Franchise Law Update

California Considering Additional Rights for Franchisees

Elizabeth Sigety — Wed, 15 May 2013 17:23:27 -0500

On April 16, 2013, the California Senate Judiciary Committee, voting along party lines 5 to 2, reported Senate Bill No. 610 (pdf) out of committee to the California Senate Floor.

This bill would amend the California Franchise Relations Act to add certain provisions to the Act. The original Act was enacted to govern the relationships between franchisors, subfranchisors and franchisees in California in order to prevent unfair practices in the termination, renewal or transfer of a franchised business. See California Corporations Code, Division 8, Chapter 5.5, Sections 20000 through 20043.

The new bill, if passed, would strengthen the franchisee's rights under the Act by adding the following provisions:

Add the standard of "good faith" to govern the dealings of parties to a franchise agreement in the enforcement and performance of the franchise agreement. Good faith is defined in the bill as "honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade".
In addition, a franchisor or subfranchisor cannot restrict a franchisee's right to join or participate in a franchisee association to the extent prohibited by existing law.
Provides for a private right of action for breach of the above-described provisions for damages, rescission or other relief the court deems appropriate and clarifies that the court may increase the award to three times actual damages sustained, as well as reasonable costs and attorney's fees to a prevailing plaintiff. Note that this does not say the prevailing party - just the prevailing plaintiff.
Allowing any franchisor or subfranchisor who becomes liable under these provisions to recover contributions from any other person who would have been liable under these provisions if sued separately.

As one would expect, there is much interest in this bill and vigorous arguments are being made on both sides by industry associations. Pro, of course, argues that the franchisor/franchisee relationship gives too many rights to the franchisor and that this will level the playing field. Click here for more "pro" arguments. Con argues that it will weaken the franchisor's ability to protect its brand's integrity, which benefits its system and franchisees, by preventing the franchisor from being able to pursue remedies against underperforming franchisees and will, ultimately, harm consumers. Click here for more "con" arguments "con".

We will keep you posted on developments with this legislation.

Court Strikes Down Rule Mandating Union Posters

John Gotaskie — Tue, 07 May 2013 17:22:35 -0500

In an important decision today, the United States Court of Appeals for the D.C. Circuit struck down a controversial rule requiring employers to post information respecting their employees' right to unionize. The Court sidestepped a key question of the controversy, and the controversies engulfing the Obama Administration's recess appointments to the National Labor Relations Board in general, by not making a decision about whether the Board had the power to mandate the posters.

Instead, the Court of Appeals noted that the National Labor Relations Act ensures an employer's right to speech so long as that speech does not contain threats. Consequently, the Court reasoned that the Act also gives employers the right to remain silent. Therefore, the Board's decision to mandate the posters was tantamount to mandating speech, which violated employers' right to remain silent.

This is the first appeals court to issue a ruling on the rule. Another appeal is presently pending before the Fourth Circuit Court of Appeals. The text of the D.C. Circuit's opinion in National Association of Manufacturers et al. v. National Labor Relations Board et al. can be found by clicking this link (PDF).

Are You Sure You Own the Trademark for Your Brand?

John Gotaskie — Wed, 01 May 2013 07:00:00 -0500

Contributed by Chris Kinkade

Only the owner of a trademark has standing to enforce rights under that trademark (limited exceptions exist, such as for exclusive licensees). This may seem like common sense, but all too often shareholders and executives of companies file for trademark registration in their own personal names. Not only does this devalue the company by depriving it of assets, but also it could hinder or outright prevent the company from enforcing its rights against competitors using the same or similar trademark. It could also jeopardize the validity of the trademark registration.

For a franchisor, brand name and trademark rights are of paramount importance and form the foundation of the franchise. Having a lose stone that invalidates or inhibits protection of that brand can be catastrophic. Franchisors should periodically self-audit their trademarks (preferably with the assistance of qualified counsel). Such audits should only to make sure that ownership and licensing rights are appropriate, but also to make sure quality control is maintained. Franchisors also need to police their franchisees to make sure that any new trademarks are approved by and assigned to the franchisor (subject to any other agreement among the parties). To aid in this effort, trademark watch services can be employed to monitor new filings incorporating the franchisor’s brand.

Federal district courts have held that a company does not have standing to assert infringement of a registered trademark where the registration is not in the company’s name, even if it is in the name of a sole shareholder. In a recent case (Inflatable Zoo Inc. v. About to Bounce, No. 12 CV 1709 (E.D. La. Apr. 11, 2013)), the plaintiff had been doing business under a registered trademark for over 20 years before the defendant (a customer) started using the same trademark. The court dismissed the plaintiff’s federal trademark infringement and cybersquatting claims because the registration was owned by the sole shareholder of the company, not the company itself. Since individuals and businesses are distinct legal entities, the company could not enforce the registration.

