What Can Franchisors Say about Financial Performance?

Pursuant to an article appearing in the Luxora Leader reports a Roast Plant franchisee is suing its franchisor based asserting it was given false figures and projections.  According to the article:

Roasting Plant founder and CEO Mike Caswell sent [franchisee] Shehadi a spreadsheet showing all of the then-existing Roasting Plant locations doing about $1.1 million in yearly revenue, with strong profits, the lawsuit says. Another spreadsheet projected that an Ann Arbor coffee shop, once open, would do $1.4 million in revenue with above-average profits. https://luxoraleader.com/franchisee-sues-roasting-plant-coffee-for-9-5m-alleging-fraud/577560/

Item 19 of the franchise disclosure document [FDD] gives franchisors the opportunity to provide prospective franchisees with information about the financial performance of the franchise brand.  Once a financial performance representative is made in item 19 of the FDD, the franchisor can then discuss the representation disclosed and substantiation for the representation.

Financial performance representation means any representation, including any oral, written, or visual representation, to a prospective franchisee, including a representation in the 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 shows possible results based on a combination of variables. 16 CFR Parts 436 and 437

Without an item 19 financial performance representation in the FDD, the Franchisor may not discuss the financial performance of the franchise brand.  Conversely, inclusion of a financial performance representation does not have to operate as a franchisor’s a free pass to speak everything financial, profits, revenue, and performance.  Franchisor must confine discussions and information sharing to the information disclosed in the FDD and supporting data to substantiate the item 19 financial performance presentation.
Item 19 financial performance representations is commonly based on the existing outlet location.  Project or future financial performance representations are not so common.  The requirement for project or future financial performance representations are quite robust.  Project or future financial performance representations must be, among other things, prepared in accordance with the AICPA Audit and Accounting Guide by qualified personnel using appropriate accounting principles.
The disclosure of an existing outlet location’s financial performance representation does give the franchisor a free pass to discuss future projected financial performance.  In order for the franchisor to discuss projected future financial performance representation, the franchisor must include a projected financial performance representation in the FDD.  A project or future financial performance representation can not be boot strapped on to a historic financial performance representation.

What is the Key to the Happy and Successful Franchisees?

What factors do you look at when recruiting franchises?  Do you look for the prospective franchisees with a college degree, prior business ownership experience, or industry experience?  Recruiting and identifying prospective franchises that will be successful and happy franchisee owners is a challenge facing every franchise.

[T]the motivation for an individual buying a franchise is much different for someone who has never owned business versus an individual who has previously owned a business.  In contrast, individuals who have been previously self-employed value the competitive advantages that franchises have over small independent businesses [Kaufmann & Stanworth, 1995].

A recent study entitled THE INFLUENCE OF HUMAN CAPITAL FACTORS ON FRANCHISING by Martin J. McDermott and Thomas C. Boyd from Purdue University Global which appeared in Small Business Institute ® Journal provides some interesting insight.  The study is based on 251 of 1,280 randomly selected home repair and improvement, maintenance, cleaning, and business service franchisees that responded to a 25 item self-administered mail survey.

While many studies have found a positive relationship between education and entrepreneurship, there were no significant differences found in satisfaction between franchisees that have a higher level of education versus franchisees with a lower level of education.

The study offers the following practical suggestions;

  • [F]franchisees who have never owned a business prior to buying a franchise most appreciate the ability to do things that don’t go against their own conscience.
  • [A]a market of aspiring entrepreneurs may be found in the Corporate America segment. A popular description of franchising suggests it is a way of being in business for yourself but not by yourself, which might appeal to the Corporate America sector.
  • [E]education and industry experience should not be core factors in deciding if a candidate is a strong fit for a franchise.
  • [I]individuals who have not owned a business prior to buying a franchise should be seen as an asset and not a liability to funding.
  • Because a system is in place, franchising allows an individual with no prior business ownership or experience the opportunity to be an entrepreneur because it can be taught and learned.

