How a Settlement can act as a Free Pass

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The American Legal System is based on the right to enter into legal contracts freely.  Individuals and businesses are free to contract with whomever they choice. And, so long as the contract is not unlawful, the courts will give deference to the agreement- contact.
Hence the case of  H.B. Automotive Group, Inc, d/b/a Kia of the Bronx, and Major Motors of Long Island City, Inc., d/b/a Major Kia of Long Island City [Dealership Franchisee or Kia Motors of the Bronx ] v.  Kia Motors America [Kia Motors].  Dealership Franchisee  was in violation of their dealership franchise agreement with Kia Motors.  Kia Motors could terminate the Dealership Franchisee’s franchise agreement, but settlement was entered instead.  Under the settlement, the termination was delayed in order to allow the Dealership Franchisee to transfer the franchise to another franchisee.
Franchisee presented 2 prospective buyers or transferees.  The franchisor rejected both saying that they have poor satisfaction ratings [and other things].  Dealership Franchisee presented a third, but time was up under the settlement agreement. Kia Motors terminated the Franchise Agreement.
The case is in New York.  And the court said editing the New York law:

[i]t shall be unlawful for any franchisor directly or indirectly to impose unreasonable restriction on the franchised motor vehicle dealer relative to transfer, sale … or termination of a franchise ….

But, the court goes on to explain, relaying prior cases, settlement agreements can act as a waiver.  Yes, waiver. Hence, settlements are like a- free pass.  Kia Motors did not have to be reasonable when it rejected the third transfer request, because under the settlement agreement, the time to get a transfer approved was up.  Under the settlement agreement, if transfer was not approved by September 1, 2013, the franchise agreement terminated.  The third buyer’s application was not completed till September 11, 2013.  The franchise agreement termination stands.
As dicta, the franchise rejected all three proposed transfers on grounds that the prospective buyers  or transferees’ satisfaction ratings were substandard.  Otherwise stated the franchisor would not approve proposed transfers of the Dealership Franchisee’s franchise agreement, because the buyer [other existing dealerships] had deficient customer service scores below the average satisfaction scores of all Kia Motor dealerships in the Kia Motors System and this was sufficient reasonable grounds for   denying the transfer per the court.  So, the important dictation note from the court is that poor satisfaction rating scores of existing prospective franchisee buyers can be reasonable good cause grounds for a franchisor to deny a franchisee transfer. presentation1_page_3
Returning to the holding in the case, settlement can be a wonderful thing for both franchisors and franchisees.  What ordinarily would have been the rule, under franchise laws and statutes, can be void if there is a properly written settlement agreement.  In this case it was the obligation to approve or disapprove a transfer.  But, settlement agreements can also operate as a release of claims, when the release is forbidden by the law.  Settlement agreements can also operate as an enforceable agreement that a material default under the franchise agreement is present and termination of the franchise agreement is permissible and enforceable.  When looking at the options, know the power of the settlement.
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Franchisor adds teeth to claims against former franchisee.

It is a story that is not unique.  Franchisee fails to pay royalties as required under a franchise agreement.  Franchisor terminates franchisee.  Franchisee continues to operate.  Franchisor sues franchisee.  This scenario is not in of itself ‘blog worth.’
What makes it ‘blog worthy’ is the franchisor’s claims against the former franchisee.  The franchisor’s complaint against the franchisee, asserts trademark infringement.  Trademark infringement has some teeth.  If a trademark infringement is found, the franchisor could be entitled to attorney fees and cost.  And, the franchisee would be disgorged of all profits from using the name improperly.
Disgorgement is a wonderful graphic word. Disgorgement is [a] remedy requiring a party who profits from illegal or wrongful acts to give up any profits he or she made as a result of his or her illegal or wrongful conduct. The purpose of this remedy is to prevent unjust enrichment.
Under the franchise agreement, the franchisor is entitled to a percentage royalty or flat fee royalty of revenues, which is typically a small percentage of all revenues.  Disgorgement is something greater.  It is all profits.  And, at the end of the day, it was what is.  A franchise agreement is licensure allowing franchisees to use the franchisor’s trademark in a limited way, limited time, and under limited conditions.  Any, use beyond what is called for in the franchise agreement is trademark infringement.
The case is Ghazi Ghori and Chooza, LLC.  Assertions of the trademark infringement is probably again not unique in the case of the claims against former franchisees, but a noteworthy reminder of the claims available, liability exposure, and need for trademarking.

