Recently in Compliance Category

People outside franchising don't understand that the franchisor is not the "boss" of the franchisees.

The franchisor, who does have considerable power because of the Franchise Agreement, cannot just tell their franchisees how to run their business.

In particular, the franchisor cannot simply require that the franchisees implement a sexual harrassment program that the franchisor favors.

Even US Sentators somtimes fails to understand.

Disclosure requirements for franchise sellers vary around the world.

Do these self-regulated disclosure jurisdictions work better than the FTC Rule?

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Few in the franchising world doubt that McDonald's is a world-class organization.

Hallam Movius and Lawrence Susskind hold out the mouth-watering proposition that McDonald's is a world-class negotiation organization. And, they offer up their recipe for turning your franchise into something similar. Their recipe is contained in Built to Win. The ingredients are familar enough to anyone with knowledge of the Harvard Negotiation Program or Mutual Gains Approach.

McDonald's Is Built to Win

Why should other franchisors care that McDonald's overwhelming advantage is due, in part, to its negotiation capability with franchisees and vendors?

Well, if true, then despite the notorious secrecy of McDonald's, Movius and Susskind offer the posibility that your franchise system could duplicate McDonald's advantage by following their Built to Win curriculum.

That's a very tempting offer.

Let's look more closely.

"Happily, we sometimes find that leaders have recognized the value of relationships and converted them into bottom-line opportunities. For many years, Bob Jackson (most recently a vice president and division operating officer) was a highly successful regional general manager at McDonald's, responsible for an area of the United States that comprised more than six hundred sites.

His region was consistently among the best performing in the country. When we first interviewed Jackson [in 2003], it was clear that he and his most successful colleagues were already following a number of practices encompassed by the mutual gains approach (my emphasis). Jackson repeatedly described negotiations in which he worked with owner-operator franchisees to implement marketing plans, technology upgrades and other operational initiatives.

'Many times we have interests and goals in common. But sometimes the corporation's interests are not identical with the owner operators.', he commented. 'We do best when we work jointly with our franchisees to solve the problems and difficulties that come up, taking their worries and concerns seriously and trying to share information and invent options to address those concerns and interests while advancing our own.

'Having a good relationshiop helps to create value far out into the future, because you gain trust and the next time a hard problem comes up, you're in a much better position to deal with it productively." Movious and Susskind [pages 40-45]

Effective Cooperation

Now, you and I know that franchisees can be downright nasty and refuse to engage in constructive dialogue with the franchisor. (And franchisors don't fix nasty -they look to terminate nasty.)

Especially when it comes to: marketing, upgrades, retrofits, menu item changes, and numerous other operational issues. Franchisees feel the dynamic is: the franchisor's plans using the franchisee's money.

Franchisor and franchisee interests, positions or goals, can be either adverse, in common, or a mixture of both.

McDonald's, says Jackson, takes these differences seriously and provides sufficient information to the franchisees to establish a collaborative working relationship which advances everyone's interests. (It also helps the franchisor's credibility that they own 20% of the units. Thus, this franchisor isn't alwasy using other people's money.)

Operational choices made by McDonald's have a long projected payback. A good working relationship extends the trust created today to commitment tomorrow. This coordination is valuable. It is not a traditional asset because it is not owned by the corporation. It is an intangible value, which nonetheless can be measured.

Increase value and get a better bottom line.

Now, do you think other franchise systems can be Built to Win or is McDonald's in a unique position?

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Happy Thanksgiving

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You are a young cartoon writer, starting your career after returning from World War II.

You don't know it, but you are going to gross over 1 billion dollars from your cartoons, during the next 1/2 century.

You start off with a fight with the syndicate, and cannot get this satirical cartoon printed.

So, over the next 50 years, you get even by publishing every Thanksgiving the famous gag between Lucy and Charlie Brown.

Now, everyone knows who you were really satirizing, in 1951.

Not much has changed, sorry to report.

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This is well known negotiation game - the Confidential Information Game.

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Before furnishing an FDD to a prospect, you must confirm that the prospect has been given, or must give the prospect, notice of the FDD formats available, and the prerequisites and conditions for obtaining those formats.

The law does not require the notice to be in writing or to be acknowledged. The notice may be given personally, by telephone or in writing by paper or electronically.

However, as a matter of policy, a franchisor may require the notice to be in writing, and may require the prospect to sign or initial an acknowledgment of the notice. This type of policy protects the franchisor and you from later claims by prospects that they were not given the notice.

The notice must be given to a prospect before an FDD is furnished to the prospect. If the notice is posted on the franchisor's website or included in the franchisor's marketing materials or franchise application form, and if the prospect has visited the website, received the marketing materials or submitted an application form, the prospect has been given notice.

However, you should not assume this to be the case. You should confirm that the prospect has been given notice, or you should give the prospect notice, before you furnish an FDD to the prospect. You should be particularly careful if you are dealing with a prospect who meets you at a trade show, a renewing franchisee, a current franchisee buying an additional franchise, or a transferee of a current franchisee.

These types of prospects are least likely to have been given the notice.

The notice must be given whether the franchisor uses just paper FDDs, just electronic FDDs, or both paper and electronic FDDs. The specific wording of the notice is not prescribed by law.

If a franchisor uses both paper and electronic FDDs, the notice could state:

Notice of Available Disclosure Formats

If you qualify as a franchisee prospect, we will furnish you with our franchise disclosure document in paper form unless you request an electronic copy by sending an email request to [name, title] at [email @franchisor]. We will provide the paper form of our franchise disclosure document to you in person if you visit our offices, or we will mail or courier the document to you at our cost. We will provide the electronic form of our franchise disclosure document to you in PDF format, sent by email to the address you provide to us. You will need to have Adobe Reader software installed on your computer to open and view the PDF document and a printer to print at least one Receipt page.

If a franchisor uses just paper FDDs, the notice could state:

Notice of Available Disclosure Formats

If you qualify as a franchisee prospect, we will furnish you with our franchise disclosure document in paper form. We will provide the document to you in person if you visit our office, or we will mail or courier the document to you at our cost.

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If you would like to know if you can franchise your business, connect with me on LinkedIn or just give me a call, 202-824-1744.

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I'm all for getting your company's name in front of as many people as possible - after all, isn't that part of the goal of engaging in social media? However, there's one thing I continue to see over and over that really bugs me.

Imagine you're out with a few friends, talking about a restaurant you recently visited. Out of nowhere, someone comes up to your group and says, "You're talking about ABC Restaurant? Let me tell you about my restaurant instead - it's great!" and continues to talk about their restaurant and why you should go there.

You'd be a little creeped out, right? It would feel like an invasion on your personal conversation, and an unwelcome intrusion.

This is how businesses need to see social media - intruding on one's conversation to pitch your own business is a no-no, and likely turns many people off.

I've seen this most times on Facebook - a good example is when I followed the conversation regarding a live chat with GoDaddy and the Honest Toddler. In the middle of the conversation, which revolved around the hilarity of the comment and speculation on what the representative was thinking, someone chimed in about how their business, a competitor to GoDaddy, was better and suggested that people who are customers of GoDaddy leave them and go to this company.

Another place I've seen this happen is on Facebook pages for news sites. The conversation could be surrounding a current news topic, and sure enough, there is always one or two that will try to pitch their business. In this case, it's mostly unrelated to the topic at hand.

Companies who do this may be trying to gain exposure; instead, they are sending the wrong message to people. This is something that I've seen all too often and for whatever reason, has become a pet peeve of mine.

If you want to get your company exposure in social media sites, join conversations that are relevant to your business, and don't "sell" your company. Post from your business page on Facebook, for example, so if people are interested in what you have to say, they can visit your page to learn more about your business.

If you want to get company exposure, use LinkedIn.

Join groups and offer relevant, insightful comments related to your industry so people can get to know the "person" behind the company.

way to do this is to monitor news articles and blogs in your industry and comment, using your real name and perhaps a link to your company website.

The two tactics mentioned above will go further in gaining exposure, credibility, and interest than intruding on other people's conversations.

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Franchise Agreements may contain minimum royalty fee requirements and performance standards.

What is the difference between the two?

Can you be in default even if you pay the minimum royalty fee amount?

Listen to the video and learn the answers.

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Last night I reviewed a franchise agreement and found a surprising, and illegal, provision buried deep in the contract. If ever there was a compelling case for being careful when you are choosing legal counsel, I just found the provision that makes it.

But first, some background. My law practice involves representing both franchisors and prospective franchisees. For franchisors, I primarily draft franchise disclosure documents ("FDDs") and franchise agreements; I assist my clients in obtaining franchise state registrations; and I assist them with day-to-day issues that arise in running their businesses. For prospective franchisees, I will review their proposed franchise agreements and FDDs and help them understand what they will be committing to do if they decide to buy the franchise. If the franchise company is willing to negotiate, I help prospective franchisees through that process.

I find that reviewing other companies' FDDs and franchise agreements also helps me in my practice for franchisors; it's always instructive to see what other industry leaders are doing. I have noticed that, in a small minority of systems, some franchisors go well beyond what is legally permitted to be included in the franchise agreement and include provisions that unquestionably violate the FTC Franchise Rule (the "Franchise Rule") as well as various state franchise laws.

The Provision

If you're on either side of the franchise relationship, you should know if your contract has a provision like this one. Pull out your franchise agreement now. Go ahead, I'll wait.

You have it now? Good. Here's the provision we're looking for:

Release of Prior Claims. By executing this Franchise Agreement, Franchisee, and each successor of Franchisee under this Franchise Agreement forever releases and discharges Franchisor and its Affiliates, Its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors. representatives, employees and agents, from any and all claims of any kind, in law or In equity, which may exist as of the date of this Franchise Agreement relating to, in connection with, or arising under this Franchise Agreement or any other agreement between the parties, or relating In any other way to the conduct of Franchisor, its Affiliates, its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors, representatives, employees and agents prior to the date of this Franchise Agreement, including any and all claims, whether presently known or unknown, suspected or unsuspected, arising under the franchise, business opportunity, securities, antitrust or other laws of the United States, any stale or locality.

In plain English: "you, the franchisee acknowledge that we, the franchisor, may have lied to you and might be lying to you right now. Our entire FDD might be one of the greatest works of fiction sinceMoby Dick. You agree, however, that you waive all your legal rights to take action against us based on those lies, even if you have invested hundreds of thousands of dollars of your hard-earned money in this phony business." Wow.

Do you have that one in your franchise agreement? You might have to do a bit of hunting for it. You would think something like that would be on the first page, bolded, in caps, with a box around it and perhaps accompanied by a self-lighting sparkler that draws your attention directly to the provision when you open the contract. But no, in the case of the contract in which I found this provision, it was buried on page 36 of a 39-page franchise agreement, with no particular emphasis placed upon it.

I will never include a provision like this in a franchise agreement I draft, nor will I ever recommend that a prospective franchise buyer sign a contract when it includes this provision. Why? It's not only unfair, but it's also illegal under the Franchise Rule and under various state franchise laws.

The Problem with Having the Provision

Now, I highly doubt that in most situations, the franchisor even knows this provision is in its franchise agreement. Most start-up franchise companies trust their franchise counsel to draft the agreement and don't necessarily carefully consider each provision in the contract. This sort of provision is typically created by counsel, who is seeking to protect his or her client. An admirable goal, to be sure.

The problem is that this provision is impossible to justify to a prospective franchisee that notices it and understands its implications. If you're a franchisor, imagine trying to explain that to a potential buyer: "we're not lying to you. But you have to agree as a condition of buying this franchise that we might be and that you won't ever do anything about it if we are.

A franchisor may be able to slip this one by a franchisee unnoticed, but a franchisee that notices and understands this provision is always going to have a problem with it. A franchisee that has experienced franchise legal counsel review the agreement for them will certainly flag the term and warn the franchisee against agreeing to it. That could cost you a sale.

To make matters worse for the franchisor, the types of franchisees that actually read the agreement before signing it and have legal counsel review it for them are exactly the type of franchisees the franchisor wants: franchisees that take their commitments seriously and are willing to put their time, effort, and money into understanding commitments before they make them.

Now, I have my doubts that this type of provision will be enforceable in any event because, as I said, including a provision like this one is an explicit violation of the Franchise Rule, which "prohibits franchise sellers from disclaiming or requiring a prospective franchisee to waive reliance on any representation made in the disclosure document or in its exhibits or amendments." This provision does exactly that - and, as a result, the franchisor that included it in its agreement is in violation of the Franchise Rule (and various state laws) just for having the term in the contract.

Violating the Franchise Rule and state franchise laws leaves the franchisor exposed to lawsuits by franchisees that may have a state law "unfair trade practices" cause of action against the franchisor because of it. When those legal claims exist, a franchisor could face claims for damages or rescission. Moreover, state franchise administrators could refuse to register the franchise offering with a provision like this one (if they notice it) or worse, later take administrative action against the franchisor based on its violation of franchise law.

The better practice for franchisors that want to protect themselves, but do so within the bounds of the law, is to use exculpatory provisions and "compliance questionnaires" as part of the agreement signing process. A well-drafted exculpatory provision will provide a measure of protection to franchisors for unauthorized statements made by a renegade sales person, but will not seek to disclaim statements made by the franchisor in its FDD (and therefore is permissible under the Franchise Rule and many state laws).

The Lesson for Franchisors and Franchisees

If you are a franchisor, inclusion of a provision like this in your franchise agreement should make you question your legal counsel. Ask yourself: are you willing to risk losing a potential sale to a qualified, savvy, and ideal franchisee because you have a provision in your franchise agreement that probably isn't enforceable anyway? Are franchisees that sign your contract without even reading or understanding it really the type of franchisees you want? And is "sneaking something past" your unwitting franchisees who don't review every term of your contract really the way you want to do business? As I explain above, there are better (and legally-enforceable) ways to protect yourself in your franchise agreement, anyway.

If you are a prospective franchise buyer, this situation highlights the importance of: (1) reading your franchise agreement, cover-to-cover; and (2) hiring legal counsel experienced in franchise law to review your contract before you sign it. Contrary to the opinion of some, franchise agreements aren't all boilerplate, and not all franchise contracts are created equally. Don't assume that your franchise agreement doesn't contain something objectionable just because other franchisees signed it.

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Throughout the United States franchisors have been able to enforce choice of law and venue selection provisions in their franchise agreements with few exceptions. A few states have proactively limited venue selection, but in the absence of rule or statute the U S Supreme Court has exonerated venue selection in the franchisor's home state as reasonable (Burger King leading case). On the issue of choice of law the primary confrontations have been over post termination covenants not to compete.

One state, California, prohibits them by statute (but see the Schlotzky's case where the California court permitted a restriction against making the Schlotzsky sandwich that was held to have secondary meaning as a source identifier for Schlotzskys).

Elsewhere when a franchisor chose its own state as the choice of law and the law of its home state was more permissive about use of post termination restrictive covenants, the question was whether the more expansive permitted use infringed the public policy of the franchisee's state. In those instances courts customarily reduce the scope of the covenant to the point at which the confrontation with public policy is eliminated.

The current direction of the law on post termination restrictive covenants, except in California, is simply to enforce them. The franchise can be old to the point of moribund and the market can already be so flooded with direct competition that enforcement of the covenant really bestows no material benefit to the franchisor other than a vendetta interest. Competent drafting of restrictive clauses today usually tie the clause in with the protection of confidential information and the non disclosure clause.

Venue selection has received little attention except for the rare prohibitory statute or rule.

Most large franchisors have now expanded extensively into foreign markets. Many of them still keep the domestic venue selection clause that facially requires franchisees in foreign countries to come to the United States and litigate or arbitrate disputes in the franchisor's home town. Just such a situation arises now in the context of an American franchisor requiring its European Community franchisees to resolve disputes here in America.

The agreement also prevents class treatment of disputes and groups as joint complainants. The EU franchisees would have to come to America one at a time and hire a USA lawyer to have their disputes sorted out by a court or arbitrator.

In the situation of poorly performing franchise systems, the franchisees' position is that this makes dispute resolution effectively unavailable to EU franchisees. This is, to be certain, part the purpose of this contractual configuration. This article offers a road map through the issues that will have to be dealt with if EU franchisees decided to attempt to defeat the USA venue selection clause.

INHERENT PRO FRANCHISOR BIAS IN THE USA

Over the last 25 years franchise law produced from decisions in dispute resolution has become more and more favorable to franchisors. Part of the reason for this tectonic shift may be attributed to the fact that every time a major court resolves a significant issue in favor of a franchisee, lawyers representing franchisor groups immediately redraft applicable franchise agreement provisions to circumvent that ruling. The "draft around" exercise has paid off handsomely for franchisors, and one would indeed be foolish not to avail itself of that technique. That is one reason lawyers go to annual seminars where they receive the benefit of the shrewd draftsmanship of the industry's best and brightest nit pickers. There is actual biblical precedent for this, but that is better left for drinking parties.

For these reasons alone, EU franchisees would win a substantial tactical and perhaps strategic advantage if they first found a way to defeat the international venue selection clause and were then able to have their disputes with their franchisors resolved in their own courts and arbitration resources, in their own languages and in context of the fairness balancing influences of their own countries and cultures.

Inasmuch as there is now no significant history of franchise litigation in EU countries, there is an opportunity for EU courts to approach franchising issues free of the pro franchisor bias so pervasive in the USA. How might one go about accomplishing that What are the issues and salient fact patterns relevant to confrontation of international venue selection provisions

THE ISSUES AND THE FACT PATTERNS

In the USA the ruling case law is that a franchisor may compel dispute resolution in its home jurisdiction under the law of its home jurisdiction. That is long established law. The rationale is that the franchisor ought to be able to operate its system in accordance with one set of legal principles and requirements and avoid the vagaries of local law that on the whole provide no significantly better legal climate than the law of the franchisor's home jurisdiction.

Even in this system, franchisors are required to provide a section of their disclosure package (FDD) that deals with state specific law that may affect the enforceability of various provisions of the franchise agreement. The shibboleth is that the essence of uniformity lies in its variables. There is essential uniformity, but not absolute uniformity from state to state.

Recognizing that the International Franchise Association spends a fortune every year to lobby franchisor favorable positions in every jurisdiction, nationally and internationally, one must begin by acquiring command of the jurisdictional trends and precedents in the EU countries relating to franchising dispute management to ascertain the extent to which there remains a meaningful opportunity to defeat an international venue selection provision under any circumstances at all. This involves the EU itself and the individual member states.

If the matter remains unsettled, then where does one initiate a proceeding seeking to upset a particular venue selection provision One thing is certain. One does not go to any USA court to try to achieve this.

It would be a total waste of resources with an almost guaranteed adverse result. This may mean a race to raise the question first, as one tribunal might not wish to devote its resources to an important question that is already before another tribunal. If the first tribunal decides the issue in a manner and pursuant to a rationale with which the EU tribunal would be comfortable, the ability to seek consideration of the matter before a potentially more sympathetic body is simply lost.

For this reason, I am somewhat surprised that USA court determination of these issues has not already been sought by the USA franchising community via declaratory judgment actions in American courts. By the time this article circulates, that tactic may be initiated as a possible means to preempt EU rulings on it. L'audace! L'audace! Toujours l'audace!

The salient fact issues will be distance, language, economic preclusion of a right to fair adjudication and the equities of the particular fact pattern before the court. It will be essential that the franchisee(s) in the case be essentially compliant even though contentious. You don't take a scoundrel to a court seeking fairness and equity.

If the initiator is a group of franchisees, it would be worthwhile to screen out the bad apples and proceed on behalf only of the more platinum plaintiffs/complainants. How that screening is accomplished is a subject for a totally separate article all by itself. Underlying every technical decision is an inherent, even though unspoken, issue of whether the party seeking relief is deserving of the relief.

With respect to the issue of distance, be mindful that a venue selection clause in an American franchise agreement may impose a more than 3,000 mile distance disadvantage, and that has not been the basis of an unreasonability ruling in a USA court. Distance from the EU to the east coast of the USA may not be much more than that. For this reason one should never raise the distance issue in isolation, but in every case in combination with language and other issues.

Consideration should be sought in light of the fact that the USA franchisor does not deem it inconvenient in any economic or distance sense to franchise its business in the EU as well as comply with EU and member state laws and regulations applicable to franchising there.

The distance and language issues should always be raised in combination with the franchisor's willingness to subject itself to EU and member state laws that enable and permit the enterprise from which the franchisor derives substantial financial benefit. That will go a long way toward blunting franchisor arguments before a European tribunal but probably not here in America.

The other crucial fulcrum of decision in this project will be the economic argument (which also would not prevail in the USA.) In the USA the concept of business risk, its assumption when you buy a franchise, not being a child or other person in need of special attention and protection in any business to business transaction tend to foreclose sympathy for "the downtrodden" in the sense of poor unprofitable franchise owners.

These so called victims, when applying to purchase the franchise, portrayed themselves to be financially and experientially capable of accepting the risks. Moreover, there are competent pre-investment due diligence assistance resources if they are not themselves astute at small business investment vetting. Additionally, the fact that the franchise agreements are in every instance rather draconian does not affect the pitch of the playing field in this discussion.

If you sign an agreement that permits the opposite party to take financial advantage of the situation and you do not expect that to happen, you are simply a fool. Actually, very few of these investors ever avail themselves of really competent pre-investment due diligence assistance at a meaningful level of competence simply because the services are not cheap. But that is their choice freely made.

There are escape hatch clauses in every franchise agreement plus a pre closing escape hatch questionnaire that further disable claims of being taken advantage of even when they have been taken advantage of in many cases and know about that before they sign the agreement.

So in the USA the "Oh poor me" gambit is usually worthless. Whether EU or member state tribunals are more receptive to the "poor me" arguments than USA courts remains to be seen. Ultimately, the USA is absolutely the worst place in the world to try franchise fraud and abuse cases today. There is no downside to trying to escape to another jurisdiction for resolution of disputes.

What constitutes an actionable complaint is probably different in the USA than elsewhere also. Notions of good faith and fair dealing are litigated here every year, and every year courts seem to find ways to deny their application other than lip service. What we just yawn at here in the USA could be a major offense against any fairness concept under EU or member state law. Equitable considerations are essentially worthless in the USA in business to business disputes. The free market means just that - the wild west.

Where then is the touchstone combination of circumstances in the making of a competent economic/predation case for escaping a venue selection and a choice of law provision in a franchise contract between an American franchisor and an EU franchisee I suggest the following approach.

Take seriously into account that an American court would accord no significance to the fact that the franchisee(s) are from another country and use another language. There will be absolutely no respect for a position that is a function of nationality. EU franchisees should make that clear to the EU or member state tribunal and suggest that a USA franchisor not be accorded preferential treatment.

The contract will have been drafted in the USA and will be in English.

There will be a local language version, but in the event of a disparity of meaning in any provision there will probably be a clause that says the English language version rules.

The EU franchisees will have been at a decided disadvantage in almost every instance when the "deal" was originally made.

One should suggest to the tribunal that one of the purposes of the EU and member state commercial law structure includes taking into account every way in which the EU party may have been disadvantageously positioned and make compensation for that by at least placing disputes before an EU or member state tribunal and applying the law of the franchisee's home country.

THE ECONOMIC POSITIONS

Usually the situation at hand will involve franchisees who invested in a franchise opportunity upon the stated or obviously implied representation that the franchised business model was a proven business concept capable of being operated by an investor acceptable to the franchisor with a positive financial performance profile.

If it is the case that the franchisees in the EU country are, as a group, unable to succeed in the business as licensed, that should be strong evidence that the opportunity was not investment worthy for this country/market and that the franchisor had no business selling it in the EU. If it is also the case that the franchisees in the USA are not doing well, that should be considered a strengthening of the conclusion that the transaction was not investment worthy in the beginning, much as a court would deal with a security that was not investment worthy.

There is a duty in all jurisdictions relevant to this discussion that the seller disclose material information that would cause a potential investor to make a negative investment decision.

In the face of such evidence, the franchisor should never be allowed to impose upon the EU franchisees an obligation to submit disputes to an American dispute resolution resource. The franchisees will be economically preempted from obtaining justice as a matter of simple economics, and no company selling investments should ever be allowed to put a victimized investor to that disadvantage. The argument that this requires prejudgment of the ultimate issue does not meet logical criteria here because we would be litigating jurisdictional issues and the findings would be for that limited use only.

In the USA the same standard is used in deciding whether preliminary relief should be granted in the course of deciding the issue whether the party seeking relief has "a likelihood of ultimate success on the merits. Taking this approach in protecting EU franchisees would not be a departure from American legal standards, and because of that the American franchisor should have no grounds to complain.

There is a countervailing argument available to franchisors in this instance. Regardless where EU franchisees must litigate their disputes, they will have to come up with resources to hire competent counsel, very few of which in the USA will accept them as clients on a contingent fee arrangement. In the EU contingent fee arrangements are much less condoned than in the USA.

The same requirements exist in the USA, and the cost of really competent representation is not going to be that different than in the EU. Depositions can be held in the locales of the witnesses, eliminating travel of everyone internationally before there is actually a trial. In each event the franchisees will need to create a common fund to share litigation costs, so there is no venue difference on that issue.

The adverse economics issue must be presented in a logical connection to other important issues rather than as a stand alone basis for decision.

If in addition to such a scenario (or even without it for that matter) the EU franchisee(s) can make a case of post execution abuses that materially adversely impacted the ability of the franchisees to make a reasonable financial return, that alone should make out a case that the franchisor is perfectly willing to engage in predatory practices no matter the impact upon the franchisees. A comparison of the measurable relationship cost as stated in the FDD to the actual costs, including extraneous revenues from franchisee operations not quantifiable from the information provided in the FDD, should serve to show that a franchise portrayed in the FDD as having a relationship cost of 15 % of gross sales actually has a relationship cost of from 20% to 25%. That would be very strong evidence of predation by the franchisor. Ten to fifteen percent of gross sales usually will equate to a negative impact of from 30 % to 50% of net profit. That is more than substantial impact to justify an EU or member state tribunal refusing to enforce a venue/choice of law provision in a franchise agreement.

How one goes about preparing such a case and obtaining evidence of sufficient quality is not part of this article, as that will vary with each case. Suffice it to say that counsel with very extensive experience in preparing and trying lawsuits involving franchise fraud and abuse should be tasked with assisting EU counsel in the entire proceeding. Knowing the theories and the art of expressing the theories effectively will not suffice without a record of competent evidence to support them.

As always, you can call me, RIchard Solomon, at 281-584-0519.

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"Financial Claims" could mean one of two things. The first possible meaning of "financial claims" is what's known as earnings claims or earnings projections that can be (but are not required to be) contained in a Disclosure Document.

This type of financial performance data is typically data that represents how certain franchisees in the system are performing financially. It can represent average performance, low/medium/high performance, and so on. This data can be verified in one of (or a combination of) three ways.

The first thing to do is gain an understanding of the data and carefully read the wording in the Disclosure Document that explains the basis of the data: this wording will tell you whether the data presented is only representative of, for example, franchisees that have been in the system for 5 years or more, or with territories of a certain size, and so on.

The second way to verify the data is by doing a little bit of due diligence. A list of all existing franchisees, as well as recently closed franchisees, should be included in the Disclosure Document. Call those franchisees, both current and past, and ask them if their performance is representative of that contained in the Disclosure Document.

If you feel you need more verification, a third way to verify the data is to attend at the franchisor's headquarters and ask to see the actual data that has been summarized in the Disclosure Document.

The second possible meaning of "financial claims" in this question could mean any claims the franchisor has made about its own performance.

This is verified by reviewing the franchisor's financial statements that are included as an exhibit to the Disclosure Document. Anyone not familiar with financial statements would be well-advised to have an accountant or other qualified financial advisor review the statements.

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This is the first of a three articles intended to raise investment care sensitivities. They are offered as a gesture of concern about what I see happening to people who invest in new and in old/over the hill franchise opportunities.

The purpose of the deceits practiced by these two groups of franchisor companies is, in the first instance, to portray itself as the investment quality equivalent of an already proven franchise concept/model, and, in the second instance, to portray itself as still being as good an investment vehicle as it once may have been but no longer is.

Is it possible for franchisors to say to prospective franchisees that profitability information is not provided when they do they provide profitability information?

It is also a very logical question to ask whether a franchisor can provide false or misleading profitability information so long as a warning is also given that there is no guaranty that you will achieve profitability and that you assume the risk of profit or loss and that there are risks.

Since risk is inherent in any investment, warnings about risks do not include or excuse risks that are produced by false statements made to induce the investor to part with his money in the first place.

How does someone who is thinking of investing in a franchise go about vetting the numbers?

This is the hottest button issue in disclosure, because assurances of potential profit are the most effective way to sell a franchise. Only an imbecile buys a franchise because of the bullshit. Real people want to know whether they will make a profit and how much, and how long it will take to reach profitability, and how much it will cost to get there.

Many years ago I published a suggestion in the ABA Franchise Newsletter that, since every franchise agreement empowers the franchisor to receive copies of periodic financial information and tax returns generated by its franchisees, compiling that information ought to be made mandatory, and that information ought to have to be disclosed in a way that displays how the franchisees are really doing.

This would include grouping franchisee performance information by levels of profitability (top third, middle third, bottom third), by region of the country, and by showing seasonality if seasonality is a significant factor. I also suggested that the information could be handled in such a way as to eliminate the impact of different franchisees treating various expenses differently for accounting or tax purposes.

If that were to happen, people might be able to appreciate at a higher level of quality just what the performance expectancies might be.

Franchisors, of course, howled at the thought. Why, if that were done, people might be able to see whether your franchise system was more profitable for its franchisees than someone else's franchise system, and the lower performing franchise systems would have a harder time selling franchises. DUH! That's one of the best reasons for doing it!

Since a potential franchisee will not receive that quality of prospective financial performance information, it remains necessary to have access to a fairly high level of sophistication in dealing with what is provided.

This article is intended to help to deal with the garbage that is thrown at you now.

Reading this article does not make you my client, and there are many other things that must be accounted for than just the questions raised here. But you can take this to your lawyer or accountant/financial planner, and maybe it will help you both better understand what you are being handed.

Are there Franchise Consultants? No.

Let's get started. Start by first asking yourself who it is that you are dealing with -- who is behind the face you are looking at when you are dealing with the person who is providing you with initial information about a franchise opportunity? If that person identifies himself/herself as a 'FRANCHISE CONSULTANT', you know you are dealing with a liar.

There is no such thing as a franchise consultant who sells franchises. While many people do that, they are not consultants in any functional meaning.

The reason for that is that they only get paid for selling franchises -- usually by a commission. That's a salesperson, not a consultant. And even if they were consultants, they aren't working for you to help you.

If you aren't the only one paying them for assistance, they are salespeople. When they tell you that they are there to help you get the right deal for your circumstances, that is total bullshit. They are there to sell you a franchise -- any franchise that will pay them a commission. You have to be extremely cynical about everything you are told.

Doubt everything until it is proven -- and you need to know what proof looks like.

What they call proof usually isn't. In once case in my office, the franchisor sales person claimed to be a vice president when he wasn't even an employee of the company. He was an outside salesman. You have to doubt EVERYTHING.

Item 19 Traps

a) - No Item 19 earnings claim is a Lie

Liar Number One tells you in Item 19 of the UFOC that the company does not give out earnings claims and that no one is authorized to provide earnings information in connection with the sale of its franchises.

This is an obvious lie for several reasons. The first reason is that the only reason to make an investment is to make a profitable return on that investment. If there is no representation of profitability potential/earnings potential, then there cannot be any reason on earth to make an investment in their franchise.

The second reason is that every one of these franchise companies does make earnings claim information to every potential franchise purchaser. The earnings claims information isn't in Item 19 of their UFOC, but it is provided by other means.

Among these other means you will see one or several of the following:

The franchise sales person provides the information either orally, on a blackboard, on a random piece of scrap paper/cocktail napkin/table cloth (and if you hang on to that piece of paper you may have a great exhibit when things later don't go as you thought they should).

b) Franchisee Verifications cannot be relied upon

The franchise sales person invites other franchisees to come appear at a meeting of franchisee prospects to tell of their experience as a franchisee. These folks always tell about their own wonderful financial performance. The presentation is intended to tell you that this is what you can expect if you buy the franchise.

The selected franchisee spokespeople are either all very successful or just shills lying through their teeth. In some instances these shills also receive a 'commission' on every franchise fee taken from each person attending that meeting who buys a franchise.

There are probably some successful franchisees in the system, but the point is that you are being provided with information that the franchisor denies providing to you, and that the information -- since it is denied it was ever given anyway -- is never reliable.

If you do buy the franchise, you will see in the franchise agreement an Acknowledgement clause that says that you agree that you were never given any earnings claims information.

If you sign that agreement knowing that you were in fact given earnings claim information, you may be out of luck even getting it admitted into evidence in court or in arbitration of any fraud claim you may later seek to assert.

Some courts are allowing the Acknowledgement clause to exonerate misrepresentation, making the defrauded franchisee seek reversal of those rulings in courts of appeal. That adds time and expense to obtaining relief.

You are provided, as is required, a list of the names, addresses and telephone numbers of all the franchisees of that franchisor so that you can contact them as part of your investigation/due diligence before you buy the franchise, to see what kind of experience they are having with the franchise.

But the franchise sales person steers you to certain franchisees. These will always say they are making tons of money and are just thrilled with the franchisor who provides great training and support. If you do buy the franchise, the sales person usually gives them a percentage of the sales commission, or they receive some other form of consideration for their assistance.

The franchisor's position is that, notwithstanding the steering, they have no part in providing you with earnings claims information. If you buy that you are too stupid for words. While it may in some strict sense be true that someone else, not the franchisor, provided you with the information, the fact is that the information was provided to you through the efforts of someone affiliated with the franchisor.

c) Financial Assistance for SBA Loans, but no Item 19

The franchisor who claims not to provide earnings claims information to persuade you to buy the franchise, does offer to assist you in seeking an SBA loan. The loan requires that you prepare a 'business plan' (another work of sheer fiction). The business plan requires a pro forma operating statement and balance sheet statement to show the lender what you expect by way of financial performance of the business for which you are borrowing the money.

The franchisor either provides you with information to use in preparing the business plan, including the financial pro forma, or steers you to a 'consultant' to assist you and the consultant provides financial pro forma information that the consultant obtained from the franchisor.

Then of course, you take your business plan to the franchisor for review, before submitting it to the SBA lender, and the franchisor tells you that you 'did a good job' or that 'your numbers are reasonable', vouching for the numbers/earnings claims information.

The lying franchisor's position is that they provided nothing and that you got that only from some third party, not from the franchisor. The franchisor's back up position is that they didn't provide you with the information in order to get you to buy the franchise. They just provided information to help you get a loan.

DUH! And -- I actually heard a franchisor person testify to this once -- the ultimate fall back position if the information is false is that the false information wasn't provided to you, but was provided to the lender.

There are other ploys by which franchisors who state in Item 19 of their UFOC that they don't give out earnings claims financial information actually do in some fashion provide it.

The fact is that it is almost never true that they don't provide earnings claim information, and if they provide it while insisting that they are not providing it, they are lying to you and you need to run like hell, not buy the franchise.

As always, you can call me, RIchard Solomon, at 281-584-0519.

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Vicarious Liability in General

Nearly every franchisor has suffered threats of litigation based upon the actions of its franchisees. These threats are not necessarily limited to claims stemming from the franchisees' delivery of services (from mold remediation to serving tasty food which does not result in gastro-intestinal distress), but may extend to those arising from the franchisees' employment decisions.

Generally, the franchisor defends on the basis that it does not direct the day-to-day actions of its franchisees, and the franchise relationship by definition is an independent contractor relationship, rather than an agent-servant relationship.

A recent case out of Washington recognizes this principle, but with a current technological and statutory gloss.

Robo Calling by Franchisee using Franchisor Mandated POS

In this case, a sizable Domino's Pizza franchisee (Four Our Families, Inc.) hired a telemarketing firm (Call-Em-All LLC) to help increase sales, and that firm engaged in "robo-calling" to offer pizza delivery specials.

A class action lawsuit was filed claiming violations of the federal Telephone Consumer Protection Act (47 U.S.C. Section 227 et seq.) and a Washington statute (Revised Code of Washington Section 80.36.400, "WADAD," governing "automatic dialing and announcing devices"). The putative class action plaintiffs claimed that they had received unsolicited auto-calls offering pizza deals from Domino's, and those calls were made without their prior consent.

The plaintiffs claimed that the franchisor was liable for the franchisee's actions under the general contract provision granting the franchisor the right to control advertising and marketing decisions. The franchisor denied that it was involved in the robo-call efforts.

In support of their claim against the franchisor, the plaintiffs pointed out that the telemarketing firm had advertised its services at a Domino's national convention, and also had used the PULSE telephone system (which Domino's Pizza requires the franchisees to use, and which is capable of producing lists for "ADAD" calling).

Ruling By Court - No Franchisor Liability for Mandating POS

The federal district court granted the franchisor's summary judgment motion and denied class certification. The court recognized that the franchisor did not conduct a robo-calling campaign itself, participate in the franchisee's campaign, or direct that franchisees conduct such a campaign.

The court stated that the "mere fact that Domino's requires franchisees to participate in marketing campaigns does not somehow mean that any franchisee's illegal use of an [automatic dialing and announcing device] is imputed to the franchisor."

This is just one more example of an effort by the plaintiffs' bar to hold franchisors accountable for the actions of franchisees.

Franchisors should take heed, and zealously defend the independent contractor relationship and the realities of the relationship.

In addition, franchisors would be well advised to inquire into the availability of insurance for these and similar claims.

The court's order may be reviewed by clicking here.

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The franchise industry is on the verge of losing a battle regarding employer liability, as old arguments fail to address new opponents.

Whatever your position on the Obama view of franchising, the reality is that Executive Branch officers are powerful and have wide discretion. As such, franchisors ignore their views at great peril.

A recent article by attorney Harold Kestenbaum made the case that state legislators are able to determine how "employer" is defined under federal law. Presumably Mr. Kestenbaum was being facetious in demonstrating the failure of the International Franchise Association and others to address the concerns of the NLRB and US Dept of Labor, but the large number of industry players who took the article as a serious comment are indicative of just how clueless the franchise industry remains today.

David Kaufmann may lack Mr. Kestenbaum's sense of satire, but Kaufmann's article in the Spring 2015 Franchise Law Journal is a serious attempt to lay out the basis for the threat and a socio-legal defense of the existing jurisprudence. The article is worthy of more serious consideration than can be dealt with in a brief BMM post, and is the starting point not only for an attack on the Obama administration viewpoint but also for a frank discussion of why David Weil is having success.

Kaufmann is blunt in identifying the root cause of the problem, and it is to this point that my comment is addressed.

American political discourse has gone thru many cycles in our history, and we are now in an environment similar to the great Progressive Era of a century ago. As Kaufmann realizes, the impetus is also similar to the last cycle: just as the Gilded Age led to a reaction against inequality of wealth and political influence, the wake of the 2007 financial collapse has led to a reevaluation of economic changes in recent decades.

Most relevant to our concerns, the gap in wages for those at the bottom of the ladder stands out in sharp contrast to the wealth of those at the top. A century ago, this led to some action at the federal level (such as the Sherman Act), but most of the activity was at the state level, and union organizing was in its infancy.

