Blawg

In the state of Washington, the franchise registrations are renewable annually. If the franchise registration is effective May 15, 2014, it does not expire until May 15, 2015.
 
The FTC franchise disclosure rule says that the franchise disclosure document [FDD] must be updated 120 days after the fiscal year. Fiscal year ends December 31. That means the FDD must be updated April 30th.
 
The question is: can you still sell in Washington post April 30th until the registration expires on May 15th?
 
Here is the FTC Answer as posted in the Amended Franchise Rule FAQ:
 

Answer: As a matter of enforcement policy, FTC staff would not recommend initiation of an enforcement action against a franchisor that continues – after the 120-day annual update deadline, pending either completion of the state registration of the franchisor’s updated FDD or expiration of the franchisor’s prior registration (whichever comes first) – to make sales in a registration state using an FDD registered in that state. Nevertheless, after the annual update deadline, a franchisor may not use an FDD without updating it to make sales in any state other than a state with a franchise investment law in which the franchisor’s registration remains in effect.

Section 436.7(a) of the Amended Rule establishes a firm deadline for the required annual update and gives a franchisor 120 days after the close of its fiscal year to complete the update. (This is 30 days longer than the original Franchise Rule allowed.) The deadline ensures that prospective franchisees receive a disclosure document that is not stale, since many of the required disclosures provide information only for the prior fiscal year. Consequently, it is important that the annual update deadline be firm.

FTC staff recognizes, however, that although several state registration laws also require annual updates within 120 days after the close of a franchisor’s fiscal year, the time required for completion of the registration process means that registration of an updated FDD may not occur until weeks or months after the deadline. If the Rule’s annual update deadline were inflexibly enforced in those states, it would require a franchisor with a valid registration under state law to stop selling franchises until completion of the registration of its updated FDD. To resolve this tension between the amended Rule and state requirements, FTC staff do not interpret the amended Rule as requiring a franchisor with an FDD validly registered in a state to suspend sales in that state after the update deadline pending either completion of the registration of its updated FDD in that state, or expiration of the existing registration. Nevertheless, to ensure that prospective franchisees receive the most up-to-date information possible in non-registration states, a franchisor must use only an updated FDD after the annual update deadline.

As a matter of enforcement policy, FTC staff would not recommend initiation of an enforcement action against a franchisor. That is comforting. The FTC did not say it is compliant with the rule to continue to use the old FDD in the registration state. So, you are not in conformity with the Rule, but the FTC, as matter of policy, may not decide to go after you?
 
Better answer: Don’t distribute your old FDD post the 120 days after the close of the fiscal year. If the registration has not expired, submit the registration renewal application early. The FTC is trying to be polite and respectful of the states. But, the Rule is to update 120 days from the fiscal year.
 

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Let’s say a deal is negotiated where a manufacturer provides logo napkins to franchisees for $5 [I am in to simple math]. The manufacture deal for the napkins is negotiated by a third party business that is owned by founders of the franchise system. The third party business entity makes $.50 from each napkin purchase. Is that a kickback?
 
In this hypothetical, we use napkins. But, it could be cleaning products, raw ingredients to make food products, beverages. It could be anything. Are franchisors or franchisors’ officers making a profit off of franchisee purchases, is it a kickback?
 
That is the heart of 17 allegations of Moe’s Southwest Grill against the franchisor and founders that lasted 8 years. The case is finally over. But, the question remains. The case was decided in favor of the franchisor. However, the case did not rest on the determination of whether a kickback was present or not.
 
There is no resolution to the 8 year old question. Are franchisor and founder profits on a franchisee purchase a kickback? The court did not answer the question. The court’s said- “Hey, franchisees you should have looked into it. You knew it existed. You can’t claim you were defrauded if you knew.”
 
The Moe’s Southwest Grill franchise disclosure document [FDD], back when the dispute arose was called the Uniform Offering Circular [UFOC], disclosed that the founders of the franchisor were owners of a brokerage company named SOC, which negotiated food supply agreements for Moe’s Southwest Grill franchisees. The court said, disclosure of SOS was sufficient notice to franchisees there may be a kickback scheme and they should look into it. The disclosure document [then called the offering circular] also said and disclosed that “we will not derive a profit from franchisees’ purchases.“
 
Okay, that sounds bad. If franchisor officers, directors, founders own an entity that negotiates deals for the franchisee, check it out because there may be a kickback. How about if an entity provides services to franchisee? How about if an entity sells a product to franchisees? Should that be checked-out, too?
 
