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Confidentiality Agreements: Do They Work?

By Newsletter

To determine the enforceability of Confidentiality Agreements, Franchising companies must be able to answer three questions affirmatively.

First, does your confidentiality agreement contain information which is outside the public domain or does it contain information compiled or combined in a unique way as the result of your business efforts? In the vast majority of business format franchises, information is one of, if not the most valuable asset of a franchise system and it is the compilation and use of that information which forms the foundation of the franchise system. This is what distinguishes your franchise from any other business.

The second area that must be examined is whether the subject matter deemed to be confidential derives value from its secrecy. If the actual loss caused by the violation of confidentiality provisions results in no damage to the party seeking protection, how can liability be imposed on a wrongdoer? It does not matter whether your entire franchise system uses special recipes or, for that matter, anything your franchise company may deem to be confidential in nature, you must be prepared to show it has value and how your company has been damaged.

The final question of our tripartite equation, is probably the most important, did the party seeking protection take reasonable precautions to maintain the secrecy of the material claimed to be confidential? It is not enough for your franchise company to argue that the parties to whom knowledge of the alleged confidential material is imparted to – should have known better. The burden is on your franchise company to show that reasonable precaution to prevent unauthorized disclosure is in place. The determination of whether  “reasonable  precaution”  was taken ultimately rests in the discretion of the trial court. As a result, you must demonstrate that not only is the information deemed to be of substantial value to your franchise system but that your company took the necessary precautions to preserve the integrity of your information, even when that information may have been voluntarily provided to third parties. So how can a Franchisor show its protection of confidential information? One way that trial courts recognize is to show that there is a process in place to protect the information through use of third party confidentiality agreements. This contractual protection is an affirmative step by your company to set out a third party’s acknowledgement that the information or material being divulged is done so under limited parameters and further, it sets out the consequences for misappropriation. Additionally, contractual protections should be supplemental by a proactive strategy to monitor franchisee compliance.

Beyond securing secrecy for your company, there is an indirect benefit of a psychological impact on your franchise system by demonstrating your company’s regard for the confidential information and its commercial sensitivity.

CONCLUSION

Your confidential information is a valuable asset in your franchise tool box for the success of the franchise system. By taking steps to proactively protect and prevent trade secret leaks, you will create positive dollars to your company’s bottom line.

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Saving Dollars By Using Intranets

By Newsletter

Does your staff spend a significant amount of time mailing or faxing new manual updates, newsletters, reports or a variety of other information to your franchise system? Are you apprehensive about sending confidential information over the Internet? If your answer to either question is yes, you should consider implementing a plan to establish an Intranet site. If you think your company is too small for its own Intranet site, then this article is definitely for you.

An Intranet site, as opposed to internet is a company internal site with limited access. By using encryption technology and limiting access to persons with passwords, the site is not available for public view like normal internet sites. With a secure Intranet site a franchise company can feel comfortable in sending franchisees information, such as:

  1. Training documents, manuals, reports and other information normally copied or printed and sent through the mail;
  2. Software upgrades for immediate use;
  3. Newsletters;
  4. Continued updating of approved vendor lists;
  5. Changes in personnel directories, with the latest areas of responsibility;
  6. Last minute vendor close outs;
  7. And the list goes on and on.

It shouldn’t take too long to see that the above list just touches the surface of potential uses for an Intranet. In fact, not only can a Franchisor disseminate information over an Intranet site, but franchisees in the system can share ideas and experiences with other franchisees by using an Intranet bulletin board. Some Franchisors use their Intranet for franchisee reporting. By compiling the reported franchisee information over a period of time, Franchisors can analyze the reports and help franchisees strategically plan for the future or help them correct existing problems.

If a Franchisor’s Intranet site is set up to allow vendors limited access, franchisees can order supplies over the site from approved vendors with password access and guess what – your franchise company now has a new means to monitor franchisee orders and an additional tool to discover under reporting (See Franchisor Alert February 2016 “Do You Have Under Reporting Franchisees?” for other under reporting tools).

The potential uses for an Intranet site are unlimited and as a client with less than forty franchisees told me: “By eliminating many of our costly and inefficient methods of doing business, our site will pay for itself, but more importantly, our relationship with franchisees is at an all-time high. If I was starting my company again, I would have an Intranet site before I sold my first franchise.”

CONCLUSION

In Franchising it is important to never be satisfied with mediocrity. Intranets have proven to be successful in Franchising and can help provide value to your bottom-line.

