The California Franchise Investment Law (“CFIL”) governs the onset of the franchisor/franchisee relationship, directing both the sale and disclosure of franchise opportunities within California.[1] The law was enacted by the California Legislature in 1970 to “provide each prospective franchisee with the information necessary to make an intelligent decision regarding franchises being offered” and to “prohibit the sale of franchises where the sale would lead to fraud or a likelihood that the franchisor’s promises would not be fulfilled.”[2] Violation of the CFIL can give rise to damages, rescission, and, under certain circumstances, impose personal liability on the directors, officers and other employees of the offending franchisor.[3]
Unlike the Federal Trade Commission’s (“FTC”) Amended Franchise Rule that can only be enforced by the FTC, the CFIL provides individual franchisees with a private right of action. This private right of action is granted by Sections 31300, 31301 and 31302.5 of the CFIL. However, navigating these sections of the CFIL can be complicated.
This article explores these private right of action sections of the CFIL, including, the underlying violations that trigger these sections, the elements a franchisee must show to prevail on a claim under these sections, and the applicable limitations periods in which to bring such a claim.
Liability Under Section 31300
Section 31300 only allows franchisees to bring suit for violations of CFIL sections 31101, 31110, 31119, 31200, or 31202. These sections provide the following:
- Section 31101 sets forth the “minimum net worth, experience, disclosure, and notice filing requirements” a franchisor can satisfy to be exempted from registering its franchise disclosure document with the state;
- Section 31110 prohibits the offer or sale of a franchise that has not been registered with the State and is not exempt from the registration requirement;
- Section 31119 requires the franchisor to provide the prospective franchisee with the then-current offering circular at least 14 days prior to (i) the execution by the prospective franchisee of any binding agreement, or (ii) the receipt of any consideration paid by the prospective franchisee, whichever occurs first;
- Section 31200 makes it “unlawful for any person willfully to make any untrue statement of a material fact in any application, notice or report filed with the commissioner under this law, or willfully to omit to state in any such application, notice, or report any material fact which is required to be stated therein, or fail to notify the commissioner of any material change as required by Section 31123”; and
- Section 31202 makes it “unlawful for any person willfully to make any untrue statement of a material fact in any statement required to be disclosed in writing pursuant to Section 31101, or willfully to omit to state in any such statement any material fact which is required to be stated therein.”
A violation of the above CFIL sections, alone, will not result in liability under Section 31300. Instead, a franchisee suing under Section 31300 must also show “damages caused thereby” before it can prevail on the claim.[4]
In its non-published opinion in DT Woodard, Inc. v. Mail Boxes Etc., Inc. (Cal. Ct. App., Oct. 17, 2007, No. B194599) 2007 WL 3018861, the California Court of Appeal explained that the language of Section 31300 requires the plaintiff to show causation, reliance, and damages to prevail on the claim. In a fraud action, causation involves actual reliance and damage resulting from such reliance. “Justifiable reliance exists when the misrepresentation or nondisclosure was an immediate cause of the plaintiff’s conduct which alters his legal relations, and when without such misrepresentation or nondisclosure he would not, in all reasonable probability, have entered into the contract or other transaction.”[5]
The court found this also to be true for a claim under Section 31300. Although Section 31300 does not include the word “reliance” – unlike section 31301, discussed below – the California Court of Appeal found that Section 31300 expresses the concept of reliance as part of its causation requirement.[6] The element of reasonable reliance for a Section 31300 was later found to exist by the Ninth Circuit in Samica Enterprises LLC v. Mail Boxes Etc., Inc. (9th Cir. 2011) 460 Fed.Appx. 664, 665 (“Reasonable reliance is required under [Section 31300].”).
Further damages may be also available under Section 31300 if the franchisee can show that the franchisor’s conduct resulting in the violation was “willful.”[7] A showing of willful conduct will pave the way for franchisee to “also sue for rescission, unless, in the case of a violation of sections 31200 or 31202, the defendant proves that the plaintiff knew the facts concerning the untruth or omission, or that the defendant exercised reasonable care and did not know, or, if he or she had exercised reasonable care, would not have known, of the untruth or omission.”[8]
In an action based upon rescission, courts can order any relief necessary to adjust the equities between the parties in an effort to restore the parties’ to their pre-contract status.[9] If rescission is granted, “[t]he aggrieved party shall be awarded complete relief, including restitution of benefits, if any, conferred by him as a result of the transaction and any consequential damages to which he is entitled; but such relief shall not include duplicate or inconsistent items of recovery.”[10]
In Mail Boxes Etc., the California Court of Appeal found that the additional showing of “willfulness” does not negate the elements of reliance and causation for a Section 31300 claim.[11] Instead, to obtain the remedy of rescission, the plaintiff must prove that (i) the statutory violation was willful, (ii) the plaintiff relied on the statutory violation in entering the contract, and (iii) the violation caused damages to the plaintiff.[12]
The statutory limitation period for bringing a claim under Section 31300 also is set forth in the CFIL. Specifically, Section 31303 provides that “[n]o action shall be maintained to enforce any liability created under Section 31300 unless brought before the expiration of four years after the act or transaction constituting the violation, the expiration of one year after the discovery by the plaintiff of the fact constituting the violation, or 90 days after delivery to the franchisee of a written notice disclosing any violation of Section 31110 or 31200, […] whichever shall first expire.”[13]
Liability Under Section 31301
Section 31301 is narrower in scope than Section 31300 and provides a private right of action for only a single section of the CFIL – Section 31201.Section 31201 makes it unlawful for any person to make any statement of untrue material fact or material omission to a prospective franchisee not contained within the application, notice or report filed with the California Department of Financial Protection & Innovation (“DFPI”). In contrast, any untrue material fact or omission contained within a franchisor’s filing with the DFPI is subject to Section 31200, referenced above, not Section 31201.
