May 7, 2015 - Franchise Articles by |

Palermo Gelato, LLC v. Pino Gelato, Inc., 2013 WL 3147312 (W.D.Pa.)

Many legal doctrines have developed over time to shield franchisors from suits based on fraudulent statements they have made to franchisees to induce them to purchase franchises. One such doctrine is the parol evidence rule, which prohibits franchisees from introducing evidence of a franchisor’s fraudulent representations if the franchise agreement in dispute can be characterized as being “the entire agreement” between the parties.

In a recent federal court case in Pennsylvania, the court, although struggling a bit with the nuances of application of the parol evidence rule, nevertheless killed the franchisee’s case by holding that the parol evidence rule prevented the franchisee from introducing evidence of the franchisor’s fraudulent statements. Recognizing that its view of the law would certainly doom the franchisee’s fraud claim, the court stated: “While the result here might be tough medicine for someone in Palermo's spot, it is in line with the Pennsylvania Supreme Court's recently amplified pronouncements refusing to allow parol evidence as to fraud in the inducement claims, especially in the presence of an integration clause.”

The court apparently felt comfortable with this harsh ruling stating that “If Palermo in fact relied on certain beliefs about the origins of the gelato it was purchasing, it could and should have ensured that those beliefs were embodied in the written Agreement between the parties.” However, although the court’s theoretical observation fits neatly within a free market theoretical construct of a franchise sales market, it arguably fails to account for the myriad market failures and defects present in the franchise sales market that create and perpetuate safe and cost-free fraud by franchisors.

Palermo, a gelato franchisee, was told by Pino, the franchisor, during negotiations for purchase of the franchise, that Pino was the “exclusive” owner of a “unique recipe” of gelato developed in Sicily. Palermo, based in part on that representation, signed a franchise agreement to sell Pino's gelato product and became the exclusive Pino licensee in the area.

When Palermo found out that the franchisor’s representations regarding a “unique gelato recipe” were false, it sued the franchisor for fraud claiming that the gelato that Pino was selling was not a unique special small-batch recipe gelato, but instead a bulk gelato that was also being sold wholesale on the internet. Palermo alleged that it was fraudulently led into the agreement under the belief that it was purchasing high-end gelato from Pino's own exclusive recipe, and that, as such, the price it was paying for Pino gelato was unfairly “marked up.”

The franchisor defended by asserting that Pennsylvania's parol evidence rule bars the consideration of the alleged gelato-centric misrepresentations that had fraudulently induced Palermo to enter into the Agreement. Specifically, the franchisor pointed to an “integration clause” that was included in the boilerplate of the franchise agreement that barred the franchisee from bringing fraud claims. The integration clause stated:

(h) Entire Agreement.This Agreement, together with the exhibits and schedules hereto, contains the entire understanding and agreement among the parties and their affiliates, or between or among any of them, and supersedes any prior understandings between or among any of them, with respect to the subject matter thereof.

The franchisor argued that under controlling Pennsylvania law the only prerequisite to applying the parol evidence rule to block the fraudulent statements was the existence of a writing that was meant to be the entire agreement of the parties, and that “[a]n integration clause which states that a writing is meant to represent the parties' entire agreement is also a clear sign that the writing is meant to be just that ..” The court then easily concluded that “there is no doubt that the “entire contract” prong is satisfied by the plain language of the “Entire Agreement Clause,” which explicitly states that the Agreement embodies “the entire understanding and agreement among the parties … and supersedes any prior understandings between or among any of them.”

Although the court recognized that some Pennsylvania courts applied the parol evidence rule based only upon the finding of an integration clause, it also pointed out that there were other courts that required additional analysis to determine whether the alleged misrepresentations involved the “same subject matter” as the franchise agreement, since the parol evidence rule, under this reasoning, barred evidence of any previous oral or written negotiations or agreements only where they involved the same subject matter.

Adopting the more expansive two-part test, the court then set out to determine whether the misrepresentations regarding gelato “involved the same subject matter as the contract.” In so doing, the court had to answer the related question “just how close does the relationship need to be in order to be the “same” for these purposes?” “Did the terms of the contract need to expressly deny the particular misrepresentation?”