Why your Franchise may come with a Money Back Guaranty

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The Franchise Disclosure Document [FDD], is given to each prospective franchisee.  It contains countless required disclosures.  The disclosures includeseverything from who are the persons with franchise management and sale responsibilities, what fees are changed, what are the revenues and profits of the franchisor, and what if any, representations the franchisor makes regarding franchisee earnings.
What if something is missing?  What if something is inaccurate in the Franchise Disclosure Document?
The general answer, if there is a material inaccuracy in the Franchise Disclosure document, is rescission.  If the FDD contains misinformation, the common remedy is the franchisee is entitled to rescission.
Rescission is like a money back guaranty.  Rescission operates to undo the transaction- to put everything back the way it was if before the franchise agreement was signed.  That means the franchisee is entitled to be reimbursed the initial franchisee fee and a lot more.  If the franchisee bought inventory, paid travel expenses for the initial training, purchased equipment, and put a deposit on utilities, the franchisee may be entitled to compensation for all these things.  How much could this cost?  How much money may the franchise be entitled?  Look at the initial investment cost listed in item 7 of the FDD.  Yes, it is all those things and anything else the franchisee paid.
Does every inaccuracy, every omission in the FDD warrant rescission?  No, of course not.  It is up to a court, a trier of fact, and perhaps state enforcement agencies.  Cases go both ways.  In a case by the Georgia court of appeals, the answer was no.  The case is Legacy Academy, Inc., et al. v. Doles-Smith Enterprises, Inc., et al.  The facts of the case revealed an accuracy in the Franchisor’s cash flow statement in the FDD.  And, that the FDD contained an inaccuracy in the Franchisor’s litigation history.  The case arose when the franchisee notified the franchisor it was unilaterally terminating the franchise agreement.  And, the franchise discontinued paying royalties, de-branded and continued business operations.  The franchisee was upset, because it was not turning a profit.  The franchisor sued for failure to pay royalties. The franchisee counter-sued saying it was entitled rescission of the franchise agreement.
The lower courts agreed and awarded the franchisee 350,000 dollars in negligent misrepresentations and 40,000 dollars in negligence.  But, the Appellate court reversed saying that the errors and omissions in the franchisor’s cash flow statement and the litigation history did not cause the franchisee to lose money.  The errors in the FDD did not depreciate or lessen the value of the franchise; therefore, the franchisee was not entitled to damages for negligent misrepresentations.  The damages that the franchisee suffered where consequential and not connected the franchisor’s errors in the FDD.  This left the franchisee with damages solely for negligent, which were offset by royalty payments that the franchisee failed to pay and were due.  It was almost a wash.  The franchisee nor the franchisor got a large payout.
Interesting didee of a case.  It shows that when it comes to errors in the FDD, the court can go either way.  The risk of the errors in the FDD can cost 40,000 dollars or 400,000  dollars or nothing.  It is all in how the court decides and there is no predictability.

How Franchisors Can Guard Against 3rd Party Liability

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Franchisor liability for employment claims has stolen the spot light from another big source of Franchisor liability- liability to customers.  In recent cases of McDonalds and other unfortunate cases, franchisors are being found liable to employees for wages and hours, discrimination and other work related claims.
But there is another big source of the liability that faces franchisors.  It is not new.  It is not uncommon.  And, it is very real.  It rides on the same principals as employee claims.  The source of the liability is customer, third party tort claims.  Customers or other third parties are injured from a slip and fall, bad food, unperformed services, and many other claims.  The customers or other persons sue the franchisee, but they also in the same law suit sue the franchisor.  The basis for the claim lies in the control that franchisors have over franchisee.
In one such case a Florida jury has awarded 10.1 million dollars to a victim of the car accident caused by a Domino driver to be paid by the Franchisor.  Why? How?  The jury said that the franchisor had control and therefore was liable for the accident.  Domino discontinued  its 30 minute delivery guarantee, but continues to offer incentives for speedy deliveries and consumer satisfaction.
3 Way to Prevent 3rd Party Liability
This sends   the historic message that in practice and in the franchise agreement, cautions need to be taken to protect third party liability by limited Franchisor control.  How is that   possible when attempting to create good quality assurances and uniformity?  Here are some suggestions;

