Franchise – Gettins Law

What Price Can Franchisors Charge Franchisees for Products or Services?

The state of Washington has a franchise relationship law that requires franchisors to only charge franchisee fair and reasonable price for products and services that it sell to franchisees.

State franchise relationship laws establish limitations on franchisors’ right to act cases in terminations, renewals, and defaults. There no federal franchise relationship laws. The federal franchise laws only govern the sale of franchises — however, there almost 2 dozen states that have enacted franchise relationship laws.

The Washington franchise relationship law beckons the question of what is fair and reasonable pricing? In a recent case[i], the Washington Supreme Court gives some insight into considerations of what is a fair and responsible price to charge franchisee for products or services.

What is the fair market value of the product or services?
What price did the franchise pay for the product or service?
What do competitors charge for the product or service?
Are all franchisees charged the same amount for the same or similar products or services?
What is the franchisor’s profit margin on the product or service?

The court gives this example of unreasonable and unfair pricing:

For example, if the franchisor obtains a product for price x, and the franchisee could only obtain it on the open market for 5x, then selling it at the price of 2x might not be unfair or unreasonable—but if all other similarly situated franchisors are selling it for 1.5x, then the price of 2x may be unfair or unreasonable.

[i] MONEY MAILER, LLC v. BREWER No. 96304-5 Washington Supreme Court, September 19, 2019

https://gettinslaw.com/fact-sheet-state-franchise-relationship-laws/

Are Franchise Application ADR Provisions Enforceable?

ADR is an abbreviation for alternative dispute resolution. Arbitrate and mediate are types of alternative dispute resolution.

Following the general rule, the court in the case of Doctor’s Associates, Inc. [Subway franchisor] v. Alemayehu held that arbitration and mediation agreements are enforceable if there is adequate consideration for a binding agreement and the intent of the parties is to arbitrate or mediate disputes.

Consideration is required for arbitration and mediation to provisions to be binding. For without consideration there can be no binding agreement or contract.

“consideration may consist of a performance or of a return promise,”
Restatement (Second) of Contracts § 71, cmt. d

This case involved an arbitration provision in Subway’s prospective franchise application. Alemayehu was seeking to purchase a Subway franchise via a transfer from another Subway franchisee and thereby was required to complete a franchise application. Alemayehu’s application was ultimately denied, and Alemayehu was found unfit to be a Subway franchise. Alemayehu filed suit against Subway.

The court held that Alemayehu’s claim must be held via arbitration. Alemayehu submitted the application in exchange for Subway reviewing of the application and Alemayehu candidacy to become a Subway franchisee.

The court held that an arbitration clause with the franchise application was enforceable.

Franchisor Auditors and Inspections

Do you complete inspections and audits of your franchise locations? Are the inspections done as a matter of routine practice? Do you only complete audits and inspections if a problem is reported? If an inspection yields findings of subpar operating standards, what do you do with the results?

Following brand standards, reporting revenues, and paying royalties
goes to the core of the franchise relationship. Failure to follow the franchisor’s brand standards can irreparably harms the goodwill of the franchisor and the franchise system.

Franchise audits and inspection can be way to ensure brand uniformity, quality, and compliance with operating standards. Read about:

How Are Compliance Audits are being Conducted
When Are Compliance Audits Done
Franchisee Perspective On Compliance Audits
What Courts Have To Say About Compliance Audits

See our article that appeared in Franchise Law Journal!

Compliance Audits Rule!

cLick here

or visit: https://gettinslaw.com/publications/the-how-when-and-why-of-franchisor-audits-and-inspections/

Read the article!

Liquidated Damages for Breach of Franchise Agreement?

Liquidated damages (also referred to as liquidated and ascertained damages) are damages whose amount the parties designate during the formation of a contract for the injured party to collect as compensation upon a specific breach (e.g., late performance).
https://en.wikipedia.org/wiki/Liquidated_damages

Yes, was the answer of court in the case of Howard Johnson International, Inc. v. Manomay, LLC. The franchise agreement, in this case, had a liquidated damage provision, which allowed the franchisor, Howard Johnson, to collect liquidated damages in the event that the franchisee breached the franchise agreement. The franchisee breached the franchise agreement by not paying. Howard Johnson terminated the franchise agreement and demand payment of unpaid royalties and liquidated damages.

The court awarded the Howard Johnson the payment of unpaid royalties, attorney fees, and liquidated damages totaling $89,691.60.

[W]hen a liquidated damages clause for a commercial transaction is negotiated by parties with comparable bargaining power, the ultimate issue is whether the amount of liquidated damages is reasonable, either at the time of contract formation or the breach.
Ramada, 2018 WL 3105421, at *5

The court citing case precedent held that liquidated damages in commercial contracts negotiated by parties with comparable bargaining power are enforceable if the amount of liquidated damages is set at the time of contacting and the amount is a reasonable forecast of the harm resulting from breach.