Much as the encyclical Rerum Novarum (1891) led to calls for a "living wage" in the 1920s, religious leaders today are calling attention to the moral aspects of how QSR workers are being treated in 2015.

Politicians are by nature attuned to popular sentiment, whatever the century. Theodore Roosevelt sought to follow Herbert Croly's prescription to achieve "Jeffersonian ends through Hamiltonian means." There are significant differences between Croly and Weil, and Obama is no TR. Yet even starting from a conservative viewpoint (as did Croly and TR), the remedy of David Weil is not without foundation in American politics or jurisprudence.

While the Great Depression marks a break from the Progressive Era, the legislation which resulted (including the creation of the NLRB) was very much informed by the progressive values of the first three decades of the century.

New Deal legislation coupled with the effects of World War II led to the locus of power shifting to Washington and in the wake of Chevron and the practical realities of statutory implementation, our time is one in which the state governments are bit players (with some exceptions such as Eric Schneiderman).

Kaufmann says that if the Obama viewpoint takes hold, then franchisors would be on the hook for increased costs due to the need to comply with Wage & Hour mandates. Costs would increase and franchising could not survive, says Kaufmann.

No doubt Weil would agree and explain that is precisely the point. Costs would increase as employees would have to be paid in accord with statute, and the ability to go after a "deep pocket" would mean that businesses would have to either comply with the law or be sued.

In fact, this is precisely the logic behind NY Attorney General Schneiderman's pursuit of pizza franchisors Domino's and Papa John's.

Kaufman realizes the problem, but he does not propose a solution and spends most of the article formulating a legal argument regarding why "joint employer" theory should not apply to the franchise industry.

Kaufmann makes a respectable case on this latter point, but that is not going to solve the underlying problem, since this is an issue which is every bit as much a public policy issue as a legal one-- and I would argue, more so.

Kaufmann is well aware of the underlying problem and his failure to address it is nothing to hold against him. But as he suggests in the beginning of his article, there is a populist and even a moral aspect to the Weil thesis which needs to be addressed.

We can debate whether the minimum wage was originally intended to be sufficient to live on (it was not), and whether the minimum wage was intended to be the support of full-time workers who are the head of household (again, it was not). We can also debate whether the top of the food chain is getting more than a fair share.

But at the end of the day, the franchise industry is left with a simple reality: the electorate perceives a gross inequality which needs to be rectified. And with every franchise owner who fails to abide by Wage & Hour statutes, and with every franchisor who turns a blind eye to wage theft and taxpayer subsidy of wages, the position of David Weil and the NLRB is going to get a more sympathetic ear.

It is time for the franchise industry to clean up its act, or at least to get through the next Presidential election cycle without suffering a disaster.

Morality aside, there are sound reasons why franchisors should take David Weil and the NLRB seriously-- answering not simply their legal arguments, but their economic arguments and the moral basis thereof.

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There are two issues regarding Franchisor control that have bubbled under the surface for a number of years and are now beginning to become significant to Franchisees and Independent Franchisee Associations alike.

Since a Federal judge ruled that Coverall North America must pay triple damages to hundreds of workers misclassified as franchisees instead of employees, everyone in franchising is now aware of the dangers of a franchisor who has too much contractual control.

The control issues are:

1. Operational Control

2. Supplier Control

Not coincidentally, these issues have become more prevalent and evident with the advent of strong Independent Franchisee Associations.

As the Franchisors continue the erosion of certain aspects of a Franchisees Business as well as the ability of an Association to exist, they may experience some dire consequences if not careful.

Note the simple graphic below:

<----------------------------------{ **** }------------------------------------------------------------------------------------------------------------------------------------->

^ ^ ^

Independent Operator Independent Contractor Employee

The scale above represents at the furthest left hand point, the ability of the Franchisee to do what ever he/she wants with very little direction from the franchisor. At the furthest point on the right hand of the scale represents the Franchisee as strictly employee and no other distinction.

The 'window' (represented by the brackets on the line) shows where the Franchisor has been on the scale.

Operational Control

The Franchisor has the exclusive rights and fiduciary duty to protect its Trademark and Brand. This certainly includes standards of operations, protecting trademarked signage, logos and products.

Franchisees sign an agreement with the Franchisor with the expectation that the Franchisor is an 'expert' ith the chosen field. "The Franchisor's Plan" will change according to the market place.

Franchisees should also enter their agreements knowing that reinvesting in the business reasonably will be a part of keeping up with the competition.

The graphic above is now showing a much different picture. The "window" is gradually and some cases dramaticlly toward the right side of the bar and is being driven by actions on the part of the Franchisor. In the case of some franchised systems, becoming a franchisee is no more that purchasing a job.

As these sifts to the right of the 'line' continue to occur, it is incumbant upon Franchisees and their Associations to become extremely aware of the State and Federal guidelines that determine whether the Franchisee is truly an Independent Operator, and Independent Contractor or an Employee.

It is very tempting in the current employment environment which features legislation such as the Fair Pay Act, Insurance Reform, Employee Free Choice Act (not yet passed and somewhat on the back burner) and others for not only Franchisors, but Small Business in general to attempt to avoid compliance by classifying their workers as Independents.

They are not only relieved of the legal issues, but don't pay FICA, Workers Comp, Unemployment Insurance and the like. There is only on small problem; It's Illegal!

These issues that have been brought to the forfront regarding the Coverall case as well as the Federal Express Drivers complaint.

Supplier Control

The issue of supplier control rests squarely on one question; "Does excercising strict controls over certain products and services protect the Brand and the Brand Image?"

The Franchisor's supply chain management in most systems have standards, supplier facility inspections, quality control metrics (checked frequently from the manufacturer) and the ability to protect itself from fragmentation, inconsistency and dereliction due to inferior or harmful products.

The Franchisor's supply chain management team must be allowed to exercise control over products which would destroy a brand if due diligence were not done.

It is in the best interest of all Franchisees to forbid the use of products that would harm customers or in some cases cause death.

However, what seems to be occurring is a not so subtle choice on the part of Franchisors to 'grab' control of products and services that have nothing whatever to do with Brand protection and the avoidance of harming the consumer.

Newsletter, work shoes, floor mats, individual websites, certain forms of business insurance and other have all been grabbed by the franchisor.

For individual Franchisees and particularly for the Independent Associations, the willingness of the Franchisor to take control of these items has encroached on the remaining ability of the operator to influence their own unit economics and have taken away from the Associations a very important source for funding.

You will see more information in the very near future as well as collaborative solutiuons in the future.

More and more issues surrounding Franchisor control will continue to be brought to light and we intend to keep you informed and even look at actions that can be taken in the future.

(This is a reprint and update of an article the late Steve Ellerhorst wrote 3 years ago, and it still rings true today.)

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Franchisors often resist franchisee requests for loosening controls in order to make the franchisee's loan eligible for SBA financing.

Thanks to several recent Court decisions, a franchisor's case for maintaining certain kinds of control over the franchisee just got a lot weaker.

Recent cases involving employment discrimination have held that too much control, which creates ineligible "affiliation" under the SBA rules and regulations, can also make franchisors liable for claims by the franchisee's employees. (Keep reading to see the nose ring case)

Franchising has historically succeeded as a business model due, in large measure, to the support the franchisee gets from the franchisor in exchange for fees and a commitment by the franchisee to preserve and protect the franchisor's system and its attributes, including especially franchisor's trade marks, trade names.

The franchisee typically agrees to be trained in the franchise system and to comply with the franchise agreement rules and procedures.

Generally, franchisors want to ensure franchisees adhere to the look and feel of its system. Small business loan applicants frequently choose franchising or similar arrangements such as licensing or distributorships as a business model and seek SBA financing for their operations.

Affiliation issues found in franchise, license and certain dealer or distributorship agreements can render the small business ineligible for SBA financing. Affiliation is found where the franchisor exercises so much control over the franchisee and the franchised business that the small business no longer has the independent right to profit from its efforts or bear the risk of loss commensurate withy ownership.

Recent court cases provide franchisee-borrowers applying for SBA loans with better ammunition for getting franchisors to back off from some controls and enable franchisees to negotiate modifications to the franchise agreement to avoid affiliation and make the agreement eligible.

Actions such as step-in rights, where the franchisor can take over the franchisee's job if the franchisee is performing inadequately (Hayes v. Enmon Enterprises, LLC d/b/a Jani-King, 2011 U.S. dist. LEXIS 66736 (S .D.. Miss.) or where the franchisor runs all payroll through its central system (Myers v. Garfield, 679 F. Supp. 2d 598 (E.D. Pa. 2010) have made franchisors liable as joint employers with the franchisee.

Factors courts are looking at to determine whether a franchisor can be held to be a joint employer include all of the following: authority to hire and fire employees, promulgate work rules and assignments and set conditions of employment, including benefits, compensation and hours; day-to-day supervision of employees including discipline; and control of employee records, including payroll, insurance, taxes and the like.

Courts say that no one single factor is dispositive in determining whether a franchisor is a joint employer.

Now, for the nose ring case -----

An employee of a fast-food franchise was fired by the franchisee for wearing a nose ring that she said was religiously required but that violated the franchisor's no-facial-jewelry policy. She filed a claim with the Equal Employment Opportunity Commission.

The EEOC, on her behalf, sued the franchisee ---- and the franchisor. In denying the franchisor's motion to be let out of the case, the court said there was enough evidence to find that the franchisor's were a joint employer with the franchisee, especially since only the franchisor had the authority to waive the no-facial-jewelry policy that was enforced by the franchisee against the employee.

The controls that give rise to a franchisor's liability as a "joint-employer" of the franchisee's employees provide a franchisee and its SBA Lender with additional leverage to negotiate fixes to a franchise agreement that is not on the SBA franchise registry to render it eligible for SBA financing.

For more information regarding franchise eligibility matters, please contact Lynn at [email protected] or call (215) 542-7070.

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On September 16, 2014, the Franchise and Business Opportunity Project Group of the North American Securities Administrators Association (NASAA) issued a Multi-Unit Commentary to provide guidance in addressing certain disclosure requirements in 3 different types of multi-unit franchising structures.

All of the state franchise regulators are members of NASAA so we can expect that the state franchise regulators will follow the guidelines addressed in the commentary in 2015. The effective date of this Commentary is 180 days after the date of adoption, or 120 days after the franchisor's next fiscal year end for Franchise Disclosure Documents already in existence.

Among other franchise offerings, the new Multi-Unit Commentary includes guidelines for the Franchise Disclosure Document used by a subfranchisor in offering unit franchises. The Franchise Disclosure Documents currently used by subfranchisors in offering its unit franchises may already be in compliance since the commentary largely provides clarification or confirmation on how FTC Guidelines should be interpreted when disclosing information on multi-unit arrangements, rather than imposing new requirements.

The following summarizes the guidelines under the Commentary that will apply to a subfranchisor's unit FDD:

A subfranchisor is not required to disclose in the FDD the financial arrangements between it and the national franchisor. The subfranchisor may disclose in Item 6 that fees paid by the unit franchisees are shared by the subfranchisor and the national franchisor.

Subfranchisors are required to amend their unit FDD when there is either a material change to the information regarding the subfranchisor or there is a material change to the information disclosed regarding the national franchisor.

Item 3 of the subfranchisor's unit FDD must include litigation information for the national franchisor and its officers and managers identified in Item 2 in addition to litigation information for the subfranchisor and its officers and managers identified in Item 2.

Item 4 of the subfranchisor's unit FDD must include bankruptcy information for the national franchisor and its officers and managers identified in Item 2 in addition to bankruptcy information for the subfranchisor and its officers and managers identified in Item 2.

Item 8 of the subfranchisor's unit FDD must disclose any rebates received by the national franchisor and its affiliates or other revenue derived by the national franchisor or its affiliates from purchases by unit franchisees, in addition to similar disclosures for the subfranchisor.

In Item 13, the subfranchisor must disclose the circumstances under which the subfranchisor's subfranchise rights may be terminated by the national franchisor, and the effect any such termination or expiration or non-renewal of the subfranchisor's agreement with the national franchisor will have on the unit franchisees' rights to continue to use the marks.

In Item 20, the subfranchisor only has to disclose information on current and former unit franchisees. Disclosure on the subfranchisors in the system is not to be included.

In Item 20 of the subfranchisor's unit FDD, there are to be two sets of Tables 1 - 5. The first set of tables should include information only on the unit franchises in the subfranchisor's territory. The second set of tables should include information on all unit franchises in the franchise system.

The subfranchisor's FDD must include two lists of current unit franchisees. The first list is to include all of the unit franchisees in the subfranchisor's territory. The second list must include unit franchisees of the franchisor and its other subfranchisors.

You can choose to list all unit franchisees in the entire system or the unit franchises in your state and, if necessary to have a minimum of 100 franchisees between the two lists, other unit franchisees in contiguous areas.

The financial statements of both the subfranchisor and national franchisor must be included in Item 21 of the subfranchisor's unit FDD.

If the national franchisor and the subfranchisor have two different fiscal year ends, the subfranchisor must update within 120 days of its fiscal year end, and then must amend its FDD when the national franchisor issues a new FDD after the end of its fiscal year to incorporate any material changes in the national franchisor's updated FDD.

Time to review with franchise counsel if changes will need to be made to your Franchise Disclosure Document (FDD) to bring it into compliance.

Section 7 of the U.S. National Labor Relations Act ("NLRA") states,

Employees shall have the right to self-organization, to form, join, or assist labor organizations, to bargain collectively through representatives of their own choosing, and to engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection . . .

U.S. Code, Title 29, Section 157.

This provision and the balance of the NLRA, which was enacted during the Great Depression of the 1930's, are primarily focused on the right to join a union and collectively bargain. As the percentage of U.S. private sector employees represented by unions has dropped substantially over recent decades, the NLRA has become a much less prominent part of the discussion of employment-related legal matters.

However, through its recent activities the current National Labor Relations Board ("NLRB") has indicated its determination to make the NLRA relevant to all U.S. employees (and employers), by focusing on the last part of the quoted portion of Section 7, "Employees shall have the right . . . to engage in other concerted activities for the purpose of . . . mutual aid or protection."

Among the areas where this emphasis is being shown is the ability of employers to limit employees' use of social media networks such as Facebook. The "social media policies" area is particularly interesting because many (if not most) of employees' online posts relating to their employers cannot be construed as "concerted activities for the purpose of mutual aid or protection."

Nevertheless, the NLRB has authority to stop an employer from maintaining a "work rule" that if that rule "would reasonably tend to" discourage employees from communicating with other employees "for the purpose of mutual aid or protection."

If the "social media policy" does not clearly restrict protected activities, such as by forbidding employees to "friend" each other on Facebook or to write posts about wages, hours or working conditions, then the policy only violates the NLRA if: "(1) employees would reasonably construe the language to prohibit Section 7 activity; (2) the rule was promulgated in response to union activity; or (3) the rule has been applied to restrict the exercise of Section 7 rights."

In several cases, the NLRB has found that an employer's social media policy has in fact been applied to restrict the exercise of Section 7 rights, and required the employer to reinstate employees terminated due to their Facebook postings and subsequent responses by Facebook friends.

For example, after an employee of a collections agency was transferred to a different position that would substantially limit her earning capacity, she posted on her Facebook page that her employer had "messed up" (using expletives) and that she was "done with being a good employee."

The employee was Facebook friends with approximately 10 current and former coworkers, including her direct supervisor. An extensive exchange ensued among the coworkers regarding the employer's management methods and preference for cheap labor, culminating with one of the former employees calling for a class action among the disaffected workers.

The employee who had prompted the exchange was fired the next work day explicitly because of her Facebook posts and the responses they triggered. The NLRB found the discharge to be a violation of the NLRA because (a) the employer had an unlawfully broad "non-disparagement policy," the violation of which was the basis for the termination, and (b) the employee had been fired for "engaging in conduct that implicates the concerns underlying Section 7 of the Act."

In other recent cases brought before it, the NLRB has concluded that, while the complaining former employee was not unlawfully discharged due to his or her online postings, the employer's policy itself violated the NLRA and needed to be modified.

In response to this, the NLRB recently issued a report summarizing its decisions specifically on acceptable social media policies, and perhaps most importantly, has in essence provided a sample policy that it has deemed to be lawful.

The policy, as amended by Wal-Mart after the initiation of an NLRB complaint regarding its prior policy, focuses fairly narrowly on refraining from posts that "include discriminatory remarks, harassment and threats of violence" or are "meant to intentionally harm someone's reputation." While the policy forbids dissemination of the company's confidential information, it provides a sufficient specific definition of "trade secrets" to put employees on notice that the policy (probably) does not include internal reports or procedures specifically touching on conditions of employment. Perhaps most importantly, the policy expressly acknowledges that employees may post work-related complaints and criticism, even while discounting the possibility that such posts are likely to result in changes that the employee seeks.

If your company has a social media policy, we can review it for purposes of conforming it to the NLRB's latest guidance on acceptable policies and help you avoid future problems that could result from overly broad restrictions on employee's online conduct. Of course, as specific situations arise we are available to counsel you as to legally appropriate measures to take in response to employee's online conduct.

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As Chief Development Officer for a capital intensive franchise, I knew that we had an advantage in the marketplace - we could tell franchise candidates how much money they could make - because of our Item 19, or what is now called a "Financial Performance Represenation".

But we had a problem. While our ads in the Wall Street Journal could explain our business model and make representations consistent with our FPR, we had to be compliant with the FTC Rules on Misleading Advertising. We had a great average unit volume story, AUV, and we just had to tell it in the right way.

I knew all of this, wrote the ad & added the FTC required disclaimer -sent the ad to our legal counsel. We were "experts" on compliant franchise sales.

It was great! We had a terrific response, and we were in compliance with the law.

My joy was short lived -replaced with nerve racking fear. Our great advertising success was about to become a liability that would kill the franchisor!

A competitor of ours phoned me up. Here is their story. "Joe, saw the ad you were running. Just a word to the wise. We ran the exact same type of ad, pulled information from our FPR, and inserted the standard FTC disclaimer language. The next thing we heard was not from a happy or excited franchise candidate, but from the dour FTC. We had forgotten something. And it was going to kill us.

We didn't put on the ads the number of units and percentage that they represented which reached or exceeded the AUV. And the FTC wanted $11,000 for each ad we ran because of that one infraction. Just a word to the wise."

Now, we never got that call from the FTC. Thank heavens. But, I sure moved quickly to change the ad so that we told franchise candidates not only the AUV, how much they could make, but how many units were hitting that mark, and what percentage of the system they represented.

The joy returned. Our aggressive ads were working.

I still see franchisors advertising and selecting figures from their FPR, but either leaving out the disclaimer language or forgetting to put in the number of units and percentage they represent. I guess that they can afford the FTC fine - but I know we couldn't.

I was thankful that a competitor who was marketing with their Financial Performance Representation - FPR in their advertising as we were, was thoughtful enough to let us know. This way we could avoid the pain of having to pay the FTC fines of well over $100,000, at $11,000 per infraction, and have our reputation needlessly damaged.

So if you see a franchisor marketing with non-compliant sales claims in their advertisements do them a favor and give them a heads up so they can make a quick and easy fix. Feel free to send them this article.

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The top stories in the franchise world continue to be about efforts by the cities of Seattle, Chicago, and others in raising the minimum wage with laws that discriminate against small business owners who own franchises. For the full story, see some of my previous blog posts on the issue. These laws are a serious concern for franchisees and franchisors alike.

In brief, these laws (which are written substantially the same way in the different cities that have adopted them) require small businesses to raise the minimum wage of their workers from the current level to $15 an hour. Under these new ordinances, businesses with more than 500 employees have 3 to 4 years to increase the minimum wage to the new $15/hour level, while "small businesses," defined as businesses with fewer than 500 employees, have up to 7 years to reach the new level.

The problem? For the purpose of calculating the "500 employees" number, all franchises in the same system are counted together. The net result of this is that these locally-owned small businesses with a few employees, which also happen to be franchises, are being discriminated against as compared to their non-franchised counterparts.

After reading some of my blog posts on the subject, another franchise attorney (one who exclusively represents franchisees) commented to me that these laws, which treat franchises differently than similarly situated non-franchise small businesses, could arguably be viewed as "industry specific" laws for the purposes of Item 1 of a franchisor's Franchise Disclosure Document (FDD). I can see the argument on both sides of that point.

The Federal Trade Commission's (FTC) Franchise Rule requires a franchisor to state in Item 1 of its FDD "any laws or regulations specific to the industry in which the franchise business operates." The FTC has elaborated on this requirement by saying that laws applying to all businesses generally do not need to be disclosed; instead, "only laws that pertain solely and directly to the industry in which the franchised business is a part must be disclosed in Item 1."

The minimum wage laws adopted by some cities like Seattle target franchises by treating them differently from other similarly-situated small businesses; laws that are specific to a certain "industry" are the types of laws that need to be disclosed in Item 1.

So, the question then becomes: is franchising as a whole an "industry?" Are these the types of laws the FTC was contemplating when creating the Item 1 disclosure requirement? Should Item 1 of a franchisor's FDD should disclose these laws?

I can see the arguments on both sides. On the one hand, franchising itself isn't really an "industry." Merriam-Webster defines "industry" as "a department or branch of a craft, art, business, or manufacture; especially: one that employs a large personnel and capital especially in manufacturing." In that sense, franchise systems are not part of the same "industry" because they are diverse, representing businesses in a multitude of different streams of commerce (like retail, food service, personal services, and business services just to name a few).

However, Merriam-Webster does recognize an alternative definition. "Industry" can also be defined as "a distinct group of productive or profit-making enterprises <ex: the banking industry>." In that sense, franchising could be considered an industry because franchise companies are in a distinct group that has its own set of goals, concerns, and issues. It is in this sense that the International Franchise Association and business periodicals regularly refer to franchising as an "industry."

In its guidance, the FTC hasn't specified which of these definitions it meant when it created the Item 1 disclosure requirement. The better argument, in my view, is that the FTC didn't intend to single out franchising as a whole as its own "industry" when it created the Item 1 disclosure requirement. That is because the FTC itself, in its rulemaking process, used the word "industry" a number of times, but used it in different contexts. Specifically, the FTC repeatedly referred to franchising itself as an "industry," and then in other contexts that are clearly different, it talked about the franchisor's duty to disclose certain information unique to "industry" in which the franchisee's business will operate. It is clear from the context of the FTC's guidance that the two uses of the word are different from one another.

Based on the contextual distinction between the two uses and definitions of the word "industry" by the FTC in its rulemaking, I think the more convincing legal argument is that a franchisor does not have to disclose minimum wage laws that discriminate against the franchise "industry" as a whole.

But, from a practical and informational perspective (and considering the purpose of the Franchise Rule), I think a good argument can be made that these laws should be disclosed anyway (even if disclosure is not legally required). That a franchisee may be required to pay its employees a higher minimum wage than his or her similarly situated non-franchise competitors is something that she or he would certainly want to know.

As a result, I am recommending to my franchisor clients that, when they update their FDDs for 2015, they include a disclosure in Item 1 that says:

Some jurisdictions have passed laws that require businesses to pay their employees a higher minimum wage than what is required under federal law, which laws may disproportionately affect franchised businesses.

It's a simple enough disclosure to include. Moreover, it would certainly help a franchisor in later defending against a legal claim by a franchisee that the franchisor knew about, but didn't disclose, the existence of these laws prior to the franchisee committing to buy the business.

What do you think? Do you think these discriminatory minimum wage laws must be, or should be, disclosed in Item 1?

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The Vanishing Competent Franchisor

Franchise investors find, often too late, that the unique systems and concepts in which they have invested are neither unique nor have even competent execution by the franchisor.

The reasons for this are several. Some of them are the natural vicissitudes of living in any competitive marketplace over time, but others are fault ridden. Which is which? What are the identifiers? How early can they be spotted and what can be done to avoid or thwart them?

So far the courts have not seemed hospitable to the notion of going beyond the explicit wording of carefully drafted agreements entered into by seemingly sentient adults. From a macroeconomic perspective this is exactly what courts should be doing, as enforceable agreements are indispensable capital that underlie the value of enterprises.

But are the franchisees caught in an ever tightening noose of business contraction so constrained by contract language that the only diagnosis is: suffer a financially excruciating death? Should bankruptcy be the only resort/cure to being in contract with people who rely on legal enforceability?

How far can franchisees go without violating fundamental contract rights and thereby effectively changing franchisor inability into franchisee liability? Where is the line between act or die on the one hand and legal suicide on the other?

The Legal Framework

In today's franchise agreement one finds that the mission statement is not a term of the agreement. None of the hortatory rhetoric of the sales pitch/marketing materials is ever to be found anywhere in the actual contract language.

There is a bright line between all the positive reasons for investment and the machinery by which the investment, once made, is to be managed, performed and observed.

Investors seem not to notice that what convinced them to invest in the first place is nowhere to be found in the agreement itself. Franchise investors are in the main due diligence illiterate.

The agreement always provides that the goodwill of the business and the brands are all the sole and exclusive property of the franchisor and that the franchisor may change its configuration at any time, for any reason and without having to field test and performance prove any change before compliance with it is demanded of the franchisees.

The franchisees covenant to execute the business model as directed by the franchisor in the manual and otherwise, including participation in all programs mandated by the franchisor on the terms stated, all as may vary from time to time, and to guaranty the payment of royalties out to the end of the contract term regardless of termination or other reason for failure.

All fault for nonperformance is placed upon the franchisees while all decision making prerogatives belong exclusively to the franchisor.

Many attempts to modify the absolutist right versus wrong, franchisee versus franchisor abrasive interface have been tried and they have all come to naught.

Most of them have been in the guise of an imaginary unwritten covenant of good faith and fair dealing and more recently in the form of a so called franchisee bill of rights that exists neither in statute, ordinance or other document having any legal force whatsoever.

Finding Operational Salvation

Where does that leave the franchisees who see themselves caught in abandonment of the brand by the franchisor and in the inability of the franchisor to respond effectively to changes in market conditions?

Litigation/confrontation seems not to provide a remedy. Self help so often leads to litigation/confrontation.

And yet no one can live at sword points.

The only present tense answer to this problem lies in effective but insistent relationship management that is initiated by the franchisees acting mostly in concert with organization and a high level of competence that seems at such moments to be available only from the franchisees themselves.

How does that work?

Up to now it doesn't work at all/yet. Commitment at any effective level seems not to be an ability of groups of franchisees. As their collective minds now work, they feel entitled to competence/protection as a matter of "right" (whatever that is) and because of that they are simply waiting for someone to provide it.

Since no "right" on earth is self executing, no matter what they taught you in political science class, attitudes of entitlement produce nothing useful. Why can't franchisees seem to recognize that obvious fact?

They didn't get what they bargained for - in their minds - and want "justice". Inasmuch as what they signed on to did not provide for what they thought they were getting, they, as adults, in law are getting what they bargained for. The correct analysis is that they failed to recognize that the agreements they signed never said that they get what the sales pitch/marketing materials said they were getting.

They are not a "family".

They are in business by themselves.

They are not their own boss.

Nor, have they invested in any commercial vehicle that has prospects for a successful future -without a lot of work being done.

The courts enforce what they signed, not what they later wish they had signed.

Where does that leave them? It leaves them with only self help and self help is fraught with liability risk. The choice in a franchise system that is draining away their resources is between slow financial death and taking the risk associated with a turnaround through self help. How in hell does one accomplish that?

The Road To Glory

The road to glory is paved with personalities. There are definable personalities who are running your franchisor company. Their characteristics are known, unfortunately not any more deeply that epithetically. The things that need to be fixed spring from what is happening in the market place and the fact that their abilities to guide the company through the happenings without hurting franchisee financial performance are inadequate.

A method of approach has to be configured. It is not realistic to expect collaboration from people if your opening gambit is to itemize in loudly proclaimed expressions all their perceived shortcomings.

There is, after all, a bit of sonofabitch in each of us. We aren't perfect either. At least tacit recognition needs to be given to the fact that a close evaluation of our own constituency would uncover some warts too.

I am good and you are awful will not yield a desired response or open that door through which you must walk. This is reality.

I have sat in too many franchisee association meetings listening to epithets hurled at franchisor managers by people who were chronically late with many obligations, to put it mildly - and the principal reason for not doing what was agreed to was always self serving opportunism.

In some instances the franchisor was aware of the defaults but tolerating them for later use as bargaining chips - something that every franchise agreement specifically allows the franchisor to do but not the franchisee.

When the pain in the ass franchisee wants consent to open additional stores there will always be this stuff in his file to justify a refusal of consent. The same goes for anything else a franchisee might want to do that requires franchisor consent. The uses of those seemingly small peccadillos are many and delicious, which I have elaborated elsewhere.

While the personality profile of the people we must deal with is configured, and we have devised a few plans for how best to make the approaches we want to make, a goals agenda should be made and ranked in order of priorities. There are several, time being one and cost efficient feasibility being another. Rank the goals. Some goals will be interrelated so that they may be presented and achieved as a package, while others may need spacing.

Goals and projects need responsible people to take charge of their execution. Within your group there will probably be more than one person with a special interest in particular goals as well as the skill sets necessary to accomplish them. Identify them and privately vet their suitability and willingness to put forth the effort in a timely manner.

Each goal must have its own business plan. The plan must be cross examined viciously before it is presented, because that is exactly what management is going to do. If you cannot defend your thesis you have just wasted a lot of time and your credibility. Debug the plan to the greatest extent possible. There is an inside track for the plan. Find the management person who controls the track and win his/her support.

Until you have actually proved your ability to create and execute brand enhancing new concepts it is a hard sell. Once you have made your bones life will become easier unless you get cocky or careless.

You save up reputational wampum just like you save money. Don't spend your credibility before you make your bones on the next projects. Winners know how to share credit and shut the hell up about how great they think they are.

The road to franchisee primary participation in brand enhancement is not easy at first.

There will always be detours. It has to be managed and counseled by people who understand the process. Find such people and bring them on board to help guide you.

Theirs will be the job to ask the tough questions that members of your group will not want to ask for reasons of political correctness.

They pull their weight.

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Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop.

Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.

As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents.

Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws. As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents ("FDDs").

Many of these mistakes, which can cause delays in a franchisor's ability to obtain registration, are easily avoided. Make them, and state regulators will refuse to register your franchise offering - sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

To read my other "common mistakes in the FDD" blog posts, click here.

The Disclosure Requirement

A common FDD mistake is failure to list all "Initial Fees" in Item 5.

Item 5, entitled "Initial Fees," is where a franchisor must disclose all initial fees paid by the franchisee, and the conditions under which the fees are refundable.

Initial Fees" are defined as "all fees and payments, or commitments to pay, for services or goods received from the franchisor or any affiliate before the franchisee's business opens, whether payable in lump sum or installments." A franchisor must also disclose whether the initial fees can be paid in installments, and what those payment terms are.

Many franchisors do not follow instructions and fail to list all initial fees in Item 5. There are two types of common mistakes.

1. Common Mistake #1: Failure to List All Initial Fees Paid to the Franchisor

The first type of mistake is that the franchisor or its counsel assumes that "Initial Fees" means only the initial franchise fee paid by the franchisee (the fee franchisors charge franchisees for the right to enter into a franchise agreement). This is wrong because it ignores the other types of fees that are paid (or that the franchisee is committed to pay) to the franchisor prior to the franchisee's business opening.

In some franchise systems, there can be a multitude of initial fees charged that need to be disclosed in Item 5. Some examples:

  • In connection with processing the franchisee's application (running credit, doing a background check, etc.), the franchisor requires a deposit or "application fee."

  • The franchisor charges a fee for the franchisee to attend initial training.

  • The franchisor requires (or has the right to require) the franchisee to pay a fixed amount directly to the franchisor so that the franchisor can conduct grand opening advertising for the franchisee.

  • The franchisor charges a technology start-up or other type of fee relating to the franchisee's use of the franchisor's point of sale or other software system.

This is only a partial list of the types of fees that can fall under the category of "initial fees." I have seen many FDDs where franchisors will clearly charge these fees, but fail to list or disclose them in Item 5.

2. Common Mistake #2: Failure to List All Initial Fees Paid to the Franchisor's Affiliates

The second type of common mistake is the franchisor lists only initial fees paid by the franchisee directly to the franchisor, but ignores the fees paid to the franchisor's affiliates. The instructions for Item 5 clearly call for these fees to be disclosed, too. Remember, an "affiliate" is defined as "an entity controlled by, controlling, or under common control with, another entity."

Some examples of fees paid to a franchisor's affiliates:

  • The franchisee must purchase an initial stock of inventory from the franchisor's affiliate.

  • The franchisor's affiliate builds out the store for the franchisee (often referred to as a "turn key" franchise), and the franchisee pays the affiliate for the build-out.

  • The franchisee is required to pay the franchisor's affiliate to buy or obtain the right to use the franchisor's proprietary software system.

  • The franchisee buys an initial supply of marketing materials from the franchisor's affiliate.

Again, these are just some examples of the types of fees that are paid to affiliates. If these fees are paid before the franchisee opens for business, they are "initial fees" and must be disclosed in Item 5.

Conclusion

Avoid making these common mistakes in Item 5 of your own FDD, and you will have an easier time of getting registered in the registration states.

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My previous post described common disclosure errors that might be used to exit a franchise system. This article describes the process by which disclosure errors can produce this result. The process is by no means automatic, and it requires the involvement of an experienced franchise attorney. In some cases, even obvious and serious disclosure violations do not translate into a pass to leave a franchise system.

But where (a) significant disclosure law violations exist, and (b) applicable state law cooperates, disclosure law violations can be used to exit a system without any continuing obligation not to compete, and sometimes franchisors can also be made to refund fees or reimburse business losses.

There is no private right of action for violation of the FTC Rule under federal law, so the consequences of violation generally depend on applicable state law. If the franchisor and franchisee are located in different states, consequences of disclosure violations can be very different under the laws of their respective states.

The Franchise Agreement almost always specifies that the law of the franchisor's state applies. Frequently that controls which state's law applies.

But sometimes the franchisor is located in a state with a law that permits private actions for disclosure violations, so that the choice of law provision actually gives the franchisee rights it would not have had otherwise. In other cases the franchisee may be located in a state where either (a) state law requires a franchisor to provide a contract amendment invalidating such provisions, or (b) state law provides that contract terms applying a different state's law are not enforceable.

In some cases, the specified state may not have any law addressing FDD disclosure violations, and no lawsuit could therefore be brought for such violations, apart from the possibility of a lawsuit alleging fraud (for example, for issuing misleading financial performance representations).

In other cases, the state may have a law directed at disclosure violations, but the law may include an exemption for certain kinds of franchise sales, for example, where the franchisor is very large (think McDonalds), or the sale of the business involves a very large investment (such as a large hotel investment).

Ohio has a Business Opportunity Law which one commentator has referred to as "the Hidden Franchise Law". The law is complex, and generalizations are hazardous.

But in substance, the law requires a franchise seller to provide the purchaser with an FDD, and gives the purchaser a right to file suit if the FDD or disclosure process violate FTC regulations in significant respects. In such cases, the purchaser can bring a lawsuit and ask the court to "rescind" (or undo) the transaction, and also to award treble damages and attorney fees. In practice, many franchisors quickly offer to settle such claims once they are shown how the FTC regulations were violated.

Attorney Stanley Dub has handled many such cases, and would be pleased to discuss your situation without obligation.

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In order to offer or sell franchises in certain states with franchise disclosure laws, the franchisor must have effective registrations or notices in those states.

A state law may cover the offer or sale of a franchise if the prospect resides in the state, if the franchised business will be fully or partially operated in the state, or if any communications about the franchise offer or sale are made in, into or from the state.

State laws vary in terms of when they apply, so if any state with franchise disclosure laws is involved in any manner, you should check with the franchisor's lawyer or compliance manager about whether that state's law applies.

If the law applies and the franchisor does not have an effective registration or notice, you may be prohibited from offering or selling the franchise until after the franchisor obtains a registration or files a notice.

If the franchisor is registered with a state, the state and the effective date of the registration should be noted at the bottom of, or immediately after, the state cover page in the FDD. No effective date for a state with a state law likely means that the franchisor will need to obtain a registration from that state before you make an offer or sale covered by the law.

An old effective date likely means that the franchisor's FDD or registration will need to be updated before you make an offer or sale covered by the law.

If you have any question about a state, check with the franchisor's lawyer or compliance manager.

No effective date, or an effective date that is not within the previous 12-month period, for a notice state such as Florida, Indiana, Kentucky, Michigan, Nebraska, Texas or Utah, may not be a problem, since effective dates for those states are not required to be in the FDD, and since some of those states permit notices to remain effective indefinitely unless specific changes occur, such as address changes.

(This was the second post in a series of 11 posts on making compliant franchise sales. If you need to know more about these exact provisions, please ask for a copy of the Franchise Seller's Handbook. We will get one right out to you.)


If you want to make a legal franchise sale, you must follow certain basic franchise sales steps.

Those steps are shown in the picture below.

We will move through each step, noting the potential compliance pitfall.

1 Key Steps in the Franchise Sales Process.jpg

1. You must have a current Franchise Disclosure Document (FDD). It must be in the format specified under the FTC franchise rule and state laws.

a. The FDD may be paper or electronic.

In either case, it must be a "single document." In other words, for example, the franchise agreement and the franchisor's financials must be integrated into the FDD, and may not be free-standing.

If the FDD is electronic, it may contain scroll bars, search features, internal links and limited external links, but it must not contain multi-media features such as audio, video, animation, pop-up screens or other external links.

b. The FDD must be current.

This generally means that it must have been updated within 120 days after the franchisor's most recent fiscal year end, and, in addition, must have been updated promptly after the occurrence of any "material change" (anything such as a lawsuit, bankruptcy, fee increase, cost increase, financial reversal, or other change that might be significant to a prospect).

For example, if the franchisor has a fiscal year ending December 31, the FDD must be updated no later than April 30 (120 days after December 31). If it is not, you must not offer or sell the franchise.

You should check with the franchisor's lawyer or compliance manager before using any FDD that might be outdated because there are exceptions that may apply. For example, you can use an FDD that has not been updated after a "material change" has occurred when only the more lenient updating requirements in the FTC franchise rule apply.

Even if you are permitted to use the previous FDD, you may be required to re-disclose the prospect with the updated FDD before you sell a franchise.

Always check with the franchisor's lawyer or compliance manager before proceeding in this type of situation, giving an outdated FDD and then re-disclosing with the correctly updated FDD.

(This was the first post in a series of 11 posts on making compliant franchise sales.)

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

If you would like all these tips in a bound book, for a handy desk reference, sign up for the Franchise Seller's Handbook.

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1. Who is a Franchise Seller?

If you are an officer, employee, representative or broker involved in the offer or sale of franchises, you are a "franchise seller."

Your involvement in the offer or sale of franchises may be obvious, such as if you are a salesperson actively pursuing franchisee prospects for a franchisor, are signing agreements with new franchisees, or are accepting payments from new franchisees.

Or, your involvement may be less obvious, such as if you are participating as a finder or consultant in discussions with prospects about their business interests, pre-screening prospects through questionnaires, recommending franchise options, or assisting prospects in completing franchise application forms.

In either case, you are involved in the offer and sale of franchises, making you a franchise seller - who has to comply with a number of regulations.