As part of the Item 8 in the Franchise Disclosure Document [FDD], franchisors must disclose if they receive a profit from franchisees’ required purchases from affiliates or vendors. And, franchisors must disclose, in item 8, any franchise supplier, in which an officer of the franchisor owns an interest.
 
Note, there is no requirement to disclose franchisor or affiliate profits from non-required purchases. Nor is there a requirement to disclose profits derived by officer owned business entities. Sometimes what is not said is as important as what is said.
 
But, wait. Is it not deductive reasoning to assume that if an affiliate offers services to franchisees, or an officer owned business entity negotiates deals for franchisee purchases, there is a kickback? Yes. It is deductive. And, maybe there is plausible benefit or justification. Yes. There are reasons and benefits for negotiated deals and closely held transactions.
 

• Required purchases from franchisors or its affiliates or designated supply may foster franchise brand uniformity.

• Designating suppliers ensures quality standards and reduces time expenditure for locating and securing suppliers.

• Requiring franchisees to buy from one supplier [whether affiliate suppliers or designated third party suppliers] leverages the buying power of the whole franchisee system.

There are caveats. If the franchisees are paying higher prices than their competitors, the franchisees are less competitive or franchisee profits may suffer.
 
Whether officer ownership of suppliers is a benefit or negative, is question to investigate. If requiring purchase from a designated supplier is good thing, is question to answer for each system and each transaction. And, just because someone earns a profit is not proof positive of a problem.
 
If benefit is given or cost and expense are incurred by the franchisor, affiliate of officer owned entities, profit franchisee purchases may be justified. Franchisees should ask the questions and franchisors should be prepared to give answers. Required purchases and franchisor profits are an area of scrutiny.
 

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The franchise disclosure document [FDD] has been updated for the New Year. There are prospective franchisees in the pipeline. You have been talking to them, they may have attended discovery day. But, they have not signed the franchise agreement. The updated FDD is issued. Should you give them a copy of the new updated disclosure document?
 
The best answer is: give prospective franchisees a copy of the updated franchise disclosure document and wait another 14 days [or 10 business days] before signing the franchise agreement.
 
That is my answer, but let’s see what the FTC says. As part of FTC Amended Franchise Rule FAQ’s, this question is posed:
 

If a prospective franchisee has received a UFOC disclosure document prior to July 1, 2008, but has not purchased a franchise by that date, must the franchisor provide the prospective franchisee with its Franchise Disclosure Document (“FDD”) 14 calendar days before he or she pays any money or signs a binding agreement in connection with the proposed franchise sale?

Answer: The Rule does not require a franchisor to give its FDD to a prospective franchisee who has already received a UFOC disclosure document prior to July 1, 2008, unless he or she makes a reasonable request for the most recent disclosure document and quarterly updates pursuant to Section 436.9(f) of the Rule.

A little history is in order. Previously the franchise disclosure document [FDD] was called the UFOC or Uniform Franchise Offering Circular. The FTC amended franchise disclosure rules and the UFOC became the FDD.
 
The FTC’s response above suggests re-disclosure is not indicated unless the prospective franchisee asks for a copy. But, think about it. The information in the previous year’s FDD is dated. There are new audited financials. There may be changes to the numbers of franchise outlets. Many things have happened over the past year. Some of those things may change if franchisee chooses to buy a franchise or not. They are material.
 
After the franchise sale, you don’t want the franchisee to say: ‘If I knew, I won’t have bought the franchise.’ Don’t give a franchisee a reason to complain. If things go awry, one of the primary franchisee allegations is that they were not disclosed properly – they were not given the material information- they were misled.
 
Give prospective franchisees a copy of the updated disclosure document. Allow another hold period to elapse before signing the franchise agreement.
 

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In our companion Privacy and Security Blawg, we post about privacy and security issues affecting the health care industry.  However, sometimes the information we post is important to the wider business community.

Here is one such issue:  The Business E-mail Compromise.
 
The Internet Crime Compliant Center [IC3] issued a warning to business owners- small and large. The warning alerts business owners to a scam being dubbed the Business E-mail Compromise [BEC] A.K.A. Man-in-the-Email Scam. The end game of the BEC scam is to generate false wire transfers. And, the scammers are using the names of your staff and vendors to do it.
 
