Opinion
No. CGC-07-460778
Filed June 15, 2009
STATEMENT OF DECISION
JTH Tax, Inc. d/b/a Liberty Tax Service (Liberty) provides tax preparation services, and offers (through its association with certain banks) certain loans to customers. The Attorney General has charged Liberty with violations of California's Unfair Competition Law and False Advertising Law. The Attorney General, also referred to as the People here, seeks penalties, restitution, and injunctive relief. For the reasons stated that relief is provided in the accompanying judgment and permanent injunction.
The Attorney General filed this lawsuit on February 26, 2007, and a bench trial was held before me on various dates in October 2008. The trial was followed by extensive post trial briefing including proposed statements of decision and objections to those. The final briefing was concluded May 26, 2009, on which date the matter was deemed submitted.
In § I, I discuss the factual background, including Liberty's relationship with its franchisees and with the banks with which it works to provide certain types of loans. I discuss theories of indirect liability and explore Liberty's substantive liability under the theories presented by the Attorney General in § II. Remedies are discussed in § III.
I. FACTUAL BACKGROUND AND CLAIMS
Liberty is a Delaware corporation with headquarters in Virginia Beach, Virginia. Complaint at 1:24-28 (admitted in Answer). Liberty provides tax preparation services, e-filing, refund anticipation loans (RALs), and electronic refund checks (ERCs) to consumers through more than 2,000 franchised and company-owned stores throughout California and the United States, all of which do business under the name Liberty Tax Service. Complaint at 1:26-28 and 2:4-6 (admitted in Answer); see also, e.g., Exhibit (Ex.) 15 at 84859. As of April 30, 2007, Liberty had 195 franchised stores in California, up from nine (9) at the end of fiscal 2002, its first year of doing business in the State. Ex.17 at 23784 and Ex.13 at 100901. Liberty had two company-owned stores in California in 2005-2006. Ex.17 at 23785.
ERCs are also called "refund transfers" or RTs, or "refund anticipation checks" or RACs, depending on the bank involved.
A. RALs and ERCs
This case concerns Liberty's practices surrounding the sale of RALs and ERCs. A RAL is a short-term loan secured by a customer's anticipated refund and issued by a third-party bank. The loan amount is based on the anticipated refund minus all fees, including a finance charge, the tax preparation fees, and an "account" or "handling" fee, and is usually disbursed in one to two days. E.g., Ex.275 at 23:1-18 and Ex.34 at 18122. In contrast, the IRS generally takes 8-14 days to process a tax refund by direct deposit into the taxpayer's bank account, or 3-4 weeks by check sent through the mail.
The RAL applications used in Liberty stores authorize the bank to set up a temporary, special purpose "account" in the customer's name for the sole purpose of receiving the customer's refund directly from the IRS. When the customer's tax return is sent to the IRS, this special purpose account is designated as the destination to which the refund should be directed. Once the IRS is notified, the destination for the tax refund cannot be changed. Complaint at 4:15-20 (admitted in Answer). When the refund arrives from the IRS in the account, the lender repays itself out of the refund. If for any reason the client's refund is not deposited into the temporary "account" or is less than expected, the consumer is still held liable for the full amount of the loan. Complaint at 5:24-26 (admitted in Answer).
With an ERC, as with a RAL, the bank sets up a temporary "account" to receive the customer's refund. After the refund is disbursed by the IRS, see, e.g., Exs.122-24, 132-33, and 135 (RAL/ERC applications), the bank deducts the tax return preparation fees, the "account" or "handling" fee, and any other applicable charges, and pays the remainder to the customer (typically) in the form of a personal check that can be picked up at the Liberty office. E.g., Ex.34 at 18127 and Ex.43 at 28673.
A substantial part of Liberty's business and its growth in recent years has stemmed from the sale of RALs and ERCs to its tax preparation customers. In 2007, Liberty earned more than $11.6 million in revenue from the sale of RALs and ERCs, accounting for 17.5 percent of its total revenues nationwide. Ex.17 at 23764. In California, RALs and ERCs have become increasingly important to Liberty's revenues, accounting for 22 percent of revenues in 2007, up from 8.28 percent in 2005. Trial Transcript (Tr.) at 414:11-416:1. Consistent with this upward trend, in 2006 and 2007 roughly 35 percent of Liberty's customers purchased either a RAL or an ERC, up from 15 percent in 2002. Ex.301 (responses to special interrogatories 10, 12-13).
Liberty benefits from sales of RALs and ERCs both directly and indirectly. From 2002-2005, it received 65 percent of the revenues on RALs and ERCs issued by First Bank of Delaware (FBOD) to Liberty customers. Ex.2 at 100004. And, from 2006-2008, when Santa Barbara Bank Trust ("SBBT") was Liberty's exclusive supplier of RALs and ERCs in California, Liberty received a flat amount for each RAL and ERC. Exs.110 and 111; see also Tr. at 422:28-423:7; 423:26-424:4; 425:1-7; and 426:22-24.
