November 1, 2024
Citation:
MRFranchise, Inc. v. Stratford Insurance Co., 2024 WL 4651195 (D.N.H. Nov. 1, 2024)
Executive Summary:
In this unpublished decision, Judge Landya B. McCafferty of the United States District Court for the District of New Hampshire resolved a dispute between MRFranchise, Inc., its CEO Mike Rafipoor (collectively “Plaintiffs”), and Stratford Insurance Company (“Defendant”). Plaintiffs alleged breach of contract and bad faith on the part of Stratford for denying coverage in connection with a counterclaim filed against them by franchisees during arbitration. The court granted partial summary judgment for Plaintiffs on defense costs and indemnification but denied their claim for tortious breach of good faith and fair dealing.
Relevant Background:
MRFranchise, Inc. is the franchisor of the Panini Kabob Grill restaurant chain, headquartered in Southern California. The company’s CEO, Mike Rafipoor, is involved in the management and oversight of the franchise system. In 2016, a group of prospective franchisees expressed interest in opening a Panini Kabob Grill location in California. These individuals eventually entered into a franchise agreement with MRFranchise.
Before signing the agreement, MRFranchise provided the franchisees with a Franchise Disclosure Document (FDD), a requirement under both federal regulations (16 C.F.R. § 436.5(c)) and the California Franchise Investment Law (CFIL) (Cal. Corp. Code § 31119(a)). The FDD is intended to protect franchisees by providing accurate and transparent information about the franchisor, including any prior litigation involving allegations of fraud, deceptive practices, or similar misconduct within the past ten years.
The franchisees later discovered that the FDD omitted information about prior fraud-related lawsuits and settlements involving MRFranchise’s CEO, Mike Rafipoor. They alleged that this omission violated CFIL, specifically Cal. Corp. Code §§ 31119(a) and 31202, which require full and truthful disclosures. As a result, the franchisees filed a counterclaim during arbitration, asserting that MRFranchise misled them and seeking rescission of their franchise agreement.
MRFranchise turned to its directors and officers (D&O) liability insurer, Stratford Insurance Company, to cover the defense costs and potential indemnification associated with the counterclaim. However, Stratford denied coverage, arguing that the claims fell within policy exclusions for contract disputes, intentional acts, and professional services. Stratford’s denial prompted MRFranchise to file a lawsuit, alleging breach of contract and bad faith refusal to defend and indemnify. Both parties filed motions for summary judgment, leading to the court’s decision.
Decision:
The court made several rulings on the key issues presented, holding in part for both Plaintiffs and Defendant. The rationale behind each decision is as follows:
- The court held that Stratford Insurance had a duty to defend MRFranchise against the counterclaims brought by the franchisees. The court reasoned that under California law, an insurer’s duty to defend arises whenever the underlying claim raises even a potential for coverage (Gray v. Zurich Insurance Co., 65 Cal. 2d 263, 275 (1966)). The franchisees’ counterclaims, alleging violations of the California Franchise Investment Law (CFIL), were statutory claims not tied exclusively to contractual breaches, thus potentially triggering coverage. The court noted that even though the franchisees sought contractual relief (rescission of the franchise agreement), the basis for their claims stemmed from MRFranchise’s alleged failure to meet disclosure obligations under Cal. Corp. Code §§ 31119(a) and 31202.
- The court found that the policy’s contract exclusion, which barred coverage for claims “based upon or attributable to liability under any contract or agreement,” did not apply. The court reasoned that while the counterclaims involved rescission of the franchise agreement, the allegations arose independently from statutory violations of CFIL, not from the terms of the agreement itself. The court emphasized that the policy language requires a direct connection between the liability and a contract, which was not present here.
- The court held that the policy’s intentional acts exclusion, which bars coverage for “willful acts” under Cal. Ins. Code § 533, was inapplicable. The court reasoned that the arbitrator found insufficient evidence of intentional misconduct by CEO Mike Rafipoor. Moreover, California law prohibits imputing one insured’s intentional acts to another insured unless explicitly stated in the policy.
- The court rejected Stratford’s argument that the claims fell under the professional services exclusion, which excluded coverage for claims “arising out of the performance of or failure to perform professional services.” The court interpreted the exclusion narrowly, concluding that the franchisees’ claims were based on pre-contractual statutory violations related to disclosure obligations, not on services requiring specialized knowledge or expertise.
- The court denied summary judgment on Plaintiffs’ claim for tortious breach of the implied covenant of good faith and fair dealing. The court found that factual disputes remained as to whether Stratford acted in bad faith by denying coverage. Evidence regarding Stratford’s handling of the claim, including whether it conducted a thorough and fair investigation, precluded a ruling as a matter of law.
Looking Forward:
The court’s decision in this case offers several important insights for franchisors and their insurers, particularly regarding the scope of directors and officers (D&O) liability coverage and the implications of California’s Franchise Investment Law (CFIL). Two key lessons emerge from the ruling:
- While the court ultimately required Stratford Insurance to defend MRFranchise, the decision underscores the importance of understanding how statutory claims, such as those under CFIL, may intersect with insurance policies. Insurers often rely on exclusions like those for contract disputes or intentional acts, but these exclusions may not apply where the claims are grounded in statutory obligations, as was the case here.
- For franchisors, this case serves as a reminder that complete and accurate disclosure in Franchise Disclosure Documents (FDDs) is not merely procedural, it is a legal requirement with significant implications. Omissions, especially regarding prior litigation or settlements involving key executives, can lead to costly disputes and potentially significant liability under CFIL.
Notably, California courts have consistently emphasized the strong public policy underlying its franchise laws, aiming to ensure transparency and fairness in franchise relationships. Hence, this case highlights the importance of tailoring agreements and compliance processes to account for state-specific laws. Franchisors and insurers should work closely to evaluate risks, clarify coverage, and ensure that policy exclusions are properly understood and narrowly applied.
By addressing these issues proactively, franchisors can minimize exposure to liability and disputes, while insurers can avoid coverage litigation by carefully drafting and applying policy terms.