2. What are Your Obligations as a Franchise Seller?

As a franchise seller, you must comply with the FTC franchise rule and numerous state laws that regulate the offer and sale of franchises.

The FTC franchise rule requires a franchisor to prepare a Franchise Disclosure Document, known as an FDD; to keep the FDD updated as "material changes" occur, new audited financials are issued and new fiscal years phase in; to follow and have its franchise sellers follow basic franchise sales steps in dealings with prospects; and to modify the basic franchise sales steps in certain special situations.

In addition, the FTC franchise rule permits and prohibits specific activities during the franchise sales process. The FTC franchise rule does not require a franchisor's FDD to be filed with the FTC, but it does permit the FTC to investigate and punish franchisors and franchise sellers believed to have violated the rule.

3. What are the Penalties for Non Compliance?

If you do not meet your obligations under the FTC franchise rule and state franchise disclosure laws ("state laws"), you and the franchisor you represent could suffer significant penalties.

The most frequent penalty is a claim or lawsuit by a franchisee which is costly to defend, and which results in a settlement or judgment requiring the franchisor to rescind or void the franchise agreement, refund the franchisee's payments, or reimburse the franchisee's damages, attorney's fees and costs.

This penalty can be financially debilitating or devastating.

Another common penalty is the loss of your job or relationship with a franchisor.

The states often seek penalties, including orders which must be disclosed to prospects for 10 years or longer, monetary payments to franchisees or the states, or restrictions on your future business activities.

In some instances, a penalty may be an FTC investigation that results in an order which you must disclose to future prospects, a freeze of your assets, civil penalties of up to $10,000 per violation, payments to franchisees, or an injunction.

In rare instances, a penalty may be a state criminal prosecution against you.

Hopefully, your desire to make legal franchise sales and this array of possible penalties will motivate you to make a serious effort to meet your legal obligations during the franchise sales process.

4. How to Effectively Comply.

Education which leads to permanent changes in business methods is the best way to effectively comply with the franchise sales laws.

To facilitate this process, we, at Akerman, have identified 11 distinct steps of franchise sales compliance which need to be understood.

Here are the 11 steps.

Step 1: Have a Current FDD

Step 2: State Registration or Notice

Step 3: Notice of FDD Formats Available

Step 4: Notice of "Franchise Sellers" Involved

Step 5: Disclosure Whenever Requested By Prospect

Step 6: Minimum Disclosure Timing

Step 7: Receipts

Step 8: Providing Final Agreements to Prospect

Step 9: Re-Disclosure If "Material Change" Occurs

Step 10: Execution of Agreements

Step 11: Post-Sale Obligations

If you would like all these tips in a bound book, for a handy desk reference, click here for the Franchise Seller's Handbook.

Many years ago I was pulled away from my usual assignments to do a major product production tolling agreement between two of America's larger food companies.

It was a stroke of luck for me because it provided something new for my interest in multivariate risks management. Since then I have prepared many multivariate high risk agreements, and it is always an enjoyable as well as remunerative adventure.

When you think of every brand as a franchise in itself, it fits perfectly into my customary practice of managing franchise relationship disconnect issues.

Recently, I have been able to mix some of my more basic interests, consuming olive oil, with my interest in being able to negotiate and prepare the enabling agreements that bring together great marketing companies in America. More specifically, working with the best producers of great Extra Virgin Olive Oil and managing risks inherent in horticulture to delivery.

This is a wonderful exercise in multivariate risk management.

Olive Oil - Fraud and Standards

The notoriety of product purity fraud in the extra virgin olive oil business has stimulated my interest intensely. I love good olive oil to a degree that borders upon religion, I think that I probably consume good olive oil at the level of a Greek.

I am now eating the world's most incredible and unquestionably pure olive oil, and every meal is almost a religious ritual.

Olive oil is something with soul. You consume it with such incredible gratitude. I long ago gave up on European wines, with occasional ventures back there only when the auguries compel it.

California and the American Pacific Northwest is to me the world's most fantastic wine producing area, but has yet to arrive when it comes to top quality and taste olive oil.

Inasmuch as good wine also enjoys the presumptuousness of highly specific imprimatur, especially in France and, to a somewhat similar degree elsewhere in Europe, one might well expect that the snooty who insist upon their nomenclature prerogatives would, when put to it, lie cheat and steal to keep the black ink flowing on their financial statements.

Tom Mueller's book and blog, Extra Virginity, depicts the degree of hardship that olive oil producers are facing in the current economic difficulties and the "blending" that has become rampant to enable what is labeled Extra Virgin Olive Oil, "EVOO", to be sold profitability.

What is blended into it is often not even olive oil.

What most Americans buy as EVOO isn't, to make a long story short.

Whole Foods Market and Standards

However, there is some hope.

I was browsing in a new Whole Foods Market in Houston last Sunday, sitting at their new wine bar placed next to the olive oil shelves.

A rather nice looking woman was looking rather lost as she tried to determine which bottle of olive oil to select.

I walked the few steps over to her and pointed to the Lapas olive oil. She asked why I suggested that and I explained to her that it was from a reliable producer and told her that it was a house brand for Whole Foods Company, one of the very few trustworthy house brands in the world olive oil trade and completely organic.

She smiled and took the Lapas bottle as her selection.

Risk Management of Sole Source Producers

Whole Foods Company had to have carefully researched this project. Contracting for a single source agricultural product in a distant and troubled economy is high risk to say the least.

I know what terms the agreement has to include, but I wondered how each of the contract risks in the Whole Foods - Blauel Group agreement was dealt with.

Fritz Blauel is an Austrian who went to Greece in the 1970s and became interested in olive oil production and cultivation in the Peloponnesus and Kalamata in particular.

The Greeks of that area were still using rather ancient methods, and he sought to influence the producers of the area in totally organic methods.

To make a long story short, he succeeded, and Whole Foods Company's house brand of really top grade olive oil (not their 360 brand), Lapas, comes entirely from Blauel's operation. He produces about 650 tons of organic top grade olive oil each year within his group of farmers, and it may be found also under the brands Mani Organic and Kalamata Gold.

The Challenge and Rewards of Risk Management

What does one think of when contemplating the establishment of such a relationship, beyond the market research and the position of the brand as a "fit" within one's business?

For the lawyer crafting the seminal protocol it is a wonderful challenge. It requires input from several specialists who will probably be found within the client company or be on retainer for the client company.

In the matter of food and agricultural products, those would include not just the market research folks but also the agronomists, food chemists, manufacturing technique specialists, those in transportation and delivery as well as the financial staff.

The issues, especially in the instance of purchasing foreign agricultural output from a single producer or single group of producers include the management of numerous risks.

When you have accounted for absolutely everything you and the group can think of you have to start playing "what if..." games. The what if games should continue throughout the process of building the relationship and the agreement, right up to the moment of signatures.

Even then you can be assured that there are contingencies you missed. When that jumps up and stares you in the face you have to rely for relief upon the credibility and trust you were able to build up during the relationship right up to the moment when the event arises, and your approach to dealing with it must be obviously fair for it to be successful.

By way of illustration, a client lost total supply from a sole source vendor for a whole product line because someone served a subpoena on the vendor without handling the diplomacy properly.

The vendor was in Iceland and it required a several day long "social event" with its Vikingesque CEO just to get talks started on the real problem. It took a few weeks to recover from the "social event". You simply cannot think of everything.

Particularly in the instance of olive oil being produced at an exceptionally high level of quality within one of the most troubled economies on the planet where no one feels secure, just the notion that minute controls can be expressed in a single writing seems farfetched.

The cultural and economic divides standing alone would be insurmountable without bringing into acute focus many talents and skills in common easy to read and effective ways.

The resulting economic engine microcosmically and with mutual compassion and grace generates profitable product integrity without sacrificing the art or the nuances of timeless beauty encapsulated within a sacred tree fruit. We are speaking of olive oil, sacred, healthful and delicious.

Commercial lawyers rarely get to work on a symphony of nuances that embrace a fundamental expression of an entire culture. Smoothing the contrapuntal rhythms into a composed useful protocol calls upon artistry of expression as it seems to seek a trivializing of the ephemeral, a capturing of spirituality.

This is an example of the grace notes of law practice. It comes to very few.

What must be produced is a reliable encapsulation of many inherently indefinite forces that are answerable in the normal course to the uncertainties of agricultural crops and worked on by farmers and associated trades as well as social and political upheaval.
At many points along the lines potential leakage can occur if care and sensitivity are not brought to bear. Investing in great things is not to be approached without the willingness to support a work of very fine art as well as a mundane agricultural food product.

Doing that with an eye upon effective economics is rather breathtaking. If you are already in this business as you read this you understand the nuances and risks.

I really enjoy this kind of work because I find myself working with extremely competent committed people who take an almost worshipful approach to the products.

Whenever I get such an assignment it is a call to celebration and wall to wall happy in addition to remunerative. Professional life doesn't get much better than that.

As always, you can call me, RIchard Solomon,  at 281-584-0519.

In this series of blog posts, we have examined the use of injunctive relief in state and federal courts in response to employees who have misappropriated confidential information and trade secrets, who have solicited clients and employees, or who have violated non-compete agreements.

In our last three posts, we identified best practices for ensuring that a company's house is in order, including the use of narrowly tailored restrictive covenant agreements (Part I); adopting a company culture and behaviors that protect its information (Part II); and why and when to seek injunctions and temporary restraining orders (Part III). In this, our fourth and final blog post in the Watch Your Assets series, we discuss the use of key injunction strategies.

A.  Who to Sue?

One of the first and most important decisions to make when seeking an injunction is who will be named as a defendant--the former employee alone or the employee and his or her new employer.  Suing the employee alone can be an effective "divide and conquer" strategy. That is, by suing the employee alone, the new employer is forced to decide whether it wants to inject itself into the proceedings or take a hands-off "wait-and-see" approach.

Generally, if the new employer has been complicit in some wrongdoing (e.g., has assisted with the misappropriation of confidential information) or has a significant monetary interest in seeing an employee avoid a non-compete (e.g., a sales employee with a significant book of business), it will team up with the employee and provide legal and other assistance. Many employers in these circumstances will also step back and suspend an offer of actual employment and tell the employee he or she must resolve the matter themselves before employment may begin.

Conversely, suing the new employer at the outset can force that employer and the former employee onto the same team, which will mean that the former employee may have company-provided legal representation and other resources available that would not have been available otherwise. It is important to think through each of these scenarios and outcomes before filing a lawsuit.

As part of the process, employers should perform due diligence about the potential adverse company, including its appetite for lawsuits, involvement in restrictive covenant cases, its outside counsel (which may inform, at least by general reputation, its level of aggressiveness), etc.

B.  Timing is Everything

As a general rule, seeking injunctive relief, especially a temporary restraining order (TRO), requires an employer to act as soon as it sees any realistic threat to its interests.

Thus, there is usually a significant amount of work required in a short period of time to gather the facts and relevant documents; examine any legal weaknesses with the contracts or claims; develop the necessary affidavits and exhibits; draft the complaint and injunction pleadings; and schedule and conduct an injunction hearing.

Of course, there are times when it makes sense to avoid a TRO and simply file a complaint with a request for a preliminary injunction, such as when there are potential enforcement issues with an agreement or other problems that can affect your ability to demonstrate a likelihood of success on the merits. In those instances, it may make sense to file a complaint with a request for a preliminary hearing but not set the hearing to put the other side back on its heels and allow you to examine the situation in more detail or try to negotiate a resolution.

Of course, taking a wait-and-see approach can be fatal to an award of temporary injunctive relief, because the other side will argue that the wait is proof of the lack of a threat of imminent harm or an otherwise adequate remedy at law.

Further, while sending a cease and desist letter prior to filing suit and waiting for a response saves expense and may possibly lead to an early compromise, there is significant risk that the former employees and competitors will take advantage of the notice period to prepare and file a declaration action in another jurisdiction before the company has an opportunity to file suit. This gives them the strategic benefit of choosing the venue and of controlling the language of the action.

The best approach is dictated by considerations of available monetary resources, likelihood of success, judgment of the litigation preparedness, and willingness of the other side, etc.

C.  Notice--Who, When, and How?

In order to secure an injunction, the requesting party will have to demonstrate to the court that it has made reasonable attempts to notify the other side that it is going before the court to seek equitable relief. This is generally not a problem with a preliminary injunction hearing, as these are usually set with the full participation of the court and the other party (who is typically already represented by counsel that has been identified in early stages of the case).

However, a TRO hearing is generally decided on very short notice without the appearance or participation of the other side, which is why the court will usually require the requesting party to provide a bond that will protect the other side from damage from an improperly issued injunction.

The tactical advantages associated with an ex parte hearing are many, not the least of which is the absence of any opposition to the motion. However, before the court will grant a TRO (and, in some jurisdictions, before it will even allow a hearing on a TRO), it will want to be satisfied that the requesting party made reasonable attempts to provide notice to the other side.

Courts are also adept at seeing attempts to game the system, such as a call to the other side from the courthouse steps when the company has been aware of the new employment for days or weeks. In general, a requesting party will want to show that it has provided at least 24 hours notice of the hearing or have a credible explanation about why it could not do so (e.g., the former employee has a copy of a trade secret formula that it is shopping to competitors or is out of town meeting with the company's biggest client in an attempt to pirate the business). Proof of attempts to provide notice of a hearing should be put in an affidavit that is submitted to the court with the injunction pleadings showing the calls, mail, service of pleadings, or other provisions of notice.

D.  Costs--Injunctive Relief Is Expensive

Securing injunctive relief can be very expensive because it requires the requesting party and its attorneys to work full speed on very short notice to review documents and interview witnesses, perform the necessary legal research, draft a complaint and a motion for an injunction with supporting affidavits and exhibits, and prepare for a hearing.

A preliminary injunction hearing usually operates like a mini (or sometimes full) trial on the merits where the parties will present live testimony, have an opportunity to cross-examine witnesses, provide opening and closing arguments, and argue the merits of the motion.

As with a regular trial, the parties will have to invest a significant amount of time, effort, and financial resources, including taking crucial employees away from their daily tasks to focus on the injunction hearing, to make a convincing argument.

As with any other expenditure of company resources, companies should engage in a significant cost-benefit analysis before committing to the injunction process. This can be difficult because these situations are usually highly emotional, which can temporarily cloud judgment.

E.  Venue--Familiarity with Local Courts, Rules, and Judges Is Key

Deciding where to sue and seek injunctive relief can be one of the most important decisions a company can make when seeking injunctive relief. Ultimately, the decision to award injunctive relief is made by a judge.

So, knowing and understanding the local judiciary can be the difference between getting an injunction or not. If federal jurisdiction is available, based either on the diversity of the parties or the existence of a federal claim with original jurisdiction, there may be a tactical advantage to suing in federal court where the judges may be more capable of managing complex facts and legal theories.

However, federal courts can be more reluctant to provide ex parteTROs and can be slower to schedule preliminary injunction hearings. Whereas in state court, you may be able to go before a judge simply by waiting in the halls of the courthouse until one will see you.

There may also be tactical advantages in forcing the other side to deal with removal or remand issues, and federal courts are widely perceived as controlling the parties and the discovery process better and being less patient with uncooperative counsel and frivolous arguments.

Ultimately, a good understanding of the local courts, judges, rules, and practice is critical when deciding when and where to seek injunctive relief.

F.  The Documents Should Never Be an Afterthought

Courts have very little time--even less than the parties in putting the documents together--to review, evaluate, and decide a TRO injunction motion and its underlying complaint.

Thus, the most critical element of success for obtaining injunctive relief is for the company to present clear, persuasive, and focused documents to the court, including the complaint and memorandum in support. The documents should marshal all of the key facts and law in persuasive, easy, and consumable bites for the court so that it (and its law clerk) has very little to do to understand and agree with the company's position.

Filing the best possible papers at the beginning of the suit also furthers the company's ability to win the credibility contest that is always front and center as the court makes initial determinations.

John C. Glancy is a shareholder in the Greenville office of Ogletree Deakins, and he co-chairs the firm's Unfair Competition and Trade Secrets Practice Group. Tobias E. Schlueter is a shareholder in the Chicago office of Ogletree Deakins, and he is on the Steering Committee for the firm's Unfair Competition and Trade Secrets Practice Group.

Two and half years ago, I wrote about the class action in Tim Horton's -part based on interviews with the class action representatives.

Now, that Burger King intends to buy Tim's, I thought it was useful to revisit the post.

Because the Burger King has an independent franchisee association, while Tim Horton's does not. Yet.

The result of the franchisee's class action lawsuit being dismissed is that Tim Horton's, the franchisor, lost a major business battle. In a rare summary judgment motion., the reasons for the judgment, part 1 and part 2 can be read here, a motions judge dismissed the franchisee's class action.

But, now Tim's will now struggle mightly to get same operator expansion as a result of this legal victory.

Like any mature franchisor, Tim's relies upon same operator expansion for its growth. It is fortunate to have a substantial number of operators who have grown with the system from near the beginning.

Sophisticated operators know that franchise operations need modification and changes. And Tim's is no exception. This type of operator needs to know how to plan and budget for such changes, paying for them in part by the expected increased return.

But, now that planning process is riddled with uncertainty.

In 2002, after considerable debate with its franchisees, Tim's introduced a centralized baking system. Tim's baked centrally and shipped frozen products to its stores. (Only in Canada could one say with a straight face that these baked goods were "Always Fresh".)

The par baking facility was funded by the TDL Group and constructed by its joint venture partner, IAWS. These joint venture partners contributed approximately $95 million (US) in 2002.

During 2002 to 2009, the 3,000 franchise owners collectively contributed approximately $100 million (Can.) for store modifications, without which the joint venture partner's par baking facility would be useless.

At issue in the class action lawsuit, was whether either the franchise contract or the equity of fair commercial dealing required that the return on the joint venture partnership be commensurate with the return on the franchise owners collective investment.

This would appear to be a difficult question of fact and law requiring a trial.

But, the motions judge handed Tims and TDL, a complete legal victory yet possibly a business disaster.

As reported by Robert Thompson, who wrote Ron Joyce's biography, the founder of Tim Horton's,

"Stores had once made upwards of 20-percent margins, a windfall for the mom-and-pop shops that were often operated by pioneers who entered the business in the early 1970s. Margins fell under Wendy's management, and Joyce was concerned they would continue to decline after the IPO, which is exactly what Jollymore alleges was the case.

These days, those close to Joyce say stores are lucky to make 13 percent, a steady decline from a decade earlier."

Sophisticated operators like the representative plaintiffs, the Jollymores, know now that the franchise contract doesn't require any equitable sharing on the returns made as the result of the franchisee's collective investment of new capital.

The Court sanctioned unfairness will make it difficult for Tim's to continue to grow with same operator expansion.

Analysts of the public company may wish to reflect on another franchisor who spurned same operator expansion - Jackson Hewitt. Bankruptcy looms nearer when the experienced franchisor operator as a group doesn't expand. The Jackson Hewitt franchisors did not share equitably with the franchisees the fruit of the Refund Anticipation Loan program, "RAL". The franchisees refused to expand the system, and so when the franchisor needed their support it wasn't there. The franchisor needed the franchisee's support for expansion when the RAL program was gutted by the IRS.

We can hope that the Jollymores, Ron Joyce, and the other franchise owners will now see the wisdom in what Colonel Sanders saw many years ago when he imbude his franchise owners with real protection - for the betterment of the franchise system.

"When Colonel Sanders sold Kentucky Fried Chicken, he feared his franchisees would lose control of their own businesses and the future that they were working toward and in which they had invested.

So he encouraged them to unite to protect the franchisees that he considered part of his own "family" and to give the franchisees a voice in the future development of a concept which would prove to be far greater than was envisioned at the time.

This brought about several small meetings with early franchisees and in 1965 the Southeastern Kentucky Fried Chicken Franchisee Association was formed and formally organized in Atlanta, Georgia.

Ten years later, the AKFCF (our national association) was incorporated in the same city.", from the Association of Kentucky Fried Chicken Franchisees website.

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You're a franchisor. You don't want to be a Joint Employer of your franchisees' employees. Your franchise agreement goes into detail on how your franchisees and their employees are not on your payroll. And you do not have any employer responsibility.

Well that was easy. Your law firm has made it clear in your contract. You are in no danger.

Not so fast.

Some people in federal and state government think otherwise.  And they don't seem to be reading your franchise agreement the way you want them to.

So what can a franchisor do?

Stop doing things that make you an employer. Even the nice things your franchisees like.

Here are a couple of true stories about kind franchisors helping out their franchise owners.

One -Train Your Franchise Business Consultants 

There once was a long time franchise owner whose only daughter was getting married. This franchisee was Greek, very religious and his daughter was having a destination wedding in Greece. The whole family was going and all the relatives from around the globe were attending. 

The franchise owner had a problem. He was going to Greece for two weeks and his family members who worked in their franchises were going too. 

He told his Franchise Business Consultant that he was concerned about being short-handed while he was away and asked him to watch over his busineses in his absence. 

The franchise business consultant knew the family well and had watched his franchisee's daughter grow up in the business.

Franchise Business Consultant agreed to oversee the businesses. 

The Franchise Business Consultant checked in with the managers daily on the phone or in person. He even used his weekend time-off to ensure things were being managed correctly. Reviewed their schedules to ensure crew labor was under control. Made certain the daily deposits made it to the bank. Reviewed the incoming mail. Took care of supplier payments. And gave direction to the managers and employees as needed. 

He solved his franchise owner's temporary management problem.

The wedding went off without a hitch the franchises were managed by the Franchise Business Consultant.

Two - Stop "Helping" with HR

Franchisor had very conscientous Vice President of Human Resources along with a great Director of Operations. Franchise owners were asking for help. 

They wanted employee handbooks for their businesses and employees. Franchisees knew that the franchisor had very good HR systems for its company owned units and thought why not use what the franchisor was using.

The franchisor's employee handbook had been developed by pros, regularly updated and had been in use for some time. No reason to reinvent the wheel.

So the Vice President of Human Resources slapped a little disclaimer on the franchisor's document saying that the franchisees should get the template reviewed by the franchisees' respective employment attorneys before using it. And that the franchisees' would hold the franchisor harmless if something went wrong.

Franchise owners were very happy they didn't have to go through the time and expense of developing their own employee handbook and their problem was solved by the conscientious Vice President of Human Resources and great Director of Operations.

Franchising is full of people who care deeply about franchise owners and would do most anything they could to help out in a pinch. 

What could possibly go wrong for the franchisor in either of these situations?

Seems harmless enough and the franchisor was just helping out franchise owners, right?Stop 

If you are a businessperson, sooner or later you will have to deal with a lawyer. In the franchise world, it helps - tremendously - to deal with attorneys who understand franchising and franchise law. It doesn't matter whether you are a franchisor or a franchisee; no matter which side of the transaction you happen to be on, you will want an experienced franchise attorney to be on the other side.

Surprisingly, the level of franchise law knowledge among attorneys who actually get involved in franchise transactions varies considerably. The majority of the time, lawyers who are knowledgeable in franchise law are on both sides of the transaction. But that is not always the case. Sometimes, the attorney on the other side is inexperienced, and "dabbling," in franchise law.

This is the second of a two-part piece on why attorneys who are inexperienced in franchise law can hinder a transaction, or worse, do harm to their clients. To read part one, discussing the problems that inexperienced franchisee counsel can cause for their clients, please click here.

This article explores the problem of inexperienced counsel from the point of view of the franchisor, which is using an attorney that has little or no familiarity with franchise law (or, even worse, the company is using a consultant who is not a lawyer).

Why Franchisors sometimes use Inexperienced Legal Counsel?

If a company is considering franchising its business (a "start-up" franchisor), one of the first things the company does is look for legal counsel. Finding an experienced franchise attorney is not a simple task; there are only a few hundred attorneys in the country that specialize in franchise law. A start-up franchisor may look to its local business attorney to help the company draft its franchise agreement and franchise disclosure document ("FDD"), and otherwise help the company comply with its legal obligations.

The business attorney may be tempted to do the work, instead of referring it to another lawyer. After all, form FDDs and franchise agreements are relatively easy to find, and many of them look similar to one another. But the problem is that franchise contracts and FDDs aren't "one size fits all" legal documents, and the franchise relationship isn't a typical business relationship. It is critical for attorneys who work in franchising to understand the documents they draft, the legal requirements for disclosure (both federal and state), and how the pieces of the documents need to fit together.

For example, an experienced franchise lawyer will understand the types of fees that are typically charged, and how those fees can be tailored to the client. The lawyer will know how fees can be used effectively to encourage compliance by the franchisee, and in what situations liquidated damages could be used effectively to decrease legal costs in the event of a dispute between the parties, and when those same fees should not be used. The experienced attorney will know where and how those fees must be disclosed in the FDD.

Counsel experienced in franchising will also understand the interplay between territorial protection (or territorial exclusivity) and the areas in which the franchisee will and won't be permitted to sell. Whether a franchisor offers exclusive or protected territories, and how those territories are defined, will depend on the type of franchise system, the franchisor's expansion plans, the nature of the business the franchisee will conduct, and the franchisor's internal franchise sales goals.

An attorney with little or no understanding of franchise law can inadvertently harm the client's business by failing to understand whether a protected territory even makes sense for the client and, if so, how the territory can or should be determined. Moreover, an inexperienced attorney may not understand the types of carve-outs from the scope of territorial protection that may be necessary or useful to protect the franchisor and its possible future expansion plans.

I could easily keep going - there are a multitude of areas that need to be addressed in the franchise agreement and FDD where the attorney must have a substantial background in franchising to adequately represent his or her client.

The Problems Caused by Inexperienced Franchisor Counsel

When an attorney who lacks franchise law experience drafts the start-up franchisor's FDD and franchise contracts, it can cause a number of substantial problems for the company.

First and most significantly, a poorly-drafted FDD can lead to significant liability for the franchisor. The form and content of the FDD is controlled by both federal and state law, and a franchisor can be held liable for an FDD that does not comply with those laws. A number of state laws give their regulators significant power to address franchisors' failure to comply with registration and disclosure requirements. These powers can include steep fines (that may be multiplied by each infraction or unlawful sale); the power to order a franchisor to rescind the franchise agreement of any franchisee who has been unlawfully sold a franchise; or, worst of all, the right to assess criminal penalties (including imprisonment) against the individuals who control or have decision-making power for the franchisor.

And that's just on the regulatory side. A franchisor can also face significant liability to its franchisees if it has sold them franchises without complying with federal or state law. Although the Federal Trade Commission's Franchise Rule does not give individual franchisees a private right of action against a franchisor for its failure to comply with the Rule, many state laws do create a separate cause of action that can be used by an aggrieved franchisee.

Even in the states where the franchisee does not have the right to sue based on a disclosure law violation, state common law will often provide a remedy to the franchisee through fraud claims. If the franchisee relied on a material representation made in the FDD that was false or misleading, and was reasonable in doing so, the franchisee can likely sustain a legal claim against the franchisor for that misrepresentation. Inexperienced counsel can lack the experience to provide his or her franchisor with the guidance needed to avoid inadvertently making a misrepresentation or false statement.

For example, an attorney who dabbles in franchise law may not have a full understanding of what is required of a franchisor who makes financial performance representations in Item 19 of its FDD. Without a full understanding of the guidelines for making an earnings claim, it is possible for a franchisor to make a misleading representation without intending to do so (by, for example, presenting an unreliable, misleading, or unreasonable subset or using numbers without a reasonable basis or written substantiation). This type of mistake could easily lead to significant liability for the franchisor - and, indirectly, for the dabbling attorney.

Even more troubling is the problem of franchise consultants - who are not attorneys - preparing FDDs and franchise agreements without the consultation or assistance of an experienced franchise lawyer. These individuals and companies risk substantial liability through an unauthorized practice of law claim in any jurisdiction where their documents are used.

Conclusion

These risks are not merely theoretical. There are a multitude of reported cases where a franchisor has been held liable for mistakes made in its FDD, with the imposition of significant damages. Often, liability could have been avoided with a more carefully-written FDD. Several other cases have also resulted in a lawyer or non-lawyer franchise consultant being held liable for malpractice or the unauthorized practice of law where material errors were made in the FDD that led to liability for the franchisor.

For these reasons, franchisors should avoid hiring attorneys who dabble in franchise law, and instead seek out experienced franchise counsel. Both franchisors and franchisees benefit when knowledgeable counsel is involved on both sides of the transaction.

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As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents. Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws.

As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents ("FDDs"). Many of these mistakes, which can cause delays in a franchisor's ability to obtain registration, are easily avoided. Make them, and state regulators will refuse to register your franchise offering - sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

To read my other "common mistakes in the FDD" blog posts, click here.

The Disclosure Requirement

A common FDD mistake is failure to list all "Other Fees" in Item 6. Item 6, entitled "Other Fees," is where a franchisor must disclose all fees, other than initial fees, that are paid to or imposed by the franchisor. Specifically, in Item 6 a franchisor is directed to disclose "all other fees that the franchisee must pay to the franchisor or its affiliates, or that the franchisor or its affiliates impose or collect in whole or in part for a third party." The franchise company must list the type of the fee, state the amount (either a fixed amount or a formula used to determine that amount), state the due date, and make any remarks, definitions, or caveats regarding the fee.

Many franchisors do not follow instructions and fail to list all "other fees" in Item 6. These mistakes typically come in two varieties.

    1.        Common Mistake #1: Failure to List All "Other Fees" Paid to the Franchisor or its Affiliates

The first type of mistake is that the franchisor or its counsel fails to list all of the fees that could be charged during the life of the franchise according to the franchise agreement. In these situations, the franchisor may list only the more "obvious" fees like the royalty fee, advertising fund fee, technology fee, and the like - the fees that are typically identified in a section of the franchise agreement devoted specifically to listing fees.

The problem with this approach is that often, a number of other possible payments are hidden within other section of the franchise agreement, and these amounts clearly fall within the definition of "other fees" in Item 6.

There can be a multitude of fees charged that may be hiding in the franchise agreement but need to be disclosed in Item 6. Some examples: 

  • The franchisor charges a "relocation fee" in the event that the franchisee wants to relocate the franchised business.
  • The franchisor charges a mark-up fee if the franchisor is required to obtain insurance for the franchisee, because the franchisee failed to purchase insurance on its own.
  • If the franchisor conducts an audit of the franchised business that shows the franchisee has understated its gross revenue to the franchisor, the franchisor charges the franchisee for the cost of the audit (in addition to the other rights that it retains under those circumstances).
  • The franchisor charges a fee for the franchisee to send a replacement manager to attend the franchisor's initial training program.
  • The franchise agreement has a liquidated damages provision that requires the franchisee to pay a set amount if the franchise agreement is terminated early due to the franchisee's material uncured breach of the contract.
  • The franchisor requires the franchisee to pay for or reimburse the franchisor for the cost of advertising, marketing or promotional materials provided by the franchisor.

This is only a partial list of the types of fees that can fall under the category of "other fees." I have seen many FDDs where franchisors will clearly charge these fees, but fail to list or disclose them in Item 6.

2. Common Mistake #2: Failure to List All Initial Fees Imposed and Collected by the Franchisor

The second type of common mistake is the franchisor lists only fees paid by the franchisee directly to the franchisor, but ignores the fees that are imposed and collected by the franchisor. The instructions for Item 6 clearly call for these fees to be disclosed, too.

Some examples of fees that might be imposed and collected by a franchisor: 

  • The franchisor uses a third-party company to conduct "mystery shop" visits, but pays the third-party directly and bills the franchisee as a pass-through cost.
  • The franchisor has a centralized toll-free phone number for the system, and charges the franchisee its pro rata share of the cost of the number.
  • The franchisor requires the franchisee to use a third-party software, the third party charges a license fee for that use, and the franchisor pays the fee on the franchisee's behalf and then bills the franchisee for the cost of the fee.

Again, these are just some examples of the types of fees that might be "imposed and collected" by the franchisor.

3.            Common Mistake #3: Over-listing Fees in Item 6

The final type of mistake is not as problematic as mistakes #1 and #2, but a franchisor should strive to avoid it anyway. Many times, a franchisor will list too many fees in Item 6, and include fees that are not called for by the FDD Guidelines. A franchisor should avoid listing these fees because they clutter and unnecessarily lengthen the FDD. Moreover, both the Federal Trade Commission and the various states that regulate franchise companies admonish franchisors to not include information in the FDD that the Franchise Rule or state law do not specifically call for.

Some of these over-disclosed fees that I have seen listed in Item 6 of franchisors' FDDs include:

  • The franchisee's required local advertising spend, which need not be included in Item 6 unless the amount will or could be paid to the franchisor or its affiliates.
  • The franchisee's rent payment obligation under its lease, which does not need to be disclosed in Item 6 unless the franchisor leases space directly to the franchisee.
  • The franchisee's expected employee salaries.

Again, the listing above is only a partial one - I have seen many different fees included in Item 6 of franchisor FDDs when they clearly did not have to be listed there.

Conclusion

Avoid making these common mistakes in Item 6 of your own FDD, and you will have an easier time of getting registered in the registration states. You may also avoid liability due to claims by franchisees that you did not comply with disclosure laws by failing to disclose fees as required by law.

Restaurant operators who think they are vigilant about the security of their customers' credit cards may want to do some double-checking in the wake of P.F. Chang's China Bistro Inc.'s reported data breach."

If there is one issue which causes sleepless nights for business executives, it has to be data privacy and security. While the laws are still being updated and drafted for new technologies and new threats, businesses need to address these issues now.

Financial, healthcare, and retail brands all have legal requirements to protect consumer data.

These have been in place for many years but federal and state agencies are increasing regulation and enforcement actions. Data breach and customer notification laws are in place in every state. A federal uniform standard has not been enacted.

Plaintiff's Bar is Prepared

The plaintiffs' bar is quickly latching onto class actions and other private enforcement actions to seek redress for consumers who have suffered privacy invasions. With new technologies and new ways to capture and use personal information, the risks are increasing and lawmakers will be forced to respond by passing more legal strictures and regulations around such data.

In the big picture, companies face three basic types of risks: (1) external; (2) internal; and (3) human error.

1. External Risks

External risks for data breaches occur when someone outside the organization "breaks into" the organization's information network to try to secure items of value - such as financial information, credit card numbers, personal codes and other information of value.

External actors obtain the information to sell to others in the "information black market" or use the information themselves to carry out fraud schemes. For example, one of the important tools for healthcare fraud is Medicare and Medicaid identification numbers which are commonly sold in the information black market.

2. Internal Risks

Internal risks for data security focus on when an organization's employees or authorized users access the information network to secure personal information for their own benefit. The employees or authorized third parties will steal the personal information for their own benefit to sell to other criminals or carry out their own schemes.

3. Human Error

The third, and perhaps most overlooked risk, is human error. Many times a security breach is the result of human error or security lapses. An information security network may be improperly designed or implemented leaving some employees at risk for error and causing harm to the organization. Even if network security controls are in place, employees or authorized affiliates or third parties can make mistakes.

It is obvious to point out that not all data breaches are alike. Whatever the cause, poor planning and security steps can have a devastating impact on an organization. The cleanup process, the notifications and remedial steps can hinder an organization for years. Civil lawsuits and possible state and federal enforcement actions are increasing and can result in fines and penalties.

Even aside from these obvious consequences, organizations can suffer serious reputational harm. Public disclosure of data breaches is more common today. Consumers, however, are taking greater account of these infractions because of increased sensitivity to the protection of personal information.

Information security does not mean adoption of a boilerplate policy with no change in network security protocols or systems. As usual, information security starts with an assessment of existing security and identification of deficiencies and risks.

Once that is done, organizations need to determine what information needs to be secured and what types of rules and protections are needed to protect that information.

A holistic approach enables an organization to allocate information security resources to areas of greatest need based on a ranking of deficiencies and risks.

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The special situations described below may excuse you from following, or may modify how you follow, the basic franchise sales steps described earlier in this handbook. As to each prospect, you must determine whether a special situation applies and how that affects your disclosure obligations.

If you think a special situation is involved, check with the franchisor's lawyer or compliance manager before making a decision not to follow the basic franchise sales steps.

Situation 1: Transfer of Franchise

FTC Franchise Rule. Under the FTC franchise rule, if an existing franchisee is transferring a franchise to a new owner, you must follow the basic franchise sales steps for the new owner if the terms of the new owner's agreements will be materially different from the terms of the existing franchisee's agreements, or if the franchisor has had or will have significant involvement with the new owner during the transfer process.

If the new owner will be signing the franchisor's current agreements, as opposed to the agreements previously signed by the existing franchisee, it is likely that the current agreements contain materially different terms and that you must follow the basic franchise sales steps. Or, if you or the franchisor located the new owner for the existing franchisee, or have or will become involved in "selling" the new owner on the benefits of becoming a franchisee, it is likely that you are required to follow the basic franchise sales steps.

If the new owner will be assuming the agreements previously signed by the existing franchisee, and if you and the franchisor have been or will be involved with the new owner during the transfer process only to determine whether to approve the transfer and to negotiate the terms of the franchisor's consent to the transfer, it is likely that you are not required to follow the basic franchise sales steps. This will be very advantageous if the transfer is occurring in a regulatory state and the franchisor is not currently registered or on file with the state, because you may proceed without following the basic franchise sales steps.

However, even if you are not required to follow the basic franchise sales steps, the franchisor may have a policy of requiring you to provide the new owner with an updated FDD "for informational purposes" before the transfer occurs. Check with the franchisor's lawyer or compliance manager before making a decision not to follow the basic franchise sales steps.

State Laws: The laws of the regulatory states  generally are consistent with the FTC franchise rule, but they contain some anomalies.

For example, the New York law requires the existing franchisee (seller) to furnish to the prospective franchisee (buyer) a copy of the franchisor's FDD currently registered with the New York Department of Law, at least 7 calendar days before the earlier of payment by the buyer to the seller, or the execution of any binding purchase agreement.

Most of the state laws excuse an existing franchisee from registering or filing a notice before dealing with a prospective new owner, as long as the transfer involves an entire franchise. Special rules may apply if the transfer involves just part of a franchise, such as part of a territory. Some state laws are silent on how transfers should be handled, but generally are enforced consistent with the approach under the FTC franchise rule. If you think a state law might apply, check with the franchisor's lawyer or compliance manager about any special requirements. 

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Did You Make this Mistake When Signing Your Commercial Lease?

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The call came just when Kevin was about to drain the last of his scotch. The muffled ring startled him a little as he gazed lazily across the soft white sands to the calm ocean waters gently caressing the beach.

He hardly ever received phone calls anymore, not since buying a condo in an exclusive St. Lucia's resort - aptly named Sugar Beach - almost five years ago.

Unless, of course, it was the concierge informing him about the dinner reservations he had made for him at yet another five star restaurant, or his masseuse confirming his weekly appointment.

His mind briefly flashed back to former times - another place in another time, when he had managed his own franchise retail stores in Virginia and Maryland, working relentlessly to make his dream come true - to be his own boss and to prove his business acumen by the only true scorecard that has ever been used for centuries - a healthy financial statement.

And a very healthy financial statement it had turned out to be after eight years running his "Pause for Paws" franchise units.

