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Monday, February 24th, 2020
The Payment Requirement required for a license to be deemed a franchise:
The last of the three definitional elements of a franchise covered by the FTC Franchise Rule is that purchasers of the business arrangement must be required to pay to the franchisor as a condition of obtaining a franchise or starting operations, a sum of at least $500 at any time prior to or within the first six months of the commencement of operations of the franchised business.
Here is what the FTC Franchise Rule states on the “Required Payment” element, directly from the FTC website at http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.
As to what constitutes a payment, the term “payment” is intended to be read broadly, “capturing all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to associate with the franchisor, market its goods or services, and begin operation of the business. Often, required payments go beyond a simple franchisee fee, entailing other payments that the franchisee must pay to the franchisor or an affiliate by contract – including the franchise agreement or any companion contract. Required payments may include: initial franchise fee, rent, advertising assistance, equipment and supplies (including such purchases from third parties if the franchisor or its affiliate receives payment as a result of the purchase), training, security deposits, escrow deposits, non-refundable bookkeeping charges, promotional literature, equipment rental and continuing royalties on sales. Payments which, by practical necessity, a franchisee must make to the franchisor or affiliate also count toward the required payment. A common example of a payment made by practical necessity is a charge for equipment that can only be obtained from the franchisor or its affiliate and no other source.”
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Monday, February 24th, 2020
Here is what the FTC Franchise Rule states on the “Significant Control or Assistance” element of a franchise relationship, directly from the FTC website at http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf.
“The FTC Franchise Rule covers business arrangements where the franchisor will exert or has the 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.”
The relevant question is when does such control become significant.
“The more franchisees reasonably rely upon the franchisor’s control or assistance, the more likely the control or assistance will be considered “significant.” Franchisees’ reliance is likely to be great when they are relatively inexperienced in the business being offered for sale or when they undertake a large financial risk. Similarly, franchisees are likely to reasonably rely on the franchisor’s control or assistance if the control or assistance is unique to that specific franchisor, as opposed to a typical practice employed by all businesses in the same industry.
Further, to be deemed “significant,” the control or assistance must relate to the franchisee’s overall method of operation – not a small part of the franchisee’s business. Control or assistance involving the sale of a specific product that has, at most, a marginal effect on a franchisee’s method of operating the overall business will not be considered in determining whether control or assistance is “significant.”
For the sake of the Rule, significant types of control include:
-site approval for unestablished businesses;
-site design or appearance requirements;
-hours of operation;
-production techniques;
-accounting practices;
-personnel policies;
-promotional campaigns requiring franchisee participation or financial contribution;
-restrictions on customers; and
-locale or area of operation.
Significant types of assistance include:
-formal sales, repair, or business training programs;
-establishing accounting systems;
-furnishing management, marketing, or personnel advice;
-selecting site locations;
-furnishing systemwide networks and website; and
-furnishing a detailed operating manual.
The following activities will not constitute significant control or assistance:
-Promotional activities, in the absence of additional forms of assistance; [This includes furnishing a distributor with point-of sale advertising displays, sales kits, product samples, and other promotional materials intended to help the distributor in making sales. It also includes providing advertising in such media as radio and television, whether provided solely by the franchisor or on a cooperative basis with franchisees.
-trademark controls designed solely to protect the trademark owner’s legal ownership rights in the mark under state or federal trademark laws (such as display of the mark or right of inspection);
-health or safety restrictions required by federal or state law or regulations;
-agreements between a bank credit interchange organization and retailers or member banks for the provision of credit cards or credit services; and
-assisting distributors in obtaining financing to be able to transact business.”
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Tags: buying a franchise, buying a franchised business, franchise agreement, Franchise Disclosure Document, franchise dispute, franchise law, franchise litigation, FTC Franchise Rule, Maryland franchise registration, selling a franchise
Monday, February 24th, 2020
Often times I have prospective franchisor clients, that is, clients who believe they have a business concept that can be expanded possibly through licensing or franchising, ask me to explain the differences between licensing and franchising from a legal perspective. Inevitably, the conversation turns to an explanation from the client as to why the concept is not truly a franchise after all. As I have explained on this blog previously, while there certainly are relationships that are true licenses, more often than not, many licensing relationships are indeed nothing more than disguised franchises.
Here is what the FTC Franchise Rule states on the issue, directly from the FTC website found at http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf. The FTC Franchise Rule covers the offer and sale of franchises. As under the original Rule, a commercial business arrangement is a “franchise” if it satisfies three definitional elements.