Relying on cases saying that parol evidence would be admissible if the language of the contract did not expressly deny the misrepresentations, the franchisee argued that the Agreement “contains no terms denying the uniqueness of the gelato recipe, nor does it deny that Defendant produces and manufactures the product.” The court rejected this argument, however, stating that it embodied “an overly stringent view” of the “same subject matter” requirement.  The court stated that: “[t]o fulfill the same subject matter requirement, the written contract need not directly contradict the prior representation, but rather need only ‘relate to subjects that were specifically addressed in the written contract.’” Then the court stated that none of the cases on the issue “ever stated that prior representations had to be explicitly denied.”

The court then proceeded to conclude that “same subject matter” prong was satisfied in this case based upon the many times that the gelato recipe was mentioned in the franchise agreement. First, the Agreement refers to Pino as “the supplier of products some of which bear [Pino] Marks …” Second, Section 2 of the Agreement then refers to the gelato recipe (“In the event [Pino] is reasonably expected to go out of business or should PG for any reason not be able to provide Product to Licensee, PG shall either train [Palermo] to manufacture the [gelato] Products or work with [Palermo] to identify a third party manufacturer to provide Products to [Palermo] directly.”) Second, the Agreement in Section 5 also refers to the gelato recipe (“In the event that [Pino] should go out of business … [Pino] shall provide [Palermo] with the recipe, equipment specifications and the 3 rd-party manufacturing specifications to enable Palermo to continue to operate its store(s)….”). According to the court, “a review of the Agreement demonstrates that it plainly “relates to” the subject matter of the alleged misrepresentation, namely, the ownership and source of the gelato and the gelato recipe.”

What is interesting about this case is that, unlike most franchise cases regarding fraud, the terms of the franchise agreement in this case mentioning the gelato recipe actually confirmed, rather than denied, the alleged misrepresentations. However, the court found this of no moment since, according to the court, “the same subject matter” requirement of the parol evidence rule, as it has been articulated above, does not appear to carry either a positive or negative valence. In other words, it is enough that the contract relates to the subject matter of the gelato recipe in order for the parol evidence rule to operate and bar other representations on that topic-it need not carry terms that run contrary to those other representations, even implicitly.”

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EXCERPTS OF CASE

Palermo Gelato, LLC v. Pino Gelato, Inc., 2013 WL 3147312 (W.D.Pa.)

MEMORANUDM OPINION

MARK R. HORNAK, District Judge.

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Palermo, seeking to open gelato stores in the Pittsburgh area, agreed to purchase the product of Pino, who prior to entering into a license agreement wither Palermo allegedly made various representations that suggested that Pino was the “exclusive” owner of a “unique recipe” of gelato developed in Sicily.2d Am. Compl. ¶¶ 11, 44, ECF No. 23. In 2008, the parties entered into a Store License Development and Supply Agreement (“Agreement”) for the licensing and supply of Defendant's gelato product at Plaintiff's places of business located in Allegheny County and Butler County, Pennsylvania. Under the Agreement, Palermo agreed to purchase Pino's gelato product at a certain price and sell it with the Pino trademark, and Palermo became the exclusive Pino licensee in the area.

The Agreement contained an integration clause that provided,

(h) Entire Agreement.This Agreement, together with the exhibits and schedules hereto, contains the entire understanding and agreement among the parties and their affiliates, or between or among any of them, and supersedes any prior understandings between or among any of them, with respect to the subject matter thereof.

2d Am. Compl. Ex, D, ECF No. 23–4 ¶ 14(h) (“Entire Agreement Clause”). The Agreement also contained a “No Franchise” clause that provided,

(b) No Franchise.The parties agree that under no circumstances is it their intent to enter into a relationship that would be, or could be deemed to be, a “franchise” within the meaning of the applicable rules and regulations of Federal Trade Commission or under applicable state law….

Id.¶ 7(b).