Caution in applying the study.
As stated the Study was limited to home repair and improvement, maintenance, cleaning, and business service franchisees.  For example, if you are a restaurant franchise model will the practice suggest hold?  The survey respondents were 41 percent business service franchisees, 32 percent maintenance and cleaning franchisee, and 26 percent home repair and improvement franchisees.
The survey respondents were overwhelming 40 years and older.  Eighty-five percent of respondents were over 40.  How about the newer generation of the franchisees?  Will the results be different? Furthermore, the study is largely based on men.  Of the 251 survey respondents, 204 or 81 percent were men.  Is the same true for women?
What is your experience?  What do you look for in franchisees?  Looking at your historical franchises, what are their educational backgrounds, work experience, and business ownership history?

Abandoning Franchisee’s Claims Against Franchise Denied!

What is a franchisee to do when faced with a notice of default?  Abandon the franchise?  Should the franchise de-brand and begin operating as an independent business?  And, counter sue the franchisor for wrongful termination of the franchise?
That is what one BW-3 franchise in Akron Ohio did.  The case is Buffalo Wild Wings, Inc. [BWW] v. BW-3 of Akron, Inc.  Franchisor BWW sent the Akron franchisee a notice of the default for failure to update operating standards.  The Akron franchisee had 30 days to cure the default.  The Akron franchisee looked at the price tag to update and decided ‘naww not doing that.’  Instead the Akron Franchisee de-branded and began operating as an independent business using the name Gridiron Grill.
Franchisor sent the Akron Franchisee a Notice of Termination of Licensing Agreement but stated that it was holding termination in abeyance pending resolution by this case at hand.

Can the Akron franchise claim wrongful termination of the franchise?

The Court said ‘No.’  The franchise was not terminated.  The Akron franchisee abandoned the franchise by ceasing to the operate the business under the BW-3 name.  The Akron franchisee’s counterclaim for wrongful termination of the franchise agreement was dismissed.
The Court further sided with franchisor BWW maintaining that the Akron franchisee’s failure to the update the franchise per brand standards could, in fact, be a violation of franchisor’s trademark rights and could possibly lead to customer confusion.

When Can the Franchisor Withhold Approval?

Franchisee enters into a Purchase Agreement for the sale of 5 franchises.  Under the Purchase Agreement, the Purchase Price is $880,000.00 for each franchise or a total Purchase Price of $4,400,000.
The franchisor refuses approval for the sale of the franchises.  A over 4 million dollar sale on the line and the franchisor refuses to give approval for the transfer. Franchisor says it would only approve the sales transaction if the purchase price is reduced to $550,000, the estimated the value of the equipment of the five franchises.  How do you reconcile this?  The Franchisor will consent to the sale if the Purchase Price is reduced to 1/5 of what the franchisee seller and buyer agreed upon in the Purchase Agreement.
Can the franchisor do that?  Franchisee asserts not. The franchisor did not even evaluate the potential buyer to see if the buyer qualifies.  A look at the Purchase Price, approve withheld.  Franchisee files a complaint for more than a half dozen claims.  The case is Picktown Foods, LLC, et al. v. Tim Hortons USA, Inc.  In a claim by claim analysis, the Court dismissed claims in turn for lack of pleading or factual deficiencies.  But the Court upholds franchisee’s claim for Tortious Interference with Contract.

The franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The premise of the franchisee claim is that the franchisor failed to act upon an obligation to proceed in good faith.  The franchisee alleges the franchisor is artificially freezing the Franchise Purchase Prices to ensure any new franchisee will have more resources to invest in the brand, building, and real estate owned by franchisor.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.

The Court rules there is sufficient evidence for the franchisee’s claims to be heard in court.  The conditions for franchisor approval of transfer as stated in the franchisee agreement did not state that the Purchase Price had to be equal to the franchise equipment value.  Item 17 of the franchise disclosure document did not state the Purchase Price must be equal to the franchise equipment value.  The franchisor did not evaluate the buyer qualifications.
Was the franchisor’s denial of the transfer in bad faith?  Was it Tortious Interference with Contract?  The case proceeds to trial for  determination.

How Your Trademark May Limit Expansion

To gain trademark rights all you have to do is begin using the trademark.  From the day that you begin using a trademark, you garner trademark rights without doing any more than using the trademark.  This is referred to common law trademarks rights.
Common law trademark rights give your superior exclusive rights to the trademark name, above all others henceforth in the area that you are doing business.  However, common law trademarks rights are limited to the area in which you do business.

