Ohio Federal Court Rejects Former Ice Cream Franchisee’s Arguments to Dissolve Preliminary Injunction and to Maintain Case for Violations of California Franchise Act

In case in which franchisee (Schulenburg) defended (and lost) franchisor’s (Handel’s) bid to enforce post term covenant not to compete, franchisee’s counterclaim that franchisor had violated the CFIL by failing to provide an updated and revised FDD to franchisee was dismissed for franchisee’s failure to show that Handel’s CFIL violations caused any damages or articulate any way in which Handel’s violations damaged him, where the revised FDD differed solely with respect to a franchisee’s ability to obtain SBA financing.

Handel’s Enters. v. Schulenburg, No. 4:18-CV-00508, 2020 U.S. Dist. LEXIS 1185 (N.D. Ohio Jan. 6, 2020)

Excerpts from Case Below:

Handel’s Enters. v. Schulenburg

United States District Court for the Northern District of Ohio, Eastern Division

January 6, 2020, Decided; January 6, 2020, Filed

CASE NO. 4:18-CV-00508; CASE NO. 4:18-CV-02094)

For [FRANCHISEE] David Scott Levaton, LEAD ATTORNEY, Franchise Legal Support, Westlake Village, CA; Rares M. Ghilezan, LEAD ATTORNEY, Global Legal Law Firm, Solana Beach, Solana Beach, CA.

For [FRANCHISOR] Andrew Gregory Fiorella, LEAD ATTORNEY, PRO HAC VICE, Benesch, Friedlander, Coplan & Aronoff LLP, Cleveland, OH; Elizabeth A. [*2]  Batts, Warren T. McClurg, II, LEAD ATTORNEYS, PRO HAC VICE, Benesch, Friedlander, Coplan & Aronoff – Cleveland, Cleveland, OH; Philip Jeng-Hung Wang, Stoel Rives, LLP, LEAD ATTORNEY, Three Embarcadero Ctr, San Francisco, CA.

Judges: PAMELA A. BARKER, UNITED STATES DISTRICT JUDGE.

MEMORANDUM OF OPINION AND ORDER

….

The parties have moved for summary judgment with respect to Schulenburg’s first and second causes of action, which allege that Handel’s violated multiple provisions of the CFIL. (Doc. No. 69 at 10-15.) Generally, the intent of the CFIL is “to provide each prospective franchisee with the information necessary to make an intelligent decision regarding franchises being offered . . . to prohibit the sale of franchises where the [*16]  sale would lead to fraud or a likelihood that the franchisor’s promises would not be fulfilled, and to protect the franchisor and franchisee by providing a better understanding of the relationship between the franchisor and franchisee with regard to their business relationship.” Cal. Corp. Code § 31001. In support of this goal, the CFIL requires a franchisor to file an application for registration of an offer of a franchise with the DBO, including a proposed franchise disclosure document, before offering a franchise for sale. Cal. Corp. Code §§ 31110, 31111, 31114. Once approved, the franchise offering is valid for a period of one year from the effective date of the registration. Cal. Corp. Code § 31120.

In Schulenburg’s first cause of action, he asserts that Handel’s violated two CFIL provisions related to the amendment of a franchisor’s franchise disclosure document. (Doc. No. 69 at 10-12.) Pursuant to CFIL § 31123, “[a] franchisor shall promptly notify the commissioner in writing, by an application to amend the registration, of any material change in the information contained in the application as originally submitted, amended or renewed.” Cal. Corp. Code § 31123. Relatedly, CFIL § 31107 provides an exemption from the disclosure requirements for “any offer (but not the sale) by a franchisor of a franchise” made “while an application [*17]  for renewal or amendment is pending” as long as the prospective franchisee receives all of the following:

(a) The franchise disclosure document and its exhibits as filed with the commissioner with the application for renewal or amendment.

(b) A written statement from the franchisor that (1) the filing has been made but is not effective, (2) the information in the franchise disclosure document and exhibits has not been reviewed by the commissioner, and (3) the franchisor will deliver to the prospective franchisee an effective franchise disclosure document and exhibits at least 14 days prior to execution by the prospective franchisee of a binding agreement or payment of any consideration to the franchisor, or any person affiliated with the franchisor, whichever occurs first, showing all material changes from the franchise disclosure document and exhibits received by the prospective franchisee under subdivision (a) of this section.

(c) The franchise disclosure document and exhibits in accordance with paragraph (3) of subdivision (b) of this section.

Cal. Corp. Code § 31107. Schulenburg asserts that Handel’s violated §§ 31123 and 31107 when it continued with the offer and sale of the franchise to Schulenburg in January 2016 while Handel’s application to amend the 2015 [*18]  FDD was pending with the DBO without providing any of the disclosures required by § 31107. (Doc. No. 69 at 10-12; Doc. No. 73 at 10-11.)