A trademark registration may be invalid if the owner is not the person or entity that controls the nature and quality of the goods and services provided under the trademark, which is typically the company providing the goods or services or, in a franchise relationship, the franchisor. In the case of a sole shareholder that is also the managing director of a company, that person likely controls the company to be a valid owner of trademark rights (although this may not be wise for at least the reasons discussed above). However, a shareholder or executive of a company who does not control the company’s goods and services is likely not appropriate to list as the owner of the company’s trademarks. Likewise, a franchisee is likely not a proper owner of a mark that is utilized by the entire franchise.

Trademarks are extremely valuable and potentially perpetual assets and should always be treated as such. Although the electronic forms for federal trademark applications may be easy to fill out and file online, and there are many firms that act as drop boxes for trademark applications, business owners and decision-makers should strongly consider consulting with a trademark lawyer who can provide guidance on how to best protect their assets, not simply obtain certificates of questionable value. Anything worth doing, is worth doing right.

Did JCP Know Its Customer? (And Why It Matters for Your Brand))

John Gotaskie — Sun, 28 Apr 2013 08:00:00 -0500

Much has been written speculating about why Ron Johnson failed--spectacularly--at J.C. Penney. What makes the episode so surprising was that Ron Johnson was not a retail novice. His successes as an executive at Target and in building the Apple Store system are, if not legendary, at least most impressive.

Much has been made of Johnson's decision to adopt a fair pricing retail strategy and make J.C. Penney into a hipper retailer--re-branding it as "JCP", for example. Frankly, I think that such articles give too little credit to the modern American consumer. Do these commentators really believe that customers cannot figure out when they are getting a fair everyday deal, as opposed to marked-up pricing and artificial sales?

I mean, Dillard's converted to a fair pricing strategy in the late-1980s. While it has regularly tweaked its strategy by offering, for example, deep discounts on slow-selling merchandise, it has not failed, growing into a very successful regional department store chain. And, as many people have correctly noted, J.C. Penney's stores had problems prior to Johnson's arrival--especially compared to rivals like Kohl's and, yes, Target. I think that Johnson's failure at J.C. Penney was much less prosaic than customers turning away from a fair pricing strategy they--allegedly--did not understand.

I began to be concerned about the new "JCP" last summer when I overheard my wife talking to some of her friends about JCP. A brand-new JCP had opened at the mall, taking over space formerly occupied by Boscov's. And these mothers were complaining that they couldn't find anything to buy in the new store. They were not suggesting the layout was poor. No, they were saying the merchandise selection was unappealing to them. These customers were core JCP customers: professional, middle-class, suburban mothers who shopped and found plenty of worthwhile merchandise at Target, Kohl's and Macy's. And they couldn't find a single thing to buy at JCP.

Unfortunately, I had overheard such comments before. For my mother's friends, in the late 1980s, when Sears embarked on a similar "fair" pricing strategy but was equally undone by poor merchandising.

What is now coming out is that the new JCP failed to understand its customers, and made wholesale merchandising changes without either making sure it had new customers or that those merchandising changes pleased its current customers. For example, the Wall Street Journal recently reported that JCP last summer eliminated the St. John's Bay brand of women's clothing (sub. req.), along with all of the staff behind the brand. St. John's Bay was a billion dollar brand for JCP--itself a $17.5 billion company in annual sales prior to Johnson's arrival. But it, and hundreds if not thousands of jobs supported by the brand, were summarily eliminated.

So, when I hear pundits talk about the failure of Ron Johnson's pricing strategy, I pause and think what really failed was his merchandising strategy. And that failure appears to have been driven by a distinct failure to understand his customers, and what his customers wanted. The lesson is important for all retailers, including franchising systems. The good news is that franchising has great leaders like Andy Puzder and David Novack, just to name two, who remind us through success that staying laser-focused on our customers' needs is essential.

Will You Be Compliant? FTC Updates COPPA Compliance FAQs

John Gotaskie — Thu, 25 Apr 2013 10:49:35 -0500

Just this morning, the FTC updated its Compliance FAQs respecting the Children's Online Protection Privacy Act (COPPA). The updates are intended to address the revised Rule implementing the Act, which will go into effect on July 1, 2013.

