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Fundamentals 201:
Transfers and Assignments in
Franchising
David BeyerQuarles & Brady LLP
Tampa, Florida
&
Phyllis Alden TrubyPhyllis Alden Truby, APC
Los Angeles, California
INTRODUCTION • Fundamentals:
– Basic principles
– Broad brush
• Basics for
– franchisor counsel drafting Franchise Agreement
– franchisee counsel reviewing transfer and
assignment provisions
Summary
• Legal Framework
• Drafting Practices and Franchise Agreement
Provisions
• Some Common Requirements
• Third Party Considerations
• Evaluating and Documenting Transfers
LEGAL FRAMEWORK
• To Disclose or Not to Disclose
–Disclosure and Registration
• FTC Rule
–Presale Disclosure
• State Laws
–Presale Disclosure / Registration
FTC Rule Legal Framework
“Franchise Seller”
–does not include existing franchisees selling own outlet
–unless otherwise engaged in franchise sales
FTC Rule Legal Framework
“Sale of a Franchise”
– “any arrangement whereby a person obtains a franchise from a franchise seller …”
– Does not include transfer by an existing franchisee if the franchisor has no significant involvement with the prospect
FTC Rule Legal Framework
What is significant involvement?
– Approval / disapproval alone is not
– But these are:
• Imposing new agreement or new material terms
• Referring potential buyers• Furnishing financial performance
information
State Law Legal Framework
• Similar to FTC Rule
– Exempt sales by franchisees for own account
• Not “by or through” franchisor
– Approval / disapproval not enough
State Law Legal Framework
• Some expressly acknowledge exemption applies
–Reasonable transfer fee
• Some impose restrictions on number:
– Isolated Sale: HI, MI, NY, OR
– MN: 1 Sale / 12 months
FDD Transfer Disclosures Legal Framework
Item 6: Other Fees
• Type and Amount
• Due Date and Explanatory
• Payable to Whom
• Refundable
• Uniformity
FDD Legal Framework
FDD Legal Framework
Item 9: Franchisee’s Obligations
Table cross-references to
• Franchise Agreement
• FDD Items
FDD Legal Framework
FDD Legal Framework
Item 17 Transfer Disclosures
• Assignment by franchisor
• Definition
• Franchisor approval
• Transfer conditions
• Franchisor right of first refusal
FDD Legal Framework
FDD Legal Framework
FDD Legal Framework
FDD Legal Framework
Item 19: Financial Performance Representations
• Actual operating results of outlet for sale excluded from FPR definition
• Making an FPR is “significant involvement”
FDD Legal Framework
FDD Legal Framework
Item 20: Outlets and Franchisee Information
• 3 fiscal years of franchise and company outlet activity
• Franchisees who sold outlet are disclosed as former franchisees
–Name, city, state, phone number
FDD Legal Framework
Table No. 2 – Separate table
• Defined as “acquisition of a controlling interest in a franchised outlet, during its term, by a person other than the franchisor or an affiliate
• Covers private sales of outlet assets and controlling ownership
FDD Legal Framework
FDD Legal Framework
Additional disclosure for franchisor sales of previously franchised outlets:
• Previous owner contact information / 5 years
• Time period for each prior owner
• Reason for change
• Time period controlled by franchisor
•
FDD Legal Framework
•
FDD Legal Framework
State Relationship Laws Legal Framework
10 States Regulate Transfers
• All 10 limit franchisor’s right to restrict transfers
• Supersede contract terms
• Regulate withholding consent by franchisor
State Relationship Laws Legal Framework
• 4 require franchisees to notify before
Arkansas Nebraska
Iowa New Jersey
• 3 specify 60 days prior and must provide transferee information
Iowa Nebraska New Jersey
State Relationship Laws Legal Framework
• 4 States require franchisor to act reasonably or in good faith in denying transfer
Hawaii Minnesota
Iowa Washington
State Relationship Laws Legal Framework
• 3 States require good cause or a legitimate business reason:
–Hawaii, Iowa, Michigan
• 2 give examples (Hawaii and Michigan):
–Failure to meet qualifications
–Competitor or doesn’t sign agreements
–Failure to cure defaults
State Relationship Laws Legal Framework
• 4 limit franchisor’s disapproval right to conditions relating to transferee qualifications:
Arkansas Nebraska
Iowa New Jersey
• Character, finances, experience
State Relationship Laws Legal Framework
5 States require written notice of denial and deem approval if not timely
Arkansas (60) Nebraska (60)
Hawaii (30) New Jersey (60)
Iowa (60)
State Relationship Laws Legal Framework
• 4 States regulate transfers in context of succession after death:
California Indiana
Iowa Washington
Legal FrameworkState Relationship Laws
Iowa (most comprehensive)
• Deemed approval if not rejected in writing in 60 days specifying reasons
• Rejection limited to failure to meet “reasonable current qualifications … for new franchisees”
Legal FrameworkIowa (cont’d) State Relationship Laws
• Qualifications must be legitimate business reasons – not arbitrary or capricious
• No discrimination: race, color, national origin, religion, sex or disability
Legal FrameworkIowa (cont’d) State Relationship Laws
Permitted Conditions:
• Completion of reasonable training
• Payment of reasonable transfer fee (reimburse reasonable and actual expenses)
