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Entries in franchise litigation (9)

Wednesday
Oct042017

Accidental Franchise = Potential Lawsuits, Fines + Other Penalties

CalBar Certified Franchise & Distribution Law Specialist

 

by Barry Kurtz

818-907-3006

 

Business owners looking to expand may leave themselves vulnerable to several obvious losses, including those related to finance, brand identity, and customer loyalty. Resources, including exemplary human resources, are sometimes spread too thin.

But there is another risk that should be considered, one that is not quite so obvious – that of accidentally franchising the business. This pitfall could lead to potential litigation, not to mention years of scrutiny and torment by government regulating agencies.

But how does a business owner inadvertently franchise a company, without specifically setting out to do so? It helps to first understand what a franchise is, and where the business operates.

For example, under California law a business relationship is a “franchise” if: 

  1. The business will be substantially associated with the franchisor’s trademark;

  2. The franchisee will directly or indirectly pay a fee to the franchisor for the right to engage in the business and use the franchisor’s trademark; and,

  3. The franchisee will operate the business under a marketing plan or system prescribed in substantial part by the franchisor.

The Federal Trade Commission and several other states use similar characteristics to determine the difference between franchises and other business opportunities.

Then there are states that incorporate different elements in their franchise definitions. In Hawaii for example, the three elements that constitute a franchise are trademark license, required fee, and “community of interest”, or the mutual interest of the franchise company and the purchasing business to market goods and services.

Franchise Trademarks

If a business uses another company’s trademark to identify itself, or uses it in its advertising, the business may likely be found to be “substantially associated” with the enterprise company’s, or franchisor’s, trademark.

Licensing agreements may be a bit challenging when trying to avoid becoming a franchise, as they usually grant rights to the purchaser to use intellectual property, and payments or royalties are definitely made in return. Pay particular attention to state and federal regulations to walk the line between franchising and licensing.

Franchise Fees

Just about any payment can be interpreted as satisfying the “fee” element, regardless of whether the parties call it something else. And fees are generally involved no matter which path to expansion a business owner chooses, because the goal of growth is profit.

Franchise Controls & Marketing

The third element, sometimes referred to as the “control” element, requires the franchisee to operate the business under a specific method or system – it’s the “recipe for success” so to speak

  • A franchisor will typically provide its franchisees with an operations manual containing a system of operations and closely monitor its franchisees for compliance to protect the integrity of its system.

  • Franchisors usually mandate the use of specific suppliers, and in some cases, act as the exclusive supplier of certain products or services sold by their franchisees.

  • Franchisees rely on their franchisors for advice, training, advertising, increased purchasing power and marketing assistance.

Differences Between Franchise, License and Distribution Agreements

Under a typical licensing arrangement, one company permits another to sell its products or services in exchange for a percentage of the proceeds without any other involvement on the part of the licensor.

In dealership and distributorship arrangements, independent businesses operate under their own trade names. The dealers or distributors usually buy products or services from the other party at wholesale prices and then resell them to the public. Neither party is substantially involved in the business affairs of the other. 

Franchises have many advantages for both franchisors and franchisees. Creating a franchise system allows franchisors to expand already successful business concepts, achieve greater brand recognition and diversify risk through the investments of its franchisees. Franchisees generally enjoy access to a proven business system and a wider customer base, greater brand name recognition, a stronger market presence, group purchasing discounts, professional marketing, research and development benefits, and continuing education and training. However, business owners and their advisors must be able to spot the telltale signs of a franchise to avoid unwittingly becoming or contracting with accidental franchisors.

Keeping with the California example, true licensing, distributorship and dealership arrangements lack at least one of the three elements of a franchise defined under state law.

But they also lack the level of scrutiny and regulation of a franchise. Business owners should decide if they’re ready for that level of commitment. The rewards are great, but franchising requires a certain “upping of the game”, if you will.

