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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.

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