US-DIST-CT, FRANCHISE-GUIDE ¶11,088, C.F.M.I., Inc. v. August S. Felish and Eileen M. Felish., (Dec. 20, 1996)

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U.S. District Court, Northern District of Illinois, Eastern Division. No. 96 C 3547. Dated December 20, 1996.

Arbitration Agreements--Scope of Agreement--Disputes "Arising Under" Agreement--Fraudulent Inducement Claim.--A convenience store franchisee’s fraudulent inducement claim against a regional franchisor and its predecessor fell within the scope of the franchise agreement’s arbitration provision. The provision required the parties to arbitrate any dispute arising under or in connection to agreement. The fraudulent inducement claim certainly was connected to the franchise agreement. The franchisee could not avoid a contractual arbitration clause simply by casting its complaint in tort. Back reference: ¶1840.

Jurisdiction--Supplemental Jurisdiction--Compulsory Counterclaims--Arising Out of Same Transaction.--A convenience store franchisee’s fraud and state law counterclaims against a regional franchisor and its predecessor were compulsory in nature because they arose out of the same transaction as the franchisor’s claims and did not require the presence of unavailable third parties in order to be adjudicated. Therefore, supplemental jurisdiction existed over the counterclaims even if the trademark claims upon which federal jurisdiction was based were voluntarily dismissed. Back reference: ¶1800.50.

Plunkett, D.J.: Plaintiff C.F.M.I., Inc. ("CFMI"), has moved to strike and dismiss the answer of defendants August S. and Eileen M. Felish (the "Felishes"), to voluntarily dismiss its own claim against the Felishes, and to compel arbitration of the Felishes, counterclaim issues against it and third-party defendants P.P. & K, Inc. ("PP&K"), and John Purcell ("Purcell"), president of PP&K. PP&K and Purcell have moved separately to compel arbitration. For the reasons set forth below, this Court denies the motion to strike, grants the motion to voluntarily dismiss, and grants both motions to compel arbitration. The Felishes’ counterclaim and third-party claim are stayed pending arbitration.

Convenient Food Mart, Inc. ("CFM") and its predecessors have operated and franchised retail food mart establishments under the name "Convenient Food Mart" since 1958. CFM has devised a standard, proprietary system for store design and equipment, interior and exterior accessories and color schemes identified by the name "Convenient Food Mart," and related trade names, logos, and trade dress. There are currently about 400 stores in the chain nationwide. CFM is the owner of the trade name "Convenient Food Mart," the service mark "Convenient Food Mart and Design," and the service mark "CCC and Design." The two service marks are registered with the United States Patent and Trademark Office. CFM also owns other Convenient Food Mart service marks and logos.

In some regions, CFM operates as franchisor, while in others, it allows third parties to do so pursuant to regional franchisor agreements. In such agreements, CFM agrees to share its systems, procedures, and expertise, and not to open or operate a Convenient Food Mart store within the assigned territory. It also licenses its service marks and logos to the regional franchisors. In exchange, the regional franchisors agree to pay a percentage of gross sales to CFM.

In June 1995, third-party defendant PP&K was the regional franchisor in Illinois. On June 8, 1995, the Felishes entered into a franchise agreement with PP&K, which they negotiated with third-party defendant Purcell. Pursuant to that agreement, the Felishes obtained the right to operate a Convenient Food Mart at 501 West 87th Street in Naperville, Illinois (the "Naperville store"), from June 8, 1995, to September 29, 2004. The franchise agreement obligated them to pay a monthly franchise fee. It also contained an arbitration clause, which stated:

A. Except as provided below, and except for disputes or claims relating to the Marks, any dispute between the parties arising under, in connection with or in relation to this Agreement, shall be resolved by binding arbitration. . . . The decision of the arbitrator shall, except for mistakes of law, be final and binding on all parties.

. . .

The arbitrator shall have no power or authority to diminish the complete and exclusive right, title and interest of CFMI in its trademarks, service marks, trade names, copyrights, trade secrets or logos or to vary the terms, conditions or payments which Company has designated for licensing one or more of the same.

This Section 14.A. shall survive and remain in full force and effect for a three (3) year period subsequent to termination of this Franchise Agreement.

