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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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.

Per Black Law Dictionary, good faith is defined as:

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:

(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.

The 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.

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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Famous Dave’s has sold its Chicago location to an existing Franchisee that currently operates in Michigan and Ohio. The transaction is going for over 1 million. The selling of an existing corporate franchisor’s operating location to a franchisee adds a layer of complexity to the franchise sales process. The buyer is also a prospective franchisee and requires the same disclosures, agreements, and holding periods as a prospective franchisee of a new outlet.
 
There may, however, be items in the franchise agreement that require modification via an addendum to the franchise agreement, such as purchase of inventory, site selection, and time for opening.
 
Layered on the franchise sales process is a purchase agreement. Yes. The acquisition of a current operating business should be addressed in a purchase agreement. The purchase agreement and sales transaction should be akin to any other purchase or sale of a business, which includes due diligence, liabilities for prior acts, employee termination and rehiring, lease assignment or subleasing, etc.
 
The transaction for the sale of the business should not be lumped into the franchise agreement or an addendum. It should be its own stand-alone agreement.
 
The purchase agreement should be delivered with the franchise documents and run with a holding period for the franchise agreement and other agreements.
 
A management agreement may be required to allow uninterrupted operating of the location during securing of the government licensures and permits.
 

 
 

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You can’t be everywhere and do everything.  But, you want to expand quickly.  One mechanism is an area representative arrangement.  An area representative helps find, train, and supports franchisees.

 
This is the expansion mechanism that Titled Kilt Pub & Eatery [Titled Kilt] employed.  However, something went awry.  When selling franchises, Titled Kilt’s area representative -1220 LLC, allegedly provided prospective franchisees with false performance representations.  1220 LLC told a prospective franchisee that he could potentially make billions of dollars.  A prospective franchisee took the deal, and in fact bought 2 Title Kilt franchises.  When the franchise business lost money, the franchisee ran to the Title Kilt franchisor demanding a refund of the initial franchise fee.  The evidence was conclusive, 1220 LLC sent an email to the then prospective franchisee with the false franchise finance performance representations.  A second investor claims that 1220 LLC also gave false information.
 

Discovery more about Area Representatives and other multi-franchise options.  Click here or go to:  http://wp.me/p4bshS-162

 
If in fact, a false or improper performance representations were made, the franchisee may be entitled not only to the return of the initial franchise fee, but also compensation for any monies expended in buying the franchise, start-up costs, and lost profits.
 

See the 10 Franchise Financial Performance Representation [FPR] Dos and Don’ts infographic! Click here or go to:  http://wp.me/p4bshS-17i

 
Under this relationship, the area representative, can well be seen as an agent for the Title Kit franchisor making the Title Kit liable. Tilt Kilt did the right thing.  They trained 1220 LLC about the do’s and don’ts of selling franchises and giving false performance representations.  When the improper conduct of the 1220 was learned, Title Kilt sought to terminate the 1220 LLC’s area representative agreement.

When selling franchises, entering into area representative agreements, referral and broken relationships it is important to:

• ·        Educate folks about the franchise sales processes and the applicable laws;
• ·        Have prospective franchisee complete questionnaire before signing the franchise agreement asking yes and no about legal sales processes.  If is noted that if proper sale processes were not followed, don’t sell the franchise;
• ·        Take immediate and quick action regarding any reported improper franchise sales practices.

 
 

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Per the Nation’s Restaurant News:

Wendy’s same-store sales rose 3.1 percent in North America during the third quarter ended Sept. 27, the company said.  

And, there are now opportunities to franchise a Wendy’s store!

[Wendy’s] Executives expect to continue selling company-owned restaurants to franchisees, with Wendy’s on track to sell 225 locations to operators this year, and another 315 units next year.

http://nrn.com/same-store-sales/wendy-s-value-deal-drives-3q-sales
 
So what can the Wendy’s franchisor tell prospective franchisees looking at buying an existing Wendy’s location?  For the last couple of weeks, we have been blogging about franchise financial performance representations [FPR] which must be disclosed in the franchise disclosure document [FDD].
 
Read the post about FPR:

If a franchisor wishes to disclose only the actual operating results for a specific outlet being offered for sale, it need not comply with this section, provided the information is given only to potential purchasers of that outlet.

