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Sears Home Appliance Showrooms, LLC v. Charlotte Outlet Store, LLC

United States District Court, N.D. Illinois, Eastern Division

June 21, 2018

CHARLOTTE OUTLET STORE, LLC, et al., Defendants/Counter-Plaintiffs.


          Young B. Kim United States Magistrate Judge

         This diversity action stems from the breakdown of the parties' franchise relationship. Sears Home Appliance Showrooms, LLC (“SHAS”) and Sears Outlet Stores, LLC (“Sears Outlet”) have sued Charlotte Outlet Store, LLC, Concord Outlet Store, LLC, Greenville Outlet Store, LLC, Raleigh Outlet Store, LLC (collectively, “Defendant LLCs”), Vadim Shlangman, and Aliaksandr Ivannikau alleging that they breached franchise agreements allowing Defendants to operate four Sears Outlet Stores in North Carolina and South Carolina. Defendants filed 11 counterclaims alleging breach of contract and various forms of fraud. Before the court are Plaintiffs' Motion to Dismiss and to Strike Portions of Counterclaims, (R. 35), and Defendants' Motion to Amend Counterclaims Instanter, (R. 58).[1] For the following reasons, Plaintiffs' motion is granted and Defendants' motion is denied without prejudice:


         The following facts are gleaned from Defendants' counterclaims and are taken as true for purposes of the current motion to dismiss. See Berger v. NCAA, 843 F.3d 285, 289-90 (7th Cir. 2016). On January 22, 2015, Defendant LLCs entered into Franchise Agreements and First Amendments to the Franchise Agreements with SHAS to take over preexisting franchise stores in Concord, Charlotte, and Raleigh, North Carolina and in Greenville, South Carolina. (R. 30, Counterclaims ¶¶ 1, 4.) Under the agreements, Defendants were to use the franchised locations to sell home appliances, hardware, tools, and lawn and garden equipment to be supplied exclusively by Plaintiffs. (Id. ¶ 5.) Shlangman and Ivannikau signed a Guaranty and Assumption of Franchisee's Obligations for each of the four franchise agreements. (Id. ¶ 2.) Defendants took possession of the four Sears Outlet franchise stores on February 15, 2015, at which time they retained most of the employees who had been operating those stores before the parties signed the Franchise Agreements. (Id. ¶ 4.)

         Less than two weeks after Defendants took possession of the franchises, Plaintiffs sent an outside auditor to perform a biannual inventory scan, which led to a finding that a significant amount of inventory was missing from the Raleigh store. (Id. ¶ 6.) Defendants discovered that the inventory had been stolen by some of the employees they had retained when Defendant took over the franchise. (Id. ¶ 7.) Plaintiffs knew about the employee theft problem at the Raleigh location but did not disclose that information to Defendants before they executed the franchise agreement for the Raleigh store. (Id. ¶¶ 8, 10.)

         The Amended Franchise Agreements state that Plaintiffs will provide Defendants with the consigned items necessary to maintain adequate inventory levels in the ordinary course of business, but according to the counterclaims, beginning in 2016 Plaintiffs regularly failed to provide sufficient inventory. (Id. ¶¶ 11, 13.) Specifically, the inventory deliveries did not meet Defendants' needs or requests, and often included off-season merchandise that was in an unsellable condition. (Id. ¶¶ 14-16.) Because of the deficient inventory deliveries, Defendants were unable to maintain store floor plans or meet customer demands and had difficulty meeting company and consumer standards. (Id. ¶¶ 18, 23.)

         Although their shipments to franchise-owned stores were deficient, Plaintiffs supplied their own company-owned and operated stores above and beyond their franchisees' stores. (Id. ¶ 20.) Plaintiffs prioritized inventory deliveries to company-owned stores without disclosing this preferential treatment to Defendants. (Id. ¶ 21.)

         Defendants notified Plaintiffs about their concerns regarding the insufficient inventory shipments on an on-going basis beginning in late 2016. (Id. ¶ 24.) Sears Outlet often responded by blaming SHAS for the inadequate deliveries and by promising that SHAS would fix the problems. (Id. ¶ 25.) After Defendants attempted several times to raise their concerns, Plaintiffs sent a notice of default to Defendants on June 14, 2017. (Id. ¶¶ 38-39.) After unsuccessful attempts at mediation and negotiation, on November 12, 2017, Defendants announced that they were terminating all four Franchise Agreements and returning all assets to Plaintiffs. (Id. ¶¶ 41-43.) Three days later, Plaintiffs issued notices of default and termination of Franchise Agreements for all four franchise locations. (Id. ¶ 44.) Plaintiffs filed this lawsuit shortly thereafter and on January 15, 2018, Defendants filed the current counterclaims.


