Author: Mary Beth Gettins

The Federal Trade Commission (FTC) drafter of the Franchise Disclosure Rule, which requires the delivery of the Franchise Disclosure Document to prospective franchisee is looking for comments.  The comment requires part of the FTC periodic review of the cost and benefits of the regulations.  Specifically, the FTC is looking for comments on the following questions: 

1.                              Is there a continuing need for the [Franchise Disclosure] Rule? Why or why not?

2.            What benefits, if any, has the Rule provided to prospective franchisees, including small businesses? What evidence supports the asserted benefits?

3.            What modifications, if any, should be made to the Rule to increase its benefits to prospective franchisees, including small businesses?

a.            What evidence supports the proposed modifications?

b.            How would these modifications affect the costs the Rule imposes on franchisors and franchise sellers, including small businesses?

c.             How would these modifications affect the benefits to prospective franchisees?

4.            What impact has the Rule had on the flow of truthful information and on the flow of deceptive information to prospective franchisees?

5.            What significant costs, if any, has the Rule imposed on prospective franchisees, including small businesses? What evidence supports the asserted costs?

6.            What modifications, if any, should be made to the Rule to reduce any costs on prospective franchisees, including small businesses?

a.            What evidence supports the proposed modifications?

b.            How would these modifications affect the benefits provided by the Rule?

7.            What benefits, if any, has the Rule provided to franchisors and franchise sellers, including small businesses? What evidence supports the asserted benefits?

8.            What modifications, if any, should be made to the Rule to increase its benefits to franchisors and franchise sellers, including small businesses?

a.            What evidence supports the proposed modifications?

b.            How would these modifications affect the costs the Rule imposes on franchisors and franchise sellers?

c.             How would these modifications affect the benefits to prospective franchisees?

9.            What significant costs, if any, including costs of compliance, has the Rule imposed on franchisors and franchise sellers, including small businesses? What evidence supports the asserted costs?

10.          What modifications, if any, should be made to the Rule to reduce the costs imposed on franchisors and franchise sellers, including small businesses?

a.            What evidence supports the proposed modifications?

b.            How would these modifications affect the costs the Rule imposes on franchisors and franchise sellers?

c.             How would these modifications affect the benefits to prospective franchisees?

11.          What evidence is available concerning the degree of industry compliance with the Rule?

12.          What modifications, if any, should be made to the Rule to account for changes in relevant technology or economic conditions? What evidence supports the proposed modifications?

13.          Provide comment on any overlap or conflict with other federal, state, or local laws, or regulations.

a.            What evidence supports any asserted conflicts?

b.            With reference to asserted conflicts, should the Rule be modified? If so, why or why not?

The questions posed by the FTC provide a chance for introspective of the Franchise Disclosure Rule and perhaps more particularly the Franchise Disclosure Document.  I would gander to say the Franchise Disclosure Rule and Franchise Disclosure Document (FDD) will not be abandon or eliminated by the FTC.  And, if the FTC did abandon the Rule, many states have enacted like statutes and regulations that mirror or greater than the federal FTC Franchise Disclosure Rule, and therefore, such abandonment will cause minor alteration the regulatory nature of franchising. 

Back in 1925, Congress passed a law allowing for the enforceability of arbitration clause in contracts.  

A written provision in . . . a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.  9 U. S. C. §2.

Throughout the almost a hundred years later since enactment, the enforceability of arbitration clauses has repeatedly been upheld.  In a case argued before the United Supreme Court on October 29, 2019[i], the high court has again reinforced the bounds of arbitration.  The question at issue before the high court was:

Who decides if a dispute is subject to arbitration pursuant to a contractual arbitration clause- an arbitrator or a judge in a court of law?

The Supreme Court says, if the contract clause such, it is an arbitrator’s place to determine if a dispute is required to resolved by arbitrated.

When the parties’ contract delegates the arbitrability question to an arbitrator, the courts must respect the parties’ decision as embodied in the contract.

HENRY SCHEIN, INC., ET AL. v. ARCHER & WHITE SALES, INC. CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT No. 17–1272. Argued October 29, 2018—Decided January 8, 2019.

Here are a few quick statements regarding arbitration in general and franchising. 

• Yes, arbitration offers a quicker resolution than litigation. On average, US District Court cases take more than twelve months longer to get to trial than cases adjudicated by arbitration (24.2 months vs. 11.6 months)[i].
• Your right to challenge an arbitration decision is considerably more limited than in litigation. 
• Arbitration decisions, unlike litigation, are not public; however, both must be disclosed in the Franchise Disclosure Document congruently.

