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Release of Claims: Question You Need to Ask.

In the franchise industry the deployment of Release of Claims is common place. A Release of Claims may be a stand-alone agreement or may be embedded in a franchise transfer agreement, franchise renewal agreement, franchise termination agreement, and numerous other transactions. Whether you are franchisor or franchisee, learn what questions you need to be concerned with when reviewing, drafting, or signing a non-compete. See the slide share below.

Handling New Deals and Closing Old Business

corporate deal - isolated
Over the last several months we have been posting about updating   the franchise disclosure document.  For many franchisors, the time to update the franchise disclosure document was April 30th.  With the deadline for updating the franchise disclosure document past, it is now time to re-focus on the franchise sales.
 
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Franchisor not liable for Franchisee!

Copyright (c) 123RF Stock Photos

Copyright (c) 123RF Stock Photos

What happens?  Consumer trips and falls at a franchise store.  Home owner complains that the franchisee’s work is shoddy and wants his money back.  Franchisee’s employee alleges a failure to pay overtime.

 More times than not, the franchisor gets sued along with the franchisee for these issues.  It happened at the franchise location, but customers, employees, and others try to hold the franchisor responsible.   This is referred to as vicarious liability.  The franchise concept is vulnerable to vicarious liability, because;

  •  The franchisor provides franchisee training about how to operate the business

  • The franchisor publishes an operations manual that has guidelines about operating the franchise business

  • The franchisee reports to the franchisor monthly

  • The franchisor provides the franchisee on-going consultation

  • The franchisor gets royalty on the franchisee profits

  • The Franchisee uses the franchisor’s software

  • The franchisor is usually bigger and has more money than the franchisee

 What defenses does the franchisor have?  Is it really equitable to hold the franchisor liable?  If the consumer falls, should the franchisor pay?  If the franchisee did a bad job, should the franchisor pay?  If the franchisee does not pay its workers, should the franchisor pay?

 In the case is Robert Leach et al v. Rafail Kaykov and J. Fletcher Creamer & Son, Inc., & Royal Dispatch Services, Inc., the court said NO, the franchisor was not liable.  Rafail was a franchisee of the Royal Dispatch Services.  He was a taxi driver.  Mr. Leach had called Royal Dispatch Services for a tax ride.  Rafail accepted the dispatch from Royal Dispatch Services.  During the tax ride, an accident occurred.

 The passenger, Mr. Leach, wanted to blame the franchisor Royal Dispatch Services.  After all he called Royal Dispatch Services for the tax ride.  And, Rafail was Royal Dispatches Services’ franchisee.  And, Royal Dispatch Services, provides training to its franchisees, gives its franchisees a operations manual or rule book to follow, Royal Dispatch Services’ computer equipment is installed in  franchisee taxis, the franchisees pay a commission to Royal Dispatch Services, and Royal Dispatch Services inspects the taxis.

The court said that’s nice, but Rafail is an independent contractor.  Royal Dispatch is not liable.  Rafail is free to accept dispatches from other persons.  Rafail had to secure his own license and permits.  Rafail did not have to accept the dispatch from Royal Dispatch Services.

 It comes down to independence.  Franchisees are independently owned and operated businesses.  This is called out specifically in the franchise agreement.  So long as the independence is respected and recorded, the vulnerability to vicarious liability is greatly diminished.

 Lesson from the Court:  Independence can free you from liability!

 How does your franchise model recognize the franchisee independence?  Are franchisees required to post that they are an independently owned and operated business?  Are franchisees free to accept or reject consumer sales?

Franchise Agreement Terminated-Without Notice

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When can a franchisor terminate a franchise? It says it right in the franchise agreement. Probably, toward the back of the franchise agreement, it says the franchise agreement may be terminated if….. These reasons for terminations in legal vernacular are called defaults. There are defaults that can warrant the franchise agreement being terminated immediately. And, there are defaults that allow a time for correction or a cure period. If a correction or cure period is stipulated, then the franchise may not be terminated until the cure period or correction period has lapsed and there is no correction. All this is laid out in the franchise agreement.
 Is there ever a case where, a franchise agreement may be terminated contrary to wording of the franchise agreement? Yes. That is the case of 7-Eleven, Inc., v. Upadhyaya et. al. The franchise agreement between 7-Eleven and Upadhyaya said, for the first event, the franchise agreement shall not be terminated without notice and opportunity to cure. 7-Eleven terminated its franchisee Upadhyaya. 7-Eleven did not follow the words of the franchise agreement. It did not allow Upadhyaya notice or time to cure. The termination notice said ‘your franchise agreement is terminated immediately.’
How can that be? The franchise agreement between 7-Eleven and Upadhyaya said that the franchisee would be entitled to a period of notice and opportunity to cure prior to the termination of the franchise agreement. Is that permissible? The court said: 7-Eleven had the right to terminate the franchise agreement per New Jersey law without following the prescribed notice and time to cure period because:
A contract may be terminated without notice and opportunity to cure in specific circumstances, even where contractual provisions require such notice. LJL Transp., Inc. v. Pilot Air Freight Corp., 599 Pa. 546 [2009]. Notice and opportunity to cure provisions are not enforceable where a breach goes “directly to the essence of the contract, which is so exceedingly grave as to irreparably damage the trust between the contracting parties.” Id. at 567.
In essence the conduct of Upadhyaya was so heinous and grave that it damaged the trust of 7-Eleven and caused 7-Eleven irreparable harm. Upadhyaya was not ringing sales through the franchise POS system thereby reducing monies owed to 7-Eleven. This was not a minor issue. And, 7-Eleven had plenty of the evidence. 7-Eleven sent secret shoppers into the store. Of the 18 secret shops sent, it found 13 where the product purchased was not recorded properly by the store. Inventory reports showed that “reported purchases of cigarettes in the store exceeded reported sales of cigarettes by over $115,000.” In other words, the store was buying far more cigarettes than it reported selling to customers. …. [R]reported sales of candy, non-carbonated beverages, tobacco [not cigarettes], and grill items exceeded reported purchases by approximately $112,000.
The act of terminating a franchise agreement is lenient with legal consequences. Termination of a franchise agreement should be done only after a careful review of the agreement, the law, and facts.  If done improperly, without cause and contrary to the franchise agreement or state laws, the legal ramifications can be huge. The franchisor could be forced to pay large sums for damages and lost profits to the franchisee.   In this case, 7-Eleven had a copious amount of evidence, reports, videos, and compute readouts.
In a previous blog we posted a business tool to help assess the risk and resolve conflicts. Get the 7 step infographic to resolving conflicts and assessing your legal risks. Make your request below to receive the infographic.
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It is that time of year again! FAQ About Franchise Sells, Disclosure, and Annual FDD Updates [A SlideShare]

