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Thursday
Mar292018

Franchise 101: Liability as Certain as Death & Taxes; and To First Refuse, or Not to Refuse

Franchise 101 News

Best Lawyers 2018 BadgeSouthern California Tier 3 Best Lawyers in Franchise Law 2018 bkurtz@lewitthackman.com
dgurnick@lewitthackman.com
tgrinblat@lewitthackman.com
swolf@lewitthackman.com
msoroky@lewitthackman.com
kwallman@lewitthackman.com



 

March 2018

 

 

Franchise Distribution Attorneys

FRANCHISOR 101:
Liability as Certain as Death & Taxes

Structuring a franchise to reduce risk of joint employment and vicarious liability means limiting a franchisor's control over franchisees. This is a challenge in a professional services franchise, where the brand is intertwined with the franchisee's personnel and the end product.

A California federal court held that a franchisee's former customer sufficiently alleged claims that tax preparation franchisor Jackson Hewitt exercised sufficient control over processing of tax returns to be vicariously liable for fraudulent conduct of a franchisee's rogue employee. The franchisor must also face claims of making fraudulent statements about accuracy of its tax preparation services.

The customer claimed the franchisee manipulated his tax returns to get a larger refund, and kept part of the refund as fees, without the customer's knowledge. In a prior ruling, the Court found the franchisor's controls were typical of a franchise relationship, and that control over certain aspects of a franchisee's operations was insufficient to create vicarious liability. This time, the customer alleged that Jackson Hewitt controlled the instrumentality of the harm by hiring and training tax preparers, and reviewing, approving and submitting tax returns to the IRS through the franchisor's proprietary and mandatory computer system. The Court was persuaded by allegations that the franchisor's "Code of Conduct" referred to the reader as an "employee" of Jackson Hewitt (not of the specific franchisee), mandated background checks and training programs to prevent preparation of fraudulent returns, and set parameters for termination of franchisee employees for failure to comply with system requirements.

Jackson Hewitt was also alleged to have made fraudulent ads touting 100% accurate returns, comparison to mom and pop tax preparers, and the "Preparer's Pledge" to handle a customer's tax return like their own. The Court said the purpose of the ads was to engender trust in potential customers, so they would hire Jackson Hewitt and its franchisees to prepare their taxes.

A professional services franchisor should be cautious in preparing training materials and manuals to delineate no more supervision than needed over franchisee personnel, to protect the franchisor's brand and intellectual property while trying to reduce the risk of vicarious liability for acts of a franchisee's employees.

Read: Lomeli v. Jackson Hewitt, Inc.

 

FRANCHISEE 101:
To First Refuse, or Not to Refuse

A franchisee looking to transfer assets of a franchised business may be subject to the franchisor's right of first refusal, the franchisor's option to purchase the business, or both, depending on the language of a franchise or dealer agreement.

In a federal court in Pennsylvania, a franchisee of seven car dealerships prevailed against Audi of America, the franchisor of one of the dealerships. Audi claimed the franchisee breached Audi's dealership agreement and violated state dealer law when, subject to the franchisor's right of first refusal, the franchisee did not provide pricing and other terms to transfer an Audi dealership.

The dealership agreement and Pennsylvania dealer law granted Audi a right of first refusal if the franchisee attempted to sell its majority ownership interest in the Audi dealership. The franchisee found a buyer and entered into an asset purchase agreement which packaged all seven dealerships as an "auto multiplex" for $17 million. The agreement did not separately price the Audi dealership. Believing the franchisee was acting in bad faith in valuing the Audi dealership at $8 million, Audi sued to block the transaction. A court granted a preliminary injunction.

After Audi filed the lawsuit, the franchisee and buyer signed two addenda to the purchase agreement, seeking to remove the Audi dealership from the sale. The franchisee contended that Audi's right of first refusal ended because it was no longer selling the Audi dealership. The trial court sided with the franchisee, finding there was no breach of the dealership agreement because the second addendum removed the Audi dealership, and the terms of the dealership agreement permitted the franchisee to withdraw the proposed sale after Audi elected its purchase right.

The Court also rejected Audi's claim that the first refusal right ripened into an irrevocable option to buy the dealership. It was only a general right of first refusal, which Audi failed to exercise before the franchisee withdrew the Audi dealership.

While Audi claimed it was unable to exercise its right due lack of a good faith price breakdown, the dealer was free to withdraw the asset from the sale. Accordingly, the franchisor received the full benefit of its right of first refusal, and was not entitled to further rights after failing to accept the right of first refusal prior to the withdrawal.

Read: Audi of America, Inc. v. Bronsberg & Hughes Pontiac, 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 2018. 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
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.

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