Bagel Enterprises, Inc. v. Baskin & Sears

LISS, Judge. This case arises out of a declaration filed in the Circuit Court for Montgomery County by Bagel Enterprises, Inc., a Maryland corporation, and by Arnold Mallinger, Rita Mallinger and James Corey, the appellants herein. The appellees in this proceeding are Baskin & Sears, a partnership engaged in the practice of law, and William Kaplan, Michael Jackley, licensed in Maryland, and Charles Whittlin of the firm’s Pittsburgh office, licensed in Pennsylvania. The gravamen of the complaint by the appellants against the appellees arose out of alleged legal malpractice and breach of contract in the purchase from Bagel Nosh, Inc. (a Delaware corporation whose principal place of business is New York) of certain franchise rights to operate a restaurant and to be permitted to sell other franchise rights to persons desiring to operate restaurants in the Washington metropolitan area and elsewhere.

Appellants in their declaration claimed in excess of one million dollars as damages. Appellees, Baskin and Sears, brought a third-party action against Bagel Nosh, Inc. and appellants subsequently amended their action to include a claim against Bagel Nosh, Inc., seeking rescission of appellants’ contract with Bagel Nosh, Inc., third-party appellee, and damages for fraud and interference with appellants’ contract rights. During the preliminary skirmishing in this matter, James Corey, one of the appellants, died. At trial the court permitted Ann Mallinger to proceed with the case both on her own behalf and on behalf of James Corey.

In order to reach the complicated legal questions to be decided by this appeal it will be necessary for us to explore the even more complex factual background of the case. ¹⁸⁸ Appellants, Ann and Arnold Mallinger, while on a business trip in Nevada, were luncheon patrons in a restaurant called Bagel Nosh. 1 Upon inquiring of the owner, they were advised that the restaurant was a franchise operation authorized by a corporation known as Bagel Nosh, Inc. Upon their return to Montgomery County, Maryland, where they lived, the Mallingers requested Mr. Mallinger’s sister Rita, who lived in New York, to obtain whatever information was available at the home office of Bagel Nosh, Inc. The Mallingers were furnished with a pro forma statement of costs to begin operation of a Bagel Nosh restaurant and with a brief description of the Bagel Nosh operation. On March 30, 1978, Ann and Arnold Mallinger visited the headquarters of Bagel Nosh, Inc. and met its president, Frank Mauro and its sales manager, James McGuirk. The officers of the corporation gave the Mallingers a detailed exposition of the history of the Bagel Nosh restaurants and a list of the persons to whom franchises for the operation of restaurants had been granted and those who had been designated as area operators of franchises. They pointed out to the Mallingers that area operator franchise agreements gave exclusive right to the entity designated as area operator to sell franchise rights to those persons who sought to operate Bagel Nosh restaurants in the area authorized.

The Mallingers were aware of no Bagel Nosh restaurants in existence in the Washington metropolitan area and were assured that the area was still available for negotiation. The price for the grant of a franchise to establish an ¹⁸⁹ individual, single restaurant was stated to be $20,000 with area operator rights being available upon payment of an additional $120,000. At the meeting in the Bagel Nosh headquarters the Mallingers were furnished with drafts of the standard franchise agreement and area franchise agreement used by the parent company. The Mallingers, after their conference, were interested in investing and persuaded Rita Mallinger and a neighbor of the Mallingers, James Corey, to join them in investing in an area franchise of the Bagel Nosh restaurants.

Ann Mallinger then called the office of Baskin and Sears, attorneys, located in Hyattsville, Maryland, and arranged an appointment with William Kaplan, one of the attorneys of the firm. Mr. Kaplan was advised of the intention of the parties to invest in the Bagel Nosh franchise and of their need for the formation of an appropriate business entity through which to conduct their business. Mr. Kaplan advised the Mallingers that he had no experience with franchise agreements but that Baskin & Sears had an association with an attorney in Pittsburgh, Charles Whittlin, who was an expert in the field. In addition, he recommended Michael Jackley, one of the members of the firm of Baskin and Sears, as an expert in the formation of business entities.

Jackley then drew the necessary documents to form a corporation known as Bagel Enterprises, Inc., in which Ann Mallinger and Arnold Mallinger, Rita Mallinger, and James Corey each became 25% stockholders. Each of the individual investors was required to advance $35,000 to purchase the franchise rights and to provide working capital for the corporation. Kaplan sent drafts of the franchise and area agreements to Whittlin in Pittsburgh. A week later a meeting with representatives from Bagel Nosh, Inc. was scheduled at the Washington office of Baskin and Sears, to negotiate a number of the contested provisions of the proposed franchise and area franchise agreements.

The appellants sought to have Bagel Nosh, Inc. agree that a portion of the funds paid by Bagel Enterprises, Inc. be held in escrow and be released for the gradual payment of fees. Bagel Nosh, Inc. refused ¹⁹⁰ to agree to any escrow agreement. Appellants also sought a recent financial statement from Bagel Nosh, Inc. but Mr. McGuirk declined to supply one because Bagel Nosh, Inc. was “in an expansion mode” and if they supplied one, “it wouldn’t look very favorable.” The parties finally agreed that the appellants would have area franchise rights and the exclusive right to sell Bagel Nosh, Inc. franchises in Prince George’s County, Montgomery County, Annapolis, Washington, D.C., Alexandria, Virginia and Arlington and Fairfax Counties in Virginia. On May 5, 1978, appellants paid Bagel Nosh, Inc. $120,000 for the area operating rights above mentioned and $20,000 for a franchise to operate a single Bagel Nosh restaurant.

