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Excellent Franchise Article from the Gazette

Tuesday, November 30th, 2010

For those of you interested in franchising, see the below link from the Gazette newspaper. It is a recent article on the state of franchising in Maryland, specifically, how local restaurant franchise chains like California Tortilla, Buffalo Wings & Beer, and Wings to Go are contemplating expansion due to a rebounding economy.

http://www.gazette.net/stories/11252010/businew172254_32545.php

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How Does a Franchisor Prove Damages in Litigation Against a Franchisee?

Friday, July 9th, 2010

In representing franchisor clients against defaulting franchisees, it is imperative to give adequate thought to how the franchisor is going to prove its damages that resulted from a franchisee’s breach of the franchise agreement. When confronted with this issue, I most often utilize a financially competent representative of the franchisor to testify with regard to that amount of monetary damage suffered by the franchisor. The franchisor’s representative must be able to prove the damage by evaluating the franchisee’s financial statements, including revenues and/or profits, expenses, and royalties paid to the franchisor, and then determine what sums the franchisor would have earned either during and/or after the franchise term had it not been for the franchisee’s breach.

In order to testify convincingly and thoroughly, the franchisor’s representative must be able to analyze the franchisee’s financial numbers and draw a conclusion from such numbers. Therefore, a chief financial officer of a small franchisor, or an auditor or accountant of a larger franchisor, is an ideal representative in these instances, provided that the representative has been with the company long enough to be able to testify knowledgeably with regard to the details of the franchisor’s system.

Generally, a well-prepared franchisor representative will be permitted to testify as to the value or the projected profits of a franchised business provided the representative has a sufficient foundation for the analysis and opinion, including particular knowledge of the financial issues presented by virtue or his or her position in the franchisor company. This simply means that a franchisor representative may opine on the issue of lost profits where they know the franchisor and franchisee’s business and financial system intimately, and have the professional ability to analyze the franchisee’s financial statements.

To see how a franchisor SHOULD NOT approach the issue of proving its damages against a franchisee, see Lifewise Master Funding v. Telebank, 374 F.3d 917 (10th Cir. 2004), which in essence holds that a company’s witness as to damages must have personal knowledge of all items factored into his opinion in order for the opinion to be admissible. The court concluded that a business owner or executive may give “a straightforward opinion as to lost profits using conventional methods based on [the company’s] actual operating history.” However, because in this case the witness lacked personal knowledge of the factors used in the damages analysis, the opinion was inadmissible.

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Must Read: The Federal Trade Commission (FTC) Franchise Consumer Guide

Monday, June 21st, 2010

Below please find a link to the FTC “Buying a Franchise: A Consumer Guide,” which is a must read for all prospective franchisees. Here is the link: http://www.ftc.gov/bcp/edu/pubs/consumer/invest/inv05.shtm.

While the information contained in the FTC Franchise Guide is no doubt basic to a franchise professional or franchisor representative, the Franchise Guide unquestionably provides useful information to prospective franchisees who often times know very little about the franchise sales process, federal and state franchise registration and disclosure laws, or the franchisor/franchisee relationship. Without a doubt it is an excellent foundation for a prospective franchisee’s due diligence.

Some topics addressed in the FTC Guide are: where to look for franchise opportunities, what makes up the Franchise Disclosure Document (FDD), to be aware of unauthorized financial performance representations/earnings claims from a franchisor if not found in the FDD, and where to obtain additional sources of information during the due diligence phase, including obtaining the assistance of experienced franchise counsel.

I strongly encourage any prospective franchisee reading this blog to click on the above link and download a copy of the FTC Guide.

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Five Questions Every Franchise Owner Should Ask

Monday, November 2nd, 2009
Questions

Questions

Every franchisee, before purchasing a franchise, receives from the franchisor a Federal Disclosure Document (“FDD”), which includes the franchise agreement that will eventually be executed by the franchisor and franchisee. This article contains five questions every franchisee should ask when reviewing a franchise agreement.

  1. Minimum Royalty Fees. Does the franchise agreement require the payment by the franchisee of minimum monthly or yearly royalty fees, regardless of the amount of actual revenue the franchisee generates? At the end of a month or year, a franchisee may have to write the franchisor a check to cover the minimum franchise fee if the royalty fee paid by the franchisee fell short of the minimum royalty fee called for in the franchise agreement. This is certainly a fact that all franchisees must be aware of prior to execution of the franchise agreement.
  2. Termination by Franchisee. Does the franchise agreement allow the franchisee to terminate the agreement without cause, or upon a material breach of the agreement by the franchisor? A franchisee’s right to terminate the franchise agreement is arguably the most important right granted to a franchisee, since a franchisee may be able to terminate an agreement if its business gets into financial trouble or if the franchisor fails to comply with its obligations under the franchise agreement. The right to terminate will also permit a distressed franchisee to avoid the fees and other obligations owed to the franchisor before disaster strikes.
  3. Post-Termination Non-Competition Covenant. Does the franchise agreement contain a post-termination covenant not-to-compete, and if so, is it reasonable? A post-termination covenant not-to-compete is the franchisor’s attempt to prohibit a franchisee from competing with the franchisor during the period immediately following termination or expiration of the franchise agreement. Courts across the country have held that in order to be enforceable, a non-competition covenant must be reasonable in scope and duration. In other words, a non-compete that prohibits competition for 10 years, or across the entire United States, will most likely be held unreasonable and therefore unenforceable. A franchisee must pay careful attention to the language of a non-compete prior to signing.
  4. Dispute Resolution. Carefully review the franchise agreement to determine exactly how and where disputes with the franchisor must be resolved. With regard to how, some franchise agreements call for arbitration, others litigation, and some a mix of both procedures. With regard to where, most franchise agreements call for dispute resolution in the home jurisdiction of the franchisor. Some but not all state laws allow the franchisee to sue or arbitrate in its home state, regardless of what the franchise agreement says. Because of the added expense a franchisee must bear in the event of a dispute being held in a place other than the franchisee’s home state, a franchisee whose state does not add such a protection must be aware of this fact and possibly add language allowing the franchisee to sue or arbitrate in its home state.
  5. Territory. Some franchise agreements grant a franchisee an “exclusive” territory. This means that the franchisee is protected from competition from other franchisees and the franchisor as well inside this exclusive territory. Most franchisees view a protected territory as a must, believing that such market protection will allow the franchisee’s business to flourish. With that in mind, read the “Territory” section carefully in order to determine exactly what is being granted. Can the franchisor compete with the franchisee in the territory? Are there development or sales quotas that must be met in order to retain exclusive territory status? Can supermarkets or other wholesalers compete with the franchisee? These and other questions must be answered to gain a complete understanding of the issue.

Interested in Learning More? Have  Questions?

Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

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