Alvord Investments LLC v. The Hartford Financial Services Group, Inc., et.al. 660 F.Supp 2d 850 (W.D. Tenn.2009) stands for the proposition that a franchisor will not be covered under its Directors and Officers policy for a franchisee claim where the policy contains broad language that excludes coverage for claims arising in any way from any franchisee in any capacity. In this case the coverage was denied even though the claimant was no longer a franchisee, the court reading the language to apply the exclusion even to former franchisees. Franchisors should examine their policies and the endorsements contained therein to confirm they are covered for claims by former or current franchisees, or claims arising from their relationships with their franchisees.

Antitrust law is a complex and changing area of the law with respect to franchising. We have previously discussed the impact on franchisors of the re-evaluation of vertical minimum price agreements in the context of the 2007 Leegin case. We read a recent case that sheds some light on the confusing subject of illegal tying arrangements.
An illegal tying arrangment is created when a party agrees to sell one product on the condition that the buyer will also purchase another different product. This is illegal under the Sherman Act where the the seller maintains "market power" in the tied products market.
In the case of Burda v. Wendy's Int'l Inc., Bus Franchise Guide (CCH) #14,240 (S.D. Ohio Sept. 21, 2009), a Wendy's franchisee claimed that the required purchase of food supplies from a Wendy's subsiduary was an illegal tied product, the "tying product" being the sale of the franchise. The court focused on an evaluation of market power based upon a "lock-in" theory; that is, once the purchaser acquired the franchise, did it become locked in to purchase the tied products and was this policy known at the time of the sale. The court found that the claim was valid if Wendy's had not revealed the requirement at the time of the sale of the franchise. If the franchisor puts the franchisee on notice of exclusive purchase requirements prior to the time the franchise is sold, the claimant would be unable to establish a "lock-in" claim.
The decision gives specific language that would serve as appropriate notice. If the franchisor states in its FDD and franchise agreement that it may decide in its sole discretion to require franchisees to purchase exclusively from the franchisor and approved suppliers, then the illegal tying antitrust claim can be avoided. The disclosure of exclusive supply arrangements should be made in the FDD in any event; the avoidance of antitrust claims makes their inclusion even more compelling.

Some recent articles suggest that the trends are strongly towards the franchise model, a trend that has become accelerated by the recent economic downturn. One recent FoxBusiness article analyzing franchise development points out that the sense of ownership and self-control that is so essential to the success of a "Mom and Pop" store can be duplicated to a certain extent in a franchise situation. However, there is always a tradeoff involving a loss of some control. In exchange for the business plan, name recognition and trademark that the franchisor has developed, as well as training and other support resources, the franchisee gives up a substantial portion of revenue and must subject itself to the system controls imposed by the franchisor. As that article notes, quoting the president of the IFA, “Some entrepreneurs are so independent-minded they don’t want to give up control of any aspect of the business ...For those business people, fitting into the structure of the corporate business isn’t for them." However, for those business people who can sacrifice some part of their own vision to take advantage of a system, the franchise model offers enormous cost and time savings advantages.

A recent article in Kiplinger on franchise growth and lending trends, states that from 2000 to 2008 the number of franchised restaurants grew by 20%, while the number of independent restaurants contracted by 4% over the same period. The article predicts that this trend will continue, observing that franchised businesses are "typically better positioned than mom-and-pop shops to survive downturns, benefiting from a strong brand presence, corporatewide marketing campaigns and access to advice and mentoring from the franchisor. Plus they can often offer customers -- and get from suppliers -- steeper price discounts. " That article also points out that lenders are more comfortable with franchised businesses, noting "lenders have a slight bias toward franchises...generally, bankers tend to perceive franchises as less of a risk. There’s a greater willingness to lend to them...adding that loans to franchisers also tend to be larger compared with loans made to independents."

So do these trends signal the end of the maverick entrepreneur who singlehandedly changes what we eat, wear and buy? No, of course not. Economic trends, particularly the negative ones of the past year and a half, may alter the direction many start-up businesses take in getting started. Buying an established business concept may seem like the far safer bet in a damaged economy. But there will always be those who buck the trend. This country and this economy will sometimes richly reward those who think and act for themselves, and the lure of that unique brand of success will always be there.

