Many of our blog commentaries address franchisor concerns. We also represent franchisees. We offer these observations to that constituency concerning the most crucial step in forming that relationship.

When buying a franchise, it is important to review the franchise agreement with an attorney, preferably one with experience in franchising. This is true regardless of whether the terms of the franchise agreement are ultimately negotiated. It is imperative that you understand the parameters of your relationship with the franchisor. Prospective franchisees sometimes focus only on the products and/or services they will be selling and the fees they will be paying the franchisor. They often do not fully review and understand the terms of the franchise agreement or their future relationship with the franchisor. This can result in dissatisfaction to the franchisee and cause substantial investment losses.

For instance, when purchasing a franchise, you may have the right to operate the franchise for a certain term such as five or ten years. But what happens at the end of that term? Does the franchise agreement provide you with a “right to renew”? And if so, what does that really mean? Are there conditions attached to the right to renew? Will you have to sign a new form of franchise agreement? Can that agreement contain new and increased fees? In what other ways may it differ from your initial agreement with the franchisor? If you are not allowed to renew the agreement, what happens to the value of your business? Will you receive any benefit from the years of operating your business? It is important to fully understand what will happen to your business and investment at the end of the term of the agreement.

Another point to consider is whether you will have the right to terminate the franchise agreement. Prospective franchisees often assume that if the business is not successful, the franchisee can simply close the doors and walk away as it would be able to do with an independent business. However, that is rarely the case in franchising. If the franchisee stops operating the franchise before the end of the term, he or she may be liable to the franchisor for its damages arising from the premature termination of the franchise agreement. Be sure to understand whether and on what grounds you have the right to terminate the agreement.

It is true that one of the benefits to buying a franchise is that the franchisee is buying into a proven system with a known name. Presumably, the franchisor has created a system and worked out the kinks before franchising the business. However, the franchise agreement is likely to provide the franchisor with the right to maintain control of the system. That control may include the right to require you to make modifications to your franchised business during the term of the agreement. These modifications can be quite costly and may include changes in equipment, computers, even changes to the brand name which may require new signs, new uniforms, new office supplies, and the like. While these modifications may ultimately benefit the system, you will be required to implement these changes at a time and cost determined by the franchisor without regard to your situation. It is important to realize that these unlimited costs may be imposed by the franchisor at any time during the franchise relationship.

These are just a few of the contract terms you should review with your attorney prior to purchasing a franchise. Buying a franchise can be a wonderful opportunity for owning a business with a proven brand and concept. Just be sure to understand the entirety of your relationship with the franchisor so that you ensure that the opportunity is right for you.

The equity markets are searching for a bottom after a historically precipitous decline. However, let’s take a look at a small part of the equity market, a selection of U.S. publicly traded franchisors referred to as the Rosenberg Center Franchise 50 Index, developed by the University of New Hampshire’s Rosenberg International Center of Franchising.

The index tracks the performance of the top 50 U.S. franchisors. These 50 franchisors represent 98% of the market capitalization of public companies engaged in business format franchising. Using a similar model as the S&P 500, the performance of those franchisors has been tracked and charted. In the 2nd quarter 2008, the RCF50 was down 4.4%, compared to the S&P 500 being down 3.2%. For the first half 2008, the RCF50 was down 12% and the S&P 500 was down 12.8%. Not much of a difference there. However, for the years 2000-2008, the RCF50 is up 59.6%, while the S&P 500 is down 8.2%. These numbers suggest that franchising has historically outpaced the general economy, but is suffering similarly in this recent downturn.

A quick review of various franchise related websites finds a similar set of statistics being advanced by those who support the franchising concept. These statistics consistently support the notion that franchised businesses are more growth oriented and survive at a higher rate than non-franchised businesses. For instance, a US Department of Commerce study is quoted on more than one site as showing that from 1971 to 1997, less than 5% of franchised businesses close each year, while those same websites cite a US SBA Study looking at the period 1978 to 1998, which found that 62% of non-franchised businesses close within the first 6 years of their opening.

