Court Considers Prior Notice, Intentional Acts, and Contract Exclusions as Applied to Insured’s Violation of California Franchise Investment Law for Incomplete Franchise Disclosures
The United States District Court for the District of New Hampshire, applying California law, considered several exclusions under a directors and officers liability policy as applied to a violation of the California Franchise Investment Law (“CFIL”). The claim involved an insured franchisor’s violation of the CFIL for failing to disclose prior fraud cases against the company’s founder when entering into a new franchise agreement. MRFranchise, Inc. v. Stratford Ins. Co., 2024 WL 4651195 (D.N.H. Nov. 1, 2024). The court held that the policy’s prior notice exclusion potentially applied, preventing resolution of the case in favor of the insured on summary judgment; however, it held that the policy’s intentional acts and contract exclusions did not bar coverage.
The insured, a kabob restaurant chain franchisor, entered into a franchise agreement with a new franchisee. As part of the process, the insured made disclosures to the franchisee as required by the CFIL. One disclosure concerned whether the insured “had been held liable in—or had paid money to settle—a civil case involving allegations of ‘fraud, unfair or deceptive practices, or comparable allegations’ in the ten years immediately preceding the disclosures.” The insured answered no. Later, the new franchise arrangement fell apart, after which the insured filed an arbitration proceeding against the franchisee. The franchisee filed a counter-complaint in the arbitration alleging that the insured had violated the CFIL by failing to disclose prior fraud cases against the insured’s founder, president, and CEO. The arbitrator found that the insured corporate entity had willfully violated the CFIL.
In coverage litigation, the court considered the policy’s prior notice exclusion, which provided that “in the event of any material misstatement, misrepresentation or omission in the Application, there shall be no coverage under this Policy for any Insured who had actual or imputed knowledge as of the inception date of the Policy Period of the facts that were misstated, misrepresented or omitted in the Application.” The insurer argued that the exclusion applied because, in the months prior to signing the application, the insured had issued a notice of default to the franchisee and disagreements had ensued regarding the terms of a buy-back agreement. The court agreed, holding that a reasonable jury could find that the insured knew of a potential claim before submitting the application.
The court also considered whether the policy’s intentional acts exclusion applied, which barred coverage for a claim “brought about or contributed to by . . . the committing of any intentional criminal or deliberate fraudulent act, if such . . . act is established by a final, non-appealable adjudication in the underlying action.” The court held that, although the arbitrator had found that the insured’s corporate entity had willfully violated the CFIL, the finding did not lead to application of the intentional acts exclusion against the insured’s CEO, who was found jointly and severally liable for the CFIL violation, because there was no willful violation of the CFIL on the CEO’s part. The court was not persuaded that the arbitrator’s finding that the CEO “materially aided” in the CFIL violation required application of the exclusion.
Finally, the court held that the policy’s contract exclusion did not bar coverage for the CFIL claim even though the arbitration dispute largely involved claims alleging breach of the franchise agreement. The exclusion barred coverage for claims “based upon or attributable to liability under any oral or written contract or agreement” “provided, however, that this exclusion shall not be applicable to an Insured’s alleged liability that exists in the absence of such contract or agreement.” The court determined that the insured’s liability to the franchisee was “based upon or attributable to” the insured’s misrepresentations in making incomplete statutory disclosures under the CFIL and did not stem from the franchise agreement itself.
