New York Franchise Law Blog

Creating Your Franchise System: Why The FDD Preparation "Process" Matters?

Charles Internicola — Thu, 10 May 2012 09:44:39 -0500

Time and again I am reminded of the critical importance of the FDD preparation "process" and why the quality of the FDD preparation "process" will substantively impact the quality of your eventual franchise system.

What do I mean by the FDD preparation "process". Basically, I am referring to the methods and communications by which you either, individually, or with your management team will be working with your franchise lawyer respecting the preparation of your Franchise Disclosure Documents. Franchise systems must evolve over a period of time (typically three to six months) require a "process" that examines the assets and core elements of a business, the unique factors of the business and, both, the personal and business goals of the start-up franchisor. After this evaluation is completed, this "process" must then focus on creating a franchise system (structured by way of the FDD and Franchise Agreement) that reflects the business being franchised.

Far too often, "process" is ignored and many just insist on creating a franchise system and franchise disclosure documents that fit within a rigid framework without flexibility and without recognition and amplification of the unique aspects of the franchised business. So if you are considering franchising or involved in the preparation of your FDD, pay attention to the "process" and question whether or not both you and your franchise lawyer have developed a clear understanding of what your business if (really) about and what your franchise system should look like in the future. Don't just accept components of a franchise system just because t"that is how everyone else is doing it".

Some things to consider:

What does your protected territory look like?
Royalty structures need not be based on a "fixed" percentage of gross sales.
How important is social media to your business?
How will your FDD and Franchise Agreement deal with web procurement and distribution of products and services.
Must every franchise unit conform to uniformity requirements or can you "localize" and "individualize" franchised units?]

There are many other things to consider but, the most important, is to know that you must actively participate in a partnership with your franchise lawyer to ensure that your franchise system is as unique as your business. By the way – if you don't think that your business is unique then you have either not properly evaluated your business or, quite possibly, your may not be ready to start a franchise.

Franchising Your Business: What is the Right Franchise Term?

Charles Internicola — Tue, 17 Apr 2012 09:30:11 -0500

This morning, in speaking with a client regarding the development of her franchise system (a system based on a well tested and unique service and business model) we discussed “what the right franchise term should be, i.e., 5 years, 7 years or 10 years”.

The answer to this question is one that must be unique to the franchise opportunity and one that is focused on the franchisee and the franchisee’s potential return on his or her investment. That is, “what is a fair franchise term that will permit a franchisee to generate a solid return on his or her franchise investment?”

As a potential franchisor, you must discuss with your franchise lawyer the start up costs that will be incurred by your prospective franchisee, the potential for profits and a sufficient time period for the franchisee to generate an acceptable rate of return. Just selecting an arbitrary time period (2, 5, 10 or 15 years), without any further analysis, may result in a mistake that shortchanges either yourself or your franchisees.

FDD Trademark Disclosures: What Disclosure is Required When Your USPTO Trademark Application is Rejected

Charles Internicola — Thu, 12 Apr 2012 07:43:23 -0500

A core component to Franchising is the inherent trademark license granted from franchisor to franchisee. In a “perfect IP world” the franchisor’s principal trademarks are registered with the USPTO and FDD Item 13 discloses the registration information.

Since nothing is ever perfect, many times, franchisors will fail to obtain registration of their primary marks. There are many reasons for a USPTO registration denial, including, the claimed mark being “descriptive” or “confusingly similar” to an existing mark that previously obtained registration.

Failure to obtain registration at the federal level does not render a tradename or trademark valueless or one that, necessarily, needs to be abandoned. One example being a trademark that has acquired common law protections and rights resulting from a franchisors use of that mark within certain geographic areas or regions.

So, when faced with disclosure of your unregistered trademarks, what information must be disclosed in Item 13. The FTC Compliance Guide is extremely instructive on this point:

First (Disclaimer): The following disclaimer must be stated in Item 13:

We do not have a federal registration for our principal trademark. Therefore, our trademark does not have as many legal benefits and rights as a federally registered trademark. If our right to use the trademark is challenged, you may have to change to an alternative trademark which may increase your expenses.

Second (Explanation): Explanations are permitted. A franchisor is permitted to disclose common law rights that a franchisor claims to an unregistered mark. The FTC Compliance Guide does a good job of illustrating a potential disclaimer. The following is a portion of the sample qualifying disclosure contained in the FTC compliance guide.

We grant you the right to operate a shop under the name “Belmont Muffler Shop”. You may also use our other current or future trademarks to operate your shop. By “trademark,” we mean names, trademarks, service marks and logos used to identify you shop. We registered the trademark on the United Stated Patent and Trademark Office principal register on May 11, 1993, as Number 379286.

You must follow our rules when you use these marks. You cannot use a name or marks as part of a corporation name or with modifying words, designs, or symbols, except for those which we license to you. You may not use Belmont’s registered name in connection with the sale of any unauthorized product or service, or in a manner that we have not authorized in writing.

