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TRANSCRIPT
UNDERSTANDING AND REVIEWING FRANCHISE AGREEMENTS, PART 1 &
PART 2
First Run Broadcast: October 18 & 19, 2016
1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes each day)
Though franchises often seem to clients like vehicles to assured success, they are nonetheless
risky ventures. The task for lawyers advising clients about franchises is to counsel them about
setting reasonable expectations and help them understand the practical implications of the
franchise agreement. This is no easy task because these agreements a complex arrangement of
restrictions, fees, operational requirements, intellectual property protections and reporting
periods. But understanding how these agreements work – and the range of what’s negotiable and
what’s not – is essential to client success. This program will provide you with a real world guide
to the framework of franchise law, practical due diligence of franchise opportunities, and
reviewing and negotiating the most important provisions of franchise agreements.
Day 1 – October 18, 2016:
How to read a franchise agreement – spotting key provisions and red flags
Phases of franchise review – due diligence, negotiation of agreement, and lease work
Setting and counseling clients about realistic franchise expectations
Practical guide to reading/understanding a Franchise Disclosure Document (FDD)
Framework of franchise law and relationship of federal/FTC regulations to state
regulation
Day 2 – October 19, 2016:
Review of major economic and non-economic provisions in franchise agreements
Determining what’s truly negotiable – and what’s not
Scope of territory – rights within in it and the opportunity to expand
Tiers of fees, royalties and marketing expenses
Operating standards and covenants – and negotiating for local modification
Transfer and exit issues when a franchisee wants out
Speakers:
H. Michael Drumm is the founder and member of a Drumm Law, LLC in Denver, Colorado,
where he has an extensive franchise, trademark and business transactional practice. He works
with franchisors across industries nationwide helping them draft, file and renew their franchise
Disclosure Documents and franchise agreements. He has a specialty representing craft breweries
to help them trademark their brands and protect their intellectual property. He has been
repeatedly honored by Franchise Times magazine as a “Legal Eagle” and has been designated by
the International Franchise Association as a “Certified Franchise Executive.” Mr. Drumm
received his BSBA from the University of Missouri-Columbia and his J.D. from the University
of Texas School of Law.
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name ________________________ Middle Initial____Last Name___________________________
Firm/Organization _____________________________________________________________________
Address ______________________________________________________________________________
City _________________________________ State ____________ ZIP Code ______________________
Phone # ____________________________Fax # ______________________
E-Mail Address ________________________________________________________________________
Understanding & Reviewing Franchise Agreements, Part 1 Teleseminar
October 18, 2016 1:00PM – 2:00PM
1.0 MCLE GENERAL CREDITS
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________
VBA Members $75 Non-VBA Members $115
NO REFUNDS AFTER October 11, 2016
VT Bar Association Continuing Legal Education Registration Form
Please complete all of the requested information, print this application, and fax with credit info or mail it with payment to: Vermont Bar Association, PO Box 100, Montpelier, VT 05601-0100. Fax: (802) 223-1573 PLEASE USE ONE REGISTRATION FORM PER PERSON. First Name ________________________ Middle Initial____Last Name___________________________
Firm/Organization _____________________________________________________________________
Address ______________________________________________________________________________
City _________________________________ State ____________ ZIP Code ______________________
Phone # ____________________________Fax # ______________________
E-Mail Address ________________________________________________________________________
Understanding & Reviewing Franchise Agreements, Part 2 Teleseminar
October 19, 2016 1:00PM – 2:00PM
1.0 MCLE GENERAL CREDITS
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________
VBA Members $75 Non-VBA Members $115
NO REFUNDS AFTER October 12, 2016
Vermont Bar Association
CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 18, 2016 Seminar Title: Understanding & Reviewing Franchise Agreements, Part 1 Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
Vermont Bar Association
CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: October 19, 2016 Seminar Title: Understanding & Reviewing Franchise Agreements, Part 2 Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
Franchise Attorney
A Brief History of Franchising
-Became common as a business model in the middle of the twentieth century. -The establishment of the interstate highway system led to a perceived need by travelers for consistent, reliable experiences on the road with familiar brands. -During the fifties and sixties, restaurant and motel companies rushed to meet these needs, and franchise companies like Holiday Inn, McDonald’s, and Howard Johnson’s became some of the most recognizable names in the country.
