Quick Fact:
Plaintiff Rib City Franchising, LLC, enters into a franchise agreement with Toni Jorgensen for Rib City franchisee. The franchise agreement is sequecently terminated for breach of contract. Toni Jorgensen sell the assets of franchise to Sara Bowen post the franchise Termination. Sara Bowen open a restaurant at the same location, using the same telephone number, website [and website content], and made no changes to the interior restaurant layout, decor, color scheme, wall hangings, artwork, dark-colored wood booths, hanging light fixtures, and hanging window frames previously used in Rib City Grill, and kept the menu basically the same. Sarah Bowen called her new restaurant Pig City BBQ.
The issues:
While there is a non-compete with franchisees and former franchisee, there is no non-compete with 3rd parties.
Solution:
Sue anyone that buys former franchisee assets and attempts to operate a completing business using the franchisee system’s décor [referred to as trade dress in legal terms], menu, and steals social media content and accounts on claims of trademark infringement and misappropriation of trade secrets [in common lingo stealing and using].
Outcome: The court said:
• No relief for similar names Pig City and Rib City. The court argued that Pig and Rib sound significantly different. And, Rib City Grill is not ‘conceptually or commercially strong.’ On the spectrum Rib City is a descriptive with diminished enforceability.
• No Relief for using Trade Dress: The décor including interior restaurant layout, decor, color scheme, wall hangings, artwork, dark-colored wood booths, hanging light fixtures, and hanging window frames was not distinctive enough to be trademark protect-able.  The décor was not distinctive enough to get trade dress protection.
• No relief for the menu and receipts. The court said that the menu was distributed to the public, so the menu could not be confidential. And the receipts, Rib City said that had to provide it that could not just say is tasted like their receipts.
Lessons to Learn:
1. Do de-identify locations post termination
2. Do create arbitrary and fanciful trademarks not descriptive trademarks
3. Do not share anything that you want to keep confidential
4. Don’t let franchisee have their own URL addresses
5. Maintain control of social media accounts
The lessons learned are not just for the benefit of franchisors. It is for all other franchisees in the system that have to compete with a copycat.
 
The case: Rib City Franchising, LLC v. Sarah Bowen, et al. in the Central District of Utah.

It is common place within the franchise industry that a franchisor requests a franchisee to complete a questionnaire before signing the franchise agreement saying that franchisor followed disclosure protocol:
 

• Franchisee was given the franchise agreement with all blanks filled in 7 days before signing or paying any money; and
• Did the Franchisor provide Franchise Disclosure Document [FDD] 14 days before signing franchise agreement or paying any money; and
• Did the franchise rely on any earning or financial representation other than those disclosed in the franchise agreement.

In some instance the franchisor may ask the franchise to attest to the proper disclosure and no financial performance as provision of the franchise agreement.
 
Is this just more boilerplate, or do these questions and attestation have any teeth.  Do they preclude the franchisee from later alleging that they did not have proper disclosure or that there was an improper earning claim or financial performance representation made?

One case provides antidotal evidence that the franchisee’s attestation and answers on the questionnaires do have meaning.  The case is Fantastic Sams Salons Corp. v. PSTEVO, LLC.  In the body of the franchise agreement there was a disclaimer that read:
 

• NO ORAL, WRITTEN OR VISUAL CLAIM OR REPRESENTATION WHICH CONTRADICTED THE DISCLOSURE DOCUMENT WAS MADE TO ME, EXCEPT: and
• NO ORAL, WRITTEN OR VISUAL CLAIM OR REPRESENTATION WHICH STATED OR SUGGESTED ANY SALES, INCOME, OR PROFIT LEVELS WAS MADE TO ME, EXCEPT:

 
There was space provided for the franchise to insert comment or statements.  The franchisee wrote ‘none’ after each disclaimer and initial his statement.