  1. Give suggestions, choices to meet objectives.
  2. State the goal, not the means to the goal.
  3. Adopt standards and guidance from recognized trade groups, associations, or governmental entities rather than creating your own.


What is Co-Branding?

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There is a new buzz term in franchising: Co-branding. Co-branding is the offer of more than one franchise concept by the franchisor/franchisee. The concept is not new. A franchisor offering more than one franchise concept is sometimes referred to as a family of brands or sister brands. Think of the food industry. Think of hotels. A deal was just announced by Doc Popcorn & Dippin’ Dots. The sister brands, Doc Popcorn and Dippin’ Dots were offered franchisees with the opportunity to operate the two concepts in joint in-line or kiosks in malls.
For co-branding the franchisor provides more than one franchise the opportunity offered to the same franchisee. There are pluses and minuses to co-branding.  How are covenants of non-competition, non-solicitation, and confidentiality handled? Are franchise terms coterminous?
A new twist on the co-branding has been the pairing of unaffiliated brands [brands not owned by the same franchisor]. As with co-branding, the pluses and minuses are still present, but the concerns regarding cross defaults, renewal, and co-mingling are enhanced and more problematic.

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What Trademark is protect-able and confidential- And, what is not

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Quick Fact:
Plaintiff Rib City Franchising, LLC, enters into a franchise agreement with Toni Jorgensen for Rib City franchisee. The franchise agreement is sequecently terminated for breach of contract. Toni Jorgensen sell the assets of franchise to Sara Bowen post the franchise Termination. Sara Bowen open a restaurant at the same location, using the same telephone number, website [and website content], and made no changes to the interior restaurant layout, decor, color scheme, wall hangings, artwork, dark-colored wood booths, hanging light fixtures, and hanging window frames previously used in Rib City Grill, and kept the menu basically the same. Sarah Bowen called her new restaurant Pig City BBQ.
The issues:
While there is a non-compete with franchisees and former franchisee, there is no non-compete with 3rd parties.
Sue anyone that buys former franchisee assets and attempts to operate a completing business using the franchisee system’s décor [referred to as trade dress in legal terms], menu, and steals social media content and accounts on claims of trademark infringement and misappropriation of trade secrets [in common lingo stealing and using].
Outcome: The court said:
• No relief for similar names Pig City and Rib City. The court argued that Pig and Rib sound significantly different. And, Rib City Grill is not ‘conceptually or commercially strong.’ On the spectrum Rib City is a descriptive with diminished enforceability.
• No Relief for using Trade Dress: The décor including interior restaurant layout, decor, color scheme, wall hangings, artwork, dark-colored wood booths, hanging light fixtures, and hanging window frames was not distinctive enough to be trademark protect-able.  The décor was not distinctive enough to get trade dress protection.
• No relief for the menu and receipts. The court said that the menu was distributed to the public, so the menu could not be confidential. And the receipts, Rib City said that had to provide it that could not just say is tasted like their receipts.
Lessons to Learn:
1. Do de-identify locations post termination
2. Do create arbitrary and fanciful trademarks not descriptive trademarks
3. Do not share anything that you want to keep confidential
4. Don’t let franchisee have their own URL addresses
5. Maintain control of social media accounts
The lessons learned are not just for the benefit of franchisors. It is for all other franchisees in the system that have to compete with a copycat.
The case: Rib City Franchising, LLC v. Sarah Bowen, et al. in the Central District of Utah.

Why Franchisee Questionnaires May Make or Break a Case?

