Chapter 36: Sole Proprietorships and Franchises

Types of Franchises

1) Distributorship 2) Chain'style business operation 3) Manufacturing arrangement

State Regulation of Franchises

1) State Disclosures 2) May Require Good Cause to Terminate the Franchise

Elements of Franchise Agreement

1) payment for the franchise 2) business premises 3) location of the franchise 4) business organization 5) quality control (means of control and degree of control) 6) pricing arrangements

Chain-style Business Operation

A franchisee operates under a franchisor's trade name and is identified as a member of a select group of dealers that engage in the franchisor's business •franchisee required to follow standardized or prescribed methods of operation and maintain certain standards of performance Example: fast-food chains

Distributorship

A manufacturer (the franchisor) licenses a dealer (the franchisee) to sell its product; covers exclusive territory Examples: car dealerships

Franchisee

A purchaser of a franchise; generally legally independent of the franchisor and economically dependent on the franchisor's integrated business system

Franchise Agreement: business premises

Agreement may specify whether the premises for the business must be leased or purchased outright and who is responsible for supplying equipment and furnishings for the premises

Franchise Rule: Reasonable basis for any representations

All representations made to a prospective franchisee must have a reasonable basis at the time they are made

Franchise

Any arrangement in which the owner of intellectual property (trademark, trade name, or copyright) licenses another to use that trademark, trade name, or copyright in the selling of goods or services

Importance of Good Faith and Fair Dealing

Courts usually try to balance the rights of both parties. If franchisor arbitrarily or unfairly terminates a franchise, the franchisee will be provided with a remedy for wrongful termination

Franchise Agreement: payment for the franchise

Franchisee pays an initial fee or lump-sum price for the franchise license May also require franchisee to pay a percentage of the franchisor's advertising and admin expenses

Franchise Agreement: business organization

Franchisor may require that the business use a particular organizational form and capital structure

Franchise Agreement: pricing arrangements

Franchisor may require the franchisee to purchase certain supplies from the franchisor at an established price. However, the franchisor cannot set the prices at which the franchisee resells at

Franchise Rule: Explanation of terms

Franchisors are also required to explain termination, cancellation, and renewal provisions of the franchise contract prior to signing

Franchise Rule: Projected earnings figures

Franchisors must indicate whether the projected earnings figures are based on actual data or hypothetical examples

Franchise Rule: Written or electronic disclosures

Franchisors must make numerous disclosures, either in writing or electronically online

Franchise Rule: Actual data

If sales or earnings projections based on actual data, franchisor must disclose the number and percentage of its existing franchises that have achieved this result

Federal Regulation of Franchises

Industry-specific standards: protect franchisee from unreasonable demands and bad faith termination

Franchise Rule

Requires franchisors to disclose certain facts to prospective franchisees: 1) Written or electronic disclosures 2) Reasonable basis for any representations 3) Projected earnings figures 4) Actual data 5) Explanation of terms

Franchise Contract

Specifies the terms and conditions of the franchise and spells out the rights and duties of the franchisor and the franchisee •If fail to perform duties, party may be subject to a lawsuit for breach of contract •If franchisee is induced to enter by franchisor's fraud misrepresentation, franchisor is liable for damages

Termination "for cause" Examples

Termination "for cause" include: 1) death or disability of the franchisee 2) insolvency of the franchisee 3) breach of the franchise agreement 4) failure to meet specified sales quotas

Means of Control

The contract will state that the franchisor is permitted to make periodic inspections to ensure that the standards are being maintained Limit franchisee's ability to sell the franchise to another party

Franchise Agreement: quality control

The day-to-day operation of the franchise business normally is left up to the franchisee Franchise agreement may specify that the franchisor will provide some degree of supervision and control

Franchise Termination

The franchise agreement specifies that termination must be "for cause" and then defines the grounds for termination

Manufacturing Arrangement

The franchisor transmits to the franchisee the essential ingredients or formula to make a particular product, who then markets the product according to the franchisor's standards Example: soft-drink companies

Franchisor

The seller of the franchise

Wrongful Termination of Franchise

The termination provisions of contracts are more favorable to the franchisor, who owns the trademark and the business, than to the franchisee

Degree of Control

The validity of a provision permitting the franchisor to establish and enforce certain quality standards is unquestioned. However, if exercises too much control, franchisor risks potential liability (respondeat superior)

Franchise Agreement: location of franchise

Typically, the franchisor determines the territory to be served