• Who Says a Party Can't Contract Out of Fraud?
  • April 27, 2004 | Author: Genevieve A. Beck
  • Law Firm: Larkin Hoffman Daly & Lindgren Ltd. - Minneapolis Office
  • Who Says a Party Can't Contract Out of Fraud? By Genevieve A. Beck When a dispute arises between a franchisee and its franchisor, it is quite common for the franchisee to raise allegations of fraudulent inducement or fraudulent misrepresentations by the franchisor as a basis for either voiding the franchise agreement and recouping its investment or recovering damages from the franchisor. The franchisee often asserts that it relied upon the franchisor's verbal representations regarding start up or operating costs, projected revenues and earnings, territorial rights, or success rates of the franchise in entering into the franchise relationship, that these representations were false and that it would not have entered into the franchise relationship if not for the allegedly false representations. The Eighth Circuit recently dealt a serious blow to these claims. In Meehan v. United Consumer's Club Franchising Corp., 312 F.3d 909 (2002), the franchisees, the Meehans, filed suit against the franchisor, Consumer's Club, after their franchised business failed. The Meehans alleged that Consumer's Club knowingly made false and misleading representations to them regarding earnings, success rates, pricing, warranties, support and service to induce them into purchasing the franchise. Consumer's Club brought a motion to dismiss based upon express disclaimers contained in the franchise agreement and offering circular. Specifically, the franchise agreement contained an express disclaimer that required the Meehans to affirm that they had not received or relied on any express or implied warranty or guaranty about the revenue, profit or success of the franchise or on any representations by Consumer's Club's employees or agents that were contrary to the offering circular. The offering circular provided that no representations of actual, average, projected or forecasted sales, profits or earnings had been made to the franchisee by Consumer's Club. The district court in Meehan held, and the Eighth Circuit affirmed, that these disclaimers in the franchise agreement and offering circular made it impossible for the Meehans to establish that they had justifiably relied on the alleged misrepresentations regarding earnings or success rates. Quoting the Seventh Circuit in Hardee's of Maumelle, Ark., Inc. v. Hardee's Food System, Inc., 31 F.3d 573, 576 (1994), the Court held that "it is simply unreasonable to continue to rely on representations after stating in writing that you are not so relying." Meehan, 312 F.3d at 912. Because justifiable reliance is an essential element of any fraud claim, summary judgment was warranted because the disclaimers prevented the Meehans from establishing justifiable reliance. The Meehan decision represents a shift in the Eighth Circuit's position on enforcement of contractual disclaimers as a bar to fraudulent inducement claims. In a 1991 decision, Commercial Property Investments, Inc. vs. Quality Inns Int'l, Inc., 938 F.2d 870 (8th Cir. 1991), the Court was unwilling to enforce a contractual disclaimer. In that case, the trial court had held that various disclaimers in the franchise agreement and a pro forma profit and loss statement given to the franchisee defeated the franchisee's claim of reliance on the alleged misrepresentations as a matter of law. The Eighth Circuit reversed the grant of summary judgment, ruling that a contractual provision will defeat a claim of fraud only if it "explicitly states a fact completely antithetical to the claimed misrepresentations." Id. at 875 (quoting Clements Auto Co. v. Service Bureau Corp., 444 F.2d 169, 179 (8th Cir. 1971)). Two disclaimers were at issue in Commercial Property Investments: a disclaimer in the franchise agreement stating that "[f]ranchisee represents and acknowledges that it has relied on no representations, written or oral, except to the extent specifically set forth herein" and a disclaimer in a pro forma profit and loss statement stating that the "accompanying financial projections are for illustrative purposes only and are based on estimates and assumptions [and] no implied or expressed representations are made that these projections actually will be achieved for a specific project." The Court found that the disclaimer in the franchise agreement was "the sort of general disclaimer and integration clause which has been deemed 'ineffective to negate reliance'" and that the disclaimer in the pro forma profit and loss statement applied only to the numbers in that document. The court held that summary judgment was not appropriate because the franchisee "may have relied on misrepresentations which were not squarely contradicted by the written disclaimers" and "[w]ithout such specific contradiction, 'a general disclaimer clause is ineffective to negate reliance.'" Id. Although many courts now recognize that, under certain circumstances, a party may contract its way out