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Tuesday
May232017

Franchise 101: State Taxes on Franchise Fees; and Breach of Contract Claims

Franchise 101 News

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
gwintner@lewitthackman.com
msoroky@lewitthackman.com

 

May 2017

 

Franchise Lawyers

New Rules re Financial Performance Representations

Tal Grinblat, a member of the Executive Committee of the Business Law Section of the State Bar of California, co-wrote a notice distributed to state bar members regarding new guidelines franchisors must follow when using financial performance representations (FPRs). The new guidelines impact all franchisors in the U.S. and its territories. The e-bulletin alerts those in the industry about the North American Securities Administrators Association's (NASAA) adoption of financial performance guidelines which require a number of new disclosures and a certain admonition. The guidelines also set requirements for franchisors using "averages" or "medians" in their FPRs.

Read the e-Bulletin: NASAA Issues New Commentary on Financial Performance Representations in Franchise Disclosure Documents


FRANCHISOR 101:
State Taxes on Franchise Fees

Franchisors collect weekly or monthly "franchise fees." In many cases, fees are for particular services, such as marketing assistance or IT support. In franchising, the parties may be in any number of different states: for example, a franchisor may be headquartered in California, provide IT support from Texas to a franchisee in Florida, and receive payments at an office in Washington. Which states may tax the franchisor on franchise fees, and in what proportion?

In Upper Moreland Township. v. 7-Eleven, the convenience store franchisor provided advertising services (store signage development) and information technology services to franchisees. Advertising services were provided from Texas. Information technology services were provided from Massachusetts. Franchisees in Pennsylvania and New England sent their payments to a 7-Eleven regional office in a Pennsylvania town where 7-Eleven also had one corporate store and one franchisee-owned store.

The town imposed "Business Privilege Taxes" (BPTs) at a rate of 3.5 mills on gross receipts of "[e]very person engaging in a business ... in the Township." 7-Eleven paid the tax on activities of its corporate store in the town, but not on fees collected at that office from franchisees. After an audit, the town assessed 7-Eleven over a million dollars for unpaid BPTs, interest, and penalties.

7-Eleven challenged the constitutionality of the assessment. A Pennsylvania court relied on a 1970s- era U.S. Supreme Court decision, Complete Auto Transit, Inc. v. Brady (1977), to determine if a local tax on interstate commerce is constitutionally permissible. To be "fairly apportioned," as Brady requires, the local tax must be "externally consistent." To be externally consistent, a tax must apply to "only that 'portion of the revenues from the interstate activity which reasonably reflects the instate component of the activity being taxed.'" A tax does not meet this standard if the amount of income taxed is "disproportionate to the business transacted by the taxpayer in that municipality."

Applying the Brady rule, the Pennsylvania court found the town's assessment was unconstitutional because it was not fairly apportioned to reflect the location of the various interstate activities that generated the 7-Eleven service charges. 7-Eleven just received payments in the town, but the rest of the activities occurred elsewhere. The court remanded the case to the town for a "constitutional recalculation of the assessment."

A franchisor may consider using constitutional limits on local tax powers to protest some municipal taxes. It may also be useful to identify as many components of its interstate commerce activity as it can in locales with lower tax rates.

Read: Upper Moreland Twp. v. 7 Eleven, Inc. 144 CD 2016, before the Pennsylvania Commonwealth Court


FRANCHISEE 101:
Contract Curveballs

In every Franchise Agreement, the franchisor and franchisee promise to fulfill obligations to the other. For some promises, whether or not they were performed can be a clear "yes" or "no." For example: either a franchisee paid the royalty to the franchisor on the specified date of the month, or it did not - there is usually no third option. However, other obligations - such as a franchisor's promise to provide the franchisee with "support" - may be vague. How much assistance and what kind of help a Franchisor must provide may not be clear. These are judgment calls that may ultimately be presented to a jury as questions to decide at trial.

In Anne Armstrong v. Curves International, Inc., franchisees owning 83 locations sued Curves International, the franchisor of 30-minute women's gyms, after suffering losses in their Curves businesses. The franchisees claimed their losses were due to Curves not giving them support promised in their franchise agreements. The agreements said Curves would "make available certain services," followed by a list of services that "may" be included, such as opening assistance, pre-opening training, periodic reviews of franchisee operations, periodic training, ongoing support, and advertising data and advice. The franchisees claimed they generally did not receive any of the promised assistance.

As evidence of their losses, the franchisees provided tax returns, and a statement by Curves' founder that Curves felt "a reasonable return on the franchise was probably $30,000 a year," though no level of profit was guaranteed by the agreements.

