Abandoning Franchisee’s Claims Against Franchise Denied!

What is a franchisee to do when faced with a notice of default?  Abandon the franchise?  Should the franchise de-brand and begin operating as an independent business?  And, counter sue the franchisor for wrongful termination of the franchise?
That is what one BW-3 franchise in Akron Ohio did.  The case is Buffalo Wild Wings, Inc. [BWW] v. BW-3 of Akron, Inc.  Franchisor BWW sent the Akron franchisee a notice of the default for failure to update operating standards.  The Akron franchisee had 30 days to cure the default.  The Akron franchisee looked at the price tag to update and decided ‘naww not doing that.’  Instead the Akron Franchisee de-branded and began operating as an independent business using the name Gridiron Grill.
Franchisor sent the Akron Franchisee a Notice of Termination of Licensing Agreement but stated that it was holding termination in abeyance pending resolution by this case at hand.

Can the Akron franchise claim wrongful termination of the franchise?

The Court said ‘No.’  The franchise was not terminated.  The Akron franchisee abandoned the franchise by ceasing to the operate the business under the BW-3 name.  The Akron franchisee’s counterclaim for wrongful termination of the franchise agreement was dismissed.
The Court further sided with franchisor BWW maintaining that the Akron franchisee’s failure to the update the franchise per brand standards could, in fact, be a violation of franchisor’s trademark rights and could possibly lead to customer confusion.

When Can the Franchisor Withhold Approval?

Franchisee enters into a Purchase Agreement for the sale of 5 franchises.  Under the Purchase Agreement, the Purchase Price is $880,000.00 for each franchise or a total Purchase Price of $4,400,000.
The franchisor refuses approval for the sale of the franchises.  A over 4 million dollar sale on the line and the franchisor refuses to give approval for the transfer. Franchisor says it would only approve the sales transaction if the purchase price is reduced to $550,000, the estimated the value of the equipment of the five franchises.  How do you reconcile this?  The Franchisor will consent to the sale if the Purchase Price is reduced to 1/5 of what the franchisee seller and buyer agreed upon in the Purchase Agreement.
Can the franchisor do that?  Franchisee asserts not. The franchisor did not even evaluate the potential buyer to see if the buyer qualifies.  A look at the Purchase Price, approve withheld.  Franchisee files a complaint for more than a half dozen claims.  The case is Picktown Foods, LLC, et al. v. Tim Hortons USA, Inc.  In a claim by claim analysis, the Court dismissed claims in turn for lack of pleading or factual deficiencies.  But the Court upholds franchisee’s claim for Tortious Interference with Contract.

The franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The premise of the franchisee claim is that the franchisor failed to act upon an obligation to proceed in good faith.  The franchisee alleges the franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.  The conditions for franchisor approval of transfer as stated in the franchisee agreement did not state that the Purchase Price had to be equal to the franchise equipment value.  Item 17 of the franchise disclosure document did not state the Purchase Price must be equal to the franchise equipment value.  The franchisor did not evaluate the buyer qualifications.
Was the franchisor’s denial of the transfer in bad faith?  Was it Tortious Interference with Contract?  The case proceeds to trial for  determination.

What Financials are Required for Startup Franchisors?

The Federal Trade Commission Franchise Disclosure Laws [FTC Franchise Disclosure Rule] requires disclosures in item 21 of the Franchise Disclosure Document [FDD] of the franchisor’s financials.  Typically, the financials of the franchisor must be audited by an accountant.  This can be costly and timely.
The FTC Franchise Disclosure Rule cuts new franchisors a little slack.  It allows startup financials for new franchisors.  In the first year of franchising, the franchisor financials do not need to be audited.  The franchisor simply needs to include an opening balance.


What is Required

Year 1 Unaudited opening balance sheet
Year 2 Audited balance sheet opinion
Year 3 All required financial statements for the previous fiscal year, plus any previously disclosed audited statements.

For year two, franchisors are going to need to contact an accountant.  But, a full-blown audit is not required. For year two franchisors will need an audited balance sheet opinion.
Year 3 the franchisor is like established zors.  A standard audit is required.
This is the federal law.  Most states accept the federal law startup financials for the franchisors.  But caution, there are a few states that do not accept startup franchisor financials including Minnesota, New York, and Rhode Island, Illinois, and Virginia.