On June 4, 2003, the United States Patent and Trademark Office rejected Belmont’s application to register the mark “Super Mufflers” because the mark was found to be confusingly similar to a previously registered mark.

Our inability to register this mark on the federal level permits other to establish rights to use the Super Mufflers mark. Such use of the Super Mufflers mark does not occur in areas where our franchisees are operating or advertising under the mark, or in the natural zone of expansion for Belmont’s shop. In addition, others outside the Belmont system who use the Super Mufflers mark must act in good faith and without actual knowledge of out prior use of the mark. However, if others establish rights to use the Super Mufflers mark, we may not be able to expand into these areas using that mark.

Caution should always be taken when proceeding with an unregistered trademark. However, if you are faced with this situation there are options.

Preparing Your FDD: Why You Must Avoid the Generic

Charles Internicola — Thu, 02 Feb 2012 11:41:03 -0500

Time and again when working on a franchise project - preparing the FDD and establishing the structure for a client's franchise system - I am always reminded of one critical fact: That when it comes to franchising, every business is different. Quite frankly, if there is nothing unique about your business, what you offer clients and how you deliver what you promise then, you should not be looking to franchise your business.

However, if you can identify the unique factors and advantages associated with your business and what you offer, it is critical that you consult and work closely with your franchise lawyer to ensure that your FDD and Franchise agreement reflect and, more importantly, protect these unique business factors. I am tired of reviewing generic agreements that, many times, leads to litigation and disruption of what could have been a great franchise system. So when working with your franchise lawyer, consider and discuss:

What are the core business assets that your franchisees will be utilizing;

What systems and procedures can you put in place to ensure that franchisees conform and follow your franchise system. What I am talking about here is not the typical litigation clauses contained in the franchise agreement but rather integrated business systems that force or, at least ensure, that franchisees have every possible incentive to comply with system requirements;

What are the core assets, services and/or products that will be delivered to your clients and how can you integrate your business systems into your FDD and franchise agreement to ensure that you maintain control over the delivery of your products and services.

There are many other factors and considerations. However the key point here, I believe, is that you must identify the unique components and characteristics of your business and ensure that your FDD and franchise agreement reflects same.

Franchisors: How to Approach the Enforcement of Your Restrictive Covenants When Negotiating a Franchisee Renewal

Charles Internicola — Tue, 03 Jan 2012 09:26:54 -0500

When a franchise agreement expires, franchisors and franchisees, many times, enter a decision making period to determine, discuss and negotiate whether or not the the franchise agreement will be renewed. Although not preferred, this post-termination negotiating period is sometimes necessitated by on-going negotiations and delayed decisions. During this critical negotiating period - one where the franchisee is, most likely, operating the franchised business without a franchise agreement - franchisors, many times, unnecessarily jeopardize the protection of their trademarks and trade dress by failing to require the Franchisee sign what should be a mandatory acknowledgment.

The Scenario - Franchise agreement expires and franchisor and franchisee negotiate the potential renewal. During the "post-termination negotiations" the franchisee continues to operate the franchised business and continues to utilize the franchisor's trademarks and trade dress. Although the Franchisor does not expressly acknowledge the franchisees continued operation, the franchisor does not continue with the enforcement of the franchise agreement's post-termination restrictive covenants.

The Problem that Arises - By permitting the franchisee to continue operations - without the benefit of an on-going franchise agreement - the franchisor is legally acquiescing to the franchisees technical infringement of the franchise systems trademarks and trade dress. In doing so, the franchisor weakens its marks and makes later enforcement of the franchisee's post termination restrictive covenants more difficult. While this "problem" is, typically, not fatal, it is nevertheless costly. Especially where negotiations break down and the franchisee continues to violate the restrictive covenants.

The Solution - During this gap negotiating period, insist that the franchisee sign an agreement whereby the franchisee acknowledges that the franchisor is withholding enforcement of the post-termination restrictive covenants for a limited period of time, i.e., two weeks

The foregoing "problem" is not that great but it is an issue that "muddies the water" in franchisor and franchisee litigation and results in unnecessary legal fees and time. That is, rather than advancing the franchisors right to restrict the former franchisees future business operations, the franchisor is exposed to the frivolous defense that, somehow, the franchisor acquiesced and waived its right to enforce the post-termination covenants.

What a Franchise Lawyer Learns from His Clients

Charles Internicola — Sat, 17 Dec 2011 10:38:15 -0500

Starting a franchise is an exciting process and undertaking. So much so, that one major benefit of being a franchise lawyer is that I get to work with extremely focused clients who understand entrepreneurship and who, more often than not, are extremely motivated to bring their business experiences to the "franchising table". So, in partnering and working with our clients to develop their own franchise system, along the way, there are many business points that I learn. Here are a few:

Business Systems are Critical. Every successful business requires established systems and procedures that are focused on the consistent delivery of product or services. Nothing should be left to chance so as a business owner and future franchisor consider what your systems are for (a) advertising and promoting your products or services, (b) communicating with prospective clients, (c) scheduling the performance of services or the delivery of product, and (d) consistently communicating and informing your clients and customers.

