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Small Entrepreneurs Turn to Litigation After Falling Victim to Alleged ‘Franchise Fraud’

 

DiTommaso Lubin Austermuehle has an active practice in franchise litigation, especially representing franchisee in disputes with franchisors they believe have not been completely honest. Because we work in this area, our Chicago franchise litigation attorneys were pleased to see a cover story on just that situation in the March/April 2009 issue of Mother Jones magazine. The article discusses allegations of “franchise fraud” — the practice by franchisors of cheating the franchisees they sign up by failing to disclose important information, writing onerous financial requirements into contracts and adding after-the-fact legal requirements franchisees didn’t agree to and can’t refuse without being sued.

The article focuses on the Coffee Beanery, a chain of cafes, and one Maryland couple’s experience when they started a Coffee Beanery franchise in Annapolis. At their initial meeting with the franchisor, Coffee Beanery vice president Kevin Shaw allegedly told them they could clear $125,000 a year in the right location. Not only did this allegedly violate a federal law that forbids franchisors from predicting future earnings, but it wasn’t quite true — the magazine said 40 franchises had already failed at the time. Another 60 have since died.

But a bigger problem was the expense of the equipment that the Coffee Beanery said they were contractually obligated to accept. The franchisor allegedly sent them expensive equipment that didn’t work, was unnecessary or wasn’t appropriate for their business. It also allegedly demanded that they abide by contractual obligations they didn’t remember signing up for, such as a gift card program. All of this cost tens or even hundreds of thousands of dollars — and refusing would have opened them up to a lawsuit.

The couple sank $90,000 of their own money plus a $300,000 loan from the federal Small Business Administration into their Annapolis franchise — but it wasn’t enough. Before the store had even opened, they had to take out a $40,000 home equity loan to keep going. Sick of the abuse, they sued — only to discover that they had signed up for mandatory binding arbitration whose costs they had to pay for themselves. Worse, the arbitrator, who the franchisor had the right to select, according to the article had a personal relationship with the attorney for the Coffee Beanery. Not surprisingly, she ruled in favor of the company and socked the couple with another $187,452 in costs for the arbitration. Many of these costs were allegedly inflated, such as $926 for the Coffee Beanery’s lawyers’ drive to the arbitration.

The couple is now bankrupt and unemployed, according to the article — but against all odds, they may yet get a fair trial. They appealed the arbitrator’s decision first to federal trial court and then to the Sixth U.S. Circuit Court of Appeals, which overturned the arbitration award. Meanwhile, regulators in both Maryland and Illinois have stepped in and ordered the Coffee Beanery to release franchisees in those states from their contracts, citing allegedly illegal misrepresentations by the company.

Similar questions and allegations have been raised about other franchises, including Quizno’s, which is accused in a class-action lawsuit of pocketing $75 million from franchisees who never actually opened stores. These actions give rise to alleged breaches of individual contracts, but more importantly, they are alleged breaches of the Federal Trade Commission Act and FTC rules that require franchisors to fully disclose certain information and to notify franchisees of contract changes at least seven days before a signing. As Illinois franchise litigation lawyers, we vigorously protect these rights on behalf of our franchisee clients, in individual actions or class actions.

DiTommaso Lubin Austermuehle is a business litigation law firm with offices in Chicago, and Oak Brook, Ill. We represent clients in the Midwest and throughout the United States in all types of business disputes, including disputes with a franchisor that you believe lied or breached its own contract. Our experience includes individual actions as well as actions on behalf of multiple franchisees who have the same problems. To set up a confidential consultation with our experienced Chicago business litigation attorneys, please contact us as soon as possible.