Tipped Employees are Not Cheap General Labor

I am writing case updates for the upcoming American Bar Association (ABA) Fair Labor Standard Act (FLSA) Midwinter Report. The annual FLSA Midwinter Report will be presented at the February 2020 Midwinter Meeting of the Federal Labor Standards Legislation Committee, and I will be listed as a contributor in the printed version.

In the first case that I am reviewing, the court expanded on some legal background worthy of a blog.

Historically, we thought of tipped employees as waitresses. However, the world of tipped employees has expanded. As consumers, we tip a large number of service persons including quick-service restaurant works, uber or cab drivers, bellhops, hair and nail stylist. The list goes on.

What qualifies as a tipped employee and what does the Fair Labor Standard Act (FLSA) require for classification of a tipped employee. Here is what the court[i] said in response to these questions.

Who qualifies as an FLSA tipped employee?

“any employee engaged in an occupation in which he customarily and regularly receives more than $30 a month in tips.”

29 U.S.C. § 203(t); accord Iowa Admin. Code r. 875-217.50(2).

What are the criteria for a tipped employee?

Employers may pay tipped employees a lower base per hour rate instead of the federally mandated minimum per hour wage rate, so long as tips make up the difference lower base per hour rate and minimum wage.

Except, however, if the employee performs untipped duties related to the employee’s tipped occupation take up a substantial amount of his or her work time—more than 20%— or duties unrelated to the employee’s tipped occupation, than the employee is entitled to be paid minimum wage for that non-tipped labor.[i]

There is another call-out. The classification of the tipped employees described above is based on the Federal Fair Labor Standard Act. States may and do have statutes and regulations regarding minimum wage, tipped employees rates and qualifications.

[i] The DOL’s Field Operations Handbook

[i] HOWE v. JOHNNY’S ITALIAN STEAKHOUSE, L.L.C., 2018 WL 6521496 United States District Court, S.D. Iowa, Central Division, Case No. 4:16-CV-00086-SMR-HCA. September 11, 2018.

You May Need More Capital To Offer and Sells Franchises in California

There are no hard and fast rules about how much capital or money a franchisor is required to have in the bank. If a franchisor has limited amounts of funds in the bank, a state may require the franchisor to include a risk factor on the state cover sheet of the franchise disclosure document [FDD]. For new franchisors or franchisors that have limited amount of funds, a state may require a franchisor to defer initial franchise fees, initial escrow fees, or secure a bond.

Based on a new policy, California is requiring Franchisors to have additional capital.

However, based on recent comment letters and conversations with the examiners in California, California requires something new. Based on a new policy, California requires Franchisors to have additional capital. The amount required is still convoluted. However, when registering in California, franchisor should plan on having an amount equal to the initial franchise fee in the bank. Without sufficient funds in the bank, the state of California may refuse the franchise registration application.

The New and Expanded Franchise State Cover Page

On May 19, 2019, the NASAA [North American Securities Administrators Association] Membership issued instructions for the new Franchise Disclosure Document [FDD] state cover page. The state cover sheet is expanding. It is now 3 pages, not just one. The pages include:

How to Use This Franchise Disclosure Document
What You Need to Know About Franchising Generally
Special Risk(s) to Consider About This Franchise

The first page, How to Use This Franchise Disclosure Document, is a table with 8 questions in the first column and in the second column, a cross-reference in the franchise disclosure document. A narrative above tables states the mission of the table. The narrative reads:

Here are some questions you may be asking about buying a franchise and tips on how to find more information:

The question includes:

How much can I earn?
How much will I need to invest?
Does the franchisor have the financial ability to provide support to my business?
Is the franchise system stable, growing, or shrinking?
Will my business be the only [XYZ] business in my area?
Does the franchisor have a troubled legal history?
What’s it like to be [an XYZ] franchisee?
What else should I know?

The next page, What You Need to Know About Franchising Generally, is 7 general statements about franchising on the topics including:

Continuing responsibility to pay fees.
Business model can change.
Supplier restrictions.
Operating restrictions.
Competition from franchisor.
Renewal.
When your franchise ends

The final page, special risk factors page, is kin to the risk factors required by the prior version of the state cover sheet.

Franchisors must comply with the new state cover page requirements by January 1, 2020.

Is a Franchise Default Notice Grounds for Wrongful Termination?

The liability for the wrongful termination of a franchise agreement can be considerable, lost profit for the remainder of the franchise term and perhaps other damages.

Here is the facts Franchisor requests licensee to remodel the franchise location to conform to current standards. Licensee does not. Franchisor sends franchisee a default notice for failing to update the location. Licensee still does not update. Franchisor sends the licensee a notice of termination, files a complaint in court staying the termination. Licensee de-brands and continues to operate under a new name.

