Author: Mary Beth Gettins

 
Jared Fogle, dubbed as the former “Subways celebrated pitchman” by USA [http://www.usatoday.com/story/news/nation/2015/08/19/jared-fogle-court/31979091/] has accepted a plea in regarding child sex and porn charges. Not good for public relations. Franchise Disclosures are probably not the first thing on Subway’s mind, but let’s take a look.
 
The FTC Franchise Disclosure Rule [FTC Rule] and NASAA guidelines [Guidelines] require Franchisors in Item 18 to disclose:

Any compensation or other benefit given or promised to a public figure arising from either the use of the public figure in the franchise name or symbol, or the public figure’s endorsement or recommendation of the franchise to prospective franchisees.

The FTC Rule and Guidelines go on to define who a ‘public figure’ is by saying:

[P]public figure means a person whose name or physical appearance is generally known to the public in the geographic area where the franchise will be located.

The FTC Franchise Rule Compliance Guide [FTC Guide] sites sports stars, actors, musicians and similar celebrities as typical figures.
 
Read closely, FTC Guide makes one important caveat public figures. It is not just any star or musician generally know. It has to be someone who endorses or recommends the franchise to prospective franchises.
 
The FTC draws out this distinction by saying:

Item 18 is limited to circumstances when a public figure’s identification with a system is for the purpose of selling franchises. Merely using a public figure as a spokesperson to promote a system’s products or services sold to consumers does not bring a franchisor within the ambit of the amended Rule’s Item 18 requirements.

So in the case of Subway’s requirement to disclose Jared Fogle in their Franchise Disclosure Document [FDD], provided he only promoted the purchasing of subway sandwiches and not the buying of Subway franchises, Jared Fogle would not have been disclosed in the FDD.
 
Here is a sample of Item 18 provided in the FTC Guide:

Belmont has paid Ralph Doister $50,000 for the right to use his name in promoting the sale of our franchise. This right expires on December 31, 2008. Belmont has produced newspaper ads, a brochure, and a video which feature Mr. Doister. Mr. Doister does not manage or own an interest in Belmont.

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Must franchise agreements say that franchisees are solely responsible and liable for franchisee operations. But saying, writing it, does not make it, so. There are times that customers claim it is the franchisor that is liable. And, there are times that the franchisor is right.
 
One such case is the one filed in Philadelphia County Court of Common Pleas against Massage Envy.   Massage Envy has been plague by a rash of  complaints regarding sexual assaults. The Court House News Service reports more than 50 complaints in more than 15 states. http://www.courthousenews.com/2015/07/31/client-ties-massage-envy-assaults-to-lax-policy.htm .
 
Per Daily News: http://www.delcotimes.com/general-news/20150803/suit-filed-against-west-goshen-massage-spa
 

In addition to monetary damages, the suit asks that the national chain be held responsible for putting policies in place that would change the way the attorneys contend allegations of sexual assault against massage therapists are handled now.

 
The Daily News goes on to quote attorney for the plaintiff as saying:

“The pattern that you see across the country is that there is a report made by a female customer against a therapist, and that the therapist is either transferred or rehired by another franchise, but no one reports it to law enforcement. In this case, from our understanding, there was little done”

 
In essence the plaintiff’s attorney is saying, if there is a pervasive problem with the franchise system, the franchisor is responsible to make policies to address the problem and if the franchisor instead does nothing to the address problem within a system, the franchisor is liable.
 
Is that deductive reasoning? Is that the assertion? Is omission, a lack of responsiveness sufficient to create franchisor liability? Or, did Massage Envy do something to further the barrage of alleged sexual assaults within its franchise system. We will see as the case progresses. However the assertions, either way, are profound.
 

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There has been a smothering dispute between Steak n’ Shake franchisor and franchisees.  The dispute centers around Steak n’ Shake’s 4 dollar menu.  In June, the Steak n’ Shake franchisor had a major victory.  The case is Steak ‘n Shake Enters, Inc. v. Globex Co.  The case is out of Colorado.
 
The 2 second elevator facts are this:  Franchisee Globex adamantly opposed Steak ‘n Shake’s menu. When franchisee efforts to work with the franchise to end the 4 dollar menu, failed.  Franchisee Globex printed secondary menus raising some 4 dollar items to 5.08.  He reprogramed POS cash registers to allow al a carte pricing.  He did not remove 4 dollar menu promotion items from the restaurant.  He reduced the size of large beverage cups.  When the franchisor discovered Franchisee Globex’s actions, the sent him a default notice and demanded that he stop.  When Franchisee Globex did not stop, the Steak ‘n Shake Franchisor terminated Franchisee Globex and filed suit.  Franchisee Globex filed counter claims.
 
