Franchise Law

October 2002

FRANCHISEES SUE AFTER SIGNING GENERAL RELEASE

by Kathleen A. Paul

Franchisees Kevin and Jennifer Lee had operated a AGreat Earth@ vitamin store at Los Angeles=s Westside Pavilion for 16 years. Then, in 1990, they opened a GNC (AGeneral Nutrition Companies@) store at the same location. Business was going well. So, in May 1991, the Lees opened a second GNC store at Southern California=s Galleria at South Bay. Their stores prospered, with the Westside Store receiving the AMillion Dollar Store@ award in 1997 and the South Bay store winning an AOperator of the Year@ award in 1998.

But sales started declining toward the end of 1998, according to the Lees, because franchisor GNC had launched what the Lees described as an Aunlawful scheme@ to drive GNC franchisees out of business so that the franchisor could retake the stores. This, according to the Lees, involved GNC using its affiliate companies (GNCC and GND) to make misrepresentations to its franchisees, then open competition stores near existing franchises, lower retail prices at the competition stores below those at the shopping center stores, offer additional discounts on products through the AGold Card@ or ABuy One Get One@ programs, use customers= Gold Card information to channel customers, via advertising, to the competition stores, and also sell GNC products at reduced rates over the Internet and within the AProtected Territory@ of the franchisees through Rite-Aid stores, which offer GNC products under the name APharmAssure@.

In point of fact, the Lees= agreements did provide AProtected Territory@ to both stores (i.e., no other GNC store was allowed within a radius of one mile from the closest point outside the boundary of the Westside Pavilion, nor Aoutside the retail development@ of the Galleria at South Bay). But, according to the signed agreements, the franchisor was permitted to sell and distribute any goods, whether directly or indirectly, to businesses and individual consumers located in or outside the Protected Territory by Adirect mail, mail order, catalog sales, or any other similar method and to sell and distribute such goods and services directly to drugstores and supermarkets or to other non-competing retailers.@ (Italics added for emphasis) Further, the agreements allowed the franchisor to use and license proprietary marks for stores similar to GNC, with the exception that such stores could not offer GNC Brand vitamins if located within GNC=s Protected Territory.

Despite their concerns, in November, 1999, the Lees renewed their Westside Pavilion agreement for another five years. They were induced to renew it, they say, by GNC=s stated intention to discontinue the alleged ACompetition Program@. However, the 1999 Agreement took the step of requiring the franchisees to additionally sign a AGeneral Release@ releasing GNC and affiliates from Aany and all liability, actions, causes of action, claims, debts, demands, damages and liabilities of Aevery nature and kind@ which relate to the operation of or development and/or franchise rights in any and all franchise locations now or at any time awarded.@

The Lees remained unhappy. In 2001, they filed a complaint with sixteen causes of action in Federal District Court, Central District of California, against GNC and its affiliates for, among other violations, fraudulent inducement, RICO violations, unjust enrichment and violation of the Robinson-Patman ActBin addition to breach of contract. GNC challenged the Lees= contentions with a Motion to Strike.

Addressing each allegation, the Court found that any alleged misrepresentations stemming from the 1990 AUFOC@ (AUniform Franchise Offering Circular@Ba disclosure document with information about the proposed franchise/franchisor) or other representation made in 1990 were time-barred by the Statute of Limitations, but the Court permitted such reliance on the UFOC of 1999 as a reasonable basis for the Lees= action.

GNC argued that the Lees= fraud claims should also be time-barred by the three-year statute of limitations on fraud, and claimed that the fraud allegations did not satisfy pleading requirements as to specificity. But the Court, citing Section 388 of the California Code of Civil Procedure, stated that fraud is not to be deemed to have accrued until discovery by the aggrieved party of the facts constituting the fraud or mistake, which one could infer the Lees did not suspect until the alleged Competition Program began and, further, that specificity of the allegations was provided.

As to oral and written representations, the Court agreed with GNC that the integration clauses precluded the Lees from presenting evidence of communications which contradict the terms of the Renewal Agreement, butBthe Court addedBthey do not bar the Lees from presenting evidence of representations that concern subjects arguably not covered by the Agreement.

The Court sided with GNC that the Lees could not use breach of the implied covenant of good faith and fair dealing to modify or override contractual terms, nor could the Lees bring a claim under the California Consumers Legal Remedies Act, since the Lees are not consumers-nor did they allege to be consumers--under the meaning of the statute. But because GNC provided no legal basis for their objection to a claim for Implied Duty to Cooperate/Hindrance of Performance, the allegation remained.

The Court also dismissed the Lees= RICO claim that there was an Aassociation@ with an Aenterprise@ engaged in racketeering activity, and dismissed the allegation of price discrimination under the Robinson-Patman Act on grounds that the ultimate interests of the parent and subsidiary in this case were identical and must be viewed as a single economic unit.

But, as to the Lees= claim of tortious interference with Contract, the Court found that, since the Lees alleged the existence of contracts between them and third parties, the CourtBunder FRCP Rule 12(b)(6)Bmust presume the truth of the factual allegations in the complaint and draw all reasonable inferences in favor of the Lees and, for that same reason, found that the Lees had alleged cognizable wrongful acts. The Court further declined to dismiss the Lees= claims for breach of the franchise agreement or to dismiss the Lees= other RICO claims, one claim alleging conspiracy and the other alleging competitive injury stemming from defendants= ill-gotten revenue.