Around the country, there are differing legal frameworks and schemes for business franchising. California law is one of the most protective for the franchisees and requires registration of the franchise with the California Department of Business Oversight (“DBO”). Many US jurisdictions do not require any sort of registration of the franchise (beyond the standard registration of corporate entities).

Here in California, part of the registration process requires that a franchisor keep on file with the Department of Business Oversight copies of the then-current franchise agreement and a sheaf of disclosure documents. These must be on file before a franchisor may offer a franchise for sale and all of the on-file documents must be tendered to the proposed franchisee prior to consummation of the sale. A case recently decided here in federal court in the Southern District of California reminds franchisors and franchisees that there must be strict compliance with the disclosure laws. Failure to comply with the disclosures can lead to significant, protracted, and expensive litigation. See Schulenburg v. Handel’s Enterprises, Inc., Case No. 18cv513-GPC(WVG) (US Dist. S.D. Cal. September 7, 2018). The Schulenburg parties are also litigating in the federal court in Ohio where the Franchisor is headquartered.

The case highlights the importance of having an experienced San Diego corporate attorney provide advice and counsel if you are offering/selling franchise or if you are buying a franchise.

Facts of the Case

Handel’s Enterprises is an ice cream shop franchise with 41 shops/restaurants in nine states around the county. As is common in the franchise industry, Handel’s business includes both company-owned and franchisee-owned locations. Handel’s franchise operations involve the use of products, equipment, methods, suppliers, and recipes that are exclusive to Handel’s in the ice cream industry. Handel’s allows its franchisees to use its methods and products and trademarks in exchange for franchising fees.

In 2015, California resident Kenneth Schulenburg wanted to open franchises in California. After discussions and negotiations, Schulenburg was offered and he agreed to buy a franchise in Encinitas with an option of opening a second franchise here in the Gaslamp Quarter of downtown San Diego. The business operations did not go as planned and the Gaslamp Quarter franchise was never opened. The parties are now engaged in extensive multi-district litigation.

Failure of Strict Compliance

In the California court, Schulenburg has sued Handel’s for various causes of action including ones related to Handel’s failure to comply with the registration and disclosure provisions of the California Franchise Investment Act. See Cal. Corp. Code § 31001 et seq. The law requires that franchisors keep their franchise agreements on file and, if there is an amendment, the amendment must be submitted for approval. With respect to Handel’s and Schulenburg, here are the relevant dates:

• Handel’s properly filed is disclosure documents in April 2015
• In October 2015, Schulenburg was given copies of the April 2015 documents
• In December 2015, Schulenburg paid his initial franchise fee deposit of $5,000
• On January 11, 2016, Handel’s applied to the Department of Business Oversight to amend its disclosure documents (other than the franchise agreement)
• On January 19, 2016, the Department of Business Oversight approved the amended disclosure documents
• On January 21, 2016, Handel’s and Schulenburg signed the franchise agreement but Schulenburg was not given the amended disclosure documents on January 21, 2016

In the California litigation, Schulenberg alleged that Handel’s violated the Act by failing to provide copies of the December 2015 amended disclosure documents and sought various damages allowed by the Act. The federal court agreed that Schulenberg stated a claim for violation of the Act. Compliance with the disclosure requirements is strict. Under the Act, Handel’s was allowed to offer the franchise while the amendment was pending, but the sale could not be closed without tendering the amended disclosure documents to Schulenberg. Handel’s argued that the amendments were minor and not material to the transaction. The court rejected the argument. Materiality is not a condition of disclosure. The court ruled that Schulenberg’s case could go forward.

Contact San Diego Corporate Law

For more information, contact franchise law attorney Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters and he proudly provides legal services to business owners in San Diego and the surrounding communities. Mr. Leonard can be reached via email or by calling (858) 483-9200. Like us on Facebook.

You Might Also Like:

Checklist When Buying Or Selling A Business

What to Expect When Selling Your San Diego Business

Pros and Cons of Buying a Franchise

Selling a Franchise

San Diego Franchise Agreements: What is California’s Negotiated Changes Law?