Business owners who suspect they may have inadvertently sold franchises when they really wanted to just expand operations, should seek legal counsel immediately.

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.

Friday
May262017

Franchisors: New Accounting Rules Will Significantly Impact Revenue Recognition

Franchise LawyerChair, Franchise & Distribution Practice Group

 

 

by Barry Kurtz

818.907.3006

 

 

An updated rule issued by the Financial Accounting Standards Board (FASB) will change when most franchisors may recognize revenue on their balance sheets from the collection of initial franchise fees.

Historically, initial franchisee fees were recognized as revenue upon receipt. Then, FASB Interpretation No. 45 mandated that initial franchise fees could not be recognized as revenue until the franchise unit opened for business. The result was additional cash on a franchisor’s balance sheet when the initial franchise fee was received, with a corresponding liability for the deferred initial franchise fee that remained on the books until a franchise unit opened for business.

Franchise Fee Accounting Sound Bad? It Gets Worse.

Recently the rules changed again. Effective as of December 17, 2017 for public companies, and December 15, 2018 for other franchisors, Accounting Standards Codification 606 issued by the FASB and the International Accounting Standards Board (IASB) will apply. The recognition of initial franchise fees will now have to be divvied up over the life of a franchise agreement.

For example, if an initial franchise fee is $10,000 and the term of the agreement is ten years, revenue will be recognized as $1,000 per year for ten years. This method will apply to multi-unit development as well – franchisors will not be able to recognize all initial franchise fees as revenue when the first location opens, but rather, as each location opens.  

The new rule could cause some problems.

Income will be reduced and liabilities will increase. The deferred liability will reduce the franchisor’s net worth and may trigger registration state restrictions on the franchisor’s ability to collect initial franchise fees when a franchise agreement is signed, which can adversely affect the system’s perceived value. Auditors may require franchisors to restate previous years’ financial statements, which could make a system look weaker as a going concern.

Additionally, restated financial statements could open the door to claims from unhappy franchisees that they were misled about a system’s financial condition. Growing franchise systems that rely on franchise sales for revenue could take a hit, as the system as a whole may be seen as less attractive to potential franchisees. 

Barry Kurtz is a State Bar of California 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.

Wednesday
Feb132013

The 10 Biggest Mistakes Franchisors Make

Business Litigation Attorney EncinoFranchise & Business Litigation Attorney

 

by David Gurnick

818.907.3285

 

 

Thousands of franchise companies offer countless goods and services in the United States. Many are successful in growing their brands, delivering quality goods and services to the public, and generating profits for franchisees and for themselves. Many, even franchisors  with long histories, are not as successful as they could be.

Here are some of the biggest mistakes franchisors make.   

1. Franchising Without Enough Capital

Why do some franchises fail? Franchisors who do not have sufficient funds in their own company, are unable to screen franchisees, perform the supervision and deliver the assistance needed for the system to succeed. Also, lack of funds makes the company appear financially weak. These franchisors are forced to lower their standards and are unable to assert proper contractual authority with franchisees. Lack of capital can be destructive to a franchise system.

 

2. Underestimating Costs 

There is temptation to show prospects that the investment to start a franchise is low. Franchisees depend on the franchisor's costs estimates being accurate. If costs are underestimated, franchisee recruits will become dissatisfied when they learn their true costs, and some will not have enough funds. Franchisors should be candid in estimating the investment costs, and should build in a margin for unanticipated expenses and costs.

 

3. Making the Franchise Agreement Too Strong or Too Weak 

Overbearing franchise agreements can scare away potential franchisees without providing the franchisor a meaningful benefit. Many over burdensome terms will never be enforced, and some, if the franchisor tried to enforce them, would be found to be unconscionable. Conversely, franchisors should review the agreement forms regularly, evaluate which subject areas address true risks for the company and system, and selectively strengthen those provisions.