Who knew that pet pedicures would be so popular? Talk about the golden dog laying the golden.... Well, anyway, he was very well off, and he had developed a warm spot in his heart - and wallet - and for those canines, felines, and other pampered pets.

The rude, persistent ring tone refused to allow Kevin to reminisce. "All right, already," he bellowed as he rummaged through his beach bag in search of his I-phone. He could see as he picked up the device that it was his accountant back in the States.

"We have a problem," Harvey announced flatly. "The buyer of your P for P store has gone out of business, and now the landlord is demanding that you pay the back rent and damages. Some $353,000, or thereabouts."

The slight breeze suddenly felt very cold as Kevin tried to process this unexpected disaster. "Why is the landlord coming after me," he asked weakly, "I haven't been involved with the business for over six years now. How could this be happening!?"

Unfortunately for Kevin, he had been so focused upon the planning, learning, hiring, training and everything else that consumes a new franchisee starting a business that he gave too little thought to the commercial lease he had to sign for his new store.

"As long as I pay the rent on time, I'll be okay," he had reasoned back then.

"Besides, I will have such a poor negotiating position, it makes no sense to waste time and money having an attorney review my lease."

He had been too distracted with the pressing demands of an exciting new venture to focus on the fact that his entire business would depend upon the soundness of his lease, by far the biggest asset - and liability - of his nascent enterprise.

Too often franchisees like Kevin fail to appreciate the substantial financial obligations he or she is being straddled with: even modest space of between 1,500 - 3,000 sq. ft. can have cumulative minimum rent obligations in the $700,000 to $900,000 range for a typical ten year term, plus common area maintenance, real estate taxes and insurance charges that keep going up over time.

Moreover, if a purchaser of the business elects to exercise extension rights, those obligations will only continue even longer. The landlord does not have to try to get any money out of the existing tenant, either; he can come directly after the fat guy downing booze on the beach.

It's true that a newly established business needing only a few thousand square feet of retail space is not going to have the same leverage as an anchor tenant, but there are many important provisions in a lease where a landlord has significant flexibility - indeed, almost all retail developers have already drafted second and third level positions on many important lease issues they anticipate a tenant's experienced legal counsel will raise; low-hanging fruit that can even the smallest tenant can grab - but only if he knows what those issues are, how to articulate the winning arguments, and how far one can push.

As Kevin found out too late, most landlord retail lease forms insist that the initial tenant remains liable under the lease for the full duration of the term - even if the business is sold to another person in the meantime.

On top of that, the standard personal guaranty Kevin was also required to sign put all of his personal assets behind that commitment.

It doesn't need to be that way, though. Often a landlord will agree to a significant but manageable liquidated damage amount for tenant defaults occurring after a certain period of time, or to the termination of the personal guaranty after the initial term, or to a full release of the initial tenant and its guarantor if a replacement tenant, together with a replacement guarantor, has at least a certain minimum net worth.

The point is, there are many ways to avoid this open-ended nightmare: if, like Kevin, you worked hard and "hit a home run" in the business world, you should not have to worry about an ugly hand from the past snatching it all away in an instant.

On-going tenant liability is only one of many ways in which a standard retail lease form can destroy a franchisee's exit strategy from a successful business. No franchisee should have his winning business plan become a financial disaster because he sought to "go budget" on the most important legal document he would ever sign.

"Don't worry," offered Harvey, "my brother, Rich, is a litigator. He'll find a way to fight this and maybe cut your losses - if we give him enough time to look into it."

"Yeah," sighed Kevin, "and we give him a big enough retainer."

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(Gordon has been representing retail tenants around the country for nearly thirty years, including serving as corporate counsel for twenty-two years leading new store site acquisition teams for major corporations, such as Costco Wholesale Corporation. In 2013, he decided to apply the extensive experience he had gained going toe-to-toe with the major retail developers around the country to the representation of the underserved small to medium-sized business client seeking to rent retail space.

Inspired by Costco's model of high quality goods and services offered with a spartan cost structure, Gordon joined a virtual law firm, Fisher Broyles, LLP, that enables him to offer all of the benefits of a major law firm - a large group of experienced, partner-level only attorneys representing clients in a broad array of practice areas ,with offices in eleven major cities throughout the United States - with the responsiveness and economy only possible through the maximum utilization of available technologies.)

As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents.

Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws. As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents ("FDDs").

Many of these mistakes, which can cause delays in a franchisor's ability to obtain registration, are easily avoided.

Make them, and state regulators will refuse to register your franchise offering - sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

The Disclosure Requirement

On the top of the list of these common FDD mistakes is the franchisor's failure to comply with the requirements for Item 2. Item 2, entitled "Business Experience," is where a franchisor must list employment history of certain of its key officers, managers, directors, and employees. The instruction for completing Item 2 is a simple one:

Disclose by name and position the franchisor's directors, trustees, general partners, principal officers, and any other individuals who will have management responsibility relating to the sale or operation of franchises offered by this document.

For each person listed in this section, state his or her principal positions and employers during the past five years, including each position's starting date, ending date, and location.

That's it - that is the entire instruction for Item 2. The instruction does not call for the franchisor to give the entire resume, or even a mini biography, for its key personnel. But that's exactly what many franchisors tend to do.

Common Mistakes in Item 2

The franchisor's natural tendency in Item 2 is to use it as a sales tool - explaining why and how its key people are well-qualified, outstanding individuals with a long history of leading successful companies, and why they are great human beings, to boot. Here's an example of how a non-compliant, overly-descriptive Item 2 might look:

Jules Winnifield, President

Jules has been the President of Jack Rabbit Slim's Franchising Company for six years, and has been the driving force behind growing our franchise system from two locations to seventy-five. Before coming to work for Jack Rabbit Slim's, Jules was the Chief Operating Officer of Red Apple Security, one of the largest private security companies in the world. During his eight years at Red Apple, Jules was responsible for a 22% increase in revenue company-wide. Jules earned his Ph.D in Behavioral Psychology from the University of Santa Cruz in 1992. In addition to his hobbies, which include walking the earth and memorizing passages from important works of literature, Jules enjoys spending time with his wife, Mia, and his children, Marsellus and Lance.

So what's wrong with the above description? A lot.

First, it provides only a small portion of the information called for by the instructions in Item 2. While it does at least describe where Jules has been employed for the last five years, it doesn't tell you the dates of employment or where those positions were located.

Second, the listing reads like a sales pitch, telling the prospective franchisee why Jules is so well-qualified for his current position. Nothing in the instructions for Item 2 asks the franchisor to provide that information.

Third, the franchisor has provided more than five years of work experience for Jules, going back more than thirteen years into Jules's prior employment.

Fourth, the Item 2 instructions do not call for educational experience - only work history. And in this situation, it's not even clear that Jules's doctoral degree is even relevant to his current line of business.

Fifth, nothing in the guidelines asks a franchisor to provide information regarding the hobbies or family members of its key personnel.

You might think I'm exaggerating non-compliance with Item 2 when I list Jules's hobbies, wife and children. I'm not. I've seen many franchisors provide exactly that type of information in Item 2 of their own FDDs. 

Here's how an Item 2 disclosure should look:

Vincent Vega, Chief Executive Officer

Vincent has been our Chief Executive Officer since March 2012. Prior to becoming our CEO, Vincent was President of Butch's Boxing Club in Inglewood, California, a position he held between December 2010 and March 2012. Before that, Vincent was the Vice President of Operations for McDonald's in Amsterdam, the Kingdom of the Netherlands, a position that he held between October 2006 and December 2010.

The above Item 2 description is correct because it provides all of the information called for by the instructions, and only that information. Vincent's work experience the location of each position he held is listed in the description, and his starting and ending dates with each employer (month and year are all that is necessary) are given. The disclosure gives enough information to cover his last five years of employment, and no more.

Conclusion

Avoid making these common mistakes in Item 2 of your own FDD, and you will have an easier time of getting registered in the registration states. While it may be tempting to include the extraneous information in Item 2, your doing so will increase the likelihood that you will obtain comment letters from those states, and that your registration will be delayed as a result.

Execution of Agreements

The franchise sales process does not end until final agreements are executed by the parties. When you receive back the final agreements signed by the prospect, they are not executed. The franchisor must countersign the agreements for them to be executed. Only when the franchisor countersigns the agreements does the franchise sale occur and the prospect become a franchisee.

If a "material change" occurs, or if a state registration expires, before the franchisor countersigns the agreements, obligations to re-disclose the prospect and re-observe all waiting periods may be triggered. So, if the franchisor wants the prospect as a franchisee, you should arrange for the franchisor to countersign the agreements as soon as possible.

Post-Sale Obligations

The franchisor must retain a copy of each materially different version of its FDD for 3 years after the close of the fiscal year when it was last used. Some states require longer retention periods.

If the prospect signs a franchise agreement, during the entire life of the franchise and for several years beyond, the franchisor should retain copies of all communications from and to the prospect during the franchise sales process, and copies of all signed FDD receipts and all executed final agreements.

By law, signed FDD receipts must be retained at least 3 years, or even longer for sales in some states.

Even if the prospect does not sign a franchise agreement, the franchisor should retain copies of all signed FDD receipts, and of all communications from and to the prospect during the franchise sales process, for at least 3 years, or even longer for offers in some states.

(This was the last post in a series of 11 posts on making compliant franchise sales. )

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If a "material change" occurs at any time after you furnish a prospect with the franchisor's FDD, the franchisor must update the FDD, and you must re-disclose the prospect with the updated FDD and re-observe all waiting periods.

A "material change" may be voluntary or involuntary.

Voluntary "material changes" include, for example, changes to any fee, the size of territories, territorial rights, any substantive term in any agreement in the FDD, the products or services offered by franchisees, the initial investment required or the franchisor's name, and may include changes to the franchisor's leadership team.

A lawsuit filed by the franchisor against a franchisee generally is not a material change that requires immediate updating and re-disclosure, even though the franchisor must disclose the lawsuit when it does its annual FDD update.

Involuntary "material changes" generally are negative, and include, for example:

    • a significant legal proceeding brought against the franchisor or anyone on its leadership team;

    • a significant deterioration in the franchisor's financial condition;

    • a bankruptcy of the franchisor or anyone on its leadership team;

    • a significant loss of franchisees in a state or nationally;

    • the loss of an important trademark registration, or;

    • a similar adverse development.

If you are concerned about whether a "material change" has occurred, check with the franchisor's lawyer or compliance manager before continuing to offer the franchise or having a prospect sign final agreements or make any payment to the franchisor or any affiliate.

You may be told that the FTC franchise rule does not require re-disclosure.

To some extent this statement is true. However, most state laws, as well as general state common law fraud principles, require re-disclosure.

(This was the ninth post in a series of 11 posts on making compliant franchise sales. )

The International Franchise Exposition ("IFE") is coming back to New York City again for this summer of 2014. In order to continue enabling franchisors that are not registered to sell franchises there, the State of New York has again renewed the limited exemption to its Franchise Sales Act (N.Y. Gen. Bus. L. § 680 et. seq.) (the "Act"). The three-day exemption allows franchisors that are not registered with the State to participate in the 2014 IFE under certain circumstances.

An eligible franchisor that files and complies with the exemption rules will be permitted to exhibit and offer for sale, but not to sell, franchises at the IFE. Before a company can actually sell a franchise covered under the Act, the franchisor would still have to register with the state as provided under New York law.

Why the distinction between making an "offer to sell" and "selling" a franchise? It's because ordinarily, an unregistered franchisor that exhibits at a trade show in a franchise registration state would potentially violate that state's registration law. The way most registration state laws are written makes it illegal to either offer to sell or to sell a franchise without first being registered there. Arguably, simply exhibiting at the show is making an "offer to sell" a franchise.

Franchise companies have long argued that these state franchise registration laws unnecessarily discourage commerce by preventing them from participating in franchise expos when they are not registered, even where those franchisors do not plan to make franchise sales without complying with applicable state law. 

Franchisors (and companies that are interested in franchising) contend that participating in trade shows can provide a valuable opportunity for them to "test the waters" to determine the market demand for their concepts. If franchisors (and companies that are interested in franchising) are allowed to participate in trade shows without having to first register in the host state, they would be able to gain valuable insight from comments and suggestions made by prospects, other franchisors, and even attending consultants.

From the franchisee's perspective, greater trade show participation by franchisors will increase the availability of information about a variety of concepts and give them the opportunity to obtain information, one-on-one, from representatives of those concepts - an opportunity that is unique to the franchise expo format. Franchisees contend that franchisors that participate in franchise expos are usually better-educated about franchising.  It follows that better-educated franchise companies make better franchisors, and will result in higher-quality Franchise Disclosure Documents and better franchise systems.

This exemption may prove critical even to franchisors that file to register in New York in advance of the IFE. During 2013 (at least based on my own experience in representing franchisors that applied to register in New York), New York was one of the slowest states to respond to franchise registration and renewal filings, often taking three or more months to register a franchise. If the same holds true in 2014, a franchisor that plans to exhibit at the IFE, but has not already obtained registration in NY by early May 2014, should consider filing for this exemption to ensure that it can do so without violating state law.

To take advantage of New York's exemption, a franchisor is required to complete and submit an application exemption form and supporting materials to the Office of the New York Attorney General. Follow the link: application form for U.S.-based franchisors / application form for international franchisors. Please note that exemptions are not automatic; the Attorney General's office will review applications and reserves the right to deny any request. For this reason, it's important for franchisors planning to take advantage of the exemption to file well in advance of this year's IFE.

The franchisor or you will be preparing and providing to the prospect the final agreements to be executed by the parties.

If the final agreements differ from those in the FDD only to the extent of "fill-in-the-blank provisions" (see definition in Appendix B) or changes made in response to negotiations initiated by the prospect, then you are not required to observe a waiting period before having the prospect sign the agreements, assuming that the minimum disclosure period for the FDD has expired.

If the final agreements differ from those in the FDD in other ways, you must observe a 7-calendar-day waiting period before having the prospect sign the agreements.

The types of changes that trigger a 7-calendar-day waiting period include, for example:

  • specifying the geographic scope of a protected territory that was not specified in the FDD;

  • specifying the initial franchise fee if it can vary;

  • specifying sales quotas or interest rates if they can vary,

  • specifying the number of outlets to be opened under an area development agreement;

  • or changing any terms in the agreements unilaterally.

When providing final agreements with these types of changes, you must highlight the changes to the prospect in some manner, such as a cover letter or black-lined document.

When counting calendar days, you may not count the "action days"---the day the final agreements are delivered or the day the prospect signs them. If the prospect negotiates additional changes during the waiting period, you are not required to re-start the waiting period.

As a matter of policy, the franchisor may require you to obtain a dated and signed receipt for the final agreements from each prospect and to observe 7-business-day waiting period with every prospect.

Check with the franchisor's lawyer or compliance manager.

You may provide the final agreements on the same day that you furnish the FDD, or you may provide the final agreements at a later time.

If you provide the final agreements when or shortly after you furnish the FDD, the 7-calendar-day waiting period for the final agreements runs concurrently with the 14-calendar-day minimum disclosure period or any 10-business-day minimum disclosure period.

(This was the eighth post in a series of 11 posts on making compliant franchise sales.)

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The franchisor's FDD should contain two last pages that are nearly identical receipts.

After you furnish the FDD to a prospect, you must obtain from the prospect the receipt indicated to be for the franchisor, after it has been dated and signed by the prospect. 

The date must be the day of disclosure, not an earlier or later date. You may help the prospect to identify or remember the day of disclosure, but the prospect, not you, must date and sign the receipt.

It is best to obtain a manually signed and dated original of the receipt, but it is acceptable to obtain a faxed or emailed copy of a signed and dated receipt, or a receipt that is electronically signed and dated.
 
The receipt may be returned by a means different from the means used to furnish the FDD to the prospect.

Under the FTC franchise rule, a prospect's signature may be handwritten, or may be a security code, password, electronic signature or other device authenticating the prospect's identity.

The franchisor, however, may have a policy of only accepting handwritten signatures. Check with the franchisor's lawyer or compliance manager. 

If you are using an electronic FDD, the receipts must be contained within the FDD. The prospect must be required to open the entire FDD in order to locate and print the receipts.

You should encourage the prospect to date, sign and keep the other receipt indicated to be for the prospect.

(This was the seventh post in a series of 11 posts on making compliant franchise sales. )

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

Rory Sutherland tries to explain the unilateral gift giving on Valentine's day as a show of commitment.

Do you think he succeeds?

"Do this for me, which I like and you hate, to prove your commitment." says the women to the man.

(This was the sixth post in a series of 11 posts on making compliant franchise sales.)

You must disclose a prospect with the franchisor's FDD a minimum amount of time before the prospect signs any binding agreement with, or pays any amount to, the franchisor or any affiliate.

If you are using a paper FDD or an FDD on a CD, disclosure occurs on the day you hand-deliver or otherwise actually deliver the FDD to the prospect, or 3 days after you mail the FDD to the prospect by first class mail. If you are disclosing electronically, disclosure occurs on the day you email the FDD to the prospect, or give the prospect directions for accessing the FDD on the Internet. The date on the signed and dated receipt received from the prospect for the FDD should correspond to the date disclosure occurs.

In most states, the minimum disclosure time is 14 calendar days before the prospect signs or pays. When counting calendar days, you may not count the day the FDD is delivered or the day the prospect signs or pays.

Some state laws require different minimum disclosure times (see Appendix A). If the Iowa, Maine, Maryland, Nebraska, New York, Oklahoma or Rhode Island law applies, you may be required to disclose the prospect at your first "personal meeting" with the prospect.

A "personal meeting" is a face-to-face meeting in a semi-private setting such as a restaurant or a lounge area at a tradeshow, or in a private setting such as a hotel conference room or your office. If the Connecticut, Maryland, Michigan, New York, Oklahoma, Rhode Island, Texas, Utah or Washington law applies, or if you are exempt as a large franchisor in California, you may be required to disclose the prospect at least 10 business days before the prospect signs or pays.

When counting business days, you may not count the day the FDD is delivered, the day the prospect signs or pays, Saturdays, Sundays, or most federal or state holidays.

Some of the state laws requiring different minimum disclosure times may be changed, so you should check with the franchisor's lawyer or compliance manager about when any changes might take effect.

Until all of the state laws are changed, however, your franchisor may require you to disclose all prospects at their first personal meetings and at least 10 business days before they sign or pay, just to be safe in case any of the laws apply.

(This is the 6th part of 11 series on franchise selling compliance.

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The franchisor must furnish its FDD to a prospect whenever the prospect reasonably requests it. If you merely represent the franchisor and do not handle disclosure directly, you must communicate the request to the franchisor. The franchisor then must fulfill the request.

A request from a person who has not yet qualified and been accepted as a prospect does not trigger this step. Only a request from a bona fide prospect triggers it.

The purpose of the step is to permit the prospect to obtain and review the FDD before incurring significant costs to investigate the franchise or travel to the franchisor's office. Therefore, the franchisor may not refuse to furnish the FDD until, for example, the prospect attends discovery day.'

The FTC franchise rule does not require a request to be in writing, and does not say how quickly an FDD must be furnished after it is requested. Presumably, most prospects will make requests by telephone or in emails. You and the franchisor must establish and maintain a system for recording and responding promptly to these requests.

The FTC franchise rule assumes a prompt response, but permits some flexibility based on extenuating circumstances such as a poorly timed request (for example, a request made late on Friday afternoon) or a request made when the FDD is being updated.

If a request is made when the FDD is being updated because of a "material change" (see "Step 9: Re-Disclosure If 'Material Change' Occurs" below), you or the franchisor may respond that the FDD is being updated and will be furnished after it is updated or registered.

The FTC franchise rule permits you to furnish the FDD directly to the prospect or to a representative of the prospect, such as a partner, owner, officer, employee, agent, lawyer or accountant.

Some states may not permit you to accomplish disclosure by merely furnishing the FDD to a representative.

Check with the franchisor's lawyer or compliance manager.

You are not required to furnish an FDD in the particular format requested by a prospect. However, if the prospect refuses to accept delivery of an FDD because of its format, you may not make a franchise offer or sale to that prospect.

Neither you nor the franchisor may charge any fee in connection with a prospect's right to receive an FDD whenever he or she reasonably requests it.

(This was the fifth post in a series of 11 posts on making compliant franchise sales.)

If you would like all 11 of these tips in a bound book, for a handy desk reference, why not click here & sign up for the Franchise Seller's Handbook.

How Do Franchises Go Bad?

Franchises start out with an initial cash requirement - initial fee, business set up costs and working capital. It is not unusual for this to be $ 500,000 to $ 1,000,000. The money comes from liquidating a lot of family assets plus SBA guaranteed loans or start up loans that are not SBA guaranteed.

Franchisees always have to personally guarantee the full performance of the agreement. In addition to the regular operating costs, there is the ongoing cost of being a franchisee, nominally in the disclosure materials around 10 % of gross sales.

Because the disclosure materials never tell the whole story, the cost of being a franchisee begins at around 15 % of gross sales.

Hidden franchise fees include the additional cost of having to buy from designated vendors who have no competition when selling to the franchisees and can charge more than competitive prices. Some parts of some franchise systems are franchised separately under add on licenses with additional royalties. Software is often licensed separately for additional charges per month.

The list is long. When I tell franchisee clients to go back and refigure their business plan pro formas using 15 % of gross sales as the true royalty and advertising cost and then come back and talk about whether the working capital number is adequate or whether they can come out at all, they are often in disbelief that people would do something like that to them.

As the franchise matures, imaginative franchisors find other things that can produce additional revenue streams from the systems at the cost of the franchisees. So called improvements, remodels, and miscellaneous fee add-ons drive the cost of being a franchisee to over 20 % of gross sales. Franchisees cannot survive.

The businesses cannot be sold to others in most instances. Avarice has bled the system dry. There are other nuances in the mix, but I think this shows the pattern of what is happening in scores of tough franchise systems today. Oddly enough, some of the profit that is removed by the franchisor resulted from franchisee cheating.

There is no difference in the honesty rate between franchisors and franchisees. Business information tracking capability has so improved over the last 35 years that cheating is harder, but it still happens. If this was about telling war stories I could use up a lot more space on the subject of shenanigans.

Sometimes a franchisor wants to pay a franchisee for helping sell a franchise.

But there are many potential problems, here. I want to point out just one and its solution.

Before furnishing an FDD to a prospect, you must confirm that both receipts at the end of the FDD identify all "franchise sellers" who have been or will be involved in offering the franchise to the prospect.

The receipts must state the franchise sellers' names, business addresses and business telephone numbers. Or, the receipts may refer to an exhibit containing the franchise sellers' names and contact information.

The meaning of the term "franchise sellers" is narrow for this purpose. The FTC wants the receipts to identify the persons who have been or will be dealing directly with the prospect, including key officers or employees and any broker. The FTC does not want the receipts to identify all persons who arguably might be franchise sellers in a broad sense, or to cross-reference lists of brokers or other persons who might sometimes represent the franchisor.

A few key persons who are involved in all or most franchise offers and sales for the franchisor may be pre-identified on all receipts. Other persons, such as brokers who deal occasionally with the franchisor's prospects, must be identified in typing or handwriting on the receipts, on a prospect-by-prospect basis.

Any person who, under a contract, will receive a sales commission or quota credit if a franchise is sold to the prospect must be identified.

This may be difficult to keep track of. What should be done if a franchise seller not identified on the receipts becomes involved with the prospect after disclosure has occurred?

When this happens, you or the franchisor must revise the dated and signed receipt previously obtained from the prospect so that the receipt identifies the new franchise seller, and must furnish a copy of the revised receipt to the prospect.

Revising the receipt may involve merely making a copy of the receipt with the new franchise seller's business card shown on the receipt or with information about the new franchise seller handwritten on the receipt. You and the franchisor are not required to have the prospect re-date or re-sign the receipt.

The cost of violating the FTC rule is $11,000 per occurrence per day.

The are a number of other risks when paying for franchisees to validate the franchisor's concept. Be sure to review your entire selling process with a franchise attorney with compliance expertise.

(This was the fourth post in a series of 11 posts on making compliant franchise sales.)

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

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This article is about how to create a modern franchise owner's group.  An owner's group that benefits the brand, maintains and enhances franchise owner's equity & is not born after a bitter legal struggle.

A modern franchise owner's group is required in all franchise systems - especially when the franchisor seeks both the benefits of controlling franchisees as if employees, but resiles from the legal and tax liabililty that attaches to such control.

The Coverall case illustrates the disaster which befalls a franchisor who becomes - in the eyes of the state- an employer. It provides a good case study of what a  modern franchise owner's group can do to benefit the franchise system.

Coverall required its franchisees to perform cleaning for the franchisee's customer, but have that customer pay Coverall directly for the job. Coverall would then remit to the franchisee payment, less deductions for royalties and other charges.

Not surprisingly, the arrangement caught the eye of the Attorney General in Massachusetts. It looked liked an employer/employee relationship with the employer making illegal deductions from the employees salary. [The case is currently under appeal, but the finding of an employer/employee relationship looks not to be overturned, and the penalties for wrongly treating employees as franchisees are increasing.]

It is not hard to imagine that there is a beneficial reason for centralized billing that is also in the franchisee's self interest. Cleaning crews are composed from an irregular work force. Relability is not easy to maintain, so a centralized billing scheme may provide better customer service. The customer can pay in advance knowing that the payments for substandard jobs will be refunded. A simple cleaning crew could not achieve this reputation.

The reason is simple. The cleaning crew I employ today and pay at the end of the day may not be the crew I have to dock pay for a job poorly done but discovered tomorrow.

Centralized billing is a reputational device, functioning in a manner similar to a cash register. The customer makes the payment directly to Coverall, and if the work is satisfactory, the payment is sent to the local operator. Because the customer no longer cares if the local operator can refund the substandard cleaning jobs -their relationship is with Coverall- the local operator has a reputational advantage over even the same crew operating outside the franchise system.

In summary, each party, franchisor and franchisee, would like the benefit of centralized billing, but the franchisor dare not provide it. There exists a gap between services needed by the system and what can be legitimately provided by the franchisor - the services/goods gap. The services/goods gap follows directly from the fact that the franchisor is not an employer of its franchisees.

The services/goods gap is what provides the the economic imperative for the  modern franchise owner's group - it can create the benefit as a condition of membership. More accurately, the  modern franchise owner's group can serve as a catalyst by creating a critical mass or tipping points for providers of services/goods to the franchise community.

In the Coverall case, their franchisee advisory council, or if they had an independent franchisee association, could have taken on the role of communicating, educating, and advocating the benefits to the franchise owners of having an neutral, trusted third party to do the invoicing, remittance, and customer service.

The communication, education and advocacy by the  modern franchise owner's group for the voluntary benefit stands in contrast to Coverall's risky decision to require the delivery of the benefit by contract.

It is of course possible that the  modern franchise owner's group proves not to be capable of being such a catalyst, and the effort fizzles without reaching critical mass.

But imagine the benefits to the system once even a small effort is successful - perhaps two or three vendors are selected to provide both billing and customer service. (The franchisor would retain control over the standards that these service providers would have to meet, but would not have a contract with them.)

Franchise owners using this reputational device get more cleaning jobs, while others would flounder. It becomes in the franchise owners self interest to join the invoicing network. As more join, the network begins to fund more communication, education, and advocacy about the benefit - which causes or drives more owners to join, bringing about increased funding.

(This mechanism is similar to how many QSR independent franchisee trade associations tax their members to fund the association's convention. The beverage company in the QSR may put aside, say 1/2 cent per gallon of syrup ordered, and remit the collected amount back to the association.)

Virtually, any  modern franchise owner's group can be started or grown in this manner.

1. Find a mission critical service or good required by the franchisor which cannot be provided by the franchisor because of legal problems.

2. Pick one or more platforms which can deliver these services or goods to franchisees.

3. Pick the right catalyst or catalyst methods which set in motion a critical mass - communicate, educate, advocate and self fund.

4. If the project enjoys systemic acceptance, then consider collaborating with the franchisor on standards for such service providers.

Each step depends upon the actual system, and there is room for all sorts of things to go wrong. But, this is a good blue print for any new franchisee association who wishes to grow and contribute to the brand's overall success in the marketplace.

If you are a businessperson, sooner or later you will have to deal with a lawyer. In the franchise world, it helps - tremendously - to deal with attorneys who understand franchising and franchise law. It doesn't matter whether you are a franchisor or a franchisee; no matter which side of the transaction you happen to be on, you will want an experienced franchise attorney to be on the other side.

Surprisingly, the level of franchise law knowledge among attorneys who actually get involved in franchise transactions varies considerably. The majority of the time, lawyers who are knowledgeable in franchise law are on both sides of the transaction. But that is not always the case.

Sometimes, the attorney on the other side is inexperienced, and "dabbling," in franchise law.

This is the first of a two-part piece on why these dabbling attorneys can hinder a transaction, or worse, do harm to their clients.

This part one looks at it from the point of view of the franchisor, which is negotiating with a prospective franchise purchaser. Let's assume this prospective franchisee is the party represented by a lawyer without franchise law experience. This situation is much more common than the reverse - where it is the franchisor, and not the franchisee, that has inexperienced counsel.

Why Franchise Agreements are Different from other Business Contracts

Some, but not all, franchise agreements are negotiable. The most significant problem involving inexperienced counsel occurs when the franchisor is otherwise willing to negotiate with the prospective franchisee.

If a prospective franchisee seeks legal counsel, s/he will typically seek out that person's usual business attorney, if there is one. If the prospective franchisee doesn't have or know an attorney, that person will ask friends and family for referrals. Frequently, the referral is to a business attorney who has little or no experience in franchise law.

The business attorney may be tempted to do the work, instead of referring it to another lawyer. After all, the terms in franchise agreements look a lot like the ones you might find in other types of business contracts. But the problem is that the franchise relationship isn't a typical business relationship. It is critical for the attorneys on either side of a negotiation to understand what makes franchising different.

Specifically, franchise agreements are (on the whole) much more one-sided than other business contracts. This is for a good reason: the provisions are there (in one way or another) to protect the health and integrity of the system as a whole, including its intellectual property and goodwill. Protecting the system is paramount, because if the system fails, all of its franchisees lose.

An attorney representing either side of the franchise transaction needs to understand this basic truth at the core of franchising. When s/he has experience in franchise law, counsel will understand which provisions are typical or atypical. They will also understand which terms may be negotiable and whether, taken as a whole, the franchise contract is more or less one-sided than is typical for those agreements. Having this experience will make the negotiation more productive and efficient. A more efficient negotiation will typically result in lower attorney fees.

The Frustrations of Dealing with Inexperienced Franchisee Counsel

You might think that the franchisor would benefit if the lawyer on the other side is inexperienced. I can assure you that is not the case.

Here's the problem: when a franchisor is negotiating with a prospective franchisee's counsel, that attorney's lack of franchise law experience frustrates and needlessly complicates the process. Because the lawyer for the prospect doesn't understand franchising, s/he may try to negotiate items that simply can't be negotiated from a system protection perspective.

Again, the provisions in a franchise agreement are there to protect the system as a whole. An attorney who understands franchise law gets this, and will instead turn his/her attention to the contract terms that a franchisor may be willing to negotiate. The dabbling attorney, on the other hand, will often try to change these critical terms.

Here is how things usually shake out in those negotiations. The prospective franchisee's counsel issues a 30-page memo outlining each and every provision of the franchise agreement that s/he wants to have changed. Or even worse, the attorney submits a redlined version of the entire contract containing his or her requested changes or revisions to the contract, which are usually voluminous.

The franchisor is likely to give one of two responses in that situation, and neither of them is good for the prospective franchisee.

1. Refusal to negotiate

The franchisor's first possible response to the attorney's negotiating position is to simply refuse to negotiate, at all. A franchisor will react this way when it is overwhelmed and frustrated by the number of requests, which the company believes seek to change key provisions of the contract.

The franchisee is then presented with a choice: (1) walk away from the deal entirely, and lose out on what may have been a good business opportunity; or (2) accept the entire franchise agreement as written, without any changes, thereby missing the chance to negotiate for some critical changes. In either case, the inexperienced attorney did his/her client a disservice by impeding the deal. This is frustrating to both sides.

2. Agreeing to limited changes

The franchisor's second possible response to the attorney's negotiating position is to agree to some, but not all, of the proposed changes. Obviously, this is better for the prospective franchisee than under the first scenario. But even in this situation, inexperienced counsel can be an impediment to the prospective franchisee.

This is when experience really matters: an attorney who understands franchising will also know which provisions are worth negotiating, and which are not. The experienced attorney will know when the franchisor can be pushed, and when it cannot. As a result, the selection of specific provisions that are the subject of any negotiation becomes critically important.

In other words, the "shotgun" approach to negotiation -- asking for everything under the sun -- lacks focus. And it's this lack of focus that can result in a less effective negotiation process, when the different / changed provisions are not the ones that can make the biggest difference for the client. By taking the unfocused approach, the dabbling franchise attorney misses the opportunity to conduct an effective negotiation for his or her client.

Conclusion

When franchise contracts are negotiable, an attorney who dabbles in the area, lacking experience in franchising, can frustrate or impede the process. For this reason, franchisors tend to prefer that their prospective franchisees hire experienced franchise counsel, and those prospective franchise buyers should seek out lawyers who understand franchising. Plus, hiring an experienced franchise lawyer will typically save money, because the knowledgeable attorney will be more efficient than the dabbler.

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"What a Hotel. The Towels were so Big and Fluffy;

I could Hardly close My Suitcase"

- Henny Youngman

Hotels used to have to deter guests from stealing towels.

Now, hotels need to compel their guests to reuse or recycle their towels during their stay.

Daily washing of towels uses too much water, too many detergents and is very heavy work. If hotel guests would treat the laundry as if it was their own, hotels could conserve water, use less pollutants and minimize back injuries & so lower worker's compensation claims.

The hotel usually has only one chance to persuade their guests to recycle or reuse - a simple card in the room requesting that the guest recycle the towels or laundry.

But, the effectiveness of these cards varies greatly.

Science, or the repeated testing of these messages, has discovered which messages are more persuasive than others.

Most standard messages stress only the importance of protecting the environment. These message are accompanied with tantalizing pictures of the pristine wilderness. These messages do work.

However, science allows us to do better. We can track who is reading what message and what the result is. We can design an effective compliance recycling program - which gets more guests to recycle their towels at least one during their stay.

Noah Goldstein describes how he, Robert Cialdini and V. Griskevicius implemented an effective green Hotel Towel program.

By making one small change in the messaging, Goldstein et. al, were able to get an increase in compliance of over 25%!

Think about the cost savings to the hotel in getting a 25% increase in a laundry recycling program. Now, that is much more tantalizing than pristine wilderness.

How did Goldstein do it?

Think of an Army Barracks and all those neat cots. What do you see? [Ignore the barking NCO]

Everyone can see what needs to be done, so most people do it. The cots get made up. Perfect. Simple. Compliant.

new-cumberland-pa-pennsylvania-army-barracks-military-militaria.jpg

(Copyright: Vintage Post Cards.)

But in a hotel, thank heavens, the rooms are private. You cannot see what needs to be done, so most people don't do it.

How do you break the walls down?

Goldstein hit upon a brilliant solution:

Tell the "guests that the majority at the hotel recycled their towels at least once during the course of their stay."

(From page 12 of Yes! 50 Scientifically Proven Ways to Be Persuasive I recommend reading the entire book.)

Paint a picture of the social part of nature.

Goldstein reported this one simple change in messaging produced a 26% increase in the number of guests who recycled their towels at least once during their stay!

Imagine the overall savings because of such voluntary compliance!

By paying attention to the science of messaging.

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In 2012, I led a Independent Franchisee Association Roundtable Discussion at the IFA Legal Symposium in Washington D.C. Below is a summary of the discussion.

Predominantly we had franchisor attorneys at our table, although in the first session I was not the only attorney who primarily represents franchisees or dealers.

1. Recent FTC Rule

The table members did not see much effect from the recent amendment to the FTC Rule in the way that franchisors deal with their associations.

This would be disappointing for franchisee advocates to hear, as there was hope that the amended rule might create more market pressure in favor of the associations.

2. Decision Making by Association

Overall the franchisor attorneys at our table, and Mr. Saukas, a franchisor, displayed what I personally found to be a surprising level of resistance to the idea that franchisees, through their independent association, should play any role in the franchisor's decision-making process with respect to the brand.

This view was forcibly stated by several participants and none of the franchisor attorneys in attendance seemed to dissent.

The sentiment seemed to be that independent associations have no business seeking to invade the franchisor's decision-making province. Franchisee arguments to the contrary did not seem to persuade this crowd.

3. Why an Association instead of an Advisory Council?

 The franchisor attorneys also questioned why the franchisees would need an independent association in systems where there is a franchisor-sponsored advisory council. Obviously, it was recognized that franchisees may tend to regard a FAC as a rubberstamp, which is often the impetus for forming an independent association.

But again there was not much sympathy expressed for this position.

4. Incentives offered by an Association

One incentive offered to encourage franchisor acceptance of associations was the notion that, on any given issue if the franchisor can persuade the association of the merits of its position, the fact that the association approved the franchisor's decision could be evidence of the franchisor's good faith, which could be useful to the franchisor in the event of any challenge by any other dissenting franchisees.

This has worked in systems in which I have represented the association. But there did not seem to be much enthusiasm at our table for this carrot.

5. When to Recognize an Association

The question of what constitutes recognition of the association was also discussed. There is no formal process for this, unless of course in a given system the franchisor and the association enter into a contract. Experience teaches that this usually happens after a lawsuit.

The question of when the association represents a sufficient number of franchisees to have standing was discussed. There is no clear bright line. 

David Cahn has an interesting, although I believe flawed, view of some recent franchisor liability cases.

"Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees' business operations.

Where a franchisor imposes and exercises substantial controls over its franchisees' operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor's exercise of control makes it liable for its franchisees' negligence or misconduct."

The dilemma here, many see, is between exercising significant enough control through the standards as enunciated in the operating manual to prevent the harm from occurring, and exercising minimal control through providing only recommendations and no guidance to prevent vicarious liability attaching.

David appears to concur, and after reviewing two Jackson Hewitt cases on vicarious liability, states:

"The conclusion to be drawn from the Jackson Hewitt litigation is that franchisorsare essentially presented with two options when drafting their franchise agreements and operations manuals.

The first option is to impose significant operational controls over their franchisees' operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates.

The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications."

My view is that this dilemma should be avoided: the franchisor should be able to limit their liability and decrease the risk from happening.

Ideally, there should exist franchise owner's group who agrees to a) provide the franchisees with sophisticated risk avoidance mechanisms, b) monitor and report their use, and c) provide continual education on compliance.

Naturally, the franchise owner's group is going to want to something in return for such a project. And such an agreement should be beneficial to the franchise system as a whole.

An example was discussed here in this story about PCI compliance (see the comments)

A franchise owner's group that can effectively take on this responsibility is a potential real win/win for the franchise system and all its constituents.

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When your franchise system is facing this type of danger, connect with me on LinkedIn and we will see what can be worked out.

Should a prospective franchisee work with a franchise broker or consultant?

I am often asked that question by prospective franchisees.

Alternatively, someone will contact me and after speaking with me may decide that they want to look at other franchise opportunities.