Sales of RALs and ERCs also benefit Liberty indirectly because they make its tax preparation services more affordable. Liberty has a high percentage of lower-income customers. Ex.301 (special interrogatory response number 18), and Liberty acknowledges that many of its customers cannot afford to pay for tax preparation out-of-pocket. Ex.25 at 3. But, as Liberty's sales documents indicate, the key selling points for RALs and ERCs is there are "no up front costs" for the customer. Ex.141 ("Product Information Sheets"); see also Ex.45 at 29426. The tax preparation fees are paid out of the loan amount in the case of a RAL and out of the refund in the case of an ERC. This expands the market for Liberty's tax preparation services and, by extension, the franchisees fees and royalties collected by Liberty from its franchisees. Tr. at 403:26-407:2 and 526:8-527:16. As Mike Piper, Liberty's chief financial officer testified, "Well, if we didn't offer bank products, customers — a lot of customers wouldn't come in our doors." Id. at 525:26-527:15.
In 2006, Liberty franchises charged an average of $147.62 for tax preparation. Ex. 18 at 24161. Liberty calculated this average using tax preparation fees charged by 702 out of 1,649 franchised offices in 2006. Id.
The advertisements at issue in this case establish that, among other things, Liberty relies on promises of speedy cash to bring in customers. Whether deceptive or not, the loan programs are an important focus of Liberty's marketing efforts. Liberty provides substantial assistance to the banks in marketing and soliciting these products and its receipt of consequent benefits, among other reasons, makes it fair to hold Liberty liable for the violations of law described below.
B. Liberty's Relationship With Its Franchisees
Liberty's relations with its franchisees are governed in large part by a standard franchise agreement and an Operations Manual. Each franchise owner must execute a franchise agreement with Liberty, and must comply with the policies and procedures set out in the Operations Manual. E.g., Ex.13 at 100916 and Ex.17 at 23954.
The Operations Manual is a "detailed extension" of the franchise agreement, id, and prescribes in minute detail the manner and means by which the franchisees do business. See generally Exs.38-45 (Operations Manuals from 2002-2008); see also Tr. at 583 (the Operations Manual "tells the franchisees everything, really, they need to know to run their business"). Compliance with Liberty's Operations Manual is mandatory. Liberty's Post-Trial Brief at 35; see also, e.g., Ex.13 at 100916 and Ex.17 at 23954.
Liberty reserves the right to unilaterally modify the Operations Manual at any time to adjust for "competitive changes, technological advancements, legal requirements and attempts to improve in the marketplace." Ex.13 at 100916 and Ex.17 at 23954. Breaches of the franchise agreement or the Operations Manual, including failing to use the RALs and ERCs supplied by Liberty's chosen lender(s), could result in termination of the franchise. E.g., Ex.13 at 100917-100918 and Ex.17 at 23955-23956.
Liberty's franchise documents provide, inter alia, that:
• Liberty must approve the site of each franchised office ( e.g., Ex.13 at 10887, 100913, and 10992; Ex.17 at 23762, 23768, and 23951; Ex.41 at 27590, 27735; and Ex.45 at 29297);
• Franchisees must attend Liberty training courses (e.g., Ex.13 at 100891-100892, 100913, 100915; Ex.17 at 23767-23768, 23951-23952);
• Franchisees must hold at least one "tax school" every year with a minimum student enrollment as dictated by Liberty for employee recruitment purposes ( e.g., Ex.13 at 100916; Ex.43 at 28593-28594; and Ex.45 at 29537);
• Liberty may enter any franchised office during normal business hours to inspect operations or inspect and copy any business records, including customer receipts; alternatively, Liberty may request copies of any records, and the franchisee must mail them to Liberty at her own expense within five days ( e.g., Ex.13 at 100917 and Ex.17 at 23955);
• Franchisees must send Liberty gross receipt reports and profit and loss statements in the manner and form and at the times specified by Liberty ( e.g. Ex.13 at 100917; Ex.17 at 23955);
• Liberty must approve each franchisee's general manager, and the general manager may be required to attend Liberty training courses ( e.g., Ex.13 at 100896,100916; Ex.17 at 23778, 23952, 23954);
• Franchisees must commit to maintaining Liberty's extensive filing system as well as the setup for the tax return processing center ( e.g., Ex.42 at 28207-28226; Ex.45 at 29590-29606);
• Franchisees may not offer any products or services without first obtaining Liberty's written consent (e.g., Ex.13 at 100887; Ex.17 at 23762; Ex.45 at 29290-29291);
• Liberty has the right to resolve disputes directly with franchise customers and bill the franchisee for any refunds that Liberty issues ( e.g., Ex. 15 at 84968 and Ex. 17 at 23950);