B. Notwithstanding the foregoing, Franchisee recognizes that Franchisee’s CFM Store is part of a system of stores selling to the public similar goods and services, and that Franchisee’s failure to comply with this Agreement could cause irreparable damage to Company and/or to some or all other CFM franchisees. Therefore, upon a breach or threatened breach of any of the terms of this Agreement by Franchisee, the Company may seek an immediate injunction restraining such breach and/or a decree of specific performance, pending arbitration or adjudication, without regard to the availability of an adequate remedy at law or otherwise. This equitable remedy is in addition to, and not in lieu of, other remedies or rights which Company might otherwise have by virtue of any breach of this Agreement by Franchisee.

. . .

Company reserves the right to commence a civil action against Franchisee to collect sums of money due and payable to Company and its affiliates, if not timely paid, to protect or enforce its rights in or under the Marks, or to compel Franchisee to make reports or permit inspections and audits provided by this Agreement.

(Compl., Ex. D, §14.)

The Felishes also executed a sublease with PP&K for the premises occupied by the Naperville store. The sublease prohibited the Felishes from operating any business other than a Convenient Food Mart at the location. It also provided that, in the event of a termination of the franchise by the licensor, default under the sublease would occur, causing the sublease to terminate as well.

In February 1996, CFMI became the regional franchisor in Illinois and thereby held the exclusive license for the relevant service marks and logos. PP&K assigned its interest in both the franchise agreement and the sublease with the Felishes to CFMI on February 20, 1996.

Beginning in December 1995, the Felishes failed to pay the franchise fee. On March 5, 1996, CFMI sent them a notice of default. The notice informed them that if the default was not cured, the sublease would end as well. At the same time, a landlord’s five-day notice was sent to the Felishes.

Two days later, the Felishes’ attorney responded by letter to CFMI, asserting that PP&K and Purcell had fraudulently induced the Felishes to enter into the franchise agreement and to agree to pay the franchise fee. He contended that, as a result, the Felishes had no liability to CFMI. The Felishes continued to operate the in Naperville store.

On March 18, 1996, CFMI sent the Felishes a notice of termination of the franchise agreement, which demanded that they vacate the Naperville store. The Felishes refused to comply.

CFMI filed this action on June 12, 1996. It asserted claims of trademark infringement, false advertising in violation of the Lanham Act, unfair competition in violation of the Lanham Act, violation of the Illinois Deceptive Trade Practices Act, and violation of the Consumer Fraud and Deceptive Business Practices Act, common law unfair competition, breach of the sublease, and for damages under the franchise agreement. In addition, it brought a claim for injunctive relief requiring the Felishes to cease using all CFMI-licensed services marks and logos; to cease using CFM’s operating manuals, products, and merchandise; to vacate the Naperville store; to transfer the assets of the store to CFMI; and to enforce the two-year covenant not-to-compete contained in the Felishes’ franchise agreement. It moved contemporaneously for a temporary restraining order ("TRO").

On June 18, 1996, the Felishes filed a demand for arbitration with the American Arbitration Association. ^{1 It is not at all clear, given the language of the demand, what issues are involved in the arbitration. In any event, the arbitration has been stayed, although CFMI and the Felishes are paying $300.00 per month to keep it alive.}

The TRO was granted by Judge Plunkett on June 21, 1996. The Felishes vacated the Naperville store on or about June 28, 1996.

On July 5, 1996, the Felishes moved to stay this action pending arbitration on the grounds that the dispute between the Felishes and CMFI fell within the arbitration clause of the franchise agreement. CFMI opposed the motion on the grounds that its claims were non-arbitrable, although it conceded at oral argument that its trademark and unfair competition claims had been resolved when the Felishes vacated the Naperville store. ^{2 However, it asserted that its claim for money damages was non-arbitrable. Judge Plunkett denied the motion on July 18, 1996.}

On August 7, 1996, the Felishes filed an answer to the complaint, along with a counterclaim against CFMI and a third-party complaint against PP&K and Purcell. They alleged that Purcell and PP&K had knowingly misrepresented the 1994 gross sales and total costs for the Naperville store and that they relied upon the misrepresentations when they entered into the franchise agreement. They asserted claims of fraudulent misrepresentation, violation of the Illinois Consumer Fraud and Deceptive Business Practices Act, and violation of the Illinois Franchise Disclosure Act. The Felishes have also asserted fraudulent inducement as an affirmative defense.