Subsequently, in July of 1978, the appellants learned that the franchise rights they had purchased were sold in violation of Article 56, § 347 of the Maryland Code known as the Franchise Registration Act which had been enacted by the 1977 session of the Maryland Legislature. The Legislature had stated its legislative intent in adopting the Act at § 346(b) as follows: It is the intent of this subtitle to provide each prospective franchisee or distributee the information necessary regarding franchises or distributorships being offered. Further, it is the intent of this subtitle to prohibit the sale of franchises if the sale would lead to fraud or a likelihood that the franchisor’s or distributor’s representations would not be fulfilled, and to protect the franchisor or distributor and franchisee or distributee with regard to their business relationship. Section 347 stated that it was unlawful after July 1,1977 to sell or offer any franchise in the State unless the offeror of the franchise were registered under the subtitle.

The statute at § 349 required a prospective franchisor to file an application containing the following: ¹⁹¹ (4) Information concerning the identity and business experience of persons affiliated with the franchisor, as the director may prescribe. (5) A statement whether any person identified in the offering prospectus: (i) Has been convicted of a felony, or pleaded nolo contendere to a felony charge, or held liable in a civil action by final judgment if the felony or civil action involved fraud, embezzlement, fraudulent conversion or misappropriation of property; or (ii) Is subject to any currently effective order of the Securities and Exchange Commission or the securities administrator of any state denying registration to or revoking or suspending the registration of this person as a securities broker or dealer or investment advisor or is subject to any currently effective order of any national securities association or national securities exchange as defined in the Securities and Exchange Act of 1934 suspending or expelling this person from membership in the association or exchange; or (7) A recent financial statement of the franchisor, together with a statement of any material changes in the financial condition of the franchisor from the date when the statement was issued. (22) When the person filing the application for registration is a subfranchisor, the application shall include the same information concerning the subfranchisor as is required from the franchisor pursuant to this section. Section 345(i) defines “subfranchisor” as a person to whom an area franchise has been granted.

It is clear that Section 349(22) contemplated registration by both Bagel Nosh, Inc., the franchisor, and Bagel Enterprises, Inc., the area subfranchisor. Bagel Enterprises, Inc. was incorporated in the period between May and July of 1978. During this time appellants selected a site for their restaurant in Congressional Plaza in ¹⁹² Rockville, Maryland. In addition, they explored the possibility of obtaining an SBA loan and actively solicited the sale of possible franchises to those interested in operating restaurants in the franchise area purchased from Bagel Nosh, Inc. In July of 1978, the appellants, the appellees, and Bagel Nosh, Inc. first became aware of the Franchise Registration Act.

Appellee lawyers admitted they had no knowledge of the existence of the Act when appellants’ contract. with Bagel Nosh, Inc. was signed. It was in July of 1978 that Jackley for the first time notified appellants that they could not offer or sell franchises until their corporation, Bagel Enterprises, Inc., registered pursuant to the Act. Appellants began the preparation of their own registration statement, rented their own corporate offices and executed a lease for their first restaurant in Congressional Plaza. When Bagel Enterprises, Inc. presented its registration application to the State Franchise Administrator in October of 1978, they were advised that more information about the parent company, Bagel Nosh, Inc., was required before the Bagel Enterprises, Inc. application could be considered.

The Administrator stated that his office would encourage Bagel Nosh, Inc. to make an offer of rescission and restitution “which would bring the parties back to square one,” and then, following compliance with Maryland law, the appellants could decide whether or not to go forward. Appellants, however, were still eager to proceed with their plans. Mr. Jackley advised the group that it seemed possible for Bagel Enterprises, Inc. to register independently of Bagel Nosh, Inc. by not designating Bagel Enterprises, Inc. as a “subfranchisor” on the area operators agreement, so as to escape the effect of the statute. Ann and Arnold Mallinger both testified that Bagel Nosh, Inc., although itself refusing to register, offered to assist them in registering.

Investigation disclosed that both Maryland and Virginia had statutes requiring the registration of all franchisors offering a franchise for sale within the respective states or to a resident of those states. Bagel Enterprises, Inc., before ¹⁹³ it could offer franchises for sale in either Maryland or Virginia, would be required to register. The District of Columbia had no such act so Bagel Enterprises, Inc. was not precluded from selling franchises in the District. In addition, the appellants could proceed to open their own restaurant without registering with the State of Maryland.