 Common law trademarks rights are limited to the area in which you do business.

To get trademark rights beyond the area in which you do business, you must register the trademark with the USPTO [United States Patent and Trademark Office].  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration even if you are not doing business nationally.  In addition, upon a USPTO registration, an infringer of your mark will be liable for greater damages including attorney fees.

  A USPTO trademark registration precludes anyone from using your trademark nationally post the registration.

The limits of common law trademark rights are being tested in a recent case reported to the Credit Union Times.  The Red River Bank has filed a trademark infringement complaint against Red River Federal Credit Union [FCU].  For years Red River Bank established 1999 in Louisiana and Red River FCU established 2008 in Texas coexisted without complaint.  Then Red River FCU acquired branches in Louisiana and Mississippi.  This was too close for comfort.  As reported in the Credit Union Times Red River Bank’s complaints states:

“RRB [Red River Bank] has received numerous inquiries from members of Shreveport Federal Credit Union and the community at large regarding their belief that RRB [Red River Bank] has taken over Shreveport Federal Credit Union.”


If you have an expansion plan or if you want to protect your name beyond the common law, a federal trademark is a must.

What a Moose of Trademark Case? 

When it comes to trademarks, it not just about words.  Trademark protections extends to words, images and, sounds.
Have you heard of Moosehead beer?  Well, they are hopping mad about Hop’N Moose Brewing Company.  Moosehead beer has been in existence since 1931.  Hop’N Moose Brewing Company began using an image of moose in connection with its beer in 2014.  After several cease and desist letters, Moosehead sued Hop’N Moose Brewing Company.

To prove its case, Moosehead must show that Hop’N Moose Brewing Company’s use of the moose will lead to customer confusion as to who is the make or manufacture of the beer.

The founder of Hop’N Moose Brewing Company reports ‘he chose the animal for the brewery’s logo because growing up in Quebec his family often went moose hunting.’ https://vtdigger.org/2017/11/05/canadian-beer-maker-hopping-mad-over-rutland-brewpubs-moose/#.WgBm52hSyUk
However, the reason for choosing the moose is immaterial.  Trademarks [unlike copyright and patents] is not about protecting the trademark owner.  It is about protecting consumers.

What?  You Can Use Competitor’s Names for SEO Purposes?

That is the decision of the FTC Initial Law Judge Decision in the case of 1-800 Contacts, Inc, In the Matter of.  1-800 Contacts entered into at least 14 agreements with contact lenses competitors.  Pursuant to these agreements 1-800 Contacts’ competitors promised and agreed not to use the word 1-800 contacts for search engine optimization [SEO] purposes.  As a result of these agreements, customers paid higher prices for contact lenses.

The Challenged Agreements restricted advertisements for the sale of contact lenses on the internet by prohibiting competitors from presenting paid advertisements on the search engine results page in response to searches for 1-800 Contacts’ trademarks.” Chief Administrative Law Judge D. Michael Chappell

We have all experienced this.  You enter a brand name into Google, and the search engine results yield a stream of the competitor websites.  Why is that?  One reason is brands commonly use the names of their competitors for search engine optimization or SEO purposes.
1-800 Contacts and others have historically and successfully argued that this practice is a trademark infringement.  Now the FTC is arguing it is a bidding agreement that

eliminated competition in auctions to place advertisements on the search results page generated by online search engines such as Google and Bing. The complaint alleges that these bidding agreements constituted an unfair method of competition in violation of federal law, by unreasonably suppressing price competition in certain online search advertising auctions, and restricting truthful and non-misleading advertising to consumers. As a result, some consumers paid higher retail prices for contact lenses, the complaint stated.

