Archives for: franchising

Vendor Rebates: Franchising’s Dirty Little Secret

In my previous column, I introduced readers to the often shockingly one-sided and overly aggressive nature of a vast number of franchise agreements. Ronald K. Gardner, Franchising From the Franchisee Lawyer Perspective, Law.com (Sept. 27, 2019). In my next few columns, I want to explore the “undisclosed” or less obvious issues that exist in franchising. And while there are many places I could start, none is more critical, or more often abused, than vendor rebates.

For the uninitiated, a vendor rebate is exactly what it sounds like—i.e., a payment by a vendor based on purchases made from that vendor. Most frequently, this payment is made to someone in compensation for bringing volume purchases or exclusivity (or both) to the vendor. In essence, in exchange for meeting certain criteria, the vendor shares its profit with the customer to incentivize continued or higher volume business.

The Purpose of Uniformity

One of the putative benefits of franchising is uniformity. Customers learn to expect the same type of products and services from one location to the next, and through this type of uniformity, franchise systems can build loyalty and goodwill associated with…read more

 

*NOTICE: This article 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 article.

Franchising From the Franchisee Lawyer Perspective

Imagine a client walks into your office wanting to get out of a contractual arrangement that they entered into three years ago. They explain that they are losing money, and that the contract makes no sense for them any longer.

In probing them, and reading the contract, you learn your client’s business is essentially controlled by the other party. The contract dictates the most basic aspects of the business—the hours of operation and the training requirements of the employees. It gives the other party approval rights over who the manager will be; the layout and appearance of the location; and controls what products and services your client can sell. Digging further you find that your client had to buy all of the original FF&E from the other party, and once open, is required to continue buying all inventory from the other party and its wholly owned affiliates, all at prices that are above what your client could get on the street for the exact same products. And, beyond controlling the price of goods (by being the only seller of those goods your client is allowed to purchase from), the contract also allows the other party to control the retail price of the goods and services your client may offer as well. In sum, your client has little to no control of their own profit margin.

The financial terms surprise you. Your client paid $75,000 to be in this one-sided relationship, and continues to pay 8 percent of their gross revenue to stay in the relationship, irrespective of whether they are making any money.

The boilerplate terms are no better. Your client is required to indemnify the other party for anything that happens at the location, even if it is the fault of the other party (and the indemnification is not reciprocal). The contract expressly disclaims any obligation the other party has to act in good faith. The dispute resolution provisions give the other party the right to bring injunctions, but your client does not have that right. Your client’s right to bring a claim is subject to a one-year statute of limitations, but there are no such limits on the other side. Venue and choice of law both favor the other party. And the attorney fee provision is also unilateral; the other party can get theirs if they win, but your client has no such stated right.

Finally, getting to the reason your client came in, you turn to the termination provisions. The agreement, which is for a 20-year term, while allowing the other side to terminate, inexplicably gives your client no right to terminate for any reason. And, if your client “breaches” by terminating because…read more

 

*NOTICE: This article 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 article.

Historical Review of Franchise Fees: Litigating the Franchise Fee Element in 2013

And the saga continues . . .

In H.C. Duke & Son, LLC v. Prism Marketing Corp., No. 411CV04006SLDJAG, 2013 WL 5460209, at *1 (C.D. Ill. Sept. 30, 2013), a producer and distributor of a line of soft-serve ice cream machinery and equipment (“plaintiff”) filed suit against one of its distributors (“defendant”). The parties entered into an agreement whereby defendant agreed to distribute plaintiff’s equipment. Roughly eight years later, plaintiff notified defendant that it was terminating the agreement. After defendant disputed this termination, plaintiff filed suit seeking a declaration of the parties’ rights and duties under the agreement.

Defendant countered, arguing that it was labeled as a “franchisee” under their agreement and that plaintiff violated various provisions of both the Illinois Franchise Disclosure Act (“IFDA”) and California Franchise Relations Act (“CFRA”) during the course of their relationship. Plaintiff then sought dismissal on the grounds that no franchise existed because defendant never paid a franchise fee. As such, both the IFDA and CFRA were inapplicable.

  1. Illinois Franchise Disclosure Act

First, the court turned to the definition of a franchise fee under the IFDA. The IFDA defines a “franchise fee” as “any fee or charge that a franchisee is required to pay directly or indirectly for the right to enter into a business or sell, resell, or distribute goods, services or franchises under an agreement, including, but not limited to, any such payment for goods or services . . . .” In addition, “[a]ny payment(s) in excess of $500 that is required to be paid by a franchisee to the franchisor . . . constitutes a franchise fee unless specifically excluded by Section 3(14) of the Act.”

Second, the court turned to defendant’s specific allegations that it paid a franchise fee. Defendant argued that:

  • It was required to assume a prior distributor’s debt in order to enter the agreement;
  • It was required to purchase and carry an “ample stock” of plaintiff’s service and repair parts;
  • It paid plaintiff for advertising and promotional materials; and
  • It was required to pay a franchise fee of $500 or more.

Third, the court determined that “taken together, these allegations state a plausible claim that a franchise fee was paid, and therefore meet Rule 8(a)’s notice pleading standard.”

  1. California Franchise Relations Act

First, the court stated that the analysis for the existence of a franchise fee under the CFRA is similar to the analysis under the IFDA. The CFRA defines a “franchise fee” as “any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay for the right to enter into a business under a franchise agreement including, but not limited to, any payment for goods or services.” The provision also provides that “the payment must exceed $100 on an annual basis or it is not a ‘franchise fee.’”

Second, the court turned to defendant’s same allegations of the payment of a franchise fee under the IFDA and stated that these allegations “raise the reasonable inference that these putative franchise costs amounted to $100 or more annually.” Accordingly, defendant made sufficient pleadings under Rule 8(a).

Because defendant had sufficiently pleaded the existence of a franchise fee under both the IFDA and the CFRA, the court denied plaintiff’s motion to dismiss.

Takeaway: This case provides a great example of the interplay between different state statutes defining the “franchise fee” element. Although there were only relatively minor definitional differences, the largest difference was the portion on required payments. The IFDA required a one-time payment in excess of $500, whereas the CFRA required a payment in excess of $100 on an annual basis. Despite these differences, the court still found that defendant had sufficiently pleaded the payment of a franchise fee under both the IFDA and the CFRA. Another lesson of this case is that when you make a motion to dismiss, all allegations are deemed true. So, good pleading can win you your motion. If you are a defendant, you have to be careful about making a motion to dismiss if a franchise fee is properly pled.

*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.