As the advent of the FTC rule’s deadline for updating the franchise disclosure document approaches, questions abound about proper disclosure, sells, and re-disclosures. Watch the slide share to get the facts and answers to frequently asked questions.
Still have more questions or need more information? Give us a call!

Attention All Franchisors!

Deadline concept
 
Are you a franchisor? Do you have any franchisee locations in New York? If you answered,” yes,” to both of these questions, you need to file an annual information return. Do not delay. The deadline is March 20th .
To prepare for the filing you will need information about the revenues and royalties reported to you by your New York franchisees broken down by franchisee. The information return is by the New York Tax Department to verify the accuracy of income and sales tax returns filed by franchisees. This is New York’s way of auditing franchisees to see if they are paying proper taxes.
New York law allows for up to a $2,000 penalty for each information return that is not submitted.
Need more information about the information return, give us a call or drop us an email.
 

Can a bankruptcy render a franchisee’s non-compete void?

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The answer is ‘yes’ in at least one case. The case is Allegra Network, LLC v. In re Michael G. Ruth. Michael G. Ruth and Elnoria J. Ruth, collectively the “Ruths” entered into a franchise agreement initially in 1984. The franchise agreement was renewed in 2006. The franchise agreement stated that the laws of the state of Michigan governed the franchise agreement.

 In 2008, the then franchisor, Allegra Network, LLC, terminated the Ruths’ franchise agreement for failure to pay royalties. Allegra Network sued the Ruths for payment of unpaid royalties and enforcement of the post franchise agreement non-compete. The Ruths filed for bankruptcy.

 This is where it gets complicated. The court goes on a tangent. Under Michigan law, if a non-compete is violated, the remedy is monetary damages. The violator of the non-compete agreement must pay money damages. Now remember we are in bankruptcy. Under Chapter 13 bankruptcy all monetary obligations are discharged or erased. So, it only follows that the money damages for violation of the non-compete are erased. A little bit of circular reasoning.

 In essence, the former franchisee can compete against the franchisor.-without any liability. The obligation to pay damages for violations of the non-compete are erased by the bankruptcy. The franchisor has no remedy.

 In a side note, the court makes an interesting statement. This decision is not the outcome in all jurisdictions. The court states that if the case were in Minnesota or Texas, bankruptcy would not render the non-compete unenforceable.

 Business Take Away: Bankruptcy changes the typical rules and not all states have the same laws.

 Do want to know the non-compete laws in your state? Call or email us!

No liability for disclosure claim: Speak now or forever hold your peace.

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Nothing lasts forever. That includes the right to sue for franchise disclosure violations. If a franchisor does not comply with franchise disclosure laws, the franchisee has only a finite time to file a complaint.

 This is referred to as the statute of limitation in the legal world. The statute of the limitations is the set period of time that claim must be filed. If the time period the complaining party has lapses, they cannot sue. There may be no remedy. No liability.

 So goes the case of Stocco v. Gemological Institute of America, Inc., Gemological Institute”. Frederick Stocco and Kathleen Stocco, collectively “Stoccos” entered into a license agreement with the Gemological Institute in 2007. The license agreement was a franchise to be operated in California. In 2012, the Stoccos sued Gemological Institute. In one count, the Stoccos alleged Gemological Institute violated California franchise disclosure laws.

 California’s disclosure law states:

 No action shall be maintained to enforce any liability created ….. unless brought before ….. [4] four years after ………the violation, [or] the expiration of [1] one year after the discovery……..

That means the Stoccos could not claim a violation of the California franchise disclosure laws past 4 years. Do the math. The violation occurred in 2007 and the Stoccos did not bring their compliant until 2012. That is 5 years. The court disregarded the discovery issue. Four years was absolute. The Stoccos did not bring the claim within the 4 year window, the claim was dismissed!

 Now, that is not the end of the story. The Stoccos had numerous other claims against Gemological Institute. So, don’t assume a franchisor is off the hook after 4 years. In this case there were 5 other claims against the franchisor that will have to be defended.

 Business Take Away: Disclosure violations have a finite life, but there are other counts to consider.

 If you have an issue regarding a franchise disclosure violation, we want to hear about it. Contact us to discuss your specific case!