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Tuesday
May232017

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

Franchise 101 News

bkurtz@lewitthackman.com
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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.

Tuesday
Jun242014

Pumped Up and Suing in Seattle

Franchise 101

bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com

June 2014

 

Top Ranked Law Firms 2014

Lewitt Hackman was named one of the Top Ranked Law Firms in California by Martindale-Hubbell for the third, consecutive year. The rankings are based on the size of the firm and the percentage of attorneys who have earned an AV Preeminent rating by Martindale-Hubbell. Lewitt Hackman well exceeds the selection criteria.

 

Franchise Distribution Lawyers*Certified Specialist, Franchise & Distribution Law - State Bar of California Board of Legal Specialization

Barry Kurtz quoted by the Los Angeles Times

Franchisees allege 7-Eleven targets the more profitable stores, accuses the owners of skimming from the till, and then pressures them to give up their businesses so the franchisor can offer them to new investors. How common is "churning" in the franchise industry?

Click Franchisees Allege Hardball Tactics, Store Seizures by 7-Eleven, to read the article.

 

Barry Kurtz and Bryan H. Clements in
The Practical Lawyer

"Prior to 1919 and the passage of the 18th Amendment, brewers and producers of alcoholic beverages sold their products directly to retailers, which led to anti-competitive business practices and unscrupulous marketing..."

Continue reading: The Yin and Yang of Beer Distribution Law and Franchising.

 

FRANCHISOR 101: 
IFA Files Lawsuit Against Seattle

On June 11, 2014, the International Franchise Association (IFA), a Washington, D.C.-based trade group, and five franchisees sued in U.S. District Court in Seattle to block Seattle's recently enacted increase of the minimum wage in the city to $15 per-hour.

The law requires large businesses, defined as those with more than 500 employees, to raise the minimum wage they pay employees to $15-an-hour over three years. Small businesses have seven years to phase in the wage increase. Under the law, a franchisee with five employees or more is considered a large employer and must begin raising its wage base next April if the franchise system has more than 500 employees nationwide.

Minimum Wage Hike Litigation

On the other hand, an independent, non-franchise company with 499 employees or less will be considered a small employer and will have additional time to comply with the law. IFA wants an injunction to prevent the new law from taking effect on April 1, 2015. The complaint alleges the law illegally discriminates against franchisees, improperly treating them not as small, locally-owned businesses, but as large, national companies, because they operate in a franchise network; and claims the law violates the Equal Protection Clause of the U.S. Constitution and the Washington State Constitution by arbitrarily discriminating against small businesses simply because they are franchises. IFA also launched SeattleFranchiseFairness.com, a website to encourage business owners to amend or overturn the law.

Read the article: Trade Group, Franchisees Sue to Block Seattle Minimum Wage Hike.  

 

FRANCHISEE 101:
Unsigned Franchise Agreement Binds Franchisee's Shareholder

A Texas Appeals Court recently held in Pritchett v. Gold's Gym Franchising, LLC that a Texas forum-selection clause in a Franchise Agreement was incorporated by reference into a personal guaranty agreement and was binding on a franchisee's out-of-state shareholder who did not sign the Franchise Agreement.

Gold's Gym and its franchisee, Bodies in Balance, entered into a Franchise Agreement in 2008. Each of Bodies in Balance's three shareholders signed a Guaranty, agreeing to be "personally bound by each and every provision in the Franchise Agreement."

The Franchise Agreement contained a "Consent to Jurisdiction" provision saying Bodies in Balance and its shareholders agreed the courts in Dallas County had exclusive jurisdiction over all disputes. The Guaranty did not have a "Consent to Jurisdiction" provision. Pritchett, a 50 percent shareholder, argued that, despite the Consent to Jurisdiction provision in the Franchise Agreement, he could not be forced to litigate claims in Texas because he had not signed the Franchise Agreement.

The court ruled that to uphold terms incorporated by reference in an agreement, "it must be clear that the parties to the agreement had knowledge of and assented to the incorporated terms." Since the Guaranty said "Guarantors do hereby agree to be personally bound by...each and every provision in the [2008 Franchise] Agreement...," the Court concluded that the parties to the Guaranty intended the entire Franchise Agreement, including its forum-selection clause, to be part of the Guaranty.

According to the Court, if Pritchett signed the guaranty, he was subject to the forum-selection clause in the Franchise Agreement and waived any jurisdictional objection to being sued in Dallas County.

Prospective franchisees should be cautious about, and fully understand the effects of, incorporation by reference clauses in their Franchisee Agreements.

Read the court opinion: Tim Pritchett, Appellant, v. Gold's Gym Franchising, LLC, Appellee.

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 2014. All Rights Reserved.

 

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