Category: Franchise

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!

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!

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!

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.
 

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.

In this week’s post we discussed a case regarding personal liability for a violation of state franchise disclosure laws.  Here is an infographic outlining the potential exposure for violations of franchise disclosure laws!

Did you see this timeline?  Did you find it helpful?  We have put together a workbook compilation.  The workbook compilation has the need to know information for franchisors and  worksheets to compile the data for updating the franchise disclosure document.  The timeline is just one of the tools in the workbook!   To see a preview of the workbook click here:   You can buy your copy by going to:  https://gettinslaw.com/landing/answers-for-franchisors-franchise-disclosure-document/

There are countless grounds for termination of a franchise agreement. Failure to pay royalties is most assuredly grounds of termination of the franchise agreement. Abandonment of the franchise business is another sure bet for termination of the franchise agreement. Not operating franchise business in compliance with franchise standards, transferring franchise assets without franchisor approval, under reporting gross revenues; these are all common grounds for terminating the franchise agreement.

What about not having enough money in the bank? Well that is what happened in one case. The case is 7-Eleven, Inc.et. al. v. Brinderjit Dhaliwal. Brinderjit Dhaliwal (“Dhaliwal”) is a 7-Eleven franchisee. He owned and operated a successful 7-Eleven franchise from 1997 to 2010, more than a dozen years. The lease on his location expires. He is forced to close the location. 7-Eleven gives him the option to take over a number of available locations free of an initial franchise fee or transfer fee. The locations available, which do not carry a waiver of the initial franchise fee, don’t work for Dhaliwal. He ends up buying a location in Rocklin, California. The initial franchise fee is $219,000.

Dhaliwal thinks it is going to be a great location! But, it does not work out that way. Projected sales don’t hit the mark. Under the 7-Eleven franchise agreement, Dhaliwal is required to maintain a net worth of $15,000. The profits are just not what were expected. The net worth of the franchise business repeatedly falls below the $15,000 threshold. 7-Elven sends Dhaliwal repeated default notices and ultimately terminates Dhaliwal’s Rocklin, California, franchise.

Why would a franchisor put a net worth requirement on the franchisees? And make it a terminable offense. I can think of several reasons. 1. The franchisor is worried about creditors taking over the franchise assets. 2. Insufficient cash flow may impede inventory levels, advertising expenditures, and staffing levels. That is not what the franchisor goes with. Get this. The franchisor argues: it has good cause to terminate a franchise if they fail to maintain a net worth of less than $15,000. This is a quote from the court’s decision: The reason for the net worth requirement, as clarified at hearing, was to ensure that the franchisee was fully invested in the operation of the store.”

Guess what? The court goes for it. The court grants a preliminary injunction in favor of 7-Eleven, ordering Dhaliwal to surrender the franchise premise and cease using the 7-Eleven name.

Lesson from the Court: Always have a reason. It does not have to be a good reason. It does have to be the best one, the logical one, but you must have one.

Grounds for termination of the franchise must be disclosed in the franchise document disclosure.

 

How can a really sweet deal turn into a really bad nightmare? That is perhaps what two franchise founders are saying to each other about now. Michael and Kathy Butler (collectively the “Butlers”) are seasoned public relations folks. Michael Butler has had his own PR firm for 30 years. The Butlers came up with the idea to open a retail store that offered PR and marketing services to small businesses. They liked the concept so much, they decided to franchise it. They called the franchise the PR Shop. They contracted with a franchise broker to sell PR Shop franchises. The broker did a good job. A franchise prospect in New York wound up buying 20 franchise outlets.

Then the nightmare began. New York requires franchisors to complete a franchise registration prior to the offering or selling of franchises in the state of New York. PR Shop filed a franchise registration. But, it was not complete or effective at the time that the PR Shop franchises were sold to the prospect in New York. This was uncovered by the prospect turned franchisee. He called the state of New York wanting to complain about 20 PR Shop franchises.

Go no further. The franchise registration was not effective when the franchisee bought the franchises. The franchisor must offer the franchisee rescission. Rescission means, pretend like the franchise agreement was never signed and the franchisee gets all his money back.

One problem, by this time the franchise has dissolved. The franchise’s founders (the Butlers) have filed personal bankruptcy. This whole thing cannot be written off that easy. Can it? Really? No. The case is In re Michael L. Butler and Kathy H. Butler v. John Mangione. The bankruptcy court did not look fondly upon the Bulters’ conduct. The court found that Michael and Kathy Butler were personally liable to John Mangione, the New York franchisee. And, the Butler’s liability to Mr. Mangione was not dischargeable in bankruptcy. The Butlers must repay Mr. Mangione his initial franchise fees, for all 20 franchises + interest + Mr. Mangione’s attorney’s fees totally $714,000.

The Butlers broke state law by not completing the franchise registration prior to selling the franchises in New York. The Butlers did not hold the initial franchise fees in escrow as instructed by the state. Failure to put the initial franchise fees in escrow, in the court’s opinion, was akin to stealing. The Butlers committed fraud by misrepresenting to the franchisee that PR Shop was registered in New York. The court did not take a soft approach in this case.

 Lesson from the Court: Register it before you sell it or the deal may be unraveled post facto.