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Historical Review of Franchise Fees: At a Glance

Whether a particular relationship is considered a franchise requires an in-depth dive into both federal and state statutes defining a “franchise.” As is common in all states that have passed franchise acts, the definition of a franchise includes various elements. While these elements nearly always include the use of a trademark or association with a trademark, a community of interest between the parties, and/or a franchisor’s marketing plan assistance and/or control, the most fundamental element is the payment of a “franchise fee.”

 

Federal Franchise Rule

The start of any inquiry into whether or not a particular business entity is considered a “franchise” should always begin with a glance at the Federal Trade Commission Franchise Rule (“FTC Rule”). Effective since October 21, 1979, the FTC Rule was designed to equip potential franchisees with protection before expending (potentially) significant funds in a franchise investment.

 

The FTC Rule provides:

 

(h) Franchise means any continuing commercial relationship or arrangement, whatever it may be called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

(1) The franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark;

(2) The franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation; and

(3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

 

16 C.F.R. § 436.1(h). As seen, the FTC Rule makes no mention of a “franchise fee.” And instead, requires a “payment.” This “required payment” element encompasses “all consideration that the franchisee must pay to the franchisor or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the franchise.” 16 C.F.R. § 436.1(s).

 

State Franchise Acts

Even though the Federal Trade Commission enacted the FTC Rule, various states can (and indeed, most have) choose to enact their own statutes to furnish both current franchisees and potential franchisees with protection. Currently, there is no uniform definition of a “franchise” among the states, and not all states require the payment of a “franchise fee” in their respective definition of a franchise. In those states that have enacted a state specific franchise act, entities should still be aware of Business Opportunity Laws, and other industry specific laws, that might still govern some aspects of a franchise or business relationship.

 

Despite statutes defining what “is” and what “is not” to be considered a franchise fee, it is not surprise that these statutes leave much ambiguity in their application. In the following blog posts, we will review cases throughout the years litigating the franchise fee element.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

Common Franchise Agreement Provisions: Right of First Refusal

What is it

A right of first refusal is extremely common in the franchise industry. Most (if not all) franchise agreements contain a provision giving the franchisor a right of first refusal on the franchisee’s proposed transfer of its business, including a proposed transfer of the franchisee’s assets or lease interest, to any third party. Pursuant to most rights of first refusal, prior to effectuating such a transfer, the franchisee must first offer to sell such interest to the franchisor, generally on the same terms and conditions offered to the third party. Accordingly, there will usually be, at least, three parties involved in a right of first refusal: the franchisee, the franchisor, and the third party.

In effect, a right of first refusal will function similar to the following:

  • Harry is a WandWorld franchisee.
  • Harry wants to transfer its obligations under its WandWorld franchise agreement to Ron (third party).
  • Harry and Ron work out agreeable terms for Ron to purchase Harry’s franchised WandWorld business, and formalize the terms of the offer in a signed Letter of Intent.
  • Harry provides Hermione (franchisor) with the Letter of Intent.
  • Hermione may either purchase Harry’s franchised business under the same terms and conditions offered to Ron, or allow Harry’s proposed transfer to Ron to go through.

 

Where is it

The right of first refusal provision is commonly located under the “Transfer” provisions of the franchise agreement.

 

Concerns with it

The right of first refusal process both slows down a franchisees ability to sell its business and makes it less likely for a potential purchaser to want to perform the due diligence required to make the franchisee an offer.

 

How to avoid it

Although it is unlikely that a franchisor will agree to remove its right of first refusal, it is best to attempt to avoid it altogether by negotiating for its removal prior to signing a franchise agreement. In the alternative, make sure the terms of the right of first refusal are reasonable. So, in the event you cannot get it removed altogether, make sure the franchisor is required to exercise its right of first refusal within a reasonable amount of time. In the past, we have seen a right of first refusal allowing the franchisor 120 days to decide whether to exercise its right of first refusal, and then 90 days to do its own due diligence with no obligation to purchase—meaning that half a year could go by, during which time the franchisee’s first third party offer would undoubtedly be off the table.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

Minnesota Supreme Court Clarifies Test and Requires Specific Language to be Used for Certain Indemnity Clauses—Dewitt v. London Road Rental Center, Inc., 910 N.W.2d 412 (Minn. 2018)

In Dewitt v. London Road Rental Center, Inc., 910 N.W.2d 412 (Minn. 2018), the Minnesota Supreme Court resolved the confusion surrounding the proper test for determining whether an indemnity clause is enforceable under Minnesota law.

 

In Dewitt, a rented picnic table collapsed on a restaurant patron causing severe injuries. Id. at 414. The injured patron filed suit against both the restaurant and the rental company. Id. The rental company filed a cross-claim against the restaurant, seeking the protection of an indemnity clause in the rental agreement. Id. The district court determined that “although the indemnity clause did not expressly include [the rental company’s] own negligence within its scope, the clause’s broad language necessarily included coverage for [the rental company’s] negligence.” Id. (emphasis in original).

 

The Minnesota Court of Appeals affirmed this decision, stating that “[t]he test is whether the language is so broad that it necessarily applies to negligence.” Dewitt v. London Rd. Rental Ctr., Inc., 899 N.W.2d 883, 891 (Minn. Ct. App. 2017). After applying this test to the indemnity clause in dispute, the court concluded that the indemnity clause was enforceable, and the restaurant had agreed to indemnify the rental company for the rental cpomnay’s neglience. Id. at 892.

