Author: Mary Beth Gettins

Over the last 10 years or so, franchisors have begun including performance standards, minimum gross sales requirements, and minimum royalty rates in their franchise agreements. Whatever vintage they are (sales requirements, minimum sale or royalty), the whole rationale is this: The franchisor wants to make sure that the franchise territory is not tied up, underperforming, or underutilized.

The performance standards, minimum gross sales requirements, and minimum royalty rates are commonly stated in straight dollar amounts. Those dollar amounts may seem a bit measly, when the franchise agreement comes up for renewal 10 years later.

The franchisor can up the dollar amounts at the time of renewal. Right? One franchisee argued no way, no go. The case is Home Instead, Inc. v. David Florance et. al. The franchise agreement in question stated, in pertinent part, “The franchisee must maintain minimum gross sales of $30,000 per month after the end of the fifth year of operation of the Franchised Business through the end of the term of this Agreement or any renewal term of a renewal Franchise Agreement (the Performance Standard).”

In this case the franchisor wanted to raise the $30,000 to $70,000, a more than double increase of the Performance Standard. The franchisee read the franchise agreement to say that the $30,000 would run forever over all renewal periods. The court called this a “strained reading” of the franchise agreement. The court went on to say that “This reading places a permanent ceiling on the Performance Standard.” The court honed in on the word “minimum.”

The court found that the $30,000 stated in the initial franchise agreement “creates a floor, not a ceiling.” “Nothing in [the franchise agreement] §2.F prohibits the franchisor from raising the minimum amount.”

 Lesson from the Court: Each word has meaning, make sure to heed the meaning.

Minimum performance standards are disclosed in several item numbers of the franchise disclosure document.

In this week’s post we discussed a case regarding personal liability for a violation of state franchise disclosure laws.  Here is an infographic outlining the potential exposure for violations of franchise disclosure laws!

Did you see this timeline?  Did you find it helpful?  We have put together a workbook compilation.  The workbook compilation has the need to know information for franchisors and  worksheets to compile the data for updating the franchise disclosure document.  The timeline is just one of the tools in the workbook!   To see a preview of the workbook click here:   You can buy your copy by going to:  https://gettinslaw.com/landing/answers-for-franchisors-franchise-disclosure-document/

There are countless grounds for termination of a franchise agreement. Failure to pay royalties is most assuredly grounds of termination of the franchise agreement. Abandonment of the franchise business is another sure bet for termination of the franchise agreement. Not operating franchise business in compliance with franchise standards, transferring franchise assets without franchisor approval, under reporting gross revenues; these are all common grounds for terminating the franchise agreement.

What about not having enough money in the bank? Well that is what happened in one case. The case is 7-Eleven, Inc.et. al. v. Brinderjit Dhaliwal. Brinderjit Dhaliwal (“Dhaliwal”) is a 7-Eleven franchisee. He owned and operated a successful 7-Eleven franchise from 1997 to 2010, more than a dozen years. The lease on his location expires. He is forced to close the location. 7-Eleven gives him the option to take over a number of available locations free of an initial franchise fee or transfer fee. The locations available, which do not carry a waiver of the initial franchise fee, don’t work for Dhaliwal. He ends up buying a location in Rocklin, California. The initial franchise fee is $219,000.

Dhaliwal thinks it is going to be a great location! But, it does not work out that way. Projected sales don’t hit the mark. Under the 7-Eleven franchise agreement, Dhaliwal is required to maintain a net worth of $15,000. The profits are just not what were expected. The net worth of the franchise business repeatedly falls below the $15,000 threshold. 7-Elven sends Dhaliwal repeated default notices and ultimately terminates Dhaliwal’s Rocklin, California, franchise.

Why would a franchisor put a net worth requirement on the franchisees? And make it a terminable offense. I can think of several reasons. 1. The franchisor is worried about creditors taking over the franchise assets. 2. Insufficient cash flow may impede inventory levels, advertising expenditures, and staffing levels. That is not what the franchisor goes with. Get this. The franchisor argues: it has good cause to terminate a franchise if they fail to maintain a net worth of less than $15,000. This is a quote from the court’s decision: The reason for the net worth requirement, as clarified at hearing, was to ensure that the franchisee was fully invested in the operation of the store.”

Guess what? The court goes for it. The court grants a preliminary injunction in favor of 7-Eleven, ordering Dhaliwal to surrender the franchise premise and cease using the 7-Eleven name.

Lesson from the Court: Always have a reason. It does not have to be a good reason. It does have to be the best one, the logical one, but you must have one.

Grounds for termination of the franchise must be disclosed in the franchise document disclosure.

 

How can a really sweet deal turn into a really bad nightmare? That is perhaps what two franchise founders are saying to each other about now. Michael and Kathy Butler (collectively the “Butlers”) are seasoned public relations folks. Michael Butler has had his own PR firm for 30 years. The Butlers came up with the idea to open a retail store that offered PR and marketing services to small businesses. They liked the concept so much, they decided to franchise it. They called the franchise the PR Shop. They contracted with a franchise broker to sell PR Shop franchises. The broker did a good job. A franchise prospect in New York wound up buying 20 franchise outlets.

Then the nightmare began. New York requires franchisors to complete a franchise registration prior to the offering or selling of franchises in the state of New York. PR Shop filed a franchise registration. But, it was not complete or effective at the time that the PR Shop franchises were sold to the prospect in New York. This was uncovered by the prospect turned franchisee. He called the state of New York wanting to complain about 20 PR Shop franchises.

Go no further. The franchise registration was not effective when the franchisee bought the franchises. The franchisor must offer the franchisee rescission. Rescission means, pretend like the franchise agreement was never signed and the franchisee gets all his money back.

One problem, by this time the franchise has dissolved. The franchise’s founders (the Butlers) have filed personal bankruptcy. This whole thing cannot be written off that easy. Can it? Really? No. The case is In re Michael L. Butler and Kathy H. Butler v. John Mangione. The bankruptcy court did not look fondly upon the Bulters’ conduct. The court found that Michael and Kathy Butler were personally liable to John Mangione, the New York franchisee. And, the Butler’s liability to Mr. Mangione was not dischargeable in bankruptcy. The Butlers must repay Mr. Mangione his initial franchise fees, for all 20 franchises + interest + Mr. Mangione’s attorney’s fees totally $714,000.

The Butlers broke state law by not completing the franchise registration prior to selling the franchises in New York. The Butlers did not hold the initial franchise fees in escrow as instructed by the state. Failure to put the initial franchise fees in escrow, in the court’s opinion, was akin to stealing. The Butlers committed fraud by misrepresenting to the franchisee that PR Shop was registered in New York. The court did not take a soft approach in this case.

 Lesson from the Court: Register it before you sell it or the deal may be unraveled post facto.