What can you tell a buyer about a franchise outlet? Click here or go to:  http://wp.me/p4bshS-17C

 
The court reasoned that the franchisee could not have been fraudulently deceived by franchisor’s representations.  The franchise wrote none when asked.  The franchisee argued that the disclaimer did not squarely ask about the representations he alleged.  The court tossed that argument to the wind saying the franchisee should have said something, wrote something other than ‘none.’

Case dismissed.

The franchisee lost his case against the franchisor.  The franchisee’s attestation in the franchise agreement, coupled with his none response, prevented the franchisee from winning its fraudulent misrepresentation case against the franchisor.
 
It the franchisee won his case, he would have been entitled to reimbursement of his initial franchise fee, all the money he spent attempting start-up and operation of the franchise, and perhaps much more.

 
Franchisees, the franchisor, and other franchisees within a franchise system are inexplicably associated with one another.  The acts of one or a couple of franchisees can adversely impact the goodwill and reputation of the brand, the franchisor, and other franchisees within a system.  Wrongdoings by franchisees can lead to the franchisor and other franchisees fighting off unwanted liabilities.  Often times if a franchisee is sued, the franchisor will be named too in hopes that the franchisor can be tied in some indirect tangential way.  It can also lead to copycat allegations and heighten scrutiny of other franchisees in the franchise system.  All around it is bad news for the system.

So how does a franchisor respond when a franchisee is charged with a wrongdoing?  Liberty Tax has taken the route of disassociating itself and the franchise system from the accused franchisees.  The accused franchisees in South Carolina were called out by federal prosecutors for allegedly preparing false and inflated tax returns by entering inflated business income, expenses, and bogus dependents.  In response to the lawsuit filed by federal prosecutors, Liberty Tax’s Chief Compliance Offer asserted that:
 

Liberty Tax has a robust compliance program, and we expect our franchisees to make sure that their offices comply with all federal and state tax requirements.  Monday’s allegations appear to be limited to a small number of independently-owned franchised offices and prior year returns. We will take appropriate action after completing a review of both current year and prior operations at these offices.

Note in the Liberty Tax’s statement, there is no promise to close or terminate the franchise agreements of the accused franchisees.  Instead the statement attempts to protect the brand and other franchisees by saying that the South Carolina franchisees are outliners in the system.  Other franchisees did not commit the same wrongful acts.

There is good reason why Liberty Tax did not say they are terminating the franchisees.  Remember, in America, everyone is innocent until proven guilty.  While the knee jerk reaction, may be to terminate the franchisee, hast can lead to wrongful termination lawsuits by franchisees.   Liberty Tax had two choices: [1] wait till the lawsuit plays out in the courts to see  if the allegations are affirmed or [2] find affirmative evidence of wrongdoing that is ground for termination.  Liberty Tax has said it will go for number 2.  Again, wise decision.  Court cases can take years to resolve.

When faced with a situation of the franchisee’s alleged illegal or improper acts, it is important to take a step back and follow the proper channels.  At the end of the day, what if the franchise agreement is terminated and the franchisee is cleared of wrongdoing?
 

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The words ‘good faith’ and ‘fair dealing’ are vehemently thrown about when there is a dispute.  But, what is good faith?  What is fair dealing? And, is it something that applies to everything and everywhere?
 
Good faith and fair dealing are implied covenants.  Good faith and faith dealing do not have to appear in the franchise agreement or any agreement to be enforced.  Implied means it is understand to be included and applicable to the agreement.

Per Black Law Dictionary, good faith is defined as:

A state of mind consisting in (1) honesty in belief or purpose, (2) faithfulness to one’s duty and obligations, (3) observation of reasonable commercial standard or fair dealing in a given trade or business, or (4) absence of intent to defraud or seek unconscionable advantage. 

Fair dealing is defined by Black Law Dictionary as:

(1) The conduct of business with full disclosure usu. by a corporate officer to the corporation. (2) A fiduciary’s transacting of business so that, although the fiduciary’ might derive a personal benefit, all interested persons are fully appraised of the potential and of all other material information about the transaction.

