What do Auditors look at when giving Consent?- Updating the FDD

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In order to include audited financials in the franchise disclosure document [FDD] and for state registration purposes, auditors must give consent for the franchisor’s audited financials to appear in the FDD. In order to get consent from the auditors, the auditors may request to see a copy of the FDD.
 
As you hand over a copy of the FDD to the auditors, you may wonder, what are they looking at? To give consent you may ask, what are the auditors looking for?
 
What auditors look at is not congruent. There is no protocol or perimeters of what the auditors can or should be looking at. Different auditors may look at different things. Some auditors will just do a demonstrative glance at the FDD. Other may do a granular read. There is no consistency. But there are some commonalities. Here are some tips for preparing for the auditor’s review.

1. Make sure the list of the franchise outlets and total number of outlets in item 20 matches the revenue source that you reported to the auditors. If the numbers are different, be prepared to explain the difference.

2. Make sure the audited financials are properly identified in item 21 of the disclosure document.

3. Make sure the total franchisor revenues and profits stated in item 8 regarding earnings from franchisee and vendor purchases mesh with the audit numbers.

4. Make sure the litigation disclosures in item 3 are consistent with information provided to the auditors.

5. Make sure that the issuance date is acceptable to the auditors. In all cases the issuance and effective date should be after auditor has give consent.

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What you need to know about offering Franchise Fee Discounts.

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Have you heard about 7-Eleven’s Zero Franchising Fee program? Under the Zero Franchising Fee offer, 7-Eleven is waiving the Initial franchise fee until June 30th on 200 stores for prospective franchisees ‘21 or older that are permanent U.S. residents, have excellent credit and $50,000 in liquid assets.’
 
Attracting qualified prospective franchisees is a challenge faced by many, most, if not all franchise systems. Offering discounts and special offers can be great way to attack prospects. However, franchisors need to be careful about discrimination and disclosure when offering discounts and special offers.
 
Many states have relationship laws, which prevent discrimination of franchisees. Yes, discrimination laws. When we think of discrimination, we think of employment issues and public accommodations. We don’t think of franchising. But, there are discrimination laws in franchising. Discrimination laws prohibit franchisors from treating similarly situated franchisees differently. Hence, charging one prospective franchisee an Initial Franchisee Fee and not another, because one is of foreign nationality or is over 50 years old, can go awry of franchise discrimination laws.
 
And, if you offer discounts or special offers, you must disclose the discounts and specials in the franchise disclosure document [FDD] at the time the special or discount is being offered and forever more. When the special or discount is being offered, the discount or special must be disclosed. When the offer expires or is withdrawn, the discount still needs to be disclosed in the disclosure documents, forever more.
 
It is common place for new or developing franchisors to offer Initial Franchise Fee discounts. It is common place for franchisors to offer discounts to defined groups such as military veterans or existing franchisees. It is all good. However, introducing such discounts should be done carefully. Before introducing discounts or specials, franchisors should:
 

1. Properly and clearly define perimeters and qualifications for the any discounts or specials, and

2. Amend franchise disclosures documents to reflect any discounts or specials.

 

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What else do I need to include in the Annual FDD Update?

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Every year franchisors are required to update their franchise disclosure documents [FDD] 120 days after the close of their fiscal year. For most franchisors the close of the fiscal year is December 31st. That means that under franchise disclosure laws, the FDD must be updated by April 30th.
 
To update the FDD, disclosures must be amended to include information about the previous year’s franchise outlets, franchisees, and franchisor financials. But, don’t stop there. Take a glance through the disclosures. Are some of the disclosures antiquated? For example do the disclosures talk about a POS system that you used 4 years ago. Are you considering an increase in initial franchise fees? Have you made changes to initial franchisee training program? During FDD updating process, it is also a good idea to review and make any changes to the FDD. These changes may include New Year initiative or simply updating any out-of-date information.
 