Understanding Your Client Base is Critical. I am always impressed by how well our franchisor clients understand their customers. When establishing a franchise one of our questionnaires relates to customer demographics and information. Our clients readily answer this question by focusing on their "perfect customer and client" and they readily provide us with a detailed description. So, if you are considering franchising, can you answer who your "perfect customer is" and are their key characteristics? When establishing the location of franchised locations, this information is critical.

Database Systems are Critical. Many of our clients utilize database systems to maintain customer lists and to facilitate consistent email communications, promotions and mailings. This makes sense and, quite frankly, is almost mandatory in todays business environment. In addition to the delivery and sale of your products and services, as a franchisor, database systems will be critical to facilitating and maintaining communications with franchisees. Following the lead of our clients, I personally utilize Infusionsoft to manage our client communications and franchise law publications. What systems do you maintain? How do you track and communicate with your customers? How will your franchisees communicate with their customers?

So when it comes to franchising, understand the significance of your "business systems" and why it is critical that your FDD and Franchise Agreement account for these business systems and create a legal platform that will allow these systems to evolve and change over time.

Franchisors: Do your Environmental Marketing Claims Comply with FTC Rules?

Charles Internicola — Fri, 28 Oct 2011 07:17:45 -0500

Proceeding with the ever increasing and costly regulation on business (a separate issue better suited for a publication on politics) the Federal Trade Commission (FTC) has issued "guidelines" respecting the use of environmental claims in advertising and marketing. Considering that many franchisors and other businesses rely on environmental claims in their advertising and packaging franchisors, franchise lawyers and all business owners need to be aware of these "guidelines".

So what are some of the basics that you need to know?

(a) Guidelines. Although identified as administrative "guidelines" as opposed to new enacted regulations it is clear that the FTC will be utilizing existing law and regulation to enforce its environmental labeling requirements.

(b) Ambiguity. The guidelines are indeed ambiguous and leave much to be interpreted. As such, implementation of environmental marking claims must be planned out with your franchise attorney and general counsel.

(c) Advertising Standards. There are many components to the FTC guidelines, but some of the base elements that you must be aware of include:

Scientific Proof. When making claims like "100% ____ Free" or "Made from Recycled Materials" the FTC Guidelines require that you base these claims on scientific evidence. An example would be to have the product tested and to maintain records of the scientific company. Basically requiring you to test the product and to maintain records of the results.

Recycling Claims. The FTC guidelines require substantial qualification and evaluation of recycling claims. When claiming a product to be made from recycled materials, among other things, you must qualify the nature and volume of the recycled components. For example:

Unqualified claims of recycled content may be made if the entire product or package, excluding minor incidental components, is made from recycled material. For products or packages that are only partially made of recycled material, a recycled claim should be adequately qualified to avoid consumer deception about the amount, by weight, of recycled content in the finished product or package.

Environmental Attribute Claims. The FTC guidelines also focus on and seek to prevent what the FTC refers to as the "overstatement of environmental attribute". So product and packaging claims "should not be presented in a manner that overstates the environmental attribute or benefit expressly or by implication.

Not only is this a tough standard - i.e. one that deals with both express and "implied" marketing statement - but also one that is ambiguous. The FTC does, fortunately, offer some examples of misleading claims.

Example 1: offered by the FTC, provides some insight into application of these guidelines;

Example 2: A package is labeled "50% more recycled content than before". The manufacturer increased the recycled content of its package from 2 percent recycled material to 3 percent recycled material. Although the claim is technicoally true it is likely to convey the false impression that the advertiser has increased significantly the use of recyled material.

Prior to finalizing product labels, packaging and advertising materials it is important to evaluate the FTC guidelines. Franchisors, franchise lawyers and general counsel should establish a set program for identifying and evaluating environmental claims and establish written procedures as to each claim.

Franchising Your Business: What you Can Learn from Existing Franchisors

Charles Internicola — Wed, 31 Aug 2011 08:33:49 -0500

For the successful business owner and entrepreneur the thought of “franchising your business” is something that requires serious consideration and a good deal of “scrutiny.” There are many legal and business factors to scrutinize and there are many sources of information that you should be evaluating (see, our franchise library). However, one great source of information includes existing franchisors and the successes, failures and lessons that they have learned.

In a recent franchise article on Business News Daily, Pierre Panos, the founder and CEO of Fresh to Order, explains what he learned about “franchising his business.” So here is what Mr. Panos has to say about the do’s and don’ts based on his own experience:

Do’s:

Ensure your unit economics work for you before franchising;
Make sure the concept is fully developed before you start franchising (minor tweaks in the future will be okay but major changes are not);
Ensure you get a well respected business and franchise attorney familiar with franchising to prepare your Franchise Disclosure Document (FDD) and related paperwork – if not one unhappy franchisee could ruin the entire system;
Have all your training manuals and operations procedures perfected before; and
Start a franchise association early – franchisees are your partners, not your employees.

