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 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!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] .

Rico
 “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 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!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 http://www.wkcheetah.com/#/read/2f4740607cda1000940090b11c18cbab01a!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 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 http://www.wkcheetah.com/?window=document&cpid=WKUS-Legal-Cheetah#/read/2f4740387cda1000ac1c90b11c18cbab017!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.

NOTHING IN THIS AGREEMENT WILL PREVENT YOU OR WE FROM OBTAINING TEMPORARY RESTRAINING ORDERS AND TEMPORARY OR PRELIMINARY INJUNCTIVE RELIEF FROM A COURT OF COMPETENT JURISDICTION. HOWEVER, YOU AND WE MUST CONTEMPORANEOUSLY SUBMIT A DISPUTE FOR ARBITRATION ON THE MERITS.

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.

Who Owns the Franchise Business Post a Notice of Termination and Termination?


Under numerous state laws, franchisees are entitled to notice prior to termination.  The amount of the time varies by states.  It could be 30, 60, or even 180 days.
Who owns the franchise business between when the franchisee is given notice, and the franchise business is terminated.  That question was posed in the case of Charter Practices Int’l, LLC, and Med. Mgmt. Int’l, Inc. [Banfield] v. John M. Robb [Franchisee].
Banfield gave Franchisee notice of termination.  Pursuant to Connecticut law, a 60-day notice was required and given.  The Termination Notice stated that Banfield would assume the daily operations of the franchise business until the termination date.  When questioned by the press, Banfield instructed personnel to state:

Dr. Robb no longer owns a Banfield hospital.

But, is that true?  Who owns the franchise business post a notice of the termination, but prior to termination.  The court’s decision turned on the expressed language in the franchise agreement.
The franchise agreement gave Banfield the right to step in and operate the franchise business in the event of default.  However, this provision deemed that the franchise business would still be owned by the franchisee and the revenues derived from the franchise business during the franchisor’s operation accrued to the franchisee.
This deem of ownership is important.  Franchisee, citing Connecticut’s Law requiring a 60-day notice of franchise termination, argued that Banfield’s takeover of the operation of the franchise business violated the Connecticut Law.  Franchisee’s argument was rejected.  Banfield gave Franchisee a 60-day notice of termination and Banfield’s exercising of step-in rights did not violate the Connecticut Law because the Franchisee still owned the franchise business during the step-in period.  Banfield’s personnel press response was a misstatement and inaccurate.

What, is the SBA Franchise Registry Back?


Yes.  It is back.  The Small Business Administration franchise registry is back.  Franchisors must be on it in order for your prospective franchisee to get funding.  Wait, I miss spoke.  It is an SBA franchise directory, not the registry, the Directory.
The Directory is not optional.  Unlike in the past, where franchises could be approved as part of the franchisee loan process, franchises must be pre-registered.

Under these changes, Lenders and CDCs will no longer have to review franchise or other brand documentation for affiliation or eligibility.

The criteria for being in the Directory is very straightforward. To be in the Directory, Franchises must meet the FTC definition of a franchise. The Directory does not replace the need for the standard of SBA Addendum.  Franchisors will still be asked to the sign the Standard SBA Addendum.
The Directory will contain the following information:

  • Whether the brand meets the FTC definition of a franchise;
  • An SBA Franchise Identifier Code, if applicable;
  • Whether an addendum to the franchise agreement is needed; and
  • Whether there are additional issues the SBA Lender must consider with respect to the brand.

The Directory will be administered by FRANdata and found on the SBA website at www.sba.gov/for-lenders.  Franchisors will be required to register on the Directory annually.  The Directory requirement won’t go into effect until January 1, 2018, but franchisors can register now.
SBA notice regarding the directory can be found at http://www.frandata.com/wp-content/uploads/2017/10/5000-17009.pdf.

When is a Franchise Non-competition Reasonable?


Just because there are words in a franchise agreement signed by a franchisor and franchisee, does not make the words enforceable.  In the case of non-competes, it is a matter of the Rule of Reason.
As stated by a Michigan court in the case of LITTLE CAESAR ENTERPRISES, INC. et al.  v. CREATIVE RESTAURANT, INC., et al., [Case No. 2:16-cv-14263] whether a noncompetition [the franchisee’s promises not to operate a like business post-termination, nonrenewal, transfer, or expiration of the franchise agreement] depend on if the noncompete clause is reasonable under the Rule of Reason.

Generally, federal courts assess commercial noncompete agreements under the rule of reason[i].  A contract clause “violates the rule of reason if it `may suppress or even destroy competition,’ rather than promote competition[ii].  

The key concern is possible suppression or destroying of competition.  No actual suppression or destruction is required.  The Rule of Reason uses the word ‘may.’  There is also a special focus on the geographic area were non-compete sought to be enforced and the market for the product or service of the competing business.