• Liberty exercises substantial control over franchisee pricing by requiring franchisees to offer a minimum number of free tax returns each season and by controlling the dollar or percentage amounts of discounts that franchisees are allowed to offer depending on the time of the year (e.g., Ex.290 at 64:18-65:8, 68:7-9; and 49:25-51:24; see also Ex.252); Liberty also reserves to itself the right to prohibit franchisees from imposing fees attendant to the offering of RALs and ERCs, including the RAL "application fees" at issue in this case;
• Liberty determines the opening date and minimum operating hours of its franchised stores ( e.g., Ex.13 at 100895, 100897, 100915; Ex.17 at 23775, 23778-23779, 23953; Ex.38 at 26577; Ex.45 at 29407);
• Franchisees must purchase their computers from Liberty's approved vendor and use Liberty's approved tax preparation software ( e.g. Ex.13 100887 and 100914-100915; Ex.17 at 23761, 23763-23764, 23774-23775, 23779, and 23953; Ex.38 at 26577; and Ex.45 at 29407);
• Liberty may run programs on its franchisees' computers, thus allowing Liberty access to electronically review whatever data is contained in each franchisee's computer system ( e.g., Ex.13 at 100917 and Ex.17 at 23955);
• Liberty provides its franchisees scripted answers and information to be provided to customers ( e.g., Ex.42 at 28074-28075 and Ex.45 at 29426-29427);
• Day-to-day tasks such as how to open the store, when to clean the bathrooms, whether to pay for employees' lunch breaks, when to answer the phone, and even reservation of the right to specify the make and model of furniture used by franchisees, are covered by the Operations Manual ( e.g., Ex.13 at 10887-10888; Ex.16 at 14941; Ex.17 at 23763, 23767, and 23952; Ex.38 at 26638, 26757; Ex.43 at 28490, 28494, and 28510-28511; and Ex.45 at 29442-29443, 29464); and
• Liberty conducts compliance reviews to ensure its operational policies and procedures are being followed.
With respect to advertising, Liberty's franchise documents require that any and all franchisee advertising be submitted to Liberty's marketing department for its review and approval prior to being used. Liberty testified that starting with the 2009 tax season it will no longer permit franchisees to create their own advertising for submission to the marketing department. Franchisees are now only supposed to use advertising content made available through Liberty's centralized "Ad Builder" system. (As of the time of trial, RAL ads were not yet part of this system.)
Liberty uses its advertising approval rights not just to protect the integrity of its marks, but also to exert control over unrelated matters such as:
• The discounts franchisees can offer depending on the time of year;
• The products and services that franchisees can advertise depending on the time of year, and strategies for soliciting particular demographic groups;
• The price quotes for tax preparation services that franchisees can give out over the telephone;
• The number of free tax returns franchisees must offer each season, and when they must be offered; and
• A franchisee's right to have its own website, even a Liberty-approved website.
Ex. 290 [O'Gorman Depo.] at 49:24-51:24 [ "I wouldn't allow a franchisee to run a $50 off coupon in January"; corporate permits deep discount offers only late in the tax season "when the traffic is not as heavy."]; Ex. 289 [Schuster Depo.] at 110:7-111:7 ["We have three different [discounts]. [Franchisees] can choose 30 percent off, 50 percent off last year, or free. And sometimes we let them do something else if they want."]; id. at 117:16-24; 120:24-121:10; and 150:1-10; Ex. 215 [dictating change in franchisee's preferred discount, despite complaint by franchisee that "I have set my pricing up for MY ads; I don't do 30% off I do $50 off"], Ex. 227 at 30671 [email to franchisee regarding "changes that must be made . . . Change 50% off to $20 off."].).
Ex. 219 at 30472 (email to franchisee rejecting ad because, in part "Wrong offer for early season. . . ."); Ex. 221 at 30525 ("No this isn't approved. Cash in a Flash is used for really early season customers . . . Hispanics should be brought in through the ITIN program.").
E.g., Ex. 42 at 28075 ("What will the charge be? Answer: During peak season you will give a quote of 80% of your targeted net fee rounded up to the nearest 9. . . ."; Ex. 43 at 29427 (during peak season, "you will give a quote of 90% of your targeted net fee rounded up to the nearest 9.")
Ex. 290 at 68:7-11; Ex. 513 at 20954; and Ex. 252 ("Do not issue any free return coupons after 4/8.)
See, e.g., Ex. 45 at 29448; Ex. 44 at 29008; and Ex. 43 at 28514-15.
With respect to the offering and sale of RALs and ERCs, Liberty's franchise documents provide that franchisees may only use a bank assigned by Liberty, and if Liberty has arrangements with more than one bank Liberty selects which franchisee will use which bank. Ex.13 at 100888 and 100916; Ex.17 at 23762-23763 and 23953; Ex.45 at 29286; and Ex.304 (response to request for admission 35). Since 2005, Liberty's standard franchise agreement has required franchise owners to offer RALs and ERCs to customers. E.g., Ex.15 at 84971.
