duell law Archives - Page 6 of 7 - Duell

Feb 10

Do You Have Underreporting Franchisees?

By Richard Duell lll Newsletter

“Oh what a tangled web we weave when at first we practice to deceive.” I am always amazed at how creative some franchisees can be when they direct all their energy into deceiving their franchisor about gross receipts and royalties due.

A number of years ago, I was involved in a case representing the franchisor whose franchisee sent in royalty reports and cash register tapes (now we use modems) that appeared to match his deposits and returns. The franchisor knew something was amiss but on the surface could not pinpoint the methodology of the underreporting. Because the Franchise Agreement permitted the franchisor or its agents to initiate an inspection or audit without notice, my first step was to engage the services of two individuals who were formally with the IRS and were very experienced on the criminal and civil side of investigations for fraud. Having drafted the Franchise Agreement, we had included a provision that the franchisee would pay for the cost of professionals, investigators, accountants, and attorneys associated with an investigation if a shortfall was discovered. We therefore felt comfortable knowing that the franchisee would be responsible for the cost of proving his deception.

When the investigators were kept from running a grand total for each cash register, they knew it was only a matter of time before the franchisee’s methodology of underreporting would be discovered. After interviewing former employees and managers, the pattern was set and, once the franchisee’s suppliers’ records were obtained and examined against the cash register grand totals, the fox was in the cage.

In discovering underreporting, your Franchise Agreement should be drafted to enable you to initiate the steps required to discover fraud. Always review your plan to investigate underreporting with your attorney because you don’t want to be faced with a suit for unlawful inspection or bad faith violation of the right of privacy.

One of the lessons my client learned was the importance of periodic inspections which help franchisees to stay honest. After my client’s shock of learning the amount underreported, we took steps to solidify systems for future franchisees which would help the franchisor monitor reporting activity.

Every franchise business is unique, but they all have common traits. By having proper controls in place and taking a proactive approach, you can trim any dishonesty out of your system to help curb underreporting franchisees.

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Jan 04

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Personal Liability in Franchising

By Richard Duell lll 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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Dec 09

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Trademark Law for Non-Lawyers

By Richard Duell lll Newsletter

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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Nov 04

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Before You Terminate

By Richard Duell lll 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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Oct 05

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Can Franchisees Be Treated Differently?

By Richard Duell lll Newsletter

If a politician were to answer the question posed in this issue of Franchisor Alert, he or she might give the retort, “it depends.” This answer would certainly be politically correct, as there are many facets of law which must be considered before a definitive answer to the question can be given. But the politically correct answer certainly does not help the franchise company make a decision on whether to discriminate among its franchisees. Hopefully, this issue will help franchisors by providing the process that a company must undergo before reaching the answer to a most difficult question about franchise discrimination.

The process of reaching a decision on whether a franchising company can treat franchisees differently starts with a franchisor’s own review of whether there exists a rational basis for different treatment. Can a franchisor pass the test that its conduct is not arbitrary? Justification might be premised upon such necessities as market conditions. Franchisors are often required to make competitive decisions responding to changing circumstances in the marketplace. For instance, a franchisor might provide a franchisee price concessions on products purchased where the franchisee is attempting to respond to a price war in a specific territory or the franchisor may allow certain franchisees to add additional menu items to a specific area to meet ethnic taste. If a franchisor has no quantifiable basis for discriminating among its franchisees, it should slam on the brakes and go no further. If however, the first step in our process receives a positive response from the franchisor, then we are ready for stage two.

Stage two consists of a legal analysis. Starting with the company’s franchise agreement and other relevant legal documents, legal counsel should review contractual language to determine if the franchising company has the contractual ability to treat franchisees differently. Is the language overbroad or are specific circumstances carved out when franchisees may be treated differently? Contractual language must also be reviewed in light of state statutory and common law.

There are at least 36 states with statutory provisions relating to franchise discrimination.

Many state laws are industry specific and require the review of a knowledgeable franchise attorney. Most franchise contracts contain a choice of law provision and if the franchisor has chosen a state with a strong anti-discrimination statute, the consequences could be disastrous to the company. As part of the legal analysis, counsel should review how anti-trust law might affect different treatment of franchisees. The principal area of concern being price discrimination. In addition, counsel should consider a franchisor’s downside and what the potential damages might be. Obviously, the franchisee receiving special treatment has no cause to complain, but to the extent another franchisee is harmed by special treatment, a franchisor’s risk escalates.

Perhaps the Indiana Act sums up our analysis in Stage One and Stage Two most succinctly. The Act makes it unlawful to discriminate “unfairly” among franchisees. Some franchisee discrimination is by definition “fair” as long as franchisees are not similarly situated.

At the very beginning of this post, we chastised politicians answer to the question – “Can Franchisees Be Treated Differently?”, but after a thorough legal examination we find that the answer “it depends” to be very accurate. Feel free to call or email me with your questions. I’ll be glad to help guide you through the uncertainty and maze.