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Trade Dress: Is Your Franchise System In Vogue?

By Newsletter

As a growing Franchisor, you constantly endeavor to make your company distinguishable from its competition. From the very beginning when you had the idea to launch your business, you no doubt struggled to find just the right name. Then after the name, you went through the legal process to register and protect that name and associated logo. In conjunction with finding the right name, you worked hard and spent many long hours to develop those secret recipes or methodology of operations and processes which formed the core of your trade secrets that set you apart from your competition. Unfortunately, many Franchisors fail to spend the same amount of time and effort in developing or protecting their company’s trade dress

Your trade dress is the overall appearance of the business. The items that make the business or product distinguishable and recognizable to the customer. When you drive down the street and see the golden arches at a fast food restaurant, is there any doubt about the name of the Franchisor? The golden arches symbolize the entire franchise system. Ask any kid.  They know what the arches mean when they are hungry. The golden arches constitute a major part of the Franchisor’s trade dress and are a very valuable asset. A company’s trade dress builds reputation and goodwill which in turn, becomes synonymous with the Franchisor’s name. But as you become successful in building greater market share through your trade dress, your competitors will seek to copy you and capitalize on that good will and reputation.

Fortunately, there is good news for Franchisors seeking to protect their trade dress. By employing Section 43(a) of the Lanham Act, a Franchisor carries a “big stick” to beat back its competitors. Under the Lanham Act, not only can a Franchisor obtain damages against the infringer, but the Franchisor can also obtain an injunction and destruction of the “copy-cat” materials. Additionally, the Act also enables a Franchisor to obtain attorney fees against the offender. And a Franchisor has the option of initiating the case in either federal or state court.

The most notable trade dress case decided under the Lanham Act was Taco Cabana v. Two Pesos. In this case, the U.S. Supreme Court upheld the Circuit Court’s finding that the defendant had appropriated the Plaintiff’s general appearance by copying the exterior of the restaurant, the identifying signage, interior kitchen floor plan, décor, servers’ uniforms and several other features of the restaurant. The court found that the above items created a “total image”. The total image constituted the Plaintiff’s trade dress and distinguished its products and services from competitors. 

CONCLUSION

Once your trade dress is developed, make sure it is used consistently by all franchisees. When used on a consistent basis, trade dress becomes a major asset of your franchise company and merits no less protection than that of your trademark and trade secrets.

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Advertising Without Crossing The Line

By Newsletter

Advertising is no doubt one of the most important components, if not the most important component, of a Franchise company’s success. It is also, however, one of the largest areas of litigation in franchising.

In today’s litigious environment, a plaintiff’s attorney representing a disgruntled franchisee searches for every mistake made by a franchisor. The ad your company places soliciting prospective franchisees can be the “crack in the door” that the litigator waits to slide through. So how can your company protect itself from the clutches of a plaintiff’s attorney waiting to attack? First and foremost, make sure you have reviewed the law of each state affected by the ad. Did your company properly register the ad before it was published? Surprisingly, a number of states require registration of ads before they appear to the public. These states maintain a listing of all ads properly registered by franchisors. An example of what can go wrong when you fail to register occurred in New York when a Franchisor advertised for franchisees using the New York Times. The Franchisor was not located in New York nor registered to sell franchises in New York. Normally the ad being placed in the New York Times would not have caused a registration problem because the majority of circulation was outside the State of New York. But the Franchisor made the mistake of also placing the ad in the New York Times Metro edition which has a majority of its circulation inside New York. As a result, the Franchisor was exposed to both civil and criminal liability under the New York Franchise Sales Act. Unfortunately, this is just one example of not having a proper compliance program for the advertising/marketing department.

A second important area that a franchisor should include in its advertising compliance program is the review of all ads to see if each ad is factually consistent with the franchisor’s Franchise Disclosure Document (“FDD”). It is only natural that a franchisor wants each prospective franchisee to think that their franchise is the “opportunity of a lifetime” and that it will provide “financial security” or that the franchise is one that a prospect has always “dreamed of owning.” The issue is not whether a franchisor “feels” the information is consistent, BUT whether the ad provides an opportunity for the litigator to show any inconsistency with FDD information provided his/her client. If there is a possible inconsistency, the franchisor has a legal problem.

CONCLUSION

If you want to be safe, include a legal review of your advertisements before they are published to ensure they have not “crossed the line” and exposed your company to civil and criminal liability.