 

4. Expanding Too Fast and Too Wide 

The chance to expand is intoxicating as it gives the appearance of success to the brand and system. But moving too fast, or having distant locations too soon, before the franchisor has infrastructure, support systems, and understanding of issues in different venues, leaves the franchisor unable to properly manage, supervise and assist franchisees. This mistake can destroy even a good franchise concept.

 

5. Insufficient Screening and Training 

The lure of initial fees and new locations tempts franchisors to lower standards for new franchisees and not devote enough attention to training. This results in franchisees who are hard to deal with and represent the brand poorly.

Franchisors should develop a profile of their preferred franchisees, addressing education, experience, motivation, cooperation, financial and other characteristics, and stick to that profile in recruiting and in evaluating potential transferees of franchised units. A significant investment in background checking, getting to know potential franchisees and providing thorough training to new franchisees in the system’s history, goals, and operations, will improve the prospects for everyone’s success.

 

6. Allowing Poor Locations 

This is really a variant of expanding too fast. Compromising standards as to the locations of franchises results in unsuccessful locations, disputes and site failures. This takes up more of the franchisor's time, costs money, and tarnishes the brand.

 

7. Quick, Do-It-Yourself Changes to the Franchise Agreement 

Negotiating changes to the franchise agreement and hurriedly preparing amendments and addendums can result in misunderstandings, ambiguities and inadvertent violations of franchise laws, all of which can lead to costly disputes. It is less costly to allow the time required for thoughtful drafting of amendments.

 

8. Failing to Deliver Value and Service to Existing Franchisees 

Too many franchisors come to take their successful existing franchisees for granted, enjoying the revenue they deliver and not delivering value in return. Franchisors should deliver continuous value and service, including marketing, support, updating of products. An existing franchisee should feel that they get value equal to or exceeding the royalties they pay, so that they remain satisfied and grateful to be part of the franchise system.

 

9. Squeezing More Revenue From Franchisees Without Considering Their Profitability 

For a franchise system to work, franchisees must be profitable. Franchisee profitability and profit growth should be as much a goal as the franchisor's own profitability.

 

10. Failing to Identify and Protect the Company's Intellectual Property 

A franchisor's brand (trademark) and confidential methods are among its most valuable assets. Failure to protect these devalues the system. The company's intellectual property should be identified and protected both contractually, and in operating procedures required of franchisees and within the franchisor company.

 

 

David Gurnick is certified as a Specialist in Franchising and Distribution Law, by the State Bar of California Board of Legal Specialization. Contact him via email: dgurnick@lewitthackman.com

 

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
Jan232013

Promises, Promises: Supreme Court Eases Up on Making Fraud Claims

Business Litigation Attorney EncinoFranchise Litigation Attorney

 

David Gurnick
818.907.3285

 

Overruling an 84 year old precedent, the California Supreme Court made it easier to claim a contract was brought about by fraud. Generally, when parties put their full agreement in writing, the law prohibits them from claiming an outside promise or assurance that differs from what the writing says.

For example, say a promissory note promises repayment in three years; but to get a reluctant lender to lend, the borrower orally promises to repay the loan in one year. Later the lender may seek to rescind the loan and cancel agreement, claiming to have been misled by the borrower’s false oral statement.  In countless situations, contracting parties claim they were promised or assured something that differs from what their written agreement says.

Under old law, the lender’s claim would not be allowed. This is because an oral promise of repayment in one year, directly conflicts with the written agreement’s statement that repayment is due in three years. The law calls this the Parol Evidence Rule

In a recent decision, the Supreme Court said it is fundamental that fraud undermines the validity of any agreement. The Court added that the Parol Evidence Rule should not be used to facilitate fraud. The court ruled a party may claim that a contract was induced by fraud, even if the inducement was an oral statement that differs from the agreement’s written terms.

The Court also gave a warning. Proving fraud "requires a showing of justifiable reliance" on the claimed misrepresentation.