In addition, Liberty controls all of the advertising and disclosures its franchisees must or can use with respect to RALs and ERCs. Liberty requires its franchisees to "conduct their business in full compliance with all agreements, guidelines and directives received from [Liberty], including, without limitation: guidelines and directives pertaining to customer data security, advertising, and disclosures; the franchisee's franchise agreement with [Liberty]; and the documents prepared and/or utilized by First Bank of Delaware and [Liberty] in connection with the offering and sale of bank products." Ex.304 (response to request for admissions 34). These governing documents include but are not limited to Liberty's Operations Manuals and the so-called "Bank Books." (Ex.281 at 62:22-63:16; 64:4-20; 70:19-71:5; and 71:19-72:2; see also Exs.33-37.
Liberty also controls whether and how much franchisees may charge customers for RAL/ERC-related services; controls whether and how much franchisees may be compensated by the banks for offering RALs and ERCs ( e.g., Ex.117); and requires that tax preparation fees, rebates, or other monies paid to franchisees by the banks be routed first to accounts controlled by Liberty, so that Liberty may deduct any amounts owed by the franchisee to Liberty. E.g., Ex.17 at 23951 and Ex.18 at 24194-95.
Tr. at 436:7-18; 437:20-25 (prior to 2005, Liberty "permitted" its franchisees to charge "application fees" to RAL customers; after the Attorney General opened his investigation, Liberty "instructed" its franchisees to stop charging them; see also id. at 540:6 (starting in 2005, "We told the franchisees not to charge that fee."); id. at 543:9-13 (same).
C. Liberty's Relationship with the Banks
Liberty is barred by the IRS from making loans directly to consumers. (Complaint at 3:27- 4:1 [admitted in Answer].) Consequently, the loans are
provided by lenders with which Liberty contracts. It is primarily Liberty, however, not the lenders, that has advertised and promoted the loans. It is also Liberty that in the course of providing its tax preparation service has offered the loans to its clients, provided its clients the multi-page loan applications, filled out the applications, and obtained the signed loan applications. Liberty has also delivered the loan applications to the lender, and subsequently distributed the loan proceeds to most of its taxpayer clients.Id. at 4:1-7 (admitted in Answer).
As noted, Liberty only allows franchisees to offer RALs and ERCs supplied by banks that have contracts with Liberty. First Bank of Delaware was Liberty's sole supplier of RALs and ERCs in 2002, 2003, and 2005 in California. Ex.300 at 2 (key to lending banks by year). In 2004, all but nine of Liberty's California offices were assigned to FBOD. Id. From 2006-2008, with the exception of a single store, Santa Barbara Bank Trust (SBBT) was Liberty's exclusive supplier of RALs and ERCs in California. Id.
The contracts between Liberty and FBOD and Liberty and SBBT are in evidence as Exhibits 2 and 74, respectively. The contracts, inter alia, create a role for Liberty in the collection of RAL-related debts, Ex.2 at 100006 (agreement between Liberty and FBOD to provide "cooperation and assistance to each other" and to other RAL lenders in "collecting delinquent RALs from applicants"); Ex.74 at 19273. See § II.C.2. infra.
D. The Claims at Issue
The Complaint states two causes of action, one for violations of the Unfair Competition Law (UCL), Business and Professions Code [BP] § 17200, and one for violations of the False Advertising Law (FAL), BP § 17500. See Complaint at ¶¶ 45-48. The People's UCL cause of action is predicated on several theories of liability, including but not limited to violations of state and federal statutes, violations of the FAL, "fraudulent" conduct, and "unfair" conduct.
The UCL prohibits "unfair competition," which it defines as any "unlawful, unfair or fraudulent business act or practice and unfair, deceptive, untrue or misleading advertising," as well as "any act prohibited by" the FAL. BP § 17200. The FAL, in turn, makes it unlawful for any person to make or cause to be made any "statement" which the person knows or by the exercise of reasonable care should know to be untrue or misleading in the course of selling or disposing of any goods, services, or property. BP § 17500. The UCL's "unlawful" prong "borrows" violations of other laws and makes those violations "independently actionable" as unfair competition under the UCL. Cel-Tech Comms., Inc. v. Los Angeles Cellular Tel. Co., 20 Cal.4th 163, 180 (1998), quoting State Farm Fire Casualty Co. v. Sup. Ct, 45 Cal.App.4th 1093, 1103 (1996). An "unlawful" business act or practice includes "anything that can properly be called a business practice and that at the same time is forbidden by law." Bank of the West v. Sup. Ct., 2 Cal.4th 1254, 1266 (1992). A "fraudulent" act or practice is one that is "likely to deceive" members of the public. Chern v. Bank of America, 15 Cal.3d 866, 876 (1976). An "unfair practice" is one that, inter alia, "offends an established public policy." People v. Casa Blanca Convalescent Homes, Inc., 159 Cal.App.3d 509, 530 (1984), but see discussion infra § II (H).
