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Franchise 101: Supreme Tax Implications; and Class NOT in Session

Franchise & Distribution Law Practice Group

Best Lawyers 2018 BadgeSouthern California Tier 3 Best Lawyers in Franchise Law 2018



June 2018


Rising Stars in Franchise/Dealership Law

Congratulations to Samuel C. Wolf and Matthew J. Soroky, both designated Rising Stars for 2018 in franchise and dealership law, by Super Lawyers Magazine. Sam and Matt were first nominated by peers of the bar, evaluated by a third party research team, and then reviewed by a panel of highly credentialed panel of outside attorneys. As few as 2.5% of the original nominees are then named Rising Stars.

Webinar: Ready to Franchise? Here’s What You Need to Know

Franchising is one, key way to expand a business, but it's not the only way. Those looking to grow their business and expand their brand through franchising should consider their options carefully. In this webinar, Tal Grinblat, Certified Specialist in Franchise Law (State Bar of California Board of Legal Specialization) and Katherine L. Wallman, an 11 year veteran in both corporate and franchise law, will discuss:

  1. Five Elements of a Successful Franchise System
  2. Steps to Begin Franchising
  3. State Registration Requirements
  4. Franchise Relationship Laws
  5. And much more…

Attorneys and Accountants attending this webinar may be eligible for CLE or CPE continuing education credit. Please add ESQ or CPA after your last name in the registration form if seeking credit. Click RSVP to register for this event.

Supreme Tax Implications

Online Goods Services Tax

On June 21 the U.S. Supreme Court reversed prior case law and let states tax online retailers that do not have physical presence in the state. The ruling also has significant implications for franchise systems that sell products and franchise their brands in multiple states.

Online retailers Wayfair,, and Newegg do not have a physical presence in South Dakota. They challenged a South Dakota law that requires out-of-state retailers to collect and pay sales tax “as if they had a physical presence in the state.” The Court’s precedent held that whether an out-of-state seller had to collect and pay taxes on sales to the state’s consumers depended on whether the Seller had a physical presence in the state. The Court upheld state taxes if they: 1) apply to an activity with a substantial nexus with the taxing state, 2) are fairly apportioned, 3) do not discriminate against interstate commerce, and 4) are fairly related to the services the state provides.

The new decision ruled that physical presence is not necessary. Now the “closely related” requirement applies. The Court acknowledged that requiring physical presence amounted to a judicially created tax shelter. It let businesses operate without physical presence in as many states as feasible to avoid taxes. The Court ruled this was unconstitutionally arbitrary as it treated identical economic actors differently.

Next, the Court said that in today’s economy, virtual presences should be subject to the same sales tax for the same items. Finally, the Court explained that the physical presence requirement was a burden on states’ ability to collect taxes and fund public functions and it put an unfair tax burden on consumers who bought goods in their state. The Court ruled that it was a mistake to give online retailers an arbitrary advantage over competitors that must collect sales tax from consumers. The Court ruled that the South Dakota law did require a substantial nexus before making out-of-state retailers liable for collecting and paying state sales tax.

This decision could lead to states taxing franchisors on royalties from out-of-state franchisees, for the use of marks and intellectual property. This could be a significant financial burden for franchise systems. Franchisors should consult their franchise and tax attorneys on the potential implications of this decision and assess what modifications to their business model and franchise agreements may reduce the impact of the decision. Franchisors might also rethink their e-commerce platforms with regard to granting or withholding rights to franchisees to sell goods out-of-state.

Read: South Dakota vs. WayFair, Inc., et al.

Class Not in Session

Class Action Arbitration Clauses

In May, the U.S. Supreme Court held that mandatory arbitration agreements containing class action or collective action waivers must be enforced as written.

The challenge to enforceability was that the National Labor Relations Act (“NLRA”) says employees can seek relief on a class basis. The Court examined three appeals involving workers whose employment agreements required all disputes to be arbitrated. The agreements required individualized arbitrations and barred employees from pursuing claims as a class or collective action.

The Court ruled that the NLRA does not override another law, the Federal Arbitration Act (“FAA”). The FAA requires courts to enforce agreements to arbitrate. The Court said the FAA treats arbitration agreements as valid, irrevocable, and enforceable. The Court directed lower courts to respect and enforce the parties’ chosen arbitration procedures and “rigorously to enforce arbitration agreements according to their terms.”

