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A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc., 87 N.Y.2d 514 (Feb. 13, 1996)

GENERAL BUSINESS LAW § 691(3) -- FRANCHISES -- JOINT AND SEVERAL LIABILITY

ALL LISTED PARTIES MUST "MATERIALLY AID" BEFORE JOINT AND SEVERAL LIABILITY ATTACHES

[SUMMARY] | [ISSUE & DISPOSITION] | [AUTHORITIES CITED] | [COMMENTARY

SUMMARY

In 1990, Respondent A.J. Temple Marble & Tile, Inc. (Temple) purchased four franchises from Appellant, Union Carbide Marble Care, Inc. (UCM). Temple failed to develop these franchises, and in 1993 filed suit against UCM, its parent corporations, and certain individual officers, directors, and employees of the corporate defendants. Temple alleged that it had been induced into purchasing the franchises based on defendants' material misrepresentations and omissions. Temple alleged that defendants were jointly and severally liable under § 691(3) of the Franchise Sales Act.

Section 691(3) imposes joint and several liability on a partner, executive officer, director or other controlling person of a franchisor, "including a person occupying a similar status or performing similar functions, and an employee of a person so liable, who materially aids in the act of [sic] transaction constituting the violation." Temple argued that the statutory phrase "materially aids" modifies only "employee." Defendants argued that § 691(3) imposes joint and several liability only on persons whose actions materially aid the violator.

The trial court held that the phrase "materially aids" qualified only the liability of controlling persons, not officers, directors, or employees. The Appellate Division summarily affirmed. The Court of Appeals, disagreed by interpreting § 691(3) to apply the "materially aids" element to all parties listed in the statute.

ANALYSIS

ISSUE

Whether § 691(3) of the General Business Law imposes joint and several liability on all persons affiliated with a franchisor who has violated the Act, regardless of whether their conduct materially aided the violation.

DISPOSITION

Yes. The certified question--whether the order of the Appellate Division, affirming the order of the New York State Supreme Court was properly made--is answered in the negative. The "materially aids" language of the statute applies to all of the statutorily enumerated persons. Judgment of the Appellate Division modified, without costs, and affirmed as so modified.

CASES CITED

  • People v. Graham, 55 N.Y.2d 144 (N.Y. 1982).
  • Budd v. Valentine, 283 N.Y. 508 (N.Y. 1940).
  • In re Schinasi's Will, 277 N.Y. 252 (N.Y. 1938).
  • In re Brooklyn Elevated Ry. Co., 125 N.Y. 434 (N.Y. 1891).
  • A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc., 625 N.Y.S.2d 904 (N.Y. App. Div. 1995).
  • A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc., 618 N.Y.S.2d 155 (N.Y. Sup. Ct. 1994).
  • Retail Software Servs., Inc. v. Lashlee , 854 F.2d 18 (2d Cir. 1988).
  • Arthur Children's Trust v. Keim, 994 F.2d 1390 (9th Cir. 1993).
  • Eastwood v. Froehlich,131 Cal. Rptr. 577 (Cal. Ct. App. 1976).
  • Vukusich v. Comprehensive Accounting Corp., 150 Ill. App. 3d 634 (Ill. App. Ct. 1986).

OTHER SOURCES CITED

By the court

Related Sources cited

  • Mon-Shore Management, Inc. v. Family Media, Inc., 584 F. Supp. 186 (S.D.N.Y. 1984).
  • Reva S. Bauch, An Update on Choice of Law in Franchise Agreements: A Trend Toward Unenforceability and Limited Application, 14 Franchise L.J. 91, 98 (1995).
  • N.Y. Gen. Bus. Law Art. 33, supplemental practice commentaries (McKinney Supp. 1996).
  • 60 N.Y. Jur.2d Franchises §§ 25-28 (1987 & Supp. 1995).

COMMENTARY

1.Court's Reasoning

A. Prior state of the law in New York

Article 33 of New York Gen. Bus. Law, the Franchise Sales Act, went into effect on January 1, 1981. Section 691(3) was part of this wide-scale amendment, which governed the offer and sale of franchises. Because the legislature had found that "widespread sale of franchises is a relatively new form of business which has created numerous problems in New York," the statute was enacted to provide franchise offerees with "material details of the franchise offering." § 680(2). Actionable elements of the statute are contained in sections 683, 684, and 687 of the New York General Business Law. Civil remedies are available to injured parties through section 691.

Section 691(3) permits joint and several liability. In doing so, the statute is similar to federal securities regulations. See, e.g., § 77o of the securities Act of 1933 and § 78t of the Securities Exchange Act of 1934. The New York statute replaces the federal "control person" language with a specific list of individuals subject to liability The statute adds a requirement of "materially aid[ing] in the act of [sic] transaction constituting the violation."

Larger franchises are partially exempted from registration requirements pursuant to § 684. Franchises with a net worth over $15 million are exempted from registration requirements, although prospectus information must still be disclosed. Franchises worth between $5 million and $15 million must apply for an exemption. See generally 60 N.Y. Jur.2d Franchises §§ 25-28 (1987 & Supp. 1995).

