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Entries in franchise agreements (5)

Monday
Jul092018

Tax Franchisee Terminated for Sharing Space With CannaBiz

Franchise LitigationFranchise Litigation

by Matthew J. Soroky

818-907-3022

 

In Devore v. H&R Block, the franchisor H&R Block was found to have lawfully terminated a franchisee for violating an in-term non-compete covenant, because the franchisee permitted its office manager and prior operator of the franchised business to offer tax return preparation services as part of his separate cannabis consulting business, all within the same office space as the franchised business, for multiple years. 

Cannabiz Tax Franchise

When the prior operator, Gordon Gates, sold the H&R Block office to the franchisee, he agreed to accept a portion of the purchase price during a three-year “earn out period” and to remain the office manager of the H&R Block until the purchase price was paid in full.  During those three years, the franchisee permitted Gates to operate “Cannabiz Accounting” from the H&R Block office. The business focused on cannabis consulting, but generated approximately 50 to 60 tax returns. None of the revenue generated by Cannabiz Accounting was reported to H&R Block. 

Gates eventually relocated offices, but he kept the franchisee’s principals and other employees of the H&R Block offices listed on his company website, which was then renamed “Gates & Associates.” The discovery of the franchisee’s names prompted the franchisor to terminate the franchisee, and to demand an accounting and payment of royalties due as a result of the breach.

Gates’ relationship with the franchisee was found to be a clear violation of the franchise agreement’s prohibition against direct or indirect engagement in a competing business. That section prohibited the franchisee from “engag[ing] directly or indirectly…in any business which offers any product or service the same or similar to [income tax preparation services] … within 45 miles of the Franchise Territory.” 

The franchisee argued that it did not engage in the competing Cannabiz Accounting business because it neither controlled nor received revenue from it. The trial court rejected this argument because it was undisputed that the franchisee breached the agreement by providing Gates with office space. 

An in-term non-compete covenant in a franchise agreement is typically broad enough to prohibit all conceivable forms of direct and indirect competition with the franchisor. Franchisees may be surprised to learn there are other, more subtle ways a franchisee may indirectly breach this covenant.  

 

Matthew J. Soroky is an attorney in our Franchise and Distribution Practice Group.

Disclaimer:
This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only, to provide general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for obtaining legal advice from a licensed professional attorney in your state.

Thursday
Jun212018

Why Today's SCOTUS Decision May Impact Franchisor Royalties

Franchise & Distribution Law

 

 

by Taylor M. Vernon

818-907-3027

 

Today, in South Dakota vs. WayFair, Inc., et al.,  the United States Supreme Court (“Court”) overturned long-standing precedents that required an out-of-state Seller to have a physical presence in a state  to collect sales tax from consumers in that state.

Online Purchase Sales Tax - SCOTUS Decision

The South Dakota law (Senate Bill 106 enacted in 2016) being challenged by giant online retailers, Wayfair, Inc., Overstock.com, Inc., and Newegg, Inc. – none of which had a physical presence in South Dakota – requires out-of-state retailers to collect and remit sales tax “as if they had a physical presence in the state.”

The Court found that the South Dakota law did provide due process, commerce clause and small business safeguards because it:

  1. Applies only to sellers that, on an annual basis, deliver more than $100,000 of goods or services into the State or engage in 200 or more separate transactions for the delivery of goods or services into the State,

  2. Forecloses the retroactive application of this requirement, and

  3. Provides means for the law to be appropriately stayed until its constitutionality has been clearly established.

The Court acknowledged the new economic realities of e-commerce, that when combined with a judicially created “physical presence” rule, provided a tax shelter and an incentive to do business out-of-state, giving an unfair advantage to e-commerce over in-state retailers. The Court’s decision largely focused on the substantial nexus requirement between the out-of-state seller and the states in which they made on-line sales and found that the physical presence requirement was arbitrary in today’s digital economy.

SCOTUS’s Impact on Franchisors

While the largest economic hit will be to e-commerce giants, such as the ones that challenged the law, this case also has potentially huge implications for franchisors and franchise systems.

Franchisors may need to rethink their e-commerce platforms with regard to the granting or withholding of rights to franchisees to sell goods out of state. More importantly, this case could permit states to tax franchisors on royalties paid by their out-of-state franchisees for the use of marks and intellectual property, which could be a significant financial burden for the primary revenue stream of a franchise system.

Franchisors should begin consulting their franchise and tax attorneys on the potential implications of this decision, as well as any needed modifications to their business model and franchise agreements to account for this change in the law.

 

Taylor M. Vernon is an attorney in our Franchise and Distribution Practice Group.