Franchisors are free and obligated to update the FDD throughout the year if material changes occur. But, amending the FDD during the year can be costly and delay franchise sales. If a change is made to the FDD during the fiscal year, franchisors may have to re-disclose prospective franchisees. And, the franchisor may be required to file amended registration with some states, which costs money and can result in delays for state registration effectiveness.
 
The number of disclosures and the amount of information contained in the FDD is huge. Trying to distill down any changes that may have occurred and not be reflected in the FDD can be confounding. To make it a little easier, we put together a checklist of the possible changes that may have occur. Take a look. Complete the check list.

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Who Should be Required to Sign a Non-Compete?

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Non-Competition agreements are common place in the general business world and particularly in franchise world. But have non-compete covenants gone too far? The state of New York and members of Congress are asking just that question. The inquiry stems around Jimmy Johns franchisees. Members of Congress have asked the Federal Trade Commission [FTC] to investigate the non-compete practice of Jimmy Johns and New York Attorney General has stated intent to request non-compete agreements distributed by franchisor Jimmy Johns.
 
Non-competition agreements, by general definition, prevent the signer from working in or having ownership in a business that offers or sells the same products or services for a specified period of time.
 
Unfettered non-compete agreements are thought to be a restraint on trade and thereby are only permissible to enforce a legitimate business. The enforceability of non-compete agreements is governed by state laws. And, the enforceability varies among states. Most notably, for example, California does not enforce non-compete agreements. California is an exception to the general rule, however. Most states will find non- competes are enforceable if they are for reasonable time period [1-2 years] in reasonable radius [i.e. 25 miles from the place of employment or other locations] and narrowly define what constitutes a competing business.
 
In a letter, which was intended to be sent to the franchisor of Jimmy Johns, released to HuffPost by Attorney General investigator Schneiderman’s office asserted that Jimmy Johns’ practices may be disfavored by New York law in that they target employees including those that “make tuna sandwiches or deliver food by bike from getting a job a sandwich shop 3 miles from a Jimmy Johns and there are multiple locations in nearly every state. http://www.huffingtonpost.com/2014/12/22/eric-schneiderman-jimmy-johns-noncompete_n_6369146.html
 
As Huffington Post article points out, Jimmy Johns is not the only franchise with broad non-compete practices. Camp Bow Wow requires its dog sitters to sign non-compete agreements.
 
Attorney General Investigator Schneiderman, acknowledges in his letter to Jimmy Johns that, in many cases, an employer may have a “legitimate concern” regarding the theft of trade secrets, but it isn’t clear how that applies to people who make tuna sandwiches or deliver food by bicycle.
When developing and implementing non-competes, franchise’s non-compete policies should consider:

1. What information is trying to be protected?

2. Which employment levels or positions come into contract with trade secrets and confidential information?

3. What are the state laws in the franchise territory?

4. Are there less alternative agreements that would be more appropriate or more enforceable in situations as a substitution or in addition such as confidentiality agreements and non-solicitation agreements?

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What you need to know before doing employee background checks?

bigstock-Fictional-characters-in-comic-6-19493876Performing an employee background check is not as simply as turning an employee’s name, birth day¸ and social security number over to a credit reporting agency and waiting for the results.
 
Employers are bound to follow a prescribed set of steps when securing and using employee background checks. If you fail to follow the proper steps the consequences can be dire.
 
The prescribed steps are listed below:

1. Secure proper authorization for employee and applicants background checks. Authorization should be on a separate form. It should not be just a check-box on your job applications.

2. Notify affected employees or applicants of intent to take any adverse employment action based wholly or in partly of a background check prior to taking any adverse action.

3. Notify affected employees or applicants of adverse decision.

 
Employers are required to provide employees and applicants with a standardized form entitled A Summary of Your Rights Under the Fair Credit Reporting Act. The form must be given prior to taking any adverse action against an employee or applicant (i.e. not hiring an applicant, denying an employee promotion, firing an employee). A copy of the prescribed form can be obtained by clicking here or at https://www.consumer.ftc.gov/articles/pdf-0096-fair-credit-reporting-act.pdf
 
Ignoring the employer mandates regarding employee background checks is not a good idea. Employers can be subject fines up to $1,000 or the actual damage for each violation plus attorney fees.