Before this case, no New York state cases had interpreted the language of section 691(3), although a federal district court upheld the Franchise Sales Act against a commerce clause challenge. See Mon-Shore Management., Inc. v. Family Media, Inc., 584 F. Supp. 186 (S.D.N.Y. 1984).

In the instant case, the trial court accepted the plaintiff's contention that § 691(3) created "presumptive liability" against all officers, directors, and employees of the franchisor. See A.J. Temple Marble & Tile, Inc. v. Union Carbide Marble Care, Inc., 618 N.Y.S.2d 155 (N.Y. Sup. Ct. 1994). This decision sparked emphatic condemnation by commentator David Kaufmann (who coincidentally was the defense attorney in that case). See N.Y. Gen. Bus. Law art. 33, supplemental practice commentaries (McKinney Supp. 1996).

B. Majority

In this case, the court of appeals applied rules of statutory construction to determine whether the qualifying phrase "who materially aids in the act of [sic] transaction constituting the violation" applies to all or only some of the categories of persons preceding this phrase in the statute. The statute in question, General Business Law § 691(3), provides in part:

A person who directly or indirectly controls a person liable under this article, a partner in a firm so liable, a principle executive officer or director of a corporation so liable, a person occupying a similar status or performing similar functions, and an employee or a person so liable, who materially aids in the act of [sic] transaction constituting the violation, is also liable jointly and severally with and to the same extent as the controlled person, partnership, corporation or employer. General Business Law § 691(3) (emphasis added).

The court concluded that both a plain reading of § 691(3) and ordinary rules of statutory construction support the conclusion that the phrase "materially aids" modifies all of the preceding enumerated persons. See Budd v. Valentine, 283 N.Y. 508, 511 (N.Y. 1940) (general words occurring at end of sentence refer to whole sentence). The court then noted that absent contrary legislative history, a statute must be interpreted in accordance with its plain and literal meaning. See In re Schinasi's Will, 277 N.Y. 252, 259 (N.Y. 1938) (courts may not reject literal construction of statute unless clear that it could not reflect legislative intent). The court therefore rejected plaintiff's construction of the statute--that the "materially aids" clause applies only to the category immediately preceding "materially aids," i.e., employees only.

The court next rejected plaintiff's argument that the court's construction is at odds with the Act's defined use of the term "person" at General Business Law § 681(13) (defining "person" to include the franchisor's officers, directors, and controlling persons). The court provided examples of the Act's use of the word "person" elsewhere in the Act which do not conform with § 681(13) and demonstrate that other sections of the Act enlarge upon the initial definition of "person" at § 681(13). The court concluded that there is no conflict in the provisions using the term "person" because the provisions imposing direct and indirect liability complement each other and form a cohesive basis for imposing liability on all of the individuals potentially involved in an unlawful or fraudulent transaction.

2. Concurring Opinion

Chief Judge Kaye concurred in the judgment but expressed concerns that the Court's construction of § 691(3) would functionally read it out of existence. Specifically, she argued that high-level executives would rarely--if ever--aid in violating the Act while maintaining the "duty of good faith and reasonable care" towards the corporation. As a result, in such cases, primary liability would arise under § 687 rather than § 691(3). Further, Chief Judge Kaye asserted that the Franchise Act "does not expand upon or materially differ" from federal law despite its enumeration of the classes of individuals subject to joint and severable liability. Instead, she read § 691(3)'s language as the functional equivalent of the federal "control persons" language.

3. Survey of the Law in Other Jurisdictions

Although most courts have held that "a choice of law provision will not preclude claims under otherwise applicable franchise or distribution law," some have "exempted out-of-state franchisors from local franchise laws." Reva S. Bauch, An Update on Choice of Law in Franchise Agreements: A Trend Toward Unenforceability and Limited Application, 14-SPG Franchise L.J. 91, 98 (1995).

Edward W. Dunham, The Liability of Shareholders, Officers, Directors, and Employees For Franchise Law Violations, 13 Franchise L.J. 101 (1994) lists the fourteen states that have statutes regarding joint and several liability in franchising. Although some states have dealt with this question (specifically California and Indiana) the vast majority have not. See Dunham at 123. The relative paucity of statutory interpretation in this area can be directly related to two factors: (1) there may be no economic incentive where claims can be settled against the franchisor (2) most of the statutes create only limited remedies (i.e., limiting to rescission.). Id.