When a dispute arises between the franchisor and franchisee, the first step is to review the franchise agreement.  Look at the covenants, obligations, rights outlined in the agreement.  Sometimes, the provisions in the agreement are fuzzy or there may be issues that arise between the franchisee and franchisor that are not covered or discussed in the franchise agreement.
 
Either way, good faith and fair dealing is something discussed and highlighted.  It is the ‘it is not fair’ arguments:  ‘You can’t do that.’  It includes the: ’that is not what we agreed to’ argument.  And, the ‘You did not disclose that’ when I bought the franchise.
 
What would happen if those claims of good faith and fair dealing were not available?  Hence the class action MYERS V. JANI-KING OF PHILA., INC. in the third circuit court.  In this class action law suit:
 

Plaintiffs allege, on behalf of themselves and all others similarly situated, that Defendants sold them rights to Defendants’ cleaning services franchise, and that the franchise agreements that secured those rights were, in reality, illegal employment agreements.

In count 4 of the franchisee’s multi-count complaint, the franchisee claimed a breach in the covenant of good faith and fair dealing.  The case was being heard in Philadelphia and franchisor asserted Texas law applied to the franchise agreement.  The court, looking at both Texas and Pennsylvania law, found that both states did not recognize good faith and fair claims in relation to franchisor and franchisee disputes.
 
Where are franchisor and franchisee left, if they cannot assert ‘good faith’ and ‘fair dealing’ arguments?  Where is the class action of MYERS V. JANI-KING OF PHILA., INC. without the count alleging a breach of ‘good faith’ and ‘fair dealing?’  The franchisees are left to the actual word, promises, and obligations in the franchise agreement.
 
When enforcing a franchise agreement, knowing the state laws regarding franchise agreement is important.  It can make difference as to a claim is dismissed or successful.

The Federal Trade Commission [FTC] has issued a Commission Enforcement Policy Statement on Deceptively Formatted Advertisements [FTC Statement].  The subject of the FTC Statement is advertising disguised to look like something else- i.e. educational information or customer reviews.
 
The subject is not new as the FTC points out.  The FTC has issued guidance and taken action against business dating back to the 1960’s, 70’s and ‘80s on the similar basis.  However, the FTC expressed the compulsion to issue the Statement pointing out changes and variations in the new the social media and technology realms such as videos and infographics.
Here are some examples of advertising from the FTC statement.

How do you know if an advertisement is considered deceptive by the FTC? The FTC’s answer is a little ambiguous:
In determining whether an advertisement, including its format, misleads consumers, the Commission considers the overall ‘net impression’ it conveys.  Any qualifying information necessary to prevent deception must be disclosed prominently and unambiguously to overcome any misleading impression created.
It is an ‘I know when I see it’ test, which is not very comforting or helpful.  However, there are somethings the FTC Statement suggests to lessen the likelihood that your advertising will be considered deceptive.  Here are their suggestions:

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Famous Dave’s has sold its Chicago location to an existing Franchisee that currently operates in Michigan and Ohio. The transaction is going for over 1 million. The selling of an existing corporate franchisor’s operating location to a franchisee adds a layer of complexity to the franchise sales process. The buyer is also a prospective franchisee and requires the same disclosures, agreements, and holding periods as a prospective franchisee of a new outlet.
 
There may, however, be items in the franchise agreement that require modification via an addendum to the franchise agreement, such as purchase of inventory, site selection, and time for opening.
 
Layered on the franchise sales process is a purchase agreement. Yes. The acquisition of a current operating business should be addressed in a purchase agreement. The purchase agreement and sales transaction should be akin to any other purchase or sale of a business, which includes due diligence, liabilities for prior acts, employee termination and rehiring, lease assignment or subleasing, etc.
 
The transaction for the sale of the business should not be lumped into the franchise agreement or an addendum. It should be its own stand-alone agreement.
 
The purchase agreement should be delivered with the franchise documents and run with a holding period for the franchise agreement and other agreements.
 