Don’ts:

Don’t grow too quickly from a small base of stores to avoid losing control of your brand standards;
Don’t grow all over the country or world before you can support stores effectively – grow around your home base first;
Be very selective when accepting franchisees into your system;
Don’t outgrow your support structure; and
Don’t run out of cash – be fully capitalized when your business is in growth mode.

As a franchise lawyer I am a big proponent of establishing a franchise system focused on “controlled growth” and Mr. Panos’ advice to treat franchisees as “partners.” There is a lot to be evaluated in Mr. Panos’ advice and many questions that you should be evaluating. So, what will your unit economics look like? What do you need to do to insure that your FDD and Franchise Agreement are developed to support future growth? What is your plan to turn franchisees into partners and raving fans?

For additional information about setting up a franchise, we recommend this article:
How to Franchise Your Business

Can You Franchise Your Health Care Related Business?

Charles Internicola — Fri, 26 Aug 2011 11:44:54 -0500

As with any other method of practicing medicine in the United States, a health care franchise is subject to a multitude of complicated federal and state health care fraud and abuse statutes, regulations, case law and administrative opinions. The concept of “franchising” a health care business is a novel approach to the practice of medicine and must undergo a systematic review and evaluation of the proposed (a) franchise system, (b) business and compensation arrangements, (c) franchise disclosure documents and (d) compliance programs.

The most common regulatory and compliance issues affecting health care franchises concern the corporate practice of medicine, prohibited self-referrals and prohibited remunerations. The failure to comply with the foregoing regulations and statutes can result in civil and/or criminal prosecution against both the franchisor and franchisees.

In certain instances the proposed franchise’s business systems and financial arrangements can fall within applicable safe harbors and/or exceptions, or can be narrowly tailored to effectuate compliance with applicable regulations and statutes. In any case, the proposed franchise will require a thorough evaluation and the preparation of strict guidelines and materials for both franchisor and franchisees to follow.

If you are considering franchising a health care business, or would like to conduct a comprehensive review of your existing health care franchise, please contact Ms. Ilana Sable, Esq. to evaluate the options available to you.

For additional health care law articles by Ilana Sable, Esq. visit the Health Care Compliance Watch blog.

Do Franchisors Really have Discretion in the Site Selection Process: An Instructive Franchise Law Decision from a New York Court applying Georgia Law

Charles Internicola — Thu, 14 Jul 2011 11:42:01 -0500

For franchisors, there are two realities when it comes to the enforcement of your franchise agreements: "Reality 1" being the rights expressly and plainly stated in your franchise agreements and "Reality 2" being how, in a court room and in litigation, a court may interpret (and even supplement) these rights. For many franchisors - from a business perspective - reality 1 and reality 2 may be very different. That is, many times court are inclined to interpret a franchise agreement in a manor that imposes additional rights and obligations on a franchisor. One such "additional right" - that is a right that cannot be found in your franchise agreement but may be imposed by a court - is an implied covenant of good faith and fair dealing. This "implied covenant" is typically asserted by franchisees in an effort to superimpose additional contract rights in a franchise agreement.

In a recent legal decision - Yamin v. Moe's Southwest Grill, et al. (2011 NY Slip Op 4803) - the New York State Appellate Division evaluated issues involving area development rights, a franchisors site selection discretion and the application of implied covenants of "good faith and fair dealing". Since the franchise agreement included a Georgia State choice of law provision, the court evaluated Georgia's version of the contract law "implied covenant of good faith and fair dealing" - a standard similar to many other states. The courts decision did not involve novel issues and is not ground breaking, but, it was extremely well reasoned and provides some instructive points for franchisors and franchise counsel about commonly imposed covenants of good faith and fair dealing.

Covenants of Good Faith and Fair Dealing. As a matter of basic contract law, courts commonly impose a "covenant of good faith and fair dealing" to contracts. When a franchise agreement affords a franchisor with discretion or right to impose an obligation on a franchisee or approve a franchisee action this "implied" covenant imposes an obligation on the franchisor to act in good faith which typically means that the franchisors decision (approval or non-approval) must be based on some consistent business standards.

An insightful point raised by the court in Yamin, is that the court may (in rare circumstances) disregard imposing this implied covenant "if" the franchise agreement expressly and clearly leaves the franchisor with "complete and absolute discretion". This is a tough standard to meet and ultimately the Yamin court did impose an implied covenant of good faith and fair dealing even though the site selection clause in the Marketing Development Agreement, expressly stated that the "franchisor may reject any proposed site for any reason in it's sole discretion". The court evaluated this seemingly absolute clause within the overall context of the agreement and cited to other agreement provisions - including one stating that the franchisor would "utilize its then current site selection policies and procedures" to evaluate a franchisees site selection - as one mitigating the franchisors "absolute discretion" and opening the door to the implied covenant of good faith and fair dealing.