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How Defend-able is Your Trademark?

Shiny Registered Trademark SymbolWhat do you do when you find out someone else is using your name to sell products or services? Send a cease and desist notice? Sue for trademark infringement? So is the case of POM Wonderful, LLC [“POM Wonderful”] v. Robert G. HUBBARD, Jr., DBA Portland Bottling Company, DBA Pur Beverages [“Pur”]. Pur Beverages began selling its pomegranate flavored energy drink using the word pom. POM Wonderful took exception. POM Wonderful filed a trademark infringement claim against Pur Beverages seeking to stop the use of the word pom in association with Pur Beverages energy drink. POM Wonderful sought an injunction. The trial court denied the preliminary injunction. The appeals court remanded the case back to the trial court to reconsider the issues.
 
When issuing a preliminary injunction, the court looks at the likelihood of prevailing on the trademark infringement claim. Here is a listing of factors considered by the appeals court:

1. trademark interest
2. likelihood of confusion
3. strength of trademark
4. the relatedness between goods or services
5. consumer care
6. similarities of the marks
7. marketing channels
8. actual confusion, intent, and expansion

 
When examining whether a trademark infringement is present all factors are considered. Not all factors have to present and no one factor is determinative if a trademark infringement is present.
 
If you see, someone else using your marks take a moment to evaluate the factors. It is not a deductive reasoning process. In the POM Wonderful case it required to 2 courts. And, we still don’t know the answer.
 

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Are You Ready for the New Multi-Franchise Disclosure Changes?

Franchising has become increasingly a vertical structured system. There are franchisees owning several numerous territories. There are third party sellers and advisers all with varying licenses and developmental rights. Within the franchise industry there is lack of the consistency about the definitions used to describe the tiers under the vertical franchise structures. And, there is confusion about the appropriate and required disclosure regarding these tiers. The NASAA has stepped in to provide some clarity!
 
Back on September 16, 2014, the Franchise and Business Opportunity Project Group of the North American Security Administrators Association [NASAA] finalized Multi State Commentary on ‘practical guidance for disclosing certain multi-unit franchising arrangements that have become common in franchising but that are not specifically addressed under NASAA’s 2008 Franchise Registration and Disclosure Guidelines or the Federal Trade Commission’s [“FTC’s”] Franchise Rule.
 
Below is a table of the 3 types of the franchise structures identified by the NASAA guidelines.
Presentation1The effective date of this Commentary is March 16, 2014. If the franchisor or subfranchisor has an effective Franchise Disclosure Document, the franchisor or subfranchisor must comply with the Commentary 120 days after the franchisor’s or subfranchisor’s next fiscal year end- April 30th for most franchisor/subfranchisors.
 
If the franchise system offers one of these structures, numerous tweaks may need to be made to the existing franchise disclosure document and a new disclosure document may need to drafted.
 

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Save the Date!

privacylawsgeneric (2)We are pairing up with Michelle Hummel from Web Strategy Plus to present a lunch and learn for Social Media Enthusiasts. The topic is How to Increase Positive Reviews and Handle Negative Ones.
 

Thursday, February 26, 2015
11:30 AM to 1:00 PM
Newport Syndicate
18 East 5th Street, Newport, KY

 
This is an extension of our recent podcast entitled Patient Reviews: Getting Fans and Making Friends Online presented by the NAIMP [National Association of Independent Medical Practices].
 
During the lunch and learn, we will conduct tutorial demonstrations on how to respond to comments using different platforms such as Yelp and FaceBook and discuss tips on how to turn disgruntled customers’ complaints into positive customer relations experiences- AND still maintain privacy of customer information.
 