The FAQs are principally intended to assist compliance with the four new categories of information added to the Rule's definition of "Personal Information":

Geolocational Information: The Rule now provides that all geolocational information must have parental consent, whether obtained before or after the implementation date.
Photos or Videos or Audio files containing images or audio of children: If collected prior to the date of the amended rule, consent is not required, but strongly suggested by the FTC.
Screen or User Names: If collected prior to the date of implementation, consent is not required unless the user associates new identifying information with the user name after the date of implementation.
Persistent Identifiers: If collected prior to the date of implementation, consent is not required unless the site obtains new information after the date of implementation that allows tracking of a user over time or across websites. There is a technical exception for information collected solely for internal operations of a website.

The revised FAQs continue to provide good examples of both best practices and safe harbors regarding COPPA, and are definitely worth a review.

How Similar Is Too Similar: Inherent Risks in Mimicking a Franchise after Termination

John Gotaskie — Sun, 21 Apr 2013 09:45:53 -0500

Contributed by Tris Fall

For better or worse, not all franchises last forever. For various reasons, a franchise relationship sometimes terminates – sometimes on amicable terms; other times, not so much. Unless the franchisee is subject to a non-compete covenant, the franchisee often continues in the same business as the franchise operation, even after the franchise relationship has ended.

And, not wanting to lose any customers, the former franchisee may seek to tread as closely as possible to the way things worked under the franchise. It may try to continue to use the same color scheme, same manner of operations and even a similar name. Of course, the former franchisee has to do this without violating the franchisor's intellectual property rights. The tough question is how close is too close.

A recent decision from the U.S. District Court for the Middle District of Florida sheds some light on this predicament. In You Fit, Inc. v. Pleasanton Fitness, LLC, You Fit (the franchisor) had granted a franchise to the defendants (the franchisee) for the operation of a series of health clubs under the name "You Fit".

For reasons unknown, the franchise relationship ended, but the defendants continued to operate health clubs. Not wanting to violate You Fit's trademark, but still wanting to retain their customer base, the defendants opted to do business as "Fit U" (ostensibly an abbreviation of "Fitness Unlimited"). As it turns out, this was a poor decision.

You Fit sued in federal court for trademark infringement, unfair competition and related claims. In evaluating the various factors that go into a "likelihood of confusion" (the test for trademark infringement), the court determined that the mark "YOU FIT" was suggestive, and therefore entitled to a heightened level of protection, even though the words "you" and "fit" were commonly used by others in the fitness market. The court also decided that the marks "YOU FIT" and "FIT U" were "very similar", despite the fact that one was essentially a transposition of the other. In evaluating the actual confusion factor, the court quoted a post from the popular website Yelp, in which a consumer stated that she was confused by the "Fit U" health club, noting that it shared a similar name and the "same basic color scheme" as did You Fit. The Yelp post concluded with "Very confusing and a big let down."

On balance, the court concluded that the plaintiff franchisor had satisfied that a likelihood of confusion existed between these two marks and ruled in favor of the franchisor. The defendant former franchisee was enjoined from using the mark "FIT U" "or otherwise using 'Fit ' in any manner in the offer, sale, or advertising of any goods or services".

This case demonstrates that franchisors who are dissatisfied with the steps that a former franchisee has taken to distance itself from the franchise have a powerful means of enforcing their rights. It also should serve as a cautionary tale to former franchisees who are trying to remain as close as possible to what they previously did as a franchisee. In general, a former franchisee is best advised to distance itself from the franchise in every way that it can, so as to avoid an outcome like that suffered by in this case.

Bloggers/Tweeters: Are you Compliant with the New FTC Disclosure Guidelines?

John Gotaskie — Tue, 09 Apr 2013 20:39:49 -0500

Okay, so you're aware that the FTC issued new guidelines last month regarding the responsibilities bloggers and other social media users have to disclose sponsored content or free product samples in exchange for reviews.

Moreover, maybe you're like me, and when you read the new guidelines, you thought, "Okay. That sounds pretty close to the types of disclaimers and disclosures the FTC has always required for advertising and endorsements."

But then it hit you right between the eyes. How in the world do I do that in 140 characters? Well, Angie Pascale over at Location3 posted today at her blog the "quick and dirty" on what all brands must know for their social media outreach programs. The significant takeaways?

Proximal Placement is Priceless: put the disclosure next to the claim or item being advertised.
Disclosure Bookends: product reviewer disclosures need to come at the beginning and the end of reviews or sponsored content where product or discounts were provided in exchange.
Tweets are NOT Exempt: make sure the tweet plainly discloses that it is an advertisement and any necessary disclosures (like the "typical" results for a weight-loss product).
No More Cryptic Shortened URLs: make the hyperlink obvious.