Here are some 2 sample versions restated from the IC3 warning:
 

Version 1
A business, which often has a long standing relationship with a supplier, is asked to wire funds for invoice payment to an alternate, fraudulent account. The request may be made via telephone, facsimile or email. If an email is received, the subject will spoof the email request so it appears very similar to a legitimate account that would take very close scrutiny to determine it was fraudulent. Likewise, if a facsimile or telephone call is received, it will closely mimic a legitimate request. This particular version has also been referred to as “The Bogus Invoice Scheme,” “The Supplier Swindle,” and “Invoice Modification Scheme.”

Version 2
An employee of a business has his/her personal email hacked. Requests for invoice payments to fraudster-controlled bank accounts are sent from this employee’s personal email to multiple vendors identified from this employee’s contact list. The business may not become aware of the fraudulent requests until they are contacted by their vendors to follow up on the status of their invoice payment.

 

Visit our privacy and security blawg at https://gettinslaw.com/hipaa/2015/03/16/have-you-heard-about-the-business-e-mail-compromise/  or click here.

 
Discover some watch-outs to help spot a BEC scam and  What can you do to protect yourself!

Previously on our blog we talked about franchise registration. As part of franchise registration, state examiners, in some of the registration states, will review the contents of the franchise disclosure document [FDD]. The examiners look to see if the FDD conforms with state and federal laws and there are no facial inconsistencies.
 
Click here to read  Which States Require a Filing or Franchise Registration?  or visit:  https://gettinslaw.com/franchising/2015/03/31/what-states-require-a-filing-or-registration/
 
What the examiners zero in on is difficult to determine. There are pages and pages of disclosures. There are pages and pages of rules about the required disclosures. Information is repeated, restated, referenced in a patchwork of the disclosures. Examiners may call out updated information or the examiners may take exception to disclosures and wording that was present in last year’s FDD where no issue was raised before. Everything is fair game.
 
When an examiner takes issue, a comment letter is issued. The franchise registration is stalled until the comments from the examiner are addressed.
 
Here is a listing of Common Mistakes to Avoid published by the Maryland Security Division:
 

1. When renewing or amending, make sure your application includes a black-lined copy of the complete revised FDD, including exhibits.

2. Do not ignore the requirement in Item 12 to specifically disclose whether or not the franchisor provides an “exclusive territory.”

3. Make sure the dollar figures on the FTC cover page match the corresponding dollar figures disclosed in Items 5 and 7, and that the franchise and company owned outlet totals disclosed in Table 1 of Item 20 match the corresponding totals in Table 3 and Table 4.

4. Include the correct “issuance date” on both the FTC cover page and receipt pages of the FDD.

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Although I believe that most employers do not draft their employee handbooks with the object of prohibiting or restricting conduct protected by the National Labor Relations Act, the law does not allow even well intentioned rules that would inhibit employees from engaging in activities protected by the Act. Richard F. Griffin, Jr. General Counsel for the NLRB.
 
The franchise world has taken considerable heat from the National Labor Relations Board [NLRB] over the issue of joint employment. But that is not the only area of scrutiny that franchisors are facing from the NLRB. Wendy’s International LLC is taking heat about some of the employee Rules.
 
On its website, it affirmatively says: The National Labor Relations Board protects the rights of most private-sector employees to join together, with or without a union, to improve their wages and working conditions.
 
Pursuant to an informal, bilateral NLRB settlement agreement, Wendy’s International LLC agreed to modify its handbook Rules. The unmodified Rules were found to be “unlawful and overboard.” Here is a look at the Rules before and after modification:
 

 
There is one other thing. While not mentioned as a modified Rule, the NLRB made a point of calling out Wendy’s International LLC’s third-party representation provision, which “communicated that unions are not beneficial or in the interest of Wendy’s: [b]ecause Wendy’s desires to maintain open and direct communications with all of our employees, we do not believe that third party/union involvement in our relationship would benefit our employees or Wendy’s.” Now, if that doesn’t make the NLRB salty? Unions are not beneficial. Don’t write that in your employee rules. Really!
 
Take a look at your employee rule book and operating manuals. Are there provisions that are unlawful or overboard? Sometimes the slightest clauses intended to protect business interest can be viewed by the NLRB as unlawful or overboard.
 

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The holder of a trademark has certain rights, among them the power to prohibit another entity from using its mark without its consent. Those rights are subject to equitable defenses, including acquiescence, where the markholder affirmatively represents to another that it may use its mark, who then relies on that representation to its prejudice.
 
Under a franchise agreement, franchisors grant franchisees the limited license to offer ‘Authorized Products and Services’ using the franchisor’s trademark. But what happens if the franchisee offers products or services that are unauthorized or unapproved by the franchisor?
 