Curves moved to dismiss the claims, arguing that the agreements stated only that Curves "may" provide the listed services. Curves also argued that clauses allowing it to exercise "business judgment" gave it "unquestionable discretion" regarding support it provided, as long as its decisions were intended to or could benefit the entire Curves system. Curves presented evidence that it provided franchisees with local marketing materials, and informed franchisees of other advertising initiatives Curves was pursuing.

A jury found that Curves breached its contracts, and awarded the franchisees more than $1.5 million. This included individual plaintiff awards ranging from $0 to $143,928. Counsel for the franchisees stated that the franchisees were pleased with the award, which they calculated to have compensated them for approximately 80 percent of their losses. Curves stated that it strongly disagreed with the decision and plans to file post-trial motions and potentially appeal the verdict.

Had Curves been able to point to text in the agreements literally stating it had no obligation to provide certain services, or that it actually had "unquestionable discretion" to decide what support to provide to franchisees, the outcome may have been different. As it was, the jury had to decide if franchisees received the reasonable support they paid for.

Read: Armstrong v. Curves International, Inc. - 6:15-cv-00294-SDD, Order on Motion for Summary Judgment, in the United States District Court for the Western District of Texas

This communication published by Lewitt Hackman is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation. Copyright Lewitt Hackman 2017. All Rights Reserved.

Friday
Apr282017

Not Your Neighborhood Tesla Dealer; and Special Delivery

Franchise 101 News

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
gwintner@lewitthackman.com
msoroky@lewitthackman.com



April 2017

 

Franchise Lawyers

Capitol Times

The International Franchise Association will host its 50th Annual Legal Symposium in early May - Barry Kurtz, Tal Grinblat, David Gurnick and Matthew Soroky will all attend, representing Lewitt Hackman in Washington D.C. The conference brings together franchise owners, operators, executives and attorneys to discuss current laws and regulatory environments.

 

FRANCHISOR 101:
Not Your Neighborhood Tesla Dealer

Among the many differences between Tesla and traditional automakers, Tesla does not sell or service its electric cars through franchised dealers; it sells direct to consumers. Recent legal challenges to Tesla's direct-to-consumer sales model highlight an auto maker's hurdles in selling through its own subsidiaries.

The Utah Supreme Court upheld an agency ruling that Utah's Motor Vehicle Business Regulation Act (the "Licensing Act") and New Automobile Franchise Act (the "Franchise Act") combined to prohibit a Tesla subsidiary from selling new Teslas in Utah showrooms. The relationship between Tesla and its subsidiary was found to be a "franchise" under both statutes, and was barred by the Franchise Act's prohibition against subsidiary relationships.

At first, the subsidiary applied for a required new car dealer license to sell Tesla vehicles at a Salt Lake City showroom. Its application was denied for not having a "franchise" to sell the vehicles, as required by the Licensing Act. The subsidiary responded by entering into a "dealer agreement" with Tesla and reapplying for the dealer license.

The dealer agreement sought to create the required "franchise" relationship needed to satisfy the Licensing Act. Unfortunately for Tesla, the Franchise Act prohibits a franchisor from owning an interest in a new car dealer. Therefore, to avoid creating a "franchise" relationship of the kind that would be subject to the Franchise Act, the agreement prohibited the subsidiary from using the Tesla name.

The court noted the subsidiary was caught "between the rock of the Licensing Act and the hard place of the Franchise Act." Either it lacked the franchise with Tesla required by the Licensing Act, or it was a franchise in conflict with the Franchise Act's prohibition against owning an interest in a new car dealer.

A "franchise" under the Licensing Act is simply "a contract or agreement between a dealer and a manufacturer . . . by which the dealer is authorized to sell any specified make or makes of new motor vehicles." The court ruled that the subsidiary had such a contract.

The Franchise Act was more complex. The first element of a "franchise" is a "license to use a trade name, trademark, service mark, or related characteristic." This requirement was satisfied by the subsidiary's use of Tesla's trademarks. The dealer agreement's disclaimer of a franchise relationship could not be reconciled with the "reality of the relationship" between Tesla and its subsidiary. The second element of a franchise -- a "community of interest" in marketing new cars, was also present because Tesla and its subsidiary had a unity of interest in selling Teslas.