“Specifically, the franchisor must: (1) promise to provide a trademark or other commercial symbol; (2) promise to exercise significant control or provide significant assistance in the operation of the business; and (3) require a minimum payment of at least $500 during the first six months of operations.”
Be aware that the name given to the business arrangement is irrelevant in determining whether it is covered by the amended Rule.
“With regard to the trademark element, a franchise entails 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.” The term “trademark” is intended to be read broadly to cover not only trademarks, but any service mark, trade name, or other advertising or commercial symbol. This is generally referred to as the “trademark” or “mark” element.
The franchisor need not own the mark itself, but at the very least must have the right to license the use of the mark to others. Indeed, the right to use the franchisor’s mark in the operation of the business – either by selling goods or performing services identified with the mark or by using the mark, in whole or in part, in the business’ name – is an integral part of franchising.
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Wednesday, October 31st, 2018
In its simplest form, “Franchising” is the license of the franchisor’s business or operating system and its trademark to a franchisee for some period of time, in exchange for a fee. The fee usually takes two forms: an initial franchise fee paid up front and an ongoing monthly royalties paid during the life of the franchise.
A common mistake of businesses wishing to expand in the U.S. is their attempts to avoid U.S. state and federal franchise laws that may apply. In other words, these would-be franchisors attempt to avoid the disclosure requirements applicable to all franchisors in order to save on legal fees in the short-term. However, this mindset may lead to substantial problems down the road. These businesses oftentimes try to hold themselves out as “licensors” instead, and in doing so fail to provide to their “licensees” the franchise disclosure document (“FDD”) required of franchisors.
Although the preparation and annual maintenance of an FDD may not be cheap, the short-term legal costs are money well spent compared to the financial and other costs associated with lawsuits from disgruntled licensees, or even worse, investigations by state franchise administrators.
For example, a company’s failure to abide by state and federal franchise laws that require franchisors to disclose to the prospect in an FDD all material facts relating to the franchise system to prospective franchisees, and to register that FDD in certain states, can be catastrophic. In addition to potentially giving a licensee/franchisee the right to rescind its agreement, other penalties include repaying back to the licensee/franchisee of all amounts paid to the company. In addition, fines and/or penalties payable to the state may also be required. Not to mention the legal fees that accrue with dealing with all of these potential issues.
The message is simple – don’t trade long-term security for short-term savings. Have an experienced franchise lawyer advise you on the requirements of franchising at the outset.
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Tags: Buy a Franchise, buying a franchise, buying a franchised business, FDD, federal franchise law, franchise agreement, franchise arbitration, franchise attorney, franchise concept, Franchise Disclosure Document, franchise dispute, franchise law, franchise law firm, franchise lawyer, franchise litigation, franchise purchase, franchise your business, FTC Franchise Rule, maryland business, maryland business law, Maryland franchise registration, sell your franchised business, selling a franchise, small business attorney, small business lawyer
Monday, October 29th, 2018
When reviewing a commercial lease on behalf of a business tenant client, my goal is twofold: to obtain the most favorable terms possible for my client in the short term, while also protecting the client’s long term interests by limiting risk and personal exposure in the event of an unforeseen event that hurts or derails the business.
These are some of the issues I look to in my review:
- Make sure all lease terms mirror the terms found in the Letter of Intent executed by my client and the landlord.
- Attempt to obtain an abatement of rent for a period of a minimum of 60 days, to as much as 180 days if possible. Regardless of the rent abatement, at minimum we also want to make sure that the rent commencement date, which is the first date rent is due, is pushed far enough out to make sure we are open and operating at that time.
- Attempt to obtain tenant improvement money, which is money paid by the landlord to my tenant client and which the tenant must use to build out and renovate the premises. The amount of any TI money can fluctuate dramatically depending on how much work the space needs, and the business of the tenant.
- Understand whether we are dealing with a gross (“all-in”) lease where the tenant makes one monthly payment including everything due, or a triple net lease (“NNN”) where rent and CAM fees and taxes and insurance are broken out separately, or a hybrid of the two? Oftentimes a client can be confused about what the monthly payments actually are and not understand terms like additional rent, operating costs, and CAM fees.
- What about the HVAC unit, which in many instances can be a costly repair or replacement in the event the tenant takes on the responsibility to maintain and replace the HVAC if it breaks down. I recommend an inspection of the HVAC prior to signing the lease, as well as some warranty period where the landlord guarantees the operation of the HVAC.