 
That means, when selling existing outlet locations, franchisors may disclose:

• To prospective franchise buyers only,
• The actual financials of the existing outlet location only,

And

• The actual financials of existing location are not subject to FTC Disclosure Rule item 19 financial performance representation requires
• The actual financial outlet information does not have to be included in the FDD

 
Before giving the actual financial, wait.  Even though the disclosure of the actual financials may not have to follow the FTC Rule, a disclaimer should be included.  Corporate operating results may be different than franchise results.  If the results are from a prior franchisee operation, you may not be able to validate or take ownership to the financials.  And, remember past operations are not necessarily a guarantee of future results.  Include a disclaimer.
 
The disclaimer should  include warnings that past performance is not a guarantee of future performance, corporate cost structures may be different from franchise, and any other circumstantial specifics that may be prudent.
 
Need help preparing a disclaimer, give us a call 513-400-3895 or send us an email [email protected]

Yes. No. Maybe. If franchisor owned outlet data can be used for franchise financial performance representation, it depends on:
 

• If there are franchise outlets
• What can kind of representations are being made, and
• If the franchisor owned outlet data is used alone are with franchise outlets

The NASAA’s [North American Securities Administrator Association] Franchise and Business Opportunity Project Group [Franchise Project Group] has released, for internal and public comment, a Proposed Franchise Commentary on Financial Performance Representations [FPR Commentary].
 
Discover 10 Franchise FPR Dos and Don’ts, click here  or visit http://wp.me/p4bshS-17i

In the FPR Commentary, clarity is provided about when and what franchise financial performance representations [FPR] can be made using company [franchisor] owned outlets.
 
To better understand the ifs and whens and okays, we made a symmetric.

 
Give us a call to review your exiting financial performance representation [FPR] or get help drafting a new FPR:  513-400-3895 or email at [email protected].

The NASAA’s [North American Securities Administrator Association] Franchise and Business Opportunity Project Group [Franchise Project Group] has released for internal and public comment a Proposed Franchise Commentary on Financial Performance Representations {FPR Commentary].
 
FPR are covered in Item 19 of the Franchise Disclosure Document [FDD].  And, the regulatory skinny is:  You can only tell prospective franchisees about the future or historic franchise earnings, if they are included in the Item 19 of the FDD.  If franchisors don’t include an Item 19, the franchisor cannot talk to franchisee about earnings.
 
That is the skinny, but there are lots and lots of rules, debates, and opinions about what can and should be in an Item 19 Financial Performance Representation.  The FPR Commentary is crafted to answer some of the questions.  It doesn’t replace or change the FTC Franchise Disclosure Rule and it does not cover everything.  You still have to read and know the Rules.
However, with those disclaimers, here are the Dos and Don’ts from the FPR Commentary.

 

 
California has amended it franchise laws!  The amendments  affect when, what, why, and how franchisors can terminate franchise agreement, prevent transfers, and choose not to renew franchises.  The California amendments are indicative of a climate change in franchising where franchisees are granted more legislative rights. The law has been mellowed from what strong franchisee advocates purposed, but the changes are still a strong movement for pro-franchisee advocates.  Below is an outline of the amendment requirements.
 
Termination:  Franchisor may only terminate the franchise agreement:

• Upon 60 day notice and cure period for ‘good cause;’ or
• Immediately upon notice in the event of
  • order for bankruptcy or insolvency
  • all or a substantial part of the assets thereof are assigned to a creditor,
  • franchisee admits his or her inability to pay his or her debts as they come due
  • franchisee fails to operate the business for 5 consecutive days during which the franchisee is required to operate the business [except in event of fire, flood, earthquake, or other similar causes ]
  • mutual agreement between franchisor and franchisee
  • material misrepresentations made in being granted franchise
  • franchisee engages in conduct which reflects materially and unfavorably upon the franchise or franchise system
  • franchisee is convicted of a felony
  • franchisee does not pay money due to franchisor or affiliates within 5 days from when due
  • franchisor believes continued franchise operations is an imminent danger to public health or safety

