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Avoiding the Quicksand When Requiring Exclusive Vendors and Mandatory Rebates

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For many Franchisors the use of required vendors is justified by the assurance of quality control, maintaining confidentiality, preserving trade secret information and increasing profitability for the Franchisor.  But when Franchisors adopt a restrictive approach by designating an exclusive supplier, Franchisees sometimes question prices charged as compared to other non-designated suppliers.

While Franchisees may recognize the advantages of some degree of control over sources of supply, they become very disgruntled when there is only one source of supply.  But, when a Franchisor is receiving consideration from the vendor based upon the volume of purchases from Franchisees or when the Franchisor receives a discounted price for itself or an affiliate owned operation and the discount is based upon the volume of Franchisee purchases, questions will be raised.

Even when a Franchisor requires Franchisees to use one designated supplier and/or collects volume rebates, lawsuits usually don’t spring up until a Franchisee fails to make the money it thought would be made, or worse, when the Franchisee is losing moneyDon’t wait for that dissatisfaction to fester.  Franchisors must plan in advance.  Before initiating a required supplier/vendor and/or rebate program, develop a plan to prevent potential legal claims from your Franchisees, which usually comes in three forms:

  1. Antitrust Violations – illegally tying the purchase of goods and services to the sale of the Franchise, in violation of the Sherman Act or claims that the rebates equal a sort of commercial bribery violating the Robinson-Patman Act.
  2. Misrepresentation or Fraud – This is often framed as i) negligent misrepresentation, ii) a deceptive or deficient disclosure (usually Item 8 of the Franchise Disclosure Document and not complying with the Amended FTC Rule), iii) violating state “Little FTC Acts” (which prohibit unfair and deceptive trade practices), and iv) breach of a fiduciary duty.
  3. Breach of Contract – Franchisees usually contend the Franchisor’s use or disposition of the rebate violates a contract (normally the Franchise Agreement or some ancillary agreement) between the Franchisee and Franchisor.

An Ounce of Prevention is Worth a Pound of Cure”

All of the legal claims set out above are fact specific, but in most cases could have been prevented with an advance legal plan in place.  Start by building a solid foundation and disclose supplier requirements and any rebate programs in Item 8 of the FDD.

The Amended FTC Franchise Rule requires disclosure of not only the existence of rebate programs but the amount received, officers or owners interest in required suppliers, how Franchisees get approval of alternate suppliers and the list of required information continues until full disclosure is before a Franchisee considering the purchase of a franchise.

When full disclosure is made by the Franchisor, courts are much more receptive to holding that the Franchisee entered into the Franchise Agreement with full knowledge of Franchisor’s standards and requirements, prior to executing the agreement.  Comprehensive disclosure documents and proper verbiage in Franchise Agreements will go a long way in preventing or mitigating legal actions by Franchisees.

CONCLUSION

Planning in advance is the key and may be that “ounce of prevention” that saves a Franchisor thousands or even hundreds of thousands in damages and legal fees.  Start with your Franchise counsel to avoid the pitfalls of using required vendors and mandatory rebates. 

Duell | Law would love to help Franchisors create the most effective prevention plan for potential legal claims in regards to required vendors, mandatory rebates and Franchisees. You can schedule your FREE consultation today by emailing us at info@duelllaw.com or calling 205.408.3025!

Securing Your Internet Communications

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The Information Age is over. We are now in what is known as the Networked Age, which features personal and professional social media profiles. Lightning fast connection speeds allow us to explore an infinite number of sites and applications through our desktops and (increasingly so) our cellphones.

But that blessing of instant communication comes with the curse of potential hackers. A variety of software feeds through the internet, grabs emails from some of the most popular web-based companies and allows hackers to selectively mine your data.

As a Franchisor, your data is sacred. In one recent lawsuit, the court stated that if intercepted emails had been sent without any form of protection (i.e. encryption), the secrecy and confidentiality of the information was forfeited and could not be maintained – a sad state for a Franchisor maintaining Trade Secrets!

If you think your Franchise Company does not need to worry about cyber security, you may be setting yourself for a not-so-pleasant attack.

So how can you protect communications over the internet?

1. Encryption: With the proper use of modern encryption, powerful cryptographic products enable individuals to securely exchange messages automatically and also secure files.

2. Intranet sites: Intranet sites allow Franchisors to create a limited-access internet network that cannot be viewed by the public, allowing you, your staff and your Franchisees to send and receive items such as software upgrades, vendor lists, training policies and other valuable Franchise information.

And why should you invest in these two processes?

1. More frequent and more secure communications with your Franchisees: No matter the amount of Franchisees your company has, keeping up with all of them can be difficult at times. A Franchisor Intranet allows for seamless communication to take place between the Franchisor and Franchisees at any time and in a way that keeps crucial and sensitive information inside the boundaries of the company.