Typically, in those situations I refer the prospective franchisee to both the IFA website (www.franchise.org) and to a franchise broker or franchise consultant who does not charge the prospective franchisee.

A franchise consultant or franchise broker works with the "candidate" or prospective franchisee by performing almost a matchmaking service.

A good broker learns about the prospective franchisee's financial and personal background and determines franchises that would be a good fit, both financially and personally, for the candidate.

Once the prospective franchisee narrows down his or her selection to a few franchises, typically the franchise broker will recommend that the prospective franchisee speak with existing franchisees of those systems, make suggestions to perform validation of the franchise and encourage the candidate to attend the franchisor's Discovery Day.

The best franchise brokers or franchise consultants also understand the importance of encouraging the prospective franchisees to utilize experienced franchise attorneys as part of their candidate's validation or due diligence.

They are not concerned about losing the deal, but rather making sure that the prospective franchisee has a clear understanding of the franchise opportunity and is properly represented.

The best franchise consultants or franchise brokers understand that good relationships  with their candidates is critical to consultant's future success.

In my experience the prospective franchisees that contact me after working with a franchise consultant or franchise broker are typically most prepared to pursue the franchise opportunity.

The relationship between a franchisee and its employees is a now massive headache for the franchisor. 

The reason is simple: Joint Employer status.

If the franchisor overreaches and actively controls the employee relationship between franchisee and it's employee, then the franchisor might be liable under the legal theory of joint employer.

But, on the other hand, if the franchisor does nothing, then the franchisor may be complicit in allowing a violation of employment law.
 
Several years ago, at the Foley & Lardner LLP website, there was a nice description of the franchisor's dilemma.
 

 "In Myers v. Garfield & Johnson Enterprises, Inc., et al., 2010 U.S. Dist. LEXIS 3468 (E.D. Pa. January 14, 2010), a federal district court in Pennsylvania held that defendant Jackson Hewitt, Inc., the franchisor of co-defendant Garfield & Johnson, was potentially liable under Title VII of the Civil Rights Act of 1964for sexual harassment allegedly committed by Garfield & Johnson managers. 

Rejecting the franchisor's motion to dismiss for failure to state a claim, the court held that plaintiff's joint-liability theory was plausible enough to proceed to discovery. 
 
What is particularly bracing about the court's analysis is its recognition that these factors could trigger potential employer liability for the franchisor even though they were, in many cases, typical of the control exercised in any franchisor/franchisee relationship. 
 
The court said that if the standards for control and authority derived from common law principles for application in the Title VII context were met, the fact that they arose between a franchisor and franchisee and reflected the type of control that almost all franchisors exercise would not insulate the franchisor from liability.
 
Because the joint employer and agency tests involve multiple considerations with no single factor dispositive, it is not clear that any single contractual or operational step (short of drastically limiting the degree of control over franchisee operations that most franchisorsfeel is essential) could foreclose the potential for liability under this court's view of the law. 
 
Taking the decision at face value, it could be argued that, under Myers, franchisors find themselves between a rock and a hard place: 
 
The more closely they monitor franchisee employment practices, the greater the risk of their being subject to Title VII liability for the franchisee's wrongful behavior.
 
If they eschew monitoring of that behavior, they may be subject to Title VII liability anyway under other elements of the applicable tests, and will not be in a position effectively to regulate conduct that could result in statutory violations. 
 
On the other hand, if they do monitor the behavior and then take draconian measures in response to franchisee violations, they may trigger liability under state dealership or franchise protection statutes."
So how does the franchisor both monitor to regulate the conduct, but not monitor so closely as to become liable, under common law or statute?
 
It is a very difficult compliance problem for franchisors, which is getting harder for them to solve.  But there are a number of solutions which help the brand and the franchise owners.
 
When your franchise system is facing this type of danger, connect with me on LinkedIn and we will see what can be worked out for you.
 

Like other areas of business, franchising has its own jargon or vocabulary.

The terms "master franchise" or "sub-franchise" and "area developer" have technical definitions, but are often used improperly. This article will help to define a master franchise or sub-franchise and area developer and distinguish them from other forms of expanding a franchise.

Franchise systems sell a master franchise (also known as a "sub-franchise") in order to more rapidly expand their brand and system. Often master franchising is used internationally. In that context, a master franchise or sub-franchise may be sold to a person or entity to sell franchises on the franchisor's behalf in another country.

The master franchisee has the responsibility of selling franchises throughout that country. Typically the master franchisee will sell, train and support the franchisees of that country and act as their franchisor. This may make sense for the franchise system that is interested in expanding globally.

In the United States, certain systems have attempted to sell master franchises for certain states or regions. For example, a system may sell a master franchise for New York state. That master franchisee would be responsible for selling, training and supporting the franchisees of New York. The concerns of this type of system is that often the master franchisee is unable to provide the appropriate support to its franchisees.

A master franchise is distinguished from an area development in which a person or entity who buys a territory or region is required to develop that region him, her or itself.

The area developer would be trained and supported by the franchisor and required to open a certain amount of locations within a certain territory and in a certain timeframe.

Panera Bread® is an example of a franchise that has expanded through area development. They sell a minimum territory of 15 units. The Panera Bread franchisee must develop that territory typically within six years.

Often a master franchise or sub-franchise is not the best manner of expanding in the United States for 3 reasons:

  1. Master franchisees are often under a lot of pressure to sell a lot of units within their territory and do not have the infrastructure to support those franchisees.
  2. The franchisor loses control over its franchisees, leaving the support to the master franchisee who is selling the franchises, and not overseeing compliance with system standards.
  3. In addition, master franchisees are required to have their own disclosure document to present to the prospective franchisees in their territory. Preparation and registration (where required) of the disclosure documents can be quite time-consuming and costly.

A master franchise or sub-franchise may be one way a franchisor can expand rapidly. However, there are concerns that any franchise system or prospective master franchisee should consider. Becoming an area developer for a territory is another means of rapid expansion and has its own concerns.

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If you would like to know more about expanding your franchise system using area developers, get in touch with me by connecting with me on LinkedIn, using my LinkedIn business card below.

Interested parties can submit comments and requests to participate

FTC (Press Release) The Federal Trade Commission will host a workshop on December 4, 2013 in Washington, DC to examine the practice of blending advertisements with news, entertainment, and other content in digital media, referred to as "native advertising" or "sponsored content." 

Increasingly, advertisements that more closely resemble the content in which they are embedded are replacing banner advertisements - graphical images that typically are rectangular in shape - on publishers' websites and mobile applications.  The workshop will bring together publishing and advertising industry representatives, consumer advocates, academics, and government regulators to explore changes in how paid messages are presented to consumers and consumers' recognition and understanding of these messages.

The workshop builds on previous Commission initiatives to help ensure that consumers can identify advertisements as advertising wherever they appear.  This includes recent updates to the Search Engine Advertising guidance, the Dot Com Disclosures guidance, and the Endorsements and Testimonials Guides, as well as decades of  law enforcement actions against infomercial producers and operators of fake news websites marketing products.

The FTC invites the public to submit original research, recommendations for topics of discussion, and requests to participate as panelists.  The Commission also invites the submission of examples and mock-ups that can be used for illustration and discussion at the workshop.  Topics the workshop may cover include: 

  • What is the origin and purpose of the wall between regular content and advertising, and what challenges do publishers face in maintaining that wall in digital media, including in the mobile environment?
  • In what ways are paid messages integrated into, or presented as, regular content and in what contexts does this integration occur?  How does it differ when paid messages are displayed within mobile apps and on smart phones and other mobile devices?
  • What business models support and facilitate the monetization and display of native or integrated advertisements?  What entities control how these advertisements are presented to consumers?
  • How can ads effectively be differentiated from regular content, such as through the use of labels and visual cues?  How can methods used to differentiate content as advertising be retained when paid messages are aggregated (for example, in search results) or re-transmitted through social media?
  • What does research show about how consumers notice and understand paid messages that are integrated into, or presented as, news, entertainment, or regular content?  What does research show about whether the ways that consumers seek out, receive, and view content online influences their capacity to notice and understand these messages as paid content?

Electronic submissions can be made online. Paper submissions should reference Native Advertising Workshop both in the text and on the envelope, and should be mailed or delivered to:  Federal Trade Commission, Office of the Secretary, Room H-113 (Annex X), 600 Pennsylvania Avenue, N.W., Washington, D.C. 20580.  The FTC requests that any paper submissions be sent by courier or overnight service, if possible, because postal mail in the Washington area and at the Commission is subject to delay due to heightened security precautions.  Requests to participate should include a statement detailing any relevant expertise in digital advertising and should be submitted by October 29, 2013 via email to[email protected].  Panelists selected to participate will be notified by November 6, 2013.

Here is an email I recently received.  I live in Maryland and not Ontario, Canada.

Chem-Dry, the world's largest and highest rated carpet and upholstery cleaning franchise system with 3,500 units in 35 countries, has recently opened new territories and will be exhibiting and recruiting new franchisees at the show.

The show is being held at THE INTERNATIONAL CENTRE in Mississauga, Ontario on September 7th and 8thChemDry has been ranked the #1 carpet cleaning franchise by Entrepreneur magazine for 25 consecutive years.

With our proprietary hot carbonating extraction cleaning process and ongoing marketing and operational support, ChemDry is a franchisor that helps you grow.

We offer in-house financing with as little as $9,995 down and total investment starting at $41,000.We also deliver top-line results.

Check out our average franchise sales numbers:

How Much Can I Make with a Chem Dry Franchise.png

Usually, I would simply look up the franchisor's FDD and compare this earning's claim with the Item 19 claim.  

But, this is a much more difficult case.  I don't know much about the Ontario Franchise Disclosure law - except Webster tells me it that it is for lawyers and not franchise investors.

So, I looked up the Item 19 for Chem-Dry in the US, How Much Can I Make.

First, the Item 19 is not based on the franchise owner's reported profit and loss statements.

"HRI does not currently require all Chem-Dry business franchise owners to provide periodic revenue and other financial reports concerning their franchises.

In February, 2013, HRI conducted a system-wide survey requesting that all franchise owners provide certain financial and other information relating to the operation of their Chem-Dry business franchises during 2012.

As of December 31,2012. HRI had 1,081 franchise owners who operated 2,039 Chem-Dry business franchises.

Of those, 211 franchise owners (the "Responding Franchise Owners"), who collectively own 475 Chem-Dry business franchises, and who have owned their businesses at least 2 years, provided complete 2012 financial information in response to the survey and operated those franchises throughout all of 2012."

Second, and it gets more tangled, here is the chart from the survey, click on it to expand it.

Chart.png

The average revenue number reported from the US survey as representative to Ontario prospects is the same: $111,184!

It is it all all plausible that the 211 franchisees who completed the Chem-Dry survey in 2012 forms a reasonable basis to tell a prospect in Ontario what he or she might make?

Does Your Franchise Sales Process Need a Tune-Up?  Visit the Our Franchise Sales Forum & Ask the Experts.

 

Most business owners do not realize that there is a difference between a franchise and a business opportunity.  Franchises are regulated by both the federal law (FTC regulation) and by certain state franchise laws.  

Business opportunities are also regulated under both certain states' laws and the FTC

What is a Franchise?

Franchises, under the federal franchise law are business arrangements that meet three criteria:

1) there is a trademark owned by the seller under which the investor operates;

2) the seller receives $500 or greater in the first 6 months that the investor is in business (for product, training or anything else);

3) the seller exercises sufficient control over the investor and the investor's business.  

If these criteria are met, the FTC franchise law states that the seller/franchisor must provide a regulated franchise disclosure document (FDD) to a prospective franchisee/investor at least 14 calendar days prior to accepting any money from the investor and prior to the investor signing any contract with the franchisor/seller.

What is a Business Opportunity?

What are business opportunity laws and why were they promulgated? The business opportunity laws were designed to reach distribution arrangements that are typically different than franchises, such as dealerships, vending machine businesses, certain work-at-home businesses and other "seller-assisted" marketing plans.

A business opportunity is defined as an arrangement in which a person:

1) offers, sells or distributes goods, commodities or services to another and;

2) the goods, services or commodities are provided by the seller of the opportunity or by someone affiliated with the seller or required by the seller and the seller secures business for the purchaser or retail outlets or accounts for the purchaser and;

3) the purchaser is required to pay or commit to pay to the seller or its affiliates at least $500 within six months after commencing operations.

The purpose of the business opportunity laws is to protect the investor in these business schemes from questionable or fraudulent offerings.

The legal definitions of a business opportunity are intentionally broad and unclear to cover a plethora of unconventional marketing schemes and businesses. Franchises are typically excluded from the definition of business opportunity in these laws.

However, without a specific exemption or exclusion, there may be franchises that will fit within the state definition of a business opportunity.

What are the requirements of the Business Opportunity laws?

The statutes typically require a disclosure document in a prescribed form be delivered to the prospective investor prior to the time any agreement is signed or any monies are paid for the business opportunity. This form varies from state to state and under the FTC.

Unlike franchise laws, there is no uniformly accepted business opportunity disclosure format that all states and the FTC accept.

Many states also require that the business opportunity disclosure document be filed or registered with the state prior to selling any business opportunities in that state.

Many states also require that a surety bond or trust account or letter of credit be posted so any future claims by business opportunity investors can be paid. Some states also require escrow accounts if greater than 20% down payments are required prior to the investor's receipt of the goods promised. Many states also have certain required language in the business opportunity contract with the investor, including cancelation rights.

There are also typically prohibited acts, such as making earnings claims without substantiation.

In certain states a violation of their laws on business opportunities may be a felony or misdemeanor.

A seller of any type of business opportunity, including franchises, should be cautious about meeting the requirements of the various state and federal laws governing the sale of the opportunity.

Penalties for failure to comply can be steep and should be avoided.

The FDD is required to be written in "plain English". What exactly does plain English mean? Section 436.1 of the FTC's Franchise Rule (16 C.F.R. §436.1(o)) states that "Plain English means the organization of information and language usage understandable by a person unfamiliar with the franchise business.

It incorporates short sentences; definite, concrete, everyday language; active voice; and tabular presentation of information, where possible. It avoids legal jargon, highly technical business terms, and multiple negatives."

As you can see, plain English is the opposite of legalese.

With that said, I am shocked how often we encounter FDDs written by attorneys using anything but "plain English".  

Long run-on sentences with many convoluted technical terms, passive tense and multiple negatives, are not unusual in certain FDDs.  

My advice to my clients who are prospective franchisees is to read through the FDD, it is "supposed" to be written in plain English.  Unfortunately, often this is completely impossible for the average person to do without legal knowledge.

The client must then rely on counsel to not only interpret the franchise agreement (which can be written in legalese), but on the 23 disclosure items as well. That is not the intent of the FTC in promulgating the Franchise Rule requiring plain English.

The purpose of the FDD is to provide the prospective franchisee with knowledge/disclosure about the franchise he or she is buying.  

As the FTC rule states, the language should be understandable by a person unfamiliar with the franchise business.  

I would add that the language should be understandable by a person who is unfamiliar with legalese and other technical language.  

As stated in the Franchise Rule, it should use everyday language.

Unfortunately certain attorneys and certain franchise systems have failed to understand the requirements of the Rule regarding plain English so that reading the 23 items of the FDD becomes next to impossible for the average person.

Connie Gentry of FSR has written a short blurb on the popular Maryland franchise The Green Turtle Sports Bar & Grille.

FRS Green Turtle.png

It is not clear whether this is an advertorial, a press release, or simply a small news piece.  It matters because if this was an advertorial, it would have to comply with the FTC's Rules on Testimonials and Endorsements.

It is further unclear as to what the * is supposed to refer to - I expect the author thought that this was sufficient notice that some disclaimer was being made about these numbers.  But no such disclaimer was in the article.

Since, it was not clear what reliance one could reasonably place on these AUV's, I decided to get the Green Turtle's 2012 FDD and look at the Item 19, directly.

This is the middle of 2013, and the 2012 Item 19 was calculated for the end of 2011, we do need to get some up to date data if we were going to make a buying decision.

But, instead I want to highlight something I have seen a number of times.

Iteme 19 Page 1.png

First, this is a gross sales only Item 19.  There is not enough data here to make a reliable cash on cash return estimate - important basic costs line rent, cost of goods solds, and labor are not disclosed.

Second, and I have seen this a number of times, is the insertion of a median annual gross sales.  In this case, 11 locations  had gross sales above the median and 11 had gross sales below the median.

The natural question is:  what was the average gross sales for the 11 locations under the median?  Could be $500k, $1million, or even up to $2.24million. Makes a big difference.

But, we don't get any more useful data - just some disclaimers.

Item 19 Page 2.png

So, what you should you do?  After all, it is important to know what the gross sales of those units below the median.

It is a flip of the coin whether your location will be above or below the median.

The answer is to ask: ask for the back-up, look at those 11 units and calculate yourself their average gross sales.  Because if you don't ask, nobody is going to tell you.

Another interesting decision has come down regarding the use of exculpatory clauses in franchise agreements -- and this time, the decision went in favor of the franchisee. 

Exculpatory clauses are provisions that parties use to disclaim the making of any promises, representations, or statements outside of the contract.

Such provisions are commonly used by franchisors in franchise agreements to give the franchisor the assurance that their franchisees are not relying on any promise, statement, or representation that was made before signing -- many of which the franchisors may not even be aware (for example, those that were made by salespeople speaking beyond the limits of their authority).

The most common form of exculpatory clause is an integration clause, which in most contracts goes by the title "Entire Agreement." An example of an integration clause (taken from the franchise agreement in this case) is below. Often, a franchisor will be able to rely on an integration clause and other exculpatory provisions to avoid liability in court for promises that were allegedly made to a franchisee that are not reflected in the terms of the franchise agreement. 

But other times, a badly-written or otherwise non-comprehensive exclupatory clause will not provide a sufficient shield to a franchisor to avoid liability.  The C&M v. True Value case, from the Wisconsin Court of Appeals, provides a good example of how courts can sometimes find that a franchisor's exculpatory clause is insufficient to protect it from liability for an alleged misrepresentation.

In this case, C&M was a True Value hardware store franchisee for a short time, having only operated the store for less than a year before closing it due to financial reasons.  Shortly after closing the doors, C&M sued True Value, claiming that (among other things) that True Value misrepresented the possible performance of the franchise business. 

The franchise agreement in question, called a "Retail Member Agreement" (the "Agreement") was signed by C&M and contained two different exculpatory clauses that said:

[True Value] has not represented to [C&M] that a "minimum," "guaranteed," or "certain" income can be expected or realized. Success depends, in part, on [C&M] devoting dedicated personal efforts to the business and exercising good business judgment in dealings with customers, suppliers, and employees. [C&M] also acknowledges that neither [True Value] nor any of its employees or agents has represented that [C&M] can expect to attain any specific sales, profits, or earnings. If [True Value] has provided estimates to [C&M], such estimates are for informational purposes only and do not represent any guarantee of performance by [True Value] to [C&M]. [TRUE VALUE] MAKES NO REPRESENTATIONS OR WARRANTIES EITHER EXPRESS OR IMPLIED REGARDING THE PERFORMANCE OF [C&M'S] BUSINESS.

 And

This Agreement, and any other agreement which [C&M] signs with [True Value], is the entire and complete Agreement between [C&M] and [True Value] and there are no prior agreements, representations, promises, or commitments, oral or written, which are not specifically contained in this Agreement or any other agreement which [C&M] signs with [True Value]. The current form of the Company Member Agreement shall govern all past and present relations, actions or claims arising between [True Value] and [C&M].

Based on these two exculpatory clauses, the trial Court determined that C&M was placed on notice that anything True Value said could and did not constitute representations or warranties about the possible performance of the business.  Based on this holding, the trial Court dismissed C&M's misrepresentation claims.

C&M appealed.  The Court of Appeals of Wisconsin first stated the general rule that exculpatory contracts are disfavored in the law.  Because of this general rule, the Court said that exculpatory contracts should be carefully reviewed by a trial court to determine whether they violate public policy.

Moreover, the Court advised that any such provisions should be strictly construed against the party seeking to rely on them.

The Wisconsin Court of Appeals stated that, to enforce an exculpatory provision in Wisconsin, the contract must specifically inform the signer of the types of risks being waived. 

The Court found that the Agreement failed to notify C&M that it was intended to operate as a "waiver of True Value's liability for misrepresentation" and that it did not make any "mention of disclaiming liability let alone specifying any specific tort." Because the two exculpatory provisions in question failed to "clearly, unmistakably, and unambiguously" inform C&M of these types of liability being waived, the Court held that the provisions failed to protect True Value.

The Wisconsin Court of Appeals also determined that the exculpatory provisions were not sufficiently conspicuous in the Agreement because they "did not stand out from the rest of the form in any manner and did not require a separate signature." 

The Court particularly noted that the exculpatory provisions were not placed together, did not have to be specifically initialed or signed by C&M, were not in a conspicuous location, were not surrounded by an attention-grabbing box, and were not emphasized by a heading. 

The provisions were in the same typeface as the rest of the contract, and, "although the last sentence in the first provision is in capital letters, it is neither a title nor a warning to C&M." 

Because the provisions were not remarkable or notable on the face of the Agreement, the Court held that they could not be enforced against C&M.

In light of the above findings, the Court of Appeals reversed the trial Court's dismissal of C&M's misrepresentation claims, holding the exculpatory provisions void because: "(1) [they] failed to clearly, unambiguously, and unmistakably explain to C&M that they were accepting the risk of True Value's negligence; and (2) the form, looked at in its entirety, failed to alert the signer to the nature and significance of the document being signed."

The lesson for franchisors (at least under Wisconsin law) in C&M is twofold: first, make sure that your exculpatory clauses are reasonably specific, addressing the types of statements that you do not authorize your salespeople to make and upon which your prospective franchisees should not rely.  

Second, your exculpatory clauses should in some way stand out from the rest of your franchise agreement -- by separating them from the agreement itself, or by using capital letters, bold, or a text box to call the reader's attention to them. Many franchisors have successfully relied on a separate "disclosure questionnaire" containing exculpatory clauses for this purpose.

For franchisees, the lesson is to carefully read your franchise disclosure document, franchise agreement and other related contracts before you sign them!

If a promise, statement, or representation was made to you by the franchisor or its salespeople and you're relying on it, make sure it's in the franchise agreement or in an addendum before you sign

What are a franchisee's rights and duties upon the termination of the franchise agreement? Upon termination of the franchise agreement for any reason, the rights and duties of the former franchisee are specified in the franchise agreement he or she signed.

Typically these obligations include several key steps that are essential to the franchisor and to other continuing franchisees.

  1. The first step is that a former franchisee should immediately cease using the logos and trademarks of the franchise system. This means that if you were a franchisee of ABC Doggie Daycare franchise, for example, you would need to remove everything showing that name and any logo, including on any signs, Yellow Pages listings, any advertisements, all stationery and brochures, etc.  
  2. You would also have to change the decor that makes your location look like an ABC location and change any clothing that identifies your employees as part of the ABC system.  If ABC was a food service franchise then any recipes and food products that were proprietary to the franchisor would also have to be removed.
  3. Typically a terminated franchisee will also have to pay all monies that are owed by the franchisee to the franchisor, its affiliates and to any suppliers.
  4. Additionally, the former franchisee would have to return all manuals and other documents which the former franchisee received during its time as a franchisee.
  5. Most franchise agreements today also have a non-compete clause in the franchise agreement or require franchisees to sign a separate non-compete agreement.
  6. Typically a former franchisee would not be allowed to remain in the same business after the franchise has been terminated or expires because the term ends.

This means that you may have a lease for your business that continues, but cannot operate the business. Often franchisors require their franchisees have Collateral Assignment of Lease provisions included in their lease so that the franchisor has the option to take over the location and run the business there until a new franchisee comes along for that territory.

This is another example of the importance of retaining experienced franchise counsel to advise a prospective franchisee prior to that prospective franchisee signing the franchise agreement.

Similarly, experienced franchise counsel should be retained to assist with any franchisee who is terminating his or her franchise agreement for whatever reason.

On October 16, the FTC issued FAQ #37 which disallows franchisors from claiming to award an "exclusive territory" if it reserves the right to open franchised or company outlets in so-called "non-traditional venues" like airports, arenas, hospitals, hotels, malls, military installations, national parks, schools, stadiums and theme parks.

Many franchisors have long excluded these closed markets from territory protection due to the unique and specialized nature of operating in such venues and the need to secure franchisees that understand, and have the knowledge to navigate, the nuances of those venues.

This is why you will frequently see the same few companies operating multiple brands in the same type of venue in multiple states. For example, have you ever wondered why you see the same neon-yellow-shirt-clad workers walking the isles at baseball parks across the country?

It's because those companies have spent precious time and resources figuring out how to successfully operate in a non-traditional setting--an endeavor which the vast majority of franchisees have no desire to undertake.

Importantly, and fortunately, the new FTC proclamation is not one which will prevent franchisors from continuing to making a reservation of rights for these closed markets.

It does, however, require that such franchisors include the "no exclusive territory" disclosure in ITEM 12 of their franchise disclosure document (i.e., "You will not receive an exclusive territory.

You may face competition from other franchisees, from outlets that we own, or from other channels of distribution or competitive brands that we control.").

With several weeks remaining in this calendar year, now may be the time to evaluate whether an FDD update is in order.

Guanxi is in the news again.  Last year, three high-profile businessmen - Neil Heywood , Sheldon Adelson and the former railways minister Liu Zhijun were considered Masters of the Guanxi Universe at one point, but are now grabbing headlines for all the wrong reasons. Heywood is the unfortunate expat fixer who died at the hands of Gu Kailai (wife of Bo Xilai) after close relations with the ruling family of Chongqing went horribly wrong.  

Adelson, CEO of the Sands Casino, is the can-do American mogul who helped build Macau into the Vegas of Asia, but is now under investigation in Beijing for massive bribery.  The year-long trial of former Ministry of Railways boss Liu Zhijun has just concluded with 6 guilty charges against him and some close associates involved in a complex, long-running network of kickbacks and corruption.

Now, "Chinese investigators said Thursday that executives from GlaxoSmithKline, the British drug giant, had admitted to using bribes, kickbacks and other fraudulent means to bolster drug sales in China."

Western negotiators in China should take note of one very important similarity in each of these three cases: at their peak, these men were held up as prime examples of the benefit - some have said the necessity - of relying on guanxi when doing business in China.

If you are arranging business deals in China, it's just a matter of time before someone tells you that A) everyone does it, and B) it's the only way to get things done in China.  

How can negotiators in China draw the line between cordial relationships and graft?

 

Guanxi and negotiation - build relationships, but state your goals and your limits early.


When the baijiu is flowing and the conversation is still light-hearted, do like the Chinese do.  Know your goals, steer the conversation where you want it to go, and establish a framework for the negotiation.  In China small talk isn't empty talk. A good Chinese negotiator starts staking out positions, assessing your assets and maneuvering for advantage from the very first meeting.

You have to do the same. Use your guanxi-building time to declare your goals, inventory their resources and capabilities, and establish limits.

Conversation in China is never as light or casual as it seems. When they ask about your family, reciprocate - and find out where their child is going to school. When they talk about travel, find out where they spend time.  If someone is a civil servants but his child goes to school in California and summers in France with Mom, then you have to do the math and draw conclusions about his source of income.  Make judgments about potential partners and associates early - and stick to your decision.  

No one gets more honest when the amount of money on the table goes up.   Westerners frequently let promises of  quick riches in China cloud their judgement and put them into bed with wrong counter-parties  (both literally and figuratively).

 

It's only guanxi until you get caught.


If you don't know what the FCPA (Foreign Corrupt Practices Act) is, get up to speed right away. When you get caught paying bribes, either in the PRC or the US, saying, "but the Chinese middleman I just met in Beijing told me it was OK" is an admission of guilt - not a legal justification. You may not get caught, but if you do the results can be devastating to your company and to you personally. If your company has a policy on gift-giving and bribery it is your responsibility to know it and abide by it.

If your company doesn't have a policy, then you need to clarify your position with the relevant people at HQ BEFORE you get into trouble. This is a conversation to have with your own people early.

 

Good guanxi and bad guanxi.


Guanxi translates as relationships or networks - not corruption. It is possible to build strong connections without bribes. The key is to select the right partners early, and communicate honestly and thoroughly. The wrong Chinese partner is going to get you into trouble by soliciting or facilitating bribes and graft. The right partner will steer you away from individuals and transactions that will cause problems.

China is much more relationship-oriented negotiating culture than the West, and it's difficult to do normal business without getting to know your counterparty on a personal level.

But there's a big difference between paying for dinner and paying a bribe. All corruption in China starts as a guanxi relationship - but not all guanxi ends up as corruption. You have to know what you are getting into and establish boundaries.

 

Guanxi may not help, but getting it wrong definitely hurts.


Should honest businessmen avoid guanxi and personal relationships completely? Some experienced expats have recently started suggesting that Westerners in China are better off dispensing with guanxi and relationship-building efforts since foreigners don't get the same benefits as Chinese do, but can run into more problems.

While this may be true, it is still a bad idea to ignore the importance of establishing cordial business relations. Good guanxi may not help you - but failing to establish a solid guanxi foundation will definitely hurt you.

For a discussion of Guanxi for Western professionals, take a look at the ChinaSolved ebook: Guanxi for the Busy American.

How's this for irony? 20th Century Fox (a subsidiary of 21st Century Fox) recently released the movie "The Internship," starring Vince Vaughan and Owen Wilson who, as desperate 40-somethings looking for work in a bad job market, land a coveted internship with Google.  This coming at a time when another subsidiary of Fox has had high-profile court trouble with regard to its practices of using unpaid interns.

First, about the movie -- it may not have struck box office gold, but I liked it.  I thought it was a fun buddy comedy with heart that speaks to a generation of people who have been left behind by rapid advances in technology. While it wasn't "laugh-a-minute," it did have some good laughs including a truly inspired scene (it's the one featuring NTSF:SD:SUV's Rob Riggle). I also liked that franchising played a small role in the movie, but hopefully I'll get to writing a separate post on that later.  

Now for the irony: another Fox subsidiary, Fox Searchlight Pictures, just last month lost a high-profile lawsuit by real-life interns. 

On June 11, 2013, the U.S. District Court for the Southern District of New York ruled that two unpaid interns on the Fox Searchlight movie, "Black Swan," should have been paid because they were essentially regular employees, not "interns" under the Fair Labor Standards Act (FLSA). 

The "Black Swan" ruling and other recent decisions are a wake-up call for companies to re-evaluate unpaid internship programs to ensure compliance with the law.

Indeed, for-profit companies that are currently using unpaid interns should be acutely aware that the FLSA's exception that allows this practice is extremely narrow, and that any "intern" who does not fit the narrow exception must actually be paid as any employee.   

Every "employee" under the FLSA must be paid at least minimum wage and, when applicable, overtime. 

Courts interpret "employee" very broadly.  In fact, courts sometimes presumptively view internships at for-profit companies as employment. However, interns who receive training for their own educational benefit, rather than the benefit of the employer, may nevertheless meet the unpaid intern exception and not be paid.

The U.S. Department of Labor (DOL) has identified six criteria that must be met for determining whether an internship program meets this narrow exclusion:

  1. The internship, even though it includes actual operation of the facilities of the employer, is similar to training that would be given in an educational environment;
  2. The internship experience is for the benefit of the intern;
  3. The intern does not displace regular employees, but works under close supervision of existing staff;
  4. The employer that provides the training derives no immediate advantage from the activities of the intern, and on occasion its operations may actually be impeded;
  5. The intern is not necessarily entitled to a job at the conclusion of the internship; and
  6. The employer and the intern understand that the intern is not entitled to wages for the time spent in the internship.

While some Courts do not require that all six factors be met, the Court in the recent Fox Searchlight decision agreed with the DOL that all six factors must be satisfied. 

In whatever Court a company finds itself, the ultimate determination as to whether an unpaid intern is an "employee" entitled to compensation will be made on a case-by-case basis and depends upon all the facts and circumstances of the internship program.  

In short, employers should undertake a proper evaluation of their unpaid internship programs now, and hopefully avoid facing those interns in Court later. (And, if you do see "The Internship," let me know what you think). 

For more of Matthew's Kreutzer articles, Please Click Here.

A word of caution about franchise businesses is indeed good advice; and our readers are wise to heed the warning. Unfortunately not all franchise opportunities are created equal.

As the vice president of Sparkle Wash International - a pressure washing franchise that has been in business since 1965 - I have had thirteen years of experience.

What has become abundantly clear during this time is there is one sure-fire way to get a handle on the legitimacy of a franchise organization... and that is through what is known as VALIDATION CALLS.

A validation call is the act of the franchise candidate conducting telephone interviews with several existing franchisees already up and operating in the franchise system.

During this process everything comes out in the wash - good, bad and ugly. To be fair to the franchisor the candidate must understand that not all franchisees within a system are going to be in love with the franchisor - and this is to be expected.

However, after several calls the candidate will start to see a pattern emerging, and THIS will be the truth behind the franchise opportunity.

Here is how to make a validation call.

 

a) Introduce yourself to the franchisee


b) Tell him you're interested in opening a _____________ franchise in (your location)

Here are three important questions you will want to ask the franchisee:


1) What were you concerned about before you bought into the franchise?
2) What have you learned since?
3) Knowing what you know now, would you do it again?

Be fair to the franchisor, not all franchisees will be in love with the system - that is only to be expected.

However, are the majority of the franchisees you speak with giving you a favorable report?

A "financial performance representation," also called an "FPR," is any representation, whether oral, visual or written, to a prospect that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits or net profits .

If the franchisor states in Item 19 of its FDD states that it and its representatives do not make FPRs to prospects, you must avoid making any oral, visual or written FPR to a prospect outside of the FDD.

If the franchisor includes FPRs in Item 19 of its FDD, you may discuss any FPR in Item 19 with a prospect, but you must avoid making any oral, visual or written FPR to a prospect that is not in Item 19. For example, if Item 19 gives the average annual sales of outlets open in the previous year, you are prohibited from representing orally that average sales in the current year have exceeded average sales in the previous year, since that oral representation is not supported in Item 19.

Here are some examples of FPRs outside of an FDD that must be avoided:

  • A chart, table or mathematical calculation that shows possible results based on a combination of variables.

  • A software program containing a spreadsheet with assumed cost percentages.

  • A copy of a published article which states that some franchisees have earned a specified amount.

  • A pro forma showing assumed low, medium and high sales and costs based on actual average cost percentages.

  • "You will earn enough to be own a new Porsche within a year."

  • "You will break even within 6 to 9 months."

  • "Your sales will increase 20% to 30% if you convert to be a franchised outlet."

  • "The sales and cost projections in the pro forma prepared by your accountant look reasonable to me."

  • "You are likely to realize a 100% return on investment within the first year of operation."

    Here are some examples of statements related to sales, profits and costs that likely are not FPRs, subject, of course, to the full context of what is said to a prospect:

  • "This franchise offers exceptional profit potential."

  • "Your sales will depend on your location and how much effort you put into the business."

  • "If you want to know about typical sales, profits and costs, you should talk with our franchisees."

  • "This is an opportunity of a lifetime."

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

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One of the important findings in behavioral economics is the discovery of "anchoring".  Anchoring is responsible many poor financial decisions and this is how it works in franchise sales.

Science has discovered that when we are presented with an estimate or percentage measure from a population that we know nothing about, we tend to anchor on the estimate and act as if it was true -even though we understand that we have no real knowledge.

Here is an example, from a QSR interview and Teriyaki Madness, which states how much you can make with Teriyaki Madness.

"He says that not only are potential franchisees attracted to the impressive numbers operators are pulling off--including an average 23 percent same-store sales increase; AUVs of $855,000; and profitability of 16-21 percent--but also to the uniqueness of the concept, which combines Asian flavors with healthy items."

Now you and I have no idea whether the AUV is correct, what the average is based upon, or how "profitability" was calculated.  However, the science says that you will anchor on these numbers and act is if they were true - despite not knowing what the Item 19 actually stated.

You will also notice that this claim made in an interview could not be compliant if it were an ad - the required disclaimer about how many units achieved that AUV is not present.  QSR can make this claim on behalf of Teriyaki Madness only if the interview is not a paid advertorial.

So for fun, let's take a look at the numbers behind the claim.

This is from Terriyaki Madnesses' 2012 FDD - and things could have changed by then.  Even so, the real numbers are revealing.

Teriyaki Madness Item 19 (2012)

We have provided the following information: the high and low annual gross revenue information for each year that the franchised locations were open; the average same store sales percentage increases for each year; the average unit volume of the group for each year; and the  number and percentages of franchisees that met or exceeded the average unit volume for each year.

For 2011, four (4) Teriyaki Madness restaurants were in operation for the entire year and for the years 2008 to 2010 only three (3) Teriyaki Madness restaurants were open for the entire year.

Teriyaki Madness Item 19.png

The financial picture disclosed in the Item 19 looks very different from the rosy picture described in the QSR article.  We find out that we have reporting only from 4 units, and two of those units had an AUV between $380,000  and $615,000 for the three years 2008-2010.

A new store would likely face a similar ramp up period.

Even the reported high is less than the AUV reported in the QSR story, compare $796,000 to an AUV of $855,000.

Further, the profitability story is taken not from a franchisee store but a company or affiliate store.

All of the reporting is designed in the writers minds to paint the glossiest story that he or she can tell - but, a smart reader like you knows to go beyond the anchoring effect, read for youself the Item 19, request the back-up for the Item 19,  and then come to a more realistic conclusion.

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The FTC franchise rule prohibits a franchisor from including any information in an FDD that is not required by the rule or state laws or regulations. The rule contemplates, however, that there will be times when a franchisor will want to provide a prospect with supplemental material information, or even will be required by other federal or state laws to provide a prospect with supplemental material information.

Supplemental information could include, for example, background in- formation on the franchisor's executives or on litigation not required to be disclosed in an FDD. 

Supplemental information may be required to be filed as "advertising" with certain states before being used, see permitted advertising.

Supplemental information is prohibited from contradicting information in an FDD, see "Prohibited 3: Information Contradictory to Information in FDD" below. 

Prohibited 1: Disclaimers or Waivers of Representations in FDD

You must not disclaim or require a prospect to waive reliance on any representation made in the franchisor's FDD, including any exhibit in the FDD. The only exception to this prohibition is when a prospect voluntarily waives specific contract terms or conditions in the course of negotiation (see "Permitted 6: Negotiation" above).

The franchisor must make sure that its franchise agreement and oth- er agreements do not contain provisions requiring a new franchisee to acknowledge reliance only on representations in the agreements. This type of provision is prohibited, since it requires a prospect to waive reliance on other representations in the franchisor's FDD. 

Prohibited 3: Information Contradictory to Information in FDD

You and the franchisor must avoid making any claim or representation to a prospect, orally, visually or in writing, that contradicts any information in the franchisor's FDD.

For example, if Item 7 in the FDD states that the initial investment ranges from $100,000 to $180,000, you are prohibited from stating orally to the prospect that the initial in- vestment often is less than $100,000.

Or, if Item 5 of the FDD states that the initial franchise fee is non-refundable, you are prohibited from stating orally to a prospect that the fee is refundable in some situations. 

