Franchising
Date for approval of FDD every year
April 30th -- sent prior for approval by then
Federal definition vs. state definition
Federal - continuing commercial relationship created by "any arrangement"; State - continuing commercial relationship based upon a "marketing plan"; federal - control of franchisor vs. state - "community interest in the marketing of goods and/or services"
Two questions a prospect asks:
How much it will it cost? Can answer this; How much money am I going to make? Have to be extremely careful answering this
Schmidt's argument for first franchise
Martha Matilda Harper's hair salon; started in 1891, over 500 locations by 1928; sold in 1972 to a competitor who shut it all down
Governing law for franchise M&A
Section 7 of the Clayton Act
First real franchise
Singer sewing machine in 1951
Harm standard clause
basically says the franchisor is free to pursue its own business interest as it seeks them and the franchisor is not obligated to refrain from doing anything in regards to the business
Common law theories affecting franchise relationship
breach of contract, promissory estoppel and recoupment for franchisee fees for those who rely on the franchise promises; trademark issues; implied contract requirements; unjust enrichment; unclean hands; encroachment; fraud; fiduciary relationship; good faith and fair dealing
Assignment
define the transfer, transfer and assignment by franchisee -- does not have rights, payment from franchisee to franchisor
Three categories of law regulate franchises
disclosure laws, registration laws, relationship laws
Signature page
do not forget the effective date and signatures; do not accept an electronic signature - have the franchisee sign and send the original
Franchisee's obligations
must include a table that lists several obligations on one column and required by statute what those labels are; next column says where those obligations are in the franchise agreement; and third column where they are in the disclosure document
Business experience
must list every person that is a director, trustee, general partner, principal officer, and any other individual who will have management responsibility relating to the sale or franchise offered
Financing - if offered must disclose
what it covers, the identity of each lender providing financing, and the relationship of the franchisor, amount of financing offered, interest rate or any other associated fees, number of payments, any security interests, and if must personally guarantee the debt, any prepayment penalty, and the potential liabilities upon default
business format franchise
a broad franchise agreement in which the franchisee pays for the right to use the name, trademark, and business and production methods of the franchisor
product distribution franchise
a franchise where the franchisee simply sells the franchisor's products without using the franchisor's method of conducting business
Advertisement fees
1-3% set aside for the franchisee
Cooling off period after presenting FDD to prospect
14 calendar days - day 1 = the day after it is presented to them
Time to cure
15 days generally, some states have 30 days, Minnesota has 60 days, some have 90 days
How many states have relationship laws?
21 states and D.C. and 2 U.S. Protectors
Format of FDD
22 items disclosed and the receipt page; must be in plain English - no legal mumbo jumbo
Statute of limitations for franchise issues
3-4 years
Royalties
4-5%
Cooling off period after providing final franchise agreement
7 days before you can execute the contract and accept money
15 states have registration (or notice) requirements
California; Hawaii; Illinois; Indiana; Maryland; Michigan; Minnesota; NY; North Dakota; Oregon; Rhode Island; South Dakota; Virginia; Washington; and Wisconsin
Franchise agreement
The legal, written contract between the franchisor and franchisee defining the rights, duties, and obligations of each
Situations where immediate termination comes into play
abandonment of the franchise, criminal conduct, bankruptcy, and danger to public safety or health
Limit franchise territory
agree that there are no other territory rights that arise under the agreement other than the specified; other franchisor's brands, replacements, and developments
Renewals
an opportunity to purge out the bad franchisees, but most good franchisees will want to renew and the franchisor will want them to renew; have to have good reason not to renew; renewal will be defined in the franchising agreement; sometimes have to pay a renewal fee; generally a notice requirement to renew exists (60, 90, 120 days out)
You are required to file with registration states and make an amendment to the FDD when:
annually - at most 120 days after fiscal year; material change to the document (either the agreement of the structure of the franchisor)
Financial statements
audited financial statements for the past 3 years in a comparative model; balance sheet, statement of operations, stockholder equity, cash flows -- usually the biggest section causing delays
Michigan, Washington, Indiana, and Iowa's relationship law reach
cannot restrict franchisee associations; cannot discriminate between and among franchisees; cannot prohibit changes in franchise management without good cause; cannot encroach; cannot receive kickbacks; cannot require litigation or arbitration outside the franchisee's state
Long term disclosures
convictions during the past 10 years, must describe any conviction of or any agreed to plea to a felony charge during the 10 year period prior to the documents issuance date
Terminations
currently 18 states have relationship laws that govern termination of a franchise group, almost all require good cause; most require an opportunity to cure; most require notice in writing
Reasons for termination that have the opportunity to cure
damaging the reputation of the franchise system; failure of franchisee to maintain the standards of operation; underreporting income/not paying royalties; buying supplies from unauthorized source, operating under another competitors franchise; failure to maintain insurance; selling unauthorized products