Unlike Section 31300, the element of reliance is expressly included within the language of Section 31301. Section 31301 provides that “[a]ny person who violates Section 31201 shall be liable to any person (not knowing or having cause to believe that such statement was false or misleading) who, while relying upon such statement shall have purchased a franchise, for damages, unless the defendant proves that the plaintiff knew the facts concerning the untruth or omission or that the defendant exercised reasonable care and did not know, (or if he had exercised reasonable care would not have known) of the untruth or omission.”[14] As a result, a claim for damages brought under Section 31301 is subject to the same reliance, causation, and damages analysis articulated in Mail Boxes Etc.[15]
A claim under Section 31301 has a potentially shorter statutory limitation period than a claim under Section 31300. Specifically, a claim under Section 31301 must be “brought before the expiration of two years after the violation upon which it is based, expiration of one year after discovery by the plaintiff of the facts constituting such violation, or 90 days after delivery to the franchisee of a written notice disclosing any violation of Section 30201 or 31202 which notice shall be approved as to form by the commissioner, whichever shall first expire.”[16]
Liability Under Section 31302.5 [The Association Rule]
The third and final section of the CFIL providing franchisees with a private right of action is Section 31302.5. A claim under Section 31302.5 may be pursued if a franchisor, directly or indirectly, violates Section 31220 by restricting or inhibiting the right of its franchisees to join a trade association or otherwise prohibits the right of free association among franchisees for any lawful purpose.[17]
A claim under Section 31302.5 must be “brought before the expiration of two years after the violation upon which it is based or the expiration of one year after discovery by the plaintiff of the facts constituting such violation, whichever occurs first.”[18]
1 This is contrasted by the California Franchise Relations Act, governing the conclusion of the franchisor/franchisee relationship. See California Business and Professions Code §§ 20000 et seq.
2 Cal. Corp. Code § 31001.
3 Cal. Corp. Code § 31302.
4 Cal. Corp. Code § 31300.
5 DT Woodard, Inc. v. Mail Boxes Etc., Inc., No. B194599, 2007 WL 3018861, at *7 (Cal. Ct. App. Oct. 17, 2007) (citing Molko v. Holy Spirit Assn., 46 Cal.3d 1092, 1108 (1988)).
6 See also Samica Enterprises LLC v. Mail Boxes Etc., Inc. (9th Cir. 2011) 460 Fed.Appx. 664, 665 (“Reasonable reliance is required under [Section 31300].).
7 Dollar Systems, Inc. v. Avcar Leasing (C.D. Cal. 1987) 673 F. Supp. 1493, 1503 (“[W]illful” is defined as “an act that is committed knowingly and intentionally,” and does not require a showing of “an intent to violate the law, an evil motive, or a purpose to gain undue advantage.”).
8 Cal. Corp. Code § 31300.
9 Ca. Civ. Code § 1692.
10 Id.
11 2007 Cal. App. Unpub. LEXIS 8388.
12 DT Woodard, Inc. v. Mail Boxes Etc., Inc. (Cal. Ct. App., Oct. 17, 2007, No. B194599) 2007 WL 3018861, *23 (“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.”).
13 Cal. Corp. Code § 31303.
14 Cal. Corp. Code § 31301.
15 DT Woodard, Inc. v. Mail Boxes Etc., Inc. (Cal. Ct. App., Oct. 17, 2007, No. B194599) 2007 WL 3018861, *32; see also Samica Enterprises LLC v. Mail Boxes Etc., Inc. (9th Cir. 2011) 460 Fed.Appx. 664, 665 (“Reasonable reliance is required under [Section 31301].”).
16 Cal. Corp. Code § 31304.
17 Cal. Corp. Code §§ 31220, 31302.5.
18 Cal. Corp. Code § 31302.5.
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This article was prepared by Kevin A. Adams (kadams@mortensontaggart.com), a Partner at Mortenson Taggart Adams LLP. Mr. Adams represents and counsels franchisors, licensors, manufacturers, and distributors on their business litigation needs, including state and federal franchise laws, intellectual property rights, California employment laws, and related trade regulation matters.
Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact Mr. Adams at kadams@mortensontaggart.com.