Disclaimer:
This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only, to provide general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for obtaining legal advice from a licensed professional attorney in your state.

Wednesday
Sep202017

Before Franchising Your Business, First Consider These Factors

Chair, Franchise & Distribution Practice Group

by Barry Kurtz

818-907-3006

 

Franchising is so much more than casual burger chains with drive through windows and dollar menus. It’s an industry that incorporates a wealth of blue and white collar services; distributes both high- and low-end products (consumables and non-consumables) around the globe; and provides the means for many first time entrepreneurs with the formulas to launch businesses successfully.

Professional Services Franchise

According to the International Franchise Association, franchises will generate over $700 billion in 2017.

While most people have a general sense of the structure of the franchise model, few realize the breadth of businesses that successfully employ the model, despite their interaction with these businesses on a daily basis.

Almost any successful business can be franchised, including those providing services in automotive, pet, business, personal care, real estate, and many other industries. They also include businesses selling products, whether the goods are foods, flowers, vehicles, clothing or other items.

However, franchising is not right for all businesses or business-owners. A certain mind-set is required to be a successful franchisor. Because the industry is highly regulated and laws vary state-to-state and country-to-country, starting a franchise requires the investment of a lot of heart and soul, as well as a lot of time and money.

Selling Franchises Means Starting Another Career

Keep in mind: selling franchises is a totally new and separate line of business.

For example, after selling her first franchise, the owner of a bedbug remediation service is no longer solely in the business of pest control; she is now in the business of selling franchises, too. To be successful, she will not only need to be able to sell the concept, but she will need to comply with all applicable laws and regulations relating to the sale of this type of investment, which is likely to be something that is outside of her wheelhouse. For these reasons, a business owner should evaluate whether the business would be right for franchising.

Franchising Requires Dedication

Franchising is regulated at the federal level by the Federal Trade Commission (FTC). In addition, many states have enacted franchise specific laws, and 13 states require franchisors to register before offering franchises within their states to provide additional protections to potential franchisees. These “registration states” have taken the position that franchise arrangements provide a greater potential for fraud, noting that franchise agreements are typically drafted by the franchisor’s attorneys and usually favor the franchisor.

Before offering franchises, the franchisor will have to prepare a franchise disclosure document (FDD) that complies with the FTC’s Franchise Rule.  

An FDD is an offering prospectus that provides prospective franchisees with information pertaining to 23 specific items about the franchisor and the proposed franchise. The FDD must include, among other things, background information about the franchisor and its executives, fee and cost information, samples of the contracts franchisees will sign, and information about the franchisor’s trademarks and patents.

Franchisors will generally need audited financial statements to include in its FDD. The FDD will have to comply with the laws of any of the “registration states” in which the franchisor intends to sell. The franchisor must register in those states before selling.

Formula for Franchise Success Required

Sushi Restaurant FranchiseFranchises must be attractive to prospective franchisees. A franchisor’s business model is attractive if it is based on a concept that is sustainable in the marketplace. Franchises based on fad products or services rarely survive. To be sustainable, the concept must be unique enough to withstand competition and must be one potential franchisees are willing to pay to learn.

Other factors to consider include: 

  • Laws and regulations that are applicable to the particular type of business;

  • Whether it is clear the concept will be profitable for both the franchisor and its franchisees;

  • Initial cost of creating the franchise;

  • Length of time it will take to achieve success;

  • Rate at which the franchisor can reasonably expect to expand; and

  • Franchisor’s ongoing ability to ensure its franchisees will be supplied with the inventory, supplies and equipment they require to operate. 

Franchising is a proven means for successful businesses to expand, but choosing to franchise one’s business is a decision that must be well considered.

In some cases, a business owner looking to expand may be better off selling licenses or distributorships instead of franchises if it is legally possible to do so. An experienced franchise attorney can help answer those questions.

Barry Kurtz is a California Bar Certified Specialist in Franchise & Distribution Law.

Disclaimer:
This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only, to provide general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for obtaining legal advice from a licensed professional attorney in your state.

Friday
Sep012017

Franchise Litigation Rising Over Dietary Considerations

Chair, Franchise & Distribution Practice Group

by Barry Kurtz

818-907-3006

 

Rising concerns over food sourcing and preparation is leading to more and more litigation for restaurants and franchises.

Most of the lawsuits claim discrimination, which makes sense as many dietary strictures are rooted in religious tradition. Other restaurant lawsuits are based on disability discrimination, as some plaintiffs suffer physical hardships when their dietary needs are not met, or are blatantly ignored.

Then there are franchisor-franchisee lawsuits, generally over how restaurants are allowed or not allowed to market, and regarding suppliers of specialty foods.