 

The Minnesota Supreme Court expressly rejected the test used by the court of appeals, stating:

 

The test is therefore not whether the language of an indemnity clause is “so broad” that it necessarily includes the indemnitee’s own negligence…. Rather, the proper test is whether the clause includes specific language that expressly shows, in clear and unequivocal language, that the parties intended the clause to obligate the indemnitor to indemnify the indemnitee for the indemnitee’s own negligence.

 

Dewitt, 910 N.W.2d at 417 (internal citations omitted) (emphasis in original).  Further, the court noted, “indemnity cannot be established by implication.” Id. at 418.

 

The court explained that the more broadly stated rule set forth in National Hydro Systems v. M.A. Mortenson Co., 529 N.W.2d 690 (Minn. 1995) and Yang v. Voyagaire Houseboats, Inc., 701 N.W.2d 783 (Minn. 2005) has never been actually applied by the court. Dewitt, 910 N.W.2d at 417–18. “The only rule that [the Minnesota Supreme Court] ha[s] applied has been whether the parties expressed their intent in ‘clear and unequivocal terms….’” Id. at 418 (emphasis in original). Applying the proper legal test to the indemnity clause before it, the court ultimately found the indemnity clause inapplicable, “because it d[id] not include express language that clearly and unequivocally show[ed] the parties’ intent for [the restaurant] to be financially responsible to [the rental company] for [the rental company’s] own negligence.” Id. at 420.

 

Takeaway: When determining whether an indemnity clause is enforceable under Minnesota law, the test is “whether the clause includes specific language that expressly shows, in clear and unequivocal language, that the parties intended the clause to obligate the indemnitor to indemnify the indemnitee for the indemnitee’s own negligence.” Id. at 417. If the contract language does not require a franchisee (for example) to specifically indemnify a franchisor against the franchisor’s own negligence, then, under Minnesota law, the franchisee will have no implied obligation to do so.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

Minnesota’s Implied Covenant of Good Faith and Fair Dealing May Not be Contracted Away

In Northwest, Inc. v. Ginsberg, 572 U.S. 273 (2014), the United States Supreme Court held that Minnesota’s implied covenant of good faith and fair dealing may not be contracted away.

 

In that case, the respondent was a member of airline’s frequent flyer program. Id. at 277. Shortly after achieving the highest level available in the program, the airline cancelled respondent’s membership because of respondent’s alleged “abuse” of the program. Id. Respondent subsequently filed a class action arguing that the airline discontinued respondent’s membership as a “cost-cutting measure,” and that the airline violated the implied duty of good faith and fair dealing. Id. at 278. The United States District Court for the Southern District of California held that respondent’s claims were pre-empted by the Airline Deregulation Act of 1978. Id. at 279. The Ninth Circuit reversed, and the United States Supreme Court granted certiorari. Id.

 

On the implied covenant of good faith and fair dealing issue, the Court noted that some states employ this doctrine as a mechanism to ensure neither party “violate[s] community standards of decency, fairness, or reasonableness.” Id. at 286 (internal quotations omitted). The Court stated that “the implied covenant must be regarded as a state-imposed obligation.” Id. As such, “under Minnesota law parties cannot contract out of the covenant.” Id. at 287 (emphasis added). The Court later went on to say that a State’s “unwillingness to allow people to disclaim the obligation of good faith . . . shows that the obligation cannot be implied, but is law imposed.” Id. (internal citations omitted). Therefore, Minnesota state law on this point was inconsistent with federal law and the Airline Deregulation Act governed (not Minnesota law).

 

Takeaway: Disclaimers of the covenant of good faith and fair dealing may be void under Minnesota law. Franchise agreements, along with many other agreements, commonly contain such disclaimers. Minnesota franchise attorneys and franchisees should keep this in mind when thinking of potential claims against franchisors for unreasonable or unfair conduct on the part of the franchisor.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

 

 

What to do if faced with franchise agreement termination or non-renewal

For a franchisee, wrongful termination or non-renewal of a franchise agreement poses a serious threat to the business you’ve worked so hard to establish. It  can often occur unexpectedly and for seemingly no reason. However, depending on your unique circumstances, you may be protected from termination or non-renewal and able to contest any such situation. Here are some key points regarding franchise agreements and what you should do if you find yourself faced with either of these life-altering events.

Termination vs. non-renewal

Franchise agreement termination and non-renewal are ultimately two different methods of achieving the same result for the franchisor. In a termination, the franchisor cancels the agreement before the end of the contract term, while non-renewal sees the franchisor refusing to renew the agreement at the end of its term. From the franchisee’s perspective, the result is the same: you lose your business.

Why franchisors terminate or choose to not renew

There are many reasons a franchisor may choose to terminate or not renew an agreement with a franchisee. In most cases, this action is done for the franchisor’s own benefit without regard for the future of the franchisee. Here are some of questionable reasons a franchisor will terminate or refuse to renew an agreement:

  • To take over a lucrative business or territory for itself
  • Consolidate multiple franchise locations in one franchisee’s hands
  • Transfer the franchise to a favored successor

All of the above circumstances put the franchisee in a seemingly powerless position, but there may be certain rights that can prevent termination or non-renewal depending on your location, agreement terms, industry, and certain other factors.

Your protections

Some states have statutes  which state that a franchisor cannot terminate an agreement without “good cause” as defined by the statute. For example, a franchisor would need to be able to demonstrate that your franchise is not paying its royalties or advertising fees, or was somehow violating health and safety requirements in order to terminate the agreement. As long as the franchise is performing to a minimum standard, the agreement must remains intact.

