Business Law Ch. 36: Small Businesses and Franchises

How may a franchise contract provide for the opportunity to cure a breach?

-A franchise agreement may allow the franchisee to attempt to cure an ordinary, curable breach within a certain time after notice so as to postpone, or even avoid termination -Even when a contract contains a notice-and-cure provisions, a franchisee's breach of the duty of honesty and fidelity may be enough to allow the franchisor to terminate the franchise

Franchisee/Franchisor relationship

-A franchisee (a purchaser of a franchise) is generally legally independent of the franchisor (seller of the franchise) -Franchisee is economically dependent on the franchisor's integrated business system

What disclosures are required by state laws regulating financing?

-A number of states have laws similar to the federal rules that require franchisors to provide presale disclosures to prospective franchisees -Many state laws also require that a disclosure document (Franchise Disclosure Document, or FDD) be registered or filed with a state official -State laws may require that a franchisor submit advertising aimed at prospective franchisees to the state for approval

What industry-specific standards has Congress put in place to regulate franchises?

-An automobile manufacturer-franchisor cannot make unreasonable demands of dealer-franchisees or set unrealistically high sales quotas -- an automobile manufacturer-franchisor who terminates a franchise on these grounds may be liable for damages -Federal law prescribes the conditions under which a franchisor of service stations can terminate the franchise -Federal antitrust laws sometimes apply in specified circumstances to prohibit certain types of anticompetitive agreements

How may a franchise contract establish the degree of control of a franchisor?

-As a general rule, the validity of a provision permitting the franchisor to establish and enforce certain quality standards is unquestioned -If a franchisor exercises too much control over the operations of its franchisees, however, the franchisor risks potential liability -Franchisor can be held liable under respondeat superior for tortious acts of the franchisees' employees

Restrictions on bank loans

-Bank may place some restrictions on future business decisions as a condition of granting the loan -Bank loans may not be available for some businesses (i.e. business not yet established) -Bank may require personal guaranty contracts from the owner, putting the owner's personal assets at risk

How may companies try to protect trade secrets?

-Companies may require employees who have access to trade secrets to agree in their employment contracts never to never divulge those secrets -A small business may choose to include a covenant not to compete in an employment contract (noncompete agreement)

What does the Franchise Rule requires franchisors to do?

-Disclose certain material facts that a prospective franchisee needs in order to make an informed decision concerning the purchase of a franchise, and all representations made to a prospective franchisee must have a reasonable basis

Three classifications of franchises

-Distributorships -Chain-style business operations -Manufacturing arrangements

How are business premises addressed in a franchise contract?

-Franchise agreement may specify whether premises for the business must be leased or purchased outright -Agreement will specify whether the franchisor or the franchisee is responsible for supplying equipment and furnishing the premises

How is payment for the franchise addressed in a franchise contract?

-Franchisee ordinarily pays an initial fee or lump-sum price for the franchise license (this fee is separate from the various products that the franchisee purchases from or through the franchisor) -Franchise agreement may also require the franchisee to pay a percentage of the franchisor's advertising costs and certain administrative expenses -Generally, the franchisor receives a stated percentage of the annual (or monthly) sales or volume of business done by the franchisee

How are pricing arrangements addressed in a franchise contract?

-Franchisor may require franchisee to purchase certain supplies from the franchisor at an established price -A franchisor cannot, however, set the prices at which the franchisee will resell the goods (violation of state and/or federal antitrust laws) -- franchisor can suggest retail prices but cannot mandate them

How is business organization addressed in a franchise contract?

-Franchisor may require that the business use a particular organizational form and capital structure -Franchise agreement may also set out standards such as sales quotas and record-keeping requirements -A franchisor may retain stringent control over the training and personnel involved in the operation and over administrative aspects of the business

Typical requirements for a chain-style business operation

-Generally required to follow standardized or prescribed methods of operation -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

Issues surrounding wrongful termination of a franchise

-Generally, the termination provisions of contracts are more favorable to the franchisor than to the franchisee -Franchisee, who normally invests substantial time and financial resources in making the franchise operation successful, may receive little or nothing for the business on termination -Federal and state laws attempt to protect franchisees from the arbitrary or unfair termination of their franchises by the franchisors

Why does a proprietor have a limited ability to raise capital?

-In raising capital, the proprietor is limited to her personal funds and any loans that she can obtain for the business -Lenders may be unwilling to make loans to sole proprietorships, esp. start-ups, because the sole proprietor risks unlimited personal liability and may not be able to pay

Two ways that the federal government regulates financing

-Industry-specific standards -The Franchise Rule

How do courts apply the principles of good faith and fair dealing in a franchise relationship

-Look to both statutory law and case law -Courts try to balance rights of both parties -If a court perceives that a franchisor has arbitrarily or unfairly terminated a franchise, the franchisee will be provided with a remedy for wrongful termination

With respect to termination, what notice requirements are usually included in a franchise contract?

-Most franchise contracts provide that notice of termination must be given -If no set time for termination is specified, then a reasonable time, with notice, is implied -A franchisee must be given reasonable time to wind up the business -- that is, to do the accounting and return the copyright or trademark or any other property of the franchisor

What taxes does a sole proprietor pay on business profits?