When is Franchise Transferee Bond?

One of the inalienable rights to owning your own business is the ability to transfer and sell your business. The sale and transfer of a business can be tenuous with many moving parts.  In the franchise world, this already tenuous transaction is further complicated.  Once a franchise seller and prospective franchisee buyer come to deal, the franchisor must approve the sale.
When approving the prospective franchise buyer, the franchisor will review the sales agreement, vet the prospective franchisee buyer, and set stipulations to the sale.  Common stipulations, among other things, includes payment of a transfer fee and payment any outstanding debt.
In some extenuating situations, there may be an urgency to the transaction because of health or family issue, finances of the franchisee, and other general life issues.  The formalities and the work-through of the sales process can be arduous.  However, the push to forgo the formalities and work-throughs should be thwarted.  Failure to do so may yield an inability to protect the franchise business and the franchise brand.
Hence the case of Rocky Mountain Chocolate Factory v. Timothy Arellano et al.  Franchisee and a buyer, defendant Arellano entered into protracted sales negotiations.  A sale agreement was sent to the franchisor, Rocky Mountain Chocolate Factory [RMCF].  Franchisor RMCF approved the franchise transfer pursuant prerequisite conditions, including among other things, the payment of delinquent amounts owed totaling $25,000.  The prospective franchisee buyer took over the operation of the franchise prior to the sale of the franchise being perfected or franchisor giving approval. Franchisor RMCF accepted and filled orders for inventory from the prospective franchisee buyer, Arellano, that had taken over the store.
The sale negotiations broke down.  No one wanted to pay the delinquent $25,000 owed to the franchisor.  Franchisor terminated the franchise agreement for failure to pay the $25,000.  But, by this time the prospective buyer and defendant Arellano has taken over the franchise business.  Despite the termination, Arellano refused to cease business operations or de-brand the business.  Franchisor sued Arellano in the franchisor’s home state of Colorado.  It was a dead stop, brick wall.  Franchisor does not have personal jurisdiction over Arellano because Arellano never signed the franchise agreement or anything else.
Hoping nothing goes wrong and bending does not always work out for the best.  When working through a transfer process, it is important to follow procedures carefully.  There are lots that can go wrong and remember until the buyer signs on the dotted line; there is not much that can be enforced.

When Can You Recognize Initial Franchise Fees?

As part of franchise disclosures, franchisors are required to disclosure financials.  The financials included in the franchise disclosure document [FDD] must be prepared in accordance with U.S. GAAP standards, which are set by the Financial Accounting Standards Board [FASB].
GAAP Standards were recently updated by the FASB.  One of the changes called into question how franchisors recognized initial franchise fees in their financials.  Instead of being able to include and recognize the entire initial franchise fee as revenue, franchisors would have to amortize the initial franchise fee over the life of the franchise agreement.
Per an article in Franchise Times:

There were a lot of changes (which you can read about here) but one of the trickiest was how initial franchise fee revenue was to be recognized……So instead of being able to take those funds into income in year one, to be spent on site selection help, training, equipment or anything else, it looked as if most of the fee revenue would have been recognized over time, which wouldn’t have been consistent with how franchisors work in practice.

This would hit hard against the franchisor’s financials in year one.  Franchisor revenues would be lower at a time when the cost to franchisors for startup cost for such things as training, site selection, and prospect franchisee vet are highest.  As a result, there would a lower bottom line for franchisors on paper and higher hard cost.
The FASB is giving a little relief.  A quote of staff issued FASB highlighted in the Franchise Times states:

One of the most prevalent questions from the franchising industry involves determining whether or not pre-opening activities constitute a distinct performance obligation. Under current GAAP, franchisors generally recognize the initial fee when the location opens and recognize the subsequent royalty stream over time. Because industry-specific GAAP exists, franchisors historically have not had to assess whether the pre-opening services are a separate deliverable. In making this determination under the new standard, the first step for the franchisor is to determine if the pre-opening activities contain any distinct services. If none of the pre-opening services are distinct, then the initial fee would be part of the transaction price for the combined performance obligation of the license and services and, thus, recognized over the entire license period.

