One of the most significant decisions construing and applying the New York Franchise Act was recently issued by Supreme Court Justice Shirley Werner Kornreich in three joined actions captioned EV Scarsdale Corp. et al. v. Engel & Voelkers North East LLC et al.[1] (Full disclosure: the author's law firm represented all prevailing defendants in this action.) We will refer to the three joined actions collectively as Engel & Voelkers. The critical import of this decision may be simply stated: For the first time ever, a New York court has held that late delivery of a franchisor's Franchise Disclosure Document, standing alone, will not trigger liability unless the subject franchisee is able to prove that it sustained damages as a result of late FDD delivery.

As stated by the court, the Engel & Voelkers cases concern claims by Engel & Voelkers real estate brokerage franchisees that the franchisor-defendants violated the New York Franchise Act in various respects and breached their franchise agreements. On this adjudication of Engel & Voelkers' motions for summary judgment, the court confined its attention to the New York Franchise Act prongs of plaintiffs' actions, noting that “… the contracts are not discussed herein because the parties agree that plaintiffs' claims that such contracts were breached implicate material factual disputes that will be adjudicated at trial.”

With respect to claims that defendants violated the New York Franchise Act (and, in one action, a claim that the defendants violated Rhode Island's franchise law), all of the plaintiffs alleged two core violations: that the defendant failed to provide them with a Franchise Disclosure Document prior to their “first personal meeting” (in purported violation of §683 of the General Business Law and, with respect to one franchisee, in violation of §19-28.1-8(a) of Rhode Island's franchise law) and that defendants fraudulently induced plaintiffs to invest in Engel & Voelkers real estate brokerage franchises based on material misrepresentations about the financial prospects of their franchised offices. The relief sought by plaintiffs for these statutory violations was rescission—a refund of their investment and out-of-pocket expenses incurred in setting up their franchised offices.

At the conclusion of discovery, both plaintiffs and defendants filed summary judgment motions. Important for New York Franchise Act purposes were defendants' seeking summary judgment on: (1) the above-referenced late disclosure claims; (2) the misrepresentation claims; (3) the enforceability of the subject franchise agreements' limitation of liability clauses, and (4) plaintiffs' punitive, exemplary and consequential damages demands.

Supreme Court Judge Kornreich granted defendants' summary judgment on the first three motions and partial summary judgment on the fourth.

Critical to the court's decision—and similarly critical to practitioners seeking guidance on the judicial interpretation and application of the New York Franchise Act—is the fact that all of the plaintiffs in Engel & Voelkers received Franchise Disclosure Documents (FDDs) after their “first personal meetings” with defendants—but it was undisputed that they all received their FDDs prior to signing their License Agreements. As readers know, §683(8) of the Act requires that a franchisor furnish its Franchise Disclosure Document to a prospective franchisee at the earlier of the “first personal meeting” between the parties or ten business days prior to the execution of any franchise agreement or payment of any monies in connection with the sale of a franchise.

However, the court in Engel & Voelkers noted that: “Plaintiffs do not cite a single case, nor is the court aware of any, where a franchisee was awarded damages where the FDD was provided after the first personal meeting but prior to the execution of the license agreement.”

In fact, noted the court, “… none of the plaintiffs claim that they did not have sufficient time to review the FDDs before deciding to invest. The conclusive evidence utterly refutes such a notion,” the court observing that the dates on which FDDs were furnished were all well in advance of the execution of the subject franchise agreements—and that, in fact, some plaintiffs gave it to their counsel, who proceeded to negotiate the subject franchise agreements. That observation pertained in two of the subject actions—with the court sharply noting that the plaintiffs in the James Ian actions received their Engel & Voelkers FDD over a month before they signed their franchise agreement but admitted that they did not read it.

The court proceeded to note that defendants' counsel (again, in the interest of full disclosure, this author's law firm) “… correctly observe that every court to have considered an analogous fact pattern at the summary judgment stage … has held that defendants' late provision of the FDD was a technical, statutory violation that could not have been material to plaintiff's investment decision and could not have caused any damages” (citing in accord Coraud v. Kidville Franchise Co., 121 F. Supp. 3d 387 (S.D.N.Y. 2015), in which, again in the interest of full disclosure, defendant franchisor was represented by the author's law firm).