In the life of a franchise agreement, one of four things will happen
expire, terminated for cause or other reasons, renewed and continued in the system, sold, transferred, and signed
Good cause
failure by the franchisee to substantially comply with the standards imposed by franchisor
10 most popular franchise opportunities
fast food (burgers, pizza, sandwiches, chicken, mexican); service industry; restaurants; building and construction business services; lodging = 10
2007
federal amendment to Franchise Disclosure Rule - did away with the OFC and replaced it with the FDD -- effective July 1, 2008
Disclosure laws
federal and state; regulate required pre-sales disclosures, franchise sales practices, information to be furnished to a prospect; mandatory cooling off period
Exhibit pages
financial statements, franchise agreements, agents of process servers in each state, state administration officials for each state, if you have a long list of franchisees
Taxes
franchisee is "solely responsible" for all taxes levied by anybody of any kind or type
unit franchise
franchisee is granted the right to develop and operate one franchise at a specific location within a defined specific and/or exclusive territory
Area franchise
franchisee is granted the right to develop and operate two or more franchises within a defined territory with development quota
3 Elements of a Franchise
franchisee pays a fee; franchisee uses franchisor's trademarks and business marks; the franchisor exercises a significant amount of control over the franchisee's operations
procedure to terminate
get the information from operational department about all of the possible breaches; put it all into a paper and provide the franchisee an official notice - either email or certified mail - list what they have done wrong, let them know the cure period, and tell them they must exemplify what they have done to cure; comply with the cure period; if no action was taken, then continue with termination
master franchise
gives franchisee an agreement granting a master franchisee limited rights to recruit and sell new franchisees and requiring it to assume some or all field support services for its franchisees. Franchisee fees and royalties are generally split between the franchisor and master franchisee
Contracts
have each one listed and examples of them
Basic rule regarding registration statements
have to disclose a prospect in these situations: wherever you meet them, wherever you're going to buy a franchise, and where they live
Receipt page
have two copies of it; shows that did disclose the franchisee and what date they were disclosed
notice states
hybrid between registration and non-registration states; require you to either provide a notice that you will be selling franchises within that state annually or just one time (depends on the state - TX = once; FL = annually); no approval process; as long as your FDD complies with the FTC federally, you can sell in these states.
Public figures
if you have someone who is being paid ownership-wise and is a public figure you must disclose
First franchising law
in California; California Franchise Investment Law
Franchisee remedies
in the event of an improper termination or non-renewal: repurchase of inventory, payment for investment - rescission, payment for good will, injunctive relief, actual damages including lost profits, expenses, punitive damages, attorney's fees, civil or criminal penalties, equitable remedies
Franchise agreement contents
introduction and recitals; grant of franchise; term of agreement; fees and payments; franchise facility location; opening; standards and consistency of operation; services and supplies; franchisee's facility; training; royalty and advertising contribution; accounting procedures: right of audit; limitations of franchisee; competition and economic development; insurance; indemnification; taxes; assignment: conditions and limitations; right of first refusal; termination; effect of termination; restrictive covenants; resolution of disputes; miscellaneous: general conditions; signature page; exhibits
What to consider when you are starting a franchise?
is franchising the best avenue to go? clone-ability, marketability; appropriate strategy for expansion of the system; do you have capital? do you have a core corporate team that can lead the franchise system to success? Is it a good economic climate? Competition; potential market; is the concept teachable? will your concept provide an adequate return to a franchisee?
Franchising
licenses a specific product or service or engage in a specific method of business, use trademarks, business plans, etc.
Alternative business structures
licensing and distributorships
2 areas in franchise law
litigation and paperwork
Business opportunity laws
look like franchises but are not quite franchises.
Insurance: Indemnification
make sure the franchisee has insurance and procured at their "sole cost and expense"; make sure the insurance policy makes sense for the business; can put in an indemnification clause that indemnifies everyone from everything
International Franchise Association (IFA)
membership organization of franchisors, franchisees, and suppliers; provided help to the industry; adopted a code of ethics - geared towards the relationship of the franchisors and franchisees; very powerful lobby in the U.S. Senate; opened an international organization in the last 10 years
Fiduciary relationship
most decisions suggest there is no fiduciary duty between franchisor and franchisee
Non-renewals
most state laws require some type of good cause for refusing to renew - i.e. breach of agreement and/or failure to agree to the current franchise agreement
1971
no federal franchise laws
Litigation
pending actions you are required to disclose - for the franchisor, affiliates, parent, predecessor, and anyone listed in item 2; list any administrative/criminal/or material civil actions if those actions allege violation of franchise, antitrust, or securities law, or fraud, deceptive practices, etc.