For a link to the full link to the FASB handout.  Visit the link above.
Franchisor financials are big deal.  Franchisor financials matter when prospective franchises consider the brand.  And, it is used by state examiners to determine if initial fees must be deferred or escrowed or alternatively a surety bond is required.

When does a Franchise Claim Becomes Stale?

As the old adage goes nothing lasts forever.  Under the Federal Trade Commission [FTC] Franchise Disclosure Rule, Franchisors are required to provide prospective franchisees with accurate and complete disclosures.  Failure to provide complete and accurate franchise disclosures can provide fertile ground for franchisee claims of unfair or deceptive trade practices.  But, a claim of a franchise disclosure violation should not be left to age and ferment on the counter like a loaf of bread. It will become stale.
The case is Haigh et al. v. Superior Insurance Management Group, Inc. out of the North Carolina.  Five franchisees sued their franchisor, Superior Insurance Management Group [Superior Insurance] for unfair or deceptive trade practices, breach of contract, breach of the covenant of good faith and fair dealing, breach of fiduciary duty, and declaratory judgment.  Superior Insurance moved to the dismiss claims of-of unfair or deceptive trade practices claiming the statute of limitation had run.

When the period of time specified in a statute of limitations passes, a claim might no longer be filed, or, if filed, may be liable to be struck out if the defense against that claim is, or includes, that the claim is time-barred as having been filed after the statutory limitations period.
In North Carolina, a claim of unfair or deceptive trade practices must be brought in 4 years or the claim is time-barred.  The franchisee plaintiff signed their franchise agreements at issue between 2009 and 2011, clearly beyond the 4-year statute of limitations.  The court held that

‘Superior Insurance’s failure to provide the disclosure and the resulting Franchise Rule violation were necessarily apparent to the plaintiffs before they signed their franchise agreements[i].

Franchisee waited too long to bring franchise disclosure disclaims.  If the franchisees were harmed by inaccurate or incomplete disclosures in the franchise disclosure [FTC], they would have brought the claims earlier.
Each state has their own statutes of limitation for unfair or deceptive trade practices.  And, that the statutes of limitations for unfair or deceptive trade practices, do not apply to breach of contract, breach of the covenant of good faith and fair dealing, and breach of fiduciary duty.  These claims have their own statute of limitations.  It is well serving if a claim arises, to raise it.  And inverse if a claim is raised, look at the date when the events occurred.
If the statute of limitations has expired or passed, it is as if the wrongdoing [if any] did not occur.  There will be no recovery, no money damages awarded.
[i] No. 17 CVS 2582 Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,072!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D–WKUS_TAL_11587%23wkus3855179a1c868c1d7818c62702944aab?searchItemId=&da=WKUS_TAL_11587

What is Unlawful About Franchise Designated Supplier?

Years after the franchise agreement was signed franchisor designated and began to require franchisees to purchase windows from a designated supplier.  The designed window supplier charged franchisee higher window prices than other window buyers.  Franchisee discovered that franchisor derived a large part of the revenues from designated suppliers including the designated window supplier.
Franchisee filed a complaint in court against the franchisor and the designated window supplier alleging a violation of the Robinson-Patman Act; violations of the Sherman Antitrust Act; and violations of the Racketeer Influenced and Corrupt Organization Act [RICO].  The case is Bendfeldt v. Window World, Inc.

The Robinson-Patman Act provides in pertinent part:
It shall be unlawful for any person engaged in commerce…to discriminate between different purchasers of commodities of like grade and quality…where the effect of such discrimination may be substantially to lessen competition or tend to create monopoly in any line of commerce or to injure, destroy, or prevent discrimination with any person who either grants or knowingly receives the benefit of such discrimination or with customers of each of them…

The franchisee could prove that it was paying high prices than other window buyers in the Midwest and Nationally.  But, the franchisee did not produce evidence showing that franchisee lost sales to any local competitor which purchased the windows at lower prices.

