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Courts, Lawyers, Franchise Agreements, Right of First Refusal, Restrictive Covenant, Competing Franchisor all combine to Create the Efficient Free Market Outcome: “No Beer for Any Consumers at an Empty Restaurant.” Interestingly, from a law and economics point of view, the legal rules and process associated with this dispute have resulted in an inefficient outcome: unused restaurant space, unemployed workers, less beer being sold, and one fewer businesses paying taxes. http://www.heraldtribune.com/news/20170327/jdubs-dub-shack-beer-bar-closes  

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Instant Replay:  According to the franchisor, the franchisees are thieves and the franchisor is the good guy who is saving the community from corrupt people. Result: Massive investigations, terminations, and take-backs. The franchisor: (1) vows to stamp out underpayment of franchisee employees; (2) removes store owners who broke the rules from its system; (3) claims that “When a franchise is terminated, an independent valuation of the franchisee’s assets is undertaken and, in general, the franchisee is paid accordingly for their assets….The process for refranchising a site is also very costly and takes considerable time and corporate resources.”; (4) announced the outcome of an independent review that he said “confirmed our [franchise] model allows franchisees to draw a wage, make a profit and pay employees in accordance with lawful wage rates”. In contrast, the franchisees: (1) claim that when Caltex forces out an owner it does so without paying compensation beyond assets, which means it could gain back stations almost free and profit from their resale or merge them into its corporate-owned store network; (2) claim that “no site with weekly shop sale of about 30K to 35K … can be profitable in your current model by fulfilling its [workplace] obligation”; (3) explain that “The truth is they [the franchisor] want the stores back to make them into company stores and that is the best way to do it – they are going to get their stores back for free.” http://www.smh.com.au/business/caltex-denies-profiting-from-terminating-franchisees-for-wage-fraud-20170221-guhqd0.html

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If you are facing a dispute with your franchisor, there is a good chance that you will need to submit to arbitration in order to obtain a resolution. Why? Because arbitration is the preferred dispute resolution method among franchisors, and franchise agreements commonly include “mandatory arbitration” clauses which require franchisees to go to arbitration instead of seeking to enforce their rights in court. What is Arbitration? Arbitration is a form of alternative dispute resolution (ADR) that can in some ways be thought of as a “light” version of courtroom litigation. The process is still adversarial (unlike mediation, where the parties seek to work toward an amicable resolution), and a neutral third-party (either an arbitrator or a panel of arbitrators) still issues a binding decision based upon the evidence and arguments presented. The parties also still engage in discovery, although discovery is typically limited, and they still attend hearings at which their attorneys present arguments and question witnesses. However, arbitration moves at a faster pace than litigation, and as a result it is generally less expensive as well. Why Do Franchisors Prefer Mandatory Arbitration? Franchisors generally prefer arbitration for a number of reasons. Some of these reasons have to do with the controls they can exercise within the terms of their mandatory arbitration provisions, but others have to do directly with the nature of the arbitration process. Five of the top reasons that franchisors generally prefer mandatory arbitration include: Arbitration denies franchisees the right to a jury trial Franchisors can designate […]

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Buying a franchise is a process. From the time you formulate the idea to become a franchisee to the time you sign the franchise agreement, you will go through a number of steps – some more complicated than others – that are all critical to ensuring that you open your doors with the best possible chance for success. If you are considering buying a franchise, here is a brief overview of what you can expect along the way: Steps in the Franchise Buying Process Step #1: Get in Touch with the Franchisor The first step is to get in touch with the franchisor. This could be through the franchisor’s website, over the phone, or at an expo or other franchise event. You will likely be asked to complete an application, and at this point you may also receive a copy of the franchisor’s Franchise Disclosure Document (FDD). By law the franchisor is required to provide a minimum 14-day waiting period before you sign a franchise agreement, and as a result you will likely be asked to sign two copies of a standard receipt page confirming the date on which you received the FDD. Step #2: Hire an Attorney to Review the Franchise Agreement and FDD Once you receive the FDD (which will include a copy of the franchise agreement), you will want to give these documents to an attorney to review. For more information on choosing an attorney to review your franchise agreement and FDD, we encourage you to read: […]

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As a struggling franchisee, you might think that your franchisor signaling its intent to terminate your franchise agreement represents the end of a long nightmare. Unfortunately, in many cases, it is just the beginning. This is because, with increasing frequency, franchisors are including “liquidated damages” clauses in their franchise agreements. A typical liquidated damages clause may look something like this: Within 30 days of the Franchisor’s termination of this Agreement, the Franchisee will pay the Franchisor, as liquidated damages and not as a penalty, an amount equal to three (3) times the royalty fees payable either (i) during the last twelve (12) months of the Franchisee’s active operations, or (ii) the entire period that the Franchisee has been in business, whichever is the shorter period. In plain English, what this says is that, 30 days after the franchisor terminates the franchise agreement, the franchisee must pay the equivalent of three years’ royalty fees to account for the royalties that the franchisor theoretically would have earned had it not terminated the agreement. This is true even though the franchisor is electing to terminate the agreement—presumably because the franchisee has been unable to meet its royalty obligations while actually trying to operate the business. Sounds fair, right? Unfortunately, many, many franchisees have liquidated damages clauses in their agreements, and several courts around the country will enforce these clauses without regard to the often-devastating financial effects they have for terminated franchisees. Challenging the Enforceability of a Liquidated Damages Clause That said, there are […]

