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Court Rules Franchise Laws Reflect Fundamental State Policies That Cannot Be Disclaimed by Contract

An Arizona court has ruled that franchise disclosure laws reflect fundamental state policies, which cannot be disclaimed by contract fine print in Zounds Hearing Franchising, LLC v. Bower.

Four franchisees of Zounds Hearing Franchising, LLC brought a group lawsuit in Ohio alleging that the franchisor violated the Ohio Business Opportunity Law by making earnings claims not in their disclosure document, making false statements, and by failing to provide a five-day cancellation right.

The franchisees had not fared well in their operations. Two were already out of business.

Zounds responded by moving to enforce multiple fine print provisions from its standard franchise agreement and then the fireworks began. Next, Zounds filed four lawsuits in Arizona seeking to enforce the one-sided provisions against each Ohio franchisee separately. The four separate Arizona lawsuits sought to enforce an individual action clause prohibiting group lawsuits, and to force individual mediations in Arizona as specified in another contract term written by Zounds. In the group lawsuit filed by the franchisees in Ohio, Zounds moved to dismiss under these many provisions, and alternatively invoked a venue provision requiring that suits be brought only on its home turf in Arizona. Zounds’ motion to transfer was granted by a federal judge in Ohio, and the case was sent to Arizona where the four individual actions were already pending.

Zounds next moved to enforce its individual action and Arizona mediation clauses and to apply Arizona law under the Arizona choice-of-law provision it had written into its franchise agreements. Arizona, unlike Ohio, had no franchise statute providing for a five-day cancellation notice, for mandatory earnings claims disclosures, and prohibiting false representations in franchise sales. Citing the Arizona choice-of-law clause, Zounds asked the court to dismiss the franchisees’ claims under Ohio law. Thus, the question was could the Ohio Business Opportunity Law claims survive the Arizona choice-of-law clause under a conflict of law analysis?

Senior United States District Judge Neil Wake said no; Zounds could not contract its way out of the laws which Ohio has enacted to protect its own residents in the sale of franchises. In a thorough opinion Judge Wake also explained why some previous cases denying enforcement of such choice-of-law clauses were correct, and why cases granting enforcement of choice-of-law provisions in such situations should not to be followed.

The decision is worth a careful reading. Here is a portion of what Judge Wake found as an “easy” decision:

Under choice-of-law principles, parties cannot circumvent by contract the investor protections a state provides to all within its boundaries, especially for its own residents . . .  First, the franchise and the franchisees are both located in Ohio. In those circumstances, a foreign-domiciled franchisor may not “contract” out of the Ohio protections any more than an Ohio-domiciled franchisor could.  There is no scenario in 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 franchise operates.

The decision continued with a five-fold victory for the Zounds franchisees. Judge Wake refused to enforce the Arizona venue clause and ordered the case transferred back to Ohio. Judge Wake also voided the bar on joint suits by franchisees, allowing the franchisees to continue jointly rather than having to pursue four separate and prohibitively expensive individual lawsuits. Accordingly, Judge Wake ordered mediation of the four franchisees claims to occur jointly in Ohio rather than Arizona. And Judge Wake ordered Zounds to pay the franchisees’ attorney’s fees. The victory of the Zounds franchisees and their counsel was critical, given the cost of individual mediations in Arizona and possible dismissal of claims in Arizona. And at the end of the day, on an issue many franchisees have fought for years, the court came down clearly and definitively on their side. Franchisors should not be able to avoid state franchise and business opportunity disclosure laws enacted as important public policy to protect their citizens, by use of venue, choice-of-law, integration, no representation and no reliance provisions.

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About Peter Lagarias

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Attorney Peter Lagarias is a partner in Lagarias & Napell, LLP of San Rafael, California and represents franchisees and franchisee associations. He is a certified specialist in franchise and distribution law by the Office of Legal Specialization of the State Bar of California and frequent lecturer and writer on franchise law. He can be contacted by email or call (415) 460-0100.

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