Franchise Lawyer Blog

We wrote a blog entry several months ago about the negative impact the global recession is having on franchise growth. Recent stories appearing across the country continue to confirm this trend. The IFA SmartBrief provides a story from Minnesota confirming continued difficulties in individual franchisees obtaining credit and reiterating the IFA's prediction, mentioned in our May blog, that overall franchise growth would show a negative 1.2% number for this year. As the first buds of economic recovery continue to appear, we will keep track of that number to see if it turns back to a positive growth number any time soon.

Last fall we wrote a blog that commented that franchisors were finding ways to help their franchisees through these difficult times by providing financing or assisting in obtaining financiing, or forgiving past due royalties and other fees, all in the interest of continuing the viability of the system. Recent economic trends may be causing some franchisors to pull back on that generosity. The Wall Street Journal reports that Papa John's is scaling back on its financial support to its franchisees, which had included a reduction in royalties and fees. With the recent decline in cheese costs, the franchisor and franchisees are seeing an increase in profits, enabling the system to move forward in a more conventional manner. Some writers have cautioned that recent economic good news could be illusory and to the extent that Papa John's move is based on a change in commodity prices, that could change again tomorrow. But others see this story as further evidence of an overall stabilizing in the marketplace.

The U.S. District Court in Colorado ruled in April in a case involving Quiznos that a provision in a franchise agreement that bars franchisees from banding together in class-action lawsuits is enforceable. The decision is seen as affecting other class-action lawsuits against Quiznos in Wisconsin, Illinois and Pennsylvania and may serve as a precedent discouraging such actions in other systems. Such prohibitions are common in franchise agreements. The extent of the impact of the decision remains to be seen. See Franchise Times June/July isse for further discussion.

The plaintiffs had argued, among other things, that fraudulent practices on the part of Quiznos rendered the entire agreement fraudulent and unenforceable. The Court disagreed. The Court held the class action provision was enforceable based upon a seven part test created by the Colorado Supreme Court in an earlier case, known as the "Davis Factors":

Is the agreement standardized, made by the parties with unequal bargaining power?
Did the parties have an opportunity to read the agreement before signing it?
Did the document bury the provision in fine print?
Is the provision commercially reasonable?
Is the provision substantively unfair?
What is the relationship between the parties?
What are the remaining circumstances surrounding the formation of the contract?

The plaintiffs remain dissatisfied with the result, which their attorneys describe as being fundamentally unfair to individual franchisees. As was reported in BlueMauMau:

Justin Klein of law firm Marks & Klein LLP, attorney for the franchisees, takes exception to the ruling. “The Quiznos franchise agreement says that franchisees have to sue Quiznos one on one,” he explains. “The purpose of our seeking a class action is because it is too expensive to sue Quiznos. It could cost hundreds of thousands of dollars for the individual to sue Quiznos in order to recover their initial franchise fee, which in some cases is $20k - $25k."

However, Judge Arguello found that the fact that the Quiznos franchise agreement is essentially a take-it-or-leave-it contract did not automatically render it unconscionable, because the plaintiffs did not have to enter into an agreement with Quiznos; being new franchisees, they were free to decline and purchase another franchise. More importantly, the plaintiffs had ample opportunity to read and consider the clause and the Court found the clause itself not to be substantively unfair or "unreasonably overreaching."
Bonanno, et.al. v The Quiznos Franchise Company,. LLC, 2009 WL 1068744 (D.Colo.)

We will keep you advised as to how this decision impacts on other judicial holdings across the nation.

New York State's 2009-2010 budget contains a new law which is intended to make it less difficult for the State's Department of Taxation and Finance to determine if franchisees of franchised chains are cheating on their taxes. This law, which received scant attention upon its creation, has recently attracted the attention of a number of franchisor trade groups as well as publications advocating franchisee and franchisor interests.

The Albany Business Review reports that the International Franchise Association (IFA) has written to the State Department of Taxation and Finance asking it to delay the enforcement of the new law. The law requires franchisors to report to the State what has been reported to them in terms of annual transactional information, including gross revenues on sales of goods and services and sales to franchisees by suppliers recommended by the franchisor.

The franchisee website BlueMauMau reports that the law's intent is to give New York the right to demand from the franchisor the gross revenue figures gathered about a franchisee. BlueMauMau quotes the IFA's letter as stating that this requirement is the first of its kind in the nation. The IFA is requesting that enforcement be stayed from the official effective date of September 20 to December 31, 2009.

Increased concern about the requirements of the law has caused it to appear in discussions on other franchise websites, such as QSR WEB, which voices the concerns of the quick service restaurant industry.

The official reason for the requested delay is that franchisors will not have time to collect the submitted information and submit it to the State in the 20 days outlined in the law. However, the real underlying concern about the law is that there are many reasons, some legitimate and some not, why the gross sales figures presented on tax returns might differ from the figures provided to the franchisor. But there will invariably be differences and the concern is that any discrepancy will become an automatic red flag for an audit, as well as giving rise to possible franchisor claims of underreporting.