To survive under the rule of reason, a party challenging a contract must allege that the contract ‘produced adverse anticompetitive effects within relevant product and geographic markets.’[iii]

For a non-compete  to be found unreasonable and therefore unenforceable, a franchisee must show that the non-competition covenant ‘produces[d] adverse anticompetitive effects within relevant product and geographic markets[iii].


[i]  LITTLE CAESAR ENTERPRISES, INC. et al.  v. CREATIVE RESTAURANT, INC., et al., [Case No. 2:16-cv-14263] citing Innovation Ventures, 499 Mich. at 514 (compiling cases).
[ii] Id quoting United States v. Blue Cross Blue Shield of Mich., 809 F. Supp. 2d 665, 671 (E.D. Mich. 2011) (quoting American Needle, Inc v. National Football League, 560 U.S. 183, 203 n.10 (2010)); see also Perceptron, Inc. v. Sensor Adaptive Machs., Inc., 221 F.3d 913, 919 (6th Cir. 2000)
[iii] Id

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.

What Happens When a Franchisee Commits a Crime?

franchisee crime

The headline reads: ‘Domino’s scandal: franchisee selling visas’ Pursuant to the undercover investigation, the Domino’s Franchisee is alleged to have offered work visas in exchange for money.

Not good. Domino’s public reputation and goodwill can be harmed by such a claim. Not only will it affect the franchisee’s business, it can affect other franchisees’ businesses and the brand. What should one do? The first instinct is to terminate the franchise; go public and denounce the franchisee. However, such knee-jerk reaction can be the wrong move.
Yes, it is bad. Even a false or unverified allegation can affect the brand and other franchisees. Franchise Agreements commonly, as a matter of course, have a provision that allows for termination in event of a criminal act. This, however, should not give rise to deductive logic and issuance of a termination.   Without the benefit of a criminal conviction, admission, or entry of no contest, there is no substantiation for termination. Many franchisee advocates and perhaps some applicable state relationship laws may show substantiation and even connectedness between the crime and performance and obligations of the franchisee, or harm to the goodwill and reputation of the franchise.
Domino’s, in response to the allegations, has launched an investigation, a prudent measure. In addition, Domino’s will want to get in front of the public news story. Again, caution is called for. Saying the wrong thing can lead to defamation or slander claims and on the flip side public outcry.

DON’T GET LEFT BEHIND. STAY INFORMED ON NEW LAWS AND REGULATIONS THAT WILL IMPACT YOUR BUSINESS.

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What is required to make an Item 19 Franchise Financial Performance Representation?

bigstock-Young-businessman-looking-at-h-14505119
With increasing frequency, franchisors are including an Item 19 Financial Performance Representation in their Franchise Disclosure Documents [FDD].
A Financial Performance Representation is defined under the Federal Franchise Disclosure law as:
Any oral written, or visual representation, to a prospective franchisee including a representation in general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table, or mathematical calculation that show possible results based on a combination of variables.
Under the Federal Franchise Disclosure law, the making of a Financial Performance Representation is optional. Franchisors can but are not required to make a Financial Performance Representation. Whichever way franchisors choose, they must include prescribed disclosure language.
If a franchisor chooses not to include an Item 19 Financial Performance Representation [FPR] in the FDD, the franchisor cannot discuss the earnings, profits, or sales of potential franchises.
The Federal franchise disclosure law categorizes permitted Financial Performance representations into 2 groups:

Historic Financial Performance Representations
Forecast of Future Financial Representations

For both categories of Financial Performance Representation, the franchisor must have a:

1. Reasonable basis; and
2. Written substantiation for the representation.

After the basic reasonableness and substantiation requirements, the disclosure requirements for historic and future Financial Performance Representations diverge.
Historic Financial Performance Representations must articulate which, when, and how many franchise outlets were used to make the representation in very regulatory explicit terms. Future Financial Performance Representations must layout assumptions, factors, and conditions related to numerous components of the representation.
Historic Performance Representations are more common than Future Financial Performance Representations. Often times Franchisors may simply use franchisee sales reports as the basis for Historic Performance Representations. However, if the franchise system is new and not sufficient samplings of the franchises are reporting to make a reasonable Financial Performance Representation, franchisors may consider a Future Performance Representation.
The reasonable basis for the claims is one of the biggest liability concerns related to Financial Performance Representations. Franchisees and state examiners may challenge the reasonable base of representation, if the representation among other things is:

Based on too few franchisee outlets
Based on corporate outlet with differing operating costs
The date of the representation is too removed from the issuance/effective date of the disclosure document
The characteristic of the outlets used for the representation differ significantly from the franchise opportunity being offered by the franchise disclosure document

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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