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Nov 02

2016 Annual Legal Checkup

By Richard Duell lll Newsletter

We all acknowledge the importance of seeing our doctor annually for a physical checkup. Unfortunately, when it comes to the well-being of your franchise business, many companies never consider the importance of an annual legal checkup. If you are not reviewing documents or systems yearly, then new technology, new legislation or changing case law among other factors, may put your franchise business at risk.

Statistics show that most franchise systems which fail, do so within the first five years, principally for one or more of the following: undercapitalization; poor operations; lack of training and support; selling franchises for survival; lack of the skills required to be a successful Franchisor; or, looking only at the short term rather than building for the long-term. All of these failure precepts are likely to result in litigation against the franchise entity and against the principals and franchise sellers of the Franchisor, who are likely to be sued individually by the disgruntled franchisees. Without question, such litigation can be avoided by the company regularly consulting with its franchise attorney to provide advice and guidance in advance of any legal entanglements.

The need for a legal checkup is not just for the new Franchisor. For the mature Franchisor to be successful, there must be constant innovation and change. Change facilitates resistance from franchisees and requires close legal support from the planning stage through the implementation of the change.

A clear example of change occurred when McDonald’s added breakfast to its franchise system. Suddenly franchisees were faced with increased cost, not just for additional equipment, but new labor cost and having to manage a whole new process.

Without legal input prior to implementing the modification, McDonalds would have been in court for years from suits by their own franchisees.

In a field so seemingly narrow as franchising, it is always interesting to me that few law students and law professors have ever heard of and many, perhaps the majority of practicing lawyers, likewise have no awareness of and do not recognize the field of franchise law and the fact that there are so many subcategories of the law to consider. Franchising is filled with numerous subfields starting with the law of contracts and includes the core of franchising, trademarks, trade secrets and copyrights. Always present in franchising are antitrust issues, changing laws, litigation and the rapidly developing areas of joint liability and ostensible agency. From the initial prospect package through the termination of a dissident franchisee, a Franchisor’s records, information and processes should be reviewed no less than annually and, when necessary, updated, modified or changed to meet legal requirements.

CONCLUSION

Does your company conduct an annual legal checkup? Will you be one of the casualties when the list of former franchise companies is posted? How successful do you want to be?

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Oct 13

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Modifying The Franchise System

By Richard Duell lll Newsletter

If there is one thing you can be sure of, it is the fact that change is imminent. In Franchising, if you don’t stay in touch with the market or consumer demands, you are setting a course for extinction. I am sure everyone can think of multiple examples of companies that remained static and are no longer with us today.

As a Franchisor, you are constantly evaluating and modifying the Franchise System to determine how new products, advancing technologies and changing consumer demands might affect your bottom line. Modifying the Franchise Systems occur in many forms. At one point, McDonalds did not serve breakfast. The modification of their Franchise System required a major investment by both Franchisees and McDonalds, with new equipment, advertising, additional labor cost and additional training. Almost all of the pizza franchises added delivery service to their system. Today you see many concepts that co-brand with other Franchise concepts. When you walk into a convenience store there are usually several franchise concepts in place under one roof. Computer technology has required many companies to modify a Franchisor’s system to stay abreast of competition.

Unfortunately, no matter how hard you work to lay the groundwork for changes to your Franchise System, there will always be one or more hostile franchisees who, even though they bought the franchise for your expertise, think they know more than expire. Be prepared for the argument that your modifications have caused a constructive termination of their Franchise Agreement or that you have modified or amended the original contract without their required written consent or that you have violated the covenant of good faith and fair dealing.

Fortunately, the good news is that courts around the country generally uphold a Franchisor’s right for modifying the Franchise System – when the Franchisor has reserved the right to do so in its Franchise Agreement. The key is reserving your right to make modifications. It is important that your franchising counsel is part of your planning team so that counsel knows what your future expectations are and can help build your documents to avoid franchisee disputes. Before making modifications to your Franchise System, be sure you have the legal ability to implement the system change. If the subject of your future Franchise System Modifications is not already on your list, make sure to add it to our annual legal checkup review.

