Non-Parties Can Enforce Franchise Agreement’s Arbitration Clause – IL Court

In a franchise dispute involving a sushi restaurant in the Chicago suburbs, the First District in Kim v. Kim, 2016 IL App (1st) 153296-U examines the scope of contractual arbitration clauses and when arbitration can be insisted on by non-parties to a contract.

The franchisee plaintiff sued the two principals of the franchisor for fraud.  He alleged the defendants tricked him into entering the franchise by grossly inflating the daily sales of the restaurant.  The plaintiff sued for rescission and fraud when the restaurant’s actual sales didn’t match the defendants’ pre-contract projections.  

The court dismissed the suit based on an arbitration clause contained in the franchise agreement and the plaintiff appealed.  He argued that since the defendants were not parties to the franchise agreement (the agreement was between plaintiff and the corporate franchisor), the defendants couldn’t use the arbitration clause as a “sword” and require the plaintiff to arbitrate his claims.

Affirming the case’s dismissal, the appeals court first discussed the burden-shifting machinery of a Section 2-619 motion to dismiss.  With such a motion, the movant must offer affirmative matter appearing on the face of the complaint or that is supported by affidavits.  Once the defendant meets this initial burden, the burden then shifts to the plaintiff who must establish that the affirmative matter is unfounded or requires the resolution of a material fact.  If the plaintiff fails to carry his burden, the motion to dismiss can be granted.  (¶ 23)

The court then zeroed in on whether the defendants – non-parties to the franchise agreement – could enforce the agreement’s arbitration clause against the plaintiff.  Generally, only parties to a contract can enforce its terms.  By contrast, non-parties cannot.  An exception to this rule is equitable estoppel: where a party is estopped or prevented from avoiding a written contract term because the party trying to enforce it isn’t technically a party to it.

For equitable estoppel to apply and subject a contracting party to arbitration against a non-party, (1) the signatory must rely on terms of a contract to make its claims (or presumes the existence a written agreement that contains an arbitration provision) against the nonsignatory, (2) the signatory must allege concerted misconduct by the nonparty and one or more contracting parties, and (3) where there is a close nexus between the alleged wrong and the claims against the non-party and where plaintiff’s claims against a defendant are factually intertwined with or based on written contract terms.  (¶¶ 44-45)

Here, the crux of plaintiff’s lawsuit was that the defendants induced him into signing the franchise agreement and related restaurant lease.  Since the plaintiff’s claims were premised on and presumed the franchise agreement’s existence, and the franchise agreement contained a broad arbitration clause, the court held that the plaintiff was subject to the arbitration clause and the defendants could enforce the clause.

Afterwords:

A third party generally cannot enforce contract provisions since the third party, by definition, is not a signatory to the contract.

But where a plaintiff’s claim against a non-party relates to or is factually intertwined with a written contract, the terms of that contract can govern and be enforced by the non-party.

 

Course of Dealing Leads to Implied-In-Fact Contract Judgment in Construction Spat – IL First Dist.

While a signed agreement is almost always preferable to an oral one, the absence of a writing won’t always doom a breach of contract action.

Trapani v. Elliot Group, Inc., 2016 IL App (1st) 143734, examines what happens when parties don’t sign a contract but still act as if an agreement exists.

In a construction dispute, the First District affirmed a trial court’s finding that an implied-in-fact contract existed between the contractor plaintiff and the real estate developer defendant.  In upholding the $250K-plus judgment for the plaintiff, the Court highlights the nature and scope of implied contracts and discusses the agent-of-a-disclosed-principal rule.

The plaintiff submitted a draft contract that identified the defendant as “owner.”  The defendant, who wasn’t the owner (it was the developer), never signed the contract.

Despite the absence of a signed contract, the plaintiff performed the work contemplated by the draft agreement and was paid over $2M over a several-month period.  Plaintiff sued to recover for its remaining work after the developer refused to pay.  The developer denied responsibility for the plaintiff work: it claimed it merely acted as the owner’s agent and that plaintiff should have looked to the owner for payment.

The trial court entered judgment for the plaintiff.  It found that the plaintiff and developer, while lacking a signed written agreement, had an implied-in-fact contract.  The developer appealed.

Result: affirmed.

Reasons:

Whether an implied in fact contract (or “contract implied in fact”) exists depends on the surrounding facts, circumstances and expressions of the parties demonstrating an intent to be bound.

A contract implied in fact is a classic contract by conduct.  It arises where the court imposes a contractual duty on a party based on the party’s promissory expression that shows an intention to be bound;

The promissory expression can be inferred from the parties’ conduct and an implied in fact contract can be found even where there is no express contract between the parties;

An implied in law contract differs in that it is an equitable remedy based on the principle that no one should unjustly enrich himself at another’s expense;

Acceptance of an implied in fact contract can be shown by conduct of the parties and a course of dealing that demonstrates the parties’ intent to form a binding agreement.