• Payment of amounts owed
Legal FrameworkIowa (cont’d) State Relationship Laws
Prohibited Conditions:
• Entering into a new or different contract
• Transferee undertaking new obligations or relinquish rights
• Sign release
Legal FrameworkIowa (cont’d) State Relationship Laws
Certain transfers automatically approved with no strings attached:
– Death or disability
– Transfers among existing owners, or spouse or child, ESOP, but must meet qualifications (50% or more owner) or controlled companies
DRAFTING PRACTICES AND
FRANCHISE AGREEMENT
PROVISIONS
Defining what constitutes a transfer or assignment
Elements of Definitions
• Who
• What
• How
Drafting Practices: Definitions
Who: Individual Franchisees
• Single Person
• Married Couples
• Domestic Partners
• De Facto Partnerships
Drafting Practices: Definitions
Who: Entity Franchisees
• Trusts
• Corporations
• Professional Corporations
• Limited Partnerships
• LLC’s
Drafting Practices: Definitions
Who: Entity Franchisees
Drafting Practices: Definitions
Some issues:
• Thresholds
• Among owners
What is Transferred
• Franchise Agreement only
• Premises lease
• Furniture, fixtures, equipment
Drafting Practices: Definitions
What is Transferred
Entity Interests
• Corporations
– Voting Stock
– Nonvoting Stock
Drafting Practices: Definitions
What is Transferred
Entity Interests
Drafting Practices: Definitions
• LLC’s
– Entire Membership
– Economic Interest Only
What is Transferred
Entity Interests
Drafting Practices: Definitions
• Partnerships
– General
– Limited
What is Transferred
Entity Interests
Drafting Practices: Definitions
• Family Trusts
Flexibility and Consistency
• Wide range of circumstances
• Wide range of transferees
Drafting Practices: Definitions
Flexibility and Consistency
Some Examples:
• Among existing owners
• Among or to family members
• To third parties
– Investors
– Operational personnel
Drafting Practices: Definitions
Some Common Standards for Consent
1. Complete Discretion
2. Not Unreasonably Withhold
3. Comparably Qualified
Drafting Practices: Standards
Some Common Standards for Consent:
Drafting Practices: Standards
Complete Discretion
• Why
• Why not
– Franchisee perception
Some Common Standards for Consent:
Drafting Practices: Standards
Not Unreasonably Withhold
• A good compromise
• What does it mean
– Commercially reasonable?
• Why not
– Franchisee perception
Some Common Standards for Consent:
Drafting Practices: Standards
Comparably Qualified
• Taking the measure of the current franchisee
• Then or now
SOME COMMON
REQUIREMENTS AND
CONSIDERATIONS
Pay Transfer Fee
• Is it a profit center?
• Purpose dictates amount
• Exceptional events
Requirements
Execute Current Form of
Franchise Agreement
• Franchisee’s perspective
• Franchisor’s perspective
• Are there exceptions?
Requirements
Continued Right to Occupy
Requirements
Review and Approval of Sale or Other
Transfer Documents
• Purpose
– Cash Flow
– All assets
– Assumption
• Risks
Requirements
Payment of All Sums Due at Time
of Transfer
• Audit
• Closing condition?
– Immediate payment
– Assumption by buyer
Requirements
Franchisee Not in Default
• When requested
• During sale process
• Upon closing
• Buyer curing default at close
Requirements
Renovating, Remodeling, and
Upgrading Franchise Location
• Franchisee’s view
• Franchisor’s view
• Compromise?
Requirements
New Owner’s Successful Training
• Timing
• Cost
• Effect of Failure
Requirements
Assignor’s Secondary Liability
• Franchisee’s view
• Franchisor’s view
• Compromises
Requirements
Release
• Franchisor’s view
• Franchisee’s view
• Mutuality
• Effect of state laws
Requirements
Not to Competitor
• Defining competitor
• Effect
Requirements
THIRD PARTY CONSIDERATIONS
Landlords
• Consent considerations
• Lease Addendum
• Timing issues
Third Party Considerations
Lenders
• Franchisee’s counsel: review loan
documents
• Request consent early and often
Third Party Considerations
EVALUATING AND PAPERING
THE TRANSFER PROCESS
Evaluating and Papering the Transfer Process
• Observe any applicable state relationship
laws
• Implied covenant of good faith and fair
dealing
Evaluating and Papering the Transfer Process
• Generally, franchisor transfer decisions exercised in good faith will be respected
• Franchisor’s legitimate business reasons for refusing transfers will be upheld
But, lack of good faith or reasonable business justification may overturn a franchisor refusal
Evaluating and Papering the Transfer Process
• Prepare and utilize transfer checklist
• Always obtain a franchise application
• Test transferee against qualifications for new franchisees
• If disapproved, specify all material reasons
Evaluating and Papering the Transfer Process
Assignment and Assumption Agreement should specify any terms and conditions:
• Release• Transfer fee• Ancillary agreements• Cure of defaults or payments due
Evaluating and Papering the Transfer Process
Assignment and Assumption Agreement should specify any terms and conditions (cont’d):
• Exclude post-term obligations to still bind seller
• Waive right of first refusal• Follow-up with any third-party
documents that may also affect franchisor in the transfer
End
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