Vicarious Liability Risks Continue

Vicarious liability claims against franchisors can extend to virtually every area of the law. Although courts generally recognize the unique control attributes of franchise systems, and are reluctant to impose liability on franchisors for franchisee conduct, the potential for vicarious liability remains when franchisors exert too much control. Highlighting this reality, a recent California case delivered a blow to a tax preparation franchisor, finding the franchisor liable for its franchisees' deceptive advertising and related activities.

In People v. JTH Tax, Inc. (D/B/A Liberty Tax Service), the California state Attorney General brought suit against franchisor Liberty Tax, charging it with violations of California's Unfair Competition Law and False Advertising Law. At the heart of JTH Tax were Liberty's practices surrounding the sale and marketing of refund anticipation loans (RALs) and electronic refund checks (ERCs) to customers. In a lengthy opinion, the California Superior Court for San Francisco County determined that Liberty's franchisees were its agents under California law, at least for the purposes of advertising, even if they were not Liberty's agents for all purposes. Consequently, the court found Liberty liable for advertisements that were false and deceptive, and/or lacked certain statutorily mandated disclosures, and assessed penalties of more than $1.1 million against Liberty.

At the outset of the opinion, the court explicitly acknowledged that the benefits enjoyed by Liberty as a result of the services at issue supported its ultimate decision-Liberty's revenue from the sale of RALs and ERCs accounted for 17.5% of its total revenues nationwide and 22% in California. The court then detailed the various elements of control set forth in the Liberty franchise agreement and operations manual-a document flatly characterized as "prescrib[ing] in minute detail the manner and means by which the franchisees do business." From those agreements, the court set forth a laundry list of provisions that it believed evidenced Liberty's extensive control over its franchisees, a list that included both controls that are common in the franchising world, as well as less typical and more invasive controls. With respect to RALs and ERCs-the products at the heart of this case-Liberty required franchisees to use a specially designated bank, it controlled all of the advertising and disclosures relating to RALs and ERCs, and it also controlled whether and how much franchisees could charge customers for those services.

Weighing all of these factors, the court determined that there was substantial evidence that Liberty's franchisees were its actual agents, and that Liberty therefore could be held liable for the illegal conduct of its franchisees at issue. The court found that the amount of control that Liberty exercised (or retained the right to exercise) extended beyond the amount required to properly exercise its rights as a franchisor. Specifically, in the context of advertising, Liberty's control was used "to dictate business strategy for franchisees" by controlling things such as the timing and availability of discounts that could be advertised, and determining the efficacy of certain advertisements. These factors led the court to conclude that Liberty exerted enough control over franchisee advertising such that it could be held liable for the ways in which the advertisements violated California law. In its analysis, the court explicitly rejected Liberty's argument that vicarious liability was unavailable in an action for unfair business practices.

Having concluded that Liberty's franchisees were its agents, the court assessed the false, misleading or otherwise illegal franchisee advertising for which Liberty could be found liable. For example, the court found that advertisements promising refunds in one day violated California law because only RALs, not refunds, could be obtained in a day, and the RALs imposed costs, fees and other restrictions. Liberty also violated state law by creating or approving ads that lacked mandatory disclosures regarding such loans that were designed to prevent customer confusion. Finally, the court concluded that both Liberty and the banks involved in the RALs acted as "debt collectors," and that Liberty also was liable for aiding and abetting the banks in violating state and federal debt collection laws.

JTH Tax highlights the reality of vicarious liability risks faced by franchisors and the need to exercise enough, but not too much, control. The case, perhaps, also highlights the continued applicability of the notion that bad facts result in bad law, since there is some element in the decision that suggests a desire to punish the franchisor because of the arguably predatory conduct the franchisor promoted and sanctioned.

For more information, please contact Kimberly L. Sikora Panza at 202.719.7461 or ksikora@wileyrein.com and Robert A. Smith at 202.719.4481 or rsmith@wileyrein.com.

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