July 2012 Archives

I am serving as the Chair of the Franchise Law Committee of the State Bar of California.

Recently, I have heard reports from some of our members that they are having greater difficulties in the last few months in obtaining approval for their clients to be part of the SBA Registry of "approved" franchisors for SBA Loans.

The reports are that provisions in franchise agreements that had never been questioned in the past are now resulting in comments that the language must be changed.

Are others having similar experiences?

I understand that the IFA Legal Legislative Committee formed a task force to work with the SBA and that the task force developed proposed standard addendum language related to the Franchisor setting prices. The SBA is considering that language.

Here are some further requests that I understand that have been made by the SBA:

1. To include in an SBA addendum language to the effect that the franchisor would not exercise its right of first refusal in the event of a franchisee partial assignment (i.e. less than 100%), the concern being that if the franchisor took an assignment of less than 100% the franchisor would become a partner in the franchise, and would thereby be able to exert control to an extent that might eliminate the independence of the franchisee.

2. The SBA will require the franchise contract to be amended to reflect a time frame in which the franchisor will operate the business which cannot be more than 90 days, renewable as necessary for up to one year and that franchisor will periodically discuss the status with the franchisee.

3. Some franchisors have experienced resistance with the services the provide, such as customer scheduling. The SBA is requiring these services be provided on an optional basis.

Dennis E. Wieczorek has a list of other changes demanded by the SBA. I would appreciate any comments that people would be willing to share.

There is no need for you to identify the client, but I would appreciate hearing (a) the type of comment; (b) the general industry segment in which the franchisor operates; and (c) any other information that you think is relevant.

You can contact me below. Thanks.

In March, the Ontario Superior Court of Justice released its decision on a motion for summary judgment in Dodd v. Prime Restaurants of Canada (Prime).

The decision offers further insight into how the courts will apply the new summary judgment rules in the franchise context and raises some interesting issues regarding the interaction between Section 11 of the Arthur Wishart Act (Franchise Disclosure) (AWA) and a mutual release agreement executed by a franchisor and a franchisee in the context of a failed franchise.

The dispute in this case arose between the owner of East Side Mario's and two of its franchisees. In 2003, the parties entered into an agreement to open a new East Side Mario's franchise in Toronto. Almost immediately after opening its doors, the venture began losing money and the franchisees fell behind on rent, royalty and financing payments.

After one year, the franchisees made a voluntary assignment in bankruptcy and the franchisor took over operation of the restaurant. Concurrently, the parties entered into a mutual release under which they released each other from any debts, claims or actions. The franchisor also agreed to pay the interest on the financing debt owed to GE Canada Equipment Financing G.P. (GE) and to use reasonable efforts to find a buyer for the restaurant that would assume the debt to GE.

Shortly after executing the release, however, the franchisees issued a Notice of Rescission (Notice) on the basis that they had received inadequate pre-sale disclosure contrary to Ontario franchise legislation. The franchisor responded to the Notice, advising the franchisees that the Notice was unenforceable due to the mutual release and stated its intention to meet its obligations under the mutual release.

For nearly two years thereafter, the franchisor did precisely that: it operated the restaurant, paid interest on the financing debt and found a buyer for the restaurant. The restaurant was sold and the debt to GE settled with the proceeds and some further contribution from the franchisor. But, two years after serving its Notice, the franchisees commenced an action against the franchisor claiming, inter alia, damages for breach of contract, negligence, misrepresentation and rescission of the franchise agreement. The franchisor brought a motion for summary judgement on the basis that the action was barred by the mutual release. In response to the summary judgment motion, the franchisees claimed that a trial was necessary to determine the validity of the mutual release which the franchisees' argued was not enforceable since it was both unconscionable and void pursuant to Section 11 of the AWA.

The Court refused to grant the franchisor's motion for summary judgment.

Enforceability of the Release: Unconscionability and Section 11 of the AWA

The franchisees argued that the release was not enforceable because it was barred by Section 11 of the AWA, which voids any "purported waiver or release by a franchisee of any right given under [the] Act." They also argued that it was an unconscionable agreement and therefore unenforceable at law.