The Manhattan Chamber of Commerce (MCC) , in conjunction with NYC Business Solutions and the U.S. Department of Commerce, will be moderating a panel discussion on "everything from A-Z about buying and growing your franchise."

Among the featured speakers in the Program, entitled "Franchising 101," will be Michael Einbinder, a partner in this firm.

Registration: NYC Business solutions website, click on Franchising 101.
Event Location: NYC Business Solutions Lower Manhattan Center, 110 Williams Street, 4th Floor, Cafe Space, New York, New York, 10038.
Workshop time: 8:00 AM to 10:00 AM, Wednesday, February 17, 2010.
For more information: Call 212-513-6472 or email Shelly Nicholas at snicholas@seedco.org.

Attendees will learn about domestic and international franchise opportunities and be provided with guidance to help determine for themselves if a franchise is right for them. The discussion is also intended to help understand the financing requirements of buying a franchise and discover free resources to help launch and grow a franchise. The distinguished panel includes a successful franchisee, financial professional, attorney, accountant, franchise consultant, U.S. Department of Commerce Director, NYC Business Solutions Lower Manhattan Center Director, and the MCC President.

A recent piece in the Law Journal Newsletters Franchising Business & Law Alert, written by Dirk Giseburt, Rochelle Spandorf and Jaymee Castrillo, reports that the State of California has now initiated efforts through its California Franchise Tax Board (FTB) to require California franchisees to begin withholding 7% of all lease and royalty payments to out-of-state franchisors that exceed $1500 per calendar year. The stated goal is to require out-of-state franchisors to become qualified to do business in the State of California, which carries with it the obligation to file State income tax returns. Apparently, some organizations, such as the IFA, are questioning the FTB's authority to impose such a withholding requirement. The inquiry into applicability in a particular instance would focus on two theories, first, that royalties and the like represent California source income; and second that a franchisor has established a business situs in California when its intangible assets are used in a California business, in this case, the asset being the franchise license.

As in New York, these fledgling regulations are still being tested. Franchisors and franchisees are well advised to refer to their accountants and franchise counsel for an up to date assessment of current applications, so that they are continually making informed decisions as to whether or not to provide different types of reporting under consideration.

New York's Department of Taxation and Finance has extended the original September 21 compliance deadline and reportedly is changing the rule to make it less burdensome. The available 90 day extensions now extend until December 20, 2009.

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.

Unfortunately, the process of arbitration does not always result in the hoped for benefits. Costs skyrocket with the addition of arbitrator fees and administrative fees. Arbitration often results in what may be perceived as an “arbitrary” determination; the oft-heard reputation of arbitrators to cut the baby in half. Also, with limited discovery and procedural safeguards, the parties can be left with a feeling that they did not have their day in court.

But arbitration does not necessarily have to result in such dissatisfaction (although, no doubt, any losing party is likely to be dissatisfied regardless of whether the claim was arbitrated or litigated). The parties should remember that arbitration is a creature of contract and the process can be tailored to the parties' satisfaction. They can contract for certain discovery or discovery limits. They can contract to limit the arbitrator’s discretion. And, the parties can decide which administrative organization to use (if any) thereby possibly substantially reducing their costs.

If the parties to a franchise agreement consider all options and variations in the course of drafting the arbitration provision, the parties will have far greater control over the dispute resolution process. This will presumably result in a more favorably received method for resolution.

Julianne Cowan Lusthaus

Which leads me to a question. Do you think mediation works? Do you use it in your franchise agreements? If so, do you phrase it as a mandatory requirement to the initial exclusion of all other remedies? If not, how do you introduce it?

This query is an experiment of sorts. I have never offered a survey type question on this blog before. It you do respond, via our contacts page, I will provide to you a summary overview of the other information I receive in response.

As is so often the case with psychology, many of the observations seemed obvious: of course franchisees are happier when they are respected and treated fairly. But if it is so obvious, why did Nathan report widespread dissatisfaction among franchisees in terms of their perception of their franchisors' treatment of them? Why do these concepts of respect and fairness get confused in their translation into the marketplace?

Because economics, or economic perceptions, interfere. Apparently, many franchisors believe that decisions that make sense according to the bottom line are acceptable even if they make people unhappy. There is a prevailing attitude of "It's just business, nothing personal." And the franchisors' assumption is that franchisees understand that. The question was asked of franchisors: does it matter if your franchisees are happy or mad? Some thought it didn't. Business is business. But the statistics Nathan presented strongly suggested otherwise.