Prohibited 4: Use of "Shills"

You and the franchisor must avoid referring a prospect to a "shill." A "shill" is any person misrepresented by you or the franchisor to be the purchaser of a franchise from the franchisor or the operator of a franchise of the type offered by the franchisor, or to be an independent and reliable source about the franchise or the experience of any current or former franchisee.

The prohibition on the use of shills applies to individual shills who are paid or otherwise compensated to provide false favorable testimonials or fictitious references to prospects, and to institutional shills that are paid to purport to act like Better Business Bureaus providing consumers with "independent" reports on their members. 

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The franchisor may negotiate with a prospect, subject to the limitations discussed below.

The information and exhibits in the franchisor's FDD must reflect the franchisor's actual initial offer to a prospect. If, based on changing conditions or other factors, the franchisor has decided to change it initial offer, for example, by increasing its initial fee from $25,000 to $30,000, it must amend its FDD before furnishing the FDD to a prospect. It may not furnish a FDD with a $25,000 initial fee and tell the prospect that the initial fee is actually $30,000, in effect "negotiating up" from what is offered in the FDD. Similarly, if the franchisor has decided to decrease its initial and royalty fees, it must amend its FDD to reflect the changes and its actual initial offer to a prospect, even though the changes favor the prospect.

A prospect may initiate negotiations with the franchisor before or after receiving the franchisor's FDD. In response, the franchisor may refuse to negotiate (except in Virginia, as discussed below), or may negotiate or indicate a willingness to negotiate. Negotiation may be about any matter, and may continue until the prospect signs final agreements.

Negotiated changes made as a result of negotiations initiated by the prospect do not trigger the 7-calendar-day waiting period for final agreements. If the prospect negotiates additional changes during any 7-calendar-day waiting period, the changes do not trigger an additional waiting period.

Give and take is permitted during negotiations. You or the franchi- sor may require the prospect to agree to terms more favorable to the franchisor, or may require the prospect to voluntarily waive terms and conditions, in exchange for agreeing to terms more favorable to the prospect. Under the FTC franchise rule, the prospect must merely be aware of all of the changes.

California is the only state that requires filings, approval and disclosures to later prospects if you or the franchisor negotiate with a prospect. Check with the franchisor's lawyer or compliance manager if you need or want to negotiate with a prospect covered by the California law.

New York requires negotiated changes overall to favor the prospect. This is not a requirement under the FTC franchise rule or an explicit requirement under other state laws. As a practical matter, however, most negotiations result in negotiated changes overall that favor the prospect.

Virginia requires the franchisor to negotiate with the prospect, but does not require the franchisor to agree to any concession requested by the prospect. 

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Communications with Probable Franchisees

Before you furnish the franchisor's FDD to a prospect, you may communicate in writing and orally to a prospect on a regular basis, as long you and the franchisor are properly registered or on file with any involved regulatory state (see Appendix A), and as long as your statements are consistent with the standards for advertising discussed above (truthfulness, consistency with the FDD, etc.).

After you have furnished the franchisor's FDD or final agreements to a prospect, you may continue to communicate in writing and orally to a prospect on a regular basis during any 14-calendar-day, 7-calendar-day or 10-business-day period that may be running.

You are not required to observe a "cooling-off" period during which you must cease all communications with the prospect.

Confidentiality with Probable Franchisees- FTC Franchise Rule

Under the FTC franchise rule, you or the franchisor may require a prospect to sign a confidentiality agreement before you furnish the franchisor's FDD to the prospect, or before you grant the prospect access to the franchisor's proprietary information or operations manual.

This type of agreement does not trigger any disclosure obligations under the FTC franchise rule, as long as it does not contain any other type of agreement that triggers disclosure.

The franchisor is not required to include the confidentiality agreement as an exhibit in its FDD.

Confidentiality with Probable Franchisees- State Laws

For a prospect covered by a state law, the franchisor may be required to include any required confidentiality agreement as an exhibit in its FDD; and you and the franchisor may be required to furnish the FDD to the prospect and observe a 14-calendar-day or 10-business-day waiting period, before requiring the prospect to sign the confidentiality agreement.

State prohibitions and requirements vary in this area, so check with the franchisor's lawyer or compliance manager.

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For so many years the quality of most of what passes for franchise investment opportunities has been so abysmally low that their selling risk has had to be hedged with capital punishment clauses galore in the franchise agreements and in the FDD materials.

Part of this is that the quality of the concept being sold has been marginal and worse almost all the time. Whole business segments are now populated junk offerings.

Along these lines one might mention sandwiches, ice cream yogurt and gelato shops, pizza, printing, car repair and maintenance and dozens more. For various reasons - a long list - these are not real business investment opportunities and only fools buy them. Since the market does not provide protection for fools, I am not going to waste any more time talking about what they are and how they are sold. Rather, I would prefer to discuss how one should sell a real, investment worthy franchise opportunity.

In a real investment opportunity you have demonstrable revenue credibility.

The franchisor, before embarking upon a franchising program, had a real business that made decent profits and showed substantial growth and could be operated by trained and monitored managers in several replications of the franchise model. This kind of franchisor paid attention to what was happening in his market and made adjustments and improvements as soon as the opportunities presented themselves, keeping the operating manual current and paying attention to detail. It is a fine tuned, well managed business at the moment that the decision is made to franchise it.

In other words, it is a real business with an identifiable attainable breakeven point that will occur within a year in the right market.

The franchise's financial performance is sufficiently monitored both in company store mode and in the franchised mode, and differences in financial performance are accounted for in terms of what causes the differences. The franchisor knows his franchise and is not just some circus clown with a glib sales pitch chock a block with slogans and meaningless pseudo information.

A real franchise is not sold to every bozo with a temperature and a room temperature IQ who can write a check for the initial fee. A real franchise is not sold in any market where its anticipated performance is not responsibly projectable.

A real franchise skims the best markets first. In that manner the franchise itself, as a system, achieves early revenue credibility that enables the franchisor to begin writing a more aggressive FDD.

A real franchise is sold to carefully vetted franchisee prospects with more than enough money than will be needed and a proven business track record that includes actually having to make serious business risk decisions, not some marginal mid level "executive" who had to remortgage his house to meet the anticipated total initial investment.

Total initial investment, as presented in almost every FDD is an inadequate range of numbers intended to speak to the first 90 days after store opening and omits far too much to be remotely reasonable. In our real franchise, the Item 7 information will be a much higher number because the caliber of investor sought will not be scared off by it.

The number will also change frequently because its underlying information is being monitored carefully. The franchisor will have a good grasp on where breakeven can be expected to occur and how long it takes to get there. This enables more aggressive FDD information that is not misleading. This is the kind of information a real investor wants to know about. This is what sells franchises to intelligent investors.

If area development deals are sold, they are sold to people who have a track record demonstrating the capability to meet a development schedule. That schedule will describe the art of the possible in an area with defined top level geographic areas and good demographics specifically measured for this franchise.

With this approach the FDD can and will become more aggressively informative each year. There will be few surprises and those easily manageable. The franchisor will be willing to make adjustments for these surprises so that they do not result in serious economic disruption and the rise of disputes. The franchisor's willingness and ability to make adjustments and accommodations where appropriate, no matter what the franchise agreement may say, will mark that franchisor as the affiliation of choice for the best operators. Good reputations grow almost as fast as bad ones, and one does not become known as a chump for using good sense.

In this kind of franchise there is no danger in demanding compliance with the agreement terms, because the business is not financially impaired by the range of possible additional charges that could be made by the piggish franchisor. Good business partners know that everyone in the deal has to make money and that only a pig tries to squeeze every last nickel and dime out of it.

However, the extraneous revenue stream temptation will always be there, and an enlightened franchisor is all too often succeeded by more opportunistic types. For this reason it is critically important that franchisees establish an effective independent franchisee association long before abuses occur. It is far easier and less expensive to prevent abuse than it is to stop abuse.

Usually franchisees assume the best and leave themselves open to abuse until it is too late. That is a terrible mistake.

Franchisor established franchisee advisory boards are no substitute for the franchisees having their own independent organization. The franchisees of Quiznos and Marble Slab Creamery and many others learned this lesson the hard way. They are now dropping like flies.

For several years the franchise world has been populated mainly by mediocrities and worse, all sold to moron FranWads who were usually corporate middle management types - glorified clerks. They accumulated close to a million dollars in many instances through hard work and frugality, only to lose it all and end up in bankruptcy.

It is time for a higher level of investment quality. There are plenty of investors for those opportunities who are financially and experientially qualified. Following the plan suggested here and elsewhere on www.FranchiseRemedies.com a solid and credible franchise investment environment can again be established. I will be very happy to help guide them through their early years into their growth phase to maturity.

The information provided to franchisee candidates is meant to be read, understood and acted upon.

Some franchise sales processes are designed to run around this information, minimize its import or in some cases to blatantly contradict this information.

Consider this marketing piece put out for Mooyah Burgers.

The advertising clearly states & makes a financial performance claim: 2 to 1 sales/investment ratio.  

2-1 Sales.png

 

Now, let's check what the franchisor actually says in their FDD. 

Item 19 from Mooyah Burgers 2013 FDD

The FTC's Franchise Rule permits a franchisor to provide information about the actual or potential financial performance of its franchisedand/or franchisor-owned outlets, if there is a reasonable basis for the information, and the information is included in the disclosure document.

Financial performance information that differs from that included in ftem 19 may be given only if:


(1) a franchisor provides the actual records of an existing outlet you are considering buying; or


(2) a franchisor supplements the information provided in this ftem 19, for example, by providing information about  performance at a particular location or under particular circumstances.

 

This franchisor does not make any representations about a franchisee's future financial  performance or the past financial performance of company-owned or franchised outlets.

We also do not authorize our employees or representatives to make any such representations either orally or in writing.

If you are purchasing an existing outlet, however, we may provide you with the actual records of that outlet.

If you receive any other financial performance information or projections of your future income, 

you  should report it to the franchisor's management by contacting Michael Mabry or our Franchise Sales  Department at:

6100 Preston Road.

5212 Tennvson Parkwav Suite 240.

Frisco 120.

Piano. Texas

7503475024 or f2141 872 4313 310-0768.

the Federal Trade Commission, and the appropriate state regulatory agencies.

This is a clear case in which the sales process & the marketing materials are at odds with the 2013 Franchise Disclosure Document.  The presentation of this contradictory information likely harms the franchisor's sales process.

SALT LAKE CITY -- The U.S. Department of Labor has filed a lawsuit against Universal Contracting LLC, CSG Workforce Partners LLC, Decorative Enterprises LLC, Mountain Builders Inc., Cory Atkinson, Tracy Burnham and Ryan Pace after an investigation by its Wage and Hour Division disclosed evidence of willful violations of the Fair Labor Standards Act's overtime and record-keeping provisions.

The department's lawsuit seeks to recover unpaid overtime compensation and liquidated damages for more than 800 current and former laborers. It also requests the court to permanently enjoin the defendants from committing future violations of the FLSA.

Employment agencies Universal Contracting and CSG Workforce Partners provided laborers to contractors--Decorative Enterprises and Mountain Builders--and charged the laborers and contractors a fee for their employment placement services. Wage and Hour Division investigators found that the companies misclassified workers as something other than employees, claiming there was no employee-employer relationship, and denied the employees overtime compensation, as required by the FLSA.

"Universal Contracting, CSG Workforce Partners and their clients are intentionally skirting the law by willfully and wrongfully claiming that their workers are not employees because they are members or owners in a limited liability company," said Cynthia Watson, Wage and Hour Division southwest regional administrator. "As demonstrated by this lawsuit, the department is vigorously pursuing corrective action in those situations where misclassified workers are actually employees, to ensure that they are paid required wages and to level the playing field for employers who play by the rules."

The department's suit was filed in the Central District of Utah, Salt Lake City, following investigations by the Wage and Hour Division's Salt Lake City Office that found the defendants violated the FLSA by failing to maintain a record of hours worked by employees and failed to pay the employees the federally mandated overtime compensation, as required by the FLSA.

The violations committed by Universal Contracting and CSG Workforce Partners are considered willful because the companies had been notified previously by the Wage Hour Division that the workers are employees. As such, they are entitled to the wages and employment protections guaranteed by the FLSA. Universal Contracting and CSG Workforce Partners willfully and purposefully pursued an operational method that makes it difficult to determine the hours its laborers worked and the corresponding compensation received for those hours.

The department's lawsuit seeks to hold Universal Contracting and CSG Workforce Partner's clients, Mountain Builders and Decorative Enterprises, severally liable for the violations. Mountain Builders and Decorative Enterprises are in a joint employment relationship with Universal Contracting and CSG Workforce Partners. The department has also filed a motion for preliminary injunction seeking an order directing Universal Contracting and CSG Workforce Partners to immediately comply with the FLSA's overtime and recordkeeping provisions.

The misclassification of employees as something other than employees, such as independent contractors, presents a serious problem for affected employees, employers and to the economy. Misclassified employees are often denied access to critical benefits and protections, such as family and medical leave, overtime, minimum wage and unemployment insurance, to which they are entitled. Employee misclassification also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers' compensation funds.

The Wage and Hour Division's Salt Lake City Office and the Denver branch of the Office of the Solicitor, through an agency memorandum of understanding with the Utah Labor Commission, have been working on employee misclassification issues, including issues regarding this case, with the Commission, the Utah Division of Occupational and Professional Licensing and the Utah Industrial Accidents Division. Under the terms of a similar information-sharing memorandum of understanding, this is the type of case that the Labor Department may refer to the Internal Revenue Service.

Memorandums of understanding with state government agencies arose as part of the department's Misclassification Initiative, with the goal of preventing, detecting and remedying employee misclassification. More information is available on the department's misclassification Web page at http://www.dol.gov/misclassification.

The FLSA requires that covered, nonexempt employees be paid at least the federal minimum wage of $7.25 for all hours worked, plus time and one-half their regular rates, including commissions, bonuses and incentive pay, for hours worked beyond 40 per week. Additionally, employers must maintain accurate time and payroll records. Employers who violate the law are, as a general rule, liable to employees for their back wages and an equal amount in liquidated damages. Back wages and liquidated damages are paid directly to the affected employees.

For more information about federal wage laws, call the Wage and Hour Division's toll-free helpline at 866-4US-WAGE (487-9243) or its Salt Lake City office at 801-524-5706. Information also is available at http://www.dol.gov/whd.

You and the franchisor may use "advertising" to promote the sale of franchises, subject to the limitations discussed below.

"Advertising" includes website pages, Internet ads, magazine ads, newspaper ads, brochures, handouts, CDs and DVDs oriented to prospects. Less obviously perhaps, "advertising" includes blank pro formas given to prospects, form letters or emails used to communicate with prospects, and copies of published articles and other materials given to prospects. For purposes of this handbook, "advertising" does not include consumer-oriented materials, such as sample ads, menus or point-of-sale displays, shown or given to prospects.

Advertising must be truthful and not misleading. For example, advertising may not reference studies that purport to show that franchisees are more successful than independent business people, if those studies, such as the discredited U.S. Department of Commerce or Gallup studies, have been found to be unreliable.

Advertising may not expressly or impliedly assure or guarantee success, profitability, earnings, or a safe investment that is free from risk of loss or default. Therefore, variations on the words "success," "profit," "proven," "lucrative" and "recession-proof," or any other term that states or implies earnings, must be used carefully and sparingly in advertising.

Advertising must be consistent with information in the franchisor's FDD. As to fees and initial investment costs, advertising must be supported by information in the FDD. For example, any initial fee or initial investment information in advertising must match, and may not go beyond, what is in the FDD. Advertising may not include financial performance representations, also called FPRs, unless the same FPRs are included in Item 19 of the franchisor's FDD. 

Advertising may provide some supplemental information that is not required or permitted to be included in the FDD. For example, a franchisor executive is required to include 5 years of employment history in Item 2 of an FDD and may not include more unless the executive has held the same position with the franchisor for longer than 5 years. Advertising may include much more information about an executive's experience and background.

A franchisor is prohibited from including a blank pro forma in its FDD, but it may provide a blank pro forma to a prospect to show typical categories of sales and costs. The franchisor may not help the prospect to fill in the blank pro forma. If used in this manner, the blank pro forma is advertising that provides permitted supplemental information to the prospect.

Advertising on the franchisor's website must include a disclaimer such as the following:

NOTE: This website is not a franchise offering. A franchise offering can be made by us only in a state if we are first registered, filed, excluded, exempted or otherwise qualified to offer franchises in that state, and only if we provide you with an appropriate franchise disclosure document. Follow-up or individualized responses to you that involve either effecting or attempting to effect the sale of a franchise will be made only if we are first in compliance with state registration or notice filing requirements, or are covered by an applicable state exclusion or exemption.

The following states regulate the offer and sale of franchises:

California, Florida, Hawaii, Illinois, Indiana, Kentucky, Maryland, Michigan, Minnesota, Nebraska, New York, North Dakota, Rhode Island, South Dakota, Texas, Utah, Virginia, Washington and Wisconsin. If you reside, plan to operate or will communicate about the franchise in one of these states, you may have certain rights under applicable franchise laws or regulations.

This disclaimer should be on or linked to the first website page oriented to franchisee prospects, but is not required to be on or linked to each website page oriented to franchisee prospects. 

You may run ads in national publications such as Franchising World, Entrepreneur, Franchise Times or Franchise Update, and may post pages oriented to franchisee propects on the franchisor's website, without pre-submitting the ads or pages to any states.

You must pre-submit, before use, other types of advertising, such as local newspaper ads, brochures, handouts, CDs, DVDs, blank pro formas, form letters and emails, and copies of articles distributed to franchisee prospects, to the following states: California, Maryland, Minnesota, New York, North Dakota, Rhode Island and Washington.

New York requires you to add the following disclaimer to advertising:

NOTE: This advertisement is not an offering. An offering can only be made by a prospectus filed first with the Department of Law of the State of New York. Such filing does not constitute approval by the Department of Law.

California and Washington sometimes require you to pre-submit written consents permitting the use of third-party endorsements, such as franchisee testimonials. 

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

This article deals with compliance with contract issues, not compliance with laws regulating franchise sales. Its opening major premise is that the concept of compliance has many dimensions, is seen from many different perspectives, and is in many instances more situational in its relevance that an institutionalized constant.

I don't mean to be flippant or casual when I suggest that compliance is a sometimes thing. The fact situations in which compliance becomes a do or die issue so often involve application of compliance standards in one situation that are not utilized or insisted upon in normal situations, that a legitimate question arises regarding selective enforcement.

Sometimes selective enforcement is justified, as in the case of a hard core recidivist constantly resisting conformity.

And, as the trial lawyers (myself included) so often say, that makes for the 'justiciable issues' revenue stream we know and love so well. It becomes in most instances a question for the trier of fact, judge or jury, whether the behavior of the parties in this particular case is acceptable, or aberrational and without just cause (whatever that means).

The general rule of contract construction is that the express terms are there for the purpose of being insisted upon. That's too elementary to be of much assistance in understanding how the contract language and the franchising agenda work together. It's one thing to be able to read and quite another to understand the 'system'.

But that's what you agreed to, so that's the standard to which you will be held, unless of course you were induced to sign the contract by misrepresentation and can prove that.

Stupidity/ignorance is not a defense, but it is still unlawful to cheat the stupid (in most states).

General rules of construction, however, are themselves subject to selective application when the ambient circumstances suggest that to do otherwise would work injustice. One important point is that whenever a variance from strict compliance is in order, the contract is written so that it is the franchisee's burden to prove that it is in order. That fact alone gives the franchisor most of the options in deciding what level of compliance may be insisted upon in any individual situation. Inasmuch as the franchise contract is written to give the franchisee the fewest possible options in time of trouble, reading the contract does not inform a potential franchisee of the 'quality' of the investment being offered.

A potential franchisee has to start out with the understanding that the contract favors the franchisor at every turn and on every question. With that level of riskiness staring you in the face, the due diligence on the quality of the investment being offered is the most critical area of inquiry. Unfortunately, new franchisees almost never go to a franchise industry specialist for that due diligence. They go to their cousin or their divorce lawyer who has absolutely no ability to inform them about what they are getting into. Is it any wonder that about 70 % of them go broke in the first three years?

What the International Franchise Association says about survival chances being enhanced if you are a franchisee is thought, by many who have good reason to know, not to be true. Judging the prospects of the newer franchise offerings by the success track of the more mature franchisors is not a reliable risk assessment technique.

There is a curious analogy that I often joke about (See 'The Ultimate Franchise' at www.SeamusMuldoon.com ). Most of us casual compliance folks think of the fundamental mandates of the Bible in terms of the Ten Commandments, supposedly a contractual construct given by our Creator and accepted by the Israelites at the theophany on Mount Sinai. Like the Sherman Antitrust Act, the Ten Commandments have sufficient constitutional vagueness to allow them to be interpreted and applied to the ambient circumstances of an ever changing world.

The more compulsive amongst us have, however, scoured the Bible and found at least 613 commandments. People like this write franchise contracts. Compliance with 613 commandments requires the dedication of life itself to compliance, with little time or energy left over to do much else. Franchise contracts are so convoluted, especially when viewed in conjunction with franchise operating manuals, compliance with which is mandated in all franchise contracts, that running a normal business can be obstructed rather than facilitated by over zealous devotion to compliance. Where is the line to be drawn that demarcates reasonable compliance from fanaticism? The answer is that it is an ever moving line.

This article is intended to suggest an approach to how to find the line in the particular situation that you face today.

A franchise contract is written to cover every conceivable situation and to maximize the likelihood that in any dispute the franchisor will have the upper hand. Those of us who draft franchise contracts have been fine tuning every provision and adding provisions over at least the last 40 years since I have been in practice to keep the advantage as far over in the franchisor's corner as possible through changes in statutes and regulations and to accommodate the variant approaches to dispute issues that have come out of court decisions and opinions.

It requires constant vigilance to counter any change that might erode a franchisor's control options regarding the franchisor's name, system, identity and the enforcement of the franchisor's will in all situations.

Because the franchise contract is written to be the ultimate safety net to enforce franchisor control options, no matter what, it may not be/is not correct to think of it as the standard for normal day-to-day operations. It deals with emergency preparedness, and emergencies simply do not occur all the time. In some companies it may seem like emergencies occur all the time, but those are not system wide emergencies unless the company is not competently managed.

There are usually different emergencies amongst many franchisee scenarios. Even the operations manual, which is supposed to be the micro management reference source, is a 'best case' construct that itself changes several times each year. What does not evolve does not survive. Once protecting the crown jewels is accounted for, no one wants the documentation to stifle progress.

The contract itself is not the crown jewel. The business relationship and its prospects for success and growth are the crown jewels, and the contract is to serve that, not to usurp that -- no matter what lawyers think.

I submit for the sake of this argument that in a well run organization, on a day-to-day basis, neither the franchise contract nor the manual is fully observed/complied with.

They are target benchmarks that are rarely/never one hundred percent met in a well run business that is making money.

Technically speaking, therefore, there is non-compliance/breach occurring every single minute of every single day.

And in a 'management by exception' mode, what we do is react to activity that it outside the margins of tolerance and perceived to be pernicious. Outside the margins of tolerance and not perceived to be pernicious is called innovation. Innovation, once field tested, is brought into the tent and becomes part of the operational fabric.

Given that 'breach' is always occurring, one must then, I think, concede that the critical talent that must come into play in any enforcement decision is management discretion.

As we say in Texas, that's why they pay us the big bucks -- to use excellent management discretion, to be able to balance competing interests and prioritize issues so that the best result with the least adverse risk becomes the most likely outcome in any situation.

There are limits on discretion. What one might wish to do in a seemingly deserving situation is sometimes influenced by considerations of precedent. What might be a salvaged relationship is sometimes lost to considerations of precedential impact, and more frequently lost to management ego issues.

Here is where a great deal of error creeps in, as many situations feared to be precedent setting are actually not precedent setting. Competent analysis is required to distinguish between the two. If I let this franchisee off the hook on this default, everyone will think they can get away with it too. Even though there is no regulation or law that requires uniform enforcement of any contract provision, there are erosion and dilution issues that can become acute if the perception amongst the franchisees is that the franchisor is not militant about enforcing the franchisor's rights and authority.

Rabble rousers are all too frequently looking for some wiggle room to find issues to use as rallying points to promote the formation of adverse constituencies around some agenda or other. And sometimes there is a situation in which tolerance should be exercised, especially if the franchisor is not blame free. Confrontations over enforcement issues that end up in court/arbitration and that go against the franchisor become worse precedents and more virulent in their impact. 

The nature of the event(s) of compliance failure, the level of gravity, is always the first step in the process of trying to decide whether to actually declare/give notice of a default under the franchise contract. The second step is due diligence. All too often the second step is ego driven/agenda driven rather than objective investigation. That's a wrong turn in practically every instance. It matters much less who is in issue here than the ability to provide adequate documentation of the default, including the ambient circumstances leading up to the default. Files must be marshaled, people interviewed and statements taken and signed.

This is lawyers' work. If management does the interviewing, there will be more concern on the part of the employees being interviewed that they respond in harmony with what the think the boss' agenda is rather than a straightforward fact statement. That concern will be there even if the lawyers do the interviews, but it will be much more palpable if the executives do or are present during the interviews. Even with the lawyers doing the interviews, it is often the case that the employees have met to assure that they are all on the same page, and sometimes there has even been a meeting with the boss where they are made keenly aware what the boss' agenda is. The employee may give false statements effectively while on his home turf with wishful thinking friendly folks in the room. He can't reliably be expected to do as well under cross examination by opposing counsel with unfriendly folks in the room and a transcript being made that can be evidence of perjury. This is the very essence of ego driven procedure, and the worst possible scenario for the production of a high quality result. When you impair the quality of your own company's due diligence, bad things happen. I ought not even have to say that. But I have seen so much of it that in my opinion it merits comment. But this article really isn't about the ego driven boss. After the facts are marshaled and able to be examined in a sensible mode, then agenda can rationally come into play. Having an agenda isn't bad per se. Letting the agenda get in the way of accuracy is very often extremely bad in the results obtained. If the agenda is a constructive agenda, accuracy won't dilute it or thwart its advancement. You really can't have an agenda that depends for its effectiveness upon management never making mistakes. Management is human, and mistakes will happen. The agenda must work despite management mistakes if it is a positive agenda, a substantive (non fluff) agenda.

The vast majority of compliance failure is dealt with at the level of the inspection report. In a well run company, copies of inspection reports are left with the franchisee at the end of the inspection visit, after discussion with the franchisee/manager of what inadequacies were found. If the problems were more than marginal, there may be a follow up inspection at an earlier date than would normally occur to be sure of cure or a detailed written cure report required of the franchisee. If people are using good sense, it ends there. If people are not using good sense, deficiencies persist and may get bucked up to operations and an operations manager may call or send an email to the franchisee requesting an explanation of why 'stuff' wasn't fixed when it should have been fixed. If compliance failure continues and the problem is significant, the director of operations will usually make personal contact to inform the franchisee of the risk of default notice, and ask if there is some agenda at work that is making the deficiencies persist. This makes good sense and it makes for a good paper trail to show a judge or jury that the franchisor is really trying to be as reasonable as possible before whipping out the big gun. Persistent compliance failure always gets more aggressive treatment in court than occasional events of compliance failure. Only the persistent failure gets the big gun treatment unless the nature of the event is such that there is an emergency need to take immediate remedial action. This is the regime for dealing with operational defaults, and I have seen CEO and COO type people get on the phone personally before resorting to the heavy hand. Default notices usually need to be approved at the top anyway, even if the honcho does not insert executive authority into the mix -- sometimes because the executive really doesn't want to be a witness if that can be avoided. Apex witnesses are a phenomenon to be avoided. They frequently make terrible witnesses, and often judges and juries simply don't buy the notion that the executive really doesn't get involved personally in the day to day operations. The Enron executive is the worst case scenario for this problem.

Above operational compliance failure would probably be financial defaults. Things don't get paid when they should get paid. This is more serious than not putting date labels on the inventory in the walk in cooler. This also goes to another part of the franchisor organization, the accounting and finance people, who should be less tolerant than operations people. Financial compliance failure is more frequently a harbinger of greater and more fundamental failures of compliance, and if they are not nipped in the bud, blossom very quickly into situations requiring surgery.

This is dealt with more effectively where the franchisor is professionally managed. When the founder is still at the helm, the franchisees are often seen as his children, and too much forgiveness of tardy financial compliance leads to systemic evils of enormous proportions. Allowing franchisees to fail in compliance with financial responsibility issues is never beneficent. Immediate resolution is the best resolution. The issue should get kicked upstairs sooner, and executive approval of default notices should be given after one attempt to find out if some emergency/calamity has befallen the franchisee that might justify exceptional consideration. The recent hurricane season on the gulf coast and health calamities epitomize the level of calamity called for. The level of clemency allowed will fit the particular situation.

If it is not done in this sanguine fashion, it is always the case that the slow paying franchisee starts to feel that the need to account and to pay up is not acute. The obligations to the franchisor go to a lower order of priority. Even in the normal pecking order of things, paying the franchisor is all too often on the lowest rung after all other expenses of operation. The psychic influence always buried in the mind of the franchisee is that the franchisor doesn't deserve to be paid if profits are down, regardless of the reason. If you don't kill this germ immediately, it grows into a monster. Franchisors who, absent calamity, allow franchisees to sign promissory notes for past due obligations are not helping anyone. The more the franchisor relents on financial performance, the worse the situation will always become, until ultimately the franchisor has a drawer full of promissory notes that are of dubious value and the auditors make you take a write off on your operating statement and balance sheet. Shame on you if this ever happens. And if you let people give you promissory notes instead of cash, you deserve what will happen to you. This is not a legitimate form of kindness. The franchisees who owe you money will eventually try to find a way to get out of paying you. The more of them who owe you money, the more enticed they will be to share costs of litigation, and the more prone they will be to foment any kind of problems within the system. This kind of kindness never goes unpunished. Any CFO with promissory notes in lieu of cash needs to be relieved of duty. If the founder owns the company and wants to throw away his/her money, that's their business. In a professionally managed company that is per se incompetence. And they brag about not paying you to each other. That leads to 'why should I pay if Charlie aint paying?' How far do I have to go on this scenario before the point is made?

The other category of defaults, neither operational nor financial, fall under the heading structural compliance failure. This includes using the name/mark in an unauthorized manner, establishment of unauthorized stores (almost always accompanied with under reporting of sales and royalties), unauthorized assignment of the franchise.

Hijacking the franchisor's identity is rarely other than intentional. Someone would have to make a clear and convincing case that is almost impossible to make to explain away anything like this. Every now and then, a franchisee who sees termination coming will find a sucker to dump it on, getting cash money at closing and hitting the road. Sometimes the sucker is really a bumpkin with money (like an immigrant) or just an opportunist. The immigrants with money may not be money bumpkins, but they are often bumpkins when it comes to how franchise assignments work. Part of this is simply that they come from countries where business is simply not done this way. Many come from cultures in which without deception it is impossible to get anything done. Bribery/extortion is so pervasive that open disclosure is suicide. I have seen many of these situations in real life. In one an established franchisor bought a major market from an area developer who had just received notice of termination of the area development agreement for failure to meet the development schedule (and who had no hope of meeting it with a reasonable extension). He bought it for cash. He did no due diligence. The deal just seemed too good to take any chance that it would get away. The buyer then called the franchisor to introduce himself as the new owner of Detroit, only to learn that the rights he just bought for cash had been terminated. He should have known better. He was impulsive about many things. If his gut told him it was a good deal, he went for it. I had to bail him out of several deals in the middle of the night over the phone from some long distance venue. Years before that, he had been talked out of the opportunity to buy Michigan from Colonel Sanders (by a lawyer who said it was a scam) when the Colonel was just getting started. He hated lawyers. He vowed never again to miss out on grabbing the gold ring. How he had gotten to trust me and start calling me first at the last minute before writing big checks is just good luck on my part, I guess. He was a sucker for any fried chicken deal.

When he learnt he had been bamboozled out of big bucks for the Detroit rights to a very hot franchise name, he called me and, with murder in his heart, ordered me to get injunctions and tie everybody up in court until they begged for mercy. As we had no case against anyone against whom a judgment might be helpful, I infuriated him all the more by telling him that was not the way to approach this. I suggested begging. He blew his stack. He was not a beggar and no one was gonna beg on his behalf. When I explained to him that all he would do by going into court was make a public record of his own stupidity, and that he would become the butt of franchise jokes all over the country for the next five years at least, he started to calm down. I learnt that I am really a wonderful beggar. We flew to the franchisor's office, met with the right people and walked out of there with a 40 store market worth of franchise rights. Maybe that's why he called me whenever people offered him the moon after a big dinner with cocktails, wine and after dinner drinks.

I have had a few immigrant situations also. Many immigrants with a lot of money have very poor insight into the intricacies of how franchising works. Many come from environments/cultures in which concealment and devious business behavior is considered to be the only way to survive. They bring these perspectives with them to every deal. Frequently they view contract signing as theater. They know how to act out the part, but have a non-compliant agenda. They would not hesitate to rip off their own countrymen, and certainly would not hesitate to do the same to a stranger. Only in recent years has franchising really made big inroads into many areas of the world other than the European Union. Pre-contract execution cultural conditioning helps a lot. You owe it to yourself to inform the potential immigrant franchisee that your contract is not a social document and that you will police compliance. That should be done in addition to the formal franchise contract language that, of course, says it will be done, but says it in lawyerese. At every franchise sale closing event there ought to be a 'Come to Jesus' discussion in which the franchisee-to-be is told rather frankly what compliance is going to be like in reality. There are a number of steps that could be taken at the closing event that could make life a great deal easier for franchisors when trouble raises its ugly head.

Franchise transfer is one of the events in which the franchisor's compliance expectations often have little to do with the seller's intended course of action. Sometimes, if the seller of a business is one of their countrymen, the greenhorn wrongfully assumes that some trust ought to be extended. This is what a crook trades on. They buy rights that a seller has no authority to sell, for cash of course. The seller hits the trail back to his homeland and finding the money is hopeless. The franchisor has the unpleasant task to tell the buyer that he bought nothing. In most of these situations, but not all, the only way to approach the nightmare in representing the buyer is expert begging. Hopefully the buyer has good business credentials of some kind that may suffice to convince a franchisor to accept him and make the distinction between the sucker who got scammed and the person who scammed him. Hopefully also, the buyer really is someone who was actually taken in, and not an active co-conspirator in a scheme to hijack a franchise.

Probably the main obstacle to be overcome in this scenario, assuming that the buyer would be a good operator and can handle the responsibility, is that if the franchisor rejects the buyer as a potential franchisee, the franchisor then has a profitable store that has now become a company store that the franchisor can sell to a new or old franchisee for its going concern value, without itself having to pay going concern value to get the store. The sucker who bought from the non-compliant franchisee is out all his investment, and the franchisor will get the going concern value if it refuses to accept that person as a new franchisee. The franchisor may not have ripped the poor bastard off in the first instance, but the franchisor will end up receiving the fair market value of this going concern by refusing to recognize the duped buyer as a new franchisee (assuming the buyer is willing to sign a then current franchise agreement). The attractiveness of that windfall is sometimes more than a franchisor can resist. Not at least allowing the buyer to sell out and recoup his investment could be viewed by a court or jury as an actionable form of over reaching, assuming that there are other operative facts that weigh heavily in favor of the buyer as a competent operator. The situation is too easily portrayed as plain old greed. Does the franchisor have the right under the applicable contract documents to do that? Of course it does. But the buyer may not yet be a party to such a contract, and the contract escape mechanisms may not apply to a buyer who has not yet been approved. That's why being able to perceive the difference between the duped buyer and the swindling former franchisee who sold the business improperly may in the long run be something worth consideration. It isn't really giving away/making gifts of corporate assets when a franchisor decides to accept the buyer in such a transaction. It's a legitimate officer's bona fide judgment call about what is the best business practice in any individual situation. Doing it does not set a precedent that could be used to require that the same be done for every unauthorized buyer. It depends upon the circumstances in each instance.

These are always cliff hangers. The situation gets sorted out very fast once the franchisor realizes what has happened, but there are several days and nights of sheer terror. The Buyer usually has everything he owns in the world tied up in this transaction and will lose his home and have to enter bankruptcy. His entire positive business history will be destroyed in a flash if the franchisor cannot be convinced to give him a break. The franchisor has to get really good results from investigating these deals to even think of the possibility of giving these folks a break. Even something like the buyer's ethnicity can work against him. Having to get a 'pass' for someone in that fix who is from the Middle East or Russia is a much tougher road. Feelings just run higher against them. There is a definite angst about whether an intentional hijack really is happening. [Cross reference 'Infiltration of Franchise Systems', another in this series of Specialized Tutorials] Even the slightest threat of litigation by the buyer is an act of suicide. Save the threats. If the deal goes south in its entirety -- the buyer isn't even allowed to sell what he bought to save his investment -- you sue if you can find something to sue about. But you never talk about it. You just do it when the time comes. If you know what you are doing and have a decent litigating reputation, the franchisor knows what's coming if some way to 'work it out' can't be found. There's no need to talk about it.

Before I will agree to be the beggar, I do my own investigation. I think that my reputation has some weight in the process. I never misrepresent and I make full disclosure up front so that the franchisor's investigation will not uncover anything I haven't already disclosed. I have to disclose the good, the bad and the ugly -- no one is all good all the time. If I can satisfy myself that my client is deserving of some consideration, then I think I can do a better job for him. If I don't believe him, why take his money and fake it? I won't be able to help him and it will hurt my own reputation. And if the client isn't fully forthcoming with me, this approach will certainly sink his ship. I tell them that so that they will come clean to me. If they don't, they are very likely to get caught, and their investment goes down the drain. So far, my reception by franchisors in these situations has been very positive. I don't always get what I hope for. Sometimes it just isn't in the cards. All too often I get the client after his so-called regular lawyer has done all the wrong things and the whole situation has become acrimonious. That's hard to overcome. People always seem to start out on any tough problem by calling each other awful names. That's really stupid.

This tour of default management issues is certainly not encyclopedic. Even if it were, someone will think of something new next week, and there will be more fodder for litigators. And there are, of course, many flavors of compliance failure within each of the major categories I have suggested.

There is one universal constant in the resolution of all this. If the decision is made to forego terminating a defaulting franchisee, the franchisor should always exact a quid pro quo.

If you have the right to send a termination notice, but opt instead for a peaceable resolution that leaves the offending franchisee with his investments intact, get the benefit at least of an acknowledgment that from that moment on you are free and clear of any claims against yourself. Get a bankable status of effectiveness confirmation. Don't let someone off the hook who may be saving in his back pocket a claim that was about to be asserted against you in the event of confrontation. In commercial leasing this is known as an estoppel certificate. In franchising, I call it a reaffirmation and ratification (ReRat). This agreement says that the franchisee acknowledges that the franchisor is foregoing the exercise of enforcement rights under the franchise agreement; that the exercise of enforcement rights by the franchisor would be a reasonable and proper act under the terms of the franchise agreement; that in consideration of that forbearance the franchisee acknowledges that the franchise agreement(s) is/are in full force and effect in accordance with the written terms and that the franchisee has no defense to the assertion by the franchisor of any term of the agreement; that the franchisee is not aware of any claim that it has against the franchisor, and none are under consideration that have not already been asserted; that the franchisee releases and waives any and every claim that it may have against the franchisor, of any kind or nature whatsoever, whether known or unknown; and that the franchisee hereby ratifies the franchise agreement and all other agreements in force between the franchisee and the franchisor, including any related entities. Be aware that in some states a release of unknown claims must be separately stated from a general release, and put a separately stated release of unknown claims in every ReRat agreement.