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Exit Strategies for Franchisees Part Two

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Economically it is good business to have a program in place to help franchisees exit the system without having to resort to litigation or arbitration. An exit plan allows you the Franchisor to control the process and bring in a new energetic franchisee who can follow your franchise system, pay royalties, become successful and be a shining example for future prospects.

As a Franchisor, you are already set up to take in new leads, so why not use some of those leads for obtaining that super star replacement franchisee. Wouldn’t it be a great turnaround to go from having a non-performing or non-compliant franchisee to have a new franchisee who is much more motivated and desirous of pleasing you, the Franchisor? Some Franchisors even have programs in place which provide credits toward future royalties or a credit toward the purchase price to employees of franchisor interested in owning a franchise. It’s a great incentive to attract good corporate employees to work for your Franchise company when they can later become successful franchisees.

From the Franchisee’s point of view, it makes sense to present their franchise in the best possible light to facilitate the sale of their business to a third party. Because the Franchisor has controlled the process, the Franchisor has created a win-win for both the Franchisor and the franchisee.

Another form of exit strategy which ultimately reaches the sale of the franchise is the Cure Agreement. This agreement can be as simple as:

  1. An acknowledgement by the franchisee that there is a breach of the Franchise Agreement; and
  2. A plan describing how the breach will be cured; and
  3. The consequences of failing to follow the plan and cure the breach.

The use of a Cure Agreement if structured correctly can be a powerful tool for the Franchisor. The details of what the defaulting franchisee must do should be fully set out. Further, if done correctly the Franchisor in many states can incorporate release language, eliminating a franchisee’s claims (if any) against the Franchisor. Also there is no lag time. If the franchisee fails to cure the breach (particularly a monetary breach) the exit plan to remove the franchisee is in place and implemented immediately. The Cure Agreement is definitely a weapon that should be in a Franchisor’s arsenal.

As a Franchisor, it is imperative that you develop strategies to deal with franchisees that don’t perform or worse, refuse to abide by your agreement. With the proper plan in place you can avoid the cost of arbitration or litigation and move quickly to prevent any collateral damage with other franchisees.

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Exit Strategies for Franchisees Before You Terminate

By Newsletter

There are times when it is more prudent to have an exit strategy in place than to employ the financial and manpower resources of your franchise company necessary for a franchisee termination. This is true from an economical standpoint as well as a legal one. Not only do many states have specific statutes dealing with termination spelling out what can and cannot be done but, believe it or not, some states require a franchisor to compensate the franchisee upon termination.

Considering the legal and economical consequences which flow from termination, it seems only logical to develop exit strategies to wean out the dissident franchisees and make room for those franchisees that are helping you build a successful franchise system.

So what should franchisors look for when determining potentially dissident franchisees? Without question the first clue is whether a franchisee is communicating with you. If a franchisee is not communicating with you, it doesn’t matter what kind of wonderful programs you have in place. Your franchise system will not work unilaterally.

There are several ways to keep the lines of communication open with franchisees. One method is to make sure your field personnel are aware of potential problems and have them meet face-to-face with the franchisee to discuss the problem(s). Only when you know what the problem is can you attempt to effect a practical solution through your exit strategies for franchisees.

If your field personnel cannot open the lines of communication, it may be prudent to have an executive pick up the phone and make contact. If you perceive a serious problem you may want to invite the franchisee for a visit. You may have to buy a plane ticket but it’s certainly less expensive than spending valuable executive time and money defending a lawsuit.

Occasionally a franchisor and franchisee need a third party to open the line of communication. Mediation sometimes works to get a franchisor and franchisee together and vent whatever animosity there may be while at the same time causing each side to get back to the problem.

A sometimes better method of encouraging communication is by using your franchise counsel. Recently, a franchise client forwarded a rather threatening letter from a franchisee’s counsel. Based upon the attorney’s letter, I realized he could not have reviewed his client’s franchise agreement. After picking up the phone and going over several key provisions of the franchise agreement, franchisee’s counsel realized his client’s vulnerable position and the expense his client would incur. Based upon our phone conversation, the line of communication opened and we were able to work out an exit strategy for the franchisee. But before an exit strategy could even be discussed, we had to communicate.

There are many great exit strategies for franchisees that work extremely well once you have found the root of a franchisee’s problem. Next month we will continue to build our arsenal of additional exit strategies for franchisees before termination.

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