The franchisor will sometimes try to achieve the end of the relationship by failing to renew the agreement at the end of its stated term.  A smaller number of states also prevent this from happening without “good cause”.  In these states, the franchisee  may continue to conduct business as long as the franchise is capably performing. “Good cause” could include such things as failure to comply with the material terms of the franchise agreement, failure to meet sales quotas, or failure to achieve  quality standards. In states with strong statutory protection against termination or nonrenewal, if you are living up to your agreement, the franchisor  has no legal grounds for terminating or refusing to renew your contract.

Know your agreement

Most Franchise Disclosure Documents state that the franchise agreement the franchisee must sign cannot be terminated without “good cause.”  However, as franchising has evolved over the years, the franchise agreements now impose so many obligations on franchisees and contain so many “automatic termination” triggers that it cannot really be said that an agreement cannot be terminated except for “good cause.”    Franchise agreements are drafted to provide franchisors with the widest possible leeway in franchisee relations.  The agreements now make it more likely the franchisee will breach some term of the agreement at some point, thus allowing the franchisor to lawfully terminate the agreement, or not renew it at the end of the term.

As stated above, some states require certain conditions for termination or non-renewal, while others require written notice within a certain time period prior to either action taking place.  Other states require an actual opportunity to cure a default prior to termination. You need to know whether you have renewal options/rightm and how to exercise them properly.  You also need to make sure you know the dates of your term and your actual substantive renewal rights. A failure to understand this information could result in the end of the term arriving without your noticing and your right to renew being lost. The language of your agreement will ultimately determine your protections and whether or not you are able to prevent termination and keep your business.

What to do in the face of termination or non-renewal

When faced with termination or non-renewal, you must take immediate action against it. From a legal standpoint, it is far easier to retain a franchise before the date of termination or nonrenewal than it is to ask a court to reinstate it once it has been lost.  Furthermore, if you do lose your franchise, you’ll also lose the income you’d need to help pay for the impending court case. Most franchise agreements also contain terms that prevent you from working in the same industry for a certain period of time following termination, hampering your ability to continue making a living either during or following the legal battle. Time is of the essence in effectively combating wrongful termination or non-renewal.

Save your franchise today

Dady & Gardner franchise attorneys have enjoyed many successes battling franchisors and suppliers over their attempts to terminate franchisees without good cause. We have helped many franchisees by winning court orders preventing termination and by winning very substantial monetary damages for terminations that were proven to be not justified. Contact us today to schedule a free consultation and prevent your own wrongful termination or non-renewal.  Or, if termination has already occurred, to determine whether you may be able to sue for damages based upon a wrongful termination or wrongful nonrenewal.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

Buying a Franchise Business: Top Eleven Things to Look for in Franchise Agreements

Are you considering becoming a franchisee and operating a franchised business? Are you currently operating a franchised business? Are you looking at a franchise agreement and wondering what on earth you are reading? We at Dady & Gardner understand that franchise agreements are generally  quite confusing and hard to parse. That is why we have compiled a list of the top eleven things for you to look for in reviewing a potential franchise agreement or an existing agreement.  If your agreement has all, or almost all of the following things, you have a favorable franchise agreement:

 

  1. A good definition of the product line. Our clients like to know that, if they continue in the relationship, they will be able to handle the entire array of products and services currently being offered as well as all new and improved variations thereof.

 

  1. Protection against same-brand competition. Our clients like to know that, if they are investing their life’s savings, and their life’s work, in building demand for the products in their trade areas, they will be able to reap the benefits of those efforts without same-brand competition (competition by fellow franchisees in the same brand or competition from the franchisor for its own account).

 

  1. “Do the job, keep the line” duration. Our clients like to know that, if they do a good job building demand for the products in their trade areas, they will be able to continue as the only representatives of that product line in their respective trade areas so long as they continue to capably perform; and, if their supplier should ever believe they are not capably performing, they will not be abruptly terminated/not renewed, rather they will be given notice of perceived deficiencies and a reasonable opportunity to address them, with termination/nonrenewal to follow only if the perceived deficiencies are not adequately addressed (Typically, distributor and dealer agreements have “early out” provisions for dealers and distributors; but franchise agreements typically do not have “early out” provisions for franchisees—something that, increasingly, is of interest to franchisees as they face dramatic changes in their franchisor/franchisee relationships, with no way other than litigation to get out of good relationships that have turned bad).

 

  1. Franchisors’ obligations. Our clients like a reasonable recitation by the franchisor that it will in fact provide some significant and meaningful support to the franchisee, and that, if fees are charged, they can expect to receive fair value for the fees paid.

 

  1. Franchisees’ obligations. Our clients like a clear recitation of what is expected from them, and, if the franchisor reserves the right to make changes in the future in the franchisees’ performance obligations, those changes should be subject to a“reasonableness” covenant (and, ideally, significant changes should first be run through a franchisee board of advisors to confirm reasonableness before implementation).

 

  1. Fair opportunity for a good return on investment. Our clients like to know that, if they work hard and do a good job, they will be able to make a good living, and that, as their sales increase, their income will increase at least proportionately.

 

  1. Ability to sell related products. For our nonexclusive dealership and distributor clients (whether designated as “franchisees” or not), it is important for them to be able to sell complimentary products and services.

