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Kavky v. Herbalife International of America

April 22, 2003


On appeal from Superior Court of New Jersey, Law Division, Atlantic County, L-3842-01.

Before Judges Stern, Coburn and Collester.

The opinion of the court was delivered by: Coburn, J.A.D.


Submitted March 25, 2003

Plaintiff, Stephen Kavky, sued defendants, Herbalife International, Inc. ("Herbalife") and Jerry Homan, Richard Palmer, and Sonia Palmer, all doing business as RPB International, as well as that entity itself, alleging common law fraud and violation of the Consumer Fraud Act, N.J.S.A. 56:8-1 to -109 (the "Act"). The action arose from plaintiff's purchase of a franchise or distributorship offered by defendants in advertising addressed to the general public at large. Herbalife responded by immediately filing a motion to dismiss the complaint for "failure to state a claim upon which relief can be granted." R. 4:6-2(e). The trial court granted the motion for two reasons: it found that the facts were alleged without sufficient particularization, and it held that the Act did not apply to investments of this nature. Plaintiff appealed. *fn1 Since we reject both determinations, we reverse and remand.


The complaint, read indulgently, as is required by Printing Mart-Morristown v. Sharp Elec. Corp., 116 N.J. 739, 746 (1989), alleges the following facts. Herbalife uses general advertising over the Internet to solicit distributors for a variety of products it sells in the United States. Plaintiff viewed the advertising in or around January 2000. Herbalife's offer was to make anyone a distributor in return for $85 and to provide "Pre-Paid Retail Internet Customers" at $8.50 per customer. Plaintiff responded to the advertisement, agreeing to become a distributor and to purchase ten customers. On January 18, 2000, Herbalife sent him a bill for $170, which he immediately paid. Although Herbalife sent him materials relating to his distributorship, it never intended to send him any "Pre-Paid Retail Internet Customers," and it failed and refused to do so.

Plaintiff spent "significant amounts of money and expended hundreds of hours of work[] to establish a network of Herbalife Distributors upon becoming a Distributor." However, his efforts proved fruitless because of Herbalife's failure to provide the promised customer leads. *fn2 As a matter of form, the complaint asserts those allegations as against the defendants generally without specifying which defendant did what or the nature of their relationships.


The Act was first applied to franchises and distributorships offered to the general public over thirty years ago. Kugler v. Koscot Interplanetary, Inc., 120 N.J. Super. 216 (Ch. Div. 1972). That case, which involved a pyramid sales scheme, was prosecuted by the Attorney General, who obtained damages for the victimized citizens and injunctive relief to protect the public at large. Id. at 232-33, 258-59. Other states have applied their consumer protection acts in similar circumstances, citing Koscot. See, e.g., State ex rel. Edmisten v. Challenge, Inc., 284 S.E. 2d 333, 336-37 (N.C. Ct. App. 1981); People ex rel. Fahner v. Walsh, 461 N.E.2d 78, 82 (Ill. App. Ct. 1984). In a later Law Division case, Koscot was followed and expanded to cover small franchise and distributorship agreements not covered by the Franchise Practices Act, N.J.S.A. 56:10-1 to -7.1. Morgan v. Air Brook Limousine, Inc., 211 N.J. Super. 84, 90-100 (Law Div. 1986).

Unfortunately, the Court of Appeals for the Third Circuit, in a case involving New Jersey law, has cast doubt on the validity of Koscot's application of the Act and the reasoning of Morgan. J & R Ice Cream Corp. v. California Smoothie Licensing Corp., 31 F.3d 1259, 1270-74 (3d Cir. 1994). The federal court concluded that the State Supreme Court "would not adopt the reasoning in Morgan or apply the result in Koscot," id. at 1271, but would hold, instead, that the Act is inapplicable to any distributor or franchise relationship, including those made available to the public at large, because those transactions involve the purchase of a business, id. at 1272, 1274. Notwithstanding our high regard for the Third Circuit, we are unable to agree with its unduly restrictive interpretation of the Act. However that is not to say that we disagree with the result reached in J & R, but that is only because it appears to have involved a substantial and complex commercial transaction, which likely fell within the Franchise Practices Act. We cannot endorse J & R's reasoning because that course would deprive the citizens of New Jersey of protection under the Act in pyramid sales schemes, and similar mass public frauds, a consequence we believe the State Supreme Court would reject.

The Act creates a cause of action for "unconscionable commercial practice[s] . . . in connection with the sale or advertisement of any merchandise or real estate . . . ." N.J.S.A. 56:8-2 ("Section 8-2"). "Merchandise" is defined as including "any objects, wares, goods, commodities, services or anything offered, directly or indirectly to the public for sale." N.J.S.A. 56:8-1(c) ("Section 8-1(c)"). Although the Act is entitled "An Act concerning consumer fraud, its prevention, and providing penalties therefor," L. 1960, c. 39, it contains no definition of consumer. The novel issue, at least at the appellate level in this state, is whether the purchaser of a franchise distributorship is protected by the Act, or to put it somewhat differently, do franchises and distributorships come within the Act's definition of merchandise. Our answer is that they are included when they are not covered by the Franchise Practices Act and are offered to the general public.

The court in J & R began its analysis by emphasizing the Supreme Court's reference to consumers in Kugler v. Romain, 58 N.J. 522, 535 (1971) and in Daaleman v. Elizabethtown Gas Co., 77 N.J. 267, 270 (1978), but those cases neither discussed who would be included within that concept, nor considered the meaning of the statutory word "merchandise." Therefore, we do not agree with J & R's conclusion that those cases support the proposition that the Act can never be applicable to the purchase of a "business." 31 F.3d at 1272.

J & R looked next to Neveroski v. Blair, 141 N.J. Super. 365 (App. Div. 1976). Neveroski concerned the sale of a private home that occurred before Section 8-2 was amended by the addition of the phrase "or real estate." Id. at 376. Relying in part on the doctrine of ejusdem generis and in part on the idea that the Act was intended to protect "consumers in the popular sense . . . in the context of the ordinary meaning of that term in the market place," ...

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