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Threshold for a Franchise Fee Under the FTC Rule Is $500 Through The First Six Months

Wednesday, August 24th, 2011

A licensing or other relationship where the trademark and system/significant control prongs of the FTC Franchise Rule are met is excluded from the scope of the franchise regulation if the total required payments by the franchisee before and during the 6-month period after the business opens do not exceed $500. 

The required fee element captures all sources of revenue paid by a licensee to a licensor for the license. The element is deliberately expansive, encompassing lump sum, installment, fixed, fluctuating, up-front, and periodic payments for goods or services, however denominated, whether direct, indirect, hidden, or refundable. 

To avoid the FTC Rule franchise fee requirement, it is possible for a licensor to defer required payments exceeding $500 for at least six months, and as a result, not be deemed a franchise under the FTC Rule and federal law.  This remains true even if the licensee signs a nonnegotiable, secured promissory note (with no acceleration clause) promising to pay the money after six months.

The deferment option is not all-encompassing however.  While the FTC Rule permits this deferment of payment option, this is applicable only in those states that do not have individual, state specific franchise laws, since in those states such license transactions are governed by the FTC Rule.  There are upwards of 15 states across the country, including Maryland, Virginia, New York, California, and Illinois, which do have specific franchise laws, and which do not grant this deferment option.  As a result, deferment is not an option in these states.  Have your franchise attorney check the franchise law of each individual state before proceeding.

 

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Vacating an Arbitration Award

Wednesday, August 17th, 2011

There are many reasons one can point to in order to explain how over the last several years arbitration has become less and less favored as a dispute resolution mechanism in the franchise arena.  One of the mean reasons that the arbitration bubble has burst is due to a lack of a valid and fair appeals process.  While it is common knowledge that a losing party in a state or federal court trial is permitted to appeal an unfavorable decision on a multitude of grounds, the same is hardly true in the arbitration process.  Rather, it is extremely difficult for most losing parties in an arbitration matter to come close to meeting the rigid criteria for vacating an arbitration award.    

For those arbitration matters resolved under the Federal Arbitration Act, the standard of review of an arbitration award under the Federal Arbitration Act provides for only four specific grounds for vacating an arbitration award, as follows:  i)  where the award was procured by corruption, fraud, or undue means; ii) where there was evident partiality or corruption in the arbitrators, or either of them; iii) where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy, or of any other misbehavior by which the rights of any party have been prejudiced; or, iv) where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.  In addition, most state arbitration statutes mirror the FAA in this area.

As a result of the rigid four categories stated above, it is extremely difficult to overturn an arbitration award except in the most egregious circumstances. A court is prohibited from vacating an arbitration award regardless of how vociferously the court may disagree with the reasoning behind the arbitrator’s decision.  Rather, parties that have been successful in appealing an arbitration award have for the most part been able to provide evidence to the court that either the arbitration committed fraud, misconduct or was biased, or the party has been able to prove that a procedural defect was committed thereby severely prejudging a party to the point the party was denied its fundamental rights of due process.

Unless an aggrieved party can show documented evidence in one of these two areas, a court is extremely unlikely to grant a motion to vacate an arbitration award.  It is for this reason, and others, that many franchisors in a variety of industries have turned away from arbitration and instead prefer to have their disputes heard by a state or federal court judge.

 

 

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Legal Requirements of an Existing Franchisee Sale of His or Her Outlet; Purchase of Additional Outlets; Extending the Term of an Existing Franchise?

Thursday, April 28th, 2011

An existing franchisee that sells his or her franchised business directly to a third party, without any significant contact with the franchisor does not need to abide by the federal franchise disclosure law, or any state franchise registration or disclosure law.

 The FTC Franchise Rule states, directly from the FTC website found at http://www.ftc.gov/bcp/edu/pubs/business/franchise/bus70.pdf. 

“Even if the franchisor has, and exercises, the right to approve or disapprove a subsequent sale (transfer) of a franchised unit, the transferee will not be entitled to receive disclosures unless the franchisor plays some more significant role in the sale. For example, if the franchisor provides financial performance information to the prospective transferee, the franchisor would be required to provide the transferee with its disclosure document.”

 Likewise, in the case of an existing franchisee that purchases one or more additional outlets from the same franchisor for the same brand, the franchisor is not required to provide a disclosure document to such a franchisee exercising a right under the franchise agreement to establish any new outlets.

Finally, the franchisor is not required to provide a disclosure document to a franchisee who chooses to keep its existing outlet post-term either by extending its present franchise agreement or by entering into a new agreement, unless the new relationship is under terms and conditions materially different from the present agreement.  In the case of a materially different franchise agreement, the franchisor must abide by state and federal franchise registration and disclosure laws.

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Types of Relationships Covered by Federal and State Franchise Laws. [Part 3]

Thursday, April 28th, 2011

The Payment Requirement.

 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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Types of Relationships Covered by Federal and State Franchise Laws. [Part 1]

Thursday, April 28th, 2011

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.

 In fact, a supplier can avoid Rule coverage of a particular distribution arrangement by expressly prohibiting the distributor from using its mark.”

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New York Franchise Act Inapplicable Where Franchisee Resides Outside New York

Wednesday, January 5th, 2011

In the recent case of JM Vidal, Inc. v. Texdis USA, Inc., 2010 U.S. Dist. LEXIS 93564 (S.D.N.Y. 2010), the New York District Court held that the New York Franchise Sales Act is inapplicable to the sale of franchises by a franchisor based in New York where the franchisee resides outside of New York and the franchised business is based outside of New York. In Vidal, a franchisee located in Washington State brought an action against a franchisor that was incorporated in Delaware and maintained its principal place of business in New York.

The franchisee alleged that the franchisor violated the New York Act by: (i) selling a franchise before it registered the UFOC; (ii) failing to timely deliver the UFOC at or before the initial meeting; and (iii) misrepresenting the estimated future earnings of the franchised unit, among other claims.

The Court dismissed the franchisee’s New York Act claim by holding that the New York Act is inapplicable and unavailable in an action by an out of state franchisee in a claim against a New York-based franchisor. The Court determined that the principal place of business of the franchisee is the essential element in the analysis – so that if the franchisee is not based in New York, then the New York Act is not applicable.

In making this determination, the Court relied on previous New York decisions, including Century Pac, Inc. v. Hilton Hotels Corp., 2004 U.S. Dist. Lexis 6904 (S.D.N.Y. Apr. 21, 2004) and Mon-Shore Mgmt., Inc. v. Family Media, Inc., 584 F. Supp. 186 (S.D.N.Y. 1984). Vidal stated that “only the franchisee’s domicile matters for the purposes of determining whether the statute applies.”

This case should be reviewed carefully by Maryland franchisors and franchisees, and their lawyers, since the specific jurisdictional language of the New York Franchise Act that was at issue in this case is nearly identical to that contained in the Maryland Franchise Act.

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