTION LAWSUIT AGAINST MCDONALD'S FOR ALLEGED MISREPRESENTATIONS REGARDING INGREDIENTS IN FRENCH FRIES AND HASH BROWNS

In In re McDonald's French Fries Litigation, 2007 WL 1576550 (N.D. Ill. May 30, 2007), the United States District Court for the Northern District of Illinois granted, in part, McDonald's motion to dismiss a class action complaint based upon the lack of subject matter jurisdiction and failure to state a claim upon which relief can be granted. Plaintiffs are a small group of individuals who brought a class action lawsuit on behalf of a nationwide class of persons who "purchased and/or consumed" french fries and hash browns ("Potato Products") against McDonald's Corporation. Plaintiffs alleged violations of various state consumer protection and fraud statutes, breach of implied and express warranties, and unjust enrichment.

Plaintiffs are individuals who cannot - or chose not to - consume gluten, milk, or wheat because of food allergies, dietary issues, or food sensitivities. Plaintiffs claim that on numerous occasions they purchased McDonald's Potato Products based upon McDonald's alleged representations that the products were free of milk, wheat, and gluten, and were safe for people with food allergies. In February 2006, McDonald's revised its "USA Food Allergens and Sensitivities Listing" on its website, with respect to its Potato Products. Since that date, McDonald's list its Potato Products as containing milk, wheat, and gluten.

In response to Plaintiffs' lawsuit, McDonald's brought a motion to dismiss all counts. With respect to Plaintiffs' fraud claims, the court dismissed those counts because Plaintiffs had failed to plead fraud with particularity. Specifically, the court held that Plaintiffs failed to allege the relevant time period of McDonald's representations, the method of its representations to Plaintiffs, and failed to allege any reliance on the alleged misrepresentations.

With respect to Plaintiffs' breach of warranty claims, the court dismissed Plaintiffs' implied warranty claim because Plaintiffs failed to allege that the Potato Products were not merchantable. For goods to be merchantable, they must conform to a set of standards which includes being "fit for the ordinary purposes for which such goods are used." The court held that Plaintiffs failed to identify what the non-ordinary use of a french fry or hash brown is, and, therefore, dismissed Plaintiffs' implied warranty claim.

McDonald's also sought to dismiss Plaintiffs' express warranty claim based upon Plaintiffs' failure to allege privity between Plaintiffs and McDonald's. The Court held that Plaintiffs had satisfied the exception to the "privity" requirement and, in any event, determined that many states do not require privity when a personal injury is alleged. Accordingly, the court denied McDonald's attempt to dismiss Plaintiffs' claims for breach of express warranty.

Finally, McDonald's argued that Plaintiffs' unjust enrichment claim must be dismissed because it cannot stand alone and must be accompanied by an underlying common law or statutory claim. The court held that

www.lathropgpm.com the claim survived because Plaintiffs had adequately pled their breach of express warranty claim. FRANCHISE ASSOCIATIONS/TERMINATIONS COLORADO FEDERAL COURT GRANTS PRELIMINARY INJUNCTION ALLOWING QUIZNOS® FRANCHISEES TO CONTINUE OPERATING AFTER RECEIPT OF NOTICES OF TERMINATION

In Bray, et al. v. QFA Royalties LLC, 2007 WL 1306517 (D. Colo. May 3, 2007), a group of QUIZNOS® franchisees, who were sent notices of termination, filed a lawsuit alleging wrongful termination and seeking an injunction prohibiting their franchisor from enforcing the notices of termination pending a trial on the merits. The federal court granted the franchisee group's motion for a preliminary injunction allowing them to continue operating their QUIZNOS® stores pending trial of their wrongful termination claims.

The franchisee group included eight QUIZNOS® franchisees who were either officers or members of the Quiznos franchisee association - a group of QUIZNOS® franchisees with an acrimonious history with the company - and who were terminated after the association posted a former QUIZNOS® franchisee's suicide note on the association's website. The deceased franchisee shot himself in one of the franchisor's company stores and left a note attributing his suicide to his protracted litigation with Quiznos. Upon learning of the posting of the suicide note, Quiznos immediately terminated the franchise rights of all association board members. In response to the terminations, the franchisee group filed its lawsuit and denied that Quiznos had justification for the terminations under the language of the Franchise Agreements or applicable law.

In response to the franchisee group's motion for preliminary injunction, Quiznos argued that because the franchisees were requesting a preliminary injunction to keep operating their stores, the injunction was mandatory in nature and, therefore, disfavored because it affirmatively required Quiznos to continue to work with the franchisees. The court held that while the injunction requested by the franchisees was technically "mandatory," it was not disfavored because the purpose of preliminary injunctive relief is to assure that the non-movant does not take unilateral action which would prevent the court from providing effective relief to the movant should he ultimately prevail on the merits. The court determined that denying the injunction in this case would deprive the franchisees of meaningful relief if they ultimately won their lawsuit because they would not be able to operate their businesses. The court found that the franchisees demonstrated irreparable injury because the immediate terminations would effectively close the franchisees' stores "resulting in a loss of customer base and community goodwill going beyond ‘simple economic loss.'"

In balancing the harms, the court rejected Quiznos' argument that a franchisor's harm in being forced to continue doing business with a franchisee it has grounds to terminate is both real and irreparable. The court found that Quiznos had failed to develop a record of egregious infractions by the franchisees justifying termination. In addition, the court held that Quiznos failed to provide any evidence that posting the suicide letter on the association website harmed Quiznos' trademarks. Without evidence of such harm, the court determined the balance of harms weighed in favor of the franchisees.

www.lathropgpm.com Finally, the court found that the franchisees demonstrated a likelihood of succeeding on the merits of their claims. Quiznos argued that termination was appropriate under the terms of the franchise agreements, which granted franchisor the right to terminate franchise rights immediately if franchisees engage "in conduct that, in the sole judgment of Franchisor, materially impairs the goodwill associated with the Marks…." In response, the franchisees provided evidence that Quiznos made the decision to terminate their franchises without any investigation and terminated the franchises in order to punish the association regardless of which franchisees actually participated in the decision to post the suicide letter. The court found that the evidence demonstrated that Quiznos did not "exercise judgment" in its swift termination of the franchisees and, as a result, the franchisees had established a likelihood that they would prevail on the merits of their claims.

ATTORNEYS WHO WROTE OR EDITED ARTICLES FOR THIS ISSUE INCLUDE:

Jimmy Chatsuthiphan, John W. Fitzgerald, Elizabeth S. Dillon, Collin B. Foulds, Michael R. Gray, Kelly W. Hoversten, Jeffrey L. Karlin, Craig P. Miller, Kevin J. Moran, Kirk W. Reilly, Iris F. Rosario, Max J. Schott, II, Jason J. Stover, Jonathan J. Toronto, Stephen J. Vaughan, Henry Wang, Quentin R. Wittrock, David E. Worthen, Eric L. Yaffe, Robert Zisk

For more information on our Franchise and Product Distribution Practice and for recent back issues of this publication, visit the Franchise and Product Distribution group page.

GRAY PLANT MOOTY

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www.lathropgpm.com The GPMemorandum is a periodic publication of Gray Plant Mooty, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult your own franchise lawyer concerning your own situation and any specific legal questions you may have.

This article is provided for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have.