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Arizona Judge Rules in Zounds Hearing Franchisees’ Favor, Sends Case back to Ohio

Zounds Hearing AidsAn Arizona federal judge handed down an order this month essentially ruling in favor of four Ohio franchisees in a lawsuit involving conflicts between the franchisor's dispute resolution provisions and Ohio's Business Opportunity statute. He also ordered the case back to Ohio, now in district court.

The lawsuit, which does not involve an arbitration clause, addresses a host of franchise matters, including choice of law (state statute vs. out of state contractual choice); enforceability of venue clause; enforceability of pre-suit mediation requirements; enforceability of bar against joint suits by plaintiffs; and appropriateness of transfer to different federal court under 28 USC 1404(a).

Stanley M. Dub, lead counsel for the franchisees, said the Arizona court issued a resounding decision in favor of the Zounds Hearing franchisees, and one that should influence decisions in other states for many years. He explained, "Among other things, the court determined that the Ohio statute expressed fundamental policy for the state of Ohio, and that it invalidated the contract's choice of Arizona law, and any other provisions that deprived the franchisees of their right to sue in Ohio."

Zounds Hearing Franchising, LLC franchises third parties to operate hearing aid centers that offer retail hearing aid devices and products under its trade name. The Arizona-based franchisor was founded in 2009 by Sam Thomasson, an engineer and entrepreneur who spent his career developing new technologies in the medical device and consumer electronics industries. On its website, Zounds Hearing is self-proclaimed to be the technology leader in the industry with 57 patents. The company states it has been franchising for six years, and currently has 90 units in 32 states.

The current case, Zounds Hearing Franchising, LLC v. Bower, first filed on May 11, 2016 in state court in Cleveland, Ohio on behalf of four hearing aid center franchisees, was based on alleged disclosure violations under Ohio law. While the defendants were Zounds Hearing Franchising and its related entity Zounds Hearing, Inc., other parties who served as brokers in the franchise sales process were also named, although most had previously settled. Legal documents show brokers FranChoice and FranNet were among the defendants at the time the lawsuit was filed.

Zounds' June 9, 2016 Franchise Disclosure Document states that the franchisees "initiated the legal action without first mediating their individual disputes as required by the franchise agreements." Their allegations include violations of the Ohio Business Opportunity Purchasers Protection Act and common law fraud in connection with the sale of franchises to the [franchisee] plaintiffs."

Zounds Hearing defendants had moved the Ohio court to dismiss for the franchisees' failure to comply with contractual prohibitions on suit until after mandatory mediation in Arizona; and contractual bars to filing suits jointly with other plaintiff franchisees. Alternatively, the motion asked the court to transfer the case to Arizona because the contract had a clause requiring an Arizona venue.

Franchisees asked the court to deny Zounds' motions on the grounds that the Ohio disclosure statute governed, and that it invalidated contractual choice of an out of state forum. The Ohio court eventually transferred the case to Arizona, but explicitly declined to decide any of the other issues. The parties then renewed their arguments on the motion in the Arizona court, and the court held a telephonic oral argument on the issues.

Senior U.S. District Judge Neil V. Wake prefaced his September 15, 2017 order stating that statutes in most states protect investors in franchises by . . . requiring certain disclosures, prohibiting certain contract terms in franchise agreements, requiring others, and giving certain rights whether or not stated in the franchise agreement. He said, "If an in-state franchisor selling an in-state franchise to an in-state franchisee tried to escape those obligations by writing in his franchise agreement that the franchisee agrees he does not have to comply with those laws, he would be laughed out of court." He added, "That is because the very nature of such statutes is to impose obligations on people that override what they might otherwise agree to among themselves. Such statutes say what you cannot agree to."

Judge Wake further clarified his order saying, "Indeed, it is in the nature of investor protection statutes generally that they override the 'freedom of contract' of investors to waive their statutory rights in advance. This is the whole point of such statutes." He explains, "under choice-of-law principles, parties cannot circumvent by contract the investor protections a state provides to all within its boundaries . . ."

Wake also points out that a few states like Arizona have no special protections for investors in franchises. "In Arizona, any contract term and anything short of fraud will go. It is now common for franchisors in laissez faire states like Arizona to try to immunize themselves from the investors protection laws of the states which they do business by saying it is so in their contracts. They include in the franchise agreement a provision choosing the law of a state other than the state where the franchise operates, a state with lesser or no franchisee protection," Judge Wake explained.

The judge does not end his order there. He adds that "the state of the franchise situs is the state with the most significant relationship to the transaction and the parties...cases that miss that result are to be forgiven but not followed...there is no scenario under which another state would have a materially greater interest in having its less protective franchise laws applied than the more protective laws of the state in which the franchisee resides and the franchisee operates..."

And he declares that investor protection laws reflect a fundamental policy of a state as to what contract terms are permitted and legal for investments and businesses in the state. "Franchisors may not exempt themselves from such laws merely by entering into the forbidden contract terms and adding that the law of some other state will substitute..."

The judge says it is hard to see how a statute making something a crime is not fundamental policy, such that a party can commit the crime in the state and contract his way out of the liability."

And Judge Wake adds, "With the 2012 amendment Ohio is now the franchisee protection state on steroids."

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Related Reading:

U.S. District Court, Arizona, Order (Sept. 15, 2017)

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About Janet Sparks

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Janet Sparks is the former publisher of the Continental Franchise Review, an industry newsletter that covered the franchise community for over 30 years. She has also been a columnist for a leading franchise magazine for the past 13 years. Today she is an independent journalist who engages in investigative reporting, tackling complex issues that impact the franchise industry.

Janet can be reached at jsparks@bluemaumau.org or at 303-799-7398.