  • CALIFORNIA: Cal. Corp. Code§ 31302 is very nearly identical to the New York act. Regardless, California courts have interpreted the "materially aids" clause, without discussion, to apply to employees only. See Eastwood v. Froelich, 131 Cal. Rptr. 577 (Cal. Ct. App. 1976).
  • HAWAII: Haw. Rev. Stat. § 482E-2, 9 provides for liability by officers, directors and controlling shareholders. Dunham observes, "[T]his statute does not create a private right of action." Dunham, supra at 123.
  • ILLINOIS: Ill. Rev. Stat. ch. 815 para. 705, 726 is nearly identical to the New York act. Illinois courts have interpreted the "materially aids" clause as applying to all persons in the section without discussion. See Vukusich v. Comprehensive Accounting Corp., 501 N.E.2d 1332 (Ill. App. Ct. 1986).
  • INDIANA: Ind. Code § 23-2-2.5-29 provides for joint and several liability for any individual who "materially aids or abets" a violator. This result comports with the extent of liability in A.J. Marble, except that the Indiana statute is not limited to specified parties.
  • MARYLAND: Md. Bus. Reg. Code Ann. § 14-227 (d)(1)(2) is very nearly identical to the New York act. The statute makes liable "each employee of a person liable under this section, if the employee materially aids in the act or transaction that is a violation under this subtitle."
  • MICHIGAN: Mich. Comp. Laws § 445.1532 omits the comma at issue in the New York statute.
  • MINNESOTA: Minn. Stat. § 80c.17 also omits the comma before "who materially aids." Prior to 1993, § 80c.17 provided no action for damages for violations. It has since been amended, but cannot be applied retroactively. See Banbury v. Omnitrom Int'l 533 N.W.2d 876, 882 (Minn. Ct. App. 1995).
  • NORTH DAKOTA: N.D. Cent. Code § 51-19-12(2) is a rewritten version of the California statute. The relevant part of the act states, "[E]very employee of a person so liable who materially aids in the act or transaction constituting the violation is also liable jointly and severally . . . ."
  • OREGON: Franchise Transactions Goods and Services, Or. Rev. Stat. § 650.020, is very nearly identical to the New York act. The relevant part of the act states, "[E]very person who participates or materially aids in the sale of a franchise is also liable jointly and severally . . . ."
  • RHODE ISLAND: Franchise Investment Act, R.I. Gen. Laws § 19-28.1-21 supports the decision in A.J. Marble. The relevant part of the act states, "[E]very agent, employee of a person so liable, who materially aids in the act or transaction constituting the violation, is also liable jointly and severally . . . ."
  • SOUTH DAKOTA: Franchises for Brand Name Goods and Services, S.D. Codified Laws § 37-5A-84, is less clear. The relevant portion of the act states, "[E]very person occupying a similar status or performing similar functions and every employee of a person so liable who materially aids in the act or transaction constituting the violation is also liable jointly and severally . . . ."
  • WISCONSIN: Wisconsin Franchise Investment Law, Wis. Stat. § 553.51(3), follows the South Dakota formulation.

4. Unanswered Questions

The majority expresses no opinion on the issue of "mistaken drafting" as explained by the concurrence. Chief Judge Kaye's opinion displays a clear skepticism for the likelihood that the majority's opinion reflects the intent of the Legislature.

Also unclear are the parameters of the "materially aids" portion of the statute. This phrase appears only infrequently in the case law. In People v. Giordano, 622 N.Y.S.2d 89 (N.Y. App. Div. 1995), the Second Department interpreted Penal Law § 225.00(4). This statute contains some examples of "materially aids" with respect to gambling activity that might be illustrative of the content of the term as applied to franchise act violations.

Finally, there remains some question as to the evidence that the Legislature did not, in fact, intend the drafting of § 691(3) to be exactly as it appears. Specifically, it may be that the change to ", and an employee" from the prior ", every employee" (i.e., redrafting the phrase to signal the last item in a coordinate list) actually indicates that the Legislature might have considered the language at issue to some degree. In that case, the adoption by numerous states of the language without the "and" seems to indicate that those states are less likely to have considered the actual language of the statute. For example, in Vukusich v. Comprehensive Accounting Corp., 501 N.E.2d 1332 (Ill. App. Ct. 1986), the court applied the "materially aids" language to every named party, but without discussion. The reason underlying this failure to discuss the issue is unclear, but in any case, New York has a statute that was redrafted from the model adopted by other states.

5. Implications

First and foremost, Chief Judge Kaye's concurrence highlights the primary implication of this decision: the limitation of liability to only those directors, partners, and other controlling persons who "materially aid" the violation. The majority opinion reveals the need for this interpretation because 15 U.S.C. § 77o does not contain a "materially aids" limitation, and thus the failure to extend this language to the "non-controlling" parties mentioned in the statute is a serious expansion of liability. It seems more likely that the Legislature instead determined that partners and directors are controlling persons, per se.

Second, this interpretation of the statute greatly reduces the number of persons liable under the statute. Even "controlling persons" are not liable unless they "materially aided" in the violation. This outcome seems to be in conflict with the rationale behind both this statute and the myriad number of similar statutes throughout the nation.

Finally, this decision issues an implied invitation to the Legislature to correct the drafting of the statute if, in fact, the intent of the Legislature was not adequately expressed by the plain language of the statute. This invitation is made more explicit by Chief Judge Kaye's concurrence.

Prepared By:

  • Richard J. Colosimo, '97
  • Scott M. Davies, '97
  • Howard K. Jeruchimowitz, '97
  • R. Tor Liimatainen, '97
  • John R. Mayer, '96
  • Reese E. Solberg, '97
  • Michelle L. Sterling, '97