2. A central location for uploading new training policies, company documents, and marketing materials: Trying to implement changes across an entire Franchise System can be cumbersome at times, especially if you have Franchisees spread out across the country. A Franchisor Intranet provides a convenient place for announcing new policies as well as keeping a secure archive of all the documents the Franchisees will need at any given point. Encouraging your Franchisees to use the resources uploaded to the intranet saves not only time and money, but keeps them engaged with the corporate headquarters and other Franchisees.

3. A launching pad for Franchisee compliance, increased productivity and new business: An ability to securely access your Company documents, reports, policies, Franchise Disclosure Document and Franchise Agreement allows you and your Franchisees to be fully aware and confident in ensuring compliance with your Franchise and franchise laws and regulations. The intranet can also be used for providing templates and checklists of important tasks, which can help speed up the productivity of Franchisees from month to month. Finally, a Franchise Intranet allows Franchisors to safely create strategies and timelines for developing and obtaining new business.

TODAY is the day to evaluate the security of your Franchise’s internal communications. As you launch into the New Year, join our annual compliance program designed to review your systems, and let us help you implement a plan to secure your Franchise Company’s valuable assets. Contact us now.

Is Bigger Always Better?

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Many years ago I represented a franchising company with a philosophy that the sale of franchises was paramount no matter how it was done. The company stressed franchise sales so much that their only qualification to become a franchisee of the company was whether the prospect had enough available credit to pay the initial franchise fee. As the company began selling more franchises, problems began to occur. With no solid foundation upon which the company had been built, litigation became common-place. The more sales – the more litigation. The company continued to ignore the real problems and adopted a mindset that even if only 50% of new franchisees survived, the company would still grow. 

Imagine a franchise company with a Franchise Disclosure Document (“FDD”) which told the story of a 50% failure rate! But how could this franchise company have expected anything more? Signing up franchisees who did not have sufficient capital to run a business was a death spiral. The franchisees started business with two strikes against them. It wasn’t long until the franchisor found that franchisees who weren’t able to pay royalties and who were losing their businesses, led to multiple lawsuits which then led to a complete drain on the franchisor’s resources, and ultimately the demise of that company.

So is bigger always better? The answer is definitely no if the company fails to start with a solid foundation under it. A solid, successful foundation starts with a truly good management team. In the beginning, that team may consist of franchisees or that team may consist of only a couple of key people. As your company grows, search for and bring in qualified team members who understand the market, your competition and the kind of franchisees that will help your company get name recognition and dominate in your field. Perhaps you are in that interim stage where you are not quite big enough to attract the team members you know you need. Consider using a Consultant who has the expertise you need and can fill the void until you are able to afford those essential members on your team. There are any number of good franchise consultants who have the essential knowledge needed and have the years of experience that help provide the solid foundation you may be lacking.

So before your company leaves the starting gate, make sure you have the building blocks under it to be successful. Build the team that will lead your company to success. Use consultants when necessary to bridge the gap. Create a plan that helps your franchisees become successful. Successful franchisees build a successful franchise system. With a solid foundation you can then have the type of company that can be as big as you want it to be!

Thank You!

A special thanks to our clients who have called expressing their appreciation for the articles in Franchisor Alert® and have given us ideas for future articles.  Your support makes a difference!

If you are a franchisor wondering if expansion is right for your business, feel free to reach out to us at 205.408.3025 or email info@DuellLaw.com.

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You Must Get it From the Company Store

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For many franchising companies, the “Company Store” has been a profitable addition to their bottom line. Franchisees must either buy all or a select number of items from the “Company Store” or alternatively, Franchisees must buy from designated suppliers who in turn pay the Franchisor a rebate. For many Franchisees, it doesn’t matter that the Franchisor makes a handsome profit. The convenience of one stop shopping is all that matters. However for other Franchisees, the thought that they are being gouged (rightly or wrongly) by the Franchisor ultimately leads to litigation.

The litigating Franchisees contend that the required purchases constitute a violation of the Sherman Antitrust Act by coercing them to purchase goods or services from specified suppliers, thus restraining competition when they should be able to make purchases from sellers of their own choosing.

In today’s litigious environment, it is crucial for any Franchising Company selling products or services or requiring Franchisees to purchase from designated sources, to understand Federal, and just as importantly, State legal regulations before launching a required supplier program. Not only is a Franchisor subject to Federal antitrust laws, but some States have their own antitrust laws. Recently a State Attorney General sought to hold one of our Franchise Clients in violation of that State’s antitrust laws, a very serious charge. Fortunately, our Client had consulted with us prior to implementing their pricing program and was ready. The charge never materialized!