Angie notes correctly that the guidelines are not law. However, anyone choosing not to follow them is risking FTC action against the brand and/or the blogger. Angie has several other good ideas posted on the blog regarding the new guidelines. I highly encourage a read.

Finally, thanks are due to Jennifer MacDonald at Engage121, whose tweet today alerted me to Angie's great post.

Does the Lawlor Case Spell the End for Mystery Shoppers? In a Word: No

John Gotaskie — Sun, 24 Mar 2013 18:15:21 -0500

Contributed by Christina A. Stoneburner

Recently, the Supreme Court of Illinois upheld a damages award against an employer who took it upon itself to go to some unorthodox lengths to determine if a former employee had violated a non-competition agreement. Although this has been a hot topic in some of the franchise world’s forums, I must say I am a little surprised by the sweeping declarations that “pre-texting” cannot be used in any circumstances.

Let’s review the very egregious facts of the case in question, Lawlor v. North American Corporation of Illinois. In Lawlor, the employer hired counsel and an investigator to try to determine if Ms. Lawlor had violated a non-competition agreement. In order to try to prove their case, the company turned over Ms. Lawlor’s address, Social Security number, and telephone numbers. The private investigators then pretended to be Ms. Lawlor, contacted her telephone providers, and requested duplicate copies of her phone records.

Is anyone shocked that committing identity theft and obtaining phone records under false pretenses is against the law and could result in liability? I should hope not. Does this necessarily mean that “mystery shoppers” cannot be used by franchisors to investigate franchisees? I don’t think so.

A mystery shopper is not at all similar to the “pre-texting” that went on in the Lawlor case or in the well-publicized HP pre-texting scandal. Instead, a mystery shopper is contacting the company like any other customer, speaking with sales personnel, and purchasing product to determine quality of service. The information the mystery shopper is getting is the same information that any member of the general public gets when transacting business with the company.

In short, I do not think the Lawlor case is the death knell of mystery shopper programs.

Further, I cannot imagine how any franchisee could legitimately complain about a bad review by a mystery shopper. What argument would be advanced by the franchisee? “If I had known you represented the franchisor, I would have treated you better than any of my other customers.” I do not see much jury appeal in that argument.

Reputational Capital Interviews Our Own Elle Gerhards

John Gotaskie — Thu, 21 Mar 2013 17:21:59 -0500

Our own Eleanor Vaida Gerhards was recently interviewed by Reputation Capital on the topic of legal blogging. Eleanor discusses how blogging fits into marketing strategy and the value of blogs (including of course, the Franchise Law Update) in relating to clients and potential clients.

You can read the full interview here.

Have You Made Full Disclosure? U.S. Bankruptcy Courts May Want to Know.

Eleanor Vaida Gerhards — Wed, 13 Mar 2013 07:00:00 -0500

Struggling franchisors who violate state franchise disclosure laws should not assume that the filing of bankruptcy by the franchisor will bring relief from the claims of wronged franchisees. A Bankruptcy Court in North Carolina recently ruled that Michael and Kathy Butler, husband and wife owners of PRS Franchise Systems, LLC were personally liable to one its franchisees for $714,000 plus interest.

PRS Franchise was a North Carolina based franchisor offering retail franchises selling promotional and advertising services to small businesses. The franchisee, New York resident John Mangione, bought 12 PR Store franchises in New York in 2007. At the time of the sale, PRS Systems was not registered in New York to sell franchises and did not escrow Mangione's franchise fees as required by the New York Department of Law when an franchise registration amendment application is pending.

Unhappy with the situation, Mangione demanded rescission of the franchise agreement and subsequently sued PRS Systems in 2009. Two months later the Butlers dissolved PRS Systems and filed for personal bankruptcy under Chapter 7. The Butlers hoped to discharge any potential personal liability to Mangione by naming him a debtor in the bankruptcy and valuing his claim at $1.00. Mangione filed an action asking the court to declare the debt non-dischargable under 523(a)(2) and (4) of the United States Bankruptcy Code on the basis of the Butler's fraud.

The Bankruptcy court found the owners personally liable under New York law. The court found no merit in the Butler's argument that each was uninvolved in the sales process. The court decision details the personal interaction between the Butlers and Mangione, and Mangione's reliance on the owners' promises and experience in the PR business. In addition, because an FDD was not provided to Mangione, he was not privy to PRS Systems 's abysmal financial statements. Testimony also confirmed that the Butler's intentionally let the franchisor's New York registration lapse and made only a half-hearted effort to reinstate it when Mangione showed interest in purchasing franchises.