If a written agreement says one thing, but a person claims something else was promised orally, there will be questions how the complaining party could rely on the oral statement. Reading the agreement would have revealed the conflict. If the party did not read the agreement, their reliance was not justified. “Negligent failure to acquaint oneself with the contents of a written agreement precludes a finding that a contract is void for fraud,” the Court noted.

The Parol Evidence Rule is still in effect. It still prevents a party from claiming an oral promise makes the parties’ agreement different from what the writing says. By allowing a claim for fraud, the Court’s decision partly changed a long-established California rule. With regard to overruling an 84 year old precedent, the Supreme Court quoted revered Justice Felix Frankfurter, that “wisdom too often never comes, and so one ought not to reject it merely because it comes late.”

The decision is Riverland Cold Storage, Inc. v. Fresno-Madera Production Credit Association 2013 Daily Journal D.A.R. 561 (Jan. 14, 2013). Look for a lot more discussion about this case in legal news.

 

David Gurnick is a Business and Litigation Attorney, a Certified Specialist in Franchise and Distribution Law (State Bar of California Board of Legal Specialization), and the author of two legal treatises. You may reach him via email for more information.

 

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
Mar222012

Franchisee Law - PMPA Protects Gas Station Franchise Owners

 

Business Litigation Attorney EncinoFranchise & Business Litigation Attorney

 

by David Gurnick
818.907.3285

 

British Petroleum or BP, one of the world's largest oil companies, owns the ARCO gas station brand. Recently, BP announced they will sell their southern California oil refinery as well as a number of their ARCO locations here, while allowing other gas station franchise agreements to expire without being renewed.  

Gas FranchiseThis announcement has caused anxiety among numerous franchised ARCO dealers in Southern California. Will many of these gas station franchisees find themselves out of business?   

Oil companies supply fuel to the public through retail gas stations. Many gas stations are operated by independent franchisees. In a typical franchise, an oil company [like  Arco (BP), Exxon, Shell or Chevron] leases the premises to the franchisee, lets the franchisee use the company's brand, and agrees to sell gasoline to the franchisee for resale. Tens of thousands of franchised gas stations serve the public across the USA. These franchisees may be protected under the Petroleum Marketing Practices Act, or PMPA. 

 

PMPA Cuts Both Ways

 

In response to unfair terminations and nonrenewals of franchise agreements, Congress enacted the PMPA in 1978. The PMPA limits the circumstances in which an oil company may terminate a franchise or choose not to renew the franchise relationship at the end of the agreement's term. A franchisor may terminate a franchise or choose not to renew only if the franchisor provides prior written notice and has a good reason, recognized in the Act.

A franchisee can sue in federal court against a franchisor that violates the PMPA's restrictions against termination or nonrenewal. Various remedies are available to a franchisee, including damages, attorney's fees, costs of expert witnesses and equitable relief. A court can grant a preliminary injunction to protect a franchisee from a wrongful termination or nonrenewal. 

Franchisee Gas StationIn the BP situation, dealers may find some solace in the PMPA. Under that federal law, an oil industry franchisor cannot terminate a franchise early, or elect not to renew when its term expires, unless certain conditions are met. One of these conditions is that the Franchisor elects "in good faith and in the normal course of business" to withdraw from marketing fuel through retail outlets in the relevant geographic market area. When such a decision is made, the franchisor must offer to sell, transfer or assign its interest in the premises to the franchisee, or offer the franchisee an opportunity to buy the premises on the same terms as the franchisor is selling to someone else.

The PMPA has other detailed provisions which, if followed, may not prevent BP from completing its plan. But franchised ARCO dealers, and franchisees of any oil company, have rights as well, and may wish to explore those rights before their franchises are terminated, or not renewed.

David Gurnick is a Certified Specialist in Franchise and Distribution Law, as designated by the State Bar of California Board of Legal Specialization. You may reach the franchise attorney by calling 818.907-3285  or by email at dgurnick@lewitthackman.com.

 

 

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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