At trial, the People sought relief based on some, but not all, of the liability theories pleaded in the Complaint. The People sought relief based on:
• False and/or deceptive statements in violation of the FAL and the UCL;
• Violations of BP §§ 22253.1(a), which requires that any advertisement for a RAL state "conspicuously" that (1) the product is a loan, (2) the name of the lender, and (3) that fees and interest apply;
• False, deceptive, or otherwise illegal advertising run by Liberty's franchisees, on the grounds that Liberty's franchisees are its agents and/or that this advertising resulted from Liberty's negligence;
• Violations of state and federal fair debt collection practices laws and the Consumer Legal Remedies Act, C.C. § 1770(a)(14), with respect to the collection of prior RAL debts;
• Deceptive marketing of ERCs as a "convenience" product when in fact it is a form of credit, i.e., a vehicle for financing the cost of tax preparation;
• Violations of BP § 17530.5, which specifies the form of consent that tax preparers must obtain from their clients in order to share their confidential taxpayer information with third-party banks for purposes of offering RALs and ERCs;
• Violations of the California Credit Services Act, which requires persons or entities providing "credit services," as defined, to register with the State before doing business in California, and to comply with certain other requirements; and
• Violations of IRS Publication 1345's requirement that participants in the federal e-file program not take "contingent fees" (fees that vary with the size of the refund or the loan amount) from RAL-lending banks.
Complaint at ¶¶ 32-33, 46, 46.a, 46.c., 48, and 48.a.
These violations are not pleaded in the Complaint, but the People put Liberty on notice well in advance of the trial through pre-trial discovery and its pre-trial brief that it intended to seek relief based on alleged violations of Section 22253.1(a), the issue was fully and fairly litigated, and there was no unfair surprise or prejudice to Liberty. People v. Toomey, 157 Cal.App.3d 1,11 (1984); see also People v. Custom Craft Carpets, Inc., 159 Cal.App.3d 676, 684 (1982) (although specific abuses were not expressly alleged in the Complaint, defendant was "clearly apprised of the Attorney General's concern . . . during pre-trial discovery, and even filed a brief addressing the issue. . . ."). In addition, the Complaint states that the alleged violations of the UCL "include, but are not limited to," the specified acts, which is broad enough to encompass alleged violations of Section 22253.1(a). Custom Craft, 159 Cal.App.3d at 684. Thus, these alleged violations are appropriately considered. There was no "prejudicially misleading variance between pleading and proof." Toomey, 157 Cal.App.3d at 11.
The Complaint does not allege liability based on Liberty's failure to supervise its franchisees (the illegal franchise ads were discovered by the Attorney General through third-party discovery conducted after the filing of the Complaint), nor was Liberty apprised of this basis before the end of the trial. See infra, § II(A)(4).
Complaint at ¶¶ 48.b., 48.c., and 48.d.(2).
Complaint at ¶¶ 46, 48, and 48.h.
Complaint at ¶¶ 48, 48.e., and 48.f.
Complaint at ¶¶ 48 and 48.i.
These violations were not specifically alleged in the Complaint, but Liberty was arguably put on notice of this liability theory before trial. In any event I have not found Liberty liable on this basis.
The People abandoned its other liability theories, including but not limited to alleged breaches of fiduciary duty, Complaint at ¶¶ 48 and 48.g.
II. DISCUSSION
A. Indirect Liability
The issue arises whether Liberty can be held liable for illegal conduct by its franchisees and/or the banks. As discussed below, there is substantial evidence that Liberty's franchisees are its actual agents. Thus I find Liberty liable for certain actions by its franchisees. I have rejected the People's other theories of indirect liability for the acts of franchisees, such as conspiracy, aider and abettor, and ostensible agency. The People have also asked me to hold Liberty directly liable for failing to supervise its agent franchisees, which I reject for reasons stated below.
1. Liberty's franchisees are its agents.
To determine the existence of a principal-agent relationship, the key test is the extent of the principal's right of control. Nichols v. Arthur Murray, Inc., 248 Cal.App.2d 610, 613 (1967); Kuchta v. Allied Builders Corp., 21 Cal.App.3d 542, 548 (1971). "It is not essential that the right of control be exercised or that there be actual supervision of the work of the agent; the existence of the right establishes the relationship." McCollum v. Friendly Hills Travel Center, 172 Cal.App.3d 83, 91 (1985); 3 B. Witkin, SUMMARY OF CALIFORNIA LAW, Agency § 24 (10th ed. 2005, 2008) (right of control, rather than exercise of the right, is key issue).