The full text of the opinion can be found here.

NYC Sugary Drink Ban Halted

John Gotaskie — Mon, 11 Mar 2013 14:44:27 -0500

Several news outlets, including The Wall Street Journal and USA Today, are reporting that a judge has entered an injunction halting New York City and Mayor Bloomberg's sugary drink ban, which was scheduled to go into effect on March 12th.

The state court judge concluded that the sugary drink regulations are fraught with arbitrary and capricious consequences. The court pointed out that certain stores, such as convenience stores and supermarkets, would not be subject to the regulations. It was also reported today that Starbucks did not intend to follow the regulation, considering itself exempt. These many "loopholes," said the judge, effectively defeat the purpose of the regulation.

The court further found that the City only has the right to regulate the food supply when the City faces imminent threat from disease. The court held that high standard had not been met in this case.

We will continue to watch and report what happens with this ruling and upcoming appeals.

First They Came for the Trans-Fats, Now They Want the Soda Pop, Too?

Elizabeth Sigety — Mon, 11 Mar 2013 07:00:00 -0500

This week, the residents of New York City are to be subject to a new law (effective March 13, 2013), banning sales by food service establishments of "sugary drinks" larger than 16 fluid ounces. A "Sugary Drink" is defined as:

"Sugary drink means a carbonated or non-carbonated beverage that:

(A) is non-alcoholic;

(B) is sweetened by the manufacturer or establishment with sugar or another caloric sweetener;

(C) has greater than 25 calories per 8 fluid ounces of beverage; and

(D) does not contain more than 50 percent of milk or milk substitute by volume as an ingredient.”

See New York City Health Code Section 81.53.

The American Bar Association's Forum on Franchise Listserve had a fun time toying around with the meaning of this regulation. If, for example, a root beer was in a cup less than 16 ounces, would the addition of ice cream which went over the top of the cup be an issue? As ice cream is a solid, would the inclusion of ice cream in a smoothie mean that a health inspector must wait for the ice cream to melt before issuing a violation? But as ice cream contains milk, perhaps one could put in a lot of ice cream and it would count as a "milk substitute"? These are all tongue in cheek (and not meant to guide the reader's interpretation of the regulation!!), but you get my drift.

Clearly, this has implications for franchisors and franchisees with business in New York. If a business wants to serve other types of non-sugary drinks in large cups or has a self-service drink station, that business will have to figure out how to make sure that these cups are not used for "sugary drinks". In addition, businesses that produce drinks with different ingredients will have to analyze the sugar and milk content against the regulation.

Businesses serving coffee may also have to adjust their service to customers. Some franchised systems plan to change their procedures, not offering to put sugar in their customer’s coffees over 16 ounces but requiring their customers to do that themselves. Some others are adopting a “wait and see” approach. Lattes, of course, are not effected no matter the size. For an in-depth analysis on the effect of these laws on coffee drinks, see the recent article in the New York Times.

This leads, of course, to the related question of the role of government. Are public health issues to be reserved for diseases that are contagious? Or should the government regulate personal health decisions? A lawsuit has been filed in the State Supreme Court in Manhattan by the soft-drink industry joined by several New York restaurant and business groups opposing this regulation.

Whatever your opinion, like smoking bans and bans on trans-fats, this trend may spread to other states. A few states have regulated serving these types of drinks in schools and many have sales taxes above those applicable to food generally for regular soda.

The New York Times has been following this issue extensively. To read more, please click on the following links ...

Health Board Approves Restriction

Soda Industry Sues to Stop Ban

Online Franchise Filing? Yes.

Eleanor Vaida Gerhards — Mon, 04 Mar 2013 06:00:00 -0500

Late last week, I received an email from the Securities Division of the Washington State Department of Financial Institutions announcing the launch of its new on-line electronic franchise filing system. The Division is strongly encouraging that all franchises use the "E-File System" for new franchise applications, franchise renewals and amendment filings.

According to the Division, franchises utilizing the E-File System may discontinue the filing of physical applications. As far as we are aware, Washington is the first state to utilize an on-line filing system although Rhode Island eliminated the filing of paper documents and moved entirely to CD-ROM filings a number of years ago.

The Division hopes to conserve its resources, reduce the time needed to process an application and provide faster response times which benefits franchisors. This is great news for franchises registered or hoping to get registered in Washington as it should help simplify an applicant's process and shorten the time to receive a notice of effectiveness.