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Sep 03

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Part Two: Multi-Unit Franchising – Is It for You?

By Richard Duell lll Newsletter

Part One of this article analyzed many of the Pros and Cons of multi-unit franchising. In Part Two, we look at whether your franchise company is ready for multi-unit franchising and if so, how do you qualify multi-unit prospects?

Are You Ready?

Having weighed the pros and cons of multi-unit franchising, your company must now decide the best multi-unit strategy to grow. Depending upon the franchise concept, target market and available resources, Franchisors have traditionally looked at the following tried and tested multi-unit growth strategies:

Master Franchising – Used both domestically and internationally, this concept usually involves three parties: a franchisor/master franchisor, a master franchisee/subfranchisor and one or more single outlet franchisees. Master Franchise Agreements grant the master franchisee a prescribed territory and also establish a required development schedule. A master franchisee is usually responsible for single outlet franchise recruitment, site selection assistance, operational support and often training of new franchisees. Initial fees and royalty fees are generally split in an agreed upon formula that is set out in the Master Franchise Agreement. Generally, Master Franchising attracts a more sophisticated party with greater liquidity than the single unit operators and enables a franchisor to provide an infrastructure that it may not possess for the territory being developed. On the other hand, the wrong master franchisee can cause severe damage to a franchisor’s reputation if the master franchisee does not enforce the single unit franchise agreement or fails to carry out the Franchisor’s normal responsibilities. Master Franchising also poses a substantial financial risk to a franchisor if the Master Agreement is terminated.
Area Development – An area development franchise has attributes of both the single unit franchise and the master franchise. Unlike the master franchise, the relationship does not involve three parties but typically just two, the franchisor and area developer. The area developer usually must own and operate a prescribed number of franchises in a specific territory. An area developer also must have the financial and human resources to open and operate the required units in the territory granted. Generally, area development agreements provide the advantage of accelerated growth with less investment or capital demands placed upon a franchisor.
Area Representative – Typically, area representation involves: (i) three parties – the franchisor, the area representative and the unit franchisee; and (ii) two distinct agreements – an area representative agreement and the unit franchise agreement. Usually the area representative acts as a franchisor’s sales agent for individual franchise units and provides service and support to the franchisor’s franchisees. This arrangement is similar to Master Franchising, but unlike Master Franchising, the area representative does not contract with unit franchisees. Thus all fees are initially paid to the franchisor who in turn pays the negotiated split with an area representative. As with Master Franchising, both concepts now require specific FDD disclosures and virtually the same risks.
Other Forms of Expansion – Less popular multi-unit formats include Joint Venture Arrangements. This concept is not as popular as other growth strategies because the franchisor has direct liability for the actions of the joint venture entity. Another less favorable growth strategy is that of conversion franchising, by which an independently owned unit operates under the franchisor’s brand. Franchisor’s must always be wary of the motivating factor precipitating the operator’s desire to convert. Refranchising is another less embraced strategy but may afford a franchisor strapped for capital with a way of expanding its business and avoiding much or most of the cost and distraction associated with day-to-day operations of multiple stores. Put simply, refranchising is when a franchisor sells company stores to franchisees. Selection of the right franchisee to buy the company operation is, as one can imagine, critical to the success of this type of multi-unit expansion.
Conclusion – Before embarking on any multi-unit strategy, look at the cost associated with each growth strategy, the legal complexity involved with each concept, the target you are trying to reach and above all, make sure your infrastructure is in place to reach your goal. Our firm works with a number of successful multi-unit franchisors. When you’re ready, we’re ready to help you successfully work through the legal implications associated with each multi-unit growth strategy.

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Aug 13

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Multi-Unit Franchising – Is It for You?

By Richard Duell lll Newsletter

Every Franchisor dreams of expanding its franchise system. But what is the most effective way to expand and how quickly do you expand? These are the two questions which plague most Franchisors. Picking the right format can make a franchise company the top player or the next casualty.

