Franchise Lawyer Blog

Tuesday's New York Times (January 19, 2010), provided an obituary of Glen W. Bell, the founder of the now enormous Taco Bell franchised restaurant chain. The obituary tells the story, inspiring in this current economic climate, of Mr. Bell's invention of the crispy-shell taco and the growth of the original Taco Tia restaurant to the 5600 unit Taco Bell franchise chain currently operated by Yum! Brands.
Mr. Bell is credited with introducing mainstream America to Mexican food, an idea that seems obvious now but was undoubtedly revolutionary when he thought of it. At the time, the late 1940's, he was competing with a number of fledgling fast food chains in what The Times describes as an "emerging Southern California car culture." One of those competitors was a hamburger stand only a few miles away that was run by two brothers named McDonald. Mr. Bell recognized that he needed a hook, something to distinguish himself from the pack, and he found it in the taco. He altered the design of the traditional taco from a soft shell to a crispy shell to make it easier to sell (and eat). The rest, as they say, is history.
Mr. Bell, who served in the Marines in the Pacific in World War II, obviously did not lack for nerve, trying to sell a completely untested food in a largely untested format. But that kind of innovation has been at the heart of nearly every successful franchise concept. You have to differentiate yourself from the competition. Doing so takes nerve, because to provide something truly innovative, it has to be something that has not been done quite that way before. And no one knows how or if that is going to work.

As we have explored on this blog previously, there has been endless discussion during this economic downturn concerning the effect current economic conditions will have on the franchising model. That discussion continues unabated, as evidenced by the following entries found through the briefest of internet searches:

A franchise fix for the recession blues? - BNET

Franchise leader says industry can lift economy - Fox Business

Fewer small business jobs lost in October - CNNmoney.com

Lackluster economy creates prime tenant market. - Franchising World.

The Franchise Decision - WSJ.com

The accepted wisdom on franchise growth is that the most valuable resource, people, is in ample supply in the marketplace. The second most valuable resource, real estate, has become more affordable, opening the door to small business devolopment. The equation goes like this: recently downsized capable business person with entrepeneurial bent cannot find a job and so creates a new business by acquiring a franchise, with the help of affordable rents.
The clouds on the horizon for this sunny view arise when one considers an enormously stingy credit environment and sharply reduced consumer spending.
There is no question that franchising presents some business opportunities that would otherwise never materialize in this economic environment. And in the long run, franchsing as a model seems destined to occupy a larger and larger segment of the US economy. Buying into an established system and brand increases the odds of success exponentially in an economic environment that moves faster and faster. However, there is also no question that people are spending less money: on eating out, clothes, electronics, almost anything you can think of. Until consumer confidence returns in full, this softness in spending is going to slow nearly every segment of the economy, and franchised businesses will fare no different.

I attended a breakfast meeting for small firms at the ABA Forum on Franchising a couple of years ago and my table's topic was technology. I have always thought of myself as relatively savvy on technology issues, but I was startled at how little I knew about some of the concepts that were discussed at that table. It made me realize that many lawyers are totally fascinated with technological advances to the practice of law. One of the reasons for this is that new technology means you get to buy new stuff, frequently cool new stuff with an intriguing gadget type quality. With all of that in mind, I was sent an article by Suzane Smith of the online publication Court Reporter Schools, entitled "Top 20 iPhone Apps for Busy Attorneys." I have an iPhone and I find it enormously useful in my day to day activities, including my law practice. I keep my calendar, contacts and email on it. I recently started using a free Voice Memo application ('app") which is extremely useful for keeping track of stray thoughts or even dictating a letter. I have not tried any of the other apps mentioned, but I will undoubtedly end up using some of them. The key to the iPhone is harnassing its usefulness while maintaining one's focus, so that I do not find myself trying to review a document, while simultaneously reading my email, instant messaging my son, texting my daughter, listening to music and playing Blackjack.

If you are reading this blog, you are most likely engaged in a search for information or sources of information regarding franchising or more specifically, franchise law. Of course, I could gratuitously point out that information relating to franchising is readily available by picking up the phone and talking to any of the lawyers at this firm, but if you are a professional who is looking to immerse him or herself in the field of franchising, you might consider attending the Legal Symposium of the International Franchise Association, held in Washington, DC on May 17 to the 19th.

The Legal Symposium is a gathering place of the franchise legal community and franchise executives that provides more than just an esoteric discussion of franchising law. It is intended as a business oriented program that provides an opportunity for the franchising legal community, including many in-house attorneys, to present and discuss topics of current concern. The Legal Symposium Task force has made a conscious effort to incorporate the participation of more in-house counsel and franchise executives, to give the meeting a business oriented feel that distinguishes it from the more scholarly atmosphere of its ABA counterpart.

This year's Symposium will focus on the unprecedented challenges facing the global economy and the inevitable effect on the franchising world of the nearly simultaneous crash of the real estate and stock markets. The legal community must view itself as a source of advice and innovative solutions that will help franchised businesses not only survive this harsh environment, but perhaps find opportunities to thrive in these difficult times. There are a number of presentations available at the Symposium in this vein.

However, it is important to not let economic anxiety overshadow the need to examine some real legal developments. There are other presentations that will address recently developing issues such as the rule changes governing financial performance representations in the Franchise Disclosure Document ("FDD") and the effect of the new FDD form on registration requirements. There will be much discussion regarding general issues that have come up in the past year regarding disclosure under the newly amended FTC rule and the new FDD. There are also presentations of interest on trademark and antitrust issues and numerous other legal issues. This firm's Julianne Lusthaus will participate in a panel discussion on "boilerplate clauses" in franchise agreements, an area that gives rise to many issues in interpretation and enforcement.

