Business Law Ch. 36

In addition, federal statutes govern particular types of franchises or aspects of franchising. For example:

(1) automobile dealer's franchise act (2) petroleum marketing practices act

Because a franchise relationship is primarily a ___(1)____ relationship, ____(2)_____ law governs most aspects of the franchise relationship.

(1) contractual (2)state contract

One or more entrepreneurs setting out to start a business should consider the following factors when deciding what form of business to organize (4)

(1) ease and expense of creation, (2) the owners' liability for the entity's obligations (are you willing to be personally liable?), (3) tax considerations (income tax expense?), and (4) the need and ability to raise capital (more opportunities to reach out for investments if LLC, more partners; applying for a loan - go to bank where they look at your liability, need a business plan).

Normally stated in the franchise agreement (6)

(1) paying for the franchise (2) business premises (3) location (4) organizational form (5) quality controls (6) price controls

Get all the __(1)____, but suffer all of the ___(2)___

(1) profits (2) liability o Personal assets at risk - creditors can pursue the owner's personal assets to satisfy any business debts o Can obtain insurance, but liability can easily exceed the policy limits Example: Shana operates a golf shop near a world-class golf course as a sole proprietorship. One of her employees fails to secure a display of golf clubs and they fall on Dean, a professional golfer, and seriously injure him ♣ If Dean sues and wins: Shana's personal liability can easily exceed the limits of her insurance policy • She can lose: o Her business o House o Car o Any other personal assets that can be attached to pay the judgement

Limited life/lack of continuity

- as soon as I die, the sole proprietorship dies with me ♣ Doesn't mean business has to shut down; it automatically becomes something else

Sole Proprietorship

A business owned by a single person or family. o If you're a control freak - ideal situation for you, don't have to answer to anyone (partners, shareholders) o Usually one person, maybe a close family (distant cousins don't count - more of a partnership) • Simplest form of business • Anyone who does business without creating a separate business organization • Can own and manage any type of business from an informal, home-office or Web-based undertaking to a large restaurant or construction firm

Quality Controls

A franchisor may establish and enforce certain quality standards in order to protect its reputation. ♣ certain quality standards may be established to protect reputation • Can't copy food recipe Wendy's o Always the same hamburger, same buns (don't heat them up); usually the same quality - uniform • Try to keep quality the same everywhere (good or bad) • Day-to-day operation of the franchise business is normally left up to the franchisee o Typically the contract will state that the franchisor is permitted to make periodic inspections to ensure that the standards are being maintained o May limit the franchisee's ability to sell the franchise to another party

Price Controls

A franchisor may suggest the price at which its franchisees will sell its product; however, a franchisor mandating price may run afoul of applicable antitrust laws Franchisor may suggest (recommend) retail prices, but CANNOT mandate (bind) them • The franchisor may require the franchisee to purchase certain supplies from the franchisor at an established price • The franchisors have all the info - generally franchisees will go with the recommended price, but they don't have to • Example: Pay more at the airport

Corporation

A legal entity formed in compliance with the statutory requirements of its state of incorporation, owned by shareholders whose liability is limited to their investment in the corporation, and managed by (i) a board of directors elected by the shareholders and (ii) officers employed by the board of directors.

Distributorship

A relationship where a manufacturer (the franchisor) licenses one or more dealers (the franchisees) to sell the manufacturer's product. Often a distributorship will cover an exclusive territory. Examples: automobile dealerships (car dealers - distributors), beer distributorships

Chain Store

A relationship where the franchisee operates under the franchisor's trade name and is identified as a member of a select group of dealers that engages in the franchisor's business. • help you with advertising • Not selling the product, selling their brand • The franchisee is generally required to follow standardized or prescribed methods of operation and often the franchisor insists that the franchisee maintain certain standards of performance • Franchisee may be required to obtain materials and supplies exclusively from the franchisor • Franchise helps you with advertising • Examples: McDonalds, Wendys and most other fast-food chains; service-related businesses (real estate brokerage firms - Century 21, tax-preparing services - H&R Block, Inc.); footlocker (selling Nikes, not Footlocker), 7/11