With respect to the latter, the franchisees argued that the mutual release contained all four of the essential elements of unconscionability: a grossly unfair and improvident transaction, the absence of independent legal advice, overwhelming imbalance in bargaining power and intentional exploitation of this vulnerability. In response, the franchisor maintained that there was insufficient evidence before the court to establish all of these requirements and the onus was on the franchisees to do so.

The Court concluded that the conflicting evidence in relation to the value of the benefits realized and rights forgone by entering into the mutual release, whether the franchisees had legal advice at the time they executed the mutual release and whether there was in fact an imbalance of power were all matters that should be resolved at trial, with the benefit of oral evidence.

The franchisor also argued that Section 11 of the AWA cannot be used as a bar to render ineffective an agreement between the parties to a franchise agreement that was intended to settle claims arising out of an alleged breach of that statute. In support of its argument they cited the Court's decision in 1518628 Ontario Inc. v. Tutor Time Learning Centres LLC (Tutor Time). In the Tutor Time case, the franchisor had provided a prospective franchisee with a disclosure document that failed to meet Ontario disclosure regulations.

Subsequently, in order to settle the ongoing dispute and with the advice of independent legal counsel the parties entered into a settlement agreement that included a mutual release of all rights and claims. Some time later, the franchisee delivered to the franchisor a notice of rescission of the franchise agreement. On a motion for partial summary judgment, the Court held that the mutual release was effective notwithstanding Section 11 stating:

s. 11 does not have application to a release given (with the advice of counsel) by a franchisee in the settlement of a dispute for existing, known breaches of the Act by the franchiser in respect of its disclosure obligations, which would otherwise entitle the franchisee to a statutory rescission.

The Court, however, declined to follow the decision in Tutor Time in this case. It distinguished the dispute before it from the Tutor Time decision on two bases. First, unlike the franchisee in Tutor Time, it was not clear to what extent the franchisees were aware of potential rescission claims at the time the release was executed. Second, there was conflicting evidence regarding the extent to which the franchisees had independent legal advice before executing the mutual release.

On this basis, the Court concluded that the extent to which Section 11 of the AWA may render ineffective the mutual release as a bar to the franchisees' action was a matter for determination at trial.

Lessons From the Decision

The decision provides some useful guidance on the way in which a court will consider a mutual release in the franchise context.

First, it should be noted that the Court appeared to accept the franchisor's argument that even if Section 11 of the AWA rendered ineffective any waiver of rights under the AWA, the release would still be effective to prevent parties to the waiver from claiming common law or equitable relief such as breach of contract, misrepresentation and negligence. In the case at bar, the franchisees made numerous common law and equitable claims that will be barred unless the mutual release is found at trial to be unconscionable. Thus, there is a clear benefit from continuing with the practice of obtaining releases from franchisees despite Section 11 of the AWA.

Second, the case provides an additional reminder to franchisors that mutual releases should only be finalized with franchisees who have received independent legal advice. The Court's refusal to summarily enforce the release in Prime flowed from the factual uncertainty as to the franchisees' access to legal advice at the time the release was executed. Had the franchisee obtained legal advice prior to signing the release, it would have been very difficult for it to assert that it was unaware of the potential rescission claim.

Any reasonable lawyer advising a franchisee in the context of a mutual release would need to review the previous disclosure document that had been provided by the franchisor to ensure that the franchisee is not inadvertently waiving a meritorious rescission claim without fair compensation.

In most cases, careful review of a disclosure document would allow counsel advising the franchisee to identify arguable deficiencies which could ground a claim for rescission under the two-year limitations period. If the franchisee insists that it only "discovered" a rescission claim after signing the release, it would need to prove this late "discovery" with clear and convincing evidence. Franchisors should therefore encourage their franchisees to obtain legal advice and request written confirmation that such advice was received prior to entering into any agreement to resolve a dispute.

Third, franchisors must be wary of entering into agreements with franchisees at a time when the franchisees are in desperate circumstances because it leaves them vulnerable to a claim of unconscionability. Moreover, simply because a franchisor has seemingly extended itself to "bail" its franchisee out by, for example, taking over rent or debt interest payments or relieving the franchisee of royalty back payments, does not mean that the release was mutually favourable.