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When considering a franchise opportunity, it is critical to conduct your due diligence. Buying a franchise is a substantial, long-term investment, and your success or failure will hinge in large part on the actions, omissions and obligations of your franchisor. Franchise due diligence is an involved process that takes time, effort and a commitment to finding real answers instead of simply trying to validate your interest in the franchise. The following is a list of 10 examples of steps prospective franchisees can take to learn more about their potential franchise opportunities: Franchise Due Diligence: 10 Steps 1. Talk to Current Franchisees. How are their businesses doing? How long did it take them to become profitable? How supportive is the franchisor? Current franchisees can provide invaluable information to help you decide whether to pursue a particular franchise opportunity. 2. Talk to Former Franchisees. Former franchisees are a key source of information as well. Why did they leave the system? Would they do it again if they had the chance? What is their opinion of the franchisor? 3. Visit the Franchisor’s Headquarters or Company-Owned Location. The in-person visit is an important step in the due diligence process. You will want to meet the franchisor’s key personnel in person, and see if you think you will be a good fit for the way they do business. You should also try to visit several franchised locations. 4. Review the Franchisor’s Franchise Agreement and FDD. While you should hire an attorney to review the franchisor’s […]

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When was the last time you visited a Starbucks franchise? You might be surprised to learn that the answer is, “Never.” Starbucks is among the largest chains in the world not to franchise, and CEO Howard Schultz had this to say about why all Starbucks locations are company-owned: "To me, franchisees are middlemen who would stand between us and our customer… If we had franchised [as some executives wanted to in the 1980s], Starbucks would have lost the common culture that made us strong.” So, are franchisees really just “middlemen” who get in the way of providing quality service to the customer? The Value Franchisees (Can) Bring to the Table I know quite a few people who would disagree with Mr. Schultz’s assessment of the franchise model. Some would even say that it demonstrates a lack of familiarity with the nature of franchising and the franchise relationship. Franchisees are independent business owners, but this does not mean that they have any less interest in seeing their businesses succeed. If anything, their independence provides even more incentive to make sure that they meet, if not exceed, their customers’ expectations. Mr. Schultz continued: “We teach baristas not only how to handle the coffee properly but also how to impart to customers out passion for our products. They understand the vision and value system of the company, which is seldom the case when someone else's employees are serving Starbucks coffee.” Of course, franchisees, like franchisors, rely on their employees to sell their products […]

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While sharing certain similar characteristics, licenses and franchises are different relationships that, by law, must also have certain key distinctions. If you are considering a franchise or another business opportunity that involves a license, it is important to have at least a basic understanding of the unique features each type of relationship entails. The Legal Definition of a Franchise We’ll start by looking at the definition of a franchise. Under the Federal Trade Commission (FTC) Franchise Rule, a business relationship must have three essential elements in order to be deemed a franchise: The franchisee must receive, “the right to operate a business that is identified or associated with the franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;” The franchisor must “exert or ha[ve] authority to exert a significant degree of control over the franchisee's method of operation, or provide significant assistance in the franchisee's method of operation;” and, The franchisee must “make [] a required payment or commit [] to make a required payment to the franchisor or its affiliate,” as a condition to opening for business. Certain states’ franchise laws include slightly-modified definitions, but they generally incorporate some variation of these same three key elements. In order for a business relationship to constitute a franchise, all three elements must be present. So, what happens if one is missing? In most cases, the would-be franchisee receives a license. The first element of a franchise (“the right to […]

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You own a franchise, and everything is going reasonably well. You have begun to turn a profit after a couple of years, you are getting repeat business, and you are finally starting to think that this could be something you could do successfully for a long time. Then, you get a site visit from your franchisor. It seems like it goes well, but a short time later you receive a notice identifying all of the ways that you are out of compliance with the franchisor’s current system standards, and stating that you need to make numerous costly updates in order to avoid defaulting under your franchise agreement. You make a call to another franchisee a few ZIP codes over, and she says that her outlet is a lot older than yours, and she’s sure her business is far more “outdated” than yours. So, what gives? When Franchisors’ System Standards Are Not Uniform As it turns out, there are a number of reasons why franchisors may choose to treat different franchisees differently. Despite franchisees’ expectations (and, in some cases, franchisors’ representations) that system standards will be uniformly enforced, it is not at all unusual for some franchisees to face more-onerous obligations than others. Here are just some of the reasons why: Different Franchise Agreements – When trying to figure out why your franchisor is treating you and other franchisees differently, one of the first questions to ask is: When did each of you sign your franchise agreements? Franchisors frequently update their […]

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For several years now, the franchise model has been growing in popularity as a way for established businesses to expand into new markets.  With Franchise Times publishing a list of the “Top 200 Franchise Systems,” there are many, many more franchise systems out there – with hundreds, if not thousands, of franchise systems registered in various states nationwide. You know some of the most-established franchise systems well: Subway, McDonald’s, 7-Eleven and Dunkin’ Donuts are perennially among the largest franchise chains in existence. Then, there are national chains, regional chains, local chains, all the way down to the independently-owned business with one location that is seeking to sell its first franchise opportunity. So, if you are thinking about purchasing a franchise, which way should you go? Should you buy into a big franchise system where you will be one of hundreds (or thousands) of franchisees; or, should you join the ride for a fledgling system that is seeking to expand? Three Factors Affecting Your Choice of Franchise Opportunity 1. Brand Recognition When it comes to choosing between different sizes of franchise systems, one of the most important factors can be brand recognition. The ability to instantly benefit from a known brand is a key benefit for many new franchisees, and this benefit will generally be stronger with a larger, more-established franchise system. On the other hand, maybe a beloved, local business has decided to franchise. In this scenario, you could still benefit from brand recognition without being perceived as a part […]

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