 

  1. Fair dispute resolution procedures. Our clients favor swift, evenhanded dispute resolution procedures. They typically do not oppose arbitration or attorneys’ fees provisions, provided the arbitration is in an acceptable venue, and the “attorneys’ fees provision” means that the prevailing party (not just the franchisor) gets attorneys’ fees from the other side when they win. They also don’t want to have to disclaim otherwise available statutory protection, or unduly limit their right to recover damages from their franchisor if it breaches its duties. Our clients typically don’t mind indemnifying the franchisor for the franchisee’s own mistakes, provided the franchisor is willing to make a reciprocal indemnification promise (and provided that neither indemnification promise is too broad).

 

  1. Right to sell/transfer. Our clients want the ability to sell the businesses which they have built for fair value, or transfer them to a son or daughter, without undue interference on the part of the franchisor (“Reasonable discretion” with respect to the franchisor’s right to approval is fine; arbitrary discretion is not). They don’t like franchisor rights of first refusal, as they tend to depress sale values. Our clients are becoming increasingly worried, in this day of mergers among competitors, and leveraged buyouts, about the franchisor’s unfettered right to assign its side of the contract.

 

  1. The right to do something else. If our clients are going to close or sell their businesses—particularly where the closings or sales are forced by the franchisor—our clients want the ability to make a living doing what they know (subject only to fair covenants against competition the actual buyers of their businesses might reasonably require).

 

  1. Good faith and fair dealing. Our clients like a written commitment from their franchisors that states what business people intuitively know, as follows:

“The parties to this relationship agree to deal with each other honestly, fairly, in good faith, and in a non-discriminatory, commercially reasonable manner.” (Who can be against that?!).

 

Are you thinking of purchasing a franchise? Our experienced attorneys regularly review franchise agreements in order to help preserve prospective franchisee’s rights early on. For more information regarding our franchise agreement review, contact one of our franchisee attorneys today.

 

*This blog item was revised adapted from “Michael Dady’s Top Ten List of Things to Look for in Franchise Agreements” Copyright © 2002 by J. Michael Dady, with the copyright author’s consent.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

 

 

 

Important Update: 7 Franchisors Now Obligated to Remove “No Poach” Clauses from Their Respective Franchise Agreements

On July 12, 2018, seven franchise systems entered into legally binding “assurances of discontinuance” with the Washington State Attorney General’s Office, which required them to remove “no poach” clauses (also known as “anti-poaching,” “non-solicitation,” and/or “no hire” clauses) from their franchise agreements on a national scale.  Those franchise systems are: Arby’s, Auntie Anne’s, Buffalo Wild Wings, Carl’s Jr., Cinnabon, Jimmy John’s, and McDonald’s.

 

While these “assurances” impose obligations upon those seven franchise systems, it is important for franchisees to know that they, too, will likely be impacted as follows:

 

  • If you are a franchisee of one of those seven franchise systems, and your franchised business is located in Washington state, your franchisor must remove the “no poach” clauses within 120 days of July 12, 2018;

 

  • If you are a franchisee of one of those seven franchise systems in any other state, Puerto Rico, or Washington D.C., your franchisor must remove the “no poach” clauses when your Franchise Agreement comes up for renewal; and

 

  • If you are a franchisee of one of those seven franchise systems, your franchisor must inform you of the specific requirements under the assurance of discontinuance.

 

What exactly does this mean for franchisees?

 

As a franchisee of any of those seven franchise systems, the “no poach” clause in your franchise agreement is likely no longer enforceable.  Depending on where your franchise business is located and where your franchise agreement is in its respective term, be aware that your franchise agreement may change to reflect the assurance of discontinuance agreed to by your franchisor.  As a result, keep in mind that neither you nor other same-brand franchisees in your area may be bound by the “no poach” clause, meaning there may be more freedom of movement of your employees and the employees of the other franchisees in your area.

 

*This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.

The Federal Fair Franchise Act of 2015 – Not So Outrageous After All

The Federal Fair Franchise Act of 2015 – Not So Outrageous After All

At least some franchisor advocates have indicated outrage at the idea that federal legislation such as the Fair Franchise Act of 2015 has been introduced (not passed, but simply introduced) to regulate the relationship between franchisees and franchisors. Even a quick look at the history of franchising and the history of federal legislation demonstrates that the idea of the federal government protecting small businessmen, small investors and everyday citizens from abuse by larger entities is not so outrageous after all.

First, the federal government already regulates the sale aspect of franchising to some extent. The Federal Trade Commission Act, and the FTC’s Franchise Rule enacted pursuant to that Act, have regulated the sale of franchises since 1979. The Franchise Rule has been amended a number of times over the past 36 years. The FTC, a federal agency, has long required that franchisees receive a prospectus-like document (now called a Franchise Disclosure Document, formerly called a Franchise Offering Circular) that contains 23 specific items involving pre-sale disclosures.  The sudden great concern of franchisors and their advocates that the federal government might become involved in franchising comes a tad too late – approximately 36 years too late.

It is not surprising that the first efforts at federally regulating franchising called for a prospectus-like document, because it is generally agreed by people who study the history of franchising that the FTC’s regulation of franchising was patterned after the Securities and Exchange Commission’s regulation of securities sales. Such regulation by the SEC goes all of the way back to the Securities and Exchange Act of 1933 enacted during the Great Depression.

Congress decided in 1933 that the federal government was going to do something about fraudulent sales of securities to investors.

This decision to pass federal legislation was made even though the victims to be protected from the securities scams that had occurred in the 1920s and 1930s would have been people of substantial financial means and not middle class workers investing in 401K retirement plans (the first 401K plans did not come into being until the 1980s, prior to that time most citizens had no personal investment in the stock market at all).

