By: Richard E. Korb[1]
Franchises are often regarded as the trouble-free method to start a business. Because prospective owners do not need to worry about new marketing strategies and corporate identities when getting involved in franchises, it may seem like the simplest way to make one’s place in the business world. However, there are many places where a new owner can run into problems– particularly when starting out.
Initial Offer & Disclosure
It is imperative to understand the disclosure requirements of the Federal government when opening a franchise. The Federal Trade Commission (FTC) enforces the rules regarding franchises, and recognizes three different types of franchises in their rules. These three are package franchises, product franchises, and business opportunity ventures.
- Package franchises: Like KFC and other fast food chains, these offer pre-packaged business programs as well as products.
- Product franchises: Franchisee is responsible for selling goods carrying the franchisor’s trade name to the public.
- Business opportunity ventures: The franchisee is responsible for buying and selling the products of the franchisor, but the franchisor arranges the location and finds business from the franchisee. This form of franchising demands the least involvement from the franchisee.
The documents required by the FTC for such franchises are officially called “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures,” more commonly known as the “FTC Rules”. States also have similar disclosure rules for franchises. This is to make sure that franchisees (also known as “dealers”) know what they’re getting into when taking on the responsibility of a franchise. Thus, background information about the franchisor, franchisee, the franchise agreement between the parties, and other information regarding financing, trademarks, etc are all to be disclosed.
Two official forms are available to the franchisor to meet the disclosure requirements of FTC: the FTC Disclosure Document (FTC Document) and the Uniform Franchise Offering Circular (UFOC). The former meets all Federal requirements, but not all states accept it. To save time, completing the UFOC will meet both Federal and all state disclosure laws.
California Requirements
In accordance with the California Investment Law and the California Franchise Relations Act, a franchise is defined as an agreement between two or more persons that gives the franchisee rights to use a franchisor’s marketing plan, trade name, trademark, advertising, or commercial symbol. The franchisee pays a franchise fee and must register with the Commissioner of Corporations with a Uniform Franchise Registration Application. There are exemptions if certain minimum requirements are met by the franchisor. Registrations are valid for one year, and there are fees associated with both applications and renewals of all registrations.
Completing these forms is of utmost importance. The federal government can impose fines, order rescission, and issue cease and desist orders against franchisors who fail to follow disclosure requirements. California itself has the “California Franchise Relations Act”, under which a franchise must register with the Commissioner of Corporations on a Uniform Franchise Registration Application. There are exemptions from certain state rules if a franchise meets minimum requirements for net worth, experience, disclosure, and has filed a notice of exemption.
The Franchise Agreement
After the UFOC is filed, the next step for both parties the franchisee and the franchiser, to sign the franchise agreement. After both have agreed to go forward with the new business, Franchise Agreement is the legal document that outlines how a franchiser would like the franchisee to run the business. Failure to comply is grounds for litigation and could result in a termination decision. The major components of a Franchise Agreement are as listed below:
- Contract Explanation: Basic outline of the type of relationship the franchiser expects from the franchisee.
- Operations Manual: Guidelines the franchiser expects the franchisee to legally follow in operating the business. The contents are confidential and later changes can be made to these rules.
- Proprietary Statements: Details how much a franchisee must contribute to national or local advertising efforts and in which ways it can use the franchise name in its own marketing.
- Ongoing Site Maintenance: Expectations about upgrades and time frames surrounding maintenance issues, etc.
Having an attorney review the document before signing is recommended, as a professional can get through to the heart of the matter and provide a clear explanation of the agreements addressed in the franchisee agreement.
Owning the Business:
The franchisee is required to make payments to the franchiser before opening and while operating the business. These include franchise fees, royalties, training fees, payments for services, and payments from sales of products, and should be addressed before signing the franchise agreement.
There are three types of franchise laws to keep in mind while operating a franchise:
Disclosure, Registration, and Relationship laws.
- Disclosure laws such as:
○ Required pre-sale disclosures
○ Prohibited franchise sales practices
○ Mandatory “cooling off” period before franchise sales
- Registration laws like:
○ Registration of the franchise itself
○ Registration of sales persons
○ Registration of franchise advertising
- Laws regarding relationship between franchisee and franchiser such as:
○ Grounds for terminating a franchise
○ Notice and cure periods before termination
○ Grounds for not renewing a franchise
○ Equal treatment of franchisees
The most common breaches of franchise law include:
- Offering or selling an unregistered franchise
- Failing to provide a UFOC on time
- Failing to provide all required disclosures in the UFOC
- Making misrepresentations to franchisee prospects
- Improperly terminating or not renewing a franchise
Termination
After the initial offer and disclosure, if things begin to head south or there is other reason to bring a franchise to its end, it is important to act with prudence and caution; business owners must be shrewd when going through with the decision.
First, the franchisee should consult with his or her attorney and determine if there is good cause for termination. Was there a failure to meet performance criteria? System-wide changes? Violations of law?
Termination provisions will either be under “termination at will” clauses or “termination for good cause” clauses. These are set forth in the franchise agreement signed at the outset and should be understood (with the help of an attorney) before the agreement is signed and before the actual undertaking of business. Next, the forum selection, arbitration, choice of law, and integration clauses should be examined to determine the options available while going through the legal termination process. Make sure you recognize protections applicable to the dealer– these include those provided by the State Franchise Acts and the state and federal “Deceptive Trade Practices Acts”. Furthermore, the franchisee should review industry specific legislation and common law considerations, which can cause further complications when ending a franchise.
Next, the franchisee should meet with the franchisor and try to find common ground for termination. If possible, the parties should meet and confer with their attorneys present. In some cases, the franchisor will want to terminate the agreement if it appears things are not working out.
In many cases, the franchisor will not voluntarily let the dealer out of the contract.
In such cases, if you are the franchisee-dealer, after you have done a thorough liability analysis with your attorney, also determine what are the potential damages that can be recovered. Depending on the type of liability, significant monetary claims can be made along with remedies such as injunctive relief or a declaratory judgment. But proceed with caution: you will also want to analyze all of the applicable defenses to termination of the agreement.
Consulting with an experienced attorney when undertaking or ending a franchise may save you thousands of dollars in legal fees and court costs. For further information, contact attorney Richard Korb, an experienced Berkeley-Oakland Business attorney, for a free consultation at 510-524-0903.
[1] RICHARD E. KORB is a seasoned attorney with 30 years of experience in business law, and other related legal experience. Over his legal career, Richard has successfully litigated, negotiated and resolved over 300 cases for individuals and companies of all shapes and sizes. Richard leverages his big firm experience to now assist individuals and smaller companies with a broad spectrum of legal matters. In addition to his legal practice, Richard is also court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts. The content in this article and on the website or blog where it is posted is for informational purposes only. It is not intended to serve as legal advice and no attorney-client relationship shall exist by virtue of its dissemination ©2011 RICHARD E. KORB. Should you wish legal advice, you may contact Richard for a consultation at 510-524-0903. ©Richard Korb. 2011.
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