Nathan suggested that everything is personal. Even decisions that make perfect financial sense can be deeply resented. It becomes essential that franchisors step away from the bottom line and examine the long term effects of short term business decisions. Nathan suggested that the construction of a healthy system might, at times, require decisions that aren't optimum from a short term economic perspective.

Growth of a system depends on satisfied franchisees. That satisfaction must become a measured economic metric for a system to succeed. Why? Because a system is an organic thing, whose growth is dependent on the overall health of the body. Nothing slows growth more than bad word of mouth from established franchisees. Does this require blatant pandering to the moods of the rank and file? No, it requires common sense. You must convince your franchisees that decisions are for the mutual good, even if they require short term financial pain. You must also sometimes be prepared to weather difficult times as a franchisor, if the immediate short term solution is going to turn your franchisees against you.

The plaintiffs in Martrano v. The Quizno’s Franchise Co., L.L.C. compose a putative class of Pennsylvania sandwich shop franchisees who allege, among other things, that their franchisor made specific misrepresentations in its UFOC. The plaintiffs asserted that reliance on those misrepresentations was not waived by the plain language of the franchise agreements and other documents executed by the parties. The franchisees alleged fraud in the inducement of execution of their franchise agreements in the context of claims that Quizno’s violated the federal RICO statute (by charging above-market markups on required services/supplies and over-saturating the market with franchises and by exploiting its economic power over the franchisees to extract exorbitant, unjustifiable payments).

Quizno’s directed the court’s attention to the “Disclosure Acknowledgement Statement” signed by each plaintiff franchisee, which document provided that (1) the franchisee was cognizant of the business risks; (2) the franchisee had reviewed, and had had an opportunity to consult with legal counsel regarding, the franchise investment and the UFOC and other documents; (3) the franchisee’s decision was not predicated upon any oral representations, assurances, warranties, guarantees, or promises made by the franchisor or any of its officers, employees, or agents as to the likelihood of success of the franchise; and (4) except as contained in the UFOC, the franchisee had not received any information from the franchisor concerning actual, average, projected, or forecasted sales, profits, or earnings.

The Disclosure Acknowledgement Statement went on to ask the subscribing franchisee to describe, in space provided, any information concerning actual, average, projected, or forecasted franchise sales, profits, or earnings other than those contained in the UFOC—or to write, “None.”

Notably, the most important basis for the franchisees’ claim of fraud—a statement in the UFOC that the franchisor negotiated with suppliers to obtain discounts for the franchisees’ benefit—was explicitly excepted from the disclaimer.

The court observed that other courts considering the issue have refused to enforce franchise agreement disclaimer provisions on the ground either that public policy forbids contractual preclusion of liability for intentional misconduct, such as fraud, or that a party cannot waive the right to sue for fraud in the inducement by a provision in the contract the validity of which itself is challenged. The court cited to both Westerfield v. Quiznos Franchise Company, LLC (in Wisconsin) and Elhilu v. Quiznos Franchise Co., LLC (in California).

“Because the disclaimer does not purport to nullify an important representation on which Plaintiffs’ fraud claim is based in substantial part,” the court wrote, “Plaintiffs are entitled to go forward with that claim; and it is not necessary at the present stage for the Court to decide whether, in view of the foregoing considerations, the disclaimer provision may be unenforceable with respect to other representations.”

What really got the Martrano court toasty under the robe, however, is the Quizno’s defendants’ invocation of the disclaimer, and in particular the emphasis on the apparent opportunity to identify other statements relied upon. The court found these, in a word, “deceptive.”

“If, as has been alleged,” the court wrote, “Quiznos pursued a policy of requiring all franchisees to write ‘none’ in the blank ostensibly provided for identification of statements relied upon, then the inclusion of a blank to be filled in by the franchisee in lieu of a pre-printed provision amounts to a sham, whose apparent purpose is to mislead a subsequent reviewer, such as this Court, into believing that Quiznos’ unilaterally-prescribed disclaimer language was actually authored without constraint by the franchisees.”

Mmmm… Shady.

by Matthew D. Brozik