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© 2015 Fox Rothschild John R. Gotaskie, Jr. Presentation to University of Pittsburgh Katz Graduate Business School January 20, 2015 Franchise Law 101 Franchise Law 101
© 2015 Fox Rothschild
John R. Gotaskie, Jr.
Presentation to University of Pittsburgh
Katz Graduate Business School
January 20, 2015
Franchise Law 101
Franchise Law 101
Franchising is Big Business
• 1 out of every 9 retail dollars spent in theUnited States every day is spent at afranchised business.
• Fully 13 percent of the private non-farm jobs inthe United States are at franchised businesses.
• 7-Eleven, one of the largest franchisors in theworld, opens a new franchised outlet every 3.5hours worldwide.
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The Inadvertent Franchise
• “Legal terms often havespecialized meaningsthat can surprise even asophisticated party. Theterm ‘franchise’ . . . isone of those words.”—United States SeventhCircuit Court of Appeals(1999).
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Error Can Be Costly
• Many manufacturers and suppliers are all toooften surprised and dismayed to learn that theirdistributorship relationships are subject tofranchise laws.
• Very prominent example is a 1999 jury casewhere a jury awarded $1.525 million to aterminated Mitsubishi forklift distributor due to aviolation of the Illinois franchise law.
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So . . . how do you know?
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The Law Defines It.
Hello. Don’t worry. We’re from the government,and we’re here to help.
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FTC Rule
• A franchise is a “continuing commercialrelationship” with all three of the followingelements:– Trademark– Significant Control or Assistance– Fee or Payment
• Found at 16 C.F.R. Part 436• The FTC’s own compliance guide runs 154
pages.
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Trademark
• The franchisee is allowed to offer, sell ordistribute goods, commodities, or serviceswhich are identified by a trademark, servicemark, trade name, advertising, or othercommercial symbol.
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Significant Control
• The franchisor exerts significant control orassistance over the franchisee’s method ofoperation.
• Usually accomplished through both thefranchise contract and a franchise systemoperating manual.
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Fee or Payment
• The franchisee is required to pay a fee to thefranchisor or its affiliates of $500 or more (otherthan for bona fide wholesale prices for inventory)at any time before or within six months aftercommencing operations of the business.
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But Wait! There’s More
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State Franchising Rules
• May be narrower or broader than the FTCRule.
• All states involve the use of franchisor’strademarks, trade name or symbols.
• Generally fall into one of two categories:– Marketing Plan– Community of Interest
• Pennsylvania, like a majority of states, doesnot have a state franchise law.
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Marketing Plan States
• Franchisor grants the franchisee the right toengage in a business pursuant to a “marketingplan or system” prescribed by the franchisor.
• Content required is often not clearly defined.
• Example states: Illinois and Indiana.
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Community of Interest States
• Franchisor and franchisee share a “communityof interest” in the marketing of goods or services.
• Parties have a common, continuing financialinterest in the operation of the franchisedbusiness or sale of the franchisor’s products.
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Community of Interest States
• The interest may be manifested in thefranchisee’s dependence on the sale of thefranchisor’s products, the franchise-specificgoodwill created by the franchisee, or merely thefranchisee’s acquired knowledge of thefranchisor’s products.
• Examples: New York, Connecticut, Missouri,New Jersey, Delaware & Arkansas
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Related State Business Laws
• Special Industry Laws: Statutes that regulatethe relationship betweenmanufacturers/suppliers and distributors anddealers.
- Examples: liquor, motor vehicle, farm equipment,petroleum, and outdoor power equipmentdealerships.
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Related State Business Laws
• Relationship laws: if a franchise relationship isestablished under state law, a number of statesimpose special duties on substantive aspectsof the business relationship, such as atermination, transfer, cancellation and non-renewal.
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State Relationship Laws
• Designed to protect franchisees from beingtreated unfairly.
• States with relationship laws: Alaska, Arkansas,California, Connecticut, Delaware, Hawaii,Idaho, Illinois, Indiana, Iowa, Maryland,Michigan, Minnesota, Mississippi, Nebraska,New Jersey, North Dakota, Rhode Island,South Dakota, Virginia, Washington, andWisconsin.
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Business Opportunity Laws
• “Franchise-lite”• FTC rule and state laws that cover business
opportunities like vending machine routes, rackdisplay operations (e.g., magazines, candy),900 number ventures, medical billing ventures,and most work-at-home ventures.
• Final FTC Amended Rule became effectiveMarch 1, 2012.
• Requires a simplified disclosure of 5key important items.
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FTC Business Opportunity Rule
• Seller's identifying information;
• Earnings Claims;
• Legal/Litigation History;
• Cancellation/Refund Policy; and
• A List Containing Purchasers for the past 3years.