Manufacturing or Processing Plant

A relationship where the franchisor transmits to the franchisee essential ingredients or the specifications to make a particular product, which the franchisee will then market at the wholesale or retail level in accordance with the franchisor's standards. Examples: Pepsi-Cola and other soft-drink bottling companies; A.B. Freeman - made his money by Coca-Cola bottling

Franchise

A relationship where the owner of a trademark, trade name, or copyright (the franchisor) allows another person or entity (the franchisee) to use that trademark, trade name, or copyright, under specified conditions or subject to particular limitations, in selling goods or services. • Examples: 7-Eleven, Holiday Inn, McDonalds

Partnership

An agreement by two or more persons to carry on, as co-owners, a business for profit.

Wrongful Termination

Because the franchisee makes a substantial investment to use, but not own, the franchisor's trademark, trade name, etc., both statutory and case law emphasize the franchisor's duty to act in good faith when terminating a franch

Most Sole Proprietors have _____ policy

CGL commercial general liability; coverage by insurance • If go over coverage amount - will have to use own money • Employee - workers compensation, certain amounts of coverage • Sexual harassment insurance for employees not covered (extra policy if buy, or pay out of pocket)

Notice

If the franchise agreement does not set a minimum period for notice prior to termination, then the franchisor must give the franchisee reasonable notice of its intent to terminate the franchisee. • Most franchise contracts provide that this notice of termination must be given • Franchisee must be given reasonable time to wind up the business - to do the accounting and return the copyright or trademark or any other property of the franchisor

Opportunity to Cure

Many franchise agreements grant a franchisee the opportunity to cure an ordinary, curable breach within a reasonable time after the franchisor's notice. If the cure is adequate, the franchisee can avoid termination. • If still cannot fix the problem - they can terminate you o Selling pizza at Wendy's - easy to stop o If not making projections can work with you, but can terminate you

State Law

Many states have franchise statutes and regulations that tend to mimic federal franchise statutes and regulations.

Termination

Most franchise agreements provide that the franchisor may terminate a franchisee before the end of the stated duration only "for cause" - e.g., death or disability of franchisee, bankruptcy or insolvency of the franchisee, breach of the franchise agreement - and only with prior notice.

Duration

Most franchise agreements specify their duration, although the franchisor and the franchisee may agree to extend that duration if they can agree on the terms of renewal. • Usually done on a longer term, can be renewed • Sometimes a franchise relationship starts with a short trial period (a year) so that the franchisee and the franchisor can determine if they want to stay in business together • Other times may correlate with the term of the lease for the business premises, and both are renewable at the end of that period

Entrepreneur

Someone who initiates and assumes the financial risk of a new enterprise.

Business Premises

The agreement should specify whether the franchisee must lease or purchase its business premises. • Agreement will specify whether the franchisor or franchisee is responsible for supplying equipment and furnishing the premises • Sometimes, a building must be constructed to meet the terms of the agreement • Most will tell you if you can lease or own the building; rent can be upped • Going to tell you what to look like o if changing store - franchisee doesn't have much say b/c written into contract ♣ given a certain amount of time to change and must change

Organizational Form

The franchise agreement may require the franchisee to use a particular organizational form and capital structure. • May also set standards (sales quotas, record-keeping requirements) • A franchisor may retain stringent control over the training of personnel involved in the operation and over administrative aspects of the business

Paying for the Franchise

The franchisee typically pays an initial fee or a lump-sum price for the franchise license, separate and apart from the cost of any equipment and products the franchisee purchases from the franchisor. In most cases, the franchisee will also pay the franchisor a percentage of annual sales and, quite often, will contribute to advertising and administrative costs of the franchisor. o Franchise agreement ♣ $ up-front, pay certain % of rev