Sometime in late October and November, Bagel Enterprises, Inc. received information from several sources that various individuals involved with Bagel Nosh, Inc. had been linked to organized crime. They were also told that one of Bagel Nosh, Inc.’s consultants, Thomas Quinn, had been convicted for stock fraud and had been disbarred from the practice of law in New York. In addition, the president of Bagel Nosh, Inc., Frank Mauro, informed them of his own personal bankruptcy and that there were cases pending against Bagel Nosh, Inc. “all over.” This information would have been available to appellants before their contracts were signed, if the Registration Act statements had been filed as required. At a meeting on November 24, 1978 with Mr. David Bortz, the State Franchise Administrator, they told of this new information.

Mr. Bortz talked of filing suit against Bagel Nosh, Inc. but Bagel Enterprises, Inc. asked for time to negotiate with Bagel Nosh, Inc. A list of demands was worked up by Bagel Enterprises, Inc. and Mr. Jackley and was presented to Mr. Mauro and Mr. Quinn on December 5, 1978 in Hyattsville. Mr. Quinn became very upset by the demands and made an offer to Bagel Enterprises, Inc. to return the $120,000 in exchange for the area operator rights. As testified to by Mrs. Mallinger, this offer was rejected by Bagel Enterprises, Inc. Negotiations continued but no final agreement was ever reached. Neither Bagel Enterprises, Inc. nor Bagel Nosh, Inc. ever registered. 2 Bagel Enterprises, Inc. was unsuccessful in financing its business and eventually defaulted, suf ¹⁹⁴ fering adverse judgments on both the lease for the corporate offices and the restaurant.

During the middle of December, the appellants fired the law firm of Baskin and Sears and retained Lewis Rudnick of the Chicago firm of Rudnick and Wolfe. Although Mr. Rudnick advised Bagel Enterprises, Inc. to do nothing until he had had an opportunity to review the situation, Mrs. Mallinger signed a lease commitment with Congressional Plaza on December 26, 1978. Through their attorney, Mr. Rudnick, Bagel Enterprises, Inc. finally made a demand on Bagel Nosh, Inc. on January 16, 1979 seeking rescission. Mr. Rudnick was unaware that the group had continued to seek financing for their own franchise restaurant.

Various telephone negotiations with the Bagel Nosh, Inc. attorneys followed and on April 16, 1979, a counter-offer was submitted by Bagel Nosh, Inc. No response was ever made to this offer because by that time the appellants had retained another law firm to file suit on the matter. Appellants brought this action against the appellee law firm alleging essentially that but for the law firm’s negligence in not knowing and informing them of the registration law, appellants would not have paid appellee Bagel Nosh, Inc. $140,000 or otherwise incurred damages. Appellee lawyers brought a third-party action against appellee Bagel Nosh, Inc. Appellants amended over to join Bagel Nosh, Inc. as a defendant, alleging fraud and interference with contract and also seeking rescission. Appellee Bagel Nosh, Inc. generally denied all allegations and denied any liability.

When the case came up for trial before the trial judge and a jury, the court submitted 10 special issues to the jury. The issues submitted and the answers returned by the jury after a full day’s deliberation were: SPECIAL ISSUES 1. Do you find that William Kaplan was negligent? V yes no ¹⁹⁵ 2.

Do you find that Charles Whittlin was negligent? j/__ yes no 3. Do you find that Michael Jackley was negligent? ✓ yes no 4. If your answer was “yes” to any of the above questions, do you further find that his or their negligence was a proximate cause of the damage to the plaintiffs? yes no 5. Do you find that the plaintiffs individually or collectively were contributorily negligent?

V yes no 6. Do you find that defendant attorneys, acting individually or collectively breached their contract with the plaintiffs? V yes no 7. If your answer to question No. 6 was “yes”, do you find that the plaintiffs, individually or collectively, after having learned of the breach, ratified their contract with defendant attorneys and thereby waived their right to sue said defendants individually or collectively for breach of contract? _/__ yes no 8.

Do you find that under the evidence, the plaintiffs were entitled to rescind? _V___ yes .no 9. If your answer to question No. 8 was “yes”, do you find that the plaintiffs, individually or collectively, after having been advised of their rights to rescind, through their actions waived their rights to rescind and thereby ratified the contract? _/__ yes no 10. After consideration of the evidence, do you find that the plaintiffs are entitled to recover against Bagel Nosh, Inc. on the basis of fraud? __/_ yes no ¹⁹⁶ Judgment was entered on behalf of all defendants and it is from that judgment that this appeal was filed. Appellants raise the two following issues to be determined by this appeal: 1.

Whether a contract made in violation of a statute designed to protect the public is illegal and void ab initio where the statute provides no civil remedies? 2. Whether there was prejudicial error in the trial court’s refusal to admit certain evidence? 1. Appellants contend that their area operators’ agreement and franchise agreement with Bagel Nosh, Inc. were void ab initio as a matter of law and that they could not, therefore, have been found to have satisfied the agreements by their subsequent conduct or have waived their right to rescind. The trial court instructed the jury considering the 10 special issues in the following fashion: You are further instructed as follows on the law of void and voidable contracts.

A void contract is one where the law of the state has declared the subject matter of conduct contemplated by the contract as illegal. In such case the contract is void, a nullity and neither party to the contract can act under the contract. A voidable contract on the other hand is one where one party to the contract engaged in unlawful conduct in entering the contract. The other party is innocent and the subject matter is otherwise lawful.

In this case you