CFMI has moved to strike and dismiss the Felishes’ answer as untimely, for leave to voluntarily dismiss its own claims against the Felishes, and to compel arbitration of the Felishes, claims against it. Similarly, the third-party defendants have moved to compel arbitration of the Felishes, claims. The Felishes oppose both motions.

At some point, the Felishes instituted a state court action against PP&K and Purcell. The nature of their claims in that case is not entirely clear. After the Felishes’ motion to stay pending arbitration was denied, they voluntarily dismissed the state court action on August 9, 1996.

I. The Motions to Compel Arbitration

CFMI, PP&K and Purcell have moved to compel arbitration on that grounds that the Felishes, claim of fraud in the inducement is arbitrable. The Felishes respond that this Court cannot now compel them to arbitrate when Judge Plunkett denied their motion to stay pending arbitration in July, and that Judge Plunkett ruled then that the arbitrator lacks the power to decide fraud in the inducement. The Felishes also contend that CFMI has waived arbitration by filing this action.

This Court considers these motions first because they are the crux of the instant dispute and because their resolution makes the outcome of the remaining motions clear. CFMI has asserted that the franchise agreement is governed by the Federal Arbitration Act, 9 U.S.C. §4, and the Felishes have not disputed this. The law is clear that, when there is no evidence that the parties intended to exempt such a claim from arbitration, a claim of fraud in the inducement of a contract as a whole must be arbitrated. Prima Paint Corp. v. Flood & Conklin Mfg. Corp., 388 U.S. 395, 404 (1967). See also Flender Corp. v. Techna-Quip Co., 953 F.2d 273, 277 (7th Cir. 1992). Moreover, "any doubt concerning the scope of arbitrable issues should be resolved in favor of arbitration." Moses H. Cone Mem. Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1985).

Thus, this Court’s analysis is limited to determining whether the Felishes, fraud in the inducement claims falls under the arbitration provision of the franchise agreement. See Flender Corp., 953 F.2d at 277. That provision requires the parties to arbitrate "any dispute between the parties arising under, in connection with or in relation to this Agreement." (Compl., Ex. D, §14A.) The fraud in the inducement claim is certainly a dispute "connected with" or "related to" the franchise agreement. Indeed, the Seventh Circuit has held that a fraud in the inducement claim was arbitrable where the arbitration clause covered all disputes "arising out of" the contract. Sweet Dreams Unlimited, Inc. v. Dial-A-Mattress Int’l, Ltd., 1 F.3d 639, 642-43 (7th Cir. 1993). See also Matthews v. Rollins Hudig Hall Co., 72 F.3d 50, 54 (7th Cir. 1995) (fraudulent inducement claim arbitrable under "relating to a breach of th[e] Agreement" language of arbitration provision). Even if the question were a close one, which it is not, the language of the arbitration provision would " ‘arguably cover[]’ such dispute[], and . . . this is all that is needed to trigger arbitration." Id. Moreover, although the Felishes assert fraud, "a party may not avoid a contractual arbitration clause merely by ‘casting its complaint in tort.’ " Id. at 643. For these reasons, this Court concludes that the Felishes, fraud in the inducement claim falls within the arbitration provision of the franchise agreement and must therefore be arbitrated.