- Is the tenant free to sublease a portion of the premises without landlord interference?
- Is there a liquidated damages clause in the event the lease is terminated early? This would mean that the tenant is on the hook for the entire remaining term for rent and all other expenses due and owing in the event of default.
- If this is a retail establishment, does my client tenant have exclusivity? In other words, is the landlord prohibited from permitting the operation of another wings place in the same plaza that my client who sells wings is in?
- Finally, there is most likely a personal guaranty. Do spouses and even silent partners have to sign it? Is there a cap on it or is it unlimited? I normally try to negotiate some type of cap on the guaranty. Six months to one year’s worth of rent is oftentimes a manageable “out” for a tenant looking to get out from under a lease for a dying business.
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Tags: business formation, business law, business lawsuit, business litigation, business start up, Buy a Franchise, commercial lease, commercial tenant, corporate litigation, Franchise Disclosure Document, franchise dispute, franchise law, franchise lawyer, franchise your business, lease for franchised business, maryland breach of contract, maryland business, maryland business law, retail lease, reviewing a lease, sell your franchised business, selling a franchise, small business attorney, small business lawyer
Monday, October 29th, 2018
When a franchisee client asks me to review a franchise agreement prior to signing, I review it with the mindset that if the franchisee’s business performs well, the franchisee will be happy with the franchise relationship and the agreement he or she signed, BUT if the franchised business ultimately fails, it is my job to protect the franchisee at the outset in the strongest way possible. Therefore I review a franchise agreement focusing on how best to protect my franchisee client’s personal assets in the event the franchised business fails. Here are some of the things I look for in the franchise agreement:
1. does the franchisee have an exclusive territory?
2. may the franchisor alter the franchisee’s territory during the term of the agreement?
3. may the franchisee advertise or market for clients outside the designated territory in areas that are not owned by other existing franchisees?
4. what are the franchisee’s renewal rights? Attempt to limit what terms of the agreement the franchisor may change on renewal.
5. what social media presence is the franchisee permitted to maintain?
6. while there is most likely a personal guaranty, who is required to sign it? ie. spouses and/or passive investors?
7. is there a cap on the personal guaranty of a reasonable amount that the franchisee and franchisor are comfortable with, or is it an unlimited guaranty? When negotiating on behalf of a franchisee, I attempt to limit the cap with the mindset that this amount is the franchisee’s buyout amount in the event the worst occurs and the franchisee has to stop operating.
8. is there a right of first refusal of the franchisor in the event the franchisee wishes to sell the business, and what are its terms?
9. is there a unilateral right of the franchisee to terminate the agreement? There are rare, but franchisee counsel should try to push for such a provision anyhow.
10. are any of the franchisor’s rights to terminate the agreement out of the ordinary or particularly onerous?
11. is there a liquidated damages clause in the event the franchise agreement is terminated?
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Tags: business law, business lawsuit, Buy a Franchise, buying a franchise, FDD, federal franchise law, franchise agreement, franchise agreement review, franchise arbitration, franchise attorney, franchise concept, Franchise Disclosure Document, franchise dispute, franchise future royalties, franchise law, franchise law firm, franchise lawyer, franchise litigation, franchise your business, FTC Franchise Rule, maryland business, maryland business law, Maryland franchise registration, sell your franchised business, small business attorney, small business lawyer
Friday, October 26th, 2018
Below is a sample franchisee questionnaire that I recommend be included as an exhibit in each FDD I prepare. In the event of a problem with the franchisee in the future, it is a powerful document for a franchisor to have, where the franchisee essentially stated at the time of sale that everything told by the franchisor to the franchisee during the sales process was included in the FDD. In other words, no oral promises, representations or statements were made by the franchisor that did not mirror the FDD.
[SAMPLE]
FRANCHISEE DISCLOSURE QUESTIONNAIRE
As you know, _____________ “Franchisor” and you are preparing to enter into a Franchise Agreement for the operation of a Franchised Business. In this Franchisee Disclosure Questionnaire, Franchisor will be referred to as “we” or “us.” The purpose of this Questionnaire is to determine whether any statements or promises were made to you that we did not authorize and that may be untrue, inaccurate or misleading. Please review each of the following questions carefully and provide honest and complete responses to each question.
1. Have you received and personally reviewed the Franchisor’s Franchise Agreement and each exhibit, addendum and schedule attached to it?
Yes No
2. Do you understand all of the information contained in the Franchise Agreement and each exhibit and schedule attached to it?