What is a Franchise?
•Under the Federal Trade Commission’s Franchise Rule (16 C.F.R. § 436 et seq.), a franchise is a contract or agreement between two or more persons in which:
–Trademark. The business involves distribution of goods or services substantially associated with the franchisor’s trademark or trade name;
–Required Payment. The franchisee pays at least $540 within the first six months for the right to enter into a franchise agreement, including a payment for goods and services; and –Significant Control or Assistance. The franchisor exercises significant control over, or provides significant assistance in, franchisee’s method of operation)
•State definitions vary
What is a Franchise?
All three of the definitional elements must be met before a business opportunity will be considered a “franchise” The name which the parties give to their relationship is not determinative as to whether the relationship is or is not a franchise
As a result, contractual language stating that the agreement “does not create a franchise relationship” is ineffectual to ensure that result
Franchise Regulation
Due to its regulation, some practices that are standard in other business transactions may be illegal in the franchise context Failing to timely deliver a Franchise Disclosure Document to a potential buyer Terminating a contract without first providing notice and an opportunity to cure
What is a Disclosure Law?
Disclosure laws require franchisors to prepare a “Franchise Disclosure Document” (or “FDD”), which is similar to a securities disclosure, and provide that document to prospective franchisees The contents of the FDD generally are governed by a combination of state and federal laws, which have been refined into a uniform set of rules circulated by the North American Securities Administrators Association (www.nasaa.org). In general, an FDD must be given to a prospect 14 calendar days before the franchisor receives any payment, or requires the franchisee to sign any contract, relating to the franchise.
What is a Registration Law?
•“Registration” means that, before a franchisor can sell in a the state, it must file its Franchise Disclosure Document with the applicable regulatory authority •The regulator will review and, in some instances, comment on the FDD and require the franchisor to make changes. •Registration must be renewed annually. If a franchisor is not registered in a jurisdiction that requires registration, it cannot sell franchises in that jurisdiction.
What is a Relationship Law?
Governs elements of the franchisee-franchisor relationship For example, among other things, some relationship laws:
Limit the circumstances under which a franchisor can terminate or refuse to renew the franchise contract; Prevent, or provide protections against, unequal treatment between franchisees; Protect the rights of franchisees to form independent associations; or Require the franchisor to buy back inventory previously sold to the franchisee
FTC’s Franchise Rule
•Governs all franchisors operating anywhere in the United States and its territories
–Purpose is to prevent fraud in the franchise relationship
•Disclosure law only
–There is NO national registration requirement. The FTC will only review an FDD after receiving complaint(s), and even then will only do so rarely. –As a result, if offer / sale is made in non-registration states, the FDD will not first be reviewed by a governmental entity
•No federal relationship law
FTC’s Franchise Rule
•Must furnish FDD to all prospective franchisees 14 calendar days before signing a binding agreement or accepting payment
–F/K/A “Uniform Franchise Offering Circular” or “UFOC” •Amended Franchise Rule (July 1, 2008)
•“Plain English Rule” – no legalese or technical jargon permitted in the FDD •FDD must be updated once a year (within 120 days of franchisor’s fiscal year end); more frequently upon the occurrence of a material change to the information disclosed in the FDD
FTC’s Franchise Rule
The Franchise Rule does not provide individuals with the right to sue franchisors for violation of the Franchise Rule Common law fraud claims or “unfair trade practices” claims can be brought based on misrepresentations in FDD or noncompliance with the Franchise Rule
Franchise Registration States
14 states have franchise registration and disclosure laws.