Let's shift gears for a moment to another compliance dimension. There is a point at which, no matter how one sided a franchise contract may be written, the franchisor's own exercise of its perceived prerogatives may be sufficiently extreme that franchisees look for ways to 'get even'. Every industry has this experience where the basic protocol of the business relationship is extremely one sided. The insurance industry is an example of this. The practice takes the form or reducing the number of items included in the franchise package without additional charges being made for them -- adding 'fees' for what used to be compris -- or adding non-essential services as compulsory items and tacking fees on for those. In this second category, I include items that may already be in the package and that the franchisees purchase from unrelated vendors, but requiring that they be obtained from a new and related entity at a higher price without improvement in quality. My most recent exposure to this phenomenon involved electronic in-store ambience systems that suddenly have to be purchased from the relative of an officer of the franchisor for substantially more than was paid in an open market transaction. This was also done in a very heavy handed manner. The officer's relative didn't even have the grace to provide a reliably working product or reasonable tech support when it didn't work. New store opening approvals were delayed if the system was not up and running, and many times the delays were due to poor response to technical support requests. When franchisees refused to pay for systems that were installed but not operating, the late payment became a cause for denial of store opening approval and for notices of default being sent out by the franchisor. It was an episode right out of 'The Sopranos', except that it was really happening to people. While this may seem an extreme example of morale destroying avarice on the part of the franchisor, it serves the purpose of demonstrating the kind of franchisor action that causes compliance morale to go into decline. That these actions tend to stack upon one another as similar opportunities to impose additional charges/revenue streams arise should not come as a surprise to anyone.

When the franchisor is doing these kinds of things, it usually is accompanied with programs of 'cheerleading' propaganda about the quality of the relationship and the opportunity. This is seen as utterly venal and cynical, and never has a morale boosting effect. Baloney is always baloney, no matter how you slice it. An excellent example of this kind of baloney is the recent General Motors advert campaign. While its competitors in Europe and Japan are producing better quality vehicles and eating General Motors' lunch out in the market place, GM elects to produce the same crapola products year after year and ride its market share and financial performance history into the toilet. The advert campaign proclaims that 'We are professional grade people'. The obvious absurdity of it is that all those professional grade people at GM can't produce reliable vehicles that can be sold at a profit. DUH! When the message is ridiculous, the relationships to which they apply can't really be expected to improve, can they? This is a B School case study for corporate stupidity. You might as well hang out a sign 'Company In Deep Trouble'. Who thinks up these ridiculous campaigns?

When any franchisor looks at compliance, neglecting to do an examination of the extent, if any, that things being done by the franchisor may be contributing to compliance problems will always produce skewed/unreliable diagnostics. In psychology it's called being in denial. Denying the obvious never produces a cure, does it? I fully understand the temptation to engage in piling on of non-essential items as a way to enhance financial performance, It's not really unlike a person who decides that he likes Martinis and drinks more of them every day than he did last year, while denying that he is becoming an alcoholic. Looking in the mirror isn't always pleasant. But if you dont look, how are you going to know what you look like? 'Nuf said?

Ultimately I must add a disclaimer. This is not intended to be legal advice to any company or person upon which they may rely in resolving or evaluating any claim or event. Each situation you encounter that may involve the assertion of contract rights and invocation of remedies requires that you consult with a competent attorney to assist in the evaluation of that specific situation. Sometimes the decision whether to go forward turns on the personalities of the people involved. I know that doesn't sound right, but based on my experience it is right. Much more is involved in making enforcement decisions than just a technical legalistic sorting out of rights and wrongs.

FTC Franchise Rule.

Under the FTC franchise rule, you are not required to follow the basic franchise sales steps if the prospect will be granted a franchise for an outlet not located in the United States or any U.S. territory.

It does not matter whether the prospect resides in or outside of the United States or its territories. The rule simply does not apply if the outlet, including all protected market area associated with the outlet, will be outside of the United States and its territories.

Please note that if you are dealing with a prospect residing outside of the United States for an outlet to be located in the United States or any U.S. territory, or if you are dealing with an outlet located outside of the United States - such as in Canada or Mexico - but grant a protected territory that extends into the United States, you must follow the basic franchise sales steps.

NOTE: For any prospect or outlet in another country, you may be required to comply with that country's franchise laws, such as the Canadian provincial franchise laws and the Mexican franchise law.

State Laws.

But, some state laws may require you to follow the basic franchise sales steps even if the prospect will be granted a franchise for a non-U.S. outlet.

For example, the Maryland and New York laws may require you to follow the basic franchise sales steps if the prospect is a resident of the state, even if the outlet will be located outside of the United States.

If you think a state law might apply, check with the franchisor's lawyer or compliance manager about your disclosure obligations. 

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

The FTC franchise rule may exempt you from following the basic franchise sales steps.

For example, you may be exempt if the franchise involves:

  • a required payment of less than $500 within the first 6 months

  • a fractional franchise within an established business

  • a leased department within an established retail business

  • a transaction covered by the Petroleum Marketing Practices Act

  • an initial investment of $1,000,000 or more, excluding the cost of unimproved land

  • a prospect with at least 5 years of business experience and a net worth of at least $5,000,000

  • a prospect related to the franchisor

  • a purely oral franchise.

Each exemption has specific requirements and conditions, so before relying on any exemption in the FTC franchise rule, check with the franchisor's lawyer or compliance manager.
 
State Laws.
 
Even if the FTC franchise rule exempts you from following the basic franchise sales steps, if a state law applies and does not exempt you from following the steps, you must follow the basic franchise sales steps because of the state law.
 
Even if the state law contains a similar exemption, the requirements of the state exemption may be narrower than the requirements of the FTC franchise rule exemption.
 
For example, the New York law's fractional franchise exemption is much narrower than the fractional franchise exemption in the FTC franchise rule.
 
Before you rely on an exemption in the FTC franchise rule, check with the franchisor's lawyer or compliance manager about whether any state law may negate the exemption.
 
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In the recent decision of 1392644 Ontario Inc. (Connor Homes) v. Canada (National Revenue) (Connor Homes), the Federal Court of Appeal (FCA) unanimously held that the shared intent or understanding of a worker and the organization that engages his or her services is not determinative of the worker's legal status as an independent contractor or employee.

The parties' subjective intent is relevant as a starting point for the analysis but must be confirmed by an objective evaluation of the factual nature of the work relationship. As stated at para. 40 ofConnor Homes, "the subjective intent of the parties cannot trump the reality of the relationship as ascertained through objective facts."

The decision in Connor Homes seeks to reconcile the recent trend of emphasizing the importance of the parties' stated intent regarding a worker's legal status with case law from the Supreme Court of Canada (SCC) requiring consideration of the factual circumstances of the work relationship.

Background
The FCA was asked to determine whether the Tax Court of Canada (TCC) judge had erred in finding that three workers were employed in pensionable and insurable employment under the Canada Pension Plan and theEmployment Insurance Act, respectively. The three workers were engaged as child and youth workers and area supervisors for two Ontario companies that operated or provided services to foster and group homes for children with serious behavioural and developmental disorders.

All three workers had signed contracts confirming the parties' mutual understanding that the workers would be providing services as independent contractors. The companies appealed the ruling of the TCC judge on the grounds that the TCC judge had failed to give appropriate weight to the parties' stated intention, which, if given effect, would relieve the companies of any responsibility to deduct and remit Canada Pension Plan contributions and Employment Insurance premiums.

Legal Framework
Mainville J.A. for the FCA began by observing that the ultimate question with respect to the legal status of a worker is whether the worker is performing services "as a person in business on his own account": 1671122 Ontario Ltd. v. Sagaz Industries Canada Inc. (SCC) (Sagaz) at para. 47. In making this assessment, there are a number of factors that will usually be relevant, as set out in both Sagaz and Wiebe Door Services Ltd. v. Canada (Minister of National Revenue) (FCA):

  • The level of control exercised by the employer over the worker's activities
  • Whether the worker provides his or her own equipment and hires his or her own helpers
  • The degree of financial risk assumed by the worker
  • The degree of responsibility for investment and management assumed by the worker
  • The worker's opportunity for profit in the performance of his or her tasks

In addition to this test, Mainville J.A. at para. 30 acknowledged the development of a new "jurisprudential trend" in recent years that "affords substantial weight to the stated intention of the parties." He identified as the chief authorities in this vein Wolf v. The Queen (FCA) and Royal Winnipeg Ballet v. Canada (Minister of National Revenue) (FCA).

Mainville J.A. held that the determination of a worker's legal status as an employee or independent contractor cannot be left to the discretion of the parties due to the significant consequences attached to this classification. In particular, he noted that the proper characterization of a worker's legal status will impact claims of vicarious liability against the employer organization in tort law, as well as tax matters, labour relations, and worker eligibility and financial contributions required for social programs, such as Canada Pension Plan and Employment Insurance.

Instead, Mainville J.A. established at paras. 39 and 40 the following analytical framework for determining the legal status of a worker:

  1. Identify the subjective intent of each party with respect to the work relationship. This determination can be made either on the basis of written contractual provisions or the actual behaviour of each party. The behavioural component may include actions on the part of a designated independent contractor such as providing invoices for services performed, obtaining a valid GST registration number and filing income taxes appropriately.
  2. Determine whether the objective reality supports the subjective intent of the parties. This step of the analysis involves consideration of the factors identified in Sagaz and Wiebe above.

Analysis and Outcome
Mainville J.A. upheld the ruling of the TCC judge finding that the workers were properly characterized as employees, despite the existence of contractual provisions stipulating that the workers would be providing services as independent contractors. He determined that this contractual intent was not reflected in the factual circumstances of the work relationship, in particular the following:

  • The workers were required to abide by the workplace policies and procedures manual and were subject to the day-to-day control and supervision of the employer companies
  • The workers performed the same duties as the recognized employees of the employer companies
  • The workers were paid either a fixed hourly rate or per diem rate per child, with little ability to increase the remuneration received due to employer controls on the scheduling of work hours
  • The workers were not required to assume significant financial risks or make investments in their business beyond the requirement to have a cellular telephone and access to a computer

Conclusion
The FCA's decision in Connor Homes brings a measure of clarity to an area of law that is often difficult to navigate when it comes to classifying workers on the ground. The ruling clearly establishes that it is insufficient, without more, to state in a contract that a worker is an independent contractor or to rely on a mutual understanding between the parties to this effect. Connor Homes serves as a reminder to organizations to ensure that the factual circumstances of a worker's engagement support the designation of the worker as an independent contractor.

If the franchisor makes a financial performance representation - also called an FPR - in Item 19 of its FDD, you or the franchisor may furnish to a prospect a supplemental FPR about a particular location or variation.

For example, if the FPR in the FDD gives average sales and cost information for all outlets in a system and the prospect is considering an urban location, the supplemental FPR could focus on the sales and costs of just urban outlets in the system.

The supplemental FPR may be a document separate from the FDD, but must:

• be in writing

• explain the departure from the FPR in the FDD

• be prepared in the same manner as a standard FPR

• be furnished to the prospect.

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

The franchisor must have written substantiation in its files for any financial performance representation - also called an FPR - made in Item 19 of its FDD. On reasonable request by a prospect, you or the franchisor must make available to the prospect the written substantia- tion for any FPR. You and the franchisor must establish and maintain a system for documenting receipt of these requests, and responding promptly to these requests.

1. Who May Ask For Substantiation. A person who has not yet qualified or been accepted as a prospect may not make a request that triggers this obligation. Only a request from a bona fide prospect who has received an FDD containing an FPR triggers this obligation.

2. Form of Request. The FTC franchise rule does not require a request to be in writing, so you may not require a prospect to submit the request in writing. Presumably, most prospects will make requests by telephone or in emails.

3. Timing for Response. The FTC franchise rule does not say how quickly the written substantiation must be made available after it is requested. The FTC franchise rule assumes prompt responses, but permits some flexibility if, for example, a request is made at an inconvenient time or the franchisor needs a reasonable period of time to review the written substantiation before making it available.

4. Form of Response. The written substantiation is not required to be in any particular format. The FTC franchise rule states that the written substantiation must be "made available" to a prospect, not that it must be "furnished," "provided" or "delivered" to a prospect. The use of "made available" indicates that it may be sufficient to give the prospect a reasonable opportunity to review the written substantiation at the franchisor's office or at another mutually convenient location, and that it may not be necessary to give the prospect copies of the written substantiation, which may contain personal or highly confidential information. 

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

Recently, I was working with a business owner interested in franchising his business.

I put together some power points slides to explain franchising, the fee structure, and the business makeup of a franchisor.

info-franchising-410x1024.jpg

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You must follow the basic franchise sales steps if the franchisor is selling an operating outlet to a prospect.

If the operating outlet was previously franchisee-owned, you must provide a prospective purchaser with the following additional information, for the franchisor's last 5 fiscal years:

  • the name, city, state, and current business telephone number (if known) or last known home telephone number of each previous owner

  • the time period when each previous owner controlled the outlet

  • the reason for each previous ownership change (for example, termination, non-renewal, voluntary transfer, ceased operations, reacquired by the franchisor, etc.)

  • the time period(s) when the franchisor controlled the outlet.

The additional information may be attached to the franchisor's FDD as an addendum when the FDD is furnished to the prospect, or may be provided later to the prospect in a supplement to the previously furnished FDD. The addendum or supplement must be given to the prospect at least 14 calendar days before the prospect signs any binding agreement with, or pays any amount to, the franchisor or any affiliate.

At your option, you may provide a prospective purchaser of the operating outlet with information about the actual operating results of that outlet. The information is not required to be attached to the franchisor's FDD or to be put into any particular format. For example, it may include unaudited financial statements for the outlet.

You may not provide the prospective purchaser with information about the operating results of other operating outlets. Similarly, you may not provide information about the operating results of the outlet to prospective purchasers of other operating outlets or of franchises for new outlets.

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

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1.  Renewal or Extension of Franchise

FTC Franchise Rule. Under the FTC franchise rule, if the franchise of an existing franchisee is being renewed or extended, you must follow the basic franchise sales steps if the existing franchisee signs agreements with materially different terms, or if there is an interruption in the operation of the franchisee's business.

If the franchisee will be signing the franchisor's current agreements, as opposed to the original agreements signed by the franchisee, it is likely that the current agreements contain materially different terms and that you must follow the basic franchise sales steps.

If the franchisee will be granted a renewal or an extension period without any other changes in the terms of original agreements, it is likely that you are not required to follow the basic franchise sales steps. This is true even if the franchisee will pay a fee for the renewal or extension period.

State Laws. The laws of the regulatory states generally are consistent with the FTC franchise rule, but some of the laws are silent on renewal and extension issues. If you think a state law might apply, check with the franchisor's lawyer or compliance manager about any special requirements. 

2. Modification of Franchise

FTC Franchise Rule. The FTC franchise rule does not require you to follow the basic franchise sales steps if the franchisor and an existing franchisee agree to modify their existing agreements, even if the modifications are material. It does not matter whether the modifications are sought by the franchisor or the franchisee.

State Laws. Most state laws are silent on the issue of modification, but some of the laws require the basic franchise sales steps or special disclosure procedures to be followed.

For example, the California law has very detailed special disclosure rules that must be followed if the franchisor seeks a material modification to a franchisee's existing agreement.

Similarly, the North Dakota law permits a material modification of an existing franchise agreement as an exemption to registration requirements if the franchisor discloses to each franchisee information about the specific sections of the franchise agreement that are proposed to be modified.

If you think a state law might apply, check with the franchisor's lawyer or compliance manager. 

 If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

Last month, the State of California filed its first enforcement action under its privacy laws against Delta Air Lines, seeking potentially millions of dollars in fines. Under California's consumer privacy law, all parties that collect personal information from California residents are required to include a privacy notice on their websites and mobile applications.

This law applies to all companies - not just those based in California. Failure to comply with California's privacy notice requirement carries a fine of up to $2,500 per violation.  

Although Delta included a compliant privacy policy on its website, California alleges the airline did not state that the policy covered its "Fly Delta" mobile application nor did it include access to the policy on the app.

This case could signal increased scrutiny and regulatory enforcement by the State of California (and possibly other governmental authorities) against large and small companies that fail to comply with consumer privacy notice requirements.

It also serves as a good reminder for website and mobile app owners, who collect personal information, to:

  • Ensure that they have a privacy policy that complies with both federal and state law.
  • Verify that the manner in which the privacy policy is posted complies with federal and state law.
  • Confirm that the privacy policy applies to its mobile applications and, if possible, that it is accessible from the mobile applications.
  • Confirm that the privacy policy reflects the actual practices of the company.
  • Respond promptly to any notice received from a governmental authority regarding potential violations.

This filing reminds franchise companies of the importance of ensuring that your website and mobile apps include access for consumers to your privacy policy. 

If you are a franchisor or other company and would like any assistance in reviewing your website, mobile applications and related privacy policy to determine whether they satisfy legislative requirements, please feel free to contact Armstrong Teasdale attorneys Joan ArcherJennifer Byrne, or Tiffany Schwartz.

Over the last 10 years or so, franchisors have begun including performance standards, minimum gross sales requirements, and minimum royalty rates in their franchise agreements.

Whatever vintage they are (sales requirements, minimum sale or royalty), the whole rationale is this: The franchisor wants to make sure that the franchise territory is not tied up, underperforming, or underutilized.

The performance standards, minimum gross sales requirements, and minimum royalty rates are commonly stated in straight dollar amounts. Those dollar amounts may seem a bit measly, when the franchise agreement comes up for renewal 10 years later.

The franchisor can up the dollar amounts at the time of renewal. Right? One franchisee argued no way, no go.

The case is Home Instead, Inc. v. David Florance et. al. The franchise agreement in question stated, in pertinent part, "The franchisee must maintain minimum gross sales of $30,000 per month after the end of the fifth year of operation of the Franchised Business through the end of the term of this Agreement or any renewal term of a renewal Franchise Agreement (the Performance Standard)."

In this case the franchisor wanted to raise the $30,000 to $70,000, a more than double increase of the Performance Standard. The franchisee read the franchise agreement to say that the $30,000 would run forever over all renewal periods. The court called this a "strained reading" of the franchise agreement. The court went on to say that "This reading places a permanent ceiling on the Performance Standard." The court honed in on the word "minimum."

The court found that the $30,000 stated in the initial franchise agreement "creates a floor, not a ceiling." "Nothing in [the franchise agreement] §2.F prohibits the franchisor from raising the minimum amount."

Lesson from the Court: Each word has meaning, make sure to heed the meaning.

Don't get caught

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Many, including myself, refer to franchising as an industry... even though we know it's really not an industry. A business model is probably one of the better definitions, but what does that really mean?

When referring to a franchise, even many within franchising choose from a variety of terms as a point of reference - franchise organization, franchise system, franchise company.

Of course, there's also the varying terms relating to the franchise relationship - franchisee, franchise partner and not to mention the slang, zee. And to the other side of the relationship - franchisor, head office, corporate office, parent company... and yes, zor.

And what's the difference between franchisor and franchiser?

Confused yet?

And, franchise locations are independently owned and operated. Yet, the franchise relationship is interdependent... or at least it should be interdependent and not dependent or independent upon... Well, you get it, right?

Now let's look at the people serving the franchise community. Yep, franchise community is another reference for the franchise list above but let's move on. Franchise consultants, do they sell or consult? How about franchise brokers, sales agents, sales representatives, and again, franchise consultants. Whew!

Moving down the chain there are franchise suppliers, service providers and vendors... What's the difference? Preferred or approved? Is there really a difference?

Of course, there are references to segments within franchising such as master franchising and sub-franchising... Which one is correct? And, isn't the sub-franchisor actually the master franchisee? I guess it all depends on which end of the relationship one is on.

How about now - confused yet?

Franchise services means what, and providing services to who? Franchisee to end-user? Franchisor to franchisee? Franchise service provider to franchisor and/or franchisee?

Same can be said of franchise marketing, right? Does marketing in a B2B or B2C scenario but within a franchise environment mean that it's franchise marketing? Or, is franchise marketing actually marketing to franchise candidates?

Speaking about franchise candidates, when is a candidate actually a candidate and not a lead or just an interested party? Does this fall under franchise sales or franchise development? And who's in charge - the VP of Franchise Sales, VP of Franchise Development, or VP of Franchising?

And then there's reference to franchise professionals. Is a franchisee a franchise professional? How about if the franchisee is a multi-unit franchisee with 25 locations? How about a franchise attorney? Franchise service provider?

If a franchise executive is a franchise professional, at what level of management does one begin to be considered a franchise professional? How about within the franchise organization itself? Secretary, if their support is purely administrative as opposed to an admin that actually communicates with franchisees?

Oh, and should the CEO of a franchise company be considered a franchisor as we often refer to them as such at franchise events?

Ironic how franchising is the replicating of a system with focus on consistency in image, appearance, product and service from one location to another. Yet, there's little consistency in the terminology used to define many aspects of franchising

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If you have ever eaten in a restaurant, you are likely to have seen an entire menu or specific menu items that do not list prices. And if you have ever been surprised by the prices you were charged for the unpriced items, you are not alone. That practice might come to an end if a vexed and crusading Houlihan's customer gets his way.

How Things Went Down

In a lawsuit currently pending in the New Jersey Federal District Court, the customer claimed he visited a Houlihan's restaurant in Brick, New Jersey and ordered several beers and mixed drinks from the menu. No prices were listed for the drinks or beers. On receiving the tab and after consuming the beverages, the customer learned that the prices far exceeded his expectations. Without objecting, the customer paid the tab and left.

Soon after that happening, the customer and his attorney filed a class action lawsuit against Houlihan's Restaurant, or the franchisor company ("Houlihan's"). The complaint stated that Houlihan's breached its contract with the customer and was unjustly enriched by the excessive charges for the drinks. See Pauly v. Houlihan's Restaurants, Inc., 2012 WL 6652754 (Dec. 20, 2012).

Houlihan's: the Franchisee Did It and Why We are Not at Fault!

The Houlihan's franchisor objected to the lawsuit and advanced several reasons for it being tossed. It claimed that as the franchisor, it had no dealings with the customer; that the franchisee, not it, overcharged the customer and thus it was not a party to the alleged contract between the customer and the franchisee; that it had no control over the franchisee's menu pricings; that the customer did not say what contract term it breached; and that the customer waived his right to sue because he accepted the prices when he paid the beverage tab without objection.

Customer's Complaint Lives to See Another Day

Over Houlihan's objections, the court refused to toss the lawsuit and allowed it to proceed. The court said the customer's complaint had alleged sufficient facts that, if true, entitled him to recover against Houlihan's.

The customer alleged that Houlihan's and the franchisee had a franchise relationship through which Houlihan's exerted control over the franchisee's menu items and shared in the franchisee's profits.

The customer also alleged that Houlihan's, through its franchisee, should have charged him a reasonable--as opposed to the excessive--price for the beverages since Houlihan's, the franchisee, and the menu remained silent about the price of the beverages.

The court also agreed that the customer had not waived his right to sue Houlihan's by paying the tab. The customer would have faced criminal charges if he had not paid since New Jersey imposes criminal penalties against diners who eat and dash without paying their tabs. Finally, the court agreed that--if the customer assertions are true--unjust enrichment would result if Houlihan's and its franchisee were allowed to keep the excessive charges from the beverage sale.

The Federal District Court's ruling in this case means the customer's complaint was not deficient in making its case for relief against Houlihan's. It does not mean the customer will win the case. Indeed, the customer will still need to prove that the facts in the complaint are true and has merit.

A Few Take-Aways

It is too early to glean a reckoning from this episode, but its very existence raises issues for businesses of all types. Do no-price menus make sense? And, although franchisors rightly shy from recommending prices for fear of anti-trust offenses and other legal entanglements, should they impose a "reasonable price" requirement across the franchise system?

No matter the ultimate outcome, this case is a reminder that each time a consumer enters a restaurant and consumes a meal or a drink, a contract is formed, and that a reasonable price is assumed if prices are absent from the menu or not discussed.

Let the attorneys of Johns Marino LLP help with your franchise and business needs.

On November 9, 2012, a federal district court in the State of Washington certified a class action against Papa John's pizza and some of its franchisees, with the potential for enormous damages, for sending unsolicited text advertising messages.

The case involves alleged violations of the federal Telephone Consumer Protection Act ("TCPA") based on texts sent to customers by Papa John's franchisees. It is significant because, among other things, it threatens Papa John's, a franchisor, with very significant potential damages -- direct or vicarious -- for the acts of franchisees.

The decision also vividly reminds all businesses that the TCPA applies to unsolicited text messages just as it does to unwelcome faxes.

Papa John's International, Inc. and Papa John's USA (collectively, "Papa John's"), enter into agreements with independent franchisees, who then own and operate Papa John's restaurants.

As franchisor, Papa John's imposes certain requirements; however, the franchisees generally control the operations of their own restaurants, including advertising.

But Papa John's employs Franchise Business Directors ("FBDs") to work with and assist the franchisees. Papa John's asserted that neither it nor the FBDs controlled the franchised businesses and, specifically, they had no control over advertising. Rather, the franchisees make all marketing decisions on their own.

The text message advertising program was offered and run by a third-party marketer, OnTime4U ("OnTime"), also a defendant. OnTime told the Papa John's franchisees that it was legal for them to send text message advertisements to their customers, without the customers' express consent, because of an existing business relationship.

Franchisees who signed up for the program provided OnTime with customer telephone numbers, derived from their point-of-sale system database of those who had bought pizza from them.

The POS System is a proprietary data system mandated for use by Papa John's. OnTime scrubbed the land lines and sent text advertisements to the remaining cell phone numbers, offering discount codes and soliciting the purchase of Papa John's products. 

The plaintiff sued Papa John's, the franchisor, asserting that certain of its franchisees and OnTime violated the TCPA by causing text messages advertising pizza to be sent to her cell phone without obtaining her prior consent. The plaintiff claimed Papa John's was also liable for any TCPA violations because of its alleged involvement in the marketing campaign.

Papa John's denied it had any involvement with OnTime or the text message advertising campaign. It denied having any contract with OnTime, and thus asserted that the plaintiff's injury could not be fairly traced to it. Plaintiff alleged, however, that Papa John's had directed, encouraged and/or authorized its franchisees to use OnTime.

In granting certification of a class action, and refusing to dismiss Papa John's from the case, the court found sufficient evidence to support the plaintiff's allegations, including testimony and emails suggesting that Papa John's, through its FBDs, had encouraged franchisees to try OnTime's text marketing service.

The court also found evidence that Papa John's had allowed OnTime to promote its services to its franchisees at a Papa John's "Operators Summit." Based on that information, the court refused to dismiss Papa John's at this preliminary stage.

Importantly, we note that the court did not decide the case on the merits, but simply allowed it to proceed as a class action on the claim of TCPA violations.

However, while Papa John's may appeal, the decision presents significant risks to Papa John's.

The TCPA enables a private litigant to recover actual damages or statutory damages of up to $500 per violation. 47 U.S.C. § 227(b)(3). The plaintiff alleges that franchisees provided OnTime with more than 68,000 phone numbers, and the case potentially involves thousands of calls; accordingly, potential damages total well into the millions.

There are multiple lessons to be drawn from the case:

  1. Know the rules about text messaging and any form of unsolicited telephone contact. The TCPA prohibits making calls to any cellular telephone number using an automatic telephone dialing system, with only minor exceptions (emergencies and calls made with the customer's express prior consent). 47 U.S.C. § 227(b)(1)(A). Multiple courts have ruled that text messages are covered, and the penalties, as noted, are significant: as much as $500 for each call.

  2. Use caution to avoid taking on liability for the acts of your franchisees. It is too early to know whether Papa John's limited involvement will be sufficient to hold it liable, but even limited involvement in franchisee advertising, or other activities, may be sufficient for a court to find liability. It is alarming that OnTime's presence at Papa John's franchise convention promoting its advertising services was considered evidence that Papa John's controlled the text advertising and could be liable for OnTime's apparent advertising mistake. Also alarming is that the court cited local business development managers encouraging email to franchisees to try OnTime's services as support for Papa John's alleged control over the actual advertising.

  3. Be wary of legal advice from third-party vendors, particularly those who stand to profit from your business. Here, according to the court's decision, OnTime reportedly told Papa John's franchisees that it was legal to send texts without express customer consent in light of the pre-existing restaurant/customer relationship. This issue is in dispute, and the risk of a contrary finding is significant.

  4. If you are sued for an advertising violation, check your insurance policies for potential coverage. Legal fees can be enormous in such cases, but Commercial General Liability policies typically provide coverage for certain "personal and advertising injury" offenses, including the cost of defense. As always, coverage will depend on the specific policy language.

When in doubt, call us with your questions regarding advertising programs and best practices. The case is Maria Agne et al. v. Papa John's International et al, 

Case No. C10-1139-JCC (U.S. District Court for the Western District of Washington).

For more details on this case, please contact Greg Everts at (608) 283-2460 / [email protected], David Beyer at (813) 387-0264 / [email protected] or your Quarles & Brady attorney.

Burger King's supply chain contracts probably do not have an explicit clause that state that dairy suppliers must treat their cows humanely, but it seems as though there is an implicit clause.

An animal activist group went undercover at Bettencourt Dairies to video employees beating, kicking, and jumping on cows.

A perhaps unanticipated result is that representatives from Burger King said the company had temporarily suspended Bettencourt Dairies LLC. from its suppliers.

This raises a couple of contracting issues:

1. Burger King, as a mass retailer, suffers a reputation loss if customers believe Burger King is indifferent to these issues. They could suffer real losses if this keeps enough customers away. Bettencourt Dairies does not deal with final consumers to the same extent and may not suffer a similar loss.This leads to a possible conflict in acceptable business practices, or at least the diligence with which firms are expected to monitor employees for violations.

2. I could be wrong, but this is probably not an eventuality that negotiators thought they would have to include in the supplier contract. (How would one determine the level of severity that leads to a breach?) Contracts cannot cover all possible contingencies. Knowing this, buyers in the relationship try to include some all-encompassing clause to cover the unanticipated. However, this leaves suppliers open to possible holdup opportunities. Suppliers do not want to be left exposed to the possibility that their customer will claim a breach of contract in order to take advantage of them.

A good contract must balance all of these concerns.

A recent Italian judgment in the Tribunal of Palermo has offered an insight into how the Italian courts will assess whether a franchisor can validly terminate a franchise agreement for delayed payments by the franchisee.

Background

The parties entered into a franchise agreement in 1998. The terms of the agreement provided the franchisor with a right to terminate immediately in the event of breach by the franchisee of certain specified contractual obligations, including the franchisee's obligation to pay for products purchased from the franchisor within 90 days of the invoice date.

During the term of the agreement, the franchisee began to fail meet its payment obligations under the agreement. Despite the fact that a termination event had been triggered under the agreement, the franchisor accepted the franchisee's delay in making payments. This eventually led to the accumulation of significant debt.

Some of this debt was reduced by a payment plan which was agreed between the parties in June 2004. In spite of the payment plan, the franchisor then terminated the agreement in July 2004, citing the franchisee's failure to make payment for the products within 90 days of invoice as agreed.

The franchisee disputed the termination on the basis that the franchisor had been accepting the delayed payments. It was argued that the franchisor had therefore waived its right to terminate and implicitly agreed to vary the payment terms of the franchisee agreement.

Decision

The Court followed a decision of the Italian Supreme Court (Cass. No. 3964 of 18/3/2003) and held that, whilst the tolerance of repeated breaches of contract is consistent with the fairness and good faith principles of the Italian Constitution and Civil Code, such tolerance does not justify the breaches by the franchisee of its contractual obligations and should not be regarded as a waiver of the franchisor's contractual rights nor an implied variation of the agreement.

The franchisee was therefore unsuccessful in its claim.

In the current difficult economic climate, it is common for franchisees to fall behind with payments to their franchisor and it is only fair and ethical for a franchisor to assist and support its franchisees.

However, such support and tolerance of late payments can cause uncertainty when the franchisor decides that it can no longer support the franchisee and the relationship needs to be terminated.

This case helps to clarify the position under Italian law

On the surface, it doesn’t appear to be too difficult to determine whether or not one is a franchise seller.

Yet, I hear time and time again the same rationalization and justification as to why a person feels they are not a franchise seller. I hear about trading off the candidate prior to the sale, only qualifying the candidate until the franchise salesperson actually talks turkey with the candidate, and just recently, I was told, about presenting the candidate with three options but the candidate is not sold anything.

Does anyone REALLY believe this crap?

So, to eliminate the confusion as to what being a franchise seller entails, I refer back to The Franchise Seller’s Handbook by Warren Lee Lewis. Here’s what Warren has written in this fine publication, right in the first section, Introduction: Making Legal Franchise Sales

A Franchise Seller

If you are an officer, employee, representative or broker involved in the offer or sales of franchises, you are a “franchise seller.” As a franchise seller, you can use [the handbook] to help you make legal sales.

Your involvement in the offer or sale of franchises may be obvious, such as if you are a salesperson actively pursuing franchise prospects for a franchisor, are signing agreements with new franchisees, or are accepting payments from new franchisees. Or, your involvement may be less obvious, such as if you are participating as a finder or consultant in discussions with prospects about their business interests, pre-screening prospects through questionnaires, recommending franchise options, or assisting prospects in completing franchise application forms. In either case, you are involved in the offer and sale of franchises, making you a franchise seller.

Still confused? Well, I highly recommend you print a copy of The Franchise Seller’s Handbook by clicking HERE. And, be sure to read it sooner, rather than later. If you’d like a hard copy, just let me know and I’ll be sure to get you one. Of course, as supplies last!

This post was originally published on July 2010, but still relevant today with minor revisions made to the original post.

When compiling a disclosure document, franchisors are faced with an uncomfortable dilemma: disclose too little and risk a costly lawsuit resulting from inadequate disclosure.

The rigorous disclosure requirements enacted by franchise laws in several Canadian provinces have increased the risks of incorrectly drawing the line on disclosure, and even those provinces without specific franchise laws are coming to demand more disclosure and transparency from franchisors.

It would be tempting to advise franchisors to find a balance in their approach to disclosure. In an ideal world, franchisors could reveal just enough information to inform potential franchisees while safeguarding the internal knowledge they have worked so hard to build up.

But such advice would mischaracterize the uncompromising nature of the laws on franchise disclosure. The law has not left a happy medium for franchise disclosure whether or not a provincial franchise statute is in effect.

Material Facts

In Ontario, the Arthur Wishart Act (Franchise Disclosure) leaves no room for a Goldilocks solution to disclosure. The Act plainly states that in addition to a litany of specifically prescribed corporate and financial information, franchisors must also reveal "all material facts" to prospective franchisees, which must be current as of the date disclosure is provided. This range of information will then allow franchisees to make fully informed decisions on whether to pursue a franchise.

The Act's definition of material facts is frustratingly vague and broad in scope.

As defined, "material facts" include: [A]ny information about the business, operations, capital or control of the franchisor or franchisor's associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be granted or the decision to acquire the franchise.

The Ontario courts are still grappling with exactly what sort of information constitutes a material fact, but the consensus is that material facts include a vast scope of information that could potentially impact a franchisee's decision to invest. As a result, franchise lawyers are treading with great caution and taking an extremely broad approach when assisting franchisors in preparing their disclosure documents to ensure compliance with the law.

While the "all material facts" requirement is specific to Ontario, failure to provide pertinent information to franchisees could lead to accusations of misrepresentation in all provinces, whether or not they have specific franchise legislation in place. A franchisor who fails to disclose material facts is largely treated by the courts with the same disdain as a franchisor that deliberately distorts material facts.

Both are considered actionable misrepresentations at common law. So franchisors across the country should take careful note of the obligation to disclose, and how it might conflict with their desire to protect their information.

A further challenge to providing disclosure that meets the requirements of the Act is that a disclosure document must be presented as a single cohesive document. It is now standard procedure for franchisees to be provided with all relevant ancillary documents at the time the disclosure document is provided (all bound together as one document), such as the head-lease between the landlord and the franchisor.

The head-lease is likely to be ripe with material facts that may impact the terms under which the franchisee operates its business on the premises. A recent court case in Ontario upheld that failing to disclose the renewal and expiration terms of a head lease was tantamount to providing the franchisee with no disclosure whatsoever.

Providing the head-lease itself may seem like a safe means of ensuring that these material facts are provided to the franchisee, but it does not ensure that the relevant material facts are provided in the disclosure document itself. In complying with the obligation to disclose all "material facts", a franchisor should conduct a careful review of the head-lease, and the material facts of relevance to the franchisee should be listed clearly as a separate section of the disclosure document.

To the dismay of franchisors who give out disclosure documents, it is now quite common to see entire operations manuals, or extracts from them, disclosed to individuals who have expressed an interest in the franchise system, but have not made any substantive commitment to becoming franchisees. Given the availability of disclosure documents, and the potentially sensitive trade information they contain, franchisors may decide to keep certain information off the public record.

However, the relative ease of bringing an action for inadequate disclosure, at least in Ontario and the other provinces with franchise legislation, should serve as a significant deterrent and a constant reminder of the risks of keeping material facts hidden.

The internet has enhanced the free flow of disclosure documents. To receive a disclosure document, the potential franchisee must generally sign a receipt confirming that the disclosure document was provided and that it will be kept private. In reality, once a disclosure document is provided, it is entirely out of the franchisor's control. In the United States, a network of franchisee-friendly websites and message boards freely distribute franchise disclosure documents and court documents which are uploaded by users.

The spread of such sites to Canada, and the rapid exchange of Canadian disclosure documents, is likely to be imminent. These websites may make franchisors uncomfortable by easing access to potentially sensitive trade information, but the corresponding potential to expose inadequate disclosure on a large scale poses an even greater risk. It is yet to be seen, but the day may come when franchisees and their counsel surf these sites in the hopes of locating an exit strategy.

Even without access to disclosure documents over the internet, anyone with a bit of time and some passing knowledge of the legal system could get a hold of an array of current disclosure documents. Once a disclosure document becomes an issue in a legal proceeding, a copy with be filed with the court and publically available for anyone to read or copy. If a lawsuit proceeds to trial, the disclosure document will have the further exposure of being dissected and analyzed by each party's lawyer and the judge.

At this point, the sensitivity attached to any material facts will be less a priority than ensuring that the disclosure document is compliant with the law.

Confidentiality Orders

Concerns about the sensitivity of disclosure documents are not entirely new, even though the pressure to disclose has been increasing in recent years. When disputes arise between franchisees and franchisors, it is not uncommon for one side to request a confidentiality order from the court, which would seal the information brought forward by the parties and keep it off the public record.

A typical confidentiality order limits access to all documents produced in the proceedings, including the disclosure documents and financial information. Access is limited to the parties' lawyers, the court staff, and potentially one or two experts retained as part of the case. While they are effective in instances where they are granted, confidentiality orders cover only a small fraction of franchise disputes that end up before the courts.