The argument made by the franchisees in this case was innovative but not unreasonable: the franchisor stepped in to protect its brand and would have done these things whether or not the franchisees released them. Moreover, it also made the point that the franchisor would not likely have pursued the franchisees personally. As such, while the franchisees gave up the right to seek rescission and make other claims, it "received little of real value in return." While there are certainly strong arguments to counter this effort to claim that a mutual release is overwhelmingly favourable to the franchisor and not the franchisee, these arguments should be considered when approaching a franchisee to negotiate an agreement to resolve a dispute.

For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.

This post was originally published on McCarthy Tétrault's website and written by Jane A. Langford, Tyler McAuley and Adam Ship

By now, employers seem to understand their obligation to keep their employees from committing sexual harassment. A California appellate court decision handed down this week emphasizes that it isn't enough to just worry about your employees.

In Patterson v. Domino's Pizza, LLC, an employee working for a Domino's franchisee alleged that her supervisor sexually harassed and assaulted her. When the franchisee filed bankruptcy, the employee focused her attention on Domino's.

Domino's argued that it was not the plaintiff's employer and pointed to language in the franchise agreement stating that the franchisee was an independent contractor, that the individuals working for the franchisee were not Domino's employees, and that the franchisee was solely responsible for hiring, training, scheduling, and supervising its employees.

The employee countered this with evidence that Domino's establishes hiring requirements and appearance standards for employees of its franchisees. Domino's also had access to the franchisees computer data, tax returns, and financial statements. It determined store hours, pricing, advertising, and what manner of payment was acceptable.

There was even evidence that it told the franchisee on two occasions to fire employees (one of whom was the alleged harasser).

The court ruled that there was enough evidence of Domino's control of the franchisee's business to raise a question as to whether the franchisee was legitimately an independent contractor. Instead of relying on the terms of a contract, the court looked at "the totality of the circumstances" to determine who actually exercises control. Here, it concluded that there was enough evidence of Domino's control over the franchisee that the issue would need to be decided by the jury.

The lesson here is that companies can't rely entirely on contract language to protect them from claims by an independent contractor's employees. While the language is a start, courts will also look at the realities of the relationship.

If a company exercises a great deal of control over an entity that it seeks to characterize as an independent contractor, the court may simply disregard that characterization.

With less colorful language than its last arbitration opinion, the First Circuit sided with the Second and Third Circuits in limiting the application of the 2010 Stolt-Nielsen decision on the availability of class arbitration. Fantastic Sams Franchise Corp. v. FSRO Assoc. Ltd., __ F.3d __, 2012 WL 2402560 (1st Cir. June 27, 2012).

Decisions from these three circuits suggest that as long as the party seeking a class action can show it did not stipulate that the agreement was "silent" on the availability of class arbitration, the courts (or the arbitrator) will consider arguments based on contractual interpretation and the parties' actions to find the parties' intent.

In Fantastic Sams, a coalition of 35 franchisees demanded arbitration against the franchisor for common violations of their agreements and statutes. Twenty five of the agreements had arbitration clauses that prohibited class arbitration. Ten agreements did not expressly prohibit class arbitration, and broadly provided for arbitration of "any controversy or claim arising out of or relating in any way to this Agreement." The franchisor brought a petition in federal court to compel the coalition members to arbitrate individually, relying on Stolt-Nielsen.

The 25 franchisees whose contracts prohibited class arbitration were compelled to arbitrate individually. But the remaining ten were not. The First Circuit concluded that Stolt-Nielsen was not as broad as the franchisor argued: "We thus reject the very different precept, on which [the franchisor's] argument depends, that there must be express contractual language evincing the parties' intent to permit class or collective arbitration.

Stolt-Nielsen imposes no such constraint on arbitration agreements." The court focused on the fact that the Stolt-Nielsen parties had stipulated that their agreement was "silent" on class arbitration, whereas in this case it was possible the arbitrator could find evidence that the parties did intend to allow class or collective arbitrations. The First Circuit noted its agreement with the Second and Third Circuit decisions on this point, but did not address the recent Fifth Circuit decision coming out in favor of the franchisor's argument.

Furthermore, the First Circuit noted that Stolt-Nielsen did not clearly apply because this coalition of franchisees was not a "class action" and did not have the same issues that SCOTUS noted with class arbitrations. (No absent parties, no certifying a class or providing public notice, etc.)