The employees invoked a clause of the FAA that lets courts refuse to enforce arbitration agreements. They claimed the NLRA decreed that the employees’ waivers of class and collective action was illegal.

The Court rejected this argument. The Court interpreted the FAA clause narrowly, stating that it “offers no refuge” for defenses that apply only to arbitration. The Court noted that the aggrieved employees did not claim they were forced to sign the arbitration agreements by fraud or duress or other unconscionability, so there was nothing to render the contracts unenforceable. Instead, the employees objected that their agreements required them to waive rights to class or collective actions.

The Court’s ruling said that lower courts may not let a contract defense “reshape traditional individualized arbitration by mandating classwide arbitration procedures without the parties’ consent.” According to the decision, the FAA required the court “to enforce, not override, the terms of the arbitration agreements before us.”

The Epic Systems case provides support for franchisors whose franchise agreement arbitration provisions prohibit class or collective actions by franchisees. Such provisions may be invalidated only “by an act of fraud or duress or in some other unconscionable way.” Franchisees should pay attention to any arbitration clause in their franchise agreement that bars class actions. Where such a clause is presented to a potential franchisee, it may be worth trying to negotiate the right to pursue class action proceedings against the franchisor.

Read: Epic Systems Corporation v. Lewis

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 2018. All Rights Reserved.


Disclosure Violations and Running the Risks of Rescission; & Pay Now or Pay Later: Liquidated Damages

Franchise 101 News

June 2015


Bryan H. Clements Named Rising Star

Congratulations to Bryan H. Clements, named one of Southern California's Rising Stars for 2015 by Super Lawyers Magazine. To be recognized, Bryan underwent Super Lawyers' rigorous selection process quantified by peer evaluations and professional achievements. Less than 2.5 percent of nominated attorneys are finally selected to the Rising Stars list. 

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

Tal Grinblat & Franchise Law Committee

The California Bar's Franchise Law Committee chaired by Tal Grinblat recently submitted proposed legislative changes to state law. One would make it easier for franchisors to negotiate terms of the franchise agreement with prospective franchisees. Another would permit franchisors to present at trade shows without formal registration, to gauge interest in a franchise concept before investing resources in developing a franchise program. If the Business Law Section's Executive Committee approves, the proposals will be submitted to the Bar for introduction in California's legislature.

David Gurnick Presents to ABA

David Gurnick, Certified Specialist in Franchise and Distribution Law, business litigation attorney and author, was invited by the American Bar Association to co-present a seminar for members attending the 38th Annual Forum on Franchising in New Orleans. The seminar topic, entitled Finders Keepers Losers Weepers: Opportunities, Risks and Considerations in Using Intellectual Property Created by Others, takes place in October.

Disclosure Violations & Running the Risks of Rescission


Despite a district court's recent decision in Braatz, LLC v. Red Mango FC, LLC, franchisors are well advised to comply with applicable disclosure requirements to a "T" to ensure new franchisees will not have an ongoing right to rescind their franchise agreements.

Braatz was disclosed with Red Mango's franchise disclosure document (FDD) on November 4, 2011. On December 28, 2011, Braatz received an execution version of the franchise agreement and a franchise compliance questionnaire from Red Mango. On January 5, 2012, Braatz paid Red Mango an initial franchise fee and entered into a franchise agreement with Red Mango for a Red Mango yogurt store.

After cashing Braatz's check for the initial fee and countersigning the franchise agreement, Red Mango re-sent a blank closing questionnaire to Braatz asking Braatz to change two answers it had previously provided and resubmit the questionnaire. Braatz completed and signed the replacement questionnaire and returned it to Red Mango before January 16, 2012. Braatz closed the store on March 2, 2014, filed for bankruptcy soon thereafter, and filed a claim against Red Mango for violation of the Wisconsin Fair Dealership Law (WFDL) on December 23, 2014. Braatz sought to rescind the franchise agreement since Red Mango had not provided Braatz 14 days to review the replacement questionnaire before accepting Braatz's initial franchisee fee payment.