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It is common place within the franchise industry that a franchisor requests a franchisee to complete a questionnaire before signing the franchise agreement saying that franchisor followed disclosure protocol:

  • Franchisee was given the franchise agreement with all blanks filled in 7 days before signing or paying any money; and
  • Did the Franchisor provide Franchise Disclosure Document [FDD] 14 days before signing franchise agreement or paying any money; and
  • Did the franchise rely on any earning or financial representation other than those disclosed in the franchise agreement.

In some instance the franchisor may ask the franchise to attest to the proper disclosure and no financial performance as provision of the franchise agreement.
Is this just more boilerplate, or do these questions and attestation have any teeth.  Do they preclude the franchisee from later alleging that they did not have proper disclosure or that there was an improper earning claim or financial performance representation made?

Franchisee Questionnaires Ask

One case provides antidotal evidence that the franchisee’s attestation and answers on the questionnaires do have meaning.  The case is Fantastic Sams Salons Corp. v. PSTEVO, LLC.  In the body of the franchise agreement there was a disclaimer that read:


There was space provided for the franchise to insert comment or statements.  The franchisee wrote ‘none’ after each disclaimer and initial his statement.

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The court reasoned that the franchisee could not have been fraudulently deceived by franchisor’s representations.  The franchise wrote none when asked.  The franchisee argued that the disclaimer did not squarely ask about the representations he alleged.  The court tossed that argument to the wind saying the franchisee should have said something, wrote something other than ‘none.’

Case dismissed.

The franchisee lost his case against the franchisor.  The franchisee’s attestation in the franchise agreement, coupled with his none response, prevented the franchisee from winning its fraudulent misrepresentation case against the franchisor.
It the franchisee won his case, he would have been entitled to reimbursement of his initial franchise fee, all the money he spent attempting start-up and operation of the franchise, and perhaps much more.
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What to do? Franchisees Charged with Illegal Acts.

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Franchisees, the franchisor, and other franchisees within a franchise system are inexplicably associated with one another.  The acts of one or a couple of franchisees can adversely impact the goodwill and reputation of the brand, the franchisor, and other franchisees within a system.  Wrongdoings by franchisees can lead to the franchisor and other franchisees fighting off unwanted liabilities.  Often times if a franchisee is sued, the franchisor will be named too in hopes that the franchisor can be tied in some indirect tangential way.  It can also lead to copycat allegations and heighten scrutiny of other franchisees in the franchise system.  All around it is bad news for the system.
So how does a franchisor respond when a franchisee is charged with a wrongdoing?  Liberty Tax has taken the route of disassociating itself and the franchise system from the accused franchisees.  The accused franchisees in South Carolina were called out by federal prosecutors for allegedly preparing false and inflated tax returns by entering inflated business income, expenses, and bogus dependents.  In response to the lawsuit filed by federal prosecutors, Liberty Tax’s Chief Compliance Offer asserted that:

Liberty Tax has a robust compliance program, and we expect our franchisees to make sure that their offices comply with all federal and state tax requirements.  Monday’s allegations appear to be limited to a small number of independently-owned franchised offices and prior year returns. We will take appropriate action after completing a review of both current year and prior operations at these offices.

Note in the Liberty Tax’s statement, there is no promise to close or terminate the franchise agreements of the accused franchisees.  Instead the statement attempts to protect the brand and other franchisees by saying that the South Carolina franchisees are outliners in the system.  Other franchisees did not commit the same wrongful acts.
There is good reason why Liberty Tax did not say they are terminating the franchisees.  Remember, in America, everyone is innocent until proven guilty.  While the knee jerk reaction, may be to terminate the franchisee, hast can lead to wrongful termination lawsuits by franchisees.   Liberty Tax had two choices: [1] wait till the lawsuit plays out in the courts to see  if the allegations are affirmed or [2] find affirmative evidence of wrongdoing that is ground for termination.  Liberty Tax has said it will go for number 2.  Again, wise decision.  Court cases can take years to resolve.
When faced with a situation of the franchisee’s alleged illegal or improper acts, it is important to take a step back and follow the proper channels.  At the end of the day, what if the franchise agreement is terminated and the franchisee is cleared of wrongdoing?

