Franchise Lawyer Blog

As we never get tired of saying, franchise law is ever changing and evolving. This is partially because the business model itself is constantly in flux as new industries are explored. But this is also true because the law governing franchising has recently changed in dramatic fashion and is in the process of being interpreted in practice and in court. Since July 2008, the Uniform Franchise Offering Circular ("UFOC") has been replaced by the Franchise Disclosure Document ("FDD"), with new regulations associated with those new documentary requirements. We have discussed these changes in depth on our website.

All attorneys try to stay up to date with trends in the law, but in franchising it is necessary to be particularly vigilant. Most practioners are familiar with the standard resources: treatises, textbooks, case law. We thought it worthwhile to mention a few other sources of valuable information.

One of the more interesting ways to stay abreast of legal developments is to join the American Bar Association's Forum on Franchising and participate in that Forum's "listserv," which is an email discussion group that provides a remarkable amount of information on a current basis on questions that are arising in the franchise practice. Recent discussions have concerned "evergreen renewal" clauses and the practice of offering variations on initial franchise fees from one franchise sale to another.

Another valuable source of current information is the ABA's Franchise Law Journal, which can be obtained on the ABA's website. The FLJ is a quarterly. The most recent issue provides an interesting prognostication of what is in store for the franchise industry for 2009, as well as its regular collection of current cases in franchising and distribution, an invaluable resource for how to avoid trouble in creating franchise documentation.

To see the types of franchise disclosure document ("FDD") that are actually being filed, either in order to review a particular filing or to get a sense for the drafting and terminology in use, one can refer to the filings made with the State of California, which are a public record. That record covers nearly the entire franchise universe, as nearly everyone in business gets to Califronia sooner or later. In order to do so, access Cal-EASI. Once there, click on the tab entitled: Access to Securities Filings ("Cal-Easi).. Once at the database main page, you will be able to search for franchise and securities filings by corporate name, federal tax ID numbers, document type and other searchable categories.

The above items have offered insight on areas that actually come up for the franchise practioner and would be of interest to anyone active in the business.

When a franchisor sues a franchisee to obtain judicial blessing of a notice of default and termination—on the franchisor’s own initiative, or because the franchisee challenges the validity of the termination—typically the franchisor will include a cause of action for trademark infringement and move early, perhaps immediately, for a preliminary injunction enjoining the franchisee from continuing to use the franchisor’s intellectual property. Such an injunction, if granted, effectively shuts down the franchisee, inasmuch as it is the use of the franchisor’s intellectual property that the franchisee is paying for, principally.

The franchisor’s argument to the court, as it must be, is that the continued use of its trade marks, et cetera, by the franchisee allegedly in default is a violation of both contract and law that will cause the franchisor irreparable harm. This is probably true if the default at issue concerns a system violation concerning heath, safety, or the quality of goods or services provided by the franchisee.

But what if the default is simply an alleged failure to pay money, or the like? The franchisor might be likely to prevail on this cause of action, and in the end would be entitled to terminate the franchise agreement (and the included license to use its marks), but there is no harm to the public during the pendency of the action. If the doughnuts are the same as they ever were, for example, then there is no risk of consumer confusion, the sine qua non of trademark protection. Accordingly there is, arguably, no reason to enjoin the franchisee’s use of the marks pending trial of the action.

To the contrary, injunction would require the franchisee to go dark, almost always ruining its business. Therefore, even if trial reveals that the franchisor is not entitled to judgment, potentially irremediable damage to the franchisee will have been done—damage that an injunction bond might not adequately protect against.

The law is, for better or worse (that is, better for franchisors, worse for franchisees), that a franchisor is entitled to stop a franchisee from using the franchisor’s marks even while it remains to be decided by a court whether the franchisee has defaulted in its obligations under its franchise agreements. But should it be so?

Continue reading " Dollars to Donuts: The Dark Side of Trademark Injunctions in Franchise Actions " »

Occasionally a prospective client will come into our office and describe a desire to exponentially expand their business without having to deal with the expense and bother of franchise registration. What they usually have in mind is some sort of licensing arrangement. In some cases they will have already set up one or more outposts of their business, operating under their name, or they have negotiated with individuals and promised them the right to operate a location under their valuable brand name.
Our answer is invariably the same. If you are attempting to set up a business and it occurs to you that you want to avoid being a franchise, it is probably too late. You already are a franchise. This is because there are simple elements to the definition of a franchise that are almost unavoidable in establishing an expandable and replicable business model.
Generally speaking, a franchise exists when the owner licenses a trademark or tradename for use in connection with a business system in exchange for a fee for that right. You can look at the FAQ's on our website for a more detailed discussion of those concepts. Most states utilize this "three prong test." The rule in New York is even broader, requiring only two of the three prongs. A franchise exists in New York when there exists either (i) a marketing plan or system and a fee; or (ii) the use of a trademark and a fee.
The client who wishes to replicate their business model will invariably be licensing the use of a brand name, usually a registered trademark. They will be charging a fee, in one form or another. Changing the nature or manner of the fee doesn't avoid the definition. And the client will typically have a business sytem or model that they will want to see utilized in order to establish control over the quality of the developed businesses. There is no sensible way to avoid any of these criteria, they are all essential elements of a successful business development plan.
So the discussion inevitably turns to the requirements for franchising: the creation of the Franchise Disclosure Document ("FDD") and, where necessary, registration. We will be discussing both the form of the FDD and the registration requirements in future entries.
In some cases, clients already have one or more operations on the ground and running by the time they get to us. In these cases, the licensor/franchisors are exposed to liabilities created by the federal and state laws on franchising. These previously established branches will be considered to be franchises that have been sold without proper adherence to the state and federal requirements regarding FDD's. The client may be subject to damages for any losses suffered by these operators and may be required to offer rescission of the contract to those operators. In those cases, in order to properly initiate a franchise system, the previously established businesses will have to be negotiated with, in order to extricate the franchisor from the prior agreements and offer those operators an appropriate FDD.