The Division is also providing a how-to guide on getting started and some Frequently Asked Questions. Applicants with additional questions are encouraged to call Cheryl Pearson at (360)-902-8762.

What I Learned at the IFA Convention

Elizabeth Sigety — Thu, 28 Feb 2013 13:04:53 -0500

Many from Fox Rothschild attended the International Franchise Association’s Annual Convention in Las Vegas last week. For those of you who have not attended before, it is a massive convention (3600 people this year) where any involved in the franchise industry can make critical industry contacts, discover best practices and more! For more information, go to the IFA’s website at www.franchise.org.

One of the main themes that was echoed over and over again was the importance of open communications between a franchisor and its franchisees. I find that, especially start-up franchisors, or franchised systems that are in turmoil, are afraid to involve their franchisees in open discussions. This may initially not be the easiest way for a franchisor to conduct business, but, in the long term, the speakers gave repeated examples of why it is the best way.

The unapologetic and proud Andrew Puzder, CEO of CKE Restaurants (owners, operators and franchisors of numerous brands including Hardees and Carl’s Jr.), spoke about how the involvement of their franchisees in major company decisions was the best way to gain critical support for those decisions. The Hardee’s brand was in a crisis and, though they met with some resistance, the franchisor worked hard to get all the franchisees behind the innovative and bold moves the company needed to make to get the concept back on track. He stated that the franchisor had to lead by example and prove the merits of the new innovations to the franchisees, which led to adoption of these innovations by the franchisees and grew trust between the franchisor and its franchisees. Trust that resulted in solid, decade-long growth for both franchisor and franchisee. He also spoke about the success of the racy Paris Hilton advertisements (SFW--just a link to Ad Age magazine)--which appealed directly to CKE's core 18-34 year old male customer and zigged while the rest of the fast-food industry was zagging. Those ads demonstrated that CKE was willing to take risks.

Speakers at the Annual Leadership Conference (which occurs just prior to the start of the IFA Conference) and in many of the other sessions supported these views. The fear that a few unsuccessful, disappointed franchisees may dominate the conversation is real, but, as the speakers pointed out, it is better for those conversations to occur with the franchisor’s involvement than behind the franchisor’s back. A franchisor should involve its successful franchisees in these conversations and use technology to increase availability of information and to structure conversations and meetings with franchisees.

The tips and tricks relating to bettering these relationships and communications can go on for pages and pages, but the point is, the franchisor should consider involving its franchisees and making its system and communications more transparent. Franchisees represent a great pool of talent and ideas, so harness that brain power and creativity and move to the next level!

Are You Ready? Virginia Franchise Filing Rules Change on March 1st

Eleanor Vaida Gerhards — Sun, 24 Feb 2013 06:38:51 -0500

Last week the Virginia State Corporation Commission adopted revisions to the state's Retail Franchising Act. The amendments (1) revise filing requirements to bring Virginia in line with the NASAA Franchise Registration and Disclosure Guidelines and (2) require a franchisor to amend its registration within 30 days of a material change.

The changes to the application filing rules include:

requiring both a CD-ROM and paper copy with every initial application, renewal, and amendment submission;
requiring CD-ROM documents be in PDF format and text-searchable; and
requiring the cover letter contain a representation that all information in the electronic file is identical to the paper documents.

While these changes are important to note, it is likely that many franchisors and legal practitioners already comply with these requirements if they undertake a uniform application filing process for all states.

The second change to note is the 30 day deadline to file material amendments. This is an improvement over the current law which requires franchisors to file immediately. The Virgina Division of Securities and Retail Franchising did not, however, adopt the comment proposed by the International Franchise Association that the proposed rule be modified to require material amendment be filed within a "reasonable time after the close of the quarter."

There is also a new retention of records rule requiring all franchisors retain material different versions of Franchise Disclosure Documents as well as each signed FDD receipt for 3 years.

The revisions to the rules are effective March 1, 2013. Anyone with questions is invited to contact contact a member of the Examination Section of the Division at (804) 371-9276 or by e-mail at SRF_Examination@scc.virginia.gov.

Independently Owned and Operated?

Eleanor Vaida Gerhards — Mon, 18 Feb 2013 06:00:00 -0500

The franchise industry is deep in renewal season and one recent California case reminds us that franchise systems, especially those with company owned outlets, must always require franchisees to clearly identify themselves as independently owned businesses. If your system's franchise agreement does not REQUIRE all franchisees have signs indicating that the franchise is independently owned and operated then you should revise it now.