Here’s a closer look at the litigation menu:

First Course, Gluten Free

Gluten-free Diner DiscriminationRecently, a living-history museum in Virginia forced a fifth grade student on a school field trip to eat his home-prepared gluten-free (GF) meal outside in the rain – the museum’s restaurant had a strict “no outside food” policy. The boy’s father tried to talk to the restaurant employee who was enforcing the rule and then to the manager, who steadfastly refused to make an exception.

The family’s GF discrimination lawsuit cites violations of Section 504 of the Rehabilitation Act of 1973, Title III of the Americans with Disabilities Act (ADA), and the Virginia Rights of Persons with Disabilities Act.

Here in California, a gluten-free class action lawsuit was recently dropped by the lead plaintiff. In this case, Anna Marie Phillips was contesting P.F. Chang’s $1 surcharge for GF menu items, pointing out that customers who asked for vegan substitutions, or peanut and peanut oil-free dishes, were not similarly charged. Phillips dropped her suit because of complaints from a group who advocates for celiac disease victims.

But even though the suit was dropped, a legal question looms: Is Celiac Disease considered a disability under the federal ADA or various state laws?

Restauranteurs wanting to avoid ADA suits may be best advised to accommodate GF diners whenever they can – without surcharges, unless the extra costs apply to all special requests. (We can hear the revamped Burger King commercial now: “Hold the pickles, hold the lettuce, special orders don’t upset us…if we can charge you just a dollar more…”)

On the other side of the healthy food coin, a customer in Massachusetts brought a class action lawsuit against 20 Dunkin’ Donuts stores last year. His complaint?  He asked for real butter on his bagel but was served a butter substitute instead. The point in this case, according to the plaintiff’s attorney, is the need for truthful representations.

Point taken. At the point of a butter knife.

Second Course: Religious Concerns

Food and Cultural ConcertsAlso of note recently are the lawsuits initiated by those concerned with kashrut (kosher) or halal diets. Though pork is forbidden in both of these, the lists of allowed and forbidden foods diversify a bit for Jews and Muslims.

A Muslim customer in Michigan sued Little Caesars for $100 million last May, alleging he accidentally ate pepperoni, which is strictly prohibited by Islamic law because it is composed of pork. The plaintiff specifically ordered halal pizzas, and though the boxes were labeled halal, they were topped with regular, non-halal pepperoni.

On the other hand, many Hindus believe in non-violence, including non-violence toward animals. Thus, many practitioners are vegetarian, or lacto-vegetarian, if not fully vegan. Some Hindus will eat meat, but draw the line at beef.

Remember the lawsuit over french fries? McDonald’s labeled their fries vegetarian, but litigation ensued when customers realized the fries and hash browns were cooked in a vegetable oil containing “the essence of beef” to enhance flavor. The franchisor paid over $10 million to settle the complaints.

It’s important for franchisors, franchisees, distributors or suppliers, and employees to know the differences between halal, kosher, Hindu, vegetarian and vegan diets. Wait staff, food expediters and kitchen staff should be especially aware of legal consequences when making a simple mistake, like putting meat-filled samosas in a vegetarian-labeled container.

Even if such mistakes don’t lead to lawsuits, they definitely lead to customer mistrust and injured reputations for the restaurant.

Third Course: Franchise Agreements and Policies That Just Won’t Fly

Unauthorized products, particularly in the food industry, can cause system-wide problems. One of the primary purposes of franchisors approving suppliers is so that the corporate office can trace problems in food quality or sanitation. Outbreaks of food poisoning, a discovery that a unit’s fries are cooked in oils containing animal byproducts, or that a hot dog isn’t really kosher all lead to an injured reputation for the unit as well as the franchise system.

Further, consistently ignoring the franchisors requirements regarding ingredient sourcing can lead to an agreement termination, and possibly, litigation.

But here’s another twist on the food supply problem:

KFC Franchisee Halal Chicken

The KFC Corporation (franchisor of Kentucky Fried Chicken restaurants, or “KFC”) was recently accused of enforcing an allegedly unknown policy that prohibits religious claims regarding KFC products.

The plaintiff, a multi-unit franchisee owner, alleges he has sold halal chicken for 14 years with KFC’s help; the religious claims prohibition is not part of the franchise agreement or disclosure statement; and at no time since opening his first restaurant did the franchisor ever mention the prohibition. The franchisee claims he was first made aware of the provision in December 2016, and that KFC’s policy violates the Illinois Halal Food Act. He expects to lose $1 million in revenue annually.

Boxing It All Up

It’s easy to sum up the lessons – be respectful, be aware, and be proactive.

