Like many jurisdictions, California has a legal doctrine called “unclean hands.” This doctrine applies as a defense to a lawsuit filed by another. The doctrine requires that, in the lead-up to a lawsuit, the plaintiff act fairly in the matter for which the plaintiff is seeking some remedy from a court. That is, the plaintiff must come into court with “clean hands” and keep them clean. If the defendant can prove to the court that the plaintiff does not have “clean hands,” then the court will dismiss the case and give the “win” to the defendant even if the plaintiff has a strong case. The actions of the plaintiff must be extreme and truly demonstrate some unconscionable act, bad faith, or inequitable conduct related to the matter covered by the lawsuit. The doctrine of unclean hands is a complete defense to both legal and equitable causes of action.

A good case example in a circumstance of a car dealership franchise is Fladeboe v. American Isuzu Motors Inc., 58 Cal. Rptr. 3d 225 (Cal. App. 4th Dist. 2007). Under California law, a new vehicle dealer franchisee must file with the California Department of Motor Vehicles a packet of documents including an OL-124 form. This form must be signed by the vehicle manufacturer — in this case Isuzu — before an automobile dealer may sell the vehicles of a particular make and line. Without the manufacturer’s authorized signature, the DMV will not accept the form and the franchisee/dealer cannot legally operate in California.

In addition, various sections and subsections of California Vehicle Code, §11713.3 prohibit a vehicle manufacturer — like Isuzu — from preventing a dealer from selling or transferring its franchise/dealership without reasonable grounds.

In the Fladeboe case, Ray Fladeboe ran a new vehicle dealership for many years. His dealership was run through a corporate entity called Ray Fladeboe Lincoln-Mercury, Inc. (“RFLM”) and was authorized to sell Ford and Lincoln-Mercury vehicles. In 1980, RFLM became an authorized dealer for Isuzu and eventually also sold Volkswagons. In 2002, RFLM and Ford Motor Company entered into discussions which led to the sale of the Ford portion of RFLM to Ford. For tax reasons, the deal was structured as an asset purchase. Further, Fladeboe needed to dissolve RFLM and “spin off” the Isuzu and Volkswagon dealerships into separate corporations. Further, the money transferred by Ford had to come into Ray Fladeboe’s possession after dissolution of RFLM. In furtherance of the plan, Fladeboe VW, Inc. and Fladeboe AG, Inc. were created. The scheduled closing was for the sale to Ford was March 29, 2002, and it was consummated on that date.

Previously, on February 19, 2002, RFLM signed an asset purchase agreement to sell all the Isuzu inventory and assets to Fladeboe VW. Those assets were transferred in mid-March. But, the request to Isuzu to transfer the dealership license to Fladeboe VW was not sent until March 19, 2002, and was not approved until April 23, 2002.

RFLM was officially dissolved on March 29, 2002. From mid-March 2002 through April 23, 2002, Fladeboe VW operated as though it was an authorized Isuzu dealership — service and sales — but without the approval or agreement from Isuzu. For months after March 29, 2002, Fladeboe VW pretended to be RFLM using the unique dealer code number that Isuzu had previously assigned to RFLM. When Isuzu approves a dealership transfer, it assigns a new code number to the new dealership. Further, Fladeboe WV operated without a valid license since an OL-124 form had not been signed or filed with the BMV.

To make matters worse, when the dealership transfer was approved on April 23, 2002, Fladeboe refused to sign the new dealership agreement. Fladeboe VW was expected to be sold — and was sold in midsummer 2002 — to Fladeboe’s son, Bruce Fladeboe. Bruce decided he did not want an Isuzu dealership because of poor sales. For this reason, in October 2002, Ray asked Isuzu to transfer the dealership to Fladeboe AG. In the meantime, since mid-March 2002, the Fladeboes had been selling and servicing Isuzu vehicles under the RFLM dealer code number.

In late November 2002, Isuzu learned that RFLM had been dissolved and learned that the Fladeboes had been falsely using the RFLM dealer code for eight months. In early January 2003, Isuzu refused to approve the transfer of the dealership to Fladeboe AG and the Isuzu dealership was terminated.

Ray Fladeboe and the various Fladeboe corporate entities sued claiming that Isuzu had no reasonable grounds for refusing to consent to the transfer and no grounds for terminating the dealership. Isuzu argued “unclean hands.” By pretending to be an authorized Isuzu dealership and by operating without a valid license from the DMV, Isuzu asserted that the Fladeboes had acted in bad faith and came to the court with unclean hands. The trial court agreed and was affirmed.

Contact San Diego Corporate Law Today

For more information, contact attorney Michael Leonard, Esq. of San Diego Corporate Law by email or by calling (858) 483-9200. Mr. Leonard has extensive experience with California and federal franchise laws and can draft or review your franchise agreements, help with the purchase (or sale) of a San Diego franchise, and/or assist with any other business-related matter. Like us on Facebook.

You Might Also Like:

San Diego Franchise Law: Ideas on Handling the Ostensible Agency Doctrine

Gas Station Franchises: The Petroleum Marketing Practices Act

Franchise vs. Licensing Agreement: What is the Difference?

Pros and Cons of Buying a Franchise

San Diego Franchises, Territories, and Non-Traditional Venues