It is difficult to independently verify those statistics and they are dated in any event. But if those trends are true, than someone looking to get into business in an unfriendly economic environment would be wise to look at franchised concepts rather than inventing his own. The question remains whether the current economic environment is so toxic that any business venture, be it franchised or self-invented, will find it impossible to thrive.

Franchisors should be aware that some lenders are paying greater attention to the information contained in the franchise disclosure document ("FDD"). Therefore, when preparing an FDD, a franchisor should take into account the necessity of prospective franchisees to obtain financing.

For instance, more lenders are looking for information that might be provided in Item 19 of the FDD. Such information is known as financial performance representations. Not surprisingly, lenders may want to know about the earnings and earning potential of units in the franchise system. Of course, a lot of factors must be considered when a franchisor decides whether to provide Item 19 information and if so, what specific information to provide. But one of those factors should be that franchisees are going to require financing and if so, some lenders may expect and require such economic data.

Also, lenders may want assurance that the franchisor will provide the franchisee with the necessary training to succeed. One of the great things about buying a franchise is that a franchise is supposed to be a “turn-key” business. That is, a franchisor is supposed to provide a franchisee with all of the knowledge and skills necessary to operate the franchise. When deciding whether to lend to a prospective franchisee, lenders are more and more interested in assessing the type and extent of training the franchisor is going to provide. Therefore, when providing information in Item 11 concerning the franchisor’s obligations, a franchisor should take care to ensure that sufficient detail is provided about the training program. This way, lenders will be able to ascertain whether a franchisee without any experience may be provided with the tools necessary to succeed.

While financing for the purchase of a franchise is harder to come by these days, it is possible for a prudent franchisor, with attention to detail, to increase a prospective franchisee’s ability to obtain such financing.

Contributed by Julianne Cowan Lusthaus

At this stage, many franchisors find that there is an art to finding the right match. We spoke to a new franchisor that this firm represents, Jason Puleio, about his franchise concept, The Barker Lounge, a dog daycare center and boarding facility offering full service dog care in large, “cage-free,” climate-controlled facilities. The Barker Lounge plans to have 4 or 5 franchises developed this year.

The Barker Lounge was recently featured in the October Franchise Times. You can find out more information about The Barker Lounge franchise system by going to the The Barker Lounge website.

Jason tells us the main component to identifying the right candidate for a franchisee is transparency – a totally honest approach. He makes the candidate aware from the start that his system is growing at a deliberate pace and that he is willing to wait for the right people. Jason provides interested parties with everything that they ask for in terms of information and guidance. And as the candidates are checking his operation out, he is simultaneously checking them out. Jason is looking for someone that is passionate about dogs, it simply won’t work otherwise. He wants franchisees who are going to love the work.

Jason says that he is breaking with convention and finding most of his interested parties in non-franchise environments. Rather than trolling the big franchise business conventions, he is meeting people through industry connections, such as pet shows and animal rescue organizations. That is where he can find the type of people who are willing to commit to Jason’s carefully developed brand of dog care.

A franchise system will ultimately succeed or fail with the quality of the franchisees running the system's operations. Jason's hands-on approach to developing his system from the ground up, with committed, passionate franchisees, describes a formula for success.

In short, going backward in time, the word “franchise” comes to modern English by way of Middle English fraunchise (circa 1290), from Old French franchise (“freedom”), from franche, the feminine of franc, from Late Latin francus, meaning, simply, “free” (or “exempt”; francus is also the root of “frank”—open, honest—and, some argue, even “France” itself.)

Coming back again to the present, the meaning of “franchise” narrowed to “a particular legal privilege” in the eighteenth century… then, in 1790, to “the right to vote” (that being a particularly particular legal privilege). The meaning of franchise of “the authorization by a company to sell its products or services” dates from 1959. (It does not appear any other specific milestone in franchising was reached in that year, though the International Franchise Association was founded in 1960.)