Michelle will key you into many social sites your business needs to be listed on to start collecting positive reviews!
 
Don’t worry, if you are not a health care provider. We promise to have plenty of the useful information for everyone! Visit the Social Enthusiast Website for more information: http://www.meetup.com/Social-Media-Enthusiasts/events/219719654/
 

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What are the SBA’s Franchise Bug-a-Boos?

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SBA loans may be a viable option for the franchisees trying to finance or buy a franchise. However, there are some catches. SBA [Small Business Administration] loans are only available for independent small businesses. The key word here is independent. If the business is not independent, there is no loan for your prospective franchisee.
 
How does the SBA decide if the franchise opportunity is independent? What makes a franchise opportunity un-independent? Simply being in a franchisee/franchisor relationship does not make the franchise opportunity un-independent.
 
In the recent request for commentary, examples of the common affiliation issues found in franchise agreement were enumerated. These affiliation issues are some of deciding factors for determining if the franchise opportunity is independent. Affiliation issues can affect if prospective franchisees may be eligible for SBA loans. Let’s take a look at the list.
 

1. Restrictions on the Ability of the Franchisee To Transfer the Business or an Interest in the Business. Every franchise agreement has a provision that requires the franchisor’s consent for transfer of the franchise business. This will not kill SBA eligibility if there is saving language allowing for “reasonableness and timeliness.”

2. Deposit of Receipts Into an Account Controlled by the Franchisor. Okay this is per se excessive control. A.K.A it is an SBA eligibility killer. For the franchise to be independent, the franchisee must have the ability to control its own funds, including the payment of royalty fees to the franchisor. If the franchise agreement gives the franchisor the right to collect and control franchisee funds, deduct the royalty fees, and remitting the remaining funds and receipts to the franchise, this is excessive control. It is also excess control if the franchisor requires the franchisee to desposit all funds into an account controlled by the franchisor.

3. Franchisor Billing and Collecting From Franchisee’s Customers. This is a red flag, but not an SBA eligibility killer. In order for this to be okay, it must be necessary per the franchise business concept and common place in the core business industry. The example given is the fitness industry where gym members are provided access to the entire fitness center network. In that case it is deemed necessary and okay for the franchisor to bill and collect monies from the franchisees’ customers in order to enable the sharing of other facilities in the network.

4. Establishing a Price for the Sale of Assets Upon Termination, Expiration, or Non-Renewal of the Agreement. It is okay for the franchisor to have the right to purchase the franchise asset from the franchisee upon termination or non-renewal, or transfer of the franchise agreement. The catch here is the purchase price. The purchase price must be at FMV [fair market value].

5. Franchisor’s Assumption of Control of Franchised Operations or Employees [“Step-In Rights”]. This is a yellow flag. It is okay for the franchisor to assume operations of the franchise business, but only for set reasons and only for a limited period of time. It is never okay for the franchisor to have hiring and firing control of the franchisee’s employees.

 
That is the historic list of 5 common provisions the SBA takes issues with. Incident to the commentary, the SBA has added 3 more watch-out provisions. Here they are. The SBA wants your comments on these. Should they be considered deal breakers for SBA eligibility?.

6. Pricing. We have seen the cases of $1 menu fights between franchisors and franchisee. The SBA take the position that “an independent business should maintain the ability to set its own pricing, which enables it to make a profit or risk a loss from its own actions.” The SBA’s current stance is that establishing pricing for national accounts or national advertising is okay so long as the  pricing maximum and minimum are not targeted at a specific franchisee or location. What are your thoughts? How does this effect your franchise brand?

7. Right of First Refusal [ROFR] on a Partial Assignment or Change of Ownership. What if a franchisee transfers part of the business ownership to a spouse, child, or relative, should the franchisor have a first right of refusal [ROFR]? What if the transfer is to an unrelated third-party- say an employee or new business partner? The SBA says EXCESSIVE control if the ROFR involves a family member. The SBA is on the fence if the partial transfer involves an unrelated third-party. Now, remember this not about consent or approval. This is about if the franchisor has the right to buy the assets in event of a partial transfer.