Around September 2011, Palermo allegedly discovered that the gelato it was purchasing from Pino was not small-batch crafted gelato, but in fact being manufactured in bulk by G.S. Gelato (“G.S .”), and that G.S. also sold its gelato wholesale on its website. Plaintiff alleges that it was fraudulently led into the Agreement under the belief that it was purchasing high-end gelato from Pino's own exclusive recipe, and that as such, the price it was paying for Pino gelato was unfairly “marked up.” It also alleges that the Agreement in fact established a franchise relationship with Pino, rather than a license relationship, and that the 30% “mark-up fees were essentially disguised royalties.” 2d Am. Compl. ¶¶ 37–38. According to Palermo, if Pino would not have misrepresented that the parties were entering into a franchise relationship instead of a license relationship, Pino would have been forced to comply with franchise law by making certain disclosures that would have revealed the less-than-exclusive nature of the gelato recipe, and Palermo would not have entered into the contract. More specifically, according to Palermo, Pino's misrepresentations, made “prior to entering the Agreement,” id. ¶ 20, were made through advertisements on its website, id. ¶ 10, promotional fliers, id. ¶ 11, and in person and telephone conversations with Defendant's Executive Vice President, John Jacobs, and Owner and President, Ramona Fantini, id. ¶¶ 12–17.

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B. Fraud in the Inducement

Defendant's argument is straightforward. According to Defendant, Pennsylvania's parol evidence rule bars the consideration of the alleged gelato-centric misrepresentations that fraudulently induced Palermo to enter into the Agreement; without those misrepresentations, Plaintiff cannot state a claim for fraud in the inducement in Count I; without a claim of fraud in the inducement, there is no basis for the claim of unjust enrichment in Count II, given the presence of a valid contract. The Court agrees.

*4Pennsylvania's parol evidence rule FN3as applied to claims of fraud in the inducement has been recently clarified in certain aspects. In Yocca v. Pittsburgh Steelers Sports, Inc.,578 Pa. 479, 854 A.2d 425, 437 n. 26 (Pa.2004), the Pennsylvania Supreme Court surveyed the Commonwealth's parol evidence rule and held that “parol evidence may not be admitted based on a claim that there was fraud in the inducement of the contract, i.e., that an opposing party made false representations that induced the complaining party to agree to the contract.” The court reaffirmed that holding in Toy v. Metro. Life Ins. Co.,593 Pa. 20, 928 A.2d 186, 203–07 (Pa.2007).

FN3.Under choice of law analysis, Pennsylvania's parol evidence rule is the one that governs here. Generally, if parties have contractually agreed to the applicable law, that agreed upon law should be given effect.   Assicurazioni Generali, S.P.A. v. Clover,195 F.3d 161, 164 (3d Cir.1999). The Agreement states that it “will be governed by … the internal laws of the Commonwealth of Pennsylvania (without reference to principles of conflicts or choice of law).” ECF No. 23–4 ¶ 14(j). Nor do the parties dispute that Pennsylvania law applies here-while neither explicitly addressed choice of law in their briefing, both apply only Pennsylvania precedents in discussing the parol evidence rule. See generally ECF Nos. 17, 19, 20. Although some courts have refused to automatically apply a contractual choice of law provision to fraud in the inducement claim, e.g. Atlantic Pier, 647 F.Supp.2d at 486 n. 13, it appears that the Third Circuit has been willing to do so, see In re Allegheny Int'l, Inc.,954 F.2d 167, 178 (3d Cir.1992). Even so, taking together the choice of law provision in the contract, the apparent agreement of the parties on the issue, the fact that the alleged misrepresentations occurred in Pennsylvania and the allegedly injured party (Plaintiff) resides in and would have suffered any harm in Pennsylvania, and the fact that Pennsylvania is the forum of this Court, the Court has no difficulty in concluding that Pennsylvania law governs here. See State Capital Title & Abstract Co. v. Pappas Bus. Servs., LLC,646 F.Supp.2d 668, 676 n. 2 (D.N.J.2009)(applying New Jersey law where parties did not raise choice of law in suit involving fraud in the inducement claim).