(¶¶ 40-44)

The Court agreed with the trial court that the parties’ conduct supported a finding of an implied in fact contract.  The Court noted that throughout the construction project, the plaintiff communicated regularly with the defendant and provided lien waivers and payment certificates to the defendant.  The defendant also provided project specifications to the Plaintiff and approved multiple change orders over the course of plaintiff’s work on the site.  Significantly, the defendant never rejected plaintiff’s work or demanded that plaintiff stop working at any time during the project.

Next, the Court tackled the developer’s argument that it wasn’t liable to the plaintiff since the developer was acting as the agent of the property owner.  In Illinois, an agent who contracts with a third party generally is not liable so long as he discloses his principal’s identity.  Where the agent fails to identify his principal, it creates an “undisclosed principal” scenario which will make the agent personally liable if the contract is later breached. (¶ 60)

The reason for the undisclosed principal rule is reliance: the third party (here, the plaintiff) relies on the agent’s credit when entering the contract.  As a result, it would be unfair to immunize the agent and have the undisclosed principal shoulder the financial burden when the agent fails to reveal the principal.  The dearth of evidence showing a relationship between the developer (agent) and the owner (principal) led the Court to sustain the trial court’s finding that the developer was responsible for the outstanding amounts owed the plaintiff contractor.

Afterwords:

1/  An implied in fact contract is a valid, enforceable contract, despite a lack of express agreement.  Instead, the parties’ intention to be contractually liable can be shown through course of dealing between parties;

2/ The agent of a disclosed principal is generally immunized from liability.  However, where the agent fails to sufficiently disclose its principal’s identity, the agent remains liable if the plaintiff can show it relied on the agent’s credit and lacked notice of the agent’s principal’s identity.

 

Illinois Joint Ventures – Features and Effects

Primo v. Pierini, 2012 IL App (1st) 103553-U discusses the key elements of a joint venture and how it differs from other common business arrangements.

The plaintiff contractor sued a construction manager to recover about $300k in building improvements it made in building a Chicago restaurant.  The construction manager was hired by the restaurant owner and was actively involved in funding the construction.

The construction manager in turn filed a third party suit against the restaurant owner for contribution.  It (the construction manager) claimed that it merely lent money to the restaurant owner and that there was no formal business relationship between them.

After a bench trial, the court found a joint venture existed between the construction manager and the restaurant owner based on their oral agreement to share restaurant profits among other reasons.

The court entered judgment for the plaintiff for nearly $300k and awarded defendant about $150K (one-half of the judgment) in its third-party claim  against the restaurant operator.  The court later reduced the judgment to about $140k after excising over $150k in extras and prejudgment interest from the judgment amount.  Each side appealed.

Result: Reduced judgment (minus extras and interest) affirmed.

Reasons:

The appeals court agreed with the trial court that there was a joint venture between the construction manager and restaurant owner.

A joint venture is an association of two or more persons or entities to carry out a single, specific enterprise;

-Whether a joint venture exists is a factual inquiry and no formulaic rules ultimately determine whether a joint venture exists;

– Where the parties’ conduct evinces an intent to share profits from a common enterprise, the court will find a joint venture exists;

– The key joint venture elements are: (1) an express or implied agreement to carry on an enterprise; (2) a manifestation of intent by the parties to be associated as joint venturers; (3) joint interest as shown by the contribution of property, money or knowledge by each joint venturer; (4) joint control or ownership over the enterprise; and (5) the joint sharing of profits and losses;

– Like a partnership, each joint venture participant is an agent of the other one and is liable to third parties for another participant’s acts taken in the regular course of the venture’s business;

– Unlike an LLC or corporation, a joint venture is not a separate legal entity (i.e. like a corporation, LLC or limited partnership is): instead, a joint venture is a contractual relationship formed between the constituent venturers;

– Joint ventures can be made up of individuals, corporations, or a combination of the two.

(¶ 56-58).

The court rejected the defendant construction manager’s claim that it was only a lender (and not a partner or joint venturer) to the restaurant business.  The construction manager relied on section 202 of the Illinois Partnership Act (805 ILCS 206/202(a), (c)), which provides that receiving debt repayments from a business venture signals a lender-borrower relationship instead of a profit sharing/partnership one. (¶ 59-60)

Here, the court credited trial testimony that the parties planned to split profits well after the restaurant owner repaid the defendant’s loan.  In addition, the construction manager’s principal’s self-serving written statement that “I am not a partner” wasn’t sufficient to cast doubt on the trial testimony that defendants and the restaurant owner agreed to share profits indefinitely. (¶ 62)

In sum, the defendants’ active and direct involvement in funding the restaurant’s construction coupled with the agreement with the owner/operator to share in the profits manifested the intent to form a joint venture.

Afterwords

– A hallmark of a joint venture is the sharing of profits and losses in a common, one-time enterprise;

– Where one party lends money to another, this generally denotes a lender-borrower arrangement; not a joint venture or partnership one;

– Each enterprise participant’s active involvement in day-to-day functioning of a business, coupled with profit and loss sharing, is strong evidence of joint venture relationship.