A management agreement may be required to allow uninterrupted operating of the location during securing of the government licensures and permits.
 

 
 

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You can’t be everywhere and do everything.  But, you want to expand quickly.  One mechanism is an area representative arrangement.  An area representative helps find, train, and supports franchisees.

 
This is the expansion mechanism that Titled Kilt Pub & Eatery [Titled Kilt] employed.  However, something went awry.  When selling franchises, Titled Kilt’s area representative -1220 LLC, allegedly provided prospective franchisees with false performance representations.  1220 LLC told a prospective franchisee that he could potentially make billions of dollars.  A prospective franchisee took the deal, and in fact bought 2 Title Kilt franchises.  When the franchise business lost money, the franchisee ran to the Title Kilt franchisor demanding a refund of the initial franchise fee.  The evidence was conclusive, 1220 LLC sent an email to the then prospective franchisee with the false franchise finance performance representations.  A second investor claims that 1220 LLC also gave false information.
 

Discovery more about Area Representatives and other multi-franchise options.  Click here or go to:  http://wp.me/p4bshS-162

 
If in fact, a false or improper performance representations were made, the franchisee may be entitled not only to the return of the initial franchise fee, but also compensation for any monies expended in buying the franchise, start-up costs, and lost profits.
 

See the 10 Franchise Financial Performance Representation [FPR] Dos and Don’ts infographic! Click here or go to:  http://wp.me/p4bshS-17i

 
Under this relationship, the area representative, can well be seen as an agent for the Title Kit franchisor making the Title Kit liable. Tilt Kilt did the right thing.  They trained 1220 LLC about the do’s and don’ts of selling franchises and giving false performance representations.  When the improper conduct of the 1220 was learned, Title Kilt sought to terminate the 1220 LLC’s area representative agreement.

When selling franchises, entering into area representative agreements, referral and broken relationships it is important to:

• ·        Educate folks about the franchise sales processes and the applicable laws;
• ·        Have prospective franchisee complete questionnaire before signing the franchise agreement asking yes and no about legal sales processes.  If is noted that if proper sale processes were not followed, don’t sell the franchise;
• ·        Take immediate and quick action regarding any reported improper franchise sales practices.

 
 

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Per the Nation’s Restaurant News:

Wendy’s same-store sales rose 3.1 percent in North America during the third quarter ended Sept. 27, the company said.  

And, there are now opportunities to franchise a Wendy’s store!

[Wendy’s] Executives expect to continue selling company-owned restaurants to franchisees, with Wendy’s on track to sell 225 locations to operators this year, and another 315 units next year.

http://nrn.com/same-store-sales/wendy-s-value-deal-drives-3q-sales
 
So what can the Wendy’s franchisor tell prospective franchisees looking at buying an existing Wendy’s location?  For the last couple of weeks, we have been blogging about franchise financial performance representations [FPR] which must be disclosed in the franchise disclosure document [FDD].
 
Read the post about FPR:

If a franchisor wishes to disclose only the actual operating results for a specific outlet being offered for sale, it need not comply with this section, provided the information is given only to potential purchasers of that outlet.

 
That means, when selling existing outlet locations, franchisors may disclose:

• To prospective franchise buyers only,
• The actual financials of the existing outlet location only,

And

• The actual financials of existing location are not subject to FTC Disclosure Rule item 19 financial performance representation requires
• The actual financial outlet information does not have to be included in the FDD

 
Before giving the actual financial, wait.  Even though the disclosure of the actual financials may not have to follow the FTC Rule, a disclaimer should be included.  Corporate operating results may be different than franchise results.  If the results are from a prior franchisee operation, you may not be able to validate or take ownership to the financials.  And, remember past operations are not necessarily a guarantee of future results.  Include a disclaimer.
 
The disclaimer should  include warnings that past performance is not a guarantee of future performance, corporate cost structures may be different from franchise, and any other circumstantial specifics that may be prudent.
 
Need help preparing a disclaimer, give us a call 513-400-3895 or send us an email [email protected]