franchisor Archives - Page 3 of 4 - Duell

Mar 13

Your Operations Manual – Is It A Legal Minefield?

The judges in our courtrooms have become much better educated about the requirements of the Federal Trade Commission’s Amended Franchise Rule (“Disclosure Requirements and Prohibitions Concerning Franchising”) and are often very aware that a Franchise Disclosure Document (“FDD”) must be provided to a prospective franchisee prior to purchasing a franchise. The requirements for Item 11 of the Amended Franchise Rule supports the supposition that prospective franchisees are entitled to rely on the information within the Operations Manual, particularly those areas identified in the manual’s Table of Contents set out in Item 11 of a franchisor’s FDD. Yet the most important document that acts as a road map of a franchisor’s entire system, houses a franchisor’s trade secrets, and governs much of the working relationship with franchisees, receives very little, if any, review from a company’s franchise counsel.

To avoid being trapped, franchisors and counsel must conduct a legal review of the franchisor’s Operations Manual. It is suggested that a review encompass, at a minimum, the following areas:

Joint Employer Liability
- Avoid any employment related advice involving hiring, firing, wages, or discipline of franchisee’s employees.
Discrimination Clauses
- Title VII of the Civil Rights Act of 1964 prohibits discrimination in any aspect of employment. The power of a franchisor to control operations should be reviewed as a potential liability issue.
Good Faith Standard
- Any Operations Manual may fuel claims that a breach of the covenant of good faith and fair dealing occurs where the Franchise Agreement and Operations Manual conflict.
Safety and Security
- A franchisor may be held liable for any harm suffered by third parties based upon both policies set forth in the Operations Manuals, and for the lack of policies.
Environmental Laws
- Franchisors may be found liable for negligent advice contained in the Operations Manual covering environmental issues.
Anti-Trust Liability
- Pricing information in the Operations Manual can create legal issues and has been used by courts to find anti-trust liability.
Deficient Manuals
- Courts have found liability where manuals were not delivered at all or not delivered timely. I believe it is only a matter of time until an educated plaintiff’s attorney is able to take an Item 11 disclosure in the FDD and the section of a franchisor’s Franchise Agreement dealing with the Operations Manual and convince a court that the Operations Manual given its franchisee is deficient or that it is not properly updated, supplemented, or revised.
Copyright
- For the small Franchisor that outsources the Operations Manual, be careful. The company you hired may own the copyright. The owner of the copyright has exclusive authority to authorize reproduction and distribution of the manual, not the franchisor.

CONCLUSION

Operations Manuals are an integral part of a franchise system. Franchisors who fail to include their franchising counsel in the development of all manuals may be easy prey for the hungry plaintiff lawyers.

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Feb 10

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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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Aug 06

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Steps to Protect Your Trade Secrets

By Richard Duell lll Newsletter

Last month’s post highlighted the requirements for defining trade secrets.

Conceptually, the trade secret grant in a Franchise Agreement is a license, which confers rights and duties on a franchisee very similar to a trademark license. Those rights and duties should be specified in your Franchise Agreement and other ancillary agreements to protect your trade secrets. I suggest, at a minimum, that you address the following specific areas:

All your agreements should protect against unauthorized disclosure of trade secret information;
The Franchise Agreement should identify the trade secret information to be disclosed in separate documents, such as your confidential operations manual;
The franchisee must acknowledge a Franchisor’s ownership of trade secrets and that the trade secret information is only disclosed because of his/her relationship as a franchisee;
The franchisee must further acknowledge that the trade secret information is not generally known to the public or trade, and the franchisee had no previous knowledge of the trade secrets;
The Franchise Agreement should contain language that is flexible enough to include future developments to be included in your ancillary documents;
A franchisee should further acknowledge that the trade secret information is only loaned to the franchisee during the term of the franchise and is to be used in conjunction with the franchise;
Your Franchise Agreement should also limit the franchisee’s right to disclose trade secret information to key employees on a need-to-know basis, and require that key employees sign confidentiality agreements;
The franchisee should agree to observe and implement all reasonable precautions against disclosure which you may implement from time to time;
The franchisee should be required to report unauthorized disclosures or uses of trade secrets; and
The trade secret provisions in your Franchise Agreement should be tied to both in-term and post-term covenants not to compete and non-use.

Contractual provisions are not enough without a pro-active strategy on the part of Franchisors to monitor franchisee compliance. Because of employee mobility, franchisee turnover, and uncertainty of courts, it is imperative that your company implement a checks and balance system to ensure strict confidentiality. Your trade secrets are the heart of the franchise system. Make sure you devote the resources to protect your investment and to protect your trade secrets.

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Jul 12

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Your Trade Secrets: What Are The Questions?

By Richard Duell lll Newsletter

How many franchisors have ever taken the time to actually define the trade secrets of their company? In many franchising companies, the general consensus is that trade secrets are those mystical items comprising their “system.” They then throw it in the attorney’s lap and say “I am not sure what they are, but I want them protected.”

It is not uncommon to find franchise marketing materials and franchise agreements which recite the uniqueness of the “system” and then claim the overall make-up of the franchise system constitutes a trade secret. Such broad recitals certainly attest to the misperception of what is legally protectable. Much of what a franchisor provides its franchisees are operating methods commonly known in the trade or industry and are not protectable. In fact, an agreement which seeks to restrict the use of an alleged trade secret and which fails to qualify as such is unenforceable against public policy. Some courts have even held allegations that clearly mistake trade secret status may constitute predatory practices under antitrust laws.

While various courts in the past have used numerous definitions of what was protectable as a trade secret, most states have now passed trade secret legislation. Generally state trade secret legislation is based upon either the Restatement of Torts format or the Uniform Trade Secrets Act. The majority of states have adopted, with some state variations, the Uniform Trade Secrets Act format. This act defines “trade secrets” as:

“[I]nformation, including a formula, pattern, compilation, program, device, method, technique or process that:

Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through appropriate means by other persons who can obtain economic value from its disclosure or use; and
Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

Obviously not all information provided to franchisees can be protected. But where a franchising company has customized information and taken measures to ensure it is inaccessible to others, such information is protectable. An example of customized information might include, specially arranged recipes and formulas, special software programs, pricing lists, cost data, list of sources of raw materials and technology sensitive research.

Franchisors should work with legal counsel to ascertain what part of their system is a trade secret and therefore, protectable. Secondly, franchisees should acknowledge either in the franchisor’s confidential manuals or elsewhere, those items in the system which are classified as a trade secret. Finally, Franchisors must take active steps to protect their trade secrets. Our next post discusses many of the steps a franchisor should use to protect its trade secrets.