Personal Liability In New York For A Franchisor’s Owners

Grandmaster Flash’s lyrics “New York, New York, big city of dreams, but everything in New York ain’t always what it seems!” must be ringing in the ears of Michael and Kathy Butler (the “Butlers“) following a recent decision by the U.S. Bankruptcy Court in Charlotte, North Carolina. The court found the Butlers personally liable for $714,000 plus interest as the owners of a franchisor that sold unregistered franchises to John Mangione (“Mangione“) for stores to be located in New York City.

The Butlers owned PRS Franchise Systems, LLC (“PRS“), a North Carolina based franchisor of retail stores providing promotional materials and services for small businesses. In May 2007, PRS sold 12 franchises to Mangione but did not provide Mangione with an offering prospectus in advance of the sale and failed to escrow Mangione’s franchise fees in a trust account, which was required since PRS’ registration had lapsed and its renewal application was pending. The Butlers dissolved PRS and filed bankruptcy. Mangione filed suit claiming the Butlers were personally liable under New York’s Franchise Sales Act (the “Act“) to reimburse him for the initial franchise fees he paid to PRS. The Butlers claimed that the “corporate shield doctrine” protected them from personal liability, regardless of whether PRS was found liable. The court disagreed and found that the Butlers intentionally allowed PRS’ New York registration to lapse, knowingly and willfully sold unregistered franchises to Mangione, and failed to escrow fees in violation of the Act. The court held that under the Act “officers are personally liable for their participation in tortious acts that cause harm to a third party” and that any person who “directly participates in an unlawful offer or sale [of a franchise, is civilly liable] for the purchaser’s resulting damages.” For some, New York may be a “big city of dreams.” But for the Butlers, selling unregistered franchises for 12 New York stores turned out to be a nightmare. Click here to see the case.

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