-Only personal income taxes -Includes social security and medicare taxes

Advantages of a sole proprietorship

-Proprietor owns the entire business and receives all of the profits (because she assumes all the risk) -Few legal formalities are required to start

SBA Programs

-Provide for loans to businessperson -One SBA program provides for loans to members of minority groups

How does a sole proprietorship allow for more flexibility than a partnership or corporation?

-Sole proprietor is free to make any decision she wishes concerning the business -- including what kinds of business to pursue, whom to hire, and when to take a vacation -Can sell or transfer all or part of the business to another party at any time without seeking approval from anyone else

What penalties may a franchisor face for violating the franchise rule?

-Subject to substantial civil penalties -FTC can sue on behalf of injured parties to recover damages

Chain-style business operation

-Type of franchising arrangement in which a franchise 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

Distributorship

-Type of franchising arrangement in which a manufacturer (franchisor) licenses a dealer (franchisee) to sell its product -Often covers an exclusive territory

How is the location of the franchise addressed in a franchise contract?

-Typically, the franchisor determines the territory to be served -Some franchise contracts give the franchisee exclusive rights, or "territorial rights" to a certain geographic area

How does a franchise agreement typically set out grounds for termination?

-Usually, specifies that termination must be "for cause" and then defines the grounds for termination -Cause might include, for instance, the death or disability of the franchisee, insolvency of the franchisee, breach of the franchise agreement, or failure to meet specified sales quotas

How may a franchise contract give the franchisor the ability to establish means of control?

-When the franchise prepares a product or provides a service, the contract often states that the franchisor will establish certain standards for the facility -Typically, the contract will state that the franchisor is permitted to make periodic inspections to ensure that the standards are being maintained -Also typically limit the franchisee's ability to sell the franchise to another party

Any business, whatever its form, has to meet a variety of legal requirements, which typically relate to the following:

1. Business name registration 2. Occupational licensing 3. State tax registration 4. Health and environmental permits 5. Zoning and building codes 6. Import/export regulations

How often should registration with the PTO be renewed?

5 years after initial registration; 10 year intervals thereafter

Why is obtaining a bank loan beneficial for small businesses?

Allows the owner to retain full ownership and control of the business

Franchise

An arrangement in which the owner of intellectual property -- such as a trademark, a trade name, or a copyright -- licenses others to use it in the selling of goods or services

In a proprietorship how are profits reported for taxation purposes?

As personal income on the proprietor's personal income tax return (business itself doesn't need to file an income tax return)

How is the duration of a franchise determined?

By the parties

General rule for a trademark

Cannot be the same as another's mark or so similar that confusion might result

A franchise relationship is primarily governed by which type of law?

Contract law

How does a sole proprietorship put an owner's personal assets at risk?

Creditors can pursue the owner's personal assets to satisfy any business debts -- liability can easily exceed the limit of what is afforded protection under insurance policy

Purpose of federal and state laws governing franchising

Designed to: -Protect prospective franchisees from dishonest franchisors -Prevent franchisors from terminating franchises without good cause

How may issues of good faith and fair dealing come into play in disputes over territorial rights?

If a franchise contract does not grant exclusive territorial rights to the franchisee and the franchisor allows a competing franchise to be established nearby, the franchisee may suffer significant lost profits -- int his case a court may hold that the franchisor breached an implied covenant of good faith and fair dealing

Who may trade secrets be divulged to?

Key employees

Besides contract law, what types of laws is a franchise relationship governed by?

Laws enacted by the federal government and by states

Congress's purpose in enacting industry-specific standards

Protect franchisee from unreasonable demands and bad faith terminations of the franchise by the franchisor

SBA requires business owners to do what?

Put some of their own funds at risk in the business

A franchisee can operate as an independent businessperson while obtaining the advantages of what type of organization?

Regional or national organization

How to get the most protection for a trademark

Register with U.S. Patent and Trademark Office (PTO)

Unless the owner affirmatively adopts some other form, the law considers all new, single-owner business as what form of business?

Sole proprietorship

Purpose of the franchise contract

Specifies the terms and conditions of the franchise and spells out the rights and duties of the franchisor and the franchisee

How are retirement accounts taxed in a sole proprietorship?

Tax-exempt until the funds are withdrawn

Risk associated with a trade secret

That a key employee might disclose the secrets to competitors -- or even set up competing businesses themselves

What is the biggest disadvantage of a sole proprietorship?

That the proprietor alone bears the burden of any losses or liabilities incurred by the business enterprise -- has unlimited personal liability for all obligations that arise in doing business should a lawsuit be brought against the business

A court will be less likely to consider a termination of a franchise wrongful if

The franchisor's decision was made in the normal course of business and reasonable notice was given

Like any form of business enterprise, a sole proprietorship can be liable for what kinds of taxes?

Those collected and applied to the disbursement of unemployment compensation

In what manner may state laws regulate the termination of a franchise?

To prevent arbitrary or bad faith terminations, a state law may prohibit termination without "good cause" or require that certain procedures be followed in terminating a franchise

Manufacturing (processing-plant) arrangement

Type of franchising arrangement in which the franchisor transmits to the franchisee the essential ingredients or formula to make a particular product -- the franchisee then markets the product either at wholesale or at retail in accordance with the franchisor's standards

What is state regulation of franchising often aimed at?

Unfair practices and bad faith terminations by franchisors

Why is there a lack of continuity in a sole proprietorship?

When the owner dies, so does the business -- it is automatically dissolved