In Schulenburg’s second cause of action, he alleges that Handel’s violated CFIL §§ 31119 and 31107. (Doc. No. 69 at 13-15.) Section 31119(a) requires a franchisor to provide a prospective franchisee with a copy of the franchise disclosure document “at least 14 days prior to the execution by the prospective franchisee of any binding franchise or other agreement, or at least 14 days prior to the receipt of any consideration, whichever occurs first.” Cal. Corp. Code § 31119(a). Similarly, § 31107(b) requires delivery of “an effective franchise disclosure document and exhibits at least 14 days prior to execution by the prospective franchisee of a binding agreement or payment of any consideration to the franchisor, or any person affiliated with the franchisor, whichever occurs first, showing all material changes from the franchise disclosure document and exhibits received by the prospective franchisee under subdivision (a) of this section.” Cal. Corp. Code § 31107(b). Schulenburg contends that when the DBO approved the Amended 2015 FDD on January 19, 2016, it became the only effective franchise disclosure document for Handel’s. (Doc. No. 69 at 14; Doc. No. 73 at 12.) [*19]  As a result, Schulenburg claims Handel’s violated both of the above provisions when it failed to provide Schulenburg with a copy of the Amended 2015 FDD prior to executing the Franchise Agreement on January 21, 2016. (Doc. No. 69 at 14; Doc. No. 73 at 12.)

Handel’s largely admits that its actions violated the CFIL. (Doc. No. 79 at 1.) However, in its Motion for Partial Summary Judgment, Handel’s argues that Schulenburg’s claims still fail for several reasons. In particular, as noted above, Handel’s asserts (1) Schulenburg’s CFIL claims are barred by the statute of limitations, (2) Schulenburg has not demonstrated how he has been damaged by the specific CFIL violations at issue, and (3) Schulenburg has not demonstrated reasonable reliance on any of Handel’s alleged misrepresentations or omissions in the 2015 FDD. (Doc. No. 72.) The Court finds that Handel’s is entitled to summary judgment on Schulenburg’s CFIL claims because Schulenburg has failed to demonstrate any damages caused by Handel’s violations.

Handel’s argues that Schulenburg’s claims fail because he has not alleged that any damages resulted from Handel’s violations of the CFIL. (Doc. No. 72-1 at 22-24.) Handel’s asserts a [*20]  showing of damages is a prerequisite to a claim for rescission. (Id.) In response, Schulenburg claims the language of the CFIL does not require a showing of damages in order to obtain rescission and that Schulenburg has shown he is entitled to restitution of certain benefits and compensatory damages. (Doc. No. 80 at 12-14; Doc. No. 81 at 5-7.)

CFIL § 31300 provides that any person who violates certain provisions of the CFIL “shall be liable to the franchisee or subfranchisor, who may sue for damages caused thereby, and if the violation is willful, the franchisee may also sue for rescission.” Cal. Corp. Code § 31300. The parties dispute the meaning of this language. Handel’s argues that this phrasing unambiguously provides that rescission is an additional remedy available for a CFIL violation if the violation is willful, but does not dispense with the requirement to establish that the CFIL violation caused damage. (Doc. No. 82 at 12.) Handel’s asserts use of the word “also” in the statute would be superfluous if the statute was interpreted to mean that a willful violation alone, without a showing of damages, entitled the plaintiff to rescission. (Id.) In response, Schulenburg contends that the language of § 31300 does not require [*21]  a showing of damages in order to obtain rescission. (Doc. No. 81 at 5-6.) Rather, rescission is an additional remedy available upon a showing of “willfulness.” (Id.)

The only case cited by either party that directly addresses this issue is an unpublished California Court of Appeal decision.⁴ In that case, the plaintiff brought a class action against defendants for violations of the CFIL. DT Woodard, Inc. v. Mail Boxes Etc., Inc., No. B194599, 2007 Cal. App. Unpub. LEXIS 8388, 2007 WL 3018861, at *1, *5 (Cal. Ct. App. Oct. 17, 2007). The plaintiff sought rescission of the class members’ contracts and argued that “section 31300 does not require proof that the franchisee relied on defendants [sic] violations of the CFIL and that such violations caused damages.” 2007 Cal. App. Unpub. LEXIS 8388 [WL] at *7. Interpreting the language of § 31300, the court rejected the plaintiff’s argument. The court noted that the statute’s wording—”shall be liable to the franchisee or subfranchisor, who may sue for damages caused thereby, and if the violation is willful, the franchisee may also sue for rescission”—contains “express causation language.” Id. (quoting Cal. Corp. Code § 31300). According to the court, that language has two consequences. Id. “First, reliance is an element of causation.” Id. More relevant here, however, is the second consequence the Court discussed:

[*22] Second, a franchisee suing for the additional remedy of rescission must also prove that the statutory violation is “willful.” This additional element is necessary to obtain rescission, however, does not dispense with a showing of reliance and causation; to obtain the rescission remedy, the plaintiff must prove that the violation is “willful” in addition to showing that plaintiff relied on the statutory violation in entering the contract and that the violation caused damages. If this were not the case, a “willful” statutory violation would give the plaintiff the opportunity to rescind, even if the franchisee did not rely on the franchisor’s violation and even if the franchisor’s violation caused no harm to plaintiff franchisee. It is illogical to condition the more expansive remedy of rescission (which includes restitution of benefits conferred by the contract, and which is not inconsistent with a claim for damages, according to Civil Code section 1692) on a lesser quantum of proof. To obtain the greater remedy of rescission should require plaintiff to prove everything necessary to obtain the lesser remedy of damages, as well as the “willful” violation of the statute.

