US v. Building Inspector of America, Inc.
| Decision Date | 26 May 1995 |
| Docket Number | Civ. A. No. 93-10838-NG. |
| Citation | 894 F. Supp. 507 |
| Parties | UNITED STATES of America, Plaintiff, v. The BUILDING INSPECTOR OF AMERICA, INC., a corporation, Ralph L. Tisei, individually, and as an officer of The Building Inspector of America, Inc., Beverly A. Tisei, individually and as an officer of The Building Inspector of America, Inc., and Lawrence Finklestone, individually and as an officer of The Building Inspector of America, Inc., Defendants. |
| Court | U.S. District Court — District of Massachusetts |
COPYRIGHT MATERIAL OMITTED
Anita Johnson, U.S. Attorney's Office, Boston, MA, Elizabeth Stein, Dept. of Justice, Office of Consumer Litigation, Washington, DC, for plaintiff.
J. Daniel Silverman, Wakefield, MA, for The Building Inspector of America and Beverly A. Tisei.
Ralph L. Tisei, The Building Inspector of America, Inc., Wakefield, MA, pro se.
David C. Grossack, Law Office of David Grossack, Boston, MA, for Lawrence H. Finklestone.
Elizabeth A. Harling, James M. Hughes, Devin & Drohan, Hingham, MA, for Franchise Consulting Group, Inc.
Daniel J. Gleason, Daniel J. Driscoll, Nutter, McClennen & Fish, Boston, MA, for Amy Robertson.
Michael J. Griffin, Sullivan, Sullivan & Pinta, Boston, MA, for George Gregson and George O. Gregson, P.C.
The United States brought this civil action on behalf of the Federal Trade Commission ("the FTC"), see 15 U.S.C. § 56(a), against The Building Inspector of America ("TBIA"), and its three shareholders: Ralph L. Tisei, Beverly Tisei, and Lawrence Finklestone. The government seeks civil penalties, consumer redress, and injunctive relief for violations of franchising regulations issued pursuant to the Federal Trade Commission Act ("FTCA"), 15 U.S.C. § 57a(a). See 15 U.S.C. §§ 45(m), 53(b) and 57b. The government alleges, in a five count complaint, that TBIA and the individual defendants violated the FTC's franchising regulations by failing to disclose certain information (and by disclosing misleading information) to prospective franchisees. It has moved for partial summary judgment on three of the five counts, while TBIA has moved for partial summary judgment on the remaining two counts. For the reasons stated below, TBIA's motion for summary judgment is ALLOWED and the government's motion for summary judgment is ALLOWED IN PART AND DENIED IN PART.
The FTC is broadly empowered to promulgate regulations prohibiting specific acts which it finds to be unfair or deceptive trade practices. 15 U.S.C. § 57a(a). Pursuant to this statutory authority, the FTC promulgated, in 1978, the so-called "Franchise Rule," 16 C.F.R. Part 436. The Franchise Rule requires franchisors to provide a prospective franchisee with a detailed disclosure statement, prior to selling a franchise. The disclosure statement must present certain enumerated pertinent facts about the franchisor's corporate history, its financial condition, the track record of other franchisees, and the background of its principal officers.
Certain states have also enacted legislation governing franchise offerings. See Cal.Corp. Code § 31110 (1992); Ill.Comp.Stat. Ch. 815 § 705/10 (1992); Ind.Code § 23-2-2.5-9 (1993); Md.Code Ann., Bus.Reg. § 14-214(a) (1992); N.Y.Gen.Bus.Law § 683(1) (1980); R.I.Gen.Laws § 19-28.1-5 (1993); Va.Code § 13.1-560 (1992). In addition to making disclosures to individual franchisees, these states ("the registration states") also require that franchisors register with state authorities, who must approve the form of their disclosures. The registration states have adopted a standardized disclosure format known as the Uniform Franchise Offering Circular ("UFOC"), which was originally developed by the Midwest Securities Commissioners Association. The UFOC requirements are similar, but not identical to those in the FTC Franchise Rule. However, in order to reduce the need for duplicative filings, the FTC has authorized franchisors to use the UFOC in lieu of the disclosure required by the FTC's Franchise Rule. See 43 Fed.Reg. 59722 (1978); 52 Fed.Reg. 22686 (1987).1 Thus, franchisors doing business in registration states may use the same document to comply with both state registration requirements as well as those of the FTC.2
TBIA franchises home inspection services and is thus subject to the FTC's Franchise Rule. It was founded in 1985 by Ralph Tisei, his wife Beverly, and Lawrence Finklestone. All three had prior experience with home inspections. Finklestone had been in the home inspection business since 1976, when he founded American Home Inspection Service, Inc. ("AHISI"). In 1982, a company owned by the Tiseis purchased the assets of AHISI, including its trade name, American Home Inspection. Finklestone continued to work for American Home Inspection as a "consultant." AHISI, Finklestone's old company, subsequently filed for bankruptcy.
