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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
msoroky@lewitthackman.com



 

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

 

 

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.

Tuesday
Nov292016

Franchise 101: Recent "Franchisor as Joint Employer" Developments

Franchise 101 News

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

 

 

November 2016

 

Franchise Lawyers

David Gurnick Quoted in Franchise Lawyer

"Everybody is aware how divided the Supreme Court is, with all sorts of 4-5 or now 4-4 decisions. This was a 9 to 0 decision that a forum selection clause in an agreement is enforceable." Click to read: Ten Cases Rise to Top for Two Attorneys 

 

FRANCHISOR 101:
Recent “Franchisor as Joint Employer” Developments

 

In the last month, McDonald's settled a class action with employees of a franchisee, and a new President of the United States was elected. These two events have something in common with regard to franchising: they are significant developments concerning the issues of franchisor liability for actions of franchisees, and joint franchisor-franchisee employment of workers at franchised locations.

The settlement was in the case of Ochoa v. McDonalds. A U.S. District Court in California certified a class of more than 800 current and former workers of a multi-unit McDonald's franchisee in the San Francisco Area. They claimed damages for unpaid wages, unpaid overtime and time spent maintaining work uniforms. They sued their direct employer and also McDonald's Corporation, claiming the franchisor was also their employer. The court ultimately ruled against McDonald's in part, saying the claims might be valid if the workers truly thought they worked for McDonald's Corporation. The workers alleged they applied for their jobs on McDonald's website, wore McDonald's uniforms, served McDonald's food, worked at restaurants named McDonald's and the McDonald's name was on their paychecks.

Private claims like this received a boost in 2014 when the National Labor Relations Board (NLRB) alleged McDonald's was a joint employer with its franchisees. In 2015 and 2016 numerous actions were brought in various franchise systems, claiming that franchisors, along with their franchisees, were joint employers of the workers. These claims were made in wide ranging industries, among them restaurants, lodging, convenience stores and fitness.

In the Ochoa case, rather than risk liability to the workers, McDonald's settled for 3.75 million. In 2015, 7-Eleven similarly settled a joint employer liability claim brought by a 19-year sales associate of a New York 7-Eleven franchisee, although that settlement was for only $5,000, including attorneys' fees. A U.S. District Court in New York approved the 7-Eleven settlement.

The NLRB claims against McDonald's in 2014 were the result of the Board adopting a new definition of "joint employer," after President Obama appointed a majority of the Board's members. Under the prior standard, which had been in effect for over thirty years, joint employer status existed where two separate entities shared or co-determined matters governing the essential terms and conditions of employment. For a franchisor (or anyone) to be a joint employer, they had to exert "direct and immediate" control over employment actions like hiring, firing, discipline, supervision, and direction. The new standard is wider, broader and vaguer, assessing whether a claimed employer has sufficient control over employees' essential terms and conditions of employment to permit meaningful bargaining. Words and phrases like "sufficient control," allow this condition to be met by direct, indirect (through an intermediary) or even a reserved right of control, even if not actually exercised.

However, relief for franchisors may be coming. By law, the NLRB is headed by a five member board, appointed by the President. Currently the Board has two vacancies. It is possible the filling of vacancies by President Trump may change the political and philosophic makeup of the board, resulting in a return to the prior joint employer definition or something closer to it.

Regardless of the particular formulation of the joint employer standard, and other standards creating potential liability for acts of franchisees (actual agency, apparent agency, direct negligence, co-venture or joint venture liability and others), there are many steps franchise companies can take to reduce the risk of being held liable for acts or omissions of their franchisees. Earlier this year, we presented an extensive list of ways franchisors and franchisees should consider to prevent or reduce risk of co-employer liability claims. Given the recent developments, please revisit: 68 Steps to Reduce Risk of Joint Employer Liability.

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.

Wednesday
Nov022016

Franchise 101: Protecting Ops Manuals; & Business Relationship Laws

Franchise 101 News

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

 

October 2016

 

Franchise Lawyers

On the way to the Forum

Barry Kurtz, David Gurnick, Tal Grinblat, Samuel C. Wolf and Gabriel A. Wintner will all attend the ABA's 39th annual Forum on Franchising in Miami next week. David will co-present the annual Judicial Update, providing a recap of key court decisions involving franchise litigation.

David Gurnick Selected

Congratulations to David Gurnick, one of only a handful of franchise attorneys to be named in the Los Angeles edition of Best Lawyers Magazine for 2017.

Barry Kurtz in Valley Lawyer

"...Clients need to be realistic about the costs of becoming a franchise..."

Click to read: How to Lead Your Clients to the Purchase of a Franchise

 

FRANCHISOR 101:
Original Content Needed to Protect Ops Manuals

 

An important part of the franchise system is the confidential operating manual. Many franchisors claim protection of operating manuals under the law of trade secrets and copyright.

Keeping the contents confidential is an important step in claiming trade secret rights. It is a good idea to include a confidentiality notice on the cover, near the front, and in a header or footer of each page, to keep track of each printed copy and restrict access to printed and online copies.

Copyright law protects original creative expression. A recent court decision demonstrated some limits of copyright protection. Civility Experts is in the business of teaching civility, etiquette and good manners, to children and others. It brought a lawsuit claiming contents of its manuals had been copied by Molly Manners, a Colorado company in the same business. The parties had previously settled a similar claim.