2007 Cal. App. Unpub. LEXIS 8388 [WL] at *8.

The Court finds the reasoning [*23]  of DT Woodard persuasive. The language of the statute, which provides that a plaintiff “may sue for damages caused thereby, and if the violation is willful, the franchisee may also sue for rescission,” Cal. Corp. Code § 31300, indicates that rescission is an additional remedy that is available only if the plaintiff first establishes that the violation damaged the plaintiff. In addition, the opposing interpretation advocated for by Schulenburg would give the plaintiff the opportunity to rescind a franchise agreement based on a willful violation without the need to show that the violation ever damaged the plaintiff. This is a perverse result, especially in a situation where a plaintiff seeks to rescind an agreement that has been in place for years based on a statutory violation that did not harm the plaintiff in any way. It is illogical to provide such a drastic remedy without requiring a showing of damages.

Schulenburg argues that Cal. Civil Code § 1692⁠—which applies to rescission claims under the CFIL and provides that “[a] claim for damages is not inconsistent with a claim for relief based upon rescission”⁠—supports his interpretation of the statute because it shows damages are not a required element of a rescission claim, but [*24]  rather a remedy available in addition to rescission. (Doc. No. 81 at 5-6.) Although the principles in Cal. Civil Code § 1692 may apply to a rescission claim under the CFIL, it does not address whether a plaintiff is entitled to rescission under § 31300 of the CFIL in the first place. Thus, the Court finds his argument unpersuasive. Accordingly, the Court finds that § 31300 requires a plaintiff to prove that the defendant’s CFIL violation damaged the plaintiff and that the violation was willful in order to obtain rescission.

In this case, Schulenburg has not demonstrated that Handel’s CFIL violations caused any damages. Schulenburg’s Second Amended Complaint contains only conclusory allegations regarding damages caused by Handel’s violations. (See Doc. No. 69 at ¶¶ 58, 60, 71.) Schulenburg also has not articulated any way in which Handel’s violations damaged him in response to Handel’s Motion for Partial Summary Judgment, as Schulenburg does not claim that Handel’s failure to provide the required disclosures under § 31107 or its failure to provide the Amended 2015 FDD prior to the execution of the Franchise Agreement harmed him in any way. Indeed, Schulenburg offers no evidence that he was prejudiced by the two-month delay between executing the [*25]  2015 FDD and receiving the Amended 2015 FDD, which differed solely with respect to a franchisee’s ability to obtain SBA financing.

Instead, in conclusory fashion, Schulenburg asserts that he is entitled to compensatory damages for attorneys’ fees and lost profits and rent for his Cali Cream store and that he is “entitled to restitution of the following damage amounts, all of which Mr. Schulenburg has incurred as result of Handel’s statutory violations: (a) return of the $50,000 franchise fee paid to Handel’s pursuant to the illegal franchise agreement; (b) return of the $288,320 in royalties paid to Handel’s from 2016 to date pursuant to the illegal franchise agreement; [and] (c) reimbursement for more than $310,758 for the cost and expense of designing, equipping and opening the Encinitas franchise.” (Doc. No. 80 at 13.) These statements provide no explanation, however, as to how any of these damage amounts were caused by, related to, or connected in any way to Handel’s violations of the CFIL as required by § 31300. Accordingly, Schulenburg has failed to establish that he has been damaged by Handel’s statutory violations, and Handel’s is entitled to summary judgment on Schulenburg’s claims [*26]  under the CFIL.

As a result, the Court need not discuss the other arguments contained in Handel’s and Schulenburg’s respective Motions for Partial Summary Judgment. Handel’s Motion for Partial Summary Judgment is granted, and Schulenburg’s Motion for Partial Summary Judgment is denied.

⁴ The Court is aware that “an unpublished California Court of Appeals case [has] no precedential value.” Farley v. Country Coach, Inc., 550 F. Supp. 2d 689, 695 n.3 (E.D. Mich. 2008); Cal. R. Ct. 8.1115 (“[A]n opinion of a California Court of Appeal or superior court appellate division that is not certified for publication or ordered published must not be cited or relied on by a court or a party in any other action.”). However, federal courts “may cite unpublished California appellate decisions as persuasive authority.” Washington v. Cal. City Corr. Ctr., 871 F. Supp. 2d 1010, 1028 n.3 (E.D. Cal. May 10, 2012).