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What does this all mean?
• Disclose, Disclose, Disclose
• Protections afforded by franchise laws generally cannotbe waived, even if there is contract language
• to the contrary!
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Franchise Disclosure Document
• Better known as the “FDD” (used to be known as theUniform Franchise Offering Circular (“UFOC”).
• The FDD is a comprehensive, pre-sale disclosuredocument that must be provided to a prospectivepurchaser of a franchise.
– 23 different items must be including, ranging from identificationof franchisor to intellectual property
• This disclosure requirement applies in all 50 states.
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Key Elements of FDD
• Business Experience of Franchisor (Item 2)
• Material Litigation of Franchise System (Item 3)
• Estimated Initial Investment (Item 7)
• Obligations of Franchisee (Items 9, 14)• Often includes things like non-competes
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Key Elements of FDD
• Terms of renewal, termination, transfer anddispute resolution (Item 17)
• Restrictions on what a franchisee may sell (Item16)
• Fair financial performance representations (Item19)
• Plain Description of System (Item 20)
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State Requirements
• In “registration states”, afranchisor must register itsdocuments with the statebefore offering a franchisefor sale.
• CA, HI, IL, IN, MD, MI, MN,NY, ND, RI, SD, VA, WA, WI.
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Examples of InadvertentFranchises
• Air Conditioning Dealer
• Appliance Dealer
• Copy Machine Distributors
• Furniture Dealers
• Lubricant Distributors
• Sales Representatives (especially in states like CT thatdo not require a franchise fee)
• Slot Machine Distributor
• Common bottom line: many “dealerships” and“distributorships” are hidden franchises
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Consequences ofNon-Compliance
• Risk of Substantial Civil and Criminal Penaltiesfrom federal and state enforcement.
• No “private right to enforce” under FTC Rule;however, state laws do often include a privateright to enforce state law or the FTC rule in statecourt.
• FTC Rule, moreover, imposes liability on officersand directors, and state laws often make thatliability joint and several.
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Ignore Law at your Peril
• Globe Distributors v. Adolph Coors Co.
• New Hampshire—not a registration state—buthas a state statute requiring notice andopportunity to cure before a distributorship maybe terminated.
• Coors terminated for nonpayment without notice,as provided in contract.
• Jury awarded double damages of $10.2 millionfor wrongful termination.
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Franchise Contract
• Formal Franchise Agreement (the Contract)• Often tracks the FDD
• Binds franchisee to system requirements andoperations
• Usually involves system operating manual (updatedregularly), including financial reporting and computersoftware requirements
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Franchise Contract
• Beginning or end of relationship is when tonegotiate special terms
• Important to use due diligence and choosesuccessful (or high potential) franchiseopportunities
• Franchisee success is tied to franchisor successto a significant degree.
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Selected Issues in Franchising
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Taxation
• And, on the Fifth Dayof Christmas, my truelove sent to me . . . anew franchise taxlaw opinion from theIowa Supreme Court.
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Taxation
• On December 30, 2010, the Iowa Supreme Courtaffirmed the power of states to impose income taxes onroyalties paid by franchisees to out-of-state franchisors.
• The Court found that the use of KFC’s intangibleintellectual property (images of Col. Sanders, the redand white bucket, etc.) by its franchisees within thephysical confines of the state of Iowa presents "asufficient connection to Iowa to amount to thefunctional equivalent of 'physical presence'".
• Issue to watch as states have strapped budgets andare searching for revenue—Georgia, Alabama andMississippi have introduced legislation.
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Taxation
• Amazon.com
• New York State case
• Amazon has no physical location in state• Traditional test for due process
• NY Courts found that contracts between New Yorkbusinesses and individuals for commissions wassufficient
• 2014: US Supreme Court refused case
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Taxation
• Franchisor vs. Franchisee
– Each Franchise is its own, independent business.
– Some—and a growing number of franchises—are so-called “master” or “area” franchisees.
– All of the responsibilities of running an independentbusiness apply
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Labor Issues
• Or, Who is the employer?
• Unions want to organize franchises
– They don’t want to go franchisee by franchisee
– Costly and time-consuming
– High turnover
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Traditional Test
• Different Circuit Courts and State SupremeCourts have slightly different tests
• Generally: An employer must be able tomeaningfully affect employment
• Things such as hiring, firing, discipline, supervisionand direction.
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Enter the NLRB
• The McDonald’s Complaints
– NLRB Office of General Counsel has filed 13complaints alleging that franchisors and franchiseesviolated the National Labor Relations Act
– Wants to replace “meaningfully affect” standard with“sufficient control” standard
– Nobody is quite sure what it means
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What’s Next?