Question: Is it really necessary to refer to a franchisors "then current site selection policies and procedures"? What value does that add to a franchise agreement?

Ultimately the franchisor prevailed on its motion for summary judgment and it did so for good reason: although the court imposed a covenant of good faith and fair dealing the court nevertheless held that the franchisor met this standard where the franchisor clearly documented the legitimate grounds by which it rejected the franchisees proposed site. For franchisors it is important to document - as a part of your customary day-to-day business practices - the franchisee communications regarding site selection. These documented communications could very well serve as evidence that helps cut short unnecessary litigation.

Injunctions and Franchise Disputes in the State of New Jersey

Charles Internicola — Thu, 19 May 2011 13:39:02 -0500

When it comes to "franchise litigation" and disputes between franchisors and franchisees almost, inevitably, the issue of injunctive relief is raised. Franchisors typically seek injunctions involving (a) the turn-over of the franchise location, (b) the de-identification of the franchise location, (c) specific performance requiring the franchisee to protect the franchisors marks, and/or (d) the enforcement of non-competition covenants where the franchisee establishes a competing business. Franchisees typically seek injunctive relief focused on the franchisee's preservation of its franchise location, enforcement of protected territories and specific performance as to the franchisor's on-going obligation to support the franchisees business and to maintain access to proprietary products and services.

So, when faced with a franchise dispute in the State of New Jersey, franchisors, franchisees and their legal counsel need to be aware of the basic but thoroughly applied standard of review that New Jersey courts apply to applications / motions for injunctive relief. The most commonly cited and relied upon legal decision is the decision of the New Jersey Supreme Court in Crowe v. DeGioia. Although the Crowe decision did not involve a business or franchise dispute (worse - it involved a marital dispute) it, nevertheless, sets the standard for New Jersey injunctions. Under the Crowe decision, franchisors and/or franchisees seeking injunctive relief must evaluate and be aware of the following legal proofs:

Demonstration of "Irreparable Harm". When seeking an injunction the moving party - whether franchisor or franchisee - must demonstrate that absent the award of a preliminary injunction that such party will suffer "irreparable harm". Irreparable harm is typically equated with a harm for which a future "monetary award" cannot serve as proper or adequate compensation. For franchisors, "irreparable harm" is typically alleged to occur where the franchisor's trademarks are in jeopardy or where the franchisors proprietary trade secrets are alleged to have been disclosed or violated by the franchisee. For franchisee's irreparable harm, typically, comes in the form of franchisor violations (i.e., non-renewal and violation of protected territories) where the goodwill of the franchisees business is placed in jeopardy.

"Likelihood of Success on the Merits". The moving party must demonstrate that as to the causes of action set forth in the underlying complaint that the moving party possesses a "likelihood of success on the merits". For franchisors it is common to rely on claims and causes of action alleging a franchisees violation of the detailed "franchisee obligations" set forth in the applicable franchise agreement. Since franchise agreements, typically, favor a franchisor, franchisees seeking an injunction are, many times, forced to rely upon New Jersey's franchise relation statute - the New Jersey Franchise Practices Act. That is a franchisee would argue that the franchisors threatened actions violate the mandates of the New Jersey Franchise Practices act and that injunctive relief is merited.

Maintenance of the "Status Quo". The purpose of a preliminary injunction and/or temporary restraints is to maintain the "status quo" pending the ultimate resolution of each parties legal rights in the litigation. Accordingly, injunctive relief proper only where the moving party seeks to preserve and maintain its rights in a condition that is the same as when the litigation began. From a franchisee perspective the proper scope of an injunction should be to preserve the status of the franchisor / franchisee relationship and the on-going operations of the franchisees business. As to this standard, franchisors are, typically, afforded more latitude due to the express terms of the franchise agreement. For Franchisor's preserving the "status quo" is typically viewed from the point in time after termination of the franchisees rights.

In all instances it is critical for franchisors and franchisees to recognize that "injunctive relief" is an equitable remedy and is subject to the jurisdiction of New Jersey's Chancery Courts. Applications for injunctive relief (and opposition thereto) must be supported and backed-up by detailed factual certifications and affidavits. Applications for injunctive relief serve a critical tactical and substantive role in New Jersey franchise litigation.

Buying a Franchise: What does the Franchise Fee Cover?