A franchisee may be the agent of the franchisor. Shoopman v. Pacific Greyhound Lines, 169 Cal.App.2d 848, 856 (1959); see also Nichols, supra; Beck v. Arthur Murray, Inc., 245 Cal.App.2d 976 (1966). The general rule is that where the franchisor has "the right of complete or substantial control over the franchisee, an agency relationship exists." 2 B. Witkin, SUMMARY OF CALIFORNIA LAW, Agency Employment § 6 (9th. ed. 1987); Nichols, 248 Cal.App.2d at 613 (agency existed because franchisor had right of "complete control" over franchisees); Kuchta, 21 Cal.App.3d at 547; Holland v. Nelson, 5 Cal.App.3d 308, 313 (1970). Further, parties cannot defeat a finding of agency by simply declaring themselves to be independent contractors as to each other; "the declarations of the parties in the agreement respecting the nature of the arrangement are not controlling." Kuchta, 21 Cal.App.3d at 548. Rather, the existence of an agency is a question of fact for this Court. Id. at 547; Nichols, 248 Cal.App.2d at 614. In the field of franchise operations, this inquiry focuses in particular on the extent to which the franchisor "retained controls beyond those necessary to protect its trademark, trade name, and good will___" Nichols, 248 Cal.App.2d at 613-614; accord Cislaw v. Southland Corp., 4 Cal.App.4th 1284, 1295 (1992).
The parties agree that Liberty exercises (or retains the right to exercise) a certain amount of control over its franchisees. Liberty contends it is just enough to properly exercise its rights as franchisor and to protect the associated marks, Krehl v. Baskin-Robbins Ice Cream Co., 664 F.2d 1348, 1353 (9th Cir. 1982); the People contend it is more than that: i.e., that the right to control Liberty reserves is enough to show the franchisees, at least in the context of their advertising activities, are Liberty's agents.
It is generally understood that franchisors are often caught between the Scylla of failing to exercise sufficient control to protect their marks, and the Charybdis of exercising so much control they are vicariously liable for the torts of the franchisees or other licensees. E.g., Philip F. Zeidman, "Franchising and Other Methods of Distribution: Regulatory Pattern And Judicial Trend," CORPORATE LAW AND PRACTICE COURSE HANDBOOK SERIES, 1714PLI/Corp. 443, 693 (January — February 2009). Courts are sensitive to the problem. "A franchisor must be permitted to retain such control as is necessary to protect and maintain its trademark, trade name and good will, without the risk of creating an agency relationship with its franchisees." Cislaw, 4 Cal.App.4th at 1295. At the core of the issue is the fact that "control" is part of the definition of a franchise:
[A] contract or agreement, either expressed or implied, whether oral or written, between two or more persons which:
(1) A franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by a franchisor; and
(2) the operation of the franchisee's business pursuant to such plan or system is substantially associated with the franchisor's trademark, service mark, trade name, logotype, advertising or other commercial symbol designating the franchisor or its affiliate; and (3) the franchisee is required to pay, directly or indirectly, a franchise fee.
A recent district court opinion noted:
Few California courts have defined "marketing plan or system," but those that have found extensive control and material assistance essential. See, e.g., People v. Kline, 110 Cal.App.3d 587 . . . (1980) (finding a "marketing plan or system" existed where restaurant franchisor offered a complete operational plan, advertising and promotional support, menu, food, supplies, and distinctive kiosks and labeled the offer "a business opportunity").Dress for Success Worldwide v. Dress 4 Success, 589 F.Supp.2d 351 (S.D.N.Y. 2008).
Thus, the inquiry must focus on the extent to which the control reserved to the franchisor plainly exceeds that required to police the mark, which is control so pervasive that it amounts to complete or substantial control over the daily activities of the franchisee's business. Singh v. 7-Eleven, Inc., 2007 WL 715488, *7 (N.D.Cal. 2007) citing, Kaplan v. Coldwell Banker Residential Affiliates, Inc., 59 Cal.App.4th 741, 746 (1997); 3 McCARTHY ON TRADEMARKS § 18:75 (2008).
To make this distinction, it is important to recall the legitimate reasons for policing a mark: to preserve its ability to identify "the goodwill and quality standards of the enterprise which it identifies" and ensure the public is not misled with respect to those. Siegel v. Chicken Delight, Inc., 448 F.2d 43, 48-49 (9th Cir. 1971), abrogated on other grounds, Principe v. McDonald's Corp., 631 F.2d 303 (4th Cir. 1980). See Rick-Mik Enterprises, Inc. v. Equilon Enterprises LLC, 532 F.3d 963, 974 n. 3 (9th Cir. 2008); Schlotzsky's, Ltd. v. Sterling Purchasing and Nat. Distribution Co., Inc., 520 F.3d 393, 405 n. 3 (5th Cir. 2008) ("We note that a franchisor has a responsibility imposed by the Lanham Act to protect the integrity and goodwill of its licensed trademark by controlling the quality of products sold under that trademark"). See generally, 3 McCARTHY ON TRADEMARKS § 18:42 (2008).
The People contend that the control exercised by Liberty, in particular as manifested through the Operations Manuals, shows control far in excess of that needed to police the mark. It is important to consider whether the Manuals' prescriptions are mandatory or only suggestions. Walker v. Pacific Pride Services, Inc., 2007 WL 42094445, 4 (N.D.Cal. 2007). Here they are mandatory.