It is an interesting proposition that could turn SEO sideways.  Trademark owners may no longer be able to prohibit others from using their trademarks for SEO purposes.  Asserting SEO trademark infringement is misleading advertising?
To buttress its argument, the FTC reports having evidence that consumers paid higher prices because 1-800 Contracts entered into an agreement with competitors to prevent SEO trademark infringement.  It is a head-on conflict between trademark protection and advertising laws, two laws designed to protect the consumer.  Trademark protection is designed to protect consumers by ensuring that consumers know whom they are buying products and services from.  Which consumer protection law will win?
1-800 Contacts has a right to appeal the FTC Initial Law Judge Decision to the full Federal Trade Commission.  If no appeal is filed, the Initial Judge’s decision will become effective.
It is not recommended that you change your SEO search terms just yet.  Wait 30 days to see what happens.  If the FTC Initial Law Judge Decision becomes final, it may open the floodgates open to SEO competition.  But, will evidence of actual higher prices be required?

Why White Collar Exemptions Concerns May Be for Not. 

Remember all the fuss around the rise of salary thresholds for white-collar exemptions?  The fuss may have been for not.  The current Labor Secretary is pointing to a lower salary threshold.

Background: In order, not to pay an employees overtime, the employee must be paid a minimum salary threshold and perform exempt job duties.   
The previous Department of Labor [DOL] Secretary proposed to increase the white-collar salary threshold requirement to $47,000. 

A new Fifth Circuit Appeal Court has agreed to stay its decision challenging increase of the salary threshold.  Read the article on Bloomberg BNA:   https://www.bna.com/labor-department-continue-n73014471445/

What FPR are You Making This Year?

image from morgue file
image from morgue file

One of the foremost questions prospective franchisees ask is ‘How much will I make?’  Unless you include an item 19, Financial Performance Representation [FPR], you must say ‘I am not at liberty to tell you that’ or you can say: ‘Don’t ask me.  Ask them.’  Them referring to existing franchisees.  Either way is not a good answer.  More and more franchisors are including an FPR in the franchise disclosure document [FPR] enabling them to ask this question and to further sales conversations with prospective franchisees.
As discussed on our Blawg previously, the NASAA [North American Securities Admiration Association] has come forth with guidance regarding an FPR.  While the guidance is not set to be effective until next year, state examiners and drafters of the NASAA guidelines take the position that the guidance embodied is the Rule and should be adhered to now!
At the ABA Franchise Legal Symposium back in November, Dale Cantone from the Maryland Attorney General’s Office and lawyers from Witmer, Karp, Warner & Ryan LLP and Gray Plant Mooty presented some wonderful feedback and takeaways from the NASAA guidance.
Here is list of the common mistakes taken from the ABA Legal Symposium materials:
Pages from w13-advanced-drafting 2

SBA’s One Size Fits All Franchise Addendum

Image provided by: https://morguefile.com
Image provided by: https://morguefile.com

Historically, when funding franchisee startups, the federal Small Business Administration [SBA] would examine the franchisor specific franchise agreement, and draft an individualized franchise specific addendum.  The process was laborious.  Each franchise agreement was reviewed.  A franchise addendum was crafted for each specific franchise agreement.  The crafting of the franchise specific addendum sometimes included jockeying over the exact verbiage.  All this took time.  The SBA complains it was draining on SBA resources.  And, for prospective franchisees, it delayed the sales and franchise startup.
No more.  Gone are the days of the franchise specific SBA addendums.  The SBA has adopted a franchise agreement addendum template- One Size Fits All.  It is a plain, simple, 1 ½ page document.  It covers only 4 provisions:
Employment– Franchisor CANNOT hire, fire or schedule franchisee employees
Real Property Leasing– Franchisor MAY NOT record environmental restrictions of use or branding requirements if the property is the franchisor owns the property
Forced Asset Sales-the purchase price must be set by mutual agreement or by appraiser selected by franchisor and franchisee
Change of Owner– Franchisor shall not unreasonably hold consent for franchisee transfer and franchisor shall have first right of refusal for partial transfers among existing franchisees.
Note:  the amended and abridged franchise addendum process does not alter SBA eligibility requirements.  Franchisors and Franchisee have to follow the same eligibility process and requirements.  Per the SBA addendum:
Note to Parties: This Addendum only addresses ‘affiliation’ between the Franchisor and Franchisee.  Additionally, the applicant Franchisee and the franchise system must meet all SBA eligibility requirements.