Confidentiality orders are generally reserved for the largest and most complex of franchise disputes, where the court will be scrutinizing every iota of the franchisor's documentation.

The standard for obtaining a confidentiality order is set deliberately high by the courts, and a typical dispute over the adequacy of a franchisor's disclosure document is unlikely to meet the standard necessary to obtain a confidentiality order.

Furthermore, confidentiality orders depend upon the whims of the legal system, and the arguments of counsel. Obtaining a confidentiality order requires a costly motion before the court, and they are never guaranteed.

Franchisors simply cannot count on confidentiality orders to limit access to sensitive information in the event a dispute does end up before the courts.

It is understandable that franchisors do not want to hold an open house with their sensitive and proprietary information. Small compromises seem to have become standard practice, such as disclosing only the table of contents of an operations manual rather than the entire contents of the manual. Despite their understandable reluctance to broaden the scope of disclosure, franchisors must also consider the dire consequences of failing to disclose anything that might be considered a material fact.

A leading Ontario franchise case states that the franchisor has a "rigorous duty to disclose all material facts as well as protect the franchisee from entering into such agreements without having all relevant information".[1] This may be counterintuitive to franchisors, who view franchisees as independent agents making their own investment decisions, but the duty of franchisors to protect franchisees is an integral part of their disclosure obligations.

Any suggestion that material facts were willfully obscured by franchisors will be treated harshly by the courts, and franchisees will continue to have access to a set of drastic remedies.

The free-flow of disclosure documents, and the increasing awareness of franchise lawsuits, will only see increasing pressure on franchisors to disclose. There is no option for franchisors to disclose "just enough" of their material facts, as franchisees, their counsel, and the applicable laws have all established an uncompromising standard for franchise disclosure.

At the end of the day, franchisors must have open and frank discussions with their counsel in determining how best to comply with all of their disclosure obligations.

Franchisors who prepare their disclosure documents without considering these issues and obtaining sound legal advice run the risk of defending lawsuits over their failure to properly meet their disclosure obligations.

[1] 6862829 Canada Limited et al. v. Dollar It Limited et al., [2008] O.J. No. 4687 (Ont. Sup. Ct.) at para. 65.

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Too often than not, franchisees are of the mindset that they've bought into a franchise system and just need to sit back and wait for the business to flow through their doors. Sometimes, it's ignorance and perception that clouds their thoughts. Thinking that the brand name they invested in should be enough for instant business success at their location. But, most of the time, it's just plain old arrogance that gets in the way.

It's the arrogance of having committed hundreds of thousands of dollars to buy a franchise as being the sole reason for success. It's also the basis of feeling that with this level of financial commitment, the franchisor should be solely responsible for making sure franchisees succeed. Almost demanding a guarantee of success!

Well, it is not the franchisor's sole responsibility, under any circumstances, for making sure that franchisees succeed. Sure, the franchisor must provide franchisees with a proven system and field-tested tools, that when utilized diligently and effectively, should provide them with the foundation to succeed.

But, it's just that, a foundation. And, the franchisor should have systems in place to monitor franchisees' progress, provide additional training and guidance, and further the overall development of the brand which all contributes to solidifying that foundation. But, as detailed and comprehensive as all this sounds, it still is not enough for most franchisees to succeed without their own desire, drive and determination.

And, not just words, but actual action.

Failure or Success?

Years ago, I was working with a franchise group on a complex marketing project. The project was ultimately a success and achieved most of the goals and objectives that were established prior to launch. Most of the franchisees embraced the strategy and were extremely instrumental in executing the plan. However, there were five franchisees that just couldn't get out of their own way to realize the benefits of the plan, and did not realize positive results as their fellow franchisees had.

As with many of my franchise clients, the franchisor requested that I work with these franchisees, ascertain the root of their problems, and develop an aggressive plan of action to move their businesses forward. You see, the franchisor truly wanted to see their franchisees succeed! By the way, these franchisees represented the bottom of the franchise group in average unit sales. Definitely, that was no coincidence. Well, to make a long story short, the obvious problem in each case pointed back to the franchisees working "in" the business, as opposed to "on" the business. Mix in some procrastination, entitlement attitudes, and of course, total denial, and the recipe for total business failure was complete.

I was able to determine that these franchisees were compensating for their path to failure by being at the business location longer hours, spending more and more time taking care of customers, while spending less and less time on anything else. All claimed to be working harder than they had ever worked before. Was it because they had to cut payroll and do the job themselves? Ironically, that was not the case as I found employees standing around while the franchisee did their jobs.

Often, I witnessed franchisees literally stepping in front of employees to take care of a customer. When I addressed the same with the franchisees, all were actually preparing for failure but didn't want to be considered the actual cause of failure. All thought that by being seen at the business long hours every day and working non-stop behind the counter, no one would be able to say they didn't work hard at making the business a success.

Certainly, they wouldn't be blamed for failure.

Of the five struggling franchisees, all but one was anxious to listen and make firm commitments to improve their situations. The remaining franchisee was thoroughly convinced he would fail and there was nothing he, or anyone else, could do to change the situation.

He placed total blame on the franchisor, claiming they didn't provide support, and strongly professed that he, himself, did everything humanly possible to succeed.

When I asked what he was referring to, he pointed to the long hours every day. When I asked about marketing efforts, he claimed he shouldn't have to do anything in that regard and pointed back to the franchisor.

He ranted about how the franchisor should have spent money on his behalf in promoting the business and how he spent over $300K on build-out and equipment and that should have been more than enough to ensure his success. Further, he felt he should be able to open the doors everyday, and if the brand name was strong enough, success would occur in a relative matter of time.

As I indicated, four of the franchisees decided to move forward. Agreeing that failure was not an option, we developed and executed an extremely aggressive, yet cost-effective, plan of action centered around getting outside the business location every day to promote their business wherever and however they could.

They all agreed they should have been doing this all along but always seemed to procrastinate in actually getting the job done. They attributed a big part of their procrastination to a strong sense of entitlement that the franchisor should be doing more because they, the franchisees, were the ones that already made an investment to grow the brand. As such, they had convinced themselves that any possibility of failure would fall firmly on the franchisor's shoulders. In turn, they buried themselves "in" the business and were awaiting the inevitable.

After many hours of discussion and debate about vision, passion, drive and determination, all four franchisees decided to take responsibility for their actions and would hold themselves to a high level of accountability, to their business, employees, family, and themselves.

Each was relentless in their quest to turn their businesses around. They spoke to whoever would listen about their products and services. They were tireless in their efforts to discover new groups and organizations that might listen and learn about what their business had to offer.

They were almost to the point of being ruthless in their desire to ask for referrals and recommendations. They were all thinking outside the box, always asking themselves, "What more can be done?" and never accepting a "nothing" answer.

Needless to say, their new attitudes became contagious and before they knew it, everyone seemed to be spreading the word. Nowadays, we would refer to that as a "viral" effect.

The Final Tally

One franchisee sold his business to an individual he met when spreading the word about his business. The new franchisee became a multi-unit operator and eventually sold the business for a significant profit.
Two franchisees took on partners they met in their efforts within the community. All are now multi-unit operators within several franchise systems.

One franchisee continues to operate her business and although happy to have survived, never had the desire to open additional locations.

And, the franchisee, who said he would fail... was absolutely right!

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.

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.

 

The Franchise vs. License Dilemma

When confronted with franchising vs. licensing, an increasing number of companies are attempting to expand using what is essentially a franchise business model, but calling it a "license." It’s a sign of our troubled economic times and the reasoning goes something like this. "If you call it a 'license,' you won't have to prepare a FDD Franchise Disclosure Document with audited financial statements and register with various regulatory agencies.

Franchising is expensive; licensing is inexpensive." It sounds good - almost too good to be true.

Not surprisingly, it is too good to be true. The list of elements required to fall into the franchise box is very short and the overwhelming majority of license agreements that allow someone to operate a business turn out to be disguised illegal franchises with significant legal ramifications and risk.

Components of The Franchise vs. License Dilemma

If you help someone get into business (allowing them to use your business brand/mark) this transaction will normally be a regulated activity, subject to substantial penalties for noncompliance. If it looks like a duck and walks like a duck, it's a duck. This guiding legal duck principle (and common sense) answers most franchise vs. license questions. It doesn't matter what terms are used by the parties in contracts or other documents to describe their relationship.

For example, the contract may call the relationship a license, a distributorship, a joint venture, a dealership, independent contractors, consulting, etc., or the parties may form a partnership or a corporation. This is entirely irrelevant in the eyes of governmental regulators and the courts.

Their focus is not on semantics, like what the contract is called, but whether a small number of defining elements are present or not.

A 2011-2012 Evolving Case Involving Franchising vs. Licensing

A home improvement company unfortunately sold "license agreements" without complying with franchise registration and disclosure laws.

The Illinois Attorney General brought an action against the company for violating the Illinois Franchise Disclosure and Registration law, resulting in a Final Judgment and Consent Decree.

That same day, on the opposite coast, the California Department of Corporations issued a Desist and Refrain Order based on failure to comply with California's Franchise Investment Law.

In early 2012, a licensee filed suit against the company for violating the Illinois Franchise Disclosure Act, seeking rescission, damages, attorneys' fees and court costs.

What the final financial hit will amount to in cases like this after attorneys’ fees, etc. are considered is impossible to estimate, but it could easily be in the millions.

How Companies End Up In A Franchise vs. License Dilemma

In many cases, companies get themselves into this mess by listening to statements found on the Internet that franchising is expensive and licensing inexpensive. Just call the contract a “license” instead of a “franchise,” and don’t worry about all the legal red tape of franchising. Again, if something sound's too good to be true, it usually is and this should be a big flashing red light. If it was really that easy, everyone would have done it that way. The 3,000-plus companies that are franchising may be a lot of things, but they're not stupid. Many can afford the very best legal talent available. It's not a coincidence they're all franchising and not licensing.

Author credentials and background

This has been a guest post by Kevin B. Murphy, Mr. Franchise, is a franchise attorney and franchise expert based in San Francisco with a 30-year practice devoted exclusively to franchise law. Since 1993, Mr. Murphy has also been an Approved MCLE (Minimum Continuing Legal Education) Provider by the State Bar of California, teaching franchise law, franchising vs. licensing (franchise vs. license), and intellectual property courses to California attorneys. In 2002 -2003 he started, operated and sold a very successful franchise. Mr. Franchise holds degrees in business administration and law from the University of San Francisco and an MBA from San Francisco State University. He is the author of over 50 franchise publications, including 4 books on franchising and one book on trade secrets.

California is rightly the envy of all for its commitment to public education, consumer protection and sophisticated agribusiness.

However, the current legal franchise model allows franchisors to either deliberately or inadvertently skirt their civic responsibilities.

First, Franchising needs to return to its roots, in which the franchisor set quality control standards for a reason and not just to trap the franchisee into paying for high fees to the preferred suppliers, who then kickback  money to the franchisors.

The standards which protect the food supply chain are too important to leave to the federal government to enforce.  We need the unintended good consequences of brands maintaining quality control and funding the appropriate training and education.  

We don't need, however, a kickback economy.

Second, the current legal franchise model has an unbalanced picture when it comes to information: there is no legal balance between what the franchisor markets the benefits of the system and what the franchisor is contractually obligated to perform.

Private Brand Standards and Public Safety

To understand the first benefit of Bill AB 2305, we have to return to 1950-1970, when McDonald's enforcement of private brand standards were of assistance to the public good and helped maintained a safe food supply chain.

Ray Kroc's franchise model - complete with Hamburger University and passing on volume pricing rebates to the operators- had quality control standard which had a beneficial and unintended good consequence. Kroc's enforcement of private standards produced a safer food supply chain for the public. Sadly, Kroc's vision is not upheld by many modern franchisors.

To see how Kroc's system worked, we have to pay attention to some details.

In the 1970's, Kroc and McDonald's set quality control standards and operating standards. But, the operators purchased food from local sources.

Here is just one clever example of how the private brand's standards had a public benefit. Kroc shipped hamburger buns in package containing enough to make 100 hamburgers. The operating standard was that an operator should go through 100 patties for each package of buns. If the operator went through more, say 110 patties, then:

"Either his meat man was shorting him or someone else was stealing from him."

A meat man who would cheat on weights and measurements is a risk to public safety.  Kroc would have the meat man dead to rights, if he was found to be cheating.  

Today, we have more difficult contamination problems to detect and solve.

But, today many brands set standards for a different reason.  They require the operators to purchase from preferred vendors. Many of these preferred vendors are simply competing on cost - how much money they can rebate to the franchisor? There is no legal requirement for the vendors to compete on value and safety.

To understand why the modern franchise standards don't produce a public good, we have to understand how legal kickbacks work in the franchise industry.

Current Brands - The Kickback Problem

The franchisors you hear from today will tell you how strong their standards are. But, what they will not tell you is is the reason for these strong standards.

Many franchisors have used the current legal model to primarily obtain kickbacks or commercial bribes from their suppliers. The franchisor mandates that the franchisees purchase supplies, at an artificially high price.  The supplier then splits all or some of this extra price with the franchisor. This is perfectly legal as long as it is adequately disclosed.

The franchisor may elect, and many do, to report these kickbacks as essentially royalty income on their intellectual property and transfer the money out of state without paying California state income tax.

But, you will rightly feel uncomfortable with this arrangement, whether or not legal. Kroc was appalled by it.

A supplier who was being richly reward by his business relationship asked Kroc what he might like in return.

"Let's get this straight. I want nothing from you but a good [safe] product. Don't wine me. Don't dine me. If there are cost breaks, pass them on to the operators."

Promises to the Small Business Operator and Consumer

The second benefit of Bill AB 2305 is to protect the consumer, the consumer of information seeking to purchase a franchise. If the brand markets to prospective purchasers by making promises about volume rebates, quality standards, or continuous training, then their legal obligations in the franchise contract will have to match these promises.

Currently, most brands are only contractually required to provide sufficient training to open a location.

Further, the brands are only required to disclose somewhere in the fine print of a 500 page plus "Disclosure" document in legalese that the operator can only expect sufficient training to open a location and there are no price discounts.

But, of course these truths make hard marketing. Bill AB 2305 simply requires the brands balance their marketing hype with what the franchise document delivers by not allowing the brands to disclaim or ignore its marketing promises by disclaiming them in the franchise agreement.

The Benefits of Balance

A return to a balance in which quality standards are used to strengthen a brand, and indirectly contribute to public safety, franchisors who live up to their marketing promises will protect the small business operator and consumer.  We can do no better to reflect upon Kroc's view of franchising.

"We are an organization of small business [operators].  As long as we give them a square deal and help them make money, we will be amply rewarded."

Bill AB 2305 provides that square deal for franchisees, and the franchisors, consumers and public will be amply rewarded by its passage.

 

 

Integrity is what you do when nobody is watching!

Some franchisors appear to believe that when a person asks for the franchisor's FDD they need not give it.

Why? Here is, slightly edited a franchisor's broker's answer,  which appeared on a major business social network.

 

"Because they [franchisor] are not required to provide an FDD upon request.

Here is the excerpt from the FTC 2008 updated ruling:

"Upon reasonable request, franchisors also must furnish a disclosure document to a prospective franchisee earlier in the 

sales process than 14 calendar days before the franchisee signs or pays.

The failure to comply with a reasonable request for an earlier delivery is an independent violation of the Rule. This does not mean that a franchisor must tender a disclosure document to any person who asks for a copy.

Rather, it applies where the parties have taken steps to begin the sales process."

The problem is that many franchisors begin a validation process with the prospective franchisee, but believe that they haven't "taken steps to begin the sales process".

joe caruso.jpg

But, the way we see it, is if a candidate is on a validation call then I think it's hard to dispute that you're not knee deep in the sales 

process!

 

 

Some brokers will argue otherwise.

"If I took a lead to many franchisors and after the first call said to the franchisor, "the candidate would like to reasonably request an FDD at this time" most of them WOULD indeed laugh or explain their "sales process" to me where the FDD is provided after the application which comes after the webinars and other phone calls.

I can only think of a handful of times where an FDD was provided after the first call with a franchisor."

Irrespective of FTC Franchise Rule enforcement, it's not the candidate's duty to know that they are entitled to an FDD upon reasonable request, it is the duty of the franchisor to comply with the FTC Rule.

If you as a broker or the franchisor has a bona fide prospect considering a particular franchise you as the broker must communicate an FDD request to the franchisor. The franchisor must fulfill the request and track and record all FDD requests.

Even if the FTC is not watching, it is not okay for franchisors and brokers to break the rule. We recommend taking a look at The Franchise Sellers Handbook. It's a great resource and most likely will answer a lot of questions that you may have.

Remember, integrity is what you do when nobody is watching!

This has been a joint post by Paul Segreto and Joe Caruso, who are the hosts of the acclaimed Franchise Talk Radio show.  Joe Caruso is a 20 year career franchise executive with leading brands like Hardee's/Carl's Jr., Mrs. Fields, Diedrich Coffee, Gloria Jean's and Kiddie Academy, franchise consultant, President of the Capital Area Franchise Association.

Jesus saith unto him, I say not unto thee,
Until seven times: but, Until seventy times
seven.
Matthew 18:22 (King James Version)

In the Bible, it says they asked Jesus,
how many times you should forgive,
and he said 70 times 7.

Well, I want you all to know
that I'm keeping a chart.
Hilary Clinton

Forgiveness is puzzling.

The strategic puzzle is presented in Charles Schulz's cartoon series which depicts Charlie Brown being continually compelled to forget Lucy's past & to try to kick that football.

1981 Again and Again.gif

Must Charlie Brown always forgive and forget?

Or can he keep a chart, instead, and end getting tricked?

(I am told that the Rabbinic tradition that Matthew 18:22 was responding to limited forgiveness to 3 strikes. Our own secular convention appears to allow only 1 strike, and then shame on me.)

Forgiveness is not the only institution which requires us to ignore the past: voters who must overlook past politicians campaign "promises", the doctrine of confession, the fathers who have to unconditionally love the prodigal daugther or son, and the hopefuls who remarry after divorce.

And -as we enter the New Year- the institution of making resolutions to bind our future selves.

After every January 1st, I will no longer eat too much, drink too much, exercise too little, and so on.

We know by past experience that these commitments, if made in or around January 1st, will not last much past Februrary.

Should we just walk away from all these institutions, priding our self on our skill as rational calculators?

Unfortnuately, the world is not that simple or forgiving.

You and I, "Y" face a choice between safe and risk, "S" and "R". The world, full of Lucy Van Pelts, "W", can respond by being naughty or nice, "N" or "G".

Forgiving Game.png

There are three outcomes in this game tree, O1, O2, and O3.

Y prefers O1 the most and O2 the least. Y prefers to take risk, if the World is nice.

W prefers O2 the most and O3 the least. W prefers to have Y take a risk, just so the World can be naughty.

We both prefer O1 to O3, which is part of the puzzle.

The standard insight from game theory is: Unless the Lucy Van Pelts of the world can credibly commit to playing nice, we will end up in a world O3 which we both dislike compared to O1.

And you and I cannot bring about this world by our own actions - acting alone without a credible commitment will ensure our worst outcome.

But, being in the franchise business, we know that sometimes the credible commitments aren't worth the paper that they are written on!


1964 Notarized.gif


Merry Christmas and Happy Holidays from Joe and Mike!

What is worse: a lack of memory or a lack of morals?

The recent appeal by Dunkin' Chief Operating Officer Paul Twohig, caught unaware when a company story went viral, reminds us that even expensive lessons may be quickly forgotten.

From a management standpoint it was surprising that a COO only found out after a story had appeared on several websites; BMM was not the first to report this story. Major companies subscribe to various free and paid services which continually monitor the Internet in real-time, and they proactively address everything from breaking news to Twitter feeds.

Paul Twohig  and Dunkin' Brands should be sensitive to this, having paid $500,000 to learn the difficulty of hiding anything for long in the Internet age.

According to Starbucks, when Twohig quit in March 2009 he signed a separation agreement in which he acknowledged his obligations under a non-compete agreement he signed back in 2004. Twohig took his severance pay and left Seattle for the balmy golf courses of Hilton Head.

But Dunkin came calling, and in August 2009 Twohig asked Starbucks to be released from his contractual obligations; Starbucks insisted that Twohig honor the contracts.

Starbucks was understandably not pleased when Dunkin SVP for Human Resources Christine Deputycalled in September 2009 and said that Dunkin was going to hire Paul Twohig. Since Christine Deputy was herself a former SBUX employee, she presumably wasn't surprised when SBUX reminded her that Twohig was subject to contractual obligations and could not work for Dunkin.

Starbucks found out on October 3, 2009 that Paul Twohig was now working at Dunkin.

How did SBUX find out this critical piece of competitive intelligence? A private investigator? The rumor mill? A deep-throat source?

No... they found out through an internet search.

Within 48 hours, Starbucks not only drafted but filed a lawsuit in federal court.

The same day the lawsuit was filed, franchise journalist Janet Sparks reported that Dunkin chief counsel Steve Horn was leaving Dunkin and by October 23 a settlement had been reached, with Starbucks being paid $500,000 to discontinue their lawsuit.

For Dunkin--a company which for decades prided itself on brutally enforcing contractual promises made to it--the Twohig scandal demonstrated not merely a casual hypocrisy but also how contractual promises are not an impediment if you are rich.

For Twohig, the lesson should have sunk in that in the Internet age, it pays to monitor your brand image and not assume that anything goes on in secret anymore.

Can an old dog learn new tricks? For the sake of DNKN stockholders, let's hope that Twohig improves both his morals and his memory.

(Cross-posted at Bluemaumau.)

 

It goes without saying that you should know, and honor, contractual obligations to your franchisor.  As a franchise owner, you already know that breaches of your Franchise Agreement can lead to the receipt of default notices, penalties, termination of your franchise, and/or liability to your franchisor for monetary damages.  If you violate your Agreement’s “exclusive territory” obligations by encroaching on someone else’s territory, however, you could face an entirely separate problem:  liability to your fellow franchisees.  In fact, you might be found liable even if your franchisor failed to stop those activities – and even if you were unaware that your activities amounted to encroachment.  These are some of the lessons of Ford v. Middleton, Case No. CAL08-01849 (Circuit Court for Montgomery County Maryland), a case in which my firm represented victims of encroachment.

The Fords and the Middletons owned respective “Comfort Keepers” in-home care franchises.  In the form Franchise Agreement that each couple signed with franchisor Comfort Keepers Franchising, Inc. (“CKFI”), the franchisee was granted a specific geographical territory – denoted by multiple zip codes – in which no other Comfort Keepers franchisee would be permitted to operate (an “exclusive territory”).  In fact, Comfort Keepers promised in each Agreement that it would not “authorize any other franchisee or licensee to provide service to clients within the [applicable] Exclusive Territory nor itself serve clients within the Exclusive Territory.”  Further, on two (2) different occasions during the Fords’ franchise term, CKFI granted the Fords a temporary enlargement of their exclusive territory to encompass additional zip codes. 

            At the same time, CKFI expressly forbade each couple to do business in someone else’s exclusive territory.  Each Franchise Agreement contained the following language: 

You may operate outside your Exclusive Territory only with Comfort Keepers’ written consent.  Comfort Keepers’ consent will be granted upon the following conditions . . .

 

(a)   The area in which you wish to provide service to clients is not included in another franchisee’s territory or in a region currently served by a company-owned Office. . . .

 

            The Fords, whom I represented, alleged in their pleadings that the Middletons had engaged in unauthorized activities in the Fords’ “original” exclusive territory and in the “enlarged” territories during the respective “enlargement” periods.  Indeed, we contended, the Middletons’ operations in the Fords’ territories were extensive and had yielded them significant income.  Accordingly, the Fords asserted counts for breach of contract and “wrongful interference with economic relations” – an “intentional tort” claim recognized by the Maryland courts.  (Your state might or might not recognize a claim for “wrongful interference with economic relations, which differs from the better known claim of “tortious interference with contract.”  Claims for breach of contract, on the other hand, are universally recognized.  For that reason, anyone whose franchisor grants exclusive territories should become aware of what happened in this case.)

At this point, it would be logical to ask the following question:  “If the Fords entered into a contract with CKFI, and the Middletons entered into a separate contract with CKFI, how could the Fords sue the Middletons for breach of contract?”  The answer is that, by relying on the “third party beneficiary” doctrine, we were able to sue the Middletons for breaching their contract with CKFI.

 

According to our theory, CKFI’s contractual provision prohibiting the Middletons from operating in the exclusive territories of other Comfort Keepers franchisees was intended to benefit those other franchisees – including the Fords.  (To help explain the context of the prohibition, we pointed out that CKFI promised in the Fords’ Franchise Agreement that it would not allow encroachment in the Fords’ exclusive territory.)  Pursuant to the third party beneficiary doctrine, we argued, the non-signatories for whose benefit the Middletons’ contractual clause was entered into had the right to sue for breach of that clause – even if the franchisor failed to do so.

            At trial, we presented evidence that the Middletons, without first seeking CKFI’s written consent as required their Franchise Agreement, had conducted business in the Fords’ various exclusive territories.  Unable to dispute those facts, the Middletons relied on several different arguments in an effort to justify or excuse their conduct.  Those arguments included, but were not limited to, the following:

  • CKFI had known that they were operating outside their exclusive territory but, with one exception, did nothing to stop them.
  • Neither CKFI nor anyone else had informed them that the Fords’ exclusive territory had been enlarged to include the new zip codes – zip codes in which the Middletons were doing business.  Thus, they claimed, they were unaware that some of their activities amounted to encroachment.
  • The Fords had stated that they had no intention of serving clients sent from a certain governmental referral source, so the Middletons’ servicing of them was purportedly fair game.  (The Fords denied having made the statement or even harboring such sentiments.)

None of the Middletons’ arguments swayed the jurors, who returned a verdict for the Fords on both counts.[1]  As we had explained to the jury, CKFI’s alleged knowledge of and failure to act upon the Middletons’ violations of the Franchise Agreement were irrelevant to the Fords’ claim for breach.  In fact, the third party beneficiary doctrine was created specifically for a situation in which the party that contracted on behalf of the third party has relatively little incentive/inclination to enforce the third party’s rights through litigation or otherwise.  Through that doctrine, wronged parties like the Fords can protect themselves if their “benefactors” do not.

Similarly, the jury clearly rejected the Middletons’ argument that their supposed ignorance of the Fords’ enlarged territories excused their encroachment in the “new” exclusive regions.  First, we noted the Middletons could have learned about the Fords’ enlarged territory if they had simply sought prior written permission from CKFI as required by the Franchise Agreement.  Their failure to do so, we argued, should not be rewarded.  Second, our claim for breach of contract did not even require a showing of intent to encroach.  We needed only to show (i) that the Middletons failed to comply with a contractual provision entitled to benefit the Fords, and (ii) that the Fords suffered damages as a result of that failure.  (In contrast, our claim for wrongful interference with economic relations did require a showing of wrongful intent.  In issuing a verdict for us on that count, the jury found that wrongful intent actually existed.)

Finally, the jury rejected the notion that the Fords’ alleged expression of disinterest in servicing certain clients in their territory effectively gave the Middletons a proverbial “green light” to obtain business from those clients.  It could be that the jury, which appeared find the Fords more credible, simply believed my clients’ denial that they had ever made such a statement.  The jury also might have – correctly – accepted our argument that, without more, such a statement would have been insufficient to constitute a waiver of my clients’ right to exclusivity in their territories.

A number of lessons can be taken from Ford v. Middleton.  First, if you desire in good faith to operate outside of your exclusive territory, follow the applicable Franchise Agreement and/or Operations Manual to the letter to ensure that (i) there are certain circumstances in which such operation is permissible, and (ii) you are following proper procedure to avoid unauthorized activities.  Second, do not be lulled into a false sense of security by what may be a lenient enforcement policy by your franchisor.  Your Franchise Agreement, like the Comfort Keepers Franchise Agreement, might just empower a victimized franchisee to fight its own litigation battles against you.  Third, the fact that another franchisee might have neglected to – or decided not to – service certain customers within his/her territory does not necessarily entitle you to service those customers. 

In short, avoid unauthorized encroachment at all costs.  Not only is it the morally and ethically correct thing to do, but it is in your self-interest. 



[1] An appellate court upheld the judgment in 2011.

 

Pursuant to the Federal Franchise Rule, 16 C.F.R.  436.5(c), franchisors are required to disclose to prospective franchisees information regarding the litigation history of the franchisor and certain related persons and entities. 

 

As to whom must disclosure be made?  Disclosure must be made as to the franchisor; a predecessor, a parent or affiliate who induces franchisesales by promising to back the franchisor financially or otherwise guarantees the franchisor’s performance; an affiliate who offers franchises under the franchisor’s principal trademark; and the franchisor’s directors, trustees, general partners, principal officers, and any other individuals who will have management responsibility relating to the sale or operation of franchises offeredby the disclosure document.

 

What must be disclosed?

 

  1. Pending Actions.  The franchisor must disclose whether any of the persons/entities listed above have any actions pending against them, including:  (1) an administrative, criminal, or material civil action alleging a violation of a franchise, antitrust, or securities law, or alleging fraud, unfair or deceptive practices, or comparable allegations; and, (2) civil actions, other than ordinary routine litigation incidental to the business, which are material in the context of the number of franchisees and the size, nature, or financial condition of the franchise system or its business operations.

 

  1. Actions in the Last Fiscal Year.            The franchisor must also disclose whether any person/entity listed above was a party to any material civil action involving the franchise relationship in the last fiscal year. For purposes of this section, ‘‘franchise relationship’’ means contractual obligations between the franchisor and franchisee directly relating to the operationof the franchised business (such as royalty payment and training obligations).  It does not include actions involving  suppliers or other third parties, or indemnification for tort liability.

 

  1. Previous 10 Years.  The franchisor must also disclose whether any person/entity listed above has in the 10-year period immediately before the disclosure document’s issuance date has/have:  (1) been convicted of or pleaded nolocontendere to a felony charge; and, (2) been held liable in a civil action involving an alleged violation of a franchise, antitrust, or securities law, or involving allegations of fraud, unfair or deceptive practices, or comparable allegations. ‘‘Held liable’’ means that, as a result of claims or counterclaims, the person must pay money or other consideration, must reduce an indebtedness by the amount of an award, cannot enforce its rights, or must take action adverse to its interests.

 

  1. Injunctive – Restrictive Orders.  The franchisor must also disclose whether the franchisor, a predecessor, a parent or affiliate who guarantees the franchisor’s performance, an affiliate who has offered or sold franchises in any line of business within the last 10 years, or any other person identified in § 436.5(b) of this part is subject to a currently effective injunctive or restrictive order or decree resulting from a pending or concluded action brought by a public agency and relating to the franchise or to a Federal, State, or Canadian franchise, securities, antitrust, trade regulation, or trade practice law.

 

As to each of these matters, the franchisor must disclose the following information regarding such actions: the title, case number or citation, the initial filing date, the names of the parties, the forum, and the relationship of the opposing party to the franchisor (for example, competitor, supplier, lessor, franchisee, former franchisee, or class of franchisees). The franchisor must also summarize the legal and factual nature of each claim in the action, the relief sought or obtained, and any conclusions of law or fact, and state the status of any pending action, and the date when judgment was entered and any damages or settlement terms of any prior action.  For injunctive or restrictive orders, the franchisor must state the nature, terms, and conditions of the order or decree.  Regarding convictions or pleas, thefranchisor must set forth the crime or violation, the date of conviction, and the sentence or penalty imposed. For any other franchisor-initiated suit which is a material civil action involving the franchise relationship in the last fiscal year the franchisor may comply with the disclosure requirements by listing individual suits under one common heading that will serve as the case summary (for example, ‘‘royalty collection suits’’).

 

Why Are These Disclosures Important to Review Carefully

 

A careful review of this section will let you know with whom you are getting into bed, so to speak.  It will be important to review this section for both the franchisor’s history of initiating litigation against its current or former franchisees, i.e., if the franchisor or its representative is telling you it never enforces its covenant not to compete but there are pending or prior litigations listed involving such matters that would certainly be a red flag.  It can also give you valuable information regarding the character of the franchisor and associated persons/entities.  For instance, are there any fraud or misrepresentation actions past or pending?  An experienced franchise law attorney can also review this section in context with the remainder of the franchise disclosure document, i.e, Item 20, which requires disclosure on outlets and franchisee information and attrition rate, and Item 1, which requires disclosure regarding the franchisor, and any parents, predecessors and affiliates, as well as Item 2, which requires disclosure of the business experience of the franchisor’s directors, trustees, general partners, principal officers, and any other individuals who will have management responsibility relating to the sale or operation of franchises offered, and finally, Item 4, which requires disclosure of bankruptcy related issues of such persons/entities.  

Steve Memorial.jpg

Steve Ellerhorst was a firm believer in the value and necessity of franchisee associations.  Steve's entire working life was spent in franchising: franchisor executive, franchisee operator and as a franchisee association leader. 

Steve, along with others in the Hardee's system, was instrumental in forming the Independent Hardee's  Franchisee Association. 

The  Independent Hardee's Franchisee Association exists today because of the foresight of Steve, his deep appreciation of the three different views and needs of the franchisee, franchisor, and supplier -and how to reconcile those needs within the business framework.

Steve was a master of finding great ideas, presenting them to the right person in the franchise system - then stepping out of the way so that person could get their necessary credit and applause.  He created the best audience for great ideas, which then got implemented because of the audience's enthusiasm.

Steve was also instrumental in the growth of a number of franchisee associations: the Meineke Dealers Association, the American Association of Franchisees and Dealers,  the Curves Association,  and the Coalition of Franchisee Associations.

Steve was also one of  the founders of the International Association of Franchisees and Dealers.

The IAFD is a testimonial to Steve Ellerhorst's grand vision of how franchisee associations exist to strengthen, help and promote the franchise brand through member benefits, communication, advocacy and education.

A great organizer, with a keen and penetrating mind peering out of a loveable soul, Steve will be dearly missed by all his family, friends,  franchisees, suppliers, and franchisors.

Please feel free to add your own remembrances of Steve in the comments section.   (You will have to register by providing your name and email.)

 

Memorial Notice

 

Beloved husband of Lisa Krummen Ellerhorst; loving father of Elizabeth 
(Matt) Yingling and Katie Ellerhorst

Loving grandfather of Micah Yingling;  dear son of Margie and the late 
Jack Ellerhorst;  dear brother of John (Julie), Dan (Lucy), Tom (Vicki), 
Scott and Patti;  dear uncle of many nieces and nephews.

Died May 30, 2011 in Indianapolis, Indiana.  Graduated from Purcell High 
School in 1975; was CEO/Executive Director at International Association 
of Franchisees and Dealers;  


Memorial service to be held Saturday, June 
4 at 11:00 am at Holy Trinity Church, 201 Clark Street, Middletown, Ohio 
45042.  

If sending flowers, please send by Friday, June 3, 2011 to Holy 
Trinity Church;  In lieu of flowers, family asks that donations be made 
to the American Cancer Society.

A recent case1 has highlighted the courts reluctance to intervene in "rewriting" RC's to make them enforceable. This means it is even more important to ensure that your RC's are reasonable.

RC's - the Law
The general rule is - a franchisor has a legitimate right to protect its interests in the territory where its franchisees operate - i.e. when a franchise comes to an end for a reasonable period of time the franchisor can prevent the former franchisee from competing with the incoming franchisee, and from poaching staff and/or employees etc.

What is reasonable?
In the Pirtek case2 the court held that a post termination restraint of 1 year that prevented the franchisee from, in the franchise territory, carrying on a similar or competing business was reasonable.

This case established a two-fold test (1) looking at whether the restriction is necessary to protect the franchisor's goodwill3 and (2) whether, the restraint is essential to prevent the risk that knowhow and assistance provided by a franchisor will after termination, be used by a franchisee to aid the franchisor's competitors4.

Your Options.png

 

Fiona is a Senior Associate Solicitor at Freeth Cartwright LLP and Head of FC Franchise Build, Manage, Grow, Exit ™ Unit. You can contact Fiona on 0845 070 3812 or e-mail [email protected]

1Francotyp-Postalia Ltd v Whitehead and others [2011] EWHC 367
2Pirtek (UK) Ltd v Joinplace Ltd (t/a Pirtek Darlington) & Ors ([2010] EWHC 1641 (Ch))
3ChipsAway International Ltd v Errol Kerr [2009] EWCA Civ 320
4Case 161/84 - Pronuptia de Paris GmbH v Shillgallis [1986] 1 CMLR 414
Whilst every effort has been made to ensure the accuracy of this article, it does not provide complete coverage of the subjects referred to, and it is not a substitute for professional legal advice and should not be relied upon as such.

"The state franchise registration process, virtually unchanged for nearly forty years, is archaic, time-consuming, and extremely costly for franchisors; offers little protection for prospective franchisees; and fails to take advantage of current computer technology. 

The time has come for a twenty-first-century solution." wrote franchisee attorney Keith Kanouse in the ABA's Franchise Law Journal, Summer 2009.

Keith argues that when the FTC changed their franchise disclosure documents, effectively bringing the federal disclosure in line with the state disclosure requirements, the FTC missed a golden opportunity to require federal registration.

Think about the possible advantages that franchisors would have enjoyed, had the FTC required federal registration:

1. Franchisors would have effectively had one registration process, at the national level. This would lower their filing costs.

2. The renewal dates for registration would be uniform, making it less likely that franchisors would inadvertently miss a registration date, which has resulted in at least one successful legal malpractice suit by a franchisor against its attorneys.

3. There would be an end to the practice of selling in franchises in the unregistered states, as precursor to selling in the registrant states. Less money would flow to more speculative franchise systems, which would benefit the better systems.

4. Prospective franchisees would be able to obtain the FDD from the federal registry, read and comprehend it long before they did their pre-sale investigation.

5. Finally, with the many of state's in dire financial condition, the number of people needed to review the registration has been cut back - leaving these franchise systems without the ability to sell in a registrant state.

On the later point, Keith notes: "The states don't want to give up their power even though they complain about being understaffed and underfunded. There have been cutbacks and furloughs as you know.

With most franchisors on a calendar year fiscal year, most renewal filings are made in April/May creating an enormous backlog.

For existing franchisors in states where there is no automatic effectiveness of the renewal application, it causes them to cease selling until these until the states get around to reviewing the renewal.

There is no urgency on the examiners."

This is an issue that all franchisee associations should agree on, with the franchisors, it just makes sense to have one single registry system which minimizes costs, delay and increases proper pre-sales research.

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ESPN reporter Erin Andrews filed a lawsuit Thursday against Ohio State doing business as the Blackwell Inn for negligence, emotional distress and invasion of privacy as part of a larger suit against two additional hotels and the man that published nude footage of the television reporter last year.


The lawsuit is interesting because in part because of the simple facts.  Erin Andrew's stalker was able to obtain information from the hotel where she was staying, get her room number, and book a room right beside her.  How could this happen?  No doubt the depositions on this will prove fascinating.

But the incident shows again the problems that any franchisor and franchisee have: how to divide the responsibilities up for upholding compliance with privacy standards.

Erin Andrews has advanced a number of theories in this case for franchisor liability, agency, co-venturers, and community interest.

The franchising world will be watching this case unfold with great interest.

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