This event and the ABA's Franchise Forum in October are the two primary legal gatherings for franchise law practioners. If you are the type of attorney who is engaged on a consistent basis in the franchise practice with a "hands-on" approach to the businesses involved, this Symposium could be of particular interest to you.

Contact us on our contact sheet if you have any questions concerning this discussion or any other matter.

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.

The Wall Street Journal has reported that President Obama and congressional leaders plan to take steps to resuscitate the estate tax, also known as the death tax, despite years of efforts by various political interests to have it repealed. Why is this of interest to anyone reading this blog? It could be of enormous importance if you are a small or mid-sized business owner, as many franchisees and some franchisors are. Bear with me briefly and I will explain.
As commentators have noted , many small business groups, including the National Association of Small Business, have long fought for the repeal of the estate tax. But those efforts may ulitmately prove to be unavailing.
President Obama reportedly will propose that the estate tax be maintained at its current levels, rather than be permittted to expire. Current levels call for a 45% tax rate on individual estates valued at more than $3.5 million. Historically, the rich have found various means of avoiding the estate tax. But small and mid-sized businessowners have been less successful, in part because they do not have access to the tax planning resources that the rich do and in part because the asset in question, the family business, can be difficult to manipulate to a tax advantage.
Here is how the estate tax can affect you. Say you are the sole or principal owner of the entity operating a franchised business. You own 750 shares of XYZ Corporation, which owns and operates four franchised Salty Sea Dog seafood restaurants. The other 250 shares are owned by your two daughters, who work in the business. Let's assume you are divorced and the four restaurants all are doing relatively well.
Now you die (sorry). Your will provides that the 750 shares of XYZ Corporation pass to your daughters. The restaurants are valued at a total of $7 million dollars fair market value by a hired appraiser. Subject to some limited deductions and whatever else is in your estate, that valuation alone creates an estate tax liability of $1,575,000, even if your daughters do not sell the businesses. Where will your girls get that much money? They'll have to sell some or all of the Salty Sea Dogs. And there goes your family business.
The inclusion of a divorce in that scenario was crucial. There is an unlimited tax exemption for the value of the estate that passes to a spouse. But there is no escape for those who are divorced or widowed.
There are various planning techniques that can be used to diminish the impact of the estate tax, which an informed trusts and estates attorney can help you with. These steps can help you retain control of your business while developing it for the next generation.
Keep an eye on the news on this topic and think about getting in touch with your Congressman or Congresswoman. This matter has not yet been resolved and your input could matter.

Some of our prior entries have addressed issues relating to the franchise industry as a whole and the relative performance of the franchise business concept in an economic downturn. We have noted the failure of a system such as Bennigans. We commented upon some related concepts more generally in a subsequent post, such as what franchisees can do when a franchisor goes out of business.
As time has passed the downturn has continually revealed itself to be worse than originally expected. And yet there are some writers who suggest that franchising will weather this storm better than other business models.
Plug in the terms "franchising" and "recession" into a Google search and the first four entries offer favorable commentaries on the franchise model in a recession. One author notes how franchising offers the opportunity for the recently unemployed to "replace routine employment with self-employment," in fact, to create a whole new lifestyle by purchasing a franchise. Another website offers "recession proof franchises for sale." Some one else suggests that existing franchisors can expand in a recession, reasoning that "as job losses and redundancies kick in, many workers decide not to return to the workplace as employees."
Is this true? No one really knows. Economic facts frequently do not reveal themselves clearly until long after they have actually occurred. We are now told that we have been in a recession since last January, but no one told us that at the time. There are some economic indicators that franchising companies are not being punished as severely as the general economy. The Rosenberg Center Franchise 50 index (previously discussed in this blog) handled the severe downturn in the third quarter 2008 significantly better than the S&P 500, dropping .4% relative to the 9% drop in the S&P.
But there are other indicators that are less sunny. Those of us in the legal community are attuned to the possiblity of an uptick in lawsuits between franchisees and franchisors as either individual franchises or franchise systems fail because of economic hardship. Blogs and websites are tracking lawsuits, pending claims and troubled or troublesome franchised systems. It is premature to count those claims and measure them against prior time periods, but it stands to reason that hard times would give rise to additional claims.
Our firm is involved in the development of several franchise disputes that may form the basis for future entries. Another related topic that we will be commenting upon in future entries is the development of the low cost entry franchise, which should prove attractive in difficult economic times. In the past, first time franchisees had frequently financed acquisitions with home equity loans. As home refinancing has become more difficult, franchise opportunities that present a lower start-up cost look much more feasable. One example of this is the "man and a truck" model (or woman and a truck); one example of which is the Sir Grout home improvement system discussed in a prior post here.

Depending upon your source of information, we are headed into a recession or a depression or even a catastrophic cessation of all business activities. By any definition, things do not look promising and we are looking at a new economic landscape. The question arises as to how that will affect franchising. People will tell you that franchising is counter-cyclical, that it continues to thrive during a downturn in the general economy. We have touched on this before, but let’s try to approach the question with numbers.

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.

Understandably, much more attention is given to the present and future of franchising than to the past, but this entry considers (very briefly) the origins of franchises. Not the start of the practice, though, but rather the etymology of the word franchise.

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.

Your choice of candidate for the U.S. presidency will no doubt be made after a complex consideration of various factors. However, since we are focused on franchising in this space, let’s try to consider the election just from that perspective.

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.

Welcome to Franchise Lawyer Blog, published regularly by Einbinder & Dunn LLP, a New York City law firm with a broad based commercial practice and a finely tuned expertise in franchise law. Our firm has attained a unique perspective over the years as a small firm that routinely deals with the largest firms and as a franchise firm that deals regularly with both franchisees and franchisors. We'd like to share that cutting edge expertise with you on a regular basis.

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.