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. 

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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:

  1. How much can I earn?
  2. How much will I need to invest?
  3. Does the franchisor have the financial ability to provide support to my business?
  4. Is the franchise system stable, growing, or shrinking?
  5. Will my business be the only [XYZ] business in my area?
  6. Does the franchisor have a troubled legal history?
  7. What’s it like to be [an XYZ] franchisee?
  8. 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:

  1. Continuing responsibility to pay fees.
  2. Business model can change.
  3. Supplier restrictions.
  4. Operating restrictions.
  5. Competition from franchisor.
  6. Renewal.
  7. 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.

Possible New Limits for Franchisors in Florida

The Florida senate is putting forth a bill to limit franchisor ability to renew, terminate, or refuse franchisee transfer. The bill written by Senator Latvala purposes, per the bill, to create laws, unless under good cause and/or certain circumstances and notice, prohibiting franchisors from:

  • terminating a franchise
  • refusing to renew a franchise
  • denying ownership of a franchise after the death of the franchisee
  • preventing a franchisee from selling or transferring a franchise, assets of the franchise business, or an interest in the franchisee
  • intentionally misrepresenting or failing to disclose specified information;

The bill being considered in for Florida is not unique. Many states have laws regarding the termination, renewal, and transfer of the franchise.
The law carries some teeth providing that violations constitute a misdemeanor of the second degree; providing penalties; providing that a person may be awarded certain damages, attorney fees, and other costs under specified circumstances; providing that certain actions are deemed unfair and deceptive; authorizing the Department of Legal Affairs by itself or jointly with the Department of Agriculture and Consumer Services to sue a franchisor on behalf of certain persons for specified violations.
The bill also provides remedies for a franchisee or an aggrieved or injured person under certain circumstances; authorizes punitive damages under certain circumstances; authorizes the Department of Legal Affairs or the state attorney to bring an action for injunctive relief or other civil relief under certain circumstances; and clarifies that specified remedies are in addition to existing remedies.
This bill is not law and will not be law until and unless enacted. However, this highlights the need to review state laws prior to not renewing, terminating, or denying franchisee transfers. As mentioned, many states already have laws regarding renewal, termination, and franchisee transfers.
Franchise Relationship Laws.

HIPAA Alert: Is Your Franchise System Covered?

bigstock-Business-team-covering-face-wi-46872919There are franchises in countless industries: food service, home repair, business services, entertainment and recreation, personal care services, and health care. Yes, health care franchises. Health care franchises include concepts that provide health, nursing, physical therapy, dental, urgent care, massage, chiropractic, and rehabilitation services. And, franchises that offer and sell health care devices and products such as hearing aids and prescription eye glasses and contacts. It does not stop there.
Being part of the health care industry carries special privacy and security considerations. Every business is concerned about privacy and security, but entities working in the health care industry, are held to a higher standard. At the federal level, there is the HIPAA privacy and security and at the state level there are numerous health care privacy and security laws.   HIPAA is the federal law that covers health care privacy and security. The mandates of HIPAA can be robust and a concern for everyone in the health care industry.

As with laws that directly affect the franchise business operations, the franchisors may take the position, it is the responsibility of the franchisee to comply.  Yes, as part of the franchise disclosure document or FDD, the franchisor is required to disclose laws that affect the franchise business operations in Item 1.  And, the franchisor may provide an overview of HIPAA during the initial training.  But, at the end of day, the fall back is the provision in the franchise agreement that says:  “It is the franchisee’s sole obligation and responsibility to operate the Franchise Business in compliance with any and all applicable laws.” 

Wait, no so fast.  HIPAA ALERT:  IF YOUR FRANCHISEES ARE COVERED BY HIPAA, FRANCHISOR MAY BE OBLIGATED TO CONFORM TO HIPAA STANDARDS.