Yes No
If “No”, what parts of the Franchise Agreement do you not understand? (Attach additional pages, if necessary.)
3. Have you received and personally reviewed our Franchise Disclosure Document we provided to you?
Yes No
4. Do you understand all of the information contained in the Franchise Disclosure Document?
Yes No
If “No”, what parts of the Franchise Disclosure Document do you not understand? (Attach additional pages, if necessary.)
5. Have you discussed the benefits and risks of operating a Franchised Business with an attorney, accountant or other professional advisor and do you understand those risks?
Yes No
6. Do you understand that the success or failure of your business will depend in large part upon your skills and abilities, competition from other businesses, interest rates, inflation, labor and supply costs, lease terms and other economic and business factors?
Yes No
7. Has any employee or other person speaking on our behalf made any statement or promise concerning the revenues, profits or operating costs of a Franchised Business that we or our franchisees operate?
Yes No
8. Has any employee or other person speaking on our behalf made any statement or promise concerning a Franchised Business that is contrary to, or different from, the information contained in the Franchise Disclosure Document?
Yes No
9. Has any employee or other person speaking on our behalf made any statement or promise concerning the likelihood of success that you should or might expect to achieve from operating a Franchised Business?
Yes No
10. Has any employee or other person speaking on our behalf made any statement, promise or agreement concerning the advertising, marketing, training, support service or assistance that we will furnish to you that is contrary to, or different from, the information contained in the Franchise Disclosure Document?
Yes No
11. If you have answered “Yes” to any of questions seven (7) through ten (10), please provide a full explanation of your answer in the following blank lines. (Attach additional pages, if necessary, and refer to them below.) If you have answered “No” to each of such questions, please leave the following lines blank.
12. Do you understand that in all dealings with you, our officers, directors, employees and agents act only in a representative capacity and not in an individual capacity and such dealings are solely between you and us?
Yes No
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Wednesday, March 7th, 2012
N.Y. CLS Gen. Bus. Law § 684(3)(c) of the New York Franchise Act provides an exemption to franchisors from the general registration requirements of the Act for what is deemed an “isolated franchise sale.” Under this exemption, no franchisor is required to register its FDD/UFOC in New York where:
(1) “The transaction is pursuant to an offer directed by the franchisor to not more than two persons . . .
(2) if the franchisor does not grant the franchisee the right to offer franchises to others,
(3) a commission or other remuneration is not paid directly or indirectly for soliciting a prospective franchisee in this state, and
(4) the franchisor is domiciled in this state or has filed with the department of law its consent to service of process on the form prescribed by the department.” N.Y. CLS Gen. Bus. Law § 684(3)(c).
New York courts have interpreted § 684(3)(c) to mean in essence that the sale of the first franchise unit is exempt from registration if the unit was only offered to a maximum of two people (See BMW Co., Inc. et al. v Workbench Inc. et al. (No. 86 CIV 4200 1988 WL 45594 (S.D.N.Y. April 29, 1988); CCH Business Franchise Guide ¶ 9104, at 18,850).
This exemption is well settled law in New York: “This isolated franchise sale exemption is potentially useful for new U.S. franchisors or foreign franchisors that are new to the United States. It permits them to sell one franchise in New York without having to register a disclosure document with the state.” LJN, Law Journal Newsletters, Franchising Business & Law Alert, Volume 18, Number 4, January 2012, by George J. Eydt.
Further, in a recent New York case, Burgers Bar Five Towns, LLC v. Burger Holdings Corp., 897 N.Y.S. 2d 502 (2d Dep’t 2010), again upheld the existence of the isolated franchise sale exemption under § 684(3)(c) provided the franchisor is able to meet the four prongs of the statute. In reversing a summary judgment that had been entered by the trial court against a franchisor that had failed to register its UFOC/FDD, the appeals court stated that the matter be remanded back to the trial court to determine whether the franchisor indeed met the exemption factors. Further, the appeals court held that even if the exemption was not available, the franchisee had to prove that it sustained damages as a result of the failure to register and that the failure to register was willful.
There is some support for the proposition that not only does § 684(3)(c) exempt a franchisor from the registration requirement of the New York Franchise Act for the isolated franchise sale, the franchisor is also exempted from the disclosure requirements of the Act.
§ 683(8) of the New York Franchise Law provides that: “A franchise which is subject to registration under this article shall not be sold without first providing to the prospective franchisee, a copy of the offering prospectus, together with a copy of all proposed agreements relating to the sale of the franchise.”
