You buy a franchise with great hopes of success. During discovery day, you meet franchisees that are successful. The franchisor layouts out processes and systems that are in place aimed to help you and other franchisees be successful. But, what if does not come to fruition? Your franchise is not successful. You lose money and then finally close the doors. Can you sue the franchisor claiming “it was understood when I bought this franchise it would be successful? I relied on what you said. I reasonably believed that your system would lead to a successful franchise business for me.”
That is one of the many claims made by David and Denis Wojcik and their corporation in a recent case against the Saladworks franchisor and Saladworks designated vendors. The case is David J. Wojcik et al v. Interarh, Inc. et. al. The court said there is no general implied promise of success. A global promise of success just does not fly. A franchisee cannot just sue a franchisor because their franchise is not a success. In order for a franchisee to make a case, the franchisee must specifically plead a breach of an express or implied franchise covenant or misrepresentation to make a viable case.
In addition to the overall complaint that their franchise was not a success, the Wojcik made other specific claims for breach of the franchise agreement. The claims are congruent with common franchise business issues. Let’s take a look at their other complaints and see if they can withstand summary judgment. Here they are:
Problems with site selection, specifically the site selected was too small to provide adequate income and the site build-out costs were high, because of the prior use of the site.
Altering of the franchise model such as discontinuation of the fountain machines in exchange for bottled beverages and reduction of POS system terminal which lead to lower consumer sales.
Designating inexperienced vendors and contractors that had little or no knowledge of local laws or regulations, which lead to construction cost overruns.
Understating labor and food estimates in the franchise disclosure document (FDD) that lead to faulty business plans and projects.
Failing to apply adequate national brand and market fund dollars for the benefit of the franchisee’s market and new business.
Misinforming them about Saladworks loan default rates.
So let’s take a look at these objections. Franchisors modify their system model from time to time. Franchisors make estimates in Item 7 of the FDD regarding initial costs. Franchisors designate vendors that franchisees must buy from for purposes of uniformity. Franchisors make judgment call about how national advertising fund dollars will be used. These are all things that franchisors commonly do. Can all these decision lead to an implied breach of the franchise agreement or misrepresentation?
Yes, is the court’s answer. If under the express terms of the franchise agreement, the franchisor is given the right to use its discretion, then “yes” the franchisor can be held liable for breach of implied duty of the good faith and fair dealing if the franchisor uses its discretion improperly. So for franchisors, when you use your discretion or make judgment calls, consideration should be given to the impact on franchisees. It is a balancing act. Not all decisions will result in positive impact for all franchisees. One way to protect against vulnerabilities is to get buy-in and feedback from franchisees. This can be done in a number of ways. Here are several ways: 1. Ask franchisees to complete satisfaction surveys regarding their use of the approved and designated vendors. 2. Present system changes to the Franchisee Advisory Counsel for input and feedback. 3. Ask select franchisees to beta test system changes before implementing wide-spread system changes. 4. Survey franchisees about their operating cost to obtain better estimates of operating and start-up costs.
If you have a website, you may be asking yourself: “Do I need a notice of privacy posted on my website?” Well it is “strongly recommended but it is not required” unless your website collects information from persons under 13 years of age or you are a financial institution or HIPAA covered entity. That is the federal law answer. Some states however, may require you to have a privacy notice on your website. California just passed a law this summer, which requires such a notice. Undoubtedly with the continued focus on privacy and personal information, we will see heightened requirements for privacy policies and safeguards for personal information. When it comes to privacy policies and the internet, the answer is “Yes” you should have a privacy notice. But, use caution. You will be held to what is contained in your privacy notice.
The internet is the new Wild West. Courts have repeatedly refused to enter into the fray of arbitrating disputes involving the internet. If entities secure a URL address or domain name using your name, you may be left without a remedy. This situation happens in franchising. Either third party entities or even franchisees within the system register or secure a URL using the name of the franchisor or franchise system. Franchisors are often left without recourse; powerless to take down the URL.