Can the Franchisor be held liable for wrongful termination?

The case is Buffalo Wild Wings, Inc., v. BW-3 of Akron, Inc., et al.[i] No, said the court. Since the Licensee closed the business, de-branded, and opened under a different name, the Licensee abandoned the business. The Franchisor never terminated the license. The Franchisor is not liable for wrongful termination.

Interesting case, but would the come be different if the franchisor had not stayed the termination?

[i] No. 17-4291

Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,378

Buffalo Wild Wings, Inc., Plaintiff/Counter-Defendant-Appellee v. BW-3 of Akron, Inc., et al.

Free is Not a Violation of a Franchise Non-Compete Covenant

The enforceability of a non-competition covenant is based on state law. Generally, and perhaps uniformly, non-competitions are disfavored under the law. Hence they are very narrowly construed.

Restrictive covenants on employment may not be used to bar individuals from entire fields of work simply to limit the employer’s competition.
e.g., RLM Commc’ns, Inc. v. Tuschen, 831 F.3d 190, 196–97 (4th Cir. 2016)

A case out of Maryland involving Senior Helpers provides a real-life example[i]. Franchisee signs a Senior Helpers franchise agreement barring the use of Senior Helpers confidential information and engaging in a competitive business post the termination of the franchise agreement. Competitive business under the franchise agreement is defined as Any home health care or in-home care agency or business that offers or provides non-medical care, companionship services, personal assistant services.

Franchisee sales its Senior Helpers franchise to another franchisee and starts a business offering dementia care training and consultation to senior care facilities and family members of individuals with dementia.

[A} a non-compete provision restricting a former employee from working directly with similar businesses was overbroad and thereby unenforceable because the restriction was not tethered to actual work the employee had performed for the employer)

Seneca One Finance, Inc. v. Bloshuk, 214 F. Supp. 3d 457, 461-62 (D. Md. 2016)

Senior Helpers sues for the breach of the non-competition. In promoting its services and preparing treatment plans, Senior Helpers includes information and education about dementia. Hence, dementia care training and consultation to senior care facilities and family members of individuals with dementia is a violation of the non-competition.

The court rejected this deduction. Senior Helpers franchises offer companionship services and assistance. Senior Helpers offers dementia education free to promote its services, and incorporated dementia education into their treatment plans without charging. Senior Helpers does not charge for dementia education. Senior Helpers cannot bar others from selling and competing based on a service they do not charge.

[i] SH Franchising, LLC d/b/a, Senior Helpers v. Newlands Homecare, LLC, et at. Civil Action No. CCB-18-2104 Business Franchise Guide – Explanations, Laws, cases, rulings, new developments ¶16,353

How Much Can Franchisees Be Charged?

It shall be an unfair or deceptive act or practice or an unfair method of competition and therefore unlawful and a violation of this chapter for any person to sell, rent, or offer to sell to a franchisee any product or service for more than a fair and reasonable price.

RCW 19.100.180(2)(d)

One long hot button issue in franchising is charges, profits, and rebates that franchisors receive from franchisee purchases. In addition to being the brand owner, franchisors may also be the supplier of goods or services to franchisees. Franchisors have the right to be paid for service and value tendered. But on the flip side, exorbitant charges can render the franchisee unprofitable and uncompetitive in the market place.

Within ever contract, including franchise agreements and supplier agreements, there is implied a duty of good faith and fair dealing. This can translate into to not charging unreasonable fees. The obligation of good faith and fair dealing is not written in the agreement, but rather is an implied obligation in every agreement. It is assumed.

Washington state’s franchise law has codified into law the obligation of good faith and fair dealing. In pertinent part, the codification is quoted above. The Washington law says it is “unfair or deceptive act or practice or an unfair method of competition……to sell, rent, or offer to sell to a franchisee any product or service for more than a fair and reasonable price.

A test of what is a fair and reasonable price was challenged in the case of Brewer v. Money Mailer, LLC. The court declined to state a bright line rule about what is an unreasonable price. But did say:

Selling printing services to a franchisee at more than twice what those services cost violates this provision.

ORDER GRANTING IN PART BREWER’S MOTION FOR SUMMARY JUDGMENT – 5

The court’s in its order granting summary judgment solely looked at the franchisor’s actual cost of services and the fee charged franchisees. The court did not, and it is unknown if the parties present evidence regarding of fair market valve or competitor pricing for like services. The court, in hand, disregarded per se the franchisor’s argument that it provided considerable benefit for the fees charged franchisees.

As a matter of law, huge markups in the price of a product or service that a franchisee is required to purchase from the franchisor are simply not permitted.
Id.

The take away is when determining fees charged franchisee. Look at the cost. Irrespective of the benefits bestowed or competitor pricing, the fees charged franchisee must be reasonable something less than twice the actual cost.