Many of Liberty's restrictions appear designed to police its trademarks and the good will associated with those, such as executing the franchise agreement, approving sites, requiring franchisees to attend trainings on filling out tax returns, performing compliance reviews, and perhaps providing scripted answers for interactions with customers.
But other restrictions do not have this goal. For example, as noted above,
• Compliance with Liberty's Operations Manual is mandatory;
• Liberty mandates the banks to be used by each franchisee, and requires its franchisees to offer RALs and ERCs; more generally, franchisees cannot offer any products and services without first obtaining permission from Liberty;
• Liberty determines the franchisees' minimum operating hours;
• Liberty mandates the computers to be used;
• The Operations Manual governs day-to-day tasks such as how to open the store and when to clean the bathrooms;
• Liberty reserves the right to intervene in disputes between customers and franchisees, to pay refunds directly to customers, and then bill the franchisees;
• Franchisees must commit to maintaining Liberty's prescribed filing system as well as the setup for the tax return processing center;
• Liberty exercises control over franchisee pricing by controlling the discounts that franchisees may offer depending on the time of year.
In sum, as in Nichols and Kuchta, Liberty's right of control extends not only to the products and services franchisees may offer, but also to the manner and means by which its franchisees prepare tax returns, offer RALs and ERCs, and interact with customers, and extends beyond that needed to protect its marks.
Liberty's right of control over franchisee advertising is particularly extensive, and is in particular relevant to the issue before me, viz., the extent to which Liberty may be liable for the acts of its franchisee in the advertising context. As noted above, Liberty requires its franchisees to submit all advertising material to the marketing department for review and approval before it may be used. But Liberty uses its control over advertising not just to protect its marks, but also to dictate business strategy for franchisees. Thus, for example, Liberty controls the discounts that franchisees may advertise depending on the time of year, not because offering $50 off in the early part of the tax season would damage Liberty's trademark or goodwill, but because, in Liberty's estimation, early season customers are not as price sensitive as late season customers. Similarly, Liberty controls the products and services that franchisees may advertise, not because doing so is necessary to protect the integrity of the marks, but because Liberty believes that certain advertising is a waste of time and money. Liberty's control of advertising is pervasive, extending from the provision of sample copy, review procedures, and detailed instructions in the Operations Manuals. Those Manuals, while not always using terms such as `must' or `shall,' provide detailed instructions on advertising, such as breaking down the year into various temporal "Tiers;" mandate pre-approval of all Liberty marks (which inevitably requires approval of virtually all advertising since "Liberty Tax Service" is a registered mark); set out a host of marketing and advertising methods, provide samples of copy, and so on, literally providing a detailed, step-by-step guide for every aspect of marketing and advertising. The provisions are expressed as imperatives, and include "General Rules" for marketing and advertising (Ex. 38, p. 26675). See e.g. Ex. 38 at [Bates stamped] pp. 26654-26689. And Liberty retains an open-ended right to modify the Operations Manual without consent of the franchisees. This right of essentially complete control over franchisee operations, and specifically advertising operations, exceeds what Liberty reasonably needs to protect its trademark and goodwill.
E.g., Ex 38 at 16, Bates Stamped 26660.
Thus substantial evidence shows Liberty's franchisees are its agents. Even if Liberty's franchisees are not its agents for all purposes, they are its agents at a minimum for purposes of advertising. 2. Toomey 's Discussion of Vicarious Liability.
The notion that "vicarious liability" is not available in an action for unfair business practices stems from People v. Toomey, 157 Cal.App.3d 1, 14 (1984). See also, Emery v. Visa Internat. Service Ass'n, 95 Cal.App.4th 952, 960 (2002). And so Liberty argues here. Other decisions do rely on Toomey for this proposition, including federal cases seeking to apply California law. E.g., Amalgamated Transit Union v. First Transit, Inc., 2004 WL 2806328 (C.D. Cal. Nov. 30, 2004).
This issue has been extensively briefed here. But a close review of Toomey shows it does not stand for the proposition that principal-agency liability is unavailable in an unfair business practices case.
The issue depends on what Toomey means by `vicarious liability'. Vicarious liability ordinarily has a very broad meaning indeed: it covers any situation in which one is liable for the acts of another. See e.g., 6 B. Witkin, SUMMARY OF CALIFORNIA LAW, Torts § 1220 (10th ed. 2005, 2008). These situations include agency, employment, joint enterprises, and a host of other special relationships by which (either under common law or by statute) one is liable for another's actions. See generally, J. King, Jr., "Limiting the Vicarious Liability of Franchisors For The Torts of Their Franchisees," 62 WASH. LEE L. REV. 417, 427 (2005).
Toomey is a civil enforcement action brought under Business and Professions Code § 17200. Toomey does not explain why "vicarious liability" is unavailable, but rather relies on two cases, People v. Regan, 95 Cal.App.3d Supp. 1, 4 (1979), and People v. E. W.A.P. Inc., 106 Cal.App.3d 315, 322 (1980). Neither case supports Toomey's supposed conclusion that vicarious liability, broadly speaking, is inappropriate in an unfair business practices case.