Franchise Law Agreement Gavel

In 1979, 46 years after its regulation of securities sales, the federal government made the same decision with respect to the sale of franchises to franchisees; the federal government wanted to do something about fraudulent franchise sales.

Both federal securities laws and federal franchise laws prohibit improper disclosures and prohibit false and misleading statements, and both the SEC and FTC have enacted rules that are written in a manner such that they can be read as forming the basis for a private party’s complaint against a fraudulent seller. One key difference, however, is that the federal courts limited the ability of franchisees to sue in court while permitting a defrauded securities purchaser to sue in court.

In other words, a securities investor who feels defrauded can sue in court under Rule 10b-5 enacted by the SEC, but a franchisee who feels defrauded is NOT allowed to sue under the FTC’s Franchise Rule.

This shift in the federal judiciary’s willingness to imply a “private right of action” in a federal statute (unfortunately for franchisees, the shift began around 1979), has left franchisees with a federal right for which the franchisees cannot generally pursue a remedy in court. A franchisor sued for a violation of the FTC Act or the Franchise Rule can win in court with this argument: “Even if we did violate the FTC Franchise Rule, there is nothing the franchisee can do about it.”

When amending the Franchise Rule in 2008 the FTC’s Office of the General Counsel stated that it had conducted an extremely minimal number of enforcement actions against franchisors since 1979 (the number stated was well under 100). In roughly 30 years, the FTC had enforced its FTC Franchise Rule….well, almost never. A franchisee who is harmed by a violation of his or her federal franchise law rights cannot sue in court, and the franchisee’s complaint to the FTC will almost certainly never result in an enforcement action. (We at Dady & Gardner used to report violations to the FTC in the mid-1990s. No enforcement action was ever brought, and if the franchisor learned of the report to the FTC it would use the FTC’s inaction to argue that “the FTC investigated this and said that we did nothing wrong.” Reporting matters to the FTC was actually counterproductive to our representation of franchisees. Therefore, we stopped the practice after a few years.)

The Fair Franchise Act of 2015 seeks to remedy this ridiculous situation of having a federal law that is almost never enforced.

The Act allows franchisees the same right that securities investors have had for 82 years – the right to sue to enforce a federal anti-fraud statute. How revolutionary is that? Not very. Franchisees should have a right that others who are similarly situated were given when FDR first became President.

Second, even outside of the securities context (securities laws, it should be noted don’t just deal with initial fraud in sales situations, the securities laws also includes restrictions on insider trading, short swing trading, initial public offerings, reporting requirements, record keeping, etc.) the federal government also regulates various aspects of commerce every day. Certainly innkeepers and restaurateurs in the South in 1964 were surprised to learn that they had to open their doors to African Americans. Having been allowed to do business in the same manner since at least the end of Reconstruction, these business owners certainly had to be shocked that the federal government could question the way they did business or treated actual or potential customers. Yet the federal government regulated them, and Congress has also passed laws requiring businessmen to limit their commercial activities in many other ways. For example, we have federal prohibitions on unfair housing practices, discrimination against those with disabilities, and clean air and/or clean water violations. Each of these federal laws regulates commerce and prohibits certain actions that a business person might want to take. The federal government also regulates conduct toward employees, including employee retirement plans, and tax withholding. For franchisors (who are already regulated by the federal government both through the FTC Rule and otherwise) to claim some sort of “overreach” through the enactment of the Fair Franchise Act of 2015 is, at best, disingenuous.

It is clear that franchising in a great many ways is already regulated by the federal government. Then what exactly is the complaint of franchisors about the newly proposed federal legislation that has been introduced? That the Act is somehow grossly unfair to the franchisor?

Let’s review some of the specific provisions in the Act.

Under the Fair Franchise Act of 2015, Franchisors cannot:

1.) Hinder the formation of or participation in franchisee associations
2.) Charge “excessive and unreasonable” renewal fees
3.) Impose a “standard of conduct or performance” on franchisees unless the franchisor can prove that the standard is “reasonable” and “necessary”.
In addition, Franchisors
4.) Must deal “fairly” and “in good faith” and exercise “due care” with franchisees, and
5.) Cannot sell a product or service to a franchisee unless the price is “fair and reasonable” or unless the franchisor has a “reasonable expectation” that the sale will be profitable for the franchisee’s business.

Let’s stop here and try to recap – are franchisors fighting this legislation because the franchisors want the absolute and unquestionable right to A) prohibit franchisees from having an association and talking with one another, B) charge excessive and unreasonable fees, C) act in an unnecessary and unreasonable manner, D) act in bad faith and without due care, E) sell products to franchisees at a markup so high that the franchisor knows the franchisee will not make a profit upon resale?

contract-franchise-law-agreementAre these really the inalienable rights for which franchisors are fighting? If this is the case, then we know that the California Court of Appeals was correct when it described the oppressive nature of the franchise relationship way back in 1996:

The relationship between franchisor and franchisee is a significant issue, and growing more important each year.

As recently explained, “Franchising is rapidly becoming the dominant mode of distributing goods and services in the United States. According to the International Franchise Association, one out of every twelve businesses in the United States is a franchise. In addition, franchise systems now employ over eight million people and account for approximately forty-one percent of retail sales in the United States. Even conservative estimates predict that franchised businesses will be responsible for over fifty percent of retail sales by the year 2000.”