However, the exact scope of the parol evidence rule in Pennsylvania has not been as clearly delineated. The court in Yocca explained, for the parol evidence rule to apply, there must be a writing that represents the entire contract between the parties. To determine whether or not a writing is the parties* entire contract, the writing must be looked at and if it appears to be a contract complete within itself, couched in such terms as import a complete legal obligation without any uncertainty as to the object or extent of the parties' engagement, it is conclusively presumed that the writing represents the whole engagement of the parties. An integration clause which states that a writing is meant to represent the parties' entire agreement is also a clear sign that the writing is meant to be just that and thereby expresses all of the parties' negotiations, conversations, and agreements made prior to its execution. Once a writing is determined to be the parties' entire contract, the parol evidence rale applies and evidence of any previous oral or written negotiations or agreements involving the same subject matter as the contract is almost always inadmissible to explain or vary the terms of the contract.

Id.at 497–98, 854 A.2d 425(internal marks, citations, quotations omitted; emphasis added). Lower courts have diverged in interpreting this analysis. Some have held that for the parol evidence rule to apply, only a fully integrated contract is needed, without regard to whether the contract also speaks to the subject matter of the alleged misrepresentation. See, e.g., Greylock Arms, Inc. v. Kroiz, 879 A.2d 846, 848 (Pa.Commw.Ct.2005); Heritage Surveyors & Eng'rs, Inc. v. Nat'l Penn Bank,801 A.2d 1248, 1252 (Pa.Super.Ct.2002); Vino 100, LLC v. Smoke on the Water, LLC,CIV.A. 09–4983, 2011 WL 2604338, at *6 (E.D.Pa. July 1, 2011). Others have held that the parol evidence rule has two requirements: (1) that the written agreement “contains terms which directly deal with the subject matter of the alleged oral representation; and (2) represents the entire contract between the parties, particularly where the written agreement also contains an integration clause.”   Atlantic Pier Assocs., LLC v. Boardakan Rest. Partners,647 F.Supp.2d 474, 486 (E.D.Pa.2009)(citing Bardwell v. The Willis Co.,375 Pa. 503, 100 A.2d 102 (1953); accord Wall v. CSX Transp., Inc.,471 F.3d 410, 419 (2d Cir.2006); Cabot Oil & Gas Corp. v. Jordan,698 F.Supp.2d 474 (M.D.Pa.2010); 7726 Cherry St. P'ship v. Bell Atlantic Props.,439 Pa.Super. 141, 653 A.2d 663, 666 (Pa.Super.Ct.1995). A review of the above-cited cases reveals that the latter interpretation appears to be the interpretation that enjoys an increasing consensus of judicial opinions, is the more thoroughly-reasoned of the two, and is more in line with Pennsylvania Supreme Court pronouncements, see Yocca,854 A.2d at 436(observing same subject matter); HCB Contractors v. Liberty Place Hotel Assocs.,539 Pa. 395, 652 A.2d 1278, 1279–80 (Pa.1995)(same); Bardwell v. Willis Co.,375 Pa. 503, 100 A.2d 102, 104 (Pa.1953)(same).

*5Having determined that for the parol evidence rule to apply, the previous misrepresentations must “involve[e] the same subject matter as the contract,” the question becomes, just how close does the relationship need to be in order to be the “same” for these purposes? There is language in a Pennsylvania Superior Court opinion that seems to suggest that the terms of the contract must expressly deny the particular misrepresentation: “when the contract contains no such term denying the existence of such representations, parol evidence is admissible to show fraud in the inducement.” Youndt v. First Nat'l Bank of Port Allegany,868 A.2d 539, 546 (Pa.Super.Ct.2005). The court in Youndt held that a real estate contract that stated “[b]uyer has inspected the property … and has agreed to purchase it as a result of such inspection and not because of or in reliance upon any representation made by the seller” precluded the buyer from introducing evidence that the seller fraudulently misrepresented that “there were no problems” with the property, when in fact there were. Id. at 544, 549.