The court said it issued a "narrow, legal decision" that did not rule on "broad policy questions" about how cars should be sold. The Court stopped short of deciding whether Tesla itself was barred from obtaining its own dealer license. A car maker could presumably do so, but the practical and legal effects of Tesla selling direct to customers without the protection of using a subsidiary are likely to leave Tesla between the proverbial rock and hard place.

Read: Tesla Motors UT, Inc. v. Utah Tax Commission

FRANCHISEE 101:
Special Delivery

For a relationship to meet the legal definition of a "franchise" in some jurisdictions, the franchisor must give significant assistance to, or have significant control over, the franchisee's business. A franchisor's prescribed marketing plan can be enough to meet this requirement.

The "marketing plan" element is multifaceted and imprecise. A distributor's marketing plan may be based on a contract, course of dealing or industry customs. A marketing plan need not be mandatory. And a plan need not include traditional advertising or marketing. It is enough for a franchisor to give franchisees instructions or advice on operating techniques or skill training, so that independent franchisees appear to consumers as if they are centrally managed and follow uniform standards.

In Neubauer v. FedEx, a former delivery contractor claimed FedEx violated the North Dakota Franchise Investment Law (NDFIL) when it offered and sold him an unregistered franchise. A federal appeals court in St. Louis found an absence of any appearance of central management in this delivery context, and affirmed a lower court decision to dismiss the contractor's claim.

The court noted FedEx's business is direct-to-customer package delivery. The delivery contractor picked up and delivered packages, but did not claim a right to offer, sell or distribute services to individual customers.

The contract with FedEx said he was an independent contractor who provided transportation services to FedEx, and received payments from FedEx - not from customers - through a weekly settlement check. Noting that the NDFIL's definition of "marketing plan" was nearly identical to the definition in California's Franchise Investment Law, the Court cited a California decision in which a similar delivery contractor failed to prove the existence of a franchise relationship.

In the California case, because there was no allegation that the delivery contractor cultivated customer relationships, the court found the contractor did not offer and distribute goods and services to customers within the meaning of the franchise law.

The "marketing plan" element required to establish a franchise relationship may be satisfied in various ways. A delivery contractor that can allege sufficient encounters with individual customers has a better chance to establish the existence of a marketing plan, but should bear in mind each component of the marketing plan element and the subtle variations to assert a plausible franchise claim.

Read: Neubauer v. FedEx Corporation

This communication published by Lewitt Hackman is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation. Copyright Lewitt Hackman 2017. All Rights Reserved.

Friday
Mar242017

Franchisor 101: Ostensible Agency Victory; and Technical Disclosure Violations

Franchise 101 News

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
gwintner@lewitthackman.com
msoroky@lewitthackman.com



March 2017

 

Tal Grinblat Recognized

Once again, Tal Grinblat will be named a 2017 Legal Eagle in franchising, by Franchise Times Magazine. He has been designated as such by his professional peers and the editorial board of the publication each year since 2014. The magazine will publish the list in April.

 

FRANCHISOR 101:
Ostensible Agency Victory

 

Franchise Lawyers

A California federal judge dealt a major blow to employees of a Bay Area McDonald's in their effort to hold the franchisor responsible for its franchisee's alleged failure to pay wages and provide meal and rest breaks. The ruling shut the door on the plaintiffs' argument that franchisor McDonald's could be liable for its franchisees' labor code violations based on an "ostensible agency" relationship.

In Salazar v. McDonald's Corp., the court previously concluded the franchisor was not liable as a joint employer with the franchisee or as the franchisee's principal under an "actual agency" rationale, and that the crew workers' remaining theory that the fast-food giant "ostensibly" controlled their wages was not amenable to class treatment.

With the workers' remaining theory against McDonald's disposed, franchisors who do not directly hire, fire or pay franchisee workers, or control their hours or working conditions, can take a cue from McDonald's to defeat similar "ostensible agency" claims.

In "ostensible agency," the alleged agent "appears" to a reasonable observer to be acting on behalf of a principal. This appearance alone is enough to create liability for the principal party, assuming it bears some responsibility for allowing the appearance to exist. Previously, the crew workers declared that it appeared to them that they and the franchisee worked for McDonald's, with the franchisee acting as McDonald's agent to employ them.

Under California law, an "employer" is one who "directly or indirectly, or through an agent or any other person, employs or exercises control over the wages, hours, or working conditions of any person." The employees argued that the clause "through an agent" was sufficient to render even McDonald's, which only appeared to act as a principal through a franchisee agent, an "employer".

However, the court ruled that the phrase "employs or exercises control over" indicated that to be an employer under California law, there must be actual control, not just the appearance of it.