Regan, a § 17500 case decided by the appellate department of the Superior Court, was not a civil case. Its holding was critically based on the fact that criminal scienter was an essential element of the criminal case, and for that, the "control or knowledge appellant had of his employee's activities" had to be established. There are two things to note here. In Regan, control or knowledge, it appears, could have been enough even for criminal liability (neither was in fact established). That does not support the notion that vicarious liability is unavailable for, e.g., the acts of an agent over which the principal has control. Second, Regan as a criminal case is driven by the usual scienter requirements of such cases, an important contrast to civil cases such as Toomey or the present case.
Then Toomey cites People v. E. W.A.P., Inc., 106 Cal.App.3d 315 (1980), stating that in E. W.A.P. "the defendant argued that civil penalties cannot be imposed under section 17206 absent a showing of scienter. The court responded by explaining that the evidence established defendant's participation in the unlawful acts, thereby impliedly recognizing the need to prove active and knowing involvement in the offending conduct by the defendant. ( Id., at p. 322.)." Toomey, 157 Cal.App.3d at 14-15.
But this is what E. W.A.P. really says:
On the contrary, the People's theory in this case is that defendants' business practices are unlawful because they violate Penal Code section 311.2, and thus to establish that defendants' conduct comes within section 17200 the People would have to prove that defendants "knowingly" distributed or possessed for distribution obscene matter. (Pen. Code, section 311.2.)106 Cal.App.3d at 322. That is, the scienter requirement was a function of the Penal Code section, not the fact that E. W.A.P. was a civil UCL case.
Toomey also mentions four other cases, albeit not in support of the proposition that vicarious liability is unavailable under the UCL. These cases are cited to show that theories of more direct liability, such as for conspiracy or aider and abettor, are available. While the availability of these direct theories does not mean that vicarious liability is unavailable in UCL actions, it is instructive to note that none of these cases supports the argument that Toomey's rejection of `vicarious liability' extends to the rejection of general principal-agency liability.
People v. Bestline Products, Inc., 61 Cal.App.3d 879, 918 (1976) endorses conspiracy and aider and abettor liability, but does not say that agency liability is not available; the Court only noted that the trial court had not relied on vicarious liability, and so the issue was moot. 61 Cal.App.3d at 918.
Then there is People v. Witzerman, 29 Cal.App.3d 169, 181 (1972). Here too, the court just held that the "knew or should have known" test for scienter is enough. Nothing suggests that variations of vicarious liability are not applicable. Next, we have People v. Arthur Murray, Inc., 238 Cal.App.2d 333, 341-342 (1965), which expressly avoids the agency issue because there was enough evidence of aider and abettor liability.
The last case Toomey cites is International Art Co. v. FTC, 109 F.2d 393, 396 (7th Cir. 1940), which actually endorses the agency liability at stake here:
Petitioners' argument and authorities are largely concerned with the relation between a manufacturer and a retail merchant. For example, it cites Marshall Field and Company, a store which sells the products of the American Woolen Company, and argues that the latter is not liable for representations made by the former as to the products sold. We assume, however, that Marshall Field and Company acts entirely in an independent capacity, and not as a representative of the Woolen Company. It is also sought to compare the instant situation with the relation existing between the automobile manufacturer and its local agent. This is another instance, however, of the agency conducting its business in its own right and in an independent manner. These illustrations have no analogy to the present situation. Here, the agent was clothed with apparent and, we think, real authority to speak and act for and on behalf of the principal, and the latter is bound thereby.
We know of no theory of law by which the company could hold out to the public these salesmen as its representatives, reap the fruits from their acts and doings without incurring such liability as attach thereto.International Art Co., 109 F.2d at 396.
Finally, I note that a type of vicarious liability, that flowing from the employer/employee relationship, is patently available under Toomey. 157 Cal.App.3d at 14 (holding that a corporation "can, of course, be held liable for violations of sections 17200 and 17500 by its employees"; see also id. at 15 (holding that a "managing officer of a corporation with control over the operation of the business is personally responsible for the acts of subordinates done in the normal course of business"). Toomey does not explain why this type of vicarious liability in the employment context is acceptable, but not other types of vicarious liability. See generally, 3 B. Witkin, SUMMARY OF CALIFORNIA LAW, Agency (10th ed. 2005, 2008) (agent and employee vicarious liability are generally indistinguishable).
Thus Toomey's use of the term `vicarious liability' must be far more limited than the usual expansive notion reflected in the Witkin treaties cited above and commonly used to encompass all types of liability for the acts of another. Toomey's emphasis on the personal participation or
It is clear that there is no universally accepted scope of the term. The most recent RESTATEMENT seems to limit it to liability for the torts of one's (i) employees and (ii)