Charles Internicola — Thu, 12 May 2011 12:26:28 -0500

When evaluating the purchase of a franchise, prospective franchisees, frequently, question the purpose of a franchise fee and question: "what do I get in exchange for paying the franchise fee". The following are some important factors that prospective franchisees should know about "franchise fees":

A franchise fee is a one-time fee charged to franchisees when purchasing a franchise;

Franchise fees are, typically, paid at the time of signing the franchise agreement;

Franchise fees are, typically, non-refundable. So, after signing your franchise agreement and paying the franchise fee if you later change your mind, chances are, that your fee will not be refunded;

Franchise fees, almost always, do not entitle you to assets or future services. Franchise fees serve as the "price of admission" for joining the franchise system and "obtaining the rights" to become a franchisee;

Franchise fees are typically non-negotiable. However fee fee variations do occur when purchasing multi-unit opportunities.

Franchise fees are legitimate fees (assuming that you have selected the right franchisor) designed to compensate the franchisor for the goodwill and systems that, presumably, the franchisor has developed and refined.

When evaluating a franchise opportunity consider that a franchise fee represents a legitimate expenditure designed to provide you with access to the franchisor's business systems, training and licensed marks. The value of a franchise investment should not be judged based on the dollar amount of the franchise fee but rather the quality of the franchise system. Factors more important than the "amount of the franchise fee" include: (a) the franchisors track record, (b) satisfaction of existing franchisees, (c) the quality of the franchisors training program, and (d) customer recognition of the franchisors goods or services.

What Constitutes a "Franchise" in the State of New Jersey and Why Should You Care?

Charles Internicola — Thu, 05 May 2011 12:52:30 -0500

In the State of New Jersey any determination as to the existence or non-existence of a franchise relationship requires a a factual evaluation of the legal rights and obligations between the parties.

What Constitutes a Franchise in New Jersey?

The parameters and factors to be evaluated are defined and proscribed by the New Jersey Franchise Practices Act, N.J.S.A. 56:10-3(a), which defines a "franchise" and "franchise relationship" as one requiring:

a written agreement for a definite or indefinite period, in which a person grants to another person a license to use a trade name, trademark, service mark, or related characteristics, an in which there is a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement or otherwise.

Based on New Jersey's definition of a franchise, franchise relationships in the State of New Jersey are characterized by (a) a written agreement, (b) a trademark license, and (c) a community of interest in the marketing of goods or services. Factors (a) and (b) are relatively self-explanatory. As to factor (c), a "community of interest", typically exists, where the presumptive "franchisor" / party granting the trademark license, maintains control to direct and/or influence the potential franchisees marketing and business activities.

Why Should you Care?

If your business relationship qualifies as a franchise your legal obligations and rights will exist subject to the mandates of, among other things, the New Jersey Franchise Practices Act. That is, your relationship as "franchisor and franchisee" will not only be governed by the terms of your written agreement but also by the statutory requirements set forth in the New Jersey Franchise Practices Act. Examples of some statutory mandates that will be imposed on your business relationship include restrictions limiting a "franchisors" ability to terminate a franchise without "good cause" and restrictions prohibiting a franchisor from imposing unreasonable performance requirements on its franchisees.

If you are a manufacturer or distributor with "licensed" retail outlets you must be on guard that your distribution / licensing agreement - depending on its terms - may impose and subject your business to franchise regulation and restrictions. if you are an independent "distributor / licensee" who sells or distributes product or services - if you qualify as a franchisee - you may have more legal protections than you realize.

Franchise Supply Programs: Maximizing Payments to Franchisors and Minimizing Risk

Charles Internicola — Mon, 21 Mar 2011 10:08:07 -0500

An obvious topic of interest to any franchisor is how much money can be made by operating its business. A smart franchisor will recognize its suppliers as an important source of revenue that can contribute directly to the franchisor’s bottom line. Recently, I discussed the law applicable to supplier payments with Kenneth A. Goss, Esq., Senior Counsel for a leading franchise system. The following is Mr. Goss' guest post on this important topic:

Franchisors can, and often do, enjoy the fruits of an effective supply program by receiving payments from suppliers based on the goods and services purchased by the franchise system. Payments from suppliers, which can be a significant source of revenue for a franchisor, are generally regarded by regulators and the courts as an established franchise industry practice based on the contractual rights each franchisor reserves in its franchise agreement. However, franchisors should be mindful that plaintiffs’ counsel in franchise litigation cases often look to exploit any weakness in a supplier payment program arguing that the franchisor has unfairly benefited from payments at the franchisees’ expense. The lesson to take away is that a well-structured supply program can ensure that a franchisor obtains maximum revenue from suppliers while minimizing the potential risk from franchisee claims.

Franchisors realize revenue from suppliers in many ways. Federal regulations recognize that payments from suppliers include all revenue and other material consideration, whether direct or indirect, that franchisors receive from suppliers based on purchases by franchisees. Direct payments may take the form of an ongoing rebate, an ongoing marketing allowance or an up-front contract signing bonus. Additionally, franchisors may receive indirect payments, for example, when a supplier sells a certain good or service to units owned by the franchisor at a lower price than the supplier sells the same good or service to units owned by franchisees. In the case of an indirect payment, the franchisor is deemed to have received the cash value of the discount or other benefit to the franchisor. Simply put, a payment from a supplier is the value the franchisor receives for allowing a supplier to participate in the franchise system’s restrictive sourcing program.