• Stay Tuned
• One thing everyone agrees on: the NLRBComplaints present a huge challenge to thefranchise business model
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Immigrants and Franchising
• Over the last 20 years (ending 2012), 30% ofnew small business owners have beenimmigrants.
• Immigrants own fully 18% of all smallbusinesses in the US.
• Immigrant-owned small businesses employ4.7MM people in the US.
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Immigrants and Franchising
• Many of those businesses are franchises.
• Most common route is the EB-5 Program
– Provides conditional permanent legal residence, if• $500,000 investment in a “targeted area” or $1,000,000
investment elsewhere and
• Creation of 10 verifiable, new, full-time jobs for U.S. citizensor legal residents
• Resources may be pooled (ea. has 10 job rule)
• After 2 years, condition may be lifted
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Immigrants and Franchising
• Investment may be direct or through pooledinvestment vehicles
• Pooled vehicles are much like securitiesofferings.
• Investment fund then hires an operator, whothen enters into the franchise agreement withfranchisor
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Immigrants and Franchising
• Another Potential Option: E-2 Visa
• Conditional Resident Card
• Good for 2 years
• Renewable indefinitely, so long asrequirements continue to be met
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Immigrants and Franchising
• E-2 Requirements:
– Investor must be from a treaty country
– Must be entering US solely for purpose of directingthe operation of a business in which a “substantialamount of capital” has been invested
– Same tracing requirements as EB-5
• No set amount; at least $100,000
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Immigration
• Don’t forget L-1 (intercompany transferees), L-2(spouses and unmarried children), H-1B(specialty workers) and H-4 (spouses andunmarried children) visas.
• Generally need to be sponsored by an employerand capped at 7 years.
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Immigration
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Bottom Line:Franchising offers greatopportunities for a foreignimmigrant investor lookingto emigrate to the U.S.Potential pitfalls mean withyou need to work with anexperienced franchisorand/or franchisee.
Social Media
• 2009 FTC Report on Online BehavioralAdvertising
• 4 Principles:• Transparency and Consumer Control
• Reasonable Security and Limited Data Retention
• Affirmative Express Consent for Material Changesto Existing Privacy Promises
• Affirmative Express Consent to Using SensitiveData
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Key Elements of a Social MediaPolicy
• The franchisor must have a written social media policy and ensure thatfranchisees have a social media policy that is consistent with thefranchisor’s policy.
• The policy should be authorized in the franchise agreement and publishedin the franchise operating manual, or other document that controls thefranchisee-franchisor relationship.
• Even for older franchise agreements that do not make specific mention ofa social media policy, the provisions of a franchise agreement related toadvertising, control and use of the franchise system’s trademarks,preserving confidentiality, and termination and post-terminationobligations all likely support the establishment of a social media policy.
• All franchisees (and employees, as applicable) should sign anacknowledgement of receipt of the policy.
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Key Elements of a Social MediaPolicy
• Ensure that the policy provides that the franchisor owns anywebsite, blog site, Twitter account, Facebook account, and/or anyother site created on a social media platform involving the brand.
• Equally important, the policy must require franchisees to provide,and update, their franchisors with the then-current passwords forany social media involving the brand. This requirement isessential, should be included in any renewals of the franchiseagreement, and should also be included in the list of franchiseeobligations that survive any termination of the agreement.
• Examples abound of “orphan” social media websites or portalsthat can neither be accessed nor taken down because a non-cooperative or terminated and disappeared franchisee owns thesite and/or the site’s passcode is unknown.
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Key Elements of a Social MediaPolicy
• Make social media policy consistent with the other typesof rules of the franchise system regarding use andcontrol of trademarks and copyrighted materials, andadvertising. For example, a franchisor might wish toinclude policies regarding use of brand trademarks andlogos on Twitter, Facebook and other social media sites.
• Disclose what types of monitoring the franchisor willperform. Specifically state that franchisees andemployees have no expectation of privacy in informationthey post publicly and that any social media or internetsites that they access on work computers may be storedand/or reviewed by the company.
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Key Elements of a Social MediaPolicy
• Make sure franchisees understand the need to betransparent. They should not take on the persona of anyother person on social media, especially a customer,whether it is on your own site or any other site—particularly the site of a competitor. Violation of FTCregulations.
• Advise franchisees that they may not post anonymouslywhen discussing matters related to the franchise system.In fact, some states, including Pennsylvania, have heldthat the names of anonymous posters to social mediasites can be discovered if financial harm can bedemonstrated.
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Franchise Assignments inBankruptcy
• § 365 of Bankruptcy Code
• Franchise Agreements are generally assignable
• Exception for Trade Mark Cases
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Success
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John R. Gotaskie, Jr.
(412) 394-5528
Editor of Fox Rothschild Franchise Blog:
http://franchiselaw.foxrothschild.com/
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