When the Felishes brought their motion to stay pending arbitration, they did not address the arbitrability of their fraud in the inducement claim. Neither did CFMI. In the papers on the instant motions to compel, the Felishes asserted, based upon some of Judge Plunkett’s comments on July 18, 1996, that fraud in the inducement is not arbitrable. CFMI, arguing that fraud in the inducement is arbitrable, cited a district court case from Minnesota ^{3 and an unpublished opinion from the Southern District of Illinois. 4 In considering the instant motions, it became apparent that the earlier discussion during the July 18, 1996, hearing regarding the arbitrability of fraud in the inducement claims was in error. Had the parties alerted the Court to the appropriate law on the subject, the ruling on that motion might well have been different. In any event, because the law on the issue is clear, the motions to compel arbitration are granted.}

II. CFMI’s Motion to Strike and Dismiss the Felishes’ Answer

CFMI has moved under Rule 12(f) of the Federal Rules of Civil Procedure to strike and dismiss the Felishes’ answer because it was filed, without leave of court, over a month after the deadline imposed by the Court. This matters because, if the Felishes’ answer is untimely, then CFMI does not require leave of court to voluntarily dismiss its claims. See Fed. R. Civ. P. 41(a). The Felishes counter that when they filed their motion to stay on July 5, 1996, they were "otherwise pleading" to the complaint. They further argue that when their motion to stay was denied on July 18, 1996, they filed an answer within twenty days.

By minute order of June 21, 1996, Judge Plunkett ordered the Felishes to answer or otherwise plead by July 5, 1996. The Felishes did not file their answer until August 7, 1996. CFMI filed its motion to strike on September 5, 1996.

Rule 12(f) requires that a motion to strike be brought "within 20 days after the service of the pleading upon the [moving] party . . ." Fed. R. Civ. P. 12(f). Here, CFMI brought its motion twenty-eight days after the Felishes filed their answer, and it does not claim that the Felishes did not promptly serve their answer. CFMI did not file its motion within the twenty-day period set by Rule 12(f), and it is therefore untimely. This Court will not strike the answer as untimely where the motion to strike was also untimely. This Court notes, moreover, that on July 5, 1996, the day their answer was due, the Felishes brought a motion to stay this case pending arbitration. That motion was briefed by the parties and ultimately denied by this Court on July 18, 1996. This Court need not reach the question of whether a motion to stay technically falls within the "answer or otherwise plead" language of the June 21, 1996, order because the Felishes were undeniably active in this case during the relevant time period. CFMI’s motion to strike is therefore denied.

III. CFMI’s Motion to Voluntarily Dismiss Its Claims

CFMI has moved to dismiss its claims voluntarily under Rule 41(a)(2) of the Federal Rules of Civil Procedure. It contends that, because the Felishes have vacated the Naperville store and no longer operate it, its claims for trademark infringement, false advertising, unfair competition, deceptive trade practices, consumer fraud, common law unfair competition, and breach of the sublease have been resolved. It further argues that it may choose to abandon its claim for money damages against the Felishes or else bring it as a counterclaim in the pending arbitration. The Felishes respond on several grounds. First, they assert that CFMI is entitled to dismiss its claims only if the Felishes’ counterclaim remains pending. Second, they assert that they would suffer prejudice if CFMI’s claims are dismissed because they will not have had a chance to be heard on those claims. Third, they contend that granting CFMI’s motion would be an abuse of our discretion if it had the effect of terminating the counterclaim, that CFMI is attempting to circumvent an adverse result (by which we presume the Felishes mean that CFMI will inevitably lose this case on the merits), and that the Felishes cannot obtain punitive damages in an arbitration.

The only real question here is whether a voluntary dismissal of CFMI’s claims would serve to terminate the Felishes’ counterclaim, for Rule 41(a)(2) limits the plaintiff’s right to a voluntarily dismissal where a counterclaim has been filed. The rule states:

If a counterclaim has been pleaded by a defendant prior to the service upon the defendant of the plaintiff’s motion to dismiss, the action shall not be dismissed against the defendant’s objection unless the counterclaim can remain pending for independent adjudication by the court.

Fed. R. Civ. P. 41(a)(2). Here, our subject matter jurisdiction was based on CFMI’s trademark claims, while the counterclaim alleges only state law claims between non-diverse parties.

CFMI has asserted that this action is governed by the Federal Arbitration Act, 9 U.S.C. §1 et seq. That statute permits this Court to stay an action pending arbitration, but not to dismiss it. 9 U.S.C. §3. Therefore, the possible termination of the Felishes’ counterclaim arises solely from the voluntarily dismissal of CFMI’s claims, not from the conclusion that the Felishes must arbitrate their counterclaim. If this Court determines that an independent jurisdictional basis exists for the counterclaim, CFMI’s motion to voluntarily dismiss may be granted, for then the Felishes’ counterclaim will simply be stayed pending arbitration. If, however, this Court lacks jurisdiction over the counterclaim, the motion to voluntarily dismiss must be denied, for the dismissal of those claims would terminate the Felishes’ counterclaim.