To avoid potential litigation, restaurant operators should ensure all employees handling food are well trained. It may be difficult to instill knowledge about every ingredient in every menu item, but at least train workers to ask management or kitchen staff when they don’t know the answers to customer food questions. Front of the house staff should never tell the customer what s/he thinks the customer wants to hear, or provide the easy answer when busy.

Also, be very wary of triggering discrimination complaints like the ones mentioned in the gluten-free lawsuits cited earlier. There shouldn’t be one set of rules for GF requests, another for people with allergy concerns, and others for halal or kosher diets. If imposing surcharges for one type of food modification, impose the same surcharges for all. (Though it’s probably best not to initiate extra charges at all.)

Franchisors, ensure franchisees are using approved suppliers only. If making policy changes about food supply or anything else, first consider whether or not those changes are going to cause economic hardships for the franchisees, and whether or not the changes are contractually enforceable.

Franchisees, don’t go off menu with ingredients. The suppliers pre-approved by the franchisor are generally well-vetted. Their ingredients may cost a little more, but you can probably assume the higher costs are due to better quality, legitimate certifications, and the like.

Barry Kurtz is a California Bar Certified Specialist in Franchise & Distribution Law.

Disclaimer:
This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only, to provide general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for obtaining legal advice from a licensed professional attorney in your state.

Monday
Jul172017

So You Say You Want a Revolution? Franchises Evolve as Retail Declines

Franchise Distribution Attorney Barry KurtzBar Certified Franchise & Distribution Law Specialist

by Barry Kurtz

818-907-3006

 

You’ve seen the news: retailers are struggling. Traditional anchor stores like Macy’s and Sears are closing up shop, creating a domino effect of fiscal death for shopping malls across the country. The Los Angeles Times reports over 8,000 retail stores may close before years’ end. 

Empty Food Courts Hurt Franchises

This is bad for Quick Serve Restaurants (QSRs) that have done a booming business in traditional mall food courts. But like all threatened species, there is a solution: Evolve. Though the traditional mall may be singing a swan song, other types of shopping complexes are doing good business.

Brick & Mortar Restaurant Locations

Not all malls are dead or dying, of course. And some properties will attempt a comeback through “experiential retail”, converting large anchor stores into movie theaters, restaurants, gyms, laser tag playgrounds or other facilities, which will hopefully lure back the smaller retailers as well as consumer foot traffic. But for franchisees leasing space in malls that are truly facing a decline, it may be time to revise a franchise agreement to accommodate a move to a more lucrative location. Consider alternative venues:

Outlet Malls: These still draw customers and generally have booming food courts filled with QSRs and other casual eateries. Many of them also lease space to family-friendly, full service restaurants as well.

Lifestyle Centers: Also known as boutique malls, these are mixed use commercial properties and popular draws for more upscale consumer spending. CityPlace in West Palm Beach or The Grove here in Los Angeles are prime examples. Single location restaurants and chains that are a little higher end tend to set out shingles in these locations. But QSRs may have opportunities in the surrounding areas.

Marketplaces: These settings are also on the rise in the U.S. Check out Grand Central Market in Los Angeles, or a venue like Underground Atlanta in Georgia.

Franchisees, consult with your franchisor regarding pulling up the stakes.

Franchisors, don’t allow franchisees to relocate at will; however, if a franchisee can make a convincing showing that relocation will be in the best interests of both franchisee and franchisor, the franchisor’s consent may be forthcoming. Consider the economic realities – franchisees who turn good profits make for a healthier system.

Food Delivery Services Help FranchisesOther Options for QSRs

Hanging on at the traditional mall food court to the bitter end? That’s understandable in some cases, as moves can be very expensive in terms of cash, lost customer bases and good employees who simply can’t commute to a new store further down the road.

Though foot traffic may be declining, digital sales are up. Consider a mobile delivery service or curbside pickup (consult with the mall’s management for this option) to bolster the account books.

A Morgan Stanley report says $210 billion in restaurant food is consumed outside of the restaurant from which it is ordered each year – though currently, only about five percent of that spend accounts for deliveries of online orders. But a writer for The Motley Fool projects a 15 percent growth in digital deliveries annually.

Whatever a QSR or other franchises decide to do – there are still plenty of options for business growth. You just have to embrace the change.

Barry Kurtz is the Chair of our Franchise & Distribution Practice Group.

Disclaimer:
This Blog/Web Site is made available by the lawyer or law firm publisher for educational purposes only, to provide general information and a general understanding of the law, not to provide specific legal advice. By using this blog site you understand there is no attorney client relationship between you and the Blog/Web Site publisher. The Blog/Web Site should not be used as a substitute for obtaining legal advice from a licensed professional attorney in your state.

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