Although franchise agreements are commercial contracts they exhibit many of the attributes of consumer contracts. The relationship between franchisor and franchisee is characterized by a prevailing, although not universal, inequality of economic resources between the contracting parties. Franchisees typically, but not always, are small businessmen or businesswomen or people like the Sealys seeking to make the transition from being wage earners and for whom the franchise is their very first business. Franchisors typically, but not always, are large corporations. The agreements themselves tend to reflect this gross bargaining disparity. Usually they are form contracts the franchisor prepared and offered to franchisees on a take or-leave-it basis. Among other typical terms, these agreements often allow the franchisor to terminate the agreement or refuse to renew for virtually any reason, including the desire to give a franchisor-owned outlet the prime territory the franchisee presently occupies.

Some courts and commentators have stressed the bargaining disparity between franchisors and franchisees is so great fn. 8 that franchise agreements exhibit many of the attributes of an adhesion contract and some of the terms of those contracts may be unconscionable. “Franchising involves the unequal bargaining power of franchisors and franchisees and therefore carries within itself the seeds of abuse. Before the relationship is established, abuse is threatened by the franchisor’s use of contracts of adhesion presented on a take-it-or-leave-it basis.”

Postal Instant Press v. Sealy, 51 Cal.Rptr.2d 365 (Cal. App. 2 Dist. 1996)(citations omitted)

Franchisor advocates have also complained that the proposed Fair Franchise Act of 2015 addresses the parties’ rights with respect to transfers, renewals and terminations. One of the stated complaints here is that the Act regulates contract provisions that “the parties take for granted.” What the proposed Act prohibits is unfair terminations and non-renewals without good cause. It also prohibits denial of transfer rights without a valid reason. Who are the “parties” that routinely take for granted that they will be able to impose upon the other contracting party the absolute right to terminate an entire long-standing business in the community without good cause, or non-renew the long term 10 or 20 year contract without good cause, or prohibit transfers to a qualified party of a multi-million dollar business that constitutes the seller’s sole asset, all without good cause?   Apparently, the set or subset of “parties” who expect this sort of right = only franchisors. Why is that? It is because franchisors have always enjoyed the ability to impose unfair take-it-or-leave-it contracts upon their franchisees. The Fair Franchise Act of 2015 would remove this disparity of bargaining power.

But one might ask “how will franchising ever survive if franchisors are required to actually treat their franchisees in a fair and reasonable manner”?

Certainly no distribution system could ever work in this manner, correct? Incorrect.

Car Dealer Franchise LawAutomobile dealers in all 50 states enjoy significant statutory rights that prohibit the franchisor (generally called the “manufacturer” or “supplier” in the state auto dealer statutes) from taking unfair actions against these dealers. The rights of auto dealers are so substantial that the when GM and Chrysler made the decision to cut the number of dealers in their dealer network in light of the Great Recession, they each felt the need to first file for bankruptcy protection and only then “rejected” these dealer contracts in bankruptcy, hoping that federal bankruptcy law would override state dealer protection acts. What was the reaction of Congress to these dealer terminations (all of which were permitted by the bankruptcy courts and at least tacitly encouraged by the Executive Branch)? Congress almost immediately passed a law by a unanimous vote allowing the auto dealers to file for arbitration and to seek the return of the product line(s) to the dealers if the dealer was successful in the arbitration.

Since 2002, Congress has also provided automobile dealers with one additional right also sought now by franchisees – the right to not be forced to arbitrate legal claims. In 2002, Congress passed the Motor Vehicle Franchise Contract Arbitration Fairness Act which created a narrow exception to the Federal Arbitration Act. The new law allowed auto dealers to invalidate arbitration provisions in motor vehicle franchise agreements. See 15 U.S.C. § 1226(a)(2).

Again, despite the federal government becoming significantly involved in the dealer/ manufacturer relationship, and staying involved since at least 2002, there are still thousands of car and truck dealers in the nation. The world has not ended over the past 13 years because dealers are allowed to sue in their own states for statutory and contract violations.

What should strike one as odd is that a husband and wife who own one franchised Subway shop in Colorado currently have to arbitrate all of their legal disputes in Connecticut in Subway’s back yard, while a hypothetical multimillionaire football quarterback who owns car dealerships in Colorado can sue in Colorado to redress any dealership issues he has. Certainly franchisees should be treated no worse under federal law than are auto dealers.

None of the lawyers at Dady & Gardner were even born at the time the federal government started enacting regulatory systems that limit the overall discretion of business owners to operate. Legislation that would create a fairer franchisor-franchisee relationship is certainly nothing new. While the federal Fair Franchise Act of 2015 will upset certain franchisors who claim some sort of “divine right” to impose unfair and burdensome contract terms upon their franchisees, this is to be expected. No one who has always had an unfair advantage likes to play on a level playing field.

Both Democrats and Republicans claim to be supporter of the small business owners of America.

If that claim is indeed true, then all elected representatives should desire to provide tens of thousands of small businessmen with protection from unfair treatment and unfair contracts. To suggest that these small business owners should be hung out to dry and treated worse than securities investors and automobile dealers is, in reality, the idea that should be so far outside of the political mainstream that it should be rejected immediately and out of hand.

By Jeff Haff

 

If a franchisor refuses to renew, what are the franchisee’s remedies?

If a franchisor refuses to renew, what are the franchisee’s remedies?

I’ve been doing this work for franchisees and dealers for a long time and this issue about renewal comes up more and more often. I used to argue (I’ve given up, because I’ve been unsuccessful) that what’s the difference? A termination or a non-renewal, you’re out of business either way so that the protections that relate to terminations should apply to non-renewals.