In the case of Ford v. Palmden Restaurants, LLC, a California Appellate Court held that Denny's Restaurants and its affiliates, could be held liable under an "ostensible agency" theory for injuries sustained by a customer at a franchisee's Palms Springs restaurant. The customer sued the franchisee and Denny's as well as all of Denny's affiliates after he was beat up by members of a gang who consistently "took over" the restaurant every Saturday night.

Under California law, a defendant can be held liable under an ostensible agency theory when the defendant intentionally or negligently causes a third party to incorrectly believe someone is an agent. The California court described 3 cases where a franchisor was found liable for the franchisee under this theory and found similar facts existed with Denny's case. First, the Denny's franchise system utilized both franchisee operated and company owned outlets and it was not common knowledge among the population that all Denny's are franchisees. Second, the franchisee did not display any signage or provide any other notice that the restaurant was operated by a franchisee.

The signage issue was not dispositive in this case but it is important to note that the Denny's franchise agreement did not require the franchisee indicate that it was independently owned and operated. While not a fail safe remedy to avoid liability under an ostensible agency theory, it would certainly lend support for any defense.

How Do I Shut Down Twitter?

John Gotaskie — Fri, 01 Feb 2013 10:28:11 -0500

An anecdote in today’s “Heard on the Street” section of the Wall Street Journal (sub. req'd.) has an important lesson for all of us about social media policies. HMV, a United Kingdom retailer of CDs and DVDs, recently entered the British equivalent of bankruptcy protection. As part of the bankruptcy process, HMV on Thursday fired 190 persons. Including the employee responsible for the company’s Twitter account. Unfortunately, HMV’s management had not thought ahead, and the now-former employee continued to tweet live updates of the firings—which it called a “mass execution of loyal employees who love the brand.”

While the rogue tweets were eventually deleted, the person claimed that employees who really loved the brand were the ones being fired. And, oh, the account lasted long enough so that the person was able to add: “Just overheard our Marketing Director (he’s staying folks) ask ‘How do I shut down Twitter?’”. That’s not something any marketing manager wants to see tweeted to their brand’s followers.

While it is unlikely that substantial harm was done to the HMV brand as a result of the series of “inside” tweets, this episode reminds us that it is essential from marketing, public relations and, yes, legal perspectives that everyone have an effective employee Twitter use and access policy in place, along with contingency procedures for how to handle rogue users. This means at a minimum (1) taking the time to write down the policy and have it vetted by legal, (2) communicating the policy to authorized users who have access to the brand’s platform, and (3) maintaining access to account information and passwords so that immediate steps can be taken to “shut down” rogue users. You don’t want to find yourself asking any “How do I “ questions in the middle of crisis.

Are You Ready For Renewal Season?

Elizabeth Sigety — Thu, 31 Jan 2013 07:37:36 -0500

Any company that has been franchising for longer than a couple years knows the basic routine to prepare for the upcoming renewal season. Indeed, we have previously addressed many of these issues. The pointers usually include getting in touch with your accountants to prepare for your audit, compiling information needed for the Item 20 charts, and reviewing the entire Franchise Disclosure Document to reflect any and all changes in your system.

There are also some items that can be forgotten as your system matures:

Look at your sales calendar. Plan in advance for your renewals relating to the timing of your sales activity. Many registration states prohibit sales in their state when a renewal is pending so you must sign your franchise agreements before filing any renewal application. So, think ahead--whether closing sales, discovery days or any other sales activity--because you may have to "go dark" for a while!!
Is it time to include an FPR? If you are a start-up franchisor and have not included a Financial Performance Representation in Item 19, it may be time to consider it. Potential franchisees like to see financial information when considering an opportunity and can wonder why a more mature system is not including it in the FDD. It can also help them obtain financing. More and more, we see that systems are including this information, so we suggest that you consider this step. It does take a lot of careful preparation and gathering of financial information, so make sure to allow enough time to put this together properly.
Website Updates. Have you reviewed your website recently - with your attorney? Well, if you have not reviewed it, your examiner might! Though many franchisors view their website as merely a marketing tool, it is reviewed from a regulatory standpoint for financial representations, false advertisement, disclaimers and inconsistencies with the information in your FDD. Also, as this blog has noted, the government has been checking on compliance with internet privacy standards. So, if you have updated your website, or even if you have not, put a thorough review of it on your list before submitting your renewal.
Don't forget your Marks. The US Patent and Trademark Office does require filings to maintain your marks. Check in with your trademark attorney to be sure that all filings related to your marks are up to date.

This is a busy time, but some advance planning and checking can make it easier. Happy Renewal Season!!