Notably, when a business franchise arrangement comes to an end, if it is because of something inappropriate that the franchisee has done, generally we speak of the default and termination of the franchisee by the franchisor. We do not typically refer to his or her disenfranchisement, that term being reserved for the (usually unnecessary) fate that befalls one who loses the right to vote, which is most commonly the result of a failure to reregister when required… something to keep in mind this election season.

Franchising World Magazine recently published the “FranPAC Report Card.” FranPAC is the political action committee of the International Franchise Association (which also publishes Franchise World Magazine); FranPAC advertises itself as supporting “pro-franchise, pro-business” candidates. FranPAC donated to 27 candidates for the Senate—23 Republicans and 4 Democrats. FranPAC gave financial support to 83 candidates for Congress—64 Republicans, 19 Democrats. FranPAC made a donation to the National Republican Congressional Committee as well. Although FranPAC did not donate directly to either Presidential candidate, clearly it favors Republican candidates in general as the pro-business, pro-franchise candidates and presumably would favor McCain in the same manner. To the extent FranPAC’s financial activities reflect the sentiments of the franchising community as a whole, clearly there is a perception that McCain and the Republican Party will best serve the interests of the franchising community.

Others have tried to sort through the candidates’ stated views to determine who might best serve the franchising community. Blue Mau Mau, a publication primarily serving the franchisee community, analyzed how each candidate would serve the small business community. But there is no plain answer there either, as both candidates offer a litany of ideas that would serve those who might fall within that constituency.

Notably, NPR’s online publication likens the development of the Obama campaign and the Obama brand to the development of a franchise system. But Obama’s intelligent use of the grassroots business structure that forms the basis of many successful franchise systems does not necessarily mean he is naturally the best candidate for those working within the franchise industry.

The IFA went to the candidates themselves with a series of questions, some directed specifically at issues facing the franchise community. Each candidate offers specific solutions to particular problems, although the pair has a tendency to disagree on what the real issues are. Reading through this Q&A might give one a sense of how each particular candidate would address a specific issue facing a specific franchisee or franchisor. It does not give a clear indication, however, that either candidate would better serve the franchising or small business community.

Given the enormous complexities of our current financial environment, an undecided voter would be much better served examining the views of the presidential candidates on our current financial crisis generally and the solution(s) each of them proposes. One of these men will have to lead us out of this morass, and all business models are going to sink or swim together based upon how well the man ultimately elected provides that leadership.

When asking whether your business can be franchised, important things to consider are the following:
• Is your brand known? Successful franchises are built upon unique and readily recognized brands. If your brand is not already well known, you will need to make it well known as soon as possible.
• Has your business concept been tested and proven? Many entrepreneurs come to us with a concept but no established business. It is very difficult to franchise a mere concept. It is essential that at least one version of your business model is up and running before your can meaningfully consider franchising.
• Do you have a system that is replicable and that can be taught? For your business to become a successful franchise system, you must be able to teach franchisees how to operate the business in a manner that will work in various environments.
• Do you have the people to help you get your franchise off the ground? You must remember that running a franchise system is different from running your business as just a business. You will need expertise in marketing, building brand awareness, and sales. Many aspiring franchisors do not realize that even after the franchise plan is in place, it still has to be sold to the public.

We will discuss the viability of franchising a business further in entries to follow, offering actual practical case studies of successful franchising ventures.

Our August 12 blog discussed a significant case for franchisees. Franchisor rights have also been evolving. In a significant victory for franchisors, a federal appeals court has ruled that a franchisor may require the purchase and use of specific equipment by its franchisees. The United States Court of Appeals for the Eighth Circuit, in a case involving Domino’s Pizza (Bores v. Domino’s Pizza, LLC, 530 F.3d 671 [2008]), overruled the trial court and held that a provision in the Domino’s franchise agreement permitted the franchisor to require its franchisees to purchase and install custom-designed integrated computer systems created specially for Domino’s units. The lower court ruling had caused significant concern in the franchise industry, where many franchise agreements require the purchase of specific computer equipment for point-of-sale systems.