The Tiseis were apparently quite successful in running American Home Inspection and, in 1984, Ralph Tisei conceived the idea of franchising home inspection services nationwide. Together with Finklestone and Ms. Tisei, he formed a new corporation, TBIA, to implement this idea. TBIA was incorporated in 1985, with Ralph Tisei as its president and a 50% shareholder, Finklestone as Vice President for Sales and Marketing and a 25% shareholder, and Beverly Tisei as Treasurer and a 25% shareholder.
Although all of TBIA's shareholders had experience in the home inspection business, none of them knew much about the technical aspects of franchising. Accordingly, even before incorporation, Ralph Tisei contracted with a consulting firm, Franchise Consulting Group ("FCG"), to assist in the development of the necessary materials to run a franchise business. In particular, FCG was engaged to assist in developing TBIA's franchise agreement, and the UFOC which TBIA would be required to submit to state regulators and prospective franchisees.
The initial draft of the TBIA UFOC was completed in late 1984. According to the defendants, the drafting was done entirely by FCG personnel, using information supplied by Messrs. Tisei and Finklestone. Once the document was completed, Mr. Tisei reviewed it in its entirety, and made a few corrections.
TBIA began operations in 1985, and issued its first UFOC in March of that year. As required by the UFOC requirements, the March 1985 UFOC identified Lawrence Finklestone as TBIA's Vice President for Sales and Marketing. However, it failed to disclose the bankruptcy of Finklestone's former company, AHISI. This failure soon came to the attention of Amy Robertson, an attorney who had formerly worked for FCG, and who had been retained by TBIA as franchise counsel. Robertson advised TBIA's management that under the UFOC requirements, TBIA was required to disclose the bankruptcy of any company of which one of TBIA's officers had been an officer. TBIA responded by changing Finklestone's title to "Director of Sales and Marketing" and issuing a new UFOC in November, 1985, which omitted any mention of the bankruptcy, or of Finklestone whatsoever.
TBIA's franchising operation was, initially, quite successful. During the 1985-1991 period, TBIA sold over 80 franchises, at prices ranging from $12,000 to $50,000. However, in the late 1980s, TBIA's fortunes took a turn for the worse. TBIA started to receive complaints from franchisees concerning the level of advertising and training support which they were receiving. A conflict developed within TBIA concerning how to handle these complaints. Ralph Tisei felt that the complaints were groundless, and refused to accommodate the franchisees' demands. Lawrence Finklestone and Beverly Tisei desired to take a more conciliatory approach.
As a result of these conflicts, TBIA became embroiled in litigation with franchisees. In some cases, franchisees refused to pay royalties or advertising fees to TBIA. TBIA sued these franchisees who, in turn counter-claimed that TBIA had breached its franchise agreement, and had violated the FTC's Franchise Rule. Other franchisees did not wait to be sued, and took actions directly against TBIA, seeking rescissions of their franchise agreements.
It was during this period that more problems were discovered with the content of TBIA's UFOC. In 1989, California state authorities rejected TBIA's UFOC registration. Among other reasons, the California authorities objected that the financial statements which accompanied the UFOC did not appear to have been properly prepared. The UFOC requires that TBIA disclose audited financial statements for the three prior fiscal years. However, although the financial statements which TBIA submitted purported to have been audited, they did not appear to the California authorities to have been prepared in compliance with generally accepted accounting principles (GAAP) or generally accepted auditing standards (GAAS).
TBIA's financial statements were prepared by Samuel Cohen, a licensed public accountant who had performed accounting work for Ralph Tisei in various capacities for many years. Cohen had been retained by Tisei to prepare TBIA's tax returns, and to perform miscellaneous bookkeeping work, but had never been requested to conduct an independent audit of TBIA's financial statements. Nonetheless, Cohen had, since TBIA's inception, submitted yearly financial statements purporting to be audited, which had been included in TBIA's UFOCs.
In response to the objections raised by California authorities, TBIA submitted a revised financial statement which more fully complied with GAAP. TBIA also submitted a letter from Cohen promising to comply with GAAS in the subsequent year. In its submission the following year, 1990, TBIA included two separate financial statements with its UFOC. One, prepared by the firm of Burke, Dennehy & Co., was merely a compilation, and did not purport to...
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