In granting defendants' summary judgment on the late FDD disclosure claim, the court observed:

Here … plaintiffs had ample time to review the FDDs. Indeed, some of the plaintiffs consulted counsel and negotiated the terms of the contract. Others had no interest in reviewing the FDD at all. Thus, there is simply no non-speculative basis for the finder of fact to conclude that the first personal meeting preceding the delivery of the FDDs had any effect on plaintiffs' decision-making process.

The court then turned to defendants' motion to dismiss plaintiffs' New York Franchise Act misrepresentation claims, noting that the reason underlying plaintiffs' business failures was not at all any claimed misrepresentations in the Engel & Voelkers' Franchise Disclosure Document but, instead, the timing of plaintiffs' acquisition of their real estate brokerage franchises—namely, right before the financial crash and deep recession of 2008-2009 and the real estate collapse related thereto.

Held the court (quoting Basis PEC-Rim Opportunity Fund (Master) v. TCW Asset Mgmt. Co., 149 A.D.3d 146 (1st Dept. 2017)):

(W)hen the plaintiff's loss coincides with a market wide phenomenon causing comparable losses to other investors (i.e., the 2008 financial crisis), the prospect that the plaintiff's loss was caused by the fraud decreases, and a plaintiff's claim fails when it has not … proven … that its loss was caused by the alleged misstatements as opposed to the intervening events. Indeed, when an investor suffers an investment loss due to a market crash of such traumatic proportions that (the) losses would have occurred at the same time and to the same extent regardless of the alleged fraud, loss causation is lacking.

Summarized the court: “Here, as in Basis, plaintiffs' real estate investment failed at the same time the financial crisis caused virtually all real estate investments to fail.”

The court further held that where, as here, a defendant moves for summary judgment and comes forward with expert evidence that the plaintiffs' losses would have been caused by the market downturn regardless of the defendants' claimed malfeasance, the burden then shifts to plaintiffs to raise a material question of fact to the contrary. But in this case, in which the Engel & Voelkers defendants presented an expert witness describing the scope and impact of the 2008 real estate market crash, there was no response by plaintiffs. “Not only did they fail to submit any fact or expert evidence on this issue, they do not even offer a conclusory theory as to how much of their losses were caused independently of the market downturn,” stated the court (emphasis in original). “(The defendants' expert evidence), combined with the undisputed fact that each of the New York Plaintiffs actually received an FDD well prior to execution of their respective License Agreements and had their attorneys review and negotiate their terms, renders it impossible for them to establish damages causation.”

Accordingly, the court granted summary judgment to defendants on their New York Franchise Act fraud claims.

The court also granted summary judgment upholding the limitation of liability clause found in the parties' Engel & Voelkers Franchise Agreements and, as well, upheld the subject franchise agreements' preclusion of punitive, exemplary and consequential damages, the court observing that “… the contracts evidence a clear intent to restrict plaintiffs to recovering compensatory damages.”

So it is that a New York court, for the first time since the New York Franchise Act was enacted, has offered compelling guidance as to the impact of a franchisor's failure to furnish its Franchise Disclosure Document to a prospective franchisee before their “first personal meeting” and, as well, that a severe and widespread economic downturn in an economic sector (in this case, real estate and real estate brokerage) can be invoked in defense of New York Franchise Act fraud claims.

Endnotes:

[1] The three actions, joined for the purposes of discovery, are EV Scarsdale Corp. v. Engel & Voelkers North East LLC, Index No. 651169/2011; James Ian Properties Corp. et al. v. Engel & Voelkers North East LLC et al., Index No. 651611/2011; and, Riverside Homes Realty Inc. et al. v. Engel & Voelkers North East LLC, Index No. 651608/2011. Judge Kornreich's decision bore Index No. 651611/2011 and her decision, not yet officially reported, may be found at 2017 WL 5513329 (Sup. Ct. N.Y. Cty. Nov. 16, 2017).

David J. Kaufmann is senior partner of Kaufmann Gildin & Robbins and authored the New York Franchise Act while serving as Special Deputy Attorney General of New York.