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Hidden/Disguised Franchises – part 3

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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Hidden/Disguised Franchises – part 2

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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Hidden / Disguised Franchises – part 1

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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Play By the Franchise Rules

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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Reviewing a Commercial Lease

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:

  1. Make sure all lease terms mirror the terms found in the Letter of Intent executed by my client and the landlord.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. Is the tenant free to sublease a portion of the premises without landlord interference?
  7. 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.
  8. 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?
  9. 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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Reviewing a Franchise Agreement for a Franchisee Client

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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FDD – Sample Franchise Disclosure Questionnaire

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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Mandatory Maryland Franchise Agreement Amendment

Friday, October 26th, 2018

Pursuant to the Maryland Franchise Registration and Disclosure Law, below are the mandatory amendments that must be made to a franchise agreement contained in a Franchise Disclosure Document attempting to be registered in the state of Maryland.  There are additional changes that must also be made to the disclosure portion of the Franchise Disclosure Document.

Maryland Franchise Agreement Amendment

In recognition of the requirements of the Maryland Franchise Registration and Disclosure Law, the parties to the attached Franchise Agreement (the “Agreement”) agree as follows:

1.     “execute a general release, in a form prescribed by Franchisor, of any and all claims against Franchisor and its subsidiaries and affiliates, and their respective officers, directors, agents, and employees.  Notwithstanding the above, pursuant to COMAR 02.02.08.16L, the general release required as a condition of renewal, sale, and/or assignment/transfer shall not apply to any liability under the Maryland Franchise Registration and Disclosure Law.”

2.     “the Franchisee’s execution of a general release of the Franchisor, in a form satisfactory to Franchisor, of any and all claims against Franchisor and its affiliates, successors, and assigns, and their respective directors, officers, shareholders, partners, agents, representatives, servants, and employees in their corporate and individual capacities, including, without limitation, claims arising under this Agreement, any other agreement between Franchisee and Franchisor or its affiliates, and federal, state, and local laws and rules.  Notwithstanding the above, pursuant to COMAR 02.02.08.16L, the general release required as a condition of renewal, sale, and/or assignment/transfer shall not apply to any liability under the Maryland Franchise Registration and Disclosure Law.”

3.     “Notwithstanding the above, the provision in the Franchise Agreement which provides for termination upon bankruptcy of the franchisee may not be enforceable under federal bankruptcy law (11 U.S.C. Section 101 et seq.).”

4.     “Notwithstanding the above, the parties agree that only with respect to claims arising under the Maryland Franchise Registration and Disclosure Law, Franchisee may bring such claims in any federal or state court in the state of Maryland.”

5.      “Limitations of Claims.  ANY AND ALL CLAIMS AND ACTIONS ARISING OUT OF OR RELATING TO THIS AGREEMENT, THE RELATIONSHIP OF FRANCHISEE AND FRANCHISOR, OR FRANCHISEE’S OPERATION OF THE FRANCHISED BUSINESS, INCLUDING ANY PROCEEDING, OR ANY CLAIM IN ANY PROCEEDING (INCLUDING ANY DEFENSES AND ANY CLAIMS OF SET-OFF OR RECOUPMENT), MUST BE BROUGHT OR ASSERTED BEFORE THE EXPIRATION OF THE EARLIER OF (A) THE TIME PERIOD FROM BRINGING AN ACTION UNDER ANY APPLICABLE STATE OR FEDERAL STATUTE OF LIMITATIONS; (B) ONE (1) YEAR FROM THE DATE UPON WHICH A PARTY DISCOVERED, OR SHOULD HAVE DISCOVERED, THE FACTS GIVING RISE TO AN ALLEGED CLAIM; OR (C) TWO (2) YEARS AFTER THE FIRST ACT OR OMISSION GIVING RISE TO AN ALLEGED CLAIM; OR IT IS EXPRESSLY ACKNOWLEDGED AND AGREED BY ALL PARTIES THAT SUCH CLAIMS OR ACTIONS SHALL BE IRREVOCABLY BARRED; EXCEPT THAT ANY AND ALL CLAIMS ARISING UNDER THE MARYLAND FRANCHISE REGISTRATION AND DISCLOSURE LAW (MD. CODE BUS. REG. §§ 14-201 THROUGH 14-233) SHALL BE COMMENCED WITHIN THREE (3) YEARS FROM THE GRANT OF THE FRANCHISE. CLAIMS OF FRANCHISOR ATTRIBUTABLE TO UNDERREPORTING OF SALES, AND CLAIMS OF THE PARTIES FOR FAILURE TO PAY MONIES OWED AND/OR INDEMNIFICATION SHALL BE SUBJECT ONLY TO THE APPLICABLE STATE OR FEDERAL STATUTE OF LIMITATIONS.”