Federal trade commission regulations governing the offer and sale of franchises are concerned primarily with imposing upon franchisors the obligation to disclose payments from suppliers in the franchisor’s disclosure document. Specifically, federal regulations state that each franchise disclosure document should disclose whether the franchisor or any of its affiliates have the right to receive payments from suppliers and, if so, require franchisors to further disclose: (a) the precise basis by which the franchisor or its affiliate derives such revenue; and (b) the total revenue, either as a flat dollar amount or percentage of the franchisor’s total revenue, that the franchisor and its affiliates receive from the purchase and lease of required products and services by franchisees. Franchisors must also disclose the identity of suppliers that contribute to the franchisor’s advertising fund in each case where the franchisor collects payments from a supplier for that purpose. As long as a franchisor complies with its disclosure obligations under federal regulations, the franchisor is largely free to enter into whatever payment relationships with a supplier it wants.

A franchisor’s right to receive payments from suppliers, and any limitation on that right, is primarily a contract matter between the franchisor and each of its franchisees. Courts have traditionally held that the parties to a franchise relationship are independent contractors, free to pursue their own business interests including free to agree to the disposition of payments from suppliers as the parties deem best. This means that, on the one hand, a franchisor may reserve in its franchise agreement the right to receive payments from suppliers without restriction whatsoever. Because most franchisors provide services in connection with payments from suppliers, for example, by investigating and evaluating suppliers, negotiating supply agreements, collecting franchisee orders and otherwise administering its supplier program, it may make sense for some franchisors to keep all of the revenue it receives from suppliers. On the other hand, franchisors may agree to deposit some or all of the payments received from suppliers into a marketing fund or otherwise use such revenue for the benefit of franchisees. This latter approach can be useful in growing the system while heading off certain equitable challenges to the franchisor’s practice of collecting payments from suppliers.

Attacks on a franchisor’s rights to receive payments have traditionally and consistently been rejected by the courts. Such attacks are usually based on a contract theory of an implied covenant of good faith and fair dealing and on a variety of antitrust theories, such as unlawful tying under the Sherman Act, unearned brokerage, commercial bribery, and racketeering. So far, these claims tend to not be resolved in favor of franchisees. For example, a typical equitable argument in cases where a franchise agreement is silent as to whether the franchisor may accept payments from suppliers, is that a franchisor is bound by an implied covenant of good faith and fair dealing. An implied covenant of good faith and fair dealing would preclude the franchisor from deciding how best to use payments from suppliers and would obligate the franchisor to turn the revenue from suppliers over to franchisees in most situtations. Courts tend to disagree with this approach. Instead, courts generally hold that there is no right to share in payments from suppliers where a franchise agreement is silent because silence simply means that the parties have not reached an agreement as to the distribution of revenue from suppliers.

Taking into account the legal aspects as briefly described above is only part of structuring the right supplier payment program. Franchisors and their counsel must also consider important business implications in trying to strike the right balance for a franchise system. By doing so, a franchisor can strive to obtain maximum revenue from suppliers while minimizing the risk from franchise claims.

FDD Earnings Claims: A General Guide for Franchisors and Franchisees

Charles Internicola — Mon, 28 Feb 2011 14:29:37 -0500

For both franchisors and prospective franchisees alike, issues concerning "earnings claims", or the lack thereof, merit serious consideration and evaluation:

For Franchisors:

The decision making process starts with an initial determination as to whether or not the franchisor will include an earnings claims in its their FDD (Item 19). The typical advantage to including an earning claim representation is to assist with franchise sales and, in certain circumstances, to limit future litigation exposure. If a franchisor elects to include an earnings claim then the next level of inquiry resorts to assembling, documenting and properly structuring the information contained in Item 19. If the franchisor elects to "not" include an earnings claim (a decision made by many franchisors) then the franchisor's primary task will require the establishment and enforcement of a compliance program designed to prevent the inadvertent (or intentional) disclosure of "earnings" related information to prospective franchisees.

For Franchisees:

The evaluation of a franchisor's Item 19 earnings claims - or the lack thereof - represents a critical due diligence task for prospective franchisees. If Item 19 disclosures are included, franchisees must evaluate the earnings information disclosed and whether or not such "claims" provide insight into the potential "profitability" of a franchise unit. If earnings claims are "not" included then franchisees must be certain that they do not rely on any oral "earnings" statements or representations made the franchisors sales staff - that is franchisors are not permitted to make earnings claims or representations unless they are contained in writing in FDD Item 19.

Some basic - but critical - information to be aware of when considering "earnings claims":

Not Required by Law. Earnings claims are "not" required by law. However, if a franchisor, in connection with the offer or sale of a franchise, wishes to disclose an earnings claim or any earnings based information, such information must be disclosed in Item 19 of the franchisor's FDD.