This is not the first case involving Steak ‘n Shake’s $4 menu.  But on this one, the Franchisor is looking to come out the winner.  The Colorado court held that the franchise agreement language requiring the franchisee to comply with the ‘System’ including honoring and promoting the $4 menu, and franchisee’s failure to do so constituted a material breach warranting termination of the franchise agreement.  The franchise agreement did not explicitly state price setting.  Instead, the price setting requirement was boot strapped to the idea of the System.
 
It is common, if not universal, for franchise agreements to mandate compliance with the franchise ‘System’ standard.  This case exemplifies the breath of the ‘System’ uniformity and compliance mandates.
 
As with every case there is an admonishment about not all courts reaching the same conclusion and differing outcomes based on difference facts.  And, this case is no exception.  The concept of the $4 and $1 menus has long been an area of dispute between franchisors and franchisees.  It is unlikely that a simple conclusion that pricing is part of ‘System’ standards will settle the dispute. 
 

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Buying a franchise is typically a 10 year commitment. But, what if you get into a franchisee business and decide, oh, this is not for me. What if a couple of years go by and you decide, hey, I don’t want to do this anymore. Do you just stop operating? Close the doors one night and never come back.
 
That is what happened in the case of Super 8 Worldwide, Inc., formerly known as Super 8 Motels, Inc. [Franchisor] and Anu, Inc. et al. Or, supposedly this is what  happened. Anu, a Motel 8 franchisee [Franchisee], stopped operating. Franchisor has pictures to prove it. Anu just stopped operating his Motel 8 franchise. Who knows why? So what is a franchisor going to do? What can the franchisor do?
 
In this case the Franchisor sent Franchisee an acknowledgment of termination notice. And, sued the Franchisee and the individual franchisee owners for breach of contract. Franchisor wanted 114, 000 dollars from Franchisee for breach of contract. The Franchisee did not answer the complaint. Franchisor filed a motion for summary judgement. In an unpublished decision, the Federal District Court in New Jersey granted the Franchisor’s motion for judgement and orders the Franchisee to 317,591.65 dollars in liquidated damages.
 
In order to prevail in breach of contract case, as stipulated by the court, you need:
 

1. A valid contract
2. Breach of the contract [aka failure to perform under the contract]
3. Damages to the complaining party

 
Sounds fairly simple. The Court thought so, too. The franchise agreement was a valid contract. Under the franchise agreement, Franchisee was ‘permitted’ to operate a Motel 8 franchise.  Even though the franchise agreement said Franchisee was ‘permitted’ to operate a franchisee, the Franchisee was truly obligated to operate the franchise business and the Franchisee did not. As a result of not operating the franchisee business, Franchisor did not get royalties; therefore the Franchisor was damaged.
 
So what are the take-a-ways? First, if you don’t answer a complaint in court, a judgement most probably will be entered against you and you may be ordered to pay damages.
 
Second, the decision to stop operating a franchise business, before the franchise agreement term ends can result in a judgement and order to pay money to the franchisor for royalties that would have been paid in the future.  Most courts will award such damages, but courts may reduce or limit the amount of damages based on the franchisor’s duty to find a new franchisee.
 

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The Fairness in Class Action Litigation Act of 2015 has been sent to the House or Senate for consideration.  The Act introduced is summarized in only two sentences, but it could have a large impact.
 

Fairness in Class Action Litigation Act of 2015

Amends the federal judicial code to prohibit federal courts from certifying any proposed class unless the party seeking to maintain a class action affirmatively demonstrates through admissible evidentiary proof that each proposed class member suffered an injury of the same type and extent as the injury of the named class representatives.

 

It defines “injury” as the alleged impact of the defendant’s actions on the plaintiff’s body or property.

 
Let’s look at franchisee class actions against franchisors.  While franchisees may claim the same type or injury [for example a franchise disclosure violation or a breach in the implied duty of good faith and fair dealing], will franchisees have the same extent of injury?  Will all franchisees alleging a disclosure violation have the same losses?   Could one franchisee have suffered more monetary damages than another?  The answer is probably yes.  How many times are franchisee positions and injuries alike- the same?
 
The Act is not law yet.  It is on the long road to enactment.  We will keep you posted.
 

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Prior to signing a franchise agreement, many franchisors ask prospective franchisees to complete a disclosure questionnaire. The franchise disclosure questionnaire is designed to be an affirmation from the prospective franchisee that they received the franchise disclosure document 14 days and the agreements 7 days before signing, and that no unauthorized financial performance representations were made. The completed disclosure questionnaire is evidence that the franchisor complied with the federal FTC franchise disclosure laws.
 