Location

Typically, the franchisor determines the franchisee's territory and whether it will be exclusive. • Some contracts give the franchisee exclusive rights, or "territorial rights," to a certain geographical area • Others may state the franchise is nonexclusive or are silent on the issue of territorial rights • tell you where your location will be (none available in NOLA, but one spot picked for you in Mississippi) o can be based on mileage, zip code, population o can't have two dealerships too close to each other o one store covers this many people o intersection - if they're all in that area they tend to do better o a lot of lawsuits involving franchises have to do with if the territory is going well o can the city support it? ♣ Can't have too many Honda dealerships in NOLA ♣ Nola small • If don't follow, franchisor can revoke the franchise agreement

Sole Proprietorship Advantages (4)

a proprietorship is easy and inexpensive to form (few legal formalities are required, generally NO documents need to be filed with the government or Secretary of State to start one, occupational license, such as child care operation, real estate license, still needed); the proprietor receives all of the profits (owns the entire business, gets all the profits because assumes all the risk); the owner has the maximum degree of control over business decisions; and the proprietor may establish a tax-exempt retirement account (only taxed when the funds are withdrawn).

Franchisee:

a purchaser of a franchise; generally legally independent of a franchisor o Economically dependent on the franchisor's integrated business system o Can operate as an independent businessperson, but still obtain the advantages of a regional or national organization

If notice is given and the franchisee has failed to cure the problem, the franchisor must give the franchisee

a reasonable amount of time to wind up the business to do an accounting, and return the franchisor's trademark, copyright

In carrying out the franchise contract it is very important for the franchisor to (2)

act with Good faith and fair dealing

More generally, the Federal Trade Commission's Franchise Rule requires

franchisors to disclose material facts that a prospective franchisee needs in order to make an informed decision whether to purchase a franchise.

If change status from sole proprietor to something else and sued, liable?

liable as a sole proprietor if at the time still a sole proprietorship

Tell you that you need to be operating 24/7 all the time and you refuse and not making the revenue (cause?)

o Can terminate you for cause here

Mac's Shell Service, Inc. v. Shell Oil Products Co. (2010)

o Facts: ♣ Here a group of service-station franchisees claimed their franchisor had violated the Petroleum Marketing Practices Act (PMPA) of 1979 - which limits the circumstances in which petroleum franchisors may terminate a franchise ♣ Franchisor - Shell Oil ♣ Shell joined with 2 other oil companies to create Motiva Enterprises LLC and Shell gave its rights and obligations under the relevant franchise agreements to Motiva ♣ Motiva ended a volume-based rent subsidy for the franchisees which increased their rent and 63 franchisees filed suit against Shell and Motiva claiming that ending the rent subsidy was a breach of contract under state law and that they violated the PMPA o Ruling: in favor of Shell and Motiva. The court held that a franchisee cannot recover for constructive termination under the PMPA if the franchisor's allegedly wrongful conduct did not compel the franchisee to abandon its franchise. The Court further held that a franchisee who signs and operates a renewal agreement with a franchisor may not maintain a constructive nonrenewal claim under the PMPA. The Court reasoned when a franchisee signs a renewal agreement, there has been no "failure to renew," and, thus no violation.

***Case: Quality Car & Truck Leasing, Inc. v. Sark (2013)

o Facts: ♣ Issue of personal liability of the owner of a sole proprietorship ♣ Michael Sark operated a logging business as a sole proprietorship ♣ To acquire equipment for the business, him and his wife borrowed funds from Quality Car ♣ When the business had financial difficulties, Sark became unable to pay his creditors, including Quality ♣ They sold their house to their son (Michael, Jr.) for $1, but continued to live in it (fraudulent transfer) ♣ Three months later Quality obtained a judgement (Ohio State Court) against Sarks and then filed a claim to set the transfer of the house to Michael, Jr. as a fraudulent conveyance ♣ Sarks appealed arguing that they didn't intend to defraud Quality and that they weren't actually Quality's debtors o Ruling: ruled in Quality's favor stating that the Sarks were clearly judgement debtors to Quality and their judgement was NOT satisfied