A recent case outside of the franchise realm suggests using the franchisor‘s trademark for the sale of unauthorized goods or services may be trademark infringement. The case is Pennzoil-Quaker State Company v. Miller Oil and Gas Operation, et al [Miller Oil] out of the fifth circuit federal court.
 
Pennzoil was granted and had an understanding with Pit Stop [Miller Oil] for a ‘non-exclusive license’ to use and display the Pennzoil marks. In return, Miller Oil agreed that it would not blend any Pennzoil products with non-Pennzoil products, or represent a non-Pennzoil liquid as one produced by Pennzoil. Pennzoil got a third party inquiry. Was Pit Shop oil really Pennzoil? Pennzoil did some investigating. A laboratory test was done on the oil. The oil that Miller was selling under the Pennzoil signage was not Pennzoil. Pennzoil sued for trademark infringement. And, they won. Miller Oil hence forth was prohibited from using the Pennzoil name.
 
Remember trademark infringement is all about consumer confusion. A trademark denotes the maker of the product. When folks buy a brand trademarked product or service, they are buying on an expectation. Customers are buying on the goodwill and reputation of the brand trademarked name. The sale of the off labeled, mislabeled products is an attempt to fool, misguide, and confuse the customer into buying a product that does not come from the trademarked entity.
 
Most, if not all, franchise agreements say that franchisees may only sell authorized products and services. The selling of unauthorized products and services probably, if not assuredly, is a breach of the franchise agreement. And, franchisees’ offering and sales of unauthorized products and services may very well be trademark infringement.
 

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In order to include audited financials in the franchise disclosure document [FDD] and for state registration purposes, auditors must give consent for the franchisor’s audited financials to appear in the FDD. In order to get consent from the auditors, the auditors may request to see a copy of the FDD.
 
As you hand over a copy of the FDD to the auditors, you may wonder, what are they looking at? To give consent you may ask, what are the auditors looking for?
 
What auditors look at is not congruent. There is no protocol or perimeters of what the auditors can or should be looking at. Different auditors may look at different things. Some auditors will just do a demonstrative glance at the FDD. Other may do a granular read. There is no consistency. But there are some commonalities. Here are some tips for preparing for the auditor’s review.

1. Make sure the list of the franchise outlets and total number of outlets in item 20 matches the revenue source that you reported to the auditors. If the numbers are different, be prepared to explain the difference.

2. Make sure the audited financials are properly identified in item 21 of the disclosure document.

3. Make sure the total franchisor revenues and profits stated in item 8 regarding earnings from franchisee and vendor purchases mesh with the audit numbers.

4. Make sure the litigation disclosures in item 3 are consistent with information provided to the auditors.

5. Make sure that the issuance date is acceptable to the auditors. In all cases the issuance and effective date should be after auditor has give consent.

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Have you heard about 7-Eleven’s Zero Franchising Fee program? Under the Zero Franchising Fee offer, 7-Eleven is waiving the Initial franchise fee until June 30th on 200 stores for prospective franchisees ‘21 or older that are permanent U.S. residents, have excellent credit and $50,000 in liquid assets.’
 
Attracting qualified prospective franchisees is a challenge faced by many, most, if not all franchise systems. Offering discounts and special offers can be great way to attack prospects. However, franchisors need to be careful about discrimination and disclosure when offering discounts and special offers.
 
Many states have relationship laws, which prevent discrimination of franchisees. Yes, discrimination laws. When we think of discrimination, we think of employment issues and public accommodations. We don’t think of franchising. But, there are discrimination laws in franchising. Discrimination laws prohibit franchisors from treating similarly situated franchisees differently. Hence, charging one prospective franchisee an Initial Franchisee Fee and not another, because one is of foreign nationality or is over 50 years old, can go awry of franchise discrimination laws.
 
And, if you offer discounts or special offers, you must disclose the discounts and specials in the franchise disclosure document [FDD] at the time the special or discount is being offered and forever more. When the special or discount is being offered, the discount or special must be disclosed. When the offer expires or is withdrawn, the discount still needs to be disclosed in the disclosure documents, forever more.
 
It is common place for new or developing franchisors to offer Initial Franchise Fee discounts. It is common place for franchisors to offer discounts to defined groups such as military veterans or existing franchisees. It is all good. However, introducing such discounts should be done carefully. Before introducing discounts or specials, franchisors should:
 

1. Properly and clearly define perimeters and qualifications for the any discounts or specials, and

2. Amend franchise disclosures documents to reflect any discounts or specials.

 

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