If the franchisor views patient information for consultation with the franchisees,completes audits or consumer satisfaction surveys, or has access patient information- the franchisor may be considered a business associate and thereby obligating the franchisor to comply with HIPAA mandates.
What does HIPAA compliance require? HIPAA compliance requires the:
Signing of business associate agreements
Developing of privacy policies and procedures
Developing of security policies and procedure
Training of staff and workforce members
Providing of notification to patient and the Department of Health and Human Services in event of breach
The ideology of franchising is built-on uniformity; the use of a single brand name and the uniformity of one operating system that transcends varying demographic and geographic territories. The innate uniformity of franchising beckons for the development of franchise system-wide HIPAA safeguards and HIPAA compliance. Does not make sense if franchisors and franchisees alike use the same mode and means of communication, the same mode and means of storing information, and access information that system-wide HIPAA policies and procedures are developed uniformly to safeguard these means and modes of communication, storage, access, and disclosure of information.
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For more information about HIPAA and health care privacy and security, sign up for our HIPAA newsletter at:  http://eepurl.com/IB1kH
 



 

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!

Franchisor left on the hook for state law violations.

Copyright 123RF Stock Photos
Copyright 123RF Stock Photos

Recently on the Gettins’ Blawg, we discussed the case of CHUTICH et al v. PAPA JOHN‘S INTERNATIONAL. In that case, consumers were trying to hold the Papa John franchisor accountable for endorsing a franchisee practice of texting a consumer contrary to federal consumer protect laws. Franchisors working nationally should be aware and informed about national laws. That is a no brainer!

Should franchisors be responsible for complying with laws in all 50 states? Knowing and acting in compliance with federal law is hard enough. But, that may not be enough! If franchisors are implementing nationwide franchise programs, franchisors need to know and comply with laws in all 50 states! Take the case of Simpson v. Best Western International, Inc. Simpson and a group of the callers to the Best Western reservation line are suing Best Western for recording their cell phone calls to the reservation line in violation of the California law.

We have all heard the pre-record message: “This call may be recorded for quality assurance purposes.” That message is given in order to comply with state law requirements. States have various laws regarding the recording of the phone conversations. State laws are not the same. The statute in this case is a California law that pertains to cell phone calls. Not all states have this same law or even a law similar. Best Western could be liable for $5,000 for each cell phone call made to or from a California caller. How many calls do you think occurred between the Best Western reservation line and California callers? This could add up to a huge liability for Best Western!

So what is the best practice for franchisors that are implementing national or centralized franchise programs? The franchisor cannot possibly engineer a national reservation line or other national initiatives specifically tailored to the laws in each state. What is a franchisor to do? Franchisors need to apply the highest dominator approach. Franchisors need to be aware of differing state laws and implement national programs that satisfy the most restrictive state law mandates.

Business take away: Apply the highest dominator approach when implementing national franchise programs!

I paid the minimum royalty fee. Can I still be in default of the franchise agreement?

Franchise Agreements may contain minimum royalty fee requirements and performance standards. What is the difference between the two? Can you be in default even if you pay the minimum royalty fee amount? Listen to the video and learn the answers.
 

Minimum Sales Requirement More Than Double in 10 Years

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Over the last 10 years or so, franchisors have begun including performance standards, minimum gross sales requirements, and minimum royalty rates in their franchise agreements. Whatever vintage they are (sales requirements, minimum sale or royalty), the whole rationale is this: The franchisor wants to make sure that the franchise territory is not tied up, underperforming, or underutilized.

The performance standards, minimum gross sales requirements, and minimum royalty rates are commonly stated in straight dollar amounts. Those dollar amounts may seem a bit measly, when the franchise agreement comes up for renewal 10 years later.

The franchisor can up the dollar amounts at the time of renewal. Right? One franchisee argued no way, no go. The case is Home Instead, Inc. v. David Florance et. al. The franchise agreement in question stated, in pertinent part, “The franchisee must maintain minimum gross sales of $30,000 per month after the end of the fifth year of operation of the Franchised Business through the end of the term of this Agreement or any renewal term of a renewal Franchise Agreement (the Performance Standard).”

In this case the franchisor wanted to raise the $30,000 to $70,000, a more than double increase of the Performance Standard. The franchisee read the franchise agreement to say that the $30,000 would run forever over all renewal periods. The court called this a “strained reading” of the franchise agreement. The court went on to say that “This reading places a permanent ceiling on the Performance Standard.” The court honed in on the word “minimum.”

The court found that the $30,000 stated in the initial franchise agreement “creates a floor, not a ceiling.” “Nothing in [the franchise agreement] §2.F prohibits the franchisor from raising the minimum amount.”

 Lesson from the Court: Each word has meaning, make sure to heed the meaning.

Minimum performance standards are disclosed in several item numbers of the franchise disclosure document.

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