Date: February 2, 2022
By: Thomas O’Connell
Citation:
Shaw v. Ultimate Franchises, Inc., Slip Copy, 2022 WL 2132688 (C.D. Cal. 2022)
Executive Summary:
In this unpublished decision, Judge Josephine L. Staton of the United States District Court for the Central District of California granted a motion for default judgment filed by Plaintiffs John K. Shaw, Midori G. Shaw, and Shipshape Collective of Fitchburg, LLC against Defendants Ultimate Brands, Inc. and 2UlitimateBrands, Inc. The court found that Defendants were liable for fraudulent misrepresentation and violations of the California Franchise Investment Law (CFIL), Cal. Corp. Code § 31200, due to their material misstatements and omissions in franchise-related disclosures. The court awarded Plaintiffs $749,467.99 in damages, $196,346.57 in prejudgment interest, and eligible litigation costs under Local Rule 54-3. However, the court denied the Plaintiffs’ motion for attorney fees because they failed to adequately identify billing specific to claims against these Defendants.
Relevant Background:
This case centers on Plaintiffs John K. Shaw, Midori G. Shaw, and their entity, Shipshape Collective of Fitchburg, LLC (collectively referred to as “Plaintiffs”), who purchased three franchises of 18|8 Fine Men’s Salons based on representations made by Defendants Ultimate Brands, Inc. and 2UlitimateBrands, Inc. (collectively referred to as “Defendants”). The Plaintiffs alleged that the Defendants, who are the parent companies of Ultimate Franchises, Inc., fraudulently induced them to invest by providing misleading financial projections and omitting critical information about operational costs and prior litigation against a predecessor company.
Notably, this case builds on issues previously raised in Shaw v. Ultimate Franchises, Inc., 2021 WL 678687 (C.D. Cal. Jan. 15, 2021)., where Plaintiffs alleged similar violations of the California Franchise Investment Law (CFIL). In the earlier case, the court denied a motion for partial summary judgment, leaving unresolved claims about the Defendants’ representations and omissions in their Franchise Disclosure Document (FDD). These included projections about profitability and operational costs, as well as the nondisclosure of a prior fraud lawsuit involving the franchisor’s predecessor, Mana Concepts, Inc.
Thus, in this case, Plaintiffs reiterated claims that Defendants had misrepresented operational costs by failing to disclose that franchisees would incur higher expenses due to the requirement to classify stylists as employees, unlike the franchisor-owned salons that used independent contractors. The Plaintiffs also alleged that FDD failed to disclose a prior fraud lawsuit against Defendants’ predecessor, Mana Concepts, Inc., which resulted in a $209,002.84 judgment.
Relying on these representations, Plaintiffs invested $100,000 to purchase three franchises, incurred substantial buildout costs, and launched their first salon in 2016. Despite adhering to Defendants’ system, the franchise failed to perform as represented, with operating expenses exceeding 64% of total revenue and continuous losses. Attempts to resolve disputes through mediation and arbitration were unsuccessful, as Defendants refused to meaningfully participate. After initial litigation engagement, Defendants ceased defending the case, leading to the entry of default judgment.
Decision:
The court granted Plaintiffs’ motion for default judgment and awarded damages totaling $749,467.99, along with $188,748.93 in prejudgment interest and litigation costs. The decision was grounded in the following legal and factual findings:
- The court found that Defendants violated Cal. Corp. Code § 31200 by making untrue statements of material facts and omitting necessary information to avoid misleading franchisees. Under Geddes v. United Fin. Grp., 559 F.2d 557, 560 (9th Cir. 1977), factual allegations in a complaint are deemed admitted upon default unless related to damages.
- The court emphasized Defendants’ liability under CFIL, which prohibits offering or selling a franchise by means of untrue or misleading statements (Cal. Corp. Code § 31200). Additionally, liability extends to entities directly or indirectly controlling violators (Cal. Corp. Code § 31302).
- Plaintiffs substantiated claims for $749,467.99 in damages through documentation, including franchise fees, buildout costs, operating losses, and lease liabilities was granted. The court noted that damages aligned with the injury caused by Defendants’ misrepresentations (HICA Educ. Loan Corp. v. Warne, 2012 WL 1156402 (N.D. Cal. Apr. 6, 2012)).
- The court awarded prejudgment interest under Cal. Civ. Code §§ 3287(a) and 3289, finding Plaintiffs entitled to a 10% annual rate on liquidated claims and a discretionary rate on unliquidated claims.
- Plaintiffs’ request for $237,404 in attorney fees was denied because they failed to isolate fees attributable solely to the claims against these Defendants. The court stressed that billing entries for unrelated defendants could not be recovered.
Looking Forward:
This case underscores critical lessons for franchisors.
- The court’s finding of liability under Cal. Corp. Code § 31200 highlights the importance of transparency in financial disclosures. Franchisors must ensure that FDDs are accurate, detailed, and address key differences in operational costs between franchisor-owned and franchisee-owned models to avoid claims of misrepresentation.
- The franchisor’s failure to meaningfully engage in mediation, arbitration, or litigation was another key factor that undermined their defense. By defaulting, the franchisor allowed the court to deem the plaintiffs’ allegations admitted, as established in Geddes v. United Fin. Grp. Therefore, franchisors should note that proactive engagement in disputes not only demonstrates good faith but also provides opportunities to negotiate settlements or challenge allegations, potentially reducing damages or avoiding liability altogether.