6.     “No Waiver.  The foregoing acknowledgments are not intended to nor shall they act as a release, estoppel or waiver of any liability incurred under the Maryland Franchise Registration and Disclosure Law.”

7.     Each provision of this amendment shall be effective only to the extent, with respect to such provision, that the jurisdictional requirements of the Maryland Franchise Registration and Disclosure Law are met independently without reference to this amendment.

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Washington State Franchise Addendum

Friday, October 26th, 2018

This is the mandatory addendum that must be included in any Franchise Disclosure Document that a franchisor is attempting to register in the state of Washington.  No edits/changes may be made:

Washington Franchise Agreement Addendum

The state of Washington has a statute, RCW 19.100.180 which may supersede the franchise agreement in your relationship with the franchisor including the areas of termination and renewal of your franchise. There may also be court decisions which may supersede the franchise agreement in your relationship with the franchisor including the areas of termination and renewal of your franchise.

In any arbitration involving a franchise purchased in Washington, the arbitration site shall be either in the state of Washington, or in a place mutually agreed upon at the time of the arbitration, or as determined by the arbitrator.

In the event of a conflict of laws, the provisions of the Washington Franchise Investment Protection Act, Chapter 19.100 RCW shall prevail.

A release or waiver of rights executed by a franchisee shall not include rights under the Washington Franchise Investment Protection Act except when executed pursuant to a negotiated settlement after the agreement is in effect and where the parties are represented by independent counsel. Provisions such as those which unreasonably restrict or limit the statute of limitations period for claims under the Act, rights or remedies under the Act such as a right to a jury trial may not be enforceable.

Transfer fees are collectable to the extent that they reflect the franchisor’s reasonable estimated or actual costs in effecting a transfer.

The undersigned does hereby acknowledge receipt of this addendum.

Dated this _____ day of __________________ 20______.

 

 

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Collecting on a Judgment in Maryland – Post Judgment Interrogatories

Friday, October 26th, 2018

A common misconception that many business owners have about litigating a dispute is the belief that just because a party wins at trial, the money won in the judgment automatically is transferred to the winner.  Usually, that is far from the case.  While it is never easy to go to trial and win a money judgment against another party, sometimes winning is actually easier than collecting on the money judgment won.  A judgment is simply a piece of paper from the Court stating who won and who lost.  However, if the losing party is not financially ready and willing to pay you, a judgment holder has to be prepared to continue to work. Maryland law permits a judgment holder to take certain steps to collect.  One of these steps is the use of post-judgment interrogatories, which are questions the winner may ask of the losing party, known as the debtor, about the amount and location of his/her/its wages, assets, bank accounts and property.  Here is a sample of some of the questions I ask.  Once the amount and location of the debtor’s assets are revealed, an experienced collections attorney will be able to pursue the amounts you are owed.

  1. Provide the address and fair market value of all real estate owned by Defendant either individually or jointly with another person or entity.
  2. Provide Defendant’s federal and state income tax returns for the years x, y and z, including any Schedules thereto, whether such returns were filed individually or jointly.
  3. Detail Defendant’s net worth, including all such assets owned jointly.
  4. Provide the year, make, model, mileage, blue book value, and VIN number of all vehicles owned by Defendant.
  5. Detail the name and address of each financial institution where Defendant has an account, including the routing number and the account number for each.
  6. Detail the balances for each account detailed in your response to Interrogatory #5.
  7. Provide Defendant’s bank statements for each account specified in your response to Interrogatories #5 from x through the present.
  8. Detail all other assets owned by Defendant not yet mentioned and the fair market value for each.
  9. Detail whether Defendant has disposed of or transferred any asset within the last 180 days. If yes, give the name and address of each person or entity who received any asset and describe each asset.
  10. Detail any ownership interest Defendant has in any corporation, partnership, or limited liability company. In so doing, identify the name of the corporation, partnership, or limited liability company, the state of incorporation or organization, the amount or percentage of the ownership interest, and the fair market value of the ownership interest.
  11. For any corporation, partnership or limited liability company named in your response to Interrogatory #10, provide any shareholder, partnership or operating agreement to which Defendant is a party.
  12. Detail all income, wages, or other compensation of any kind received by Defendant within the last 180 days.

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