of liability for fraud, the level of specificity in the contractual disclaimer or integration language required to avoid a fraud claim varies from state to state and from case to case. In Hardee's of Maumelle, the case relied on by the Eight Circuit in Meehan, the Seventh Circuit considered the effect of a boilerplate disclaimer in a licensing agreement. The disclaimer provided that the agreement constituted the entire agreement between the parties, "no other representation having induced LICENSEE to execute this Agreement, and no representations, inducements, promises or agreements, oral or otherwise, not embodied herein or attached hereto (unless of subsequent date) were made by either party¿." The Seventh Circuit found that general, boilerplate disclaimer was sufficient to preclude a franchisee's claim of reasonable reliance on alleged verbal representations regarding opportunities to purchase company owned stores. Similarly, in L.A.R. Service Center, Inc. v. Whirlpool Corp., 896 F. Supp. 48 (D.Mass. 1995), the trial court held that the franchisee's fraudulent inducement claims failed as a matter of law because a general integration clause in the agreement prevented the franchisee from establishing reasonable reliance on the franchisor's alleged representations. See also Wootton Enterprs., Inc. v. Subaru of Amer., Inc., 134 F.Supp.2d 698 (D.Md. 2001); Elias Bros. Rest., Inc. v. Acorn Enterprs., Inc., 831 F.Supp. 920 (D.Mass. 1993). However, other courts have held that general, boilerplate disclaimers and integration clauses will not bar fraudulent inducement claims. Rosenberg v. Pillsbury Co., 718 F.Supp. 1146, 1153 (S.D.N.Y. 1989) (under Massachusetts law, "a party may not contract out of fraud in cases involving the use of general or ambiguous disclaimer and integration clauses"). Like the Eighth Circuit in Commercial Property Investments, these courts generally require that a disclaimer clause expressly and unambiguously state that the franchisee did not rely upon the specific representations or types of representations in dispute in order to bar the franchisee's fraudulent inducement claim. See, e.g. Id. at 1152-53; Dunbar Medical Systems, Inc. v. Gammex Inc., 216 F.3d 441 (5th Cir. 2000). Some other courts have taken yet another position, ruling that the issue of justifiable reliance is almost always a question of fact and a party to a contract cannot avoid a claim of fraud in the inducement as a matter of law no matter how specific and detailed the contractual disclaimers and integration provisions. See, e.g., The People, ex rel. Department of Corps. v. Speedee Oil Change Systems, Inc., Bus. Franchise Guide (CCH) 12,245 (January 28, 2002); Dee-Witt C. Sperau v. Ford Motor Co., Bus. Franchise Guide (CCH) 10,726 (June 9, 1995). Although the decisions are hardly uniform, under the law of most states, when a franchise agreement unambiguously states that the franchisee disclaims the existence of or reliance upon representations concerning revenues, costs, income, profit or success rates, the franchisee will not be allowed to claim later that it was induced into entering into the franchise agreement in reliance on representations as to those matters. See Meehan, supra; Prince Heaton Enterprises, Inc. v. Buffalo's Franchise Concepts, Inc, 117 F.Supp.2d 1357 (N.D.Ga. 2000) (plaintiffs cannot prove justifiable reliance on representations about projected financial success of franchise where franchisee acknowledged in franchise agreement that franchisor did not make representations regarding sales, profits, earnings or success of the business); California Bagel Co. v. American Bagel Co., Bus. Franchise Guide (CCH) 11,880 (June 9, 2000) (disclaimer making it clear that representations regarding performance and profits of existing franchises were not authorized made it unreasonable for franchisees to rely on such representations as a matter of law); Motor City Bagels, L.L.C. v. American Bagel Co., 50 F.Supp.2d 460 (D.Md. 1999) (reliance on statements about the sales of established franchises was unreasonable as a matter of law where UFOC contained disclaimer of representations regarding franchise sales, profits or earnings); Carlock v. Pillsbury Co., 710 F.Supp. 791 (D. Minn. 1989). At a minimum, therefore, franchisors are well advised to include in the franchise agreement language specifically stating that the franchisee disclaims any reliance on representations concerning actual or anticipated revenues, profits, earnings or levels of success of the franchise and lawyers representing franchisees should warn their clients that a boilerplate disclaimer clause may well be given very specific meaning by the court. As the Meehan case confirms, disclaimer clauses in franchise agreements provide a means for a franchisor to cut off franchisee defenses and obtain summary dismissal as a matter of law on any fraud claims later raised by a franchisee. Genevieve A. Beck is an attorney in the Minneapolis firm of Larkin, Hoffman, Daly & Lindgren, Ltd. Reprinted with permission from The Franchise Lawyer, Summer 2003.