It is also not uncommon for States to have relationship laws which directly affect your Franchise Agreements. As a result, you must understand how to successfully structure. Franchisee programs from a legal perspective. For example, several States restrict a Franchisor’s ability to require its Franchisees to buy goods and services from the Franchisor or its designee as well as restricting rebates. A few States even prohibit sourcing restraints if goods of comparable quality are available elsewhere, or they place the burden on the Franchisor to show that restrictive purchasing arrangements are reasonably necessary.

Franchisors must also pay close attention to the disclosure requirements of the Amended FTC Franchise Rule. Now Franchisors are required to disclose supplier payments received by the Franchisor and the basis of payments made to the Franchisor from suppliers. In most cases, a Franchisor must disclose gross revenue from required Franchisee purchases.

CONCLUSION

With all these obstacles standing at the door, can it be said that the “Company Store” is still a good place to increase a Franchisor’s bottom line? Absolutely! But, the “Company Store” takes planning before it can be opened. It is essential that the legal requirements be understood in order to develop and properly structure the “Company Store” and the required purchase program before it is launched. Duell | Law is ready to help you. Plan ahead. Don’t be the next TV ad for the local Plaintiff’s lawyer which announces the multi-million dollar judgment against your Franchise Company.

If you are a franchisor who has any questions about developing a Company Store, feel free to reach out to us at 205.408.3025 or email info@DuellLaw.com.

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At The Crossroads: To Merge, Acquire or Sell

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You’ve built your franchise Company on a solid foundation and it has reached the first stage of success. Congratulations! You have reached the crossroads of growing the Company to the next level or selling it and obtaining the fruits of your labor. Either direction can be filled with potholes if you fail to plan ahead. Proper planning is accomplished by looking at the goals you initially set and determine where you want the Company to be in the next 3, 5 and 7 years. Your decision might be premised upon what capital and resources are needed for growth and what capital and resources are available. Are you looking for diversification, attempting to reduce the impact of a particular industry’s performance on the Company’s profitability? Perhaps your goal is to eliminate future competition, enabling your Company to gain a larger market share or increase supply-chain pricing power by buying out one of your supplier’s or distributor’s, thus reducing one level of cost in your profitability matrix. The decision on whether to grow may even be based on leadership. What are the strengths and weaknesses of your current management team?  Do you see a competitor with a management team in place that would fill in the gaps existing in your team? If so, it may make bottom line sense to acquire the other company in order to grow your business.  Maybe your decision is predicated on a complimentary product or service line which has synergy with those lines in your Company. By combining business lines or activity, performance at your Company will increase and costs will decrease. 

Whatever the motivating factor, without growing your Company you have only one road left to choose – the sale of your Company. Not a bad choice, and many Franchisors travel this road. To obtain the best possible price for your franchise Company, you must first do your due diligence to see if your Company is ready to sell. Due diligence requires preparation to present the best picture of a company that is organized and has each business system in place to enable a purchaser to succeed. Each of the following areas should be addressed to assure a prospective purchaser that the acquisition of your Company will lead to their success. 

  1. Make sure your Company has copies of all FDDs, UFOCs or other Disclosure Documents from the date of each Franchise Agreement. Catalog all FDDs, UFOCs or other Disclosure Documents from franchise registrations for each of your FDDs or UFOCs.  Do you have all required Transfer Agreements or Renewals for expired Agreements?
  2. Audit franchise files for proper execution of all agreements, including signed FDD and UFOC Receipt Pages.
  3. Focus on resolving compliance issues with your Franchisees. Are all royalty payments up to date? Do you have all of the ACH-Payment Agreements in place? Are Franchisees in compliance with required sales or have Area Developers completed required development schedules? If you have under-reporting or non-reporting Franchisees, make sure you have a plan in place to bring them current or establish an exit strategy when necessary.
  4. List those employees who are critical to your transition process and then establish a plan for keeping those employees in place.
  5. Determine which Franchisees have Addendums and chart any inconsistencies in your documents. It is always better to point out inconsistencies up front and explain why they are in place than to have a prospective purchaser discover inconsistencies while they are doing their due diligence.
  6. Finally, make sure you terminate Franchise Agreements with closed units or Area Development Agreements with territories that have not been developed according to the required schedule.

CONCLUSION

Whether merging with another franchise company, acquiring an existing business or preparing for the sale of your Company, don’t wait to get your franchise attorney involved in your decision.  Without the involvement of your franchise counsel, the best laid plans for success may result in a lawsuit from your own Franchisees or from the Franchisees of the other company seeking to enjoin the transaction.  Plan ahead.  Don’t wait!  Start the process of getting your Company ready now.  Put the proper systems in place straightaway and your decision at the crossroads will be like a super highway leading to success rather than the next wreck on a two lane road.

If you are a franchisor wondering if you should merge, acquire or sell, feel free to reach out to us at 205.408.3025 or email info@DuellLaw.com.

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