8. Option To Purchase/Lease Real Estate Owned by the Franchisee. The franchisee has a brick and mortar location. The franchise agreement expires. Should the franchisor have the right to assume the brick and mortar location? What if the franchisee owns the land? What if the franchise agreement does expire, but is terminated. Still the same outcome?

The SBA starts off with saying that if the franchisor wants the location, the franchisor should buy or lease the property and sublease or lease the property to the franchisee. In many franchise relationships traditionally, that is how it worked. But, with changes in real property condition, the cost of owning and leasing property, franchisors have gotten away for owning property and subleasing property to franchisee. What is the solution?

Here is the SBA’s position. If the franchisee owns the property and the franchise agreement expires, not default, hands down, the franchisee gets to keep the property. They may be required to de-brand the property, but the franchisee gets to keep the property. The franchisor may have a ROFR, but the franchisor can not force the franchisee to sell or lease the property.
The issue becomes more fuzzy if the franchisee does not own the property and/or if there is a default. The SBA wants your comment on this issue.

 
 
The issues presented in the commentary have wider value. If you are a prospective franchisee, considering buying a franchise, consider these issues. They are recognized issues of control that may affect the value of the franchisee’s opportunities and operational issues.
 
If you are franchisor, take a look at the provision in your franchise agreement. Do any of the provisions go against the SBA’s excessive control positions? Even if you are not interested or concerned about SBA eligibility, these issue are worth visiting. These issues will likely be raised by attorneys representing prospective franchisees.

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What do you think about the SBA lending process?

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The SBA [U.S. Small Business Association] is asking for your comment. In December the SBA published a request for comment regarding the franchise reviews, affiliations and eligibility for the financial assistance.
SBA can be great source for franchisee start-up capital. But, many franchisors will tell you that the lending process can be rough. Here are the issues up for comment. The list is long……
 

(1) How can the review of franchise relationships be simplified?

(2) What relationships require review under the standard independence standard, franchises, licenses, dealers, jobbers, and what other similar relationships?

(3) How does SBA’s process for determining excessive control of franchisors and franchisees affect small businesses during and upon termination of the franchise agreement?

(4) Should regulations be modified to specifically address the franchise provisions SBA has determined evidence excessive control by the franchisor?

(5) Should regulations be modified to incorporate a reference to “Loan Program Requirements?

(6) Should SBA develop a process to accept a certification of non-affiliation from a franchisor and/or its counsel, based on standards established by SBA, in lieu of SBA or lender review of the franchise agreement and related documents?

(7) If so, should that process be available only with respect to “renewal requests”—i.e., only for franchisors that have had franchise agreements reviewed and approved by SBA in a prior year?

(8) If an applicant is not a franchisee but has an affiliate that is a franchisee, should SBA continue to review the affiliate’s franchise agreement and related documents as part of the small business size determination of the applicant?

(9) Should SBA continue to list agreements on a central registry and, if so, where should that registry be maintained and by whom?

(10) If there is a cost associated with the maintenance of the registry, who should bear that cost? Should there be a charge for listing of agreements on a registry and, if so, who should bear the cost for such listing? SBA notes that there are statutory limitations on SBA’s current authority to charge, retain and use fees.

(11) In light of the fact that SBA lists approved franchises on its Web site, is there a need to continue to post the Franchise Findings List as well?

(12) Should the franchise agreement review process be streamlined and/or simplified and, if so, in what way?

(13) Should the franchise appeal process be changed and, if so, in what way?

 
Hurry, if you have a comment. The deadline for responding to the SBA’s request for comment is February 6, 2014. Contract us about making a comment on the SBA lending process.
 
Look for our next post discussing SBA list of the hot button issue commonly found in franchise agreements.
 

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