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Personal Liability in Franchising

By Newsletter

In the traditional corporate environment, the corporate umbrella shelters individuals from personal liability while conducting business.  Franchising, however, is not your traditional corporate setting.  With the abuses that once occurred in franchising, the federal government and many states determined that the unsophisticated purchaser required additional protection.  As a result, franchise law evolved from an amalgamation of common law principles, federal and state statues and judicial decisions.  Blended together, these legal precepts override the traditional corporate umbrella protection and make individual liability a very real concern for everyone involved in the Franchise process. 

At the Federal level, individuals within the Franchise Company face personal liability from Section 5 of the Amended FTC Act, which makes unlawful any unfair method of competition or deceptive act or practice in or affecting commerce. 

While the FTC Act sets minimum standards, most states have enacted their own legislation affecting Franchising and at the same time, exposed individuals in franchising to personal liability.  These state statutes also provide for both governmental enforcement and private action. 

If an unsatisfied franchisee files suit, their claims usually appear in multi-count complaints which not only include statutory claims, but also common law remedies against both the franchisor and individuals employed by the franchisor in the area in which the franchisee’s claims arose.  Examples of areas where individuals could be exposed to personal liability occur in the sales process, real estate, inspection, build-out, training and support.  Suits also normally include the officers and/or directors overseeing the area where the claims arose.  Because the claims are intentional in nature, many states allow punitive or exemplary damages which can far exceed the actual out-of-pocket loss claimed.  How can Franchisors and their employees protect themselves?  Skilled drafting of every franchise document can help shield officers, directors and employees from personal liability.  At risk individuals can further obtain protection by entering into indemnity agreements with their Franchise company.  Franchise companies should also consider initiating programs to obtain written acknowledgements from Franchisees at every step of the franchise process.   Additionally, all franchise companies should consider “D&O” insurance to protect officers and directors. 

Perhaps the best safeguard to prevent individual liability is the implementation of a personal liability analysis as part of each franchise company’s annual legal checkup.  For clients we work with in completing annual renewals, we incorporate this liability analysis into our clients annual renewal review.

The rapid growth of franchising has contemporaneously produced greater Franchise litigation and with it, personal exposure of individuals involved with the franchise process.  Make sure you have initiated your annual legal check-up to protect those individuals who might be at risk.

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Trademark Law for Non-Lawyers

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Trademarks are the banner for a franchise concept, enabling franchisors to operate under one distinct name which is, or becomes, well known to consumers or third parties.

In other words, trademarks lend a particular image to the franchise company. Like brand recognition, your trademark provides you with an identity associated with the franchised goods or services.

Many franchisors commonly use the term  “trademark” to encompass both service marks and trademarks, either of which can be afforded federal and state protection under the federal Trademark Act of 1946 (“Lanham Act”) or various state statutes. Although the terms service mark and trademark are often used interchangeably, they actually are quite distinct. A trademark is technically a name or symbol associated with a good or product that distinguishes itself from another manufacturer, while the term service mark refers only to services.  Both, trademark and service mark, allow the consumer to recognize and identify the product or service from one franchisor to another.

To be registered with the U.S. Patent and Trademark Office, the mark must identify a single source, distinguishing it from that of another party. To be distinguishable, the mark cannot be a generic term or confusingly similar to another mark or trade name.  It cannot be the name, portrait or signature of a living individual or deceased person without express permission of the deceased representative, nor can it compromise our flag.  It also cannot be a coat of arms or insignia of another country or state or contain scandalous, deceptive or immoral matter.

Trademarks and service marks provide protection from others attempting to establish recognition through your company’s identity, recognition being the “key” to any successful franchise system. Once your trademark or service mark is registered on the Principal Register of the U.S. Patent and Trademark Office, you acquire national recognition, conferring superior rights.

Even after registration, you must file affidavits of continued use with the U.S. Patent and Trademark Office to maintain your registration. If you fail to file the continued use affidavits, you may lose your rights to the registered mark. Therefore, make sure you track all registered marks for your franchise and make sure they are timely renewed.

If you would like to find out more information on federal and state registrations, please call or e-mail us.

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Before You Terminate

By Newsletter

Your patience is exhausted. You have done everything in your power to help your unappreciative franchisee. You may have even suggested the best course might be to sell the franchise and you would be willing to refer your franchisee leads for his/her territory. The franchisee still will not comply with his or her franchise agreement. Perhaps the franchisee is the type that believes their way is better than yours and their conduct is starting to have a detrimental effect on your franchise system. Whatever the reason, you have reached a point of no return for this particular franchisee and believe he or she must be expunged from the franchise system.

What should you know and do before making the decision to terminate? The starting point for termination is to look at your Franchise Agreement and determine the conduct of your franchisee that constitutes a default and grounds for termination. Next, determine if you have adequate documentation to prove the violation. If you are terminating for a reason other than a standard violation (for example, failure to meet sales requirements) consult us; there are special rules which apply and careful contract drafting is essential. Review all of your contractual obligations to make sure you have fully complied with your side of the bargain; for example, if you are providing a product, has it always been timely supplied? Also, review what your prior course of dealing has been with other similarly situated franchisees. You may have modified your contractual rights. Believe it or not, there are states that permit written agreements to be modified without a subsequent writing even if the contract provides otherwise.  Be prepared for your franchisee’s argument that the covenant of good faith and fair dealing requires uniform treatment and he or she is being singled out.

Make sure you are familiar with applicable state franchise protection statutes. There are at least 17 states that require a type of good cause for termination and/or an opportunity to cure. Keep in mind that many states ignore contractual choice of law provisions if that state franchise law would otherwise be circumvented. Some states, like Texas, have a Deceptive Trade Practices Act holding the franchisor liable for certain business conduct.

Make sure you have not given your franchisee any arguments that assist him or her in claiming you have caused a defacto termination because you are in violation of the agreement or that you are actually terminating the franchisee as a penalty for his or her refusal to participate in illegal activity; for example, an unlawful tying or price fixing scheme in violation of antitrust law and “little FTC Acts.”

The main point I want to stress is the importance of knowing how to build your file before termination. Correctly done, the integrity of your franchise system will be preserved.

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