Not Prohibited by Law. In many franchise sales settings franchisees are advised (typically by a franchisors sales agent) that "by law" the franchisor "is not permitted to make an "earnings claim" . The intended implication of such statement, sometimes, is for the prospective franchisee to assume that "the earnings are great and that the franchisor would be glad to disclose them but cant because of the franchise laws". Prospective franchisees need to know that this is not the case and that a franchisor's decision as to whether or not to include an Item 19 earnings claim is an optional decision. For many legitimate reasons many franchisors elect to "not "include earnings claims representations, however, this decision is optional.

Must have a Reasonable Basis. When drafting and preparing an earnings claim, franchisor's and their legal counsel must ensure that the franchisor possesses a "reasonable basis" for the earnings claim. Faced with this ambiguous legal standard, franchisors must ensure that the earnings claim is based on representative and current information that is documented in writing. Factors that should be included in this disclosure include the basis for the earnings claim, whether or not the claim is based on actual franchisee data and variations within the data pool.

When it comes to "earnings claims" that are many more factors to consider. When drafting Item 19 disclosures, sometimes, the process is more art than science. However when approached properly and diligently, earnings claims will serve as an important information and legal tool benefitting both franchisors and franchisees.

Retail Franchisors Beware: New Consumer Protection Developments in California

Charles Internicola — Thu, 24 Feb 2011 09:23:10 -0500

Franchisors of retail stores should become familiar with federal consumer protection laws and the consumer protection laws of each state in which the franchisor has retail operations. Recently, when discussing this issue with Kenneth A. Goss, Esq., Senior Counsel for a leading franchisor of retail businesses, Mr. Goss mentioned a development in California’s law. The following is Mr. Goss' guest post on this important topic:

California’s highest court recently expanded the Song-Beverly Credit Card Act of 1971 (the “Act”) to prohibit brick and mortar outlets in California from asking customers for zip codes in connection with credit card transactions. Franchisors with units in California should be aware of this expanded application of the Act and consider whether any changes are needed to system standards to keep franchisees in California operating within the bounds of the law.

By way of background, the Act (codified at Cal.Civ.Code § 1747 et seq.) prohibits retailers from asking customers who pay by credit card for personal identification information. The Act defines the term “personal identification information” to mean information concerning the cardholder that is not set forth on the credit card, including the cardholder's address and telephone number. According to the Act, a retailer could violate the law, for example, simply by asking a customer for his or her address at the point of sale. A retailer could also violate the Act by having space for a customer to provide personal identification information on a credit card transaction form. In any case, a violation of the Act could cost a retailer up to $1,000 in penalties per transaction plus other liabilities.

On February 10, 2011, the California Supreme Court ruled that a zip code alone can constitute personal identification information within the meaning of the Act in the case of Pineda v. Williams-Sonoma Stores, Inc. (2011 WL 44692), which overturned an earlier Court of Appeal decision. The issue in Pineda arose when a cashier at a Williams-Sonoma store asked the customer/plaintiff, Jessica Pineda, for her zip code at the time Ms. Pineda was making a purchase with her credit card. Williams-Sonoma recorded Ms. Pineda’s credit card number, her name and zip code in a database and subsequently used that information to determine Ms. Pineda’s address. Williams-Sonoma obtained Ms. Pineda’s address for the purpose of marketing products to Ms. Pineda and possibly also selling her information to other businesses. The California Supreme Court held that the act of asking for and recording Ms. Pineda’s zip code violated the Act because “the word ‘address’ in the [Act] should be construed as encompassing not only a complete address, but also its components.” The Court’s reasoning included that the legislature intended for the Act “to provide robust consumer protections by prohibiting retailers from soliciting and recording information about the cardholder that is unnecessary to the credit card transaction.” In light of the Pineda decision, franchise systems should be wary of their California units collecting information in connection with a credit card transaction.

The good news for retailers is that there continues to be important exceptions to the application of the Act. For example, the Act provides for exceptions in certain circumstances to (a) the collection of information for purposes incidental to the credit card transaction, such as when the retailer asks for an address to fulfill a delivery obligation; (b) the collection of personal identification information in connection with a credit card transaction if the retailer is contractually obligated to the card issuer to provide personal identification information in order to complete the credit card transaction; and (c) a retailer requiring a customer to provide reasonable forms of positive identification, provided that no information on the identification is written or recorded. Moreover, the Act has been held by a federal court not to apply to a consumer's credit card transaction in connection with purchases online because of the unique fraud concerns associated with online transactions. (See Saulic v. Symantec Corp., 596 F.Supp.2d 1323 (2009)). These exceptions simply mean that a franchisor should pay close attention to the practices of its California units because not all instances of a retailer asking for information is a violation of the Act.

Franchisors and their counsel