One method of expansion which has a consistently winning track record is that of multi-unit franchising. In fact, IFA studies have found that although multi-unit Franchisors make up a fraction of the total franchisee population, they account for more than 50% of all franchise units.But not all concepts are suited for multi-unit franchising. The following are pluses and minuses you should consider when deciding whether your company is a candidate for multi-unit franchising:

Pros:

Accelerated Growth – The ability to expand at a much faster rate than through the sale of single units. This also enables a Franchisor to obtain a quick injection of cash into the system.
Attract Potential Franchisees – Usually the multi-unit purchaser is more sophisticated with more liquidity and has an infrastructure already in place. This is especially true of existing multi-unit franchisees looking to expand via other franchises within an area they are already operating in.
Operating Market Efficiencies – A multi-unit franchisee usually has a well-organized professional management team. It may take a single-unit franchisee years to obtain similar efficiencies.
Market Penetration – Location! Locations! Location! A multi-unit operator often has a distinct advantage of obtaining prime retail locations with the liquidity to open multiple locations at the same time.
Reduction of Training Assistance – Even if the first store opening requires the Franchisor to fully train the multi-unit operator, additional training and assistance for subsequent locations is normally minimal.
Reward to Productive Franchisees – Perhaps no bigger win-win scenario can be found than to reward successful franchisees with the ability to open multiple locations. A productive franchisee can replicate success at other locations, thus enhancing a Franchisor’s chance of having more successful stores and greater royalty income.

Cons:

Loss of Capital – There is no bigger detriment to a franchise system than a franchisee which is too big for a Franchisor to control. Litigation with a large multi-unit franchisee could destroy the franchise system.
Loss of Prime Territory – Although the development of prime territories can be advantageous, the elimination of prime territory can be a distinct disadvantage. A Franchisor normally requires a multi-unit franchisee to develop a territory with a pre-determined minimum number of locations over a set period of time. The period for opening new locations is generally a number of years and thus the territory is taken off the market for years in the future. If a Franchisor has a number of long-term development contracts, large territories are not available and other potential franchisees will go to other competing Franchisors or other unrelated franchise concepts.
Impact on System Franchisees, Vendors, and Suppliers – The franchising grapevine has no equal. When a dominant franchisee in the system creates ill-will, it permeates the entire franchise system.
Problems Addressing Defaults and Terminations Quite often the multi-unit franchisee consists of multiple entities and without proper cross-default provisions, a Franchisor may find itself in a quagmire trying to address defaults and terminations. This becomes even more complicated when a multi-unit franchisee is conducting business in more than one state.

Conclusion:

So many Franchisors jump into multi-unit franchising without knowing the pros and cons of this method of expansion. The uniformed decision to implement multi-unit franchising can and sometimes does speak trouble. In our next post we will address “When is a Franchisor Ready for Multi-Unit Franchising?”; Qualifying Multi-Unit Franchisees; and More!

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Jun 08

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How Compliance Programs Equals Preventative Maintenance

By Richard Duell lll Newsletter

When you are in the courtroom, it’s too late to say – “If only I had started a good Compliance Program, I would not be in this mess now!” Why not be proactive and start your Compliance Program before it’s too late?

The goal of a good Compliance Program is to further the business objectives of the franchise system while avoiding disputes and franchise litigation, whenever possible. But, if a franchise company finds itself in litigation, a well-developed and properly implemented Compliance Program can serve as a shield to protect the business interest of your company, and serve as a sword to enforce the franchise system requirements of your Franchise Agreement. For example, consistently applied procedures leading up to termination of a franchise can act as strong evidence in an injunction lawsuit where the franchisee contests the franchisor’s action or refuses to acknowledge the termination. Evidence that a franchisor not only followed the provisions of the franchise agreement but also its policies and procedures should defeat a franchisee’s claim for wrongful termination. The ultimate goal of a good Compliance Program is being able to show that the franchise company acted fairly, reasonably and consistently with the provisions of the franchise agreement.

Your development and implementation of a Compliance Program can create a solid foundation for your franchise company by incorporating four fundamental steps: 1) Determine what issues are the most important when analyzing your particular franchise system. 2) Establish the policies and procedures to facilitate the franchise system’s particular business objectives. 3.) Make sure your company communicates it policies and procedures, and standards clearly and regularly to franchise personnel, as well as all franchisees. There should never be a dispute over what your policies are or whether the franchisees are aware of your policies and procedures. 4) Actively monitor and apply policies and procedures diligently and consistently throughout the entire franchise system.