Oregon has a disclosure law only (no registration requirement)
Broadly speaking, a state’s registration or disclosure law may be implicated where:
The franchisor is located within that state; The prospective franchisee lives in that state; or The contemplated franchise will be located in that state
Franchise Registration States
Before any offer of a franchise is made, franchisor must register the offering with the state Registration lasts for one year; in some cases, expires within 90-120 days after the franchisor’s fiscal year end. In other cases, expires one year after registration. Certain exemptions apply per statute (but federal law differs)
Negotiated Changes
California and Wisconsin are the only states that specifically regulate the disclosure of negotiated terms. If the franchisor has negotiated changes, franchisees are entitled to a list of such changes which could be beneficial in the current negotiation process.
Franchise Laws
A “franchisor” must furnish a disclosure document to all prospective franchisees before signing a binding agreement or accepting payment
“Franchisor” is a person who offers franchises Includes subfranchisors and area representatives / regional developers
Unlawful to offer to sell a franchise with a document that contains an “untrue statement of material fact” or to make a material omission Potential civil and criminal liability for knowing violations
Franchise Laws
•Aggrieved individuals can sue for damages resulting from violation; if violation was willful, can seek rescission of franchise contract
–Many state registration / disclosure laws authorize franchisees located in the state to sue in their own state court
•Contractual forum selection clauses overridden
•Joint and several civil liability for every person who “controls” franchisor, officers, directors, and “employees who materially aid” the franchisor in committing the violation
–Unless they lacked knowledge or reason to know
The Franchise Disclosure Document
It contains 23 items of information that the Federal Trade Commission (FTC) has determined to be important to prospective franchisees. The FDD is not a legally binding agreement, franchisee attorneys should carefully review the franchise agreement as that is the binding document that controls the relationship.
The Franchise Disclosure Document
The proposed franchise agreement will be included; disclosures in the FDD should match the terms in the contract
–Item 17: Tabular summary of key contract terms •Item 1: History of the company (how long has it been in business?) •Item 2: History of the key officers and employees •Item 3: Litigation history •Items 5, 6, and 7: Fee and investment information
The Franchise Disclosure Document
•Item 8: Restrictions on sources of products and services
–Is franchisor exclusive supplier? Or does it name third party sources?
•Item 10: Financing offered by Franchisor •Item 11: Assistance offered by Franchisor
–Prior to opening (including training program) –After opening
•Item 12: Territory –Is one offered? –Consider carve-outs
The Franchise Disclosure Document
Item 13: Trademark Registered vs. not registered Indemnification; defense of franchisee’s use of marks
Item 14: Patents and copyrights Registered vs. not registered
Item 15: Obligation to Participate in Operations Active vs. passive ownership
The Franchise Disclosure Document
Item 19: Financial Performance Representations All franchisors are permitted but not required to make FPRs Some franchisors don’t make them. If they do, the FPRs MUST be included in Item 19 Providing FPRs not contained in Item 19 = presumptive violation of Franchise Rule
Item 20: System / franchisee information Number of outlets, company-owned and franchise-owned Growth / shrinkage over last 3 years Names / contact information for existing franchisees
Franchise Agreements
Major Economic Provisions -Tiers of fees, royalties and marketing expenses Major Non-Economic Provisions -Operating standards and covenants -Territory = Is it exclusive?
Franchise Agreements: Non-Negotiable Documents?
Most franchise agreements are generally not negotiable
Franchisor wants uniformity in system; different deals cause complexity in administration Also, different / better / sweetheart deals can cause resentment
Generally, the newer the system, the more likely the franchisor is to negotiate
Confirm Franchisor’s Willingness to Negotiate
Certain franchisors refuse to negotiate. Some states penalize franchisor for not being “willing” to negotiate. If a franchisor is willing to negotiate, it is the franchisee attorney’s responsibility to guide its client on what is important.