Listen to one novel approach taken by a business attempting to protect its name and presence on the internet. Petroleum National Berhad, an oil company based in Malaysia and owner of the Petronas trademark, sued Godaddy.com, Inc. for contributory cybersquatting based upon a third party’s use of the Godaddy.com’s domain forwarding service. Godaddy.com’s domain forwarding services allows registrant of a URL or domain name to automatically and seamlessly forward internet traffic from one domain website to another website. In this case a third party registrant owner of the domain “petronastower.net” and “petronastowers.net” employed Godaddy.com’s domain forwarding services to forward traffic to “camfunchat.com,” an adult website.
Both the US government and the Malysian government contacted Godaddy.com on behalf of Petroleum National Berhad. To no avail, Godaddy.com refused to take action against the third party owner of “petronastower.net.” The stance case of PETRONAS V. GODADDY.COM ensued. Court action like the governments’ efforts, however, proved unsuccessful. The court in the case held there is no such thing as contributory cybersquatting. The law simply does not provide for a contributory claim under the cybersquatting laws. So for now [I have not confirmed this] all internet traffic to “petronastower.net” shall continued to be forward to the adult website, “camfunchat.com.”
Note, however, the court’s decision in this case is not universal. Courts in other cases have upheld a cause of action for contributory cybersquatting, including a case in California involving Verizon, a case in Washington involving Microsoft and a case in Michigan involving Ford Motor Company.
So what should franchisors do? Here are 3 suggestions: 1. Google your franchise system name often to see if your name is being used. Consider setting up Google alert that will tell you when your name is being used. 2. Include a provision in your franchise agreement that franchisees are not permitted to register or establish a URL address or domain name using the franchise name and enforce this prohibition. 3.Address trademark issues when they arise. Allowing time to pass without addressing issues will result in diminished enforceability.
The world of franchising has become layered with complexity. In every franchise system there is always a franchisor that grants the license and owns the trademark. There is always a franchisee that uses the trademark and operates the franchise location or unit. But there may be many layers in between. There could be subfranchises, area developers, and representatives. What is a Subfranchise? What is an Area Developer? What is an Area Representative? How are they the same? How are they different? The 3 concepts are somewhat fungible and there is much confusion about the overlap and the differences. Recognizing this, the Franchise and Business Opportunity Project of the North American Security Administrators Association, Inc. [NASAA] post consultation with the Federal Trade Commission [FTC] has published Multi-Unit Commentary [“Commentary”] for public comment.
In the words of the Commentary: These structures [Area Developer, Subfranchise, and Area Representative] are not mutually exclusive; that is, a franchisor may use just 1 structure or may use a combination of 2 or 3 structures. There are no universally accepted terms for these structures within the franchise industry. The terms used to describe the structures in different franchise systems, and in different laws and regulations, vary widely.
Previously on our blog we discussed Area Developers. Click here to see our post on Area Developers.
Today we are going to discuss Subfranchises. The Commentary defines Subfranchisor as: a person [or entity] that is granted, for consideration paid to the franchisor, the right to grant unit franchises to third parties, generally within a delineated geographic area. So in essence, within a defined geographic area, the Subfranchisor steps in the shoes of the franchisor. The Subfranchisor is given some portion of the initial franchise and royalty fee paid by the franchisee. The franchisee, under the subfranchisee model, is referred to as the Subfranchisee.
Now, you may be saying: ‘I have never heard the word Subfranchisor.’ You are not alone. This term is rarely used in the industry. Subfranchisees are typically referred to as master franchisees or regional franchisors.
This is the graphic depiction provided in the Commentary:
So how disclosure issues handled under a subfranchising relationship? Take a listen.
Again, let’s keep things in prospective. The Commentary has not been adopted. It is only being published for public comment. The Commentary may change, be modified, or redrafted after public comment. The Commentary is not intended to override Federal Franchise Disclosure Laws. Look for our Post on Area Representatives.
