Need a Franchise Attorney? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

Continued from Part 1 & Part 2

The practice of franchise law is a niche area when it comes to the representation of franchisors.  Franchise attorneys draft complicated, tedious Franchise Disclosure Documents that must comply with the Federal Trade Commission Revised Rule as well as certain state disclosure law.

There is no reason, however, for a competent business attorney familiar with basic contract law to feel overwhelmed at the idea of reviewing a franchise agreement and advising a prospective franchisee. With that in mind, here are ten tips for the non-franchise attorney to keep in mind when reviewing a franchise agreement.

9. Recovery of Attorney Fees.  The issue of the recovery of attorney fees spent by either party when a dispute arises between a franchisor and franchisee is a topic that must be looked at carefully when reviewing a franchise agreement.  Fees paid to attorneys are costly in even the simplest of matters, and such fees can escalate dramatically as the disputes get more complex and the parties involved get more acrimonious towards one another.  It is a priority when reviewing the franchise agreement to determine whether the recovery of attorney fees is addressed in the agreement, and if so, who has the right to recover such fees and how.  There are several different methods by which franchisors address the recovery of attorney fees.  The most popular method for recovering attorney fees is through the use of a “prevailing party” clause, which enables the winner of a lawsuit or arbitration to collect its attorneys’ fees from the losing party, provided the judge or arbitrator chooses to enforce such language.  This type of clause is popular with franchisors who believe it is useful as a deterrent to franchisees who may otherwise attempt to bring questionable actions against the franchisor.  Other franchisors choose the opposite route and simply state that either party to a dispute is responsible to pay its own attorney fees and costs.  A third type of clause is the one-sided franchisor attorney fees clause, which states that if the franchisor is forced to bring an action to enforce its rights under the agreement, or is forced to defend itself from an action brought by a franchisee, the franchisor is entitled to recover its fees as long as it prevails in the action.  This language gives the franchisor the best of the prevailing party language without having to share the benefit with a franchisee.   This one-sided type of clause is frowned upon by some courts due to the lack of mutuality between the parties.  However, rather than rely on a court to strike the language down, it is recommended that a franchisee’s attorney look to change this language to make it mutual for both parties at the outset.

• Recovery of Attorney Fees. The issue of the recovery of attorney fees spent by either party when a dispute arises between a franchisor and franchisee is a topic that must be looked at carefully when reviewing a franchise agreement.  Fees paid to attorneys are costly in even the simplest of matters, and such fees can escalate dramatically as the disputes get more complex and the parties involved get more acrimonious towards one another.  It is a priority when reviewing the franchise agreement to determine whether the recovery of attorney fees is addressed in the agreement, and if so, who has the right to recover such fees and how.  There are several different methods by which franchisors address the recovery of attorney fees.  The most popular method for recovering attorney fees is through the use of a “prevailing party” clause, which enables the winner of a lawsuit or arbitration to collect its attorneys’ fees from the losing party, provided the judge or arbitrator chooses to enforce such language.  This type of clause is popular with franchisors who believe it is useful as a deterrent to franchisees who may otherwise attempt to bring questionable actions against the franchisor.  Other franchisors choose the opposite route and simply state that either party to a dispute is responsible to pay its own attorney fees and costs.  A third type of clause is the one-sided franchisor attorney fees clause, which states that if the franchisor is forced to bring an action to enforce its rights under the agreement, or is forced to defend itself from an action brought by a franchisee, the franchisor is entitled to recover its fees as long as it prevails in the action.  This language gives the franchisor the best of the prevailing party language without having to share the benefit with a franchisee.   This one-sided type of clause is frowned upon by some courts due to the lack of mutuality between the parties.  However, rather than rely on a court to strike the language down, it is recommended that a franchisee’s attorney look to change this language to make it mutual for both parties at the outset.

• Territory. Some franchise systems grant franchisees “exclusive” territories, meaning that these franchisees are protected from competition from other franchisees, and in many respects from the franchisor as well, inside this designated territory.  Though it depends on the industry, many franchisees view a protected territory as a must.  The franchisee believes this market protection will allow its business to flourish, and an agreement that does not contain a protected exclusive area will cause the franchised business to fail.  There are several opinions on either side of this argument but hardly an exact answer.  As an attorney preparing to advise your franchise client, you must review the franchise agreement in order to understand what the franchisor is offering in the way of territories.  While doing so you must keep the following questions in mind:  Does the franchisee understand that even with a protected territory, he will still most likely be competing against several, if not dozens, of competitors from other brands inside an exclusive franchise territory?  How does the franchisee view the theory of market saturation that the more of a particular brand, product, or service a customer sees, the more popular and acceptable the brand becomes?   Given the choice, would the franchise client prefer to be a franchisee of a system that grants enormous exclusive territories to each franchisee, but with small number of total franchisees overall?  Or would the client prefer a franchise system that grants smaller or even no territories, but where the number of franchisees, and thus the number of outlets at which the product or service is available, is much greater?    In conjunction with the idea of exclusive territories, make sure to pay attention to the language of the franchise agreement discussing the franchisee’s right to advertise and sell products and services in areas located outside the franchisee’s territory that are not owned by other franchisees of the system.  Just as important, also pay attention to any language that reserves to the franchisor the right to compete with the franchisee inside the franchisee’s territory, especially when it comes to the sales of products over the internet.

Conclusion: As mentioned above, the above tips address only some of the issues that you should be aware of when reviewing a franchise agreement.  A diligent attorney reviewing a franchise agreement will often find several other issues that are material to the prospect’s decision to purchase a franchise.  In addition, please note that this paper does not discuss registration or disclosure issues in the state of Maryland or elsewhere.  The Maryland Franchise Registration and Disclosure Law requires  each franchisor to register its FDD with the Securities Division of the Maryland Attorney General’s Office prior to making an offer of sale of a franchise in the state of Maryland or to a Maryland resident.  In addition, the revised FTC Franchise Rule mandates that 14 days pass between the day a prospect is given an FDD and the day a franchise agreement is executed and/or a prospect pays money to a franchisor.  In the event you have a question regarding a franchise registration or disclosure issue, consult an experienced franchise attorney.

Need a Franchise Attorney? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com