But, what if the questionnaire does just the opposite? What? How? What if the prospective franchisee checks that he did not get the disclosure document 14 days before signing? Or, what if the prospective franchisee notes that financial performance representation was made, which was not included in the franchise disclosure document [FDD].
 
Would it not follow that the completed questionnaire would then be evidence that the franchisor violated the franchise disclosure law? The outcome may surprise you!
 
The case is Braatz, LLC v. Red Mango FC, LLC. The facts of the case go like this. Prospective franchisees, Mr. and Ms. Braatz sign a franchisee agreement and complete a ‘Franchise Compliance Questionnaire.’ As part of their completed questionnaire they mark ‘No’ to the following:
 
 

• It is true no employee or other person speaking on our [the Franchisor’] behalf made any statements or promise regarding the costs involved in the operating a RED MANGO Store franchise that is not contained in the Franchise Disclosure Document……….

 

• It is true no employee or other person speaking on our [Franchisor’] behalf made any statement or promise regarding the actual, average or projected profits or earnings………..

 
The Braatzes were given a business plan and financial projects from an existing RED MANGO by the Franchisor’s Regional Manager. That is part of the facts of the case. It is a fact they were given a business plan and financial projects; therefore  Mr. and Ms. Braatz marked no on the questionnaire and signed the franchise agreement.
 
 
The franchisor gets the signed franchise agreement, completed questionnaire, and a check from the Braatzes. The franchisor deposits the check, signs the franchise agreement, but contacts the Braatzes and says they cannot open a RED MANGO until they correct their answers on the questionnaire. The franchisor does not give the Braatzes a copy of the franchise agreement signed by the franchisor, but instead gives them a second questionnaire to complete.
 
Now remember, the franchisor has signed the franchise agreement and cashed the check. The Braatzes complete a second questionnaire answering ‘Yes’ to the questions, return the second completed questionnaire to the Franchisor, form Braatz, LLC limited liability company, open the franchise, and several years latter file bankruptcy and want to rescind the franchise agreement.
 
 
No go. The Court dismisses their claim. Yes. The franchisor may have improperly given financial projects, information about cost, but the Court reasoned the Braatzes did not materially rely on the Regional Manager’s disclosures, because when they were asked to correct the questionnaire, the Braatzes corrected the form and formed their limited liability company and opened their franchise. The Regional Manager’s disclosure may have been contrary to the FTC disclosure law, but they were not material.
 
 
Unexpected outcome. Not one to rest your hat on. The franchisees’ compliant was dismissed, but the court left room for the franchisees to amend and refile their claim against the franchisor.
 

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If you answer ‘yes’ to that question, if may be considered a paid endorsement that should be disclosed on your Face Book page.  The Federal Trade Commission [FTC] has recently updated its Endorsement Guide FAQ.  The FAQ were updated to reflect questions received by the FTC and to cover the ‘trending and topical.”  The updated FAQ do not reflect changes in the rules, but rather interpretive guidance regarding application of the existing rules to social media and advertising trends.
 
Topics touched on in FAQs include:

• Blogging product reviews
• YouTube view reviews
• Informational Employee FaceBook page
• Celebrity tweet endorsements
• Television product placements

 
 
Here are several FAQ for the FTC guides about to make endorsement disclosure:
 
If I upload a video to YouTube and that video requires a disclosure, can I just put the disclosure in the description that I upload together with the video?
No, because it’s easy for consumers to miss disclosures in the video description. Many people might watch the video without even seeing the description page, and those who do might not read the disclosure. The disclosure has the most chance of being effective if it is made clearly and prominently in the video itself. That’s not to say that you couldn’t have disclosures in both the video and the description.
 
Would a button that says DISCLOSURE, LEGAL, or something like that which links to a full disclosure be sufficient?
No. A hyperlink like that isn’t likely to be sufficient. It does not convey the importance, nature, and relevance of the information to which it leads and it is likely that many consumers will not click on it and therefore miss necessary disclosures. The disclosures we are talking about are brief and there is no reason to hide them behind a hyperlink.
 
What about a platform like Twitter? How can I make a disclosure when my message is limited to 140 characters?
The FTC isn’t mandating the specific wording of disclosures. However, the same general principle – that people get the information they need to evaluate sponsored statements – applies across the board, regardless of the advertising medium. The words “Sponsored” and “Promotion” use only 9 characters. “Paid ad” only uses 7 characters. Starting a tweet with “Ad:” or “#ad” – which takes only 3 characters – would likely be effective.
 
To see all the FTC guides FAQ visit the FTC website at:  https://www.ftc.gov/tips-advice/business-center/guidance/ftcs-endorsement-guides-what-people-are-asking
 

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“How much will I make?’ is one of the first questions asked by many, if not every, prospective franchisee. Under the FTC franchise disclosure laws, franchisors are not allowed to answer that question unless they include a Financial Performance Representation disclosure in item 19 of the franchise disclosure document [FDD].
 