The WFDL provides "No franchise [...] may be sold in [Wisconsin] unless a copy of an offering circular is provided to the prospective franchisee at least 14 days prior to [its] execution of any binding franchise agreement or other agreement with the franchisor or at least 14 days prior to the payment of any consideration...." If the franchisor materially violates this provision, the franchisor shall be liable to the franchisee and the franchisee may bring an action for rescission.

The court ruled that even if Red Mango was required to provide Braatz an additional 14 days to review, complete and resubmit the questionnaire, the alleged violation was not material. Since Braatz promptly completed and resubmitted the questionnaire, the court opined, the violation did not affect Braatz's decision to enter the franchise. Also, the representations Red Mango had asked Braatz to change in the questionnaire conflicted with representations Braatz had made in the franchise agreement. In the court's opinion, asking Braatz to align its representations did not present any new requirements for franchise ownership, and thus, was not enough to amount to a material violation of the WFDL's disclosure requirements. Accordingly, the court granted Red Mango's motion to dismiss Braatz's claim.

Had this case been heard by a different court, or had the court been asked to apply the franchise disclosure laws of a different state, the result could have been different. So, keeping in mind that an ounce of prevention is worth a pound of cure, franchisors are best advised to provide franchisees no less than 14 full days to review all documents before accepting any signed documents or monies for a new franchise.

See: Braatz, LLC v. Red Mango FC, LLC.


Pay Now or Pay Later – Liquidated Damages & Future Royalties


Super 8 Worldwide, Inc. v. Anu, Inc. serves as a reminder to franchisees that, in general, courts will hold franchisees and their guarantors liable to their franchisors for losses suffered when franchisees abandon their franchises before their franchise agreements have expired.

Super 8 sued its former franchisee and the franchisee's guarantors for breach of contract alleging the franchisee unilaterally terminated the franchise when it stopped operating the facility without Super 8's prior consent. Applying New Jersey law, the court granted Super 8's motion for summary judgement against the franchisee's guarantors and awarded Super 8 liquidated damages, lost royalties and attorney's fees (the court had earlier granted Super 8's Motion for Default Judgment against the franchisee and awarded Super 8 $317,591.65 in liquidated damages and recurring fees).

The result in this case would likely have been the same had it been tried in California. California generally follows the rule that a non-breaching franchisor "... is entitled to recover damages, including lost future profits, which are proximately caused by the franchisee's specific breach." Postal Instant Press, Inc. v. Sealy, 43 Cal.App.4th 1704. Therefore, if a California franchisee's actions, such as abandonment of the franchise, are the cause of the franchisor's failure to realize future profits, the franchisor may recover its lost profits from the franchisee. Interestingly, though, a district court interpreting California law in Radisson Hotels Intern., v. Majestic Towers, Inc. went a step further. It ruled, based on a specific provision in the franchise agreement, that Radisson's franchisee was liable to Radisson for lost future profits, even though Radisson had terminated the franchisee for its failure to pay past due royalties.

Most states, though, including Washington and New York, follow the general rule that "a [franchisor] is entitled to recover lost profits [future royalties] if the [franchisor] demonstrates that (1) the [franchisee's] breach caused [the franchisor's loss of future royalties]; (2) the loss may be proved with reasonable certainty; and (3) the particular [lost future royalties] were within the contemplation of the parties to the contact at the time it was made." ATC Healthcare Services, Inc. v Personnel Solutions, Inc., 2006 WL 3758618; see also Ashland Mgt, Inc. v. Janien, 82 N.Y.2d 395 (1993); and see Tiegs v. Watts 135 Wash.2d 1. Following this rule, a franchisor would not be able to collect lost future royalties if it terminates its franchisee for failing to pay past due royalties, but could for acts by the franchisee, such as abandonment, which proximately cause the franchisor's damages.

Many franchise agreements provide a provision calculating the damages the franchisor will be entitled to receive if the franchisee abandons or otherwise terminates the franchise before its expiration date (i.e. 2 years' royalties based on the past 12 months). As the Super 8 case demonstrates, these provisions are typically enforceable, even against the franchisee's guarantors

Click: Super 8 Worldwide, Inc. v. Anu, Inc.


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 2015. All Rights Reserved.




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