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[i] A New AAA Study Confirms That Arbitration Is Faster To Resolution Than Court – And The Difference Can Be Assessed Monetarily. Posted by John P. Ahlers  https://www.acslawyers.com/a-new-aaa-study-confirms-that-arbitration-is-faster-to-resolution-than-court-and-the-difference-can-bassessed-monetarily/

[i] HENRY SCHEIN, INC., ET AL. v. ARCHER & WHITE SALES, INC. CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT No. 17–1272. Argued October 29, 2018—Decided January 8, 2019

Almost universally, franchise agreements expressly state that the filing of a claim in bankruptcy is grounds for immediate termination of the franchise agreement.  But, in reality, bankruptcy laws, prohibit the franchisor from terminating the franchise agreement based on the franchisee’s filing in bankruptcy.  This is referred to as a stay in bankruptcy. 

A debtor [franchisee] in bankruptcy is shielded by the automatic stay under Sec. 362 of the Bankruptcy Code [11 U.S.C. 362] from debt-related proceedings brought by creditors [franchisor] based on pre-petition events.

A bankruptcy stay means the franchisor is not permitted to terminate or default a franchisee because of the filing of bankruptcy, delinquent royalties, or any other deficiencies that are pre-date the bankruptcy filing. 

So what recourse does a franchisor have against a franchisee in bankruptcy?  Two options include moving to dismiss the bankruptcy and seeking to lift the automatic bankruptcy stay, may be available.  Either way, the franchisor must file a petition with the bankruptcy court.  This is not a matter that can be handled by simply sending a notice to the franchisee or the franchisee’s attorney. 

These two options were pursued by GNC in the case of In re: Meena, Inc[i]. While GNC was not successful in getting the franchisees’ bankruptcy dismissed or the automatic stay lifted,[ii] the court provided a nice outline of what is required for dismissal of bankruptcy claim and was is required to the lift the automatic bankruptcy stay.

The bankruptcy may be dismissed if:

1. the continuing loss to or diminution of the estate [franchised business] and absence of a reasonable likelihood of rehabilitation;
2. inability to effectuate a plan;
3. unreasonable delay by the debtor [franchisee] that is prejudicial to creditors [franchisor]; [or]
4. failure to propose a plan under section 1121 of this title [the federal bankruptcy law] within any time period fixed by the court.4[iii]

To the lift the automatic bankruptcy stay, the franchisor must show:

1. the debor [franchisee] lack of adequate protection of an interest in property [franchise agreement or franchised business assets] of such party in interest; or
2. the debtor [franchisee] does not have an equity in such property [franchise agreement or franchised business assets], and such property is not necessary for an effective reorganization.

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[i] In re: Meena, Inc., Debtor. In re: Desa of NY, Inc., Debtor. In re: SDA, Inc., Debtor. In re: Choudry Sajid Javaid and Gulmeena Javaid, Debtors. ¶16,304. U.S. Bankruptcy Court, E.D. New York. Case Nos. 8-18-74693-reg, 8-18-74694-reg, 8-18-74695-reg, 8-18-74804-reg. Dated November 6, 2018.

[ii] GNC was not successful in getting the franchisees’ bankruptcy dismissed or the automatic stay lifted in part due to issues non-conveyance of the franchise agreement and money security agreement from the individual franchisees to the business entity franchisee.  See are previous blog https://gettinslaw.com/franchising/2018/12/20/who-owns-this-franchise/

[iii] In re C-TC 9 th Avenue Partnership , 113 F.3d. 1304, at 1311 (2d Cir. 1997).

Poaching in the employment realm is the act of scouting, soliciting, recruiting, and hiring employees already employed by another entity.  The consequence of having a key employee poached can be a great hardship on the business, and it can create hard feelings between poacher and poached companies. 

The rationale of anti-poaching clauses are to avoid discord among and promote harmony between franchisees.  Anti-poaching clauses are common in franchise agreements.  Often the anti-poaching clause is cushioned within the non-solicitation provision.  A non-solicitation clause goes something like this:

You covenant that you will not, during the Term and for a period of one year after expiration or termination of the Franchise, employ or seek to employ any person who is employed by us, our Affiliates or by any of our franchisees, or otherwise directly or indirectly solicit, entice or induce any such person to leave their employment

Greer v. Papa John’s, S.D.N.Y., Case No. 1:18-cv-11312, December 4, 2018

The non-solicitation clause prohibits the franchisees from during and post the term of the franchise agreement from deriving Franchised Business customers and employees from another. 

Recent claims by employees are claims are challenging the premise the rationale of anti-poaching clauses is to promote harmony and avoid discord amount franchisees. In two recent cases involving Papa Johns[i] and Jiffy Lube[ii], employees are asserting that anti-poaching clauses unfairly suppress competition and suppress wages. 