Relying on that language, Plaintiffs here stake their claim on the fact that the Agreement “contains no terms denying the uniqueness of the gelato recipe, nor does it deny that Defendant produces and manufactures the product.” PL's Br. Opp. Def.'s Mot. Dismiss at 6, ECF No. 19. Plaintiff reads the language in Youndt too narrowly. First, the Youndt statement on which Plaintiff relies is dicta, because there the court did find terms that explicitly denied the existence of prior representations. See Youndt,868 A.2d at 548–49.

Second, to the extent that the Youndt statement extends beyond its holding, it expresses an overly stringent view of the “same subject matter” requirement. See Atlantic Pier,647 F.Supp.2d at 490 n. 19. The Atlantic Pier court carefully surveyed Pennsylvania law in determining the specificity required by the “same subject matter” requirement, and concluded that “[t]o fulfill the same subject matter requirement, the written contract need not directly contradict the prior representation, but rather need only ‘relate to subjects that were specifically addressed in the written contract.’ ” 647 F.Supp.2d at 490(quoting HCB Contractors, 652 A.2d at 1279–90) (collecting cases).

The Court agrees with the thoughtful analysis in Atlantic Pier, and further observes that a rather relaxed view of the “same subject matter” requirement has been expressed in the more recent Pennsylvania Supreme Court cases. The court in Yocca did not explicitly outline the “same subject matter requirement” as such, and instead focused on the presence of an integration clause: “[a]n integration clause which states that a writing is meant to represent the parties' entire agreement is also a clear sign that the writing is meant to be just that and thereby expresses all of the parties' negotiations, conversations and agreements made prior to its execution….” It noted that the contract at issue directly referenced the subject matter of the alleged misrepresentation, but that “[m] ost importantly, the [contract] explicitly stated that it represented the parties' entire contract …” Yocca,854 A.2d at 436(emphasis added). In Toy, the court expounded further on why the parol evidence rule remains in full force for claims of fraud in the inducement, observing, “a party to a contract has the ability to protect himself from fraudulent inducements by insisting that those ‘inducements' be made part of the written agreement, and refusing to contract if they are not.” 928 A.2d at 206 n. 24. Neither Yocca nor Toy ever stated that prior representations had to be explicitly denied. The Court concludes that in Pennsylvania, the better view of the parol evidence rule in fraud in the inducement claims is that, at least in cases where a fully integrated contract is present, the “same subject matter” requirement is a more modest one.

*6Applying that standard to this case, there is no doubt that the “entire contract” prong is satisfied by the plain language of the “Entire Agreement Clause,” which explicitly states that the Agreement embodies “the entire understanding and agreement among the parties … and supersedes any prior understandings between or among any of them.” ECF No. 23–4 ¶ 14(h). It is also apparent from the face of the nineteen-page Agreement that it encompasses the entirety of matters regarding Palermo's license of Pino gelato.

The “same subject matter” prong is also satisfied here. Palermo's argument is that because Pino misrepresented to Palermo that it was the owner (and perhaps originator) of a top-shelf, special gelato recipe, rather than a private labeler of somebody else's gelato recipe, Palermo entered a contract it otherwise would not have, agreeing to buy Pino gelato at more-than-basement prices. First, the Agreement refers to Pino as “the supplier of products some of which bear [Pino] Marks …” Id.at 1, 928 A.2d 186. Section 2 of the Agreement then refers to the gelato recipe:

In the event [Pino] is reasonably expected to go out of business or should PG for any reason not be able to provide Product to Licensee, PG shall either train [Palermo] to manufacture the [gelato] Products or work with [Palermo] to identify a third party manufacturer to provide Products to [Palermo] directly. [Pino] shall have said recipe and equipment held on file at the firm of Baker & Daniels in Indianapolis, Indiana, for [Palermo’s] benefit and use in the event such third party is not identified timely, thereby permitting Licensee to secure any alternate manufacturer or prepare the product itself.

Agreement ¶ 2. Section 5(d) does as well:

In the event that [Pino] should go out of business … [Pino] shall provide [Palermo] with the recipe, equipment specifications and the 3 rd-party manufacturing specifications to enable Palermo to continue to operate its store(s)…. [Pino]’s obligations hereunder shall be met by providing [Palermo] with names, addresses, and other contact information of all vendors who supply any of the product provided to [Palermo] under this Agreement, and if any of the vendors will no longer provide Product, shall provide [Palermo] with all recipes, formulas, mixing directions, sources for ingredients and any other information.