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What is Good Faith and Fair Dealing and where does not it not Apply?

The words ‘good faith’ and ‘fair dealing’ are vehemently thrown about when there is a dispute.  But, what is good faith?  What is fair dealing? And, is it something that applies to everything and everywhere?
Good faith and fair dealing are implied covenants.  Good faith and faith dealing do not have to appear in the franchise agreement or any agreement to be enforced.  Implied means it is understand to be included and applicable to the agreement.
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Per Black Law Dictionary, good faith is defined as:
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A state of mind consisting in (1) honesty in belief or purpose, (2) faithfulness to one’s duty and obligations, (3) observation of reasonable commercial standard or fair dealing in a given trade or business, or (4) absence of intent to defraud or seek unconscionable advantage. 

Fair dealing is defined by Black Law Dictionary as:
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(1) The conduct of business with full disclosure usu. by a corporate officer to the corporation. (2) A fiduciary’s transacting of business so that, although the fiduciary’ might derive a personal benefit, all interested persons are fully appraised of the potential and of all other material information about the transaction.

When a dispute arises between the franchisor and franchisee, the first step is to review the franchise agreement.  Look at the covenants, obligations, rights outlined in the agreement.  Sometimes, the provisions in the agreement are fuzzy or there may be issues that arise between the franchisee and franchisor that are not covered or discussed in the franchise agreement.
Either way, good faith and fair dealing is something discussed and highlighted.  It is the ‘it is not fair’ arguments:  ‘You can’t do that.’  It includes the: ’that is not what we agreed to’ argument.  And, the ‘You did not disclose that’ when I bought the franchise.
What would happen if those claims of good faith and fair dealing were not available?  Hence the class action MYERS V. JANI-KING OF PHILA., INC. in the third circuit court.  In this class action law suit:

Plaintiffs allege, on behalf of themselves and all others similarly situated, that Defendants sold them rights to Defendants’ cleaning services franchise, and that the franchise agreements that secured those rights were, in reality, illegal employment agreements.

In count 4 of the franchisee’s multi-count complaint, the franchisee claimed a breach in the covenant of good faith and fair dealing.  The case was being heard in Philadelphia and franchisor asserted Texas law applied to the franchise agreement.  The court, looking at both Texas and Pennsylvania law, found that both states did not recognize good faith and fair claims in relation to franchisor and franchisee disputes.
Where are franchisor and franchisee left, if they cannot assert ‘good faith’ and ‘fair dealing’ arguments?  Where is the class action of MYERS V. JANI-KING OF PHILA., INC. without the count alleging a breach of ‘good faith’ and ‘fair dealing?’  The franchisees are left to the actual word, promises, and obligations in the franchise agreement.
When enforcing a franchise agreement, knowing the state laws regarding franchise agreement is important.  It can make difference as to a claim is dismissed or successful.

Advertising vs. Non-Promotion. FTC Warns About Blurring the Line

spamThe Federal Trade Commission [FTC] has issued a Commission Enforcement Policy Statement on Deceptively Formatted Advertisements [FTC Statement].  The subject of the FTC Statement is advertising disguised to look like something else- i.e. educational information or customer reviews.
The subject is not new as the FTC points out.  The FTC has issued guidance and taken action against business dating back to the 1960’s, 70’s and ‘80s on the similar basis.  However, the FTC expressed the compulsion to issue the Statement pointing out changes and variations in the new the social media and technology realms such as videos and infographics.
Here are some examples of advertising from the FTC statement.
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How do you know if an advertisement is considered deceptive by the FTC? The FTC’s answer is a little ambiguous:
In determining whether an advertisement, including its format, misleads consumers, the Commission considers the overall ‘net impression’ it conveys.  Any qualifying information necessary to prevent deception must be disclosed prominently and unambiguously to overcome any misleading impression created.
It is an ‘I know when I see it’ test, which is not very comforting or helpful.  However, there are somethings the FTC Statement suggests to lessen the likelihood that your advertising will be considered deceptive.  Here are their suggestions:
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