Unfortunately the case law, the decision by judges over the years said, “No, a non-renewal at the expiration of the term and written agreement is different than a termination during the term of that agreement and so different principles apply.” And so, if you receive a notice that you aren’t going to be renewed, that’s an issue that we have to deal with.

One way we deal with it is to help get enacted, and about 16 states have (enacted), statutes that prohibit franchisors from not only not terminating, except if they have good cause after notice of deficiency and opportunity to cure, but also they may not non-renew absent good cause, notice of deficiency, and opportunity to renew. So statute protection is helpful. If the writing is bad, we also want to know: might that bad language in the writing have been changed by a course of dealing that this particular franchisor or supplier always renews if indeed the franchisee or dealer is capably performing. But we like to see something in the writing that’s helpful; if not, we like to see something in the statute that’s helpful; if not, we also need to take a look at the course of dealing to see what we might argue.

The related issue on renewals is interesting, and that is: sometimes franchisors and suppliers will come out with a new contract at renewal time. So it’s not non-renewal really, but it’s “here, sign this new agreement if you want to be renewed.” And the agreement is so dramatically different and onerous to the franchisee or dealer that they look at it and say “I can’t possibly make any money with this document.” I had a case down in the southern Midwest, a couple states down from Minnesota here, where they were proposing a very different contract and my client was an implement dealer and just knew he couldn’t make a living with this new document. So we went in to court and asked for an injunction prohibiting them from non-renewing us and directing the supplier to give us a contract like what we had before. What I said to the judge was, “Judge, if my wife says ‘Let’s renew our marriage vows’, I’m thinking she means with me. And secondly, when she says renew our marriage vows, I’m thinking ‘she’s not gonna propose one of these open marriage deals’ either. It’s going to be like what we had before, that’s what the word ‘renew’ means.” And the judge chuckled when I said that and granted the injunction.

The concept of renewal is to do again what you were doing before. And so (I call it a Michael Dady amendment), a lot of suppliers and franchisors cross the word “renewal” out of their documents and they now say “At the end of this agreement, we may offer you a new agreement but it could be substantially different than the one you now have.” So then we have to come up with other arguments to help our clients be able to continue that relationship in a way that makes sense for them and their supplier or franchisor.

If a franchisor refuses to renew, what are the franchisee’s remedies?

From ReelLawyers on Vimeo.

 

Change In Franchise Business Model

What if your franchisor requires a significant system change

Can My Franchisor Really Make Me Do That?

Imagine receiving notice from your franchisor outlining a significant system change (a costly store renovation, a new menu, a new point-of-sale (POS) system). The notice provides that you as the franchisee are not only required to follow the system change, but are also obligated to expend significant capital to implement it. Absent language in your franchise agreement that specifically provides for the exact change, whether you as a franchisee must comply, or whether you have reasonable grounds to push back, may turn on the contractual standard applied to your franchisor’s discretion.

Disagreements over unilateral decisions made by the franchisor, like the examples above, are common in franchise relationships. This article briefly discusses the implications of the varying standards of discretion applied to franchisor decision making during the term of the agreement and outlines general, practical considerations for both prospective and current franchisees.

 

Discretion in Franchise Agreements

Franchise agreements do not contemplate a single event, such as purchasing a vehicle, but rather, ongoing conduct over a time period that can span as much as 10 to 20 years beyond the date the agreement is executed. Because it is simply not possible to anticipate all future scenarios, the parties are necessarily left with discretion to take certain actions during the term of the agreement. The lion’s share of discretion, however, is frequently left in the hands of the franchisor, while franchisee duties are specifically defined in the franchise agreement, and to the extent not covered in the franchise agreement, in the ever-changing operations manual. This imbalance is especially concerning because a simple exercise of the franchisor’s discretion can threaten the franchisee’s financial stability and, in turn, put a franchisee’s entire investment at risk.

 

Good Faith & Fair Dealing

While the franchise agreement is the key document that outlines the parties’ rights and responsibilities within the business model, under the common law, in most states, an implied covenant of good faith and fair dealing attaches to every contract, including, in general, franchise agreements. The implied covenant of good faith and fair dealing requires that when a contract grants one party discretion, that party is required to exercise its discretion in a fair and reasonable manner, consistent with the reasonable expectations of the parties.

business-handshake

In a perfect world for franchisees, the franchise agreement would require both parties to adhere to a discretionary standard of good faith and fair dealing. Indeed, whether implied by law or expressly provided as a discretionary standard in the franchise agreement, good faith and fair dealing has empowered franchisees to combat unreasonable exercises of franchisor discretion. See, e.g., Nat’l Franchisee Assoc. v. Burger King Corp., 715 F. Supp. 2d 1232 (S.D. Fla. 2010); Carvel Corp. v. Diversified Mgmt. Grp., Inc., 930 F.2d 228 (2d Cir. 1991).

 

Modified Discretion: Absolute, Exclusive, Sole or Business Judgment

More commonly, however, franchisors draft agreements that grant the franchisor wide discretionary latitude, reserving the right to exercise its “absolute,” “exclusive” or “sole” discretion, or to exercise its “business judgment.” While seemingly innocuous, the foregoing discretionary standards may actually become quite costly for franchisees. In these scenarios, significant franchisor decisions are more likely to withstand judicial scrutiny. See, e.g., Burger King Corp. v. H&H Rest., LLC, 2001 WL 1850888 (S.D. Fla. Nov. 30, 2001) (finding that Burger King Corporation (BKC) did not unreasonably withhold its consent to a proposed transfer because BKC had the “sole discretion” to determine whether the proposed transfer was acceptable); but see Northwest, Inc. v. Ginsburg, No. 12-462 (U.S. Apr. 2, 2014) (finding that despite a contractually reserved “sole discretion” standard, the implied covenant of good faith and fair dealing under Minnesota law cannot be waived or contracted around).