Examples of product distribution franchises
pepsi, coke, exxon, ford
Two types of franchises
product distribution and business format franchising
Purpose of the FDD
provide a prospective franchisee enough information to make a decision about whether or not to purchase a franchise unit; franchisor cannot offer a franchise for sale until a prospect has been disclosed with an FDD
Competition and economic development
put an unfair competition clause in the agreement; impact of franchisors economic development; limit franchise territory; harm standard clause
3 things you can do when you purchase a franchise
reimage; shut the doors; keep it running and let them compete with each other
1979 Franchise Disclosure Rule
required franchisors to deliver to any prospective buyer certain information regarding the franchise
Restrictions on sources of products and services
restriction on obligation on goods, services, suppliers operation of the business; must provide information if you're dealing with a corporation whereby you get money off of the franchisees; must disclose if you have ownership interest in the supplier; must disclose revenue for last fiscal year for any required purchasers; used buying power to get cheaper products for franchisee
two major things to consider with structure
speed of growth and market target
McDonald's
started by the McDonalds brothers and Crockett (he bought out the brothers and kicked them out)
Curves
started in Waco, Tx; took 7 years to reach 10,000 units
Registration laws
states (but not all); require registration of the franchise or the FDD in that particular state before a sale can be made; in some states, registration of franchise salespersons; in some states, registration of franchise advertising
Remedies if you fail to disclose or register FDD
stop-order issued; administrative investigation with subpoena power and reimbursement of the investigation cost; fees of up to $50k per failure; may fall under the states DTPA
Audits
strict language that the franchisor has a right to audit and any other restrictions on it that you want to put
State relationship laws govern
terminations, renewal rights, transfers or resells, and some encroachment issues (selling too close to another franchise)
Franchise laws focus on
terminations; renewals; transfers
Estimated initial investment
the fees the franchise has to pay before they open the franchise; all pre-opening fees
Puerto Rico
the first U.S. jurisdiction to pass a law protecting franchisees in 1964
23 required disclosure items
the franchisor and any parents, predecessors and affiliates; business experience; litigation; bankruptcy; initial fees; other fees; estimated initial investment; restrictions on sources of products and services; franchisee's obligations; financing; franchisor's assistance, advertising, computer systems and training; territory; trademarks; patents, copyrights ad proprietary information; obligations to participate in the actual operation of the franchise business; restrictions on what the franchisees may sell; renewal, termination, transfer & dispute resolution; public figures; financial performance representations; outlet and franchisee information; financial statements; contracts; receipt page
How much can an audit cost?
up to $15K...most expensive thing
trademark
the franchisor's identifying marks, brand name, and logo that are licensed to the franchisee
1979
the government started holding hearings and passed the Federal Franchise Act - the Franchise Disclosure Rule (16 CFR 436)
Franchise fee
the initial payment to the franchisor for the grant of a franchise
1960
the international franchise association (IFA) was formed
franchisee
the person or company that is granted the right from the franchisor to operate a franchise pursuant to franchisor's trademark or trade name, business methods, etc.
franchisor
the person or company that operates the franchise system and grants the franchisee the right to do business under their trademark or trade name.
Royalty
the regular payments made the franchisee to the franchisor, usually based on a percentage of the franchisee's gross sales
sub franchises
the sub-franchisor does everything...steps into the shoes of the franchisor; does all the training, development, etc.
Hart-Scott Rodino Act of 1976
threshold for filing - have to file if a transaction is above $68.2mm
2 hallmarks in franchising
trademarks and uniform products (same name, same inside of place, etc.)
Limitations of the franchisee
trademarks, trade names, trade dress, service marks, business marks, and copyrights and trade secrets; the franchisor owns everything;
Delaware and Arkansas
two states that follow their own definition
Specifics about fee disclosure required
type of fee - royalties, ad fees, additional training fees, inventory fees, transfer fees, renewable fees, software fees, any fee that is in the document that the franchisee is going to be required by the franchisor; amount of fee; due date of the fee; what the fee is about
Generalized list of docs required for state registration process
uniform franchise application page; franchisor's cost and sources of funds; consent to service of process; franchise seller disclosure form; FDD; application fee; guarantee of performance - usually when franchisor is not strong financially; consent of accountant to use the audit; and any advertising materials
Four business formats for franchise arrangements
unit franchise; area franchise; sub franchises; master franchises