The reversal turned on interpretation of the words “any” and “specification.” The franchisee plaintiffs argued that the provision at issue—“We will provide you with specifications for… computer hardware and software…. You may purchase items meeting our specifications from any source.”—had meaning only if the equipment at issue were available for sale from more than one source. The court disagreed. The court held as well that in fact a franchisee could purchase the point-of-sale equipment mandated either new from Domino’s or used from another franchisee.

Franchise practioners continue to assemble these fresh readings of contract language and statutory references to make certain that their own documents present their clients with the most advantageous interpretation.

Given the current state of the economy, a number of franchisors are either filing or contemplating petitions in bankruptcy or simply ceasing operations (see this Blog's entry of July 30). There are many reasons why this is happening, but the common result is that this event can be devastating for future franchisees. Franchisees are left without any support, having paid thousands of dollars in franchise fees and royalties and getting nothing in return.

The lack of operational support may be most devastating. Franchisees who rely on the franchisor for menu choices, inventory, even scheduling of appointments, may find themselves out of business. When a franchisor simply disappears, the only choice may be to have the franchisees band together in a cooperative arrangment to fund support.

Among other questions, however, is whether or not the franchisees can continue to use the franchisor's trademark. A more sophisticated approach is necessary when the franchisor is a larger company which liquidates in an orderly fashion and whose assets, including the extant franchise agreements and trademarks, are actually sold to a new owner. In that instance, franchisees may choose to look for a white knight with whom they can chart the course of their ongoing business.

Unless the Court of Appeals rules otherwise—and whether the high court of New York State will even hear the issue remains to be seen—a franchisor may not employ a pre-sale questionnaire subscribed by a prospective franchisee to summarily defeat the franchisee’s claims of fraud brought under the New York Franchise Act.

In Emfore Corp. v. Blimpie Associates, Ltd, et al., the Appellate Division, First Department reversed the trial court’s dismissal of a franchisee plaintiff’s claims of fraud in the inducement under section 687 of the NY Franchise Act, holding that subsections (4) and (5), the “anti-waiver” provisions of the Act, preclude such dismissal.

Blimpie, supported by the International Franchise Association as amicus curiae, moved the First Department to reconsider, maintaining that questionnaires are used to root out fraud, not to foster it; the appellate court in May modified its decision and order, but did not alter its general holding. Again with the IFA in its corner, Blimpie most recently moved the First Department for a clarification of its ruling or, in the alternative, leave to appeal to the Court of Appeals. The First Department last week denied the motion in its entirety.

Einbinder & Dunn represents Emfore Corp.
Submitted by Matthew D. Brozik, Esq.

What the future holds in store for Bennigan's cannot be known at this point, but the bankruptcy is a painful indication of the Darwinian survival process that is evolving in the fiercely competitive franchise restaurant landscape. That does not mean that all franchised restaurants are a bad bet in this environment. Only time will tell if the economy is driving a broad move away from eating out, or simply to restaurants that offer cheaper, fast food meals. The latter concept could bode well for the franchisors of those concepts. We will examine how the more nimble franchisors are adjusting to the environment and look at some of those concepts in coming posts.

Every day the attorneys in this office wrestle with issues of first impression raised by the new FTC disclosure requirements that became mandatory just this month, as well as creating and improving the new form Franchise Disclosure Document (FDD). We are also addressing in both negotiation and litigation classic franchise questions such as when does a business become a franchise despite the parties' desperate attempts to call it something else? All the while we are aiding clients in developing franchise systems and acquiring established franchises.

We will share our own experiences as well as national developments with you and hopefully add to your understanding of this rapidly developing area of the law. Many people believe that the franchising current flows counter to that of the mainstream economy, as downsized individuals look to buy a job in established small businesses. That theory may be sorely tested as our economy continues to turn downward.

Stop by and visit with us here and you will leave more informed about franchising and, by extension, about the overall nature and condition of our economy.