 

Furthermore, to the extent a franchisor retains unrestricted discretion to act, the risk that the franchisor might exploit franchisees increases. For instance, an opportunistic franchisor might decide to increase its revenue by extracting additional funds from franchisees. To do so, franchisors may increase the prices of goods sold to franchisees or require unnecessary renovations. Under lax discretionary standards, franchisors have more incentive to target additional revenue at the expense of franchisees because their discretionary decisions receive less scrutiny and are more likely to be upheld.

 

Practical Considerations for Franchisees

 

  1. Prior to Signing, Be Mindful of the Standards in the Franchise Agreement That Apply to Your Franchisor’s Ability to Take Unilateral Actions

 

Franchisees should attempt to negotiate standards that require both parties to deal with each other, and exercise their discretion, reasonably, in good faith, with honesty, in a non-discriminatory manner, and in accord with recognized standards of fair dealing in the industry. In the same fashion, franchisees should beware of discretionary provisions that permit a franchisor to exercise “absolute,” “exclusive” or “sole” discretion, or to exercise its “business judgment.”

 

The likelihood that a franchisor will negotiate its discretionary standard will likely depend on the relative bargaining power of the parties. Generally, however, franchisors have the upper hand, and seldom concede their discretionary rights. Franchisees should understand that unfavorable discretionary standards provide franchisors with a significant amount of leeway in making important decisions under the franchise agreement, and as a result, the franchisor may not be obligated to treat the franchisee in a reasonable manner, and instead, may act entirely in its own self-interest.

 

  1. Evaluate Your Rights If You Believe Your Franchisor Has Unreasonably Exercised Its Discretion

 

Franchisees should evaluate their rights when facing what they believe is an unreasonable exercise of their franchisor’s discretion. The franchise agreement defines the rights and responsibilities of franchisors and franchisees and it is the logical starting point in this analysis. Franchisees generally have no claims against franchisors for conduct that is expressly permitted in the franchise agreement. La Quinta Corp. v. Heartland Properties, LLC, 603 F.3d 327 (6th Cir. 2010); Burger King Corp. v. E-Z Eating, 41 Corp., 572 F.3d 1306 (11th Cir. 2009).However, there are cases in which the implied covenant of good faith and fair dealing has limited the express rights of franchisors under the agreement. See, e.g., JOC, Inc. v. Exxon Mobil Oil Corp., 2010 U.S. Dist. LEXIS 32305, Bus. Franchise Guide (CCH) 14,352 (D.N.J. Apr. 1, 2010) (holding that under New Jersey law, “a party’s performance under a contract may breach [the] implied covenant even though that performance does not violate a pertinent express term”).

 

sign documentIf the franchise agreement does not specifically permit the franchisor’s conduct, franchisors frequently attempt justify their conduct with their contractually reserved discretion in particular areas. For example, franchisors reserve the right to make important decisions, such as whether to approve store locations and transfers or to impose marketing and advertising fees, among others, according to their own discretion. Similarly, franchisors commonly reserve the right to modify system standards, which may be provided for in the franchise agreement, or more commonly in the operations manual. Case law has shown that the discretionary standard applied to franchisor decisions and changing system standards has a significant impact on the franchisee’s rights. See, e.g., Johnson v. Arby’s Inc., Bus. Franchise Guide (CCH) ¶ 12,018 (E.D. Tenn. Mar. 15, 2000) (permitting Arby’s to require that new stores comply with its new building design in part because Arby’s reserved its “sole discretion” to implement system standard changes in its operations manual).
Franchise laws are another source of rights for franchisees. Various states, such as Arkansas, Connecticut, Hawaii, New Jersey, among others, have enacted franchise relationship statutes that impose a general standard of good faith or commercial reasonableness in the franchise relationship. However, while some courts have construed these statutes liberally to insulate franchisees, others have done the opposite. Compare Beilowitz v. General Motors Corp., 233 F. Supp. 2d 631 (D.N.J. 2002) (finding that it was clearly a violation of the New Jersey Franchise Practices Act to require a franchisee to operate at a substantial financial loss while the franchisor attempts to implement a new and unproven marketing strategy); with Remus v. Amoco Oil Co., 794 F.2d 1238, 1241 (7th Cir. 1986) (holding that Wisconsin’s franchise relationship statute does not prohibit franchisors from implementing nondiscriminatory system-wide changes without unanimous franchisee consent).

Summary

Prospective franchisees should be mindful of the discretionary standards reserved by the franchisor in the franchise agreement. While not always negotiable, a prospective franchisee should seek a mutually applicable discretionary standard that requires the parties to act and exercise their discretion in good faith, honestly, and in a reasonable manner.

 

With regard to disputes arising out of franchisor decisions during the term of the agreement, franchisees are particularly vulnerable against the franchisor’s expressly reserved rights and the discretionary standard reserved in the franchise agreement. Still, the success or failure of challenges to franchisor decisions is factually specific, and may vary considerably with differing jurisdictions and applicable laws.

 

We encourage prospective franchisees negotiating franchise agreements and current franchisees that feel their franchisor has acted unreasonably, and against the business model, to contact one of the attorneys at Dady & Gardner.