A Sherman Act prohibits A tying arrangement that
is ‘defined as an agreement by a party to sell one product but only on the condition that the buyer also purchases a different (or tied) product.’ Tying suppresses competition in two ways: ‘First, the buyer is prevented from seeking alternative sources of supply for the tied product; second, competing suppliers of the tied product are foreclosed from that part of the market which is subject to the tying arrangement.’” It's My Party, Inc. v. Live Nation, Inc., 811 F.3d 676, 684 (4th Cir. 2016) (internal citations omitted). The Amended Complaint alleges that WW's “‘license’ for use of its trademarks, trade dress and business methods was the ‘tying’ product and that [AMI's] windows and associated materials served as the ‘tied’ product.” (Am. Compl. ¶119.) No. 5:17CV39-GCM Business Franchise Guide - Explanations, Laws, cases, rulings, new developments ¶16,048!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D--WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

The franchisee could not show that the franchisor and the designated supplier had market control [dominance] .

 “When pled as RICO predicate acts, mail and wire fraud require a showing of: (1) a plan or scheme to defraud, (2) intent to defraud, (3) reasonable foreseeability that the mail or wires will be used, and (4) actual use of the mail or wires to further the scheme.” Wisdom v. First Midwest Bank, of Poplar Bluff, 167 F.3d 402, 406 (8th Cir. 1999). “[T]he term ‘scheme to defraud’ connotes some degree of planning by the perpetrator, [and] it is essential that the evidence show the defendant entertained an intent to defraud.” Atlas Pile Driving Co. v. DiCon Fin. Co., 886 F.2d 986, 991 (8th Cir.1989) (alterations in original) (quoting United States v. McNeive, 536 F.2d 1245, 1247 (8th Cir.1976)). No. 5:17CV39-GCM Business Franchise Guide - Explanations, Laws, cases, rulings, new developments ¶16,048!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D--WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

There was no fraud.  The franchisor did not deceive the franchisee.  The franchisee knew that the franchisor could designate suppliers.  And, the franchisee know it would have to buy from the suppliers that franchisor designated.

The Bendfeldts [Franchisee] knew from the moment they signed their agreements that WW [Franchisor] could change the number and identity of approved window suppliers. They admit that they agreed to buy windows only from WW-approved suppliers: In other words, Plaintiffs [Franchisee] were on notice that WW [Franchisor] could designate one approved window supplier if it wished to do so. No. 5:17CV39-GCM  Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,048!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D–WKUS_TAL_11587%23wkusd11363f92971876f09323a8ab40c1a1f?searchItemId=&da=WKUS_TAL_11587

In short, all of the franchisee’s claims regarding designated suppliers failed.  It is not unlawful for franchisors to designate new or different supplier after signing the franchise agreement.  And, it is, not unlawful for the franchisor to derive revenues from designator supplier sales to franchisees.
It may make a franchisee or all franchisee mad.  It may increase franchisees’ operating cost.  But, these things alone are not sufficient to be unlawful.  More is required to show required for wrongdoing.

How Your Trademark May Limit Expansion

To gain trademark rights all you have to do is begin using the trademark.  From the day that you begin using a trademark, you garner trademark rights without doing any more than using the trademark.  This is referred to common law trademarks rights.
Common law trademark rights give your superior exclusive rights to the trademark name, above all others henceforth in the area that you are doing business.  However, common law trademarks rights are limited to the area in which you do business.

 Common law trademarks rights are limited to the area in which you do business.

To get trademark rights beyond the area in which you do business, you must register the trademark with the USPTO [United States Patent and Trademark Office].  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration even if you are not doing business nationally.  In addition, upon a USPTO registration, an infringer of your mark will be liable for greater damages including attorney fees.

  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration.

The limits of common law trademark rights are being tested in a recent case reported to the Credit Union Times.  The Red River Bank has filed a trademark infringement complaint against Red River Federal Credit Union [FCU].  For years Red River Bank established 1999 in Louisiana and Red River FCU established 2008 in Texas coexisted without complaint.  Then Red River FCU acquired branches in Louisiana and Mississippi.  This was too close for comfort.  As reported in the Credit Union Times Red River Bank’s complaints states:

“RRB [Red River Bank] has received numerous inquiries from members of Shreveport Federal Credit Union and the community at large regarding their belief that RRB [Red River Bank] has taken over Shreveport Federal Credit Union.”