 
Mandated Franchise Purchase of Inventory, Supplies, Equipment, Fixtures, and Furnishing.  Even when the franchisor lawfully terminates or does not renew the franchise agreement the franchisor must purchase from the franchisee the inventory, supplies, equipment, fixtures, and furnishing.  And, the purchase price is determined by law as:
 

Franchisee Purchase Price  minus  Depreciation  equals  Franchisor’s Purchase Price

The mandate for the franchisor to purchase franchise inventory, supplies, equipment, fixtures, and furnishing is not required if:

• personalized items, inventory, supplies, equipment, fixtures, or furnishings are not reasonably required to conduct the operation of the franchise business
• franchisee does not have clear title the item
• franchisee opts not to renew
• franchisor does not prevent franchisee from retaining control of the franchise premises
• franchisor publically announces decision to withdraw from the ‘geographic market area’ where the franchise is located

 
And, yes.  The franchisor may offset against the amounts owed to a franchisee under this section any amounts owed by the franchisee to the franchisor.
 
Transfers:  The franchisor CAN NOT prevent a franchisee transfer if the person meets the franchisor’s then-existing standards for franchisees made available to the franchisee.
 
This prohibition does not negate the franchisor’s right to approve or any franchisor’s right to first refusal.
 
The amendment [presumption ally] prescribes the protocol franchisor should use in the transfer.  It says:

• Franchisor must approve or disapprove the transfer within 60 days in writing [or the transfer is approved].
• The approval or disapproval is matter of fact, which can be determined by court motion for summary judgment.
• Franchisor does not have to exercise its first right of refusal in the notice of approval or disapproval
• If the franchisor exercises the first right of refusal it must be equal in offer.

 
These amendments go into effect in 2016.  To effectuate these changes, franchisors need to amend their franchise agreements or the California addendum to their franchise agreements and FDD.

Need assistance with making the changes.  Call us at 513-400-3895 or send an email to [email protected] for assistance!

 

 
The way it usually works is the franchisor grants a franchisee a development area, franchisee selects a site where the franchisee wants the franchise business to be located, and the franchisee submits the proposed site to the franchisor for approval. It is a back and forth process. Franchisors may provide varying levels of support, but at the end of the day, franchisors have the final approval on where a franchise is located. And, not all the time do franchisees and franchisors agree. But, when does site selection process become a matter of discrimination? How?
 
The Case is MICHAEL ANTHONY G. WILBERN and WILBERN ENTERPRISES, LLC v. CULVER FRANCHISING SYSTEM, INC. Michael Wilbern purchased a Culver franchise, formed Wilbern Enterprises, LLC in hopes of opening a Culver franchise in the south side of Chicago. However, being persuaded by a Culver franchise consultant, Wilbern opened 2 franchises in the west side of Chicago, Franklin Park and Hilliside. Wilbern proposed a site in the south side of the Chicago in Marshfield Plaza, but the Culver franchisor never approved the site. The Culver franchisor never responded to Wilbern’s proposal for a franchise in the south side location.
 
Wilbern believed that opening a Culver franchise would bring jobs to the lower economic south side of Chicago and that he could receive public funding and extremely favorable rent or purchase opportunities in the south side of Chicago. Instead, Wilbern opened a franchise location in Franklin Park, which later failed, went into bankruptcy,  was evicted from the property, and the franchise was terminated.
 
Wilbern filed suit in the United States District Court, N.D. Illinois, Eastern Division alleging the Culver franchisor engaged in a pattern and practice of racial discrimination in violation of 42 U.S.C. § 1981, Federal Antidiscrimination Statutes.   Racial discrimination? Culver franchisor did not discriminate against Michael Wilbern, because he was black, African American. It is alleged that the Culver franchisor violated racial discrimination, because Culver did not approve a Culver franchise in the south side of  Chicago and the south side of Chicago has predominately African American residents.
 
The outcome of the case is yet to be determined, but it provokes a conversation about franchisors’ site selection processes and approval. Most probably, the Culver franchise does not have a policy or site selection criteria, which bars Culver franchises in communities with predominantly Africa American residents. However, even if the franchisor does not intend to prevent franchises in predominately African American [or other racial groups] residential communities, the acts or practices may have ‘disparaging impact’ or practice that inadvertently and unintentionally has a racial impact and can/may be actionable in court.
 

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