The requirement to include a financial performance representation in item 19 is optional. However, if the franchisor chooses not to disclosure a financial performance representation, the franchisor is not permitted discuss earnings or profits of existing or future franchises. And, a pre-proscribed FTC disclaimer must expressly be stated in item 19 of the FDD.
 
If franchisor does not include a financial performance representation in the item 19 of the FDD, when the prospective franchisee asks, ‘How much will I make?’ the franchisor must say, ‘I cannot tell you or give you information about how much you will make as a franchisee.’
 
What if the franchisor does? What if the franchisor gives information about franchisee’s outlet performance, earning, profits without including a financial performance representation [previous called earning claims] in item 19 the FDD? That is exactly the facts in a case out of Georgia. The Supreme Court of Georgia said, ‘too bad for you, franchisee. The ill doing is on you, franchisee. You didn’t read the FDD or the franchise agreement. The FDD and franchise agreement said the franchisor made no financial performance representations.’
 
In the original discussion, the jury awarded the franchisee 750,000 dollars in compensatory damages, 375,000 dollars in RICO damages, and 30,000 dollars in cost of litigation. The Supreme Court reversed the verdict and remanded the case for a new trail. The Supreme Court of George held that the franchisee should have read the franchise disclosure document, which included the item 19 disclaimer about no financial performance representations. The franchisee should have read the franchise agreement where the franchisee acknowledged that the franchisor made no representations about earning capability, levels of potential sales, income or profit.
 
Franchisors don’t get too giddy. The Franchisee claims were based in fraud misrepresentation and RICO. The issue of the per se violation of the FTC disclosure rule was not raised. Probably because the franchise agreement was signed 14 years ago, 10 years after the franchisee was in business and the update FTC rule was not in effect. And, there were not state franchise disclosure laws discussed in the case.
 
And, did you see the jury verdict? If the Supreme Court had not reversed, the franchisor would have owed: 750,000 dollars in compensatory damages, 375,000 dollars in RICO damages, and 30,000 dollars in cost of litigation. Do want to risk that kind of money?
 
Franchisees heed the warning from the court. Read the franchise agreement and disclosure document. It is no excuse to say that the franchisor pressured me to sign the franchise agreement and I did not have time to read it.
 

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I review a good number of Franchise Disclosure Documents [FDD] for prospective franchisees. And, I write and update FDD for franchisors. More and more, plentifully so, I have noticed the increase in franchise systems that use customer satisfaction surveys. Franchisors historically have maintained the right to inspect franchise location. So that is not new.
Both poor franchise outlet inspections and customer surveys can be grounds for termination under the express terms of the franchise agreement. Are the termination provisions in the franchise agreement for poor or failing marks on an inspection and consumer surveys enforceable? Or, is franchisor’s right to termination for failing inspections and satisfaction survey considered a breach of the franchisor’s duty of good faith and fair dealing?
 
Good faith and fair dealing is a promise that every party makes when entering into a contract. Good faith and fair dealing is not written down in the agreement. It is simply understood. The court will not enforce a party’s right under a contract unless it is fair and the party is acting in good faith.
 
The rationale beyond franchise inspections and customer surveys is brand quality, goodwill, and reputation. If a franchise location is not maintaining good customer service or not following standard protocols, the franchise system as a whole may suffer.
 
In a recent court case HLT Existing Franchise Holding LLC v. Worcester Hospitality Group, LLC the Second Court of Appeals Court upheld a franchisor’s right to terminate a franchise based upon failed evaluation scores as a result of poor customer satisfaction survey scores. And, the Court showed a little favoritism to customer satisfaction surveys over franchise inspections.
 
Per the Court, customer surveys have independent basis. Survey scores are the doing or opinion of the franchisor. Customer surveys are the views, judgment, and opinion of the customer. And, the franchisor conducted customer satisfaction surveys in the normal course of business in all franchisor locations. The consumer surveys were processed by a recognized third party.
 
Thereby, the Court in its decision said:
 

‘…..HLT terminated the franchising agreement based on a contractually permitted, rational, and non-arbitrary factor–the poor guest survey scores–it did not breach the implied covenant of good faith and fair dealing or act arbitrarily or irrationally.’

 
So thumbs up for consumer surveys from the Second Circuit in this case. Note, when reviewing the customer surveys, the court found it important that:
 

1. The surveys were done as part of the franchise model and not as an isolated location specific occurrence.

2. There were objective franchise system standard requirements for grades on the customer surveys

3. The customer surveys were conducted by an independent third party.

 

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