The crew workers also contended that California wage laws broadly favor workers and that it would advance these goals to adopt their ostensible agency interpretation. The court rejected this argument because it would amount to rewriting the law. Moreover, the argument presumed that McDonald's could remedy the alleged wage violations, a claim the court rejected.

A prudent franchisor facing claims that it shorted a franchisee's employees' pay, rest and meal breaks can look to McDonald's for guidance when the employee asserts a belief that he or she was working for the franchisor.

Read: Salazar v. McDonald's Corp.

FRANCHISEE 101:
Technical Disclosure Violations

The consequences to an unwitting franchisor can be severe when it fails to provide disclosure documents required by franchise law. Most franchise laws provide for rescission of the franchise agreement, allowing the franchisee to "unwind the deal" by enabling it to recover all monies it paid in connection with the franchise sale.

But what if the violation was merely a "technical" one because the franchisee did not suffer damages from non-disclosure?

The Sixth Circuit court confronted this question in Lofgren v. Airtrona Canada. After affirming that a sanitation services franchisor violated the Michigan Franchise Investment Law ("MFIL") when it failed to provide a franchisee with a disclosure statement, the court confirmed that rescission of the franchise agreement was the proper remedy under MFIL for this disclosure violation.

Plaintiff Brian Lofgren purchased equipment for a vehicle-deodorizing and sanitizing business. After Lofgren's business was struggling, he sued the franchisor Airtrona Canada and its sales representative, alleging that he was entitled to rescission and restitution because their failure to provide the disclosure statement violated the MFIL. Upon the Court's finding that Logfren's agreement did establish a franchise, the sales representative argued that rescission was a proper remedy for a violation of the MFIL only when the violation directly causes financial losses.

In rejecting this argument, the Sixth Circuit quoted directly from the MFIL, which states that "[a] person who offers or sells a franchise in violation of [the MFIL's disclosure requirements] is liable to the person purchasing the franchise for damages or rescission." The court noted that, although the absence of a disclosure statement did not directly cause the franchisee's financial struggles, there was no requirement under the MFIL to establish causation; it merely says that rescission is permitted if the franchisor fails to provide the disclosure statement.

The court observed that lower courts may choose not to permit rescission if considerations of fairness are in the franchisor's favor, such as where the franchisor inadvertently provided disclosure a few days late. In this case, however, the franchisee met his franchise requirements and took no improper actions. As a result, Lofgren had the right to rescission and restitution for even a "technical" disclosure violation, without needing proof that the failure to supply a disclosure statement actually caused his losses.

If you are a franchisee looking to "unwind" your Franchise Agreement, consider whether the franchisor dotted all 'i's and crossed all 't's when you started the relationship. If not, there may be a law out there that will grant your wish.

Read: Lofgren v. Airtrona Canada, et. al.

This communication published by Lewitt Hackman is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation. Copyright Lewitt Hackman 2017. All Rights Reserved.

Wednesday
Mar012017

Franchisor 101: Easier SBA Loan Approvals; and Perpetual Agreements

Franchise 101 News

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
gwintner@lewitthackman.com
msoroky@lewitthackman.com



Los Angeles Franchise Lawyers

February 2017

 

Barry Kurtz in Practical Lawyer

"Is the business sustainable in the marketplace? Franchises built on fad products or services rarely survive. To be sustainable, the business concept should be unique enough to withstand competition..." Click to read: How to Lead Your Clients to the Purchase of a Franchise

Our Attorneys Recognized

Barry Kurtz, Tal Grinblat and David Gurnick were named 2017 SoCal Super Lawyers in the Franchise/Dealership category. Only 12 attorneys in the entire region were so named. All three are also Certified Specialists in Franchise & Distribution Law, as designated by the State Bar of California Board of Legal Specialization -- less than 60 attorneys in the entire state share that distinction.

New Team Member!

We are pleased to announce that Matthew J. Soroky joined our Practice Group as an associate. He has nearly 10 years' experience in business litigation - and has devoted the last several years to franchise, distribution, licensing and intellectual property matters in both the transactional and litigation contexts. We look forward to introducing our clients to our newest team member. 

FRANCHISOR 101:
Simplification of SBA Loan Approvals

 

As independent small business operators, franchisees may qualify for business loans that are guaranteed by the Small Business Administration ("SBA loans"). However, the SBA considers certain types and levels of control exerted by franchisors over franchisees to create an "affiliation" between them, disqualifying controlled franchisees for the loans because the SBA does not consider them "independent."

