Franchise Lawyer Blog

One of the most important issues in franchising these days is the difficulty of obtaining credit to develop new franchisees. As reported here and elsewhere in the franchise press, many franchisors have had a significant falloff in sales over the last two years or so because of the difficulty that their franchisees face in borrowing money to open units. In fact, a number of financing companies, including CIT in the New York area, have gone out of business or substantially reduced their lending in this field. The result is stunted growth for franchise systems.

Franchisors have started to take matters into their own hands. Lending by franchisors is on the rise. Last week, The New York Times reported a 3.4 billion dollar credit shortfall, between the 10.1 billion in capital the franchise industry needs and the 6.7 billion banks are expected to lend. As a result franchisors are getting involved. Some franchisors have determined that the only way to build out their franchise systems and continue their growth is to establish lending programs for their franchisees. Other franchisors have decided to provide other types of financial assistance. In some instances, franchisors guarantee bank loans to franchisees and other franchisors reduce royalties in the first year of the franchise relationship to assist franchisees in opening units. Hopefully, these initiatives will spur growth and replace some of the lost financing previously available in the industry.

Obviously, 3.4 billion dollars is an enormous gap to fill. We will keep you advised as to whether or not these franchisor initiatives are making a measurable difference in providing the needed capital.

by Michael Einbinder

Rights to assignment are crucial to franchisees and have been discussed in this Blog previously. Less discussed, but just as important, is the franchisor's right to assign. Many franchisees buy into a system in reliance on the franchisor's reputation and experience. Franchisees are not aware that franchise agreements frequently give to the franchisors an unfettered right to sell the systems at any time. This right has been tested by the courts and has been upheld.

In a 2009 appeal of a 2007 case, Century Pac., Inc. v. Hilton Hotels Corp., 528 F.Supp.2d 206, 227-228, 230 (S.D.N.Y. 2007); aff'd 354 Fed.Appx. 496, 2009 WL 4072087 (C.A.2 (N.Y.)), Century Pacific, Inc. (“Century”), a Red Lion Hotel franchisee, alleged that the franchisor, Hilton Hotels Corp. (“Hilton”) induced Century into entering into a franchise agreement by representing that Hilton had no intention of selling the Red Lion brand. Subsequent to the franchise purchase, Hilton sold the brand to a third party.

Century asserted claims under New York law for (i) common law fraud; (ii) negligent misrepresentation; and (iii) fraudulent omission in connection with purported misrepresentations made to Century concerning Hilton's intention to keep the Red Lion brand. The District Court ruled against Century and that decision was upheld by the U.S. Court of Appeals. The ruling centered on Century's lack of reasonable reliance upon defendants' representations.

The Court of Appeals found in favor of defendants, stating that Century was a sophisticated party and was aware of the possibility of a sale of the Red Lion brand. Further, the Court of Appeals was swayed by the fact that Century attempted to negotiate a provision preventing a sale of the Red Lion brand, a concession that Century was unable to obtain. Without bargained-for language prohibiting a sale of the Red Lion brand, the Court of Appeals ruled that it was unreasonable for Century, a sophisticated party with knowledge of a risk of sale, to rely on any purported misrepresentations.

This cautionary tale warns franchisors that their franchise agreements must clearly give to them the right to assign their franchise agreements and alerts franchisees to the typical inclusion in most franchise agreements of a franchisor right to convey the system, a right that will result in franchisees dealing with entirely different parties than those from whom it purchased its franchise.

By Richard Bayer