Thinking of Expanding Internationally? Then You Need to Know about this Initiative

John Gotaskie — Fri, 18 Jan 2013 10:19:20 -0500

Were you aware that the Overseas Private Investment Corporation (OPIC), the international development arm of the United States Government, is pioneering a new international franchise financing program? News of this exciting new initiative comes to us via a very fine blog post written by Josh Merin on the IFA FranBlog entitled, "Ground Breaking Initiative to Finance International Franchising".

The OPIC is partnering with the Middle East Investment Initiative (MEII), a 501(c)(3) non-profit organization which has pioneered the financing of small and medium-sized businesses in the Middle East, to guarantee loans to non-US businesses so as to enable them to:

Acquire US franchises
Operate those franchises
Produce goods and services to supply the franchises
Establish businesses as franchisors

According to Mr. Merin, the partnership will begin in Tunisia--where the Arab Spring began--with a goal of the development of a franchising sector in that country. If successful, OPIC and MEII intend to make the project a template for other countries.

This initiative is very exciting because franchisors will be able to enter the Tunisian marketplace with greater confidence because their franchisees will have the financial backing of the United States Government. As lawyers who have helped many of our clients head to foreign markets, we too are very excited about this initiative.

The IFA promises more information to come on this initiative in future blogposts, and at both the IFA Convention and the Med Tunis Expo (Feb. 27th to March 1). Also, the IFA will be hosting a webinar on Wednesday, January 23rd at 11 am ET. You can register for the webinar by clicking here.

Your Liquidated Damages Clause: Is It Enforceable?

John Gotaskie — Mon, 07 Jan 2013 07:00:00 -0500

Recently, a U.S. District Court in Ohio rejected a liquidated damages clause in a franchise contract. The case (LSI v. Roundup) involved termination of franchisees by a franchisor for breach of the franchise agreement by the franchisees. As such, you might first think that this case falls in line with the Sealy line of jurisprudence holding that franchisors are not entitled to lost future royalties when they initiate the termination. A closer reading of the case, however, demonstrates the court's real concern was that the contractual liquidated damages clause was an unenforceable penalty and not a reasonable estimation of the franchisor's probable damages.

The case involved the franchisor of Yogi Bear-identified campgrounds, such as "Yogi Bear's Jellystone Park Camp-Resorts". The franchisor terminated three franchises for failure to make required royalty payments. Two of the franchise agreements contained a liquidated damages clause. The stipulated damages provision provided that the franchisor, upon termination of the franchisee, was entitled to damages equal to:

all sums then currently due and owing from the franchisee to franchisor
AND
the monthly average royalty and service fee paid or due by the franchisee for the three years immediately preceding termination
TIMES
the number of months remaining on the franchise agreement

That final amount was then to be reduced to net present value.

The District Court stated that Ohio law recognizes stipulated damages clauses where the amount of damages at time of contracting is likely to be uncertain and difficult of proof. Moreover, it in fact agreed with the franchisor that lost future damages on a franchise agreement are likely to be difficult to predict with certainty and that the best indicator of future loss is the amount paid by the franchisee prior to termination. The Court further saw no evidence that the clauses were unconscionable or were not entered into at arm's length by the parties.

The Court balked, however at the inclusion of all sums due and owing in the calculation of liquidated damages. It is important to note the Court was not objecting to the inclusion of a damages award that included all sums due and owing in and of themselves. Instead, it was the inclusion of that amount in the damages calculation which troubled the Court. Specifically, the Court calculated that a damages award including the sums due and owing would be roughly 11 times more than one that simply included the monthly average royalty and service fee paid or due. Such a disparity, according to the Court, would result in the imposition of stipulated damages not reasonably correlated with, and disproportionate to, the probable harm suffered by the franchisor.

Thus, the Court granted summary judgment on liquidated damages to the franchisees, and the franchisor was ordered to prove actual damages at trial--a costly result for the franchisor. Interestingly, the franchisor argued to the Court for the exclusion of the all sums due and owing portion of the liquidated damages calculation. The Court rejected this argument, stating that it was required to evaluate the clause as written.

The good news is that this case demonstrates pretty convincingly that most courts reject the Sealy model of categorically rejecting liquidated damages when the franchise agreement is terminated by the franchisor. Instead, most courts now appear willing to enforce liquidated damages clauses on their own terms, even when the franchisor terminates the agreement. The lesson is that courts will continue to carefully evaluate liquidated damages clauses so as to ensure they are reasonably correlated with, and proportionate to, the franchisor's probable harm.