Previously, a franchisor could draft an addendum to its Franchise Agreement to remove these controls and, after the addendum and Franchise Agreement were reviewed and approved annually by the SBA or an affiliate organization, franchisees signing the addendum could receive approval for SBA loans. This process was costly and time consuming.

However, as of January 1, 2017, the SBA simplified this process by prescribing a single form of addendum (the "SBA Addendum") that will make any Franchise Agreement kosher. Franchisors are now required to use these 2-page forms to qualify their franchisees for SBA loans, but now no review or approval by the SBA is needed.

SBA Addendums remain effective until either the underlying loan is paid off or the SBA no longer has any interest in the loan. In summary, the addendums modify Franchise Agreements as follows:

  • Change of Ownership: 1) The franchisor has no right of first refusal if the franchisee wants to transfer a partial interest in the franchise to a family member or one of the franchise's present owners. 2) The franchisor cannot unreasonably withhold consent to any proposed transfer. 3) After a transfer, the transferor cannot be held liable for the actions of the transferee.
  • Forced Sale of Assets: Upon the default or termination of a franchise: 1) If the franchisor exercises a right to force the franchisee to sell it the assets of the business but the parties cannot agree on a price, then the price will be determined by an appraiser appointed jointly by the parties. 2) If the franchisee owns the real estate where the franchise was located, then the franchisor cannot compel the franchisee to sell it the property, but rather only to lease it for fair market value for the remainder of the franchise's term.
  • Covenants: If a franchisee owns the real estate where the franchise is located, the franchisor cannot require the recording of any restrictions on the use of the property.
  • Employment: The franchisor may not directly hire or fire the franchisee's employees.

This simplification of obtaining approval for SBA loans will save the SBA time and money, while simultaneously allowing franchisors and franchisees to benefit from SBA loans.

Read: Notice from the SBA 

FRANCHISEE 101:
A Perpetual Franchise

When a franchisee "buys into" a franchise system by paying an "initial franchise fee," the franchisee is typically purchasing the right to use the franchisor's trademarks and business system for an initial term that lasts a certain number of years (usually between 5 and 20).

The franchisor may hope to continue its relationship with the franchisee far beyond this initial term, but nevertheless limits the term in this way so that it can periodically revise the details of the relationship with an updated agreement. The franchisee, by contrast, would understandably prefer that those details remain known and consistent as long as possible.

In H&R Block Tax Services, LLC v. Strauss, Strauss, an H&R Block franchisee, claimed that her Franchise Agreement was effectively "perpetual" and not subject to the kinds of revisions described above. The Franchise Agreement between stated that its term was 5 years and that, unless Strauss was in default, the Franchise Agreement would be "automatically renewed for successive Renewal Terms [of 5 years each]." Strauss operated for 30 years under this agreement until H&R Block told her that it would not renew, but invited Strauss to sign its "current form" of Franchise Agreement. Strauss claimed that the franchisor could not decline to renew the agreement and therefore had effectively just breached the agreement.

A federal court determined that relevant Missouri precedent required that "a contract which purports to run in perpetuity must be adamantly clear that this is the parties' intent." The language in the Franchise Agreement did not meet this standard, and therefore the court found that H&R Block was within its rights to decline to renew it perpetually.

A franchisee that is interested in a "perpetual" Franchise Agreement should be sure that the language in the agreement is explicit on the subject, and should consult with legal counsel before signing to verify that the language meets the standards of relevant state law.

Read: H&R Block Tax Services, LLC v. Strauss

This communication published by Lewitt Hackman is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation. Copyright Lewitt Hackman 2017. All Rights Reserved.

Tuesday
Dec202016

Are Franchisees Your Employees?; and Locked In to One Approved Vendor

Franchise 101 News

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
gwintner@lewitthackman.com

 

 

December 2016

 

Certified Franchise Executives

Barry Kurtz, Tal Grinblat and David Gurnick completed the experience, education and participation requirements to become Certified Franchise Executives under the auspices of the International Franchise Association (all three are already State Bar of California Certified Specialists). This distinction will be conferred on Barry, Tal and David at a ceremony at the International Franchise Association's annual convention in January, 2017. 

FRANCHISOR 101:
Are Franchisees Your Employees?

Prudent franchisors have been reducing their apparent control over franchisees' employees to reduce the risk of becoming joint employers of those employees. But could a franchisor's control over the franchisees themselves be used to prove that franchisees are the franchisor's employees?