Case: LJL Transportation, Inc. v. Pilot Air Freight Corp.

o Facts: ♣ Pilot Air Freight Corp was a franchisor that moved freight through its network of operations at airports and other sites ♣ LJL Transportation was aa franchisee ♣ The franchisee agreement required LJL to assign all shipments to the Pilot network and provided that "Pilot shall allow Franchisee an opportunity to cure a default within 90 days of receipt of written notice" ♣ After 8 years as a Pilot franchisee, LJL began to divert shipments to Northeast transportation, a competing service owned by LJL's owners ♣ Pilot then terminated the franchise agreement and LJL filed a lawsuit claiming that it should be allowed to cure its breach o Ruling: court ruled in favor of Pilot because a franchise agreement may be terminated immediately when there's a material breach so serious that it goes directly to the heart and essence of the contract

Degree of control and franchisors

o If a franchisor exercises too much control over the operations of its franchisees, the franchisor risks potential liability o A franchisor may occasionally be held liable (under the doctrine of respondeat superior) for the tortious acts of the franchisee's employees Franchisors do NOT want control over hiring - don't want the liability • Don't want to control their day-to-day activities • Hired to work at a Wendy's, getting paid by the franchisee, franchisee liable, not franchisor

Flexibility

o More flexibility offered than in a partnership or a corp. o Free to make any decision they wish concerning the business (who to hire, when to take a vacation, what kind of business to pursue) o Can sell or transfer all or part of the business to another party at any time and does NOT need approval from anyone else o Can sometimes even benefit from a lawsuit since the business is indistinguishable from the owner o Case: Ferguson v. Jenkins ♣ Facts: • James Ferguson operated "Jim's 11-E Auto Sales" as a sole proprietorship and obtained insurance from Consumers insurance company issued to "Jim Ferguson, Jim's 11-E Auto Sales" • Ferguson bought a motorcycle in his own name with the intent to repair it and sell it through his dealership • Ferguson was struck by a car and seriously injured when riding the bike • Consumers Insurance argued that since it was in his name and he was riding it at the time, that it was his personal vehicle and not covered by the dealership policy ♣ Ruling: court held that the policy covered his injuries because the business was operated as a sole proprietorship and that him and his business are one in the same

Nola after Katrina (cause?)

o Not necessarily cause

Franchisor has to give:

o Notice o Reasonable amount of time to cure the problem (OPPORTUNITY TO CURE) ♣ If still cannot fix the problem - they can terminate you ♣ Selling pizza at Wendy's - easy to stop ♣ If not making projections can work with you, but can terminate you o Must be done with utmost good faith and fair dealing when terminating o If terminate franchisor can sell your store to someone else (but not the supplies you bought in it) • Cannot sell franchising right to somebody else without approval from the franchisor

Taxes

o Pays ONLY personal income taxes (Social Security, Medicare) on the business's profits which are reported as personal income on their personal tax return

Not franchises: ♣ Chic-fil-a - usually not a franchise ♣ Canes - owned privately ♣ Starbucks

owned privately

The Petroleum Marketing Practices Act

prescribes the grounds and conditions under which a franchisor may terminate or decline to renew a gas station's franchise.

The Automobile Dealers' Franchise Act

protects automobile dealership franchisees whose franchisors impose unreasonable demands and then terminate the franchise because of the dealer's failure to satisfy them.

TRADITIONAL BUSINESS FORMS

sole proprietorship partnership corporation today - hybrids: true corporation, limited partnership

If the franchise contract does NOT grant the franchisee exclusive territorial rights and the franchisor allows a competing franchise to be established nearby, the franchisee may suffer a significant loss in profits o Here a court may hold that

the franchisor breached an implied covenant of good faith and fair dealing

Sole Proprietorship Disadvantages (3)

the proprietor has unlimited liability for any losses or liabilities incurred by the entity (responsible for acts of employees usually, few times not); the entity will not survive the proprietor's death, disability, or retirement; and the proprietor may only raise capital for the business out of his personal funds and from loans others are willing to make based on his personal liability.