Negotiation Process – Just Because
It helps the negotiation process to have valid reasons for the requested changes for the franchise agreement rather than asking for them “just because.” Pointing out valid business reasons for requested changes makes it more difficult for the franchisor to reject such requests
Negotiable Items
There are certain items of the franchise agreement that are usually non-negotiable. Non-negotiable items include personal guarantees, royalties, advertising fund contributions, and initial franchise fees.
Recognize the Negotiable Items
These items include: Right of First Refusal on Additional Territories Right of First Refusal on New Brands Additional Training Trademark Infringement Indemnification Pre-approved Transferees Extra Renewal Terms Deadline Extensions Cure Provisions Financing of the Initial Franchise Fee Tiered Royalty Deferred Royalty Removal of Franchisor’s Right of First Refusal
Recognize the Negotiable Items
These items include: Deferred Advertising Fund Contributions (especially important in new systems) Reasonableness in All Franchisor Approval Commercially Reasonable Caps on Product Purchases Required by Franchisor Commercially Reasonable Caps on Inventory Levels Addition of “Material” to Defaults Elimination of Cross Defaults Arbitration or Litigation
Recognize the Negotiable Items
These items include: Waiver of Trial By Jury Waiver of Punitive Damages Commercially Reasonable Lease Addendum Termination Fee Addendum Terms in Renewal and Transfer Agreement Same Royalty, Advertising Fee and Territory in Renewal Agreements
Addendum
Franchisors rarely make changes to the actual franchise agreement. Most negotiated changes are written as Addenda to the franchise agreement.
FA: Potential Pitfalls
Non-competes Nearly all franchise agreements contain some form of post-termination non-compete
Surprising number of franchisees are not aware that these provisions exist and try to operate independently after termination or expiration
FA: Potential Pitfalls
Purchasing Power Some systems have had problems with this (Quizno’s?) ‘Zees may end up paying more
FA: Potential Pitfalls
Purchasing Power Item 8 Supplier restrictions
Few prospective franchisees understand
“Disclose the franchisee’s obligations to purchase or lease goods, services, supplies, fixtures, equipment . . . related to establishing or operating the franchise business either from the franchisor, its designee, or suppliers approved by the franchisor, or under the franchisor’s specifications.”
FA: Potential Pitfalls
Purchasing Power Item 8 Example: “You may be required to purchase other fixtures, furnishings, and/or equipment from our approved or designated suppliers or us or our affiliate.”
Prospective Franchisee Interpretation: “I’m sure if I find better deals, I can purchase from those sources. It’s my business, right?” What it really means: “You buy from whom we tell you to buy.”
FA: Potential Pitfalls
Renewal Agreement Terms (including Territory and fees may be different)
Cross Default Multiple agreements?
Deal Breakers
It is helpful to provide franchisor with a list of provisions you want to discuss. Identifying the “deal breakers” may speed up the process and save the franchisee time and money.
Operations Manual
If properly prepared, should help mimic ‘Zors past success
Provide guidelines for aspects of the business such as store layout, vendors, advertising, etc.
Clearly lays out ‘Zor’s expectations for ‘Zee
Operations Manual
Potential Pitfalls:
‘Zors can generally revise Ops manuals at any time and ‘Zees will be required to comply with all changes
Revisions to Ops manuals may even be done through emails to ‘Zees or posts on an intranet, so ‘Zees should be sure to stay on top of these
Buying a Franchise
A good brand with a track record of success
Ability to use the brand’s experience and name recognition for your benefit
Operational support and marketing assistance
Purchasing power
Cooperative Advertising
Due Diligence
Sales process – What is said vs. Reality: “We are a family.”
We are a family until a private equity firm buys us out and then you’re on your own.
“We will support you every step of the way.” We will support you as we deem necessary in our sole discretion.
“You will benefit from our knowledge and experience.”
We will give you an operations manual and some initial training, but good luck after that.