If you have an expansion plan or if you want to protect your name beyond the common law, a federal trademark is a must.

How Far Does a Franchise Non-Compete Reach?

Perhaps without exception, franchise agreements include post-termination non-competes and non-solicitation.

A non-compete prevents the franchisee from owning or working for a business that competes with the franchise.
A non-solicitation prevents the franchisee from contacting the customers of the franchise business to offer products or service that are offered by the franchise business.

There are non-competes and non-solicitations that span during the franchise agreement and post the termination, expiration, or transfer of the franchise.  The enforceability of the franchise agreement’s non-compete and non-solicitation is dependent on state law.  Except for the case of California, non-competes and non-solicitation are enforceable if the duration of the non-compete is reasonable as to time and duration.
The general rule is that a non-compete and non-solicitation is only enforceable against the signers of the non-compete and non-solicitation.  However, this case provides an all too common exception.  The case is The Maids Int’l, Inc. v. Maids on Call, LLC. 
In this case, Plaintiff franchisor and Defendant franchisee entered into franchise agreements for the operation of the a The Maid franchises.  Franchisor terminates the franchise agreements for under-reporting gross revenues and failure to pay royalties.
Post the termination of the franchise agreement, franchisee’s daughter opened a business called Two Sisters that offers maid services at the same location and used the same Facebook page email as the former franchise business.  The location which the Two Sisters operated continued to bear the signage of the former franchise business.  Two Sister used the same vehicles that were registered to the former franchise.  The form franchisee sent a retirement letter to its customers that said:

SARA, STACEY and MILLIE are ready to take over. (They really have been running the business for many years)………..most everything will remain the same,”

No. 8:17CV208 Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,047!csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A1F7BEF-FFD4-4348-9D22-81311C5BA95F%7D–WKUS_TAL_11587%23wkusa59bc1eda5dc7d31154eda7cfd249493?searchItemId=&da=WKUS_TAL_11587

The court found privity and connectivity between the franchisee and Two Sisters.  Therefore, despite Two Sisters being a separate corporation with different owners, the non-competition and non-solicitation under the franchise agreement were enforceable again Two Sisters.  The court ordered Two Sister [in addition to the Franchisee and franchisee owners] to:

  • Stop using the franchise marks- i.e., remove the signage
  • Stop offering offer and providing service in violation of the non-compete
  • Stop soliciting the franchise business customers

An extraordinary outcome.  Would there have been the same outcome if Two Sister had not been owned in part by the franchisee’s daughter?

How a Franchise Mediation Can Precludes Injunction

There is no set way franchise disputes must be settled.  Sure, there are some state laws that require the laws where the franchise business is located to prevails and the alike.  But, there is no per se way that franchise disputes must be resolved.  The franchisor in drafting the agreement can require mediation, arbitration, litigation and any combination thereof.
However, once decided, the language in the franchise will dictate [except for the state law limitations]; therefore, it behooves one to read and re-read to ensure proper steps are followed.  Failing to do so, will result in one spinning his/her wheels.
Hence is the case of World of Beer Franchising, Inc. v. MWB Development I, LLC, et al.  Under the franchise agreement entered into between the parties’ disputes were to be resolved via non-binding mediation and arbitration, except in disrupts regarding the trademark and in which case a junction through the court may be sought so long as a petition for non-binding mediation was petitioned contemporaneously.


A dispute regarding the trademark and other issues ensued.  Franchisee was buying services and products from unapproved suppliers.  The franchisor and franchisee agreed to a mutual termination, but franchisee continued business under the trademark after the mutual termination of the franchise agreement.
The franchisor filed a petition for an injunction in court.  The court denied the injunction on the basis that no petition for non-binding mediation was filed.  This case is a reminder that once in writing alternative dispute resolution [mediation and arbitration clauses], even post the termination of the franchise agreement, shall be enforced to the fullest extent permitted by law.