Employees are to the only one to challenge anti-poaching provisions in franchise agreements.  The Papa Johns’ employee class action case, follows a settlement between Papa Johns and the Washington Attorney General, in which the Washington Attorney General asserted the Papa Johns’ anti-poaching clause

restricts worker mobility and decrease[s] competition for labor by preventing workers from moving among the chain[]’s franchise locations

[1] http://www.wkcheetah.com/?cpid=WKUS-Legal-Cheetah#/read/8ffbf8ce7d2f1000ba3d90b11c2ac4f101!csh-da-filter!WKUS-TAL-DOCS-PHC-%7BFEE144B1-5FC2-4E25-99A6-968163C6D1D7%7D–WKUS_TAL_1852%23teid-0?searchItemId=&da=WKUS_TAL_1852#8ffbf8ce7d2f1000ba3d90b11c2ac4f101-8ffbf8ec7d2f1000892990b11c2ac4f108

Papa Johns’ settled with the Washington Attorney General, and as part of the settlement, Papa Johns agreed to remove the anti-poaching clause from its franchise agreement. 

Does your franchise agreement include an anti-poaching provision?  What can you do?  What should you do? How can you preeminent any potential governmental or employee claims?

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[i] Greer v. Papa John’s, S.D.N.Y., Case No. 1:18-cv-11312, December 4, 2018

[ii] Fuentes v. Royal Dutch Shell PLC, E.D. Pa., Case No. 2:18-cv-05174-AB, November 29, 2018 priority52

Yes, it is that time of year.  Every year 120 days post the close of the franchisor’s fiscal year, the franchisor disclosure document must be updated with the previous year’s data.  The update is required by the federal FTC Franchise Disclosure Laws.  For must franchisor’s the deadline to update the franchise disclosure document is April 30^th.

It does not matter if you sold any franchises, if you tried to sell franchises last year, you will need an audit.

In the first year of franchising, startup franchisors may have been able to evade getting an audit.  However, post the first year of franchising and every year thereafter, all franchisors must have an auditor completed of the franchisor entity incident to the annual franchise disclosure update[i].

If you offered franchises in last year, you will need an audit.  It does not matter if you only offered franchises for 1 month, 3 months, or 12 months-you will need an audit.

The audit must be prepared in accordance with GAAP, and the audit must be done by an independent auditor.  The audit cannot be completed your in-house accountant or the accountant that you use to complete your taxes.  

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[i] In leu of a franchisor audit, an audit may be completed “…of any of its affiliates if the affiliate’s financial statements satisfy paragraphs (u)(1)(i) and (ii) of this section and the affiliate absolutely and unconditionally guarantees to assume the duties and obligations of the franchisor under the franchise agreement. The affiliate’s guarantee must cover all of the franchisor’s obligations to the franchisee but need not extend to third parties. If this alternative is used, attach a copy of the guarantee to the disclosure document

Pursuant to an article appearing in the Luxora Leader reports a Roast Plant franchisee is suing its franchisor based asserting it was given false figures and projections.  According to the article:

Roasting Plant founder and CEO Mike Caswell sent [franchisee] Shehadi a spreadsheet showing all of the then-existing Roasting Plant locations doing about $1.1 million in yearly revenue, with strong profits, the lawsuit says. Another spreadsheet projected that an Ann Arbor coffee shop, once open, would do $1.4 million in revenue with above-average profits. https://luxoraleader.com/franchisee-sues-roasting-plant-coffee-for-9-5m-alleging-fraud/577560/

Item 19 of the franchise disclosure document [FDD] gives franchisors the opportunity to provide prospective franchisees with information about the financial performance of the franchise brand.  Once a financial performance representative is made in item 19 of the FDD, the franchisor can then discuss the representation disclosed and substantiation for the representation.

Financial performance representation means any representation, including any oral, written, or visual representation, to a prospective franchisee, including a representation in the general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table, or mathematical calculation that shows possible results based on a combination of variables. 16 CFR Parts 436 and 437

Without an item 19 financial performance representation in the FDD, the Franchisor may not discuss the financial performance of the franchise brand.  Conversely, inclusion of a financial performance representation does not have to operate as a franchisor’s a free pass to speak everything financial, profits, revenue, and performance.  Franchisor must confine discussions and information sharing to the information disclosed in the FDD and supporting data to substantiate the item 19 financial performance presentation.
Item 19 financial performance representations is commonly based on the existing outlet location.  Project or future financial performance representations are not so common.  The requirement for project or future financial performance representations are quite robust.  Project or future financial performance representations must be, among other things, prepared in accordance with the AICPA Audit and Accounting Guide by qualified personnel using appropriate accounting principles.
The disclosure of an existing outlet location’s financial performance representation does give the franchisor a free pass to discuss future projected financial performance.  In order for the franchisor to discuss projected future financial performance representation, the franchisor must include a projected financial performance representation in the FDD.  A project or future financial performance representation can not be boot strapped on to a historic financial performance representation.