Agreement ¶ 5(d). Under the Agreement, Pino represented that it had a significant amount of dominion and control, if not outright ownership (under copyright or trade secret law, e.g.) of the gelato recipe. Therefore, a review of the Agreement demonstrates that it plainly “relates to” the subject matter of the alleged misrepresentation, namely, the ownership and source of the gelato and the gelato recipe.FN4

FN4.Additionally, Plaintiff's claim that it was fraudulently induced to entering an agreement that “amounts to” a “franchise agreement,” 2d Am. Compl. ¶ 50, is also vitiated by the terms of the Agreement's “No Franchise” Clause, ¶ 7(b), which specifically states that it is the parties' intent not to enter into a franchise relationship, easily satisfying the same subject matter requirement with regard to that claim.

While this case is slightly unusual in that the terms of the contract seem to confirm, rather than deny, the content of the alleged misrepresentation, cf. Atlantic Pier,647 F.Supp.2d at 490–91,the “relates to the same subject matter” requirement of the parol evidence rule, as it has been articulated above, does not appear to carry either a positive or negative valence. In other words, it is enough that the contract relates to the subject matter of the gelato recipe in order for the parol evidence rule to operate and bar other representations on that topic-it need not carry terms that run contrary to those other representations, even implicitly. Here, Palermo has not asserted a claim that Defendant breached any terms of the contract, nor that those terms were fraudulent in themselves. Rather, it has brought a classic fraud in the inducement claim, asserting that it was induced to contract “[b]ased on the representations and information provided by Defendant prior to entering the Agreement”, 2d Am. Compl. ¶ 20, and that “but for this misrepresentation, Plaintiff would not have [entered into the Agreement]” ¶ 47; see also id. ¶ 50. While the result here might be tough medicine for someone in Palermo's spot, it is in line with the Pennsylvania Supreme Court's recently amplified pronouncements refusing to allow parol evidence as to fraud in the inducement claims, especially in the presence of an integration clause. See, e.g., Toy, 928 A,2d at 206 n. 24. The Entire Agreement clause plainly states that “any prior understandings” are superseded by the Agreement, and discusses topics that relate to the gelato recipe. If Palermo in fact relied on certain beliefs about the origins of the gelato it was purchasing, it could and should have ensured that those beliefs were embodied in the written Agreement between the parties.

*7Without the evidence of the prior misrepresentations that induced it to contract, Palermo cannot state a viable claim for Fraud in the Inducement at Count I of the Second Amended Complaint.FN5,FN6See, e.g., Bardwell,375 Pa. 503, 100 A.2d 102. B ecause, absent Plaintiff's claim of fraud in the inducement, Plaintiff has not made any demonstration that the Agreement is invalid, and because a claim for unjust enrichment cannot stand where a valid contract exists, Lackner v. Glosser,892 A.2d 21, 34 (Pa.Super.Ct.2006), Plaintiff's claim for Unjust Enrichment at Count II must also be dismissed. Therefore. Defendant's Motion to Dismiss is granted, and the case shall be dismissed.

FN5.The elements for fraud in the inducement in Pennsylvania are “(1) a representation; (2) which is material to the transaction at hand; (3) made falsely, with knowledge of its falsity or recklessness as to whether it is true or false; (4) with the intent of misleading another into relying on it; (5) justifiable reliance on the misrepresentation; and (6) the resulting injury was proximately caused by the reliance.” Freeman v. Pittsburgh Glass Works, LLC,709 F.3d 240, 257 (3d Cir.2013)(quoting Skurnowicz v. Lucci,798 A.2d 788, 793 (Pa.Super.Ct.2002)).

FN6.Given the Court's conclusion that Plaintiff fails to state a claim because of the operation of the parol evidence rule, it need not consider Defendant's alternative argument that the “gist of the action” doctrine also bars Plaintiff's claim. See generally Def.'s Supplement Reply Br., ECF No. 22.

An appropriate order will follow.

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