What is an Area Developer? What is a Subfranchise? What is an Area Representative? How are they the same? How are they different? The 3 concepts are somewhat fungible and there is much confusion about the overlap and the differences. Recognizing this, the Franchise and Business Opportunity Project of the North American Security Administrators Association, Inc. [NASAA] post consultation with the Federal Trade Commission [FTC] has published Multi-Unit Commentary [“Commentary”] for public comment. In the words of the Commentary: These structures [Area Developer, Subfranchise, and Area Representative] are not mutually exclusive; that is, a franchisor may use just 1 structure or may use a combination of 2 or 3 structures. There are no universally accepted terms for these structures within the franchise industry. The terms used to describe the structures in different franchise systems, and in different laws and regulations, vary widely.
So let’s start with the Area Developer. Here’s the definition provided in the Commentary: An Area Developer is an agreement where the franchisor grants a right to open multiple franchise units in a designated time period in a designated area. An area development agreement itself does not itself grant a right to operate a franchise unit. Area Developer has many different aliases. Area Developers are sometimes called master franchisee, multi-unit developers, and regional developer. The nomenclature changes and are used interchangeably.
This is the graphic depiction provided in the Commentary:
In addition to defining Area Developer, the Commentary some great FAQs with insights and watch-outs for people looking to buy a franchise and franchisors. Take a listen:
Now let’s keep things in prospective. The Commentary has not been adopted. It is only being published for public comment. The Commentary may change, be modified, or redrafted after public comment. The Commentary is not intended to override Federal Franchise Disclosure Laws. Look for our Post on Subfranchise.
A jury in the case of ALASKA RENT-A-CAR, INC. v. AVIS BUDGET GROUP, INC. awarded an Avis franchisee $16 million in lost profits following the acquisition of the Budget Rent-A-Car by the Avis franchisor. At the heart of the case is a 1995 settlement agreement. Per the settlement agreement the Avis franchisor promised “the sales, marketing and reservation activities, operations and personnel of and for the Avis System will not be utilized to market, provide, and/or make available car rental services.” But in 2002, when Avis acquired Budget Rent-A-Car, Avis merged the marketing sales team of Avis and Budget into one team. From an efficiency prospective the merger of the marketing teams makes sense. Sharing office space, equipment, management, personnel can save money- be more efficient. So, what is the issue? The concern is that under the shared services model, the franchisor’s personnel could potentially steer customers from one brand to another. Okay, that’s the concern, but can it lead to liability or actionable claims by franchisees?
In the case of ALASKA RENT-A-CAR, INC. v. AVIS BUDGET GROUP, INC. the liability stemmed from a contractual obligation, a contractual promise. In the absence of a contractual obligation, is there potential liability? Perhaps. Even if there is not a contractual provision that prohibits franchisors from sharing operations across brands, the franchisor could be exposed to possible liability. There would have to be evidence: Evidence that the shared services resulted in the diversion of business from one brand to another.
The liability could be based in a common law claim for ‘tortuous interference with contractual relationships.’ That is a mouthful. Trying saying that 10 times! Trying to prove a claim for tortuous interference with contractual relationships can be equally as challenging. Aside from the viability of such a claim, there are best practices that a franchisor can employ when utilizing a shared services model. Here are 3: 1. Formalize the shared service operations with a formal contractual relationship. 2. Develop policies and procedures to create separation between brands. 3. Create a plan for taking and investigating franchisee complaints. Listen to the video blog regarding sister brands.
Perhaps without exception, all franchise agreements contain a non-compete covenant. The covenants may vary. The covenants may prohibit you from operating a competing business or any business when you are a franchisee. And after the franchise relationship ends, you may be prohibited from operating a competing business for 1 or 2 years at the franchise location, in your area, and sometimes an even greater geographic area.
When buying a franchise and signing a franchise agreement, the thoughts center on starting and building a great franchise business. It may, however, also be time to take pause. Take time to pause and consider what I am going to do in 10 years when the franchise agreement expires. What if in 5 years, I don’t what to be a franchisee?
Covenant not compete can inhibit your future options. And, say, depending on the covenants, where the franchise business is located, what state law governs the agreement and other things. The covenants not to compete can be enforceable.