The answer to this question depends upon whether the Felishes counterclaim is compulsory or permissive. Federal courts have supplemental jurisdiction over compulsory counterclaims, but an independent jurisdictional basis must exist for permissive counterclaims. Unique Concepts, Inc. v. Manuel, 930 F.2d 573, 574 (7th Cir. 1991). Rule 13(a) of the Federal Rules of Civil Procedure states that a counterclaim is compulsory "if it arises out of the transaction or occurrence that is the subject matter of the opposing party’s claim and does not require for its adjudication the presence of third-parties of whom the court cannot acquire jurisdiction." Fed. R. Civ. P. 13(a). Not surprisingly, Rule 13(b) defines a permissive counterclaim as "any claim against the opposing party not arising out of the transaction or occurrence that is the subject matter of the opposing party’s claim." Fed. R. Civ. P. 13(b).

Here, CFMI’s claims relate to the rights and obligations of both it and the Felishes under the franchise agreement. The Felishes counterclaim relates to the circumstances under which the Felishes entered into the franchise agreement and the effect of those circumstances upon the agreement’s validity. There is clearly some logical connection between the two sets of claims, although they are not based wholly upon the same facts.

In Channell v. Citicorp Nat’l Servs., Inc., 89 F.3d 379 (7th Cir. 1996), the Seventh Circuit considered whether Citicorp’s counterclaims against members of the plaintiff class for the balance under consumer automobile leases were compulsory or permissive where Citicorp had been sued under the Consumer Leasing Act over certain of its practices relating to the termination of the leases. Id. at 380, 384-86. In resolving that issue, the court explained:

Each class member’s claim against Citicorp depends on the lease, and indeed on the same clause of the lease that creates Citicorp’s claim for a termination charge. The acts creating the claims differ--the claims against Citicorp stem from the signing of the lease, while the claims against the class stem from the early termination of the lease. But the parties, the lease, the clause, and even the terminations are constants . . . .

Id. at 385-86.

Although not identical to the facts in Channell, the facts of this case are similar enough to warrant the same outcome. Here, the heart of everyone’s claims is the franchise agreement. While the Felishes’ counterclaim addresses the alleged misrepresentations by PP&K and Purcell which caused the Felishes to enter into the franchise agreement, rather than the terms of the agreement itself, their success on the merits will render the agreement invalid. That alone makes the Felishes’ counterclaim compulsory. CFMI wants to recover the unpaid franchise fees, but it will have no legal right to do so if the agreement is void because the Felishes were induced to enter into it by fraud.

This Court concludes that the Felishes’ counterclaim is compulsory, and therefore there exists supplemental jurisdiction over it under 28 U.S.C. §1367(a). On this basis, CFMI’s motion to voluntarily dismiss its claims is granted, and those claims are dismissed without prejudice pursuant to Fed. R. Civ. P. 41(a)(2). The Felishes’ counterclaim and third-party claim are stayed pending arbitration.

For the forgoing reasons, this Court grants the motions to compel arbitration of plaintiff CFMI and third-party defendants PP&K and John Purcell. CFMI’s motion to strike the answer of defendants August S. and Eileen M. Felish is denied. CFMI’s motion to voluntarily dismiss its claims is granted, and those claims are dismissed without prejudice. The Felishes’ counterclaim against CFMI and third-party claim against PP&K and John Purcell are stayed pending arbitration.

¹ The Felishes originally filed a demand for arbitration on March 14, 1996.

² The Felishes had not filed their third-party claim, so PP&K and Purcell were not yet in this suit.

³ Slomkowski v. Craig-Hallum, Inc., 644 F. Supp. 132 (D. Minn. 1986).

⁴ McCall v. Snap-On Tools Corp., Business Franchise Guide (CCH) ¶9891 (S.D. Ill. 1991).