Due Diligence
Item 20 of the Franchise Disclosure Document lists the names of all current and former franchisees as of the end of the franchisor’s previous fiscal year. Prospective franchisees should reach out to these franchisees and gather as much information on the franchisor as they are able.
Due Diligence
Questions to ask of current/former franchisees:
What do you get that makes it worthwhile to pay franchise fee and royalties? Are you getting value in the system (e.g., operations)? The brand? Does the franchisor offer support? Is it proactive? Does it respond to requests for support? Does it respond to questions? For those that closed, why did they close? What issues did they face? How is relationship with franchisor? Financial performance?
Practice Tips
What should you do when a prospective franchisee asks you for advice? • Does a state’s registration law apply?
– Where is the franchisee domiciled? – Where is the franchisor headquartered? – Where will the franchisee’s business be located? – Where is the offer made / accepted?
. • Registration states: verify that the franchise is
registered – California, Minnesota, Virginia, Washington and
Wisconsin: online databases
Practice Tips
Keep in mind that franchise contracts are one-sided as of necessity
–System stability demands that franchisor retain strong controls –Similar to a commercial lease
Registration states: verify that the franchise is registered
– California, Minnesota, Virginia, Washington and Wisconsin: online databases
Exit Plan.
The Franchise Agreement Does it have a franchisee termination provision? What will you be on the hook for monetarily?
Has there been a breach of the Franchise Agreement? Did the ‘Zor or the franchise broker make promises to you before the Agreement was signed that never panned out?
If so, how?
Exit Plan.
In franchise law there are different hurdles:
Disclaimers regarding representations made prior to signing of the Franchise Agreement that are included in the FDD and/or Franchise Agreement
Required waivers of items like collective actions, punitive damages and jury trials
‘Zor may have wide discretion under the contract
Exit Plan.
In franchise law there are different hurdles:
Franchise Agreements often include “liquidated damages” provisions
Contract law may provide ‘Zor with rights to lost future royalties
Exit Plan.
Exit strategies: Oh the Possibilities
Sell to third party
Sell to family member
Sell to ‘Zor
Shut down upon expiration
Disputed/Litigated Issues
Majority of clients complain of some sort of misrepresentation -Financial performance representation, promised support, promised national accounts, etc. Key issue is usually whether disclaimers apply -Statutory anti-waiver provision -Boilerplate? -Specific to alleged misrepresentation? -Who made the misrepresentation?
Disputed/Litigated Issues
Disclaimers Vary One line: “There have been no agreements, understandings, representations, or statements made other than those provided in this agreement.” Multi-page: Questionnaires asking franchisees to confirm no representations made about potential earnings, number of customers, profitability of existing franchisees, etc.
Disputed/Litigated Issues
Fraud by omission -Financial performance representations outside of FDD, -Even if disclaim misrepresentations, did not include required information (e.g., number who met or surpassed results, reasonable basis, whether part of a subset, etc.)
Importance of a franchise attorney
Industry-specific knowledge Insight into the reputation of a ‘Zor and/or the experiences of other franchisees in the system
Importance of a franchise attorney
Familiarity with terms that are standard to Franchise Agreements and how these may affect ‘Zees
Territorial provisions (Exclusive? Not exclusive?)
What about internet sales? Catalog sales?
Other brands owned by franchisor or affiliate?
Right to terminate for minor defaults (even if cured)?
Importance of a franchise attorney
Familiarity with what terms in Franchise Agreements may indicate overreaching by a ‘Zor Excessive liquidated damages No territorial rights Unfair dispute resolution Overreaching restrictive covenants
Importance of a franchise attorney
Franchise law is not general business law Federal regulations and state statutes may impact terms in Franchise Agreement Dispute resolution provisions may not be enforceable in some states Liquidated damages may not be enforceable Choice of law may not be enforceable
• FTC’s Franchise Rule: – www.ftc.gov/bcp/franchise/netfran.shtm
• FDD Franchise guidelines (registration states – North American Securities Admin. Association) – www.nasaa.org
Resource Links