Take the case of Novus Franchising, Inc.[“Novus”] v. Superior Entrance Systems, Inc. [“Superior”]. Novus and Superior entered into a franchise agreement. Post its expiration Superior sold its business assets to 3 of its employees. The newly formed employee owned company continued to conduct business, as usual but under a different name. The former franchise provided consultation to the new company and referred customers to the new company. What is the rub? The franchise agreement contained a non-compete provision. Franchisor sued. The court ordered the former franchisee company owners to either divest all interest and control in the on-going business or ensure that the new company did not offer any competing service. In response to the court’s order, the franchisee discontinued the consultation relationship with the new company, but continued to send business to the newly formed company. The court said this violated the “spirit” of the non-compete and ordered the former franchisee to pay the franchisor $1,000 and to stop referring business. The reaches and breath of the non-compete can be vast and imposing.
Listen to the video with more information:
Want to know about the state laws governing non-competes in your state? Give us a call or email us.
In the franchise industry the deployment of Release of Claims is common place. A Release of Claims may be a stand-alone agreement or may be embedded in a franchise transfer agreement, franchise renewal agreement, franchise termination agreement, and numerous other transactions. Whether you are franchisor or franchisee, learn what questions you need to be concerned with when reviewing, drafting, or signing a non-compete. See the slide share below.
Over the last several months we have been posting about updating the franchise disclosure document. For many franchisors, the time to update the franchise disclosure document was April 30th. With the deadline for updating the franchise disclosure document past, it is now time to re-focus on the franchise sales.
What happens? Consumer trips and falls at a franchise store. Home owner complains that the franchisee’s work is shoddy and wants his money back. Franchisee’s employee alleges a failure to pay overtime.
More times than not, the franchisor gets sued along with the franchisee for these issues. It happened at the franchise location, but customers, employees, and others try to hold the franchisor responsible. This is referred to as vicarious liability. The franchise concept is vulnerable to vicarious liability, because;
The franchisor provides franchisee training about how to operate the business
The franchisor publishes an operations manual that has guidelines about operating the franchise business
The franchisee reports to the franchisor monthly
The franchisor provides the franchisee on-going consultation
The franchisor gets royalty on the franchisee profits
The Franchisee uses the franchisor’s software
The franchisor is usually bigger and has more money than the franchisee
What defenses does the franchisor have? Is it really equitable to hold the franchisor liable? If the consumer falls, should the franchisor pay? If the franchisee did a bad job, should the franchisor pay? If the franchisee does not pay its workers, should the franchisor pay?
In the case is Robert Leach et al v. Rafail Kaykov and J. Fletcher Creamer & Son, Inc., & Royal Dispatch Services, Inc., the court said NO, the franchisor was not liable. Rafail was a franchisee of the Royal Dispatch Services. He was a taxi driver. Mr. Leach had called Royal Dispatch Services for a tax ride. Rafail accepted the dispatch from Royal Dispatch Services. During the tax ride, an accident occurred.
The passenger, Mr. Leach, wanted to blame the franchisor Royal Dispatch Services. After all he called Royal Dispatch Services for the tax ride. And, Rafail was Royal Dispatches Services’ franchisee. And, Royal Dispatch Services, provides training to its franchisees, gives its franchisees a operations manual or rule book to follow, Royal Dispatch Services’ computer equipment is installed in franchisee taxis, the franchisees pay a commission to Royal Dispatch Services, and Royal Dispatch Services inspects the taxis.
The court said that’s nice, but Rafail is an independent contractor. Royal Dispatch is not liable. Rafail is free to accept dispatches from other persons. Rafail had to secure his own license and permits. Rafail did not have to accept the dispatch from Royal Dispatch Services.
It comes down to independence. Franchisees are independently owned and operated businesses. This is called out specifically in the franchise agreement. So long as the independence is respected and recorded, the vulnerability to vicarious liability is greatly diminished.
Lesson from the Court: Independence can free you from liability!
How does your franchise model recognize the franchisee independence? Are franchisees required to post that they are an independently owned and operated business? Are franchisees free to accept or reject consumer sales?