Franchisor:

the seller of the franchise

Franchisee kind of at the ___ of a franchisor

will ♣ Franchisor • Get to pick where the store is and what it should look like • If don't follow, can revoke the franchise agreement

FRANCHISE RELATIONSHIPS

• Have to be a certain type of business entity to buy a franchise

Can terminate "for cause" - they decide what's cause

• Morals clause • Not making revenue you were supposed to make o Can just be a bad year for everyone • Franchise's identity not to be open on Sunday - you can't open on Sunday and can be terminated for that • If own a Wendy's and start selling pizza can terminate you

Franchise contract

• defines the franchise relationship between the franchisor and franchisee o Specifies the terms and conditions of the franchise and spells out the rights and duties of the franchisor and the franchisee o Tell you about the amount you should be earning and what you need to be earning ♣ most will tell you if you can lease or own the building • rent can be upped ♣ going to tell you what to look like • if changing store - franchisee doesn't have much say b/c written into contract o given a certain amount of time to change and must change

Example: Mark Keller, Inc., an authorized Jaguar franchise, contracts to sell its dealership to Henrique Autos

♣ A jaguar franchise cannot be sold without Jaguar Cars' permission ♣ Prospective franchisees must meet their customer satisfaction standards ♣ If Henrique fails to meet those standards, Jaguar can refuse to allow the sale and can terminate the franchise

Why would choose to buy into a Franchise instead of opening a business of your own?

♣ Don't have to recreate the wheel ♣ Have a marketing scheme ♣ Can recommend pricing, have the menu o Buying into a franchise ♣ Big buy-in, different per franchise ♣ Car dealership • Initial outlay huge • Have to buy a large inventory • Insurance on the cars in the lot

Why close a gas station franchise?

♣ Environmental issues with tanks underground ♣ Local franchise guy had to pay to redo the tanks (not the franchise), given a certain amount of time, couldn't sell gas when fixing tank

Case: FMS, Inc. v. Volvo Construction Equipment North America

♣ Facts: • FMS entered into a franchise agreement with Samsung Construction Equipment North America to become an authorized dealership selling Samsung construction equipment • Samsung then sold its equipment business to Volvo which was to continue selling their brand equipment • Later, Volvo rebranded the construction equipment under its own name and canceled FMS's franchise • FMS sued claiming Volvo had terminated the franchise without "good cause" in violation of state law ♣ Ruling: since Volvo was no longer manufacturing the Samsung brand equipment, the court found that Volvo had "good cause" to terminate • If Volvo had continued making the Samsung equipment, it could NOT have terminated the franchise

Possibility that franchisor can be liable: o McDonald's hot coffee lawsuit

♣ Franchisee and franchisor (mainly) both paid damages ♣ Cost-saving measure - hot water, little coffee put in ♣ Lady had 3rd degree burns and in hospital ♣ Corporate policy - McDonalds liable

o Arby's case ♣ Man decided to hire people from the work-release programs at local prisons (model prisoners) ♣ Responsibility when taking on convicted person - responsible, know who you're hiring, from prison ♣ One convict during lunch break went over to local Walmart and shoots ex fiancée and boyfriend ♣ Family of one of the people who died decided to sued Arby's and whoever recommended him for the work-release program

♣ Local hiring decision ♣ Arby's was found NOT responsible in this case • Security in parking lot - shows you have a (safety) problem, a heightened duty

If either party fails to perform its contractual duties:

♣ That party may be subject to a lawsuit for breach of contract

If a franchisee is induced to enter into a franchise contract by the franchisor's fraudulent misrepresentation:

♣ The franchisor may be liable for damages

FRANCHISE TERMINATION

♣ Usually a term in the franchise agreement for termination