In Matter of Baez, the Unemployment Insurance Appeal Board determined that franchisees of Jan-Pro Cleaning Systems, a janitorial franchisor, were Jan-Pro's employees. The Board held Jan-Pro liable as an employer to pay unemployment insurance contributions on payments it made to franchisees.

A New York appeals court said the Board may find an employment relationship if "substantial evidence" shows that an alleged employer "exercises control over the results produced or the means used to achieve the results," and said that control over the means is the more important factor. The court found there was sufficient evidence that Jan-Pro exercised such control over franchisees.

This was because Jan-Pro:

(i) Assigned geographic territories to franchisees;

(ii) Required franchisees to be trained, which Jan-Pro paid for;

(iii) Required franchisees to operate according to Jan-Pro's procedures and standards, including using only pre-approved equipment and supplies;

(iv) Could claim ownership of concepts or techniques created by franchisees;

(v) Had a contractual non-compete provision against franchisees for 1 year after termination;

(vi) Helped resolve complaints between franchisees and their clients;

(vii) Had the right to discontinue franchisees' services to any of their clients;

(viii) Provided franchisees with a starter set of business cards bearing Jan-Pro's logo, and had to approve any franchisee-designed business cards before use; and

(ix) Had the sole right to bill and collect payments from franchisees' clients.

As a result, the court upheld the Board's ruling against Jan-Pro.

Experienced franchisors will recognize much of the court's assembled "evidence of control" as common features of franchise systems. But franchisors may distinguish themselves from Jan-Pro, and hopefully avoid the same fate, by:

A) avoiding, to the extent possible, inserting themselves between franchisees and their customers as Jan-Pro did in points (vi) through (ix) above; and

B) charging franchisees a distinct "initial training fee," instead of offering training "for free" as Jan-Pro did (point (ii) above).

The latter may be potent counter-evidence against a finding of employment because employees rarely pay their employers for the right to be trained.

See In the Matter of Baez, N.Y. Sup. Ct., App. Div., ¶15,878

 

FRANCHISEE 101:
Locked In to One Approved Vendor

Franchisors often require franchisees to purchase supplies, materials, or inventory only from suppliers the franchisor approved. But where franchisors see benefits of consolidating by requiring franchisees to participate in volume purchases and ensuring product quality and consistency, franchisees see potential conflicts of interest.

In Window World of Baton Rouge v. Window World, a vinyl window sales and installation franchise, the franchisees agreed to: "sell and install only and exclusively those products, goods, equipment, and parts from vendors approved by [Window World]." The agreements added that Window World would try to get the lowest possible wholesale pricing for franchisees. Window World did not collect royalties from franchisees. Instead it collected from vendors a percentage of the sales price of items sold to franchisees.

In 2007, Window World announced that Associated Materials (AM) would be the only approved supplier of windows. Franchisees sued under antitrust law, claiming Window World and AM had an illegal conspiracy to "lock them in", forcing them to buy inventory at higher prices than they could get from other suppliers or even than they could get from AM if they weren't franchisees. The alleged price inflation increased AM's profits and Window World's royalty collections.

The North Carolina court concluded the franchisees could pursue their antitrust claim if Window World conspired to manipulate the "market" so that franchisees were forced to pay artificially high prices. But in this case Window World was able to require franchisees to buy windows solely from AM not because of power over the market, but because the license agreements gave the franchisor the right to approve even only one supplier if it wished.

The agreements were clear, so when franchisees signed they had fair warning of the risks of buying a Window World franchise. Franchisees effectively purchased windows in a free market; before signing, they had freedom in the "market" to buy a different franchise in which the franchisor didn't have the right to designate a sole supplier. The court dismissed the claim.

Before buying a franchise, a potential franchisee should be sure to understand the scope of the franchisor's right to designate approved vendors. Ask other franchisees in the system if they get competitive prices from vendors. Check the franchise agreement for terms that may limit this freedom in the future. Make sure to understand how the franchisor gets its revenue. It may be illogical to expect to pay rock bottom prices for supplies if what the vendor charges must be enough to also provide revenue to the franchisor.

But don't automatically reject a franchise just because there is a single source of supply. A franchise brand's concentration and volume purchasing from a chosen supplier may have offsetting benefits that contribute to the success of the system and its franchisees.

See Window World of Baton Rouge v. Window World, N.C. Super. Ct., ¶15,880

This communication published by Lewitt Hackman is intended as general information and may not be relied upon as legal advice, which can only be given by a lawyer based upon all the relevant facts and circumstances of a particular situation. Copyright Lewitt Hackman 2016. All Rights Reserved.

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