Finally, the court found that the question of whether the remaining ten franchisees could proceed in a collective arbitration was a decision for the arbitrator, because it characterized that question as a "procedural" one and because the agreements incorporated the AAA Rules, which delegate jurisdictional questions to the arbitrator.

At least one lesson from these cases is: never stipulate your arbitration agreement is silent regarding the availability of class actions! Give the courts some reason to distinguish your facts from the unusual facts in Stolt-Nielsen, if you want any chance of arbitrating as a class.

We talk the talk - but when was the last time you did a serious health check in your franchise system to ensure that your brand values, mission and principles are clearly understood and practiced by everyone, including headquarters staff, field support personnel, franchisees, shareholders, and stakeholders?

Do all of your team members truly understand that their purpose in the organization is to help ensure that your franchisees are as successful as possible? Is your brand a living ecosystem of continuous improvement?

This week, my new book Five Pennies was published, which was written to provide guidance to franchise brands on how to grow to be great.

Hence the term Mega-Brand. Five Pennies is based upon Ten Rules, that if followed, will help you build and grow your system into a franchise Mega-Brand.

As you read each rule, I ask that you really think about how your company measures up to it. Share these rules with your entire team and have them rate the brand on each as well. Are you talking the talk? Or are you deeply practicing the rules to become a franchise Mega-Brand? And of course... I welcome you to get a copy of  Five Pennies, which outlines the details of what it really takes to be a Mega-Brand!


Five Pennies: Ten Rules to Successfully Build a Franchise Mega-Brand and Maximize System Profits



Ten Rules Summary
 
Rule No. 1 - Tee up your franchisees for mega-success, not failure!
Show your commitment to sustainable franchisee unit profitability by adopting this as your new brand strategic statement, "Our wealth and success as a franchisor will be a by-product of developing wealthy and successful franchisees."
 
Rule No. 2 - Franchising is a mega-relationship business!
Foster a culture of positive franchisee relations and codependency. Remember - developing a culture of great franchisee engagement and relations doesn't happen overnight. It takes time, a consistent championing by leadership, a ton of hard work, and a commitment to constant system improvement.
 
Rule No. 3 - Franchising is not a drag race, it is more like the 24 hours of Daytona.
Stay ahead of your growth! Remember that building a successful franchise system is a race of endurance - not speed, and that fast track growth without proper planning or execution will cause significant problems that may, or may not, be able to be resolved.
 
Rule No. 4 - Do not have an accountant remove a brain tumor!
Develop a culture of continuous improvement and franchise education throughout the entire organization. Remember that next to undercapitalization - a lack of franchising experience and knowledge is a top reason why some franchise systems fail.
 
Rule No. 5 - Plant, cultivate, and harvest system best practices.
Create a best practices clock of continuous unit improvement that cascades tools, resources, programs, and efficiencies back to the entire system.
 
Rule No. 6 - Stack the "entire" deck with strong franchise owners.
Remember the goal of recruiting is to minimize the risk of an incompatible owner and increase the acceptance of potential superstars by establishing a desirable profile and "awarding franchises" to those that meet it.
 
Rule No. 7 - Focus on where "the rubber hits the racetrack."
Never lose site that royalties are earned when the franchisee cash register rings. Develop a relentless focus on supporting store operations and driving sales.
 
Rule No. 8 - Create partners in growth.
Create "something more" for your franchisees and brand by developing growth programs and/or tools that positively impact the entire system such as national partnerships, accounts, or other macro-level programs.
 
Rule No. 9 - Manage your system like NASA would.
Invest in technology that will keep your brand at the front of the pack. Maintain an eye on technology changes and how it will affect your brand both short and long term.
 
Rule No. 10 - Manage resources and understand the financial requirements to grow a franchise Mega-Brand.
Remember that a vibrant franchisor equals a vibrant system. Diligently manage the human, operating, and capital resources of your franchise system to ensure that you can make changes quickly.

 

Follow Us

About this Archive

This page is an archive of entries from July 2012 listed from newest to oldest.

June 2012 is the previous archive.

August 2012 is the next archive.

Find recent content on the main index or look in the archives to find all content.

Authors

Archives