In the new lawsuit the court performed a meticulous comparison of the two companies' manuals, finding numerous places where Molly Manners copied from Civility Experts. But in every instance, the court ruled the copied material was so basic, or was the only way of saying something, that the original content that had been copied, was not protectable under copyright law. The court found copying but still rejected Civility Experts' claim.

In the earlier litigation Molly Manners had entered into a settlement agreement, promising not to copy Civility Experts material. Based on the earlier agreement, the court said Civility Experts might have a claim for breach of contract. In view of this potential claim, the later dispute was also settled.

The Civility Experts case presents a valuable lesson for franchisors. Try to develop creative, original content in the operating manual, instruction manuals and other materials, so that these will be protectable under copyright law as well as trade secret law.

One further caveat. To register a copyright, a work must be filed with the U.S. Copyright Office. That makes the work public, which prevents trade secret protection. To protect a confidential manual, it is essential to use the Copyright Office's special handling procedure, which allows the applicant to file and obtain a registration, while preserving the claim of confidentiality and trade secrecy for a manual.

Civility Experts Worldwide v. Molly Manners, LLC, 167 F.Supp.3d 1179 (D. Col. Mar. 7, 2016)

 

FRANCHISEE 101:
Is It a Franchise? Yes and No

A federal court in Indiana made an interesting decision on whether a business relationship was a franchise. Wabash National Corp. is a famous maker of semitrailers. Wabash notified a dealer in Texas that its dealership was going to be terminated. The dealer sued in Indiana where Wabash is based, claiming protection under Indiana's Franchise Investment Act, which requires a franchisor to have good cause to terminate a franchisee, and under Indiana's motor vehicle franchise law, which prohibits unfair practices.

The two Indiana statutes define "franchise" differently. Under the motor vehicle statute, a relationship is a franchise if the manufacturer and dealer have a "community of interest." The court ruled there was a community of interest because the dealer had a large investment in and a large portion of its revenues came from selling Wabash semitrailers. The court allowed the dealer's claim under the motor vehicle statute to proceed. But the Indiana Franchise Act defines a franchise as a relationship involving a marketing plan, brand name and franchise fee. Because the Dealer Agreement said the dealer controls its business and decision making, the court ruled there was no marketing plan provided by Wabash, and therefore no "franchise" under the Act. So this part of the lawsuit was dismissed.

It is often said that the law can be counterintuitive. The Wabash case is an example, because the dealer was found to be a franchisee under one state law, and not a franchisee under a different law. This case shows the importance of understanding how franchise and dealer relationships align with the specific laws that apply in a particular state.

Ervin Equipment, Inc. v. Wabash National Corp. No. 4:15-CV-104-PPS-PRC, 2016 WL 2892132 (N.D. Ind. May 17, 2016).

 

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.

Tuesday
Sep132016

Franchise 101 Spotlight: The International Franchise Association

Franchise 101 News

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

 

Special Edition

 

Franchise Lawyers

President of International Franchise Association (IFA) Visits Lewitt Hackman

 

For more than 55 years, the International Franchise Association has been committed to improving methods and business practices for all participants in franchising - whether working with the Federal Trade Commission, lobbying on legislation; or collaborating with franchisors and franchisees to improve relationships. The Lewitt Hackman firm has been a strong supporter of IFA, participating in the Association's annual conventions and often speaking at the annual IFA legal symposium.

In recent years, IFA has faced an important threat to franchisors and franchisees - the changing standard on "joint employers" and increasing risks of "joint employer liability." To increase awareness about this issue, receive ideas about IFA member preferences, and meet and greet the many franchise clients of the Lewitt Hackman firm, IFA President and Chief Executive Officer Robert Cresanti traveled from Washington D.C. to visit Lewitt Hackman. President Cresanti spoke with several of our franchisor and franchisee clients and firm attorneys about the joint employer liability problem, other work of the IFA, and developments in franchising.

Mr. Cresanti provided a history of joint employer litigation. In an unprecedented move in 2014, the National Labor Relations Board's general counsel issued unfair labor practice complaints against McDonald's and several of its franchisees, seeking to hold the franchisor partially liable for alleged labor practices because the franchisor established general operating procedures. This is alarming to IFA because most franchisors establish general operating procedures.

In 2015 the NLRB decided a case involving waste disposal company Browning-Ferris. The Board changed decades of practice, deciding that direct and immediate control of an employee is no longer the standard for determining joint employer liability. Based on the Browning-Ferris precedent franchisors could be liable as joint employers by just having the right to indirectly control terms of employment, even if a franchisor never exercised that control. The decision blurred the lines, further threatening the franchise business model.

Mr. Cresanti described the numerous closed doors he and IFA encountered in trying to explain a franchisor's tenuous position in light of the NLRB's decisions. Despite obstacles, he vowed IFA will continue fighting to keep franchise business models thriving in the U.S.

Several Lewitt Hackman clients who attended indicated they wish to get more involved in IFA. Lewitt Hackman has signed up to host regular IFA networking events, and firm lawyers will continue to speak at IFA events. Lewitt Hackman thanks IFA CEO Robert Cresanti for visiting our firm and encourages franchisors and franchisees to thin about involvement in IFA. More information is at www.franchise.org.

 

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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