Once a compliance officer is chosen, it is essential that he or she maintain a good line of communication with franchise counsel, particularly in the early stages of implementing your program. Because our firm philosophy emphasizes a team approach, we already know how important it is to work closely with the compliance officer to review federal and state laws affecting your franchise business, your FDD documents for compliance with disclosure issues that are likely to arise, required amendments to your FDD, legal aspects of advertising and registering proposed ads in certain states prior to running the ad, initiating procedures to track contacts with prospective franchisees, renewal dates, and monitoring changes in new case law which may have an effect on your company. By working with our firm, we will assist the compliance officer in tracking compliance by establishing a checklist at the pre-sale, sale, pre-opening, and performance stages of the franchise process. With a compliance officer overseeing the checklist, he or she can insure that each checklist has been completed before moving to the next stage of the process.

An effective Compliance Program must be structured to fit each franchising company’s personnel and methodology. If your company has not initiated a legal Compliance Program, then you may find your company in the courtroom asking “Why didn’t I start a Compliance Program?” If your company already has a Compliance Program, make sure you have addressed the four fundamental steps for launching a solid Compliance Program. Being proactive and building a good solid Compliance Program may mean the difference between being successful or being out of business.

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May 07

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Being Proactive Can Save Attorney Fees

By Richard Duell lll Newsletter

Early in my legal career, I was contacted by a Florida franchising company that had been sued by 12 different franchisees, all represented by the same attorney. After invoking the arbitration provisions of the franchise agreement and dividing the franchisees into separate arbitrations, rather than one lawsuit with 12 plaintiffs pooling their resources, I received neatly organized packages for each arbitration from the president of the Florida franchise company. In each franchisee package was a summary of claims made by the franchisee, along with documents supporting my client’s position. In addition, my franchise client had one packet containing general information about his company and everything it had done (seminars, newsletters, workshops, etc.) to fulfill the company’s contractual obligations for all franchises.

In my naiveté, I did not realize that my first arbitrations were a utopian experience with a company that was extremely well organized and willing to devote the necessary time to succeed. My wake-up call came not long afterwards when another franchising company had an arbitration filed against it by a master franchisee in Maryland. Beside the garden variety of law-suit claims, my client was also sued for failing to fulfill its franchise contract by not devoting the resources to make the franchise concept a success. To my chagrin, the franchisor client provided little assistance in accumulating information to counter the allegations of the master franchisee. It was only after much prod-ding of the franchisor that I was able to gather enough information to mount a successful defense of the claims filed against my client. It took me months of time consuming work going from one department to the next, finding a piece of the puzzle here and there before I was able to gather the same information that was made available by my first franchise client. Can you guess which client paid thousands of dollars in unnecessary legal fees?

The first client was pleased with the success of the process and with the fees charged. The second client was pleased with the successful outcome but not with the charges to reach the success.

Whether it is running a successful efficient franchise company or avoiding the tremendous cost of litigation, a Franchisor can save attorney fees by deciding to become proactive in the legal process. Start by developing a legal plan designed to avoid unforeseen costs. That plan would normally involve a Compliance Program which addresses the following areas: 1.) Review of your Operations Manual; 2.) Monitoring all advertising to ensure compliance with federal and state laws – including registering the advertisement before issuance in registration states; 3.) Preview of your Website and pamphlets for compliance with state laws; 4.) Knowing when to call your attorney for advice on your relationship with franchisees and whether you are complying with each state’s relationship laws. 5.) Annual review with our office to update all legal documents at the end of the year for compliance with new laws, regulations and recent case decisions.

As a franchisor, you must build a solid foundation and without a legal plan in place, your foundation is resting on quicksand. My job as a franchise attorney is to be as productive as possible and provide value to my clients. I would prefer to help you by being proactive rather than reactive to the latest emergency. You truly receive the best value from an experienced franchise attorney when you lay the foundation with a good solid legal plan.