         A. Motion to Dismiss Counterclaims

         In reviewing a motion to dismiss the court takes all of the well-pleaded facts as true and views them in the light most favorable to the pleading party. See Berger, 843 F.3d at 289-90. To survive a motion to dismiss under Rule 12(b)(6), the claims-or in this case, counterclaims-“must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face.” See Id. at 290 (quotations and citations omitted). Although “detailed factual allegations” are not required, the pleading party must do more than rest on “labels and conclusions” or a “formulaic recitation of the elements of a cause of action.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007). That standard is higher with respect to fraud claims, which demand “pleading with particularity the circumstances constituting fraud, ” see Fed. R. Civ. P. 9(b), meaning the allegations “must describe the who, what, when, where, and how of the fraud, ” United States ex rel. Presser v. Acacia Mental Health Clinic, LLC, 836 F.3d 770, 776 (7th Cir. 2016) (quotation and citation omitted). That heightened standard is designed to require a plaintiff to engage in a careful pretrial investigation, to prevent irresponsible allegations of fraud from being lodged simply to cast blame after suffering a loss, and to allow a defendant to respond quickly to groundless claims of fraud that might cause reputational harm during the litigation process. See Id. On the other side of that pleading coin, a party may plead itself out of court by alleging facts demonstrating that it has no legal claim. See Atkins v. City of Chi., 631 F.3d 823, 832 (7th Cir. 2011).

         As a general rule the court is limited at the motion to dismiss stage to considering the four corners of the complaint, but an exception exists for “documents that are critical to the complaint and referred to in it.” Geinosky v. City of Chi., 675 F.3d 743, 745 n.1 (7th Cir. 2012). Here the Franchise Agreements are referred to throughout Defendants' counterclaims and were filed under seal by Plaintiffs after a protective order was put in place.[2] (R. 66.) Because they are central to the counterclaims, the court may consider the Franchise Agreements without converting the motion to dismiss into a motion for summary judgment. See id.; Williamson v. Curran, 714 F.3d 432, 435-36 (7th Cir. 2013).

         1. Breach of Contract Claims (Counts I-IV)

         Plaintiffs seek to dismiss counterclaims one through four, which allege that Plaintiffs breached each of the Franchise Agreements by failing to satisfy inventory orders or to “provide sellable inventory or supply inventory in a manner that allowed Defendants to maintain adequate inventory levels.” (R. 30, Counterclaims ¶¶ 51, 58, 65, 72.) Plaintiffs argue that all four counterclaims should be dismissed with respect to Sears Outlet and the individual Defendants because none of them are parties to the Franchise Agreements. They further argue that the Franchise Agreements' contractual one-year limitations period precludes any claims based on alleged breaches that took place before January 15, 2017, one year before the date on which Defendants filed their counterclaims.

         In response to the motion to dismiss, Defendants concede that Shlangman and Ivannikau are not proper counterplaintiffs with respect to the breach of contract claims, but argue that Sears Outlet is a proper defendant despite not being a party to the Franchise Agreements. (R. 43, Defs.' Resp. at 1 n.1, 6.) In support of that argument, they point to the doctrine of apparent authority. Under Illinois law-which the parties agree governs the breach of contract claims under the Franchise Agreements' choice-of-law provisions-an agent may bind its principal where “(1) the principal consents to or knowingly acquiesces in the agent's conduct, (2) the third party has a reasonable belief that the agent possesses authority to act on the principal's behalf, and (3) the third party relied to his detriment on the agent's apparent authority.” Bethany Pharmacal Co., Inc. v. QVC, Inc., 241 F.3d 854, 859 (7th Cir. 2001). According to Defendants, Sears Outlet is liable for breach of contract as an agent of SHAS because the Franchise Agreements' amendments state that:

we [SHAS] or our affiliates shall provide you with all necessary amounts of Consigned Items so that your store is fully stocked on the day you take over control of the Store and open for business. Thereafter, we shall provide you with Consigned Items as necessary for you to maintain adequate inventory levels of all Consigned Items in the ordinary course of business.

(R. 66, Ex. A, Franchise Agreement (“F.A.”) § 5.C.5.) In other words, Defendants argue that because the Franchise Agreements' amendments reference SHAS's “affiliates, ” Sears Outlet is liable for breach of contract based on failure to provide adequate inventory.

         Defendants' argument fails for several reasons. First, the fact that the Franchise Agreements reference SHAS affiliates in connection with inventory obligations does not make those affiliates parties to the agreements. See Northbund Grp., Inc. v. Norvax, Inc., 795 F.3d 647, 650 (7th Cir. 2015) (“The core principle of corporate law is that a corporation is a distinct legal entity, separate from its … affiliated corporations, so that the obligations of a corporation are not shared by affiliates.”). Second, it is “a basic principle of contract law” that a contract is not binding upon a non-party to the agreement. Carter v. SSC Odin Operating Co., LLC, 2012 IL 113204 ¶ 30. Third, Defendants' agency theory gets things backwards. Under Illinois's agency doctrine, an apparent agent can enter into an agreement that is binding on its principal where the principal creates the appearance of authority in the agent. Sphere Drake Ins. Ltd. v. Am. Gen. Life Ins. Co., 376 F.3d 664, 673 (7th Cir. 2004). But here, SHAS entered into the Franchise Agreements on its own behalf, not on behalf of Sears Outlet, and Defendants point to no language suggesting that the agreements are binding on any of SHAS's affiliates simply because a provision of the amendments to those agreements references unnamed affiliates. Nor have they alleged that SHAS was authorized or apparently authorized to bind any of its affiliates in contracting with Defendants. See Bethany Pharmacal, 241 F.3d at 859. For all of these reasons, neither the individual Defendants nor Sears Outlet is a proper party to the breach of contract counterclaims.

         Moving to the contractual limitations period, the Franchise Agreements specify that:

You [the Franchisee] agree that no cause of action arising out of or under this Agreement may be maintained by you against us unless brought before the expiration of one year after the act, transaction or occurrence upon which such action is based or the expiration of one year after you become aware of the facts or circumstances reasonably indicating that you may have a claim against [SHAS] hereunder, whichever occurs sooner, and that any action not brought within this period shall be barred as a claim, counterclaim, defense, or set-off.

(R. 66, Ex. A, F.A. § 19.H.) According to Plaintiffs, this limitations provision bars any breach of contract claim based on occurrences that took place before January 15, 2017, which is one year before Defendants filed their counterclaims. In response, Defendants argue that this limitations provision is unenforceable as a matter of law because, according to them, a contractual provision that shortens an otherwise statutory limitations period of 10 years under Illinois law to only 1 year “is per se unreasonable.” (R. 43, Defs.' Resp. at 7.) In support Defendants point to a Massachusetts decision asserting that an agreement to shorten a limitations period is impermissible under Massachusetts law “unless ‘the agreed upon limitations period is subject to negotiation by the parties.'” (Id. at 8 (emphasis omitted) (quoting Creative Playthings Franchising Corp. v. Reiser, 978 N.E.2d 765, 766 (Mass 2012)).) Although Defendants assert that “[t]here is no reason to believe courts in Illinois would diverge from the Massachusetts ruling, ” they cite no Illinois cases discussing the negotiation requirement and develop no argument as to why they believe Illinois would follow Massachusetts's ruling.

         In fact, under Illinois law, “[t]he parties to a contract may agree to a shortened contractual limitation period to replace a statute of limitations, so long as it is reasonable.” Country Preferred Ins. Co. v. Whitehead, 2012 IL 113365, ¶ 29. Courts applying Illinois law have enforced one-year contractual limitations periods. See, e.g., Sweiss v. Founders Ins. Co., 2017 IL App (1st) 163157, ¶¶ 59, 62; Stephan v. Goldinger, 325 F.3d 874, 877 (7th Cir. 2003) (“One year . . . is not an unreasonably short time for bringing a suit.”); Medrano v. Production Eng'g Co., 774 N.E.2d 371, 375-76 (Ill.App.Ct. 2002); Taylor v. W. & S. Life Ins. Co., 966 F.2d 1188, 1206 (7th Cir. 1992) (finding six-month contractual limitations period enforceable under Illinois law); Vill. of Lake in the Hills v. Ill. Emcasco Ins. Co., 506 N.E.2d 681, 684 (Ill.App.Ct. 1987); Florsheim v. Travelers Indem. Co. of Ill., 393 ...

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