No New York Court has yet delved this deeply into the disclosure exemption question. The few Courts that have addressed the issue, BMW Co., supra, The National Survival Game of New York, Inc., supra, and Burgers Bar Five Towns, LLC, supra., have either failed to examine the relationship between the two statutes, or resolved the merits of their cases on other grounds.
Nevertheless, a franchisor faced with a registration and disclosure violation in New York for an isolated franchise sale would be smart to argue that both registration and disclosure are exempted.
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Tags: breach of contract lawsuit, business law, business lawsuit, business litigation, Buy a Franchise, buying a franchise, buying a franchised business, corporate litigation, federal franchise law, franchise agreement, franchise arbitration, franchise attorney, Franchise Disclosure Document, franchise dispute, franchise future royalties, franchise law, franchise lawyer, franchise litigation, franchise your business, FTC Franchise Rule, Isolated Sales Exemption, New York Franchise Act, New York Franchise Exemption, new york franchise registration, sell your franchised business, selling a franchise, small business attorney, small business lawyer
Wednesday, August 24th, 2011
The New York Franchise Law defines a franchise fee as any fee or charge that a franchisee or subfranchisor is required to pay or agrees to pay directly or indirectly for the right to enter into a business under a franchise agreement, or otherwise sell, resell or distribute goods, services, or franchises under such an agreement, including, but not limited to, any such payment for goods or services. The NY Franchise Law also contains several exclusions to the franchise fee definition, but no exemptions pertain to the purchase/sale of equipment. Rather, the exemptions to the NY law are nearly identical to the Maryland law.
The dollar threshold for a franchise fee under NY law is $500.
Like Maryland, the scope of the New York Franchise Law franchise fee definition is construed broadly. For example, a one-time fee or a monthly payment during a four-year period, which was characterized as a lease, was ruled a franchise fee.
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Tags: Buy a Franchise, buying a franchise, buying a franchised business, federal franchise law, franchise, franchise agreement, franchise arbitration, franchise attorney, franchise concept, Franchise Disclosure Document, franchise dispute, franchise fraud, franchise future royalties, franchise law, franchise law firm, franchise lawyer, franchise litigation, franchise purchase, franchise renewal, franchise transfer, franchise your business, franchisor dispute, FTC Franchise Rule, maryland franchise disclosure, Maryland franchise registration, New York Franchise Act, new york franchise disclosure, new york franchise law, new york franchise registration, selling a franchise
Wednesday, August 24th, 2011
The Maryland Franchise Registration and Disclosure Law (“MD Franchise Law”), Section 14-201, defines a franchise as “an oral or written agreement in which: 1) a purchaser is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan or system prescribed in substantial part by the franchisor; ii) the operation of the business under the marketing plan or system is associated substantially with the trademark, service mark, trade name, logotype, advertising or other commercial symbol that designates the franchisor or its affiliate; and iii) the purchaser must pay, directly or indirectly, a franchise fee.”
Section 14-201 of the MD Franchise Law goes on to define a franchise fee as a charge or payment that a franchisee or subfranchisor is required or agrees to pay for the right to enter into a business under a franchise agreement. The purchase of equipment is included in the definition of a franchise fee. Section 14-201 contains several exclusions from the definition of a franchise fee, but no exclusions for the purchase of equipment by a franchisee/licensee.
Many of the Maryland exclusions are limited to products-oriented licensors, as for the sale of goods at wholesale prices. Other exemptions are for the sale or lease of real property for use in the business, and any amounts paid for sales materials used in making sales, sold at no profit by the licensor. An additional exemption exists for the sale, at fair market value, of supplies or fixtures that are necessary in order to operate the business.
Section 14-203 of the MD Franchise Law sets the threshold amount for the franchise fee at any amount exceeding $100.
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Tags: Buy a Franchise, buying a franchise, buying a franchised business, federal franchise law, franchise, franchise agreement, franchise arbitration, franchise attorney, Franchise Disclosure Document, franchise dispute, franchise fraud, franchise future royalties, franchise law, franchise law firm, franchise lawyer, franchise litigation, franchise purchase, franchise renewal, franchise transfer, franchise your business, franchising or licensing, FTC Franchise Rule, licensing v. franchising, maryland franchise disclosure, Maryland franchise law, Maryland franchise registration, maryland fraud law, New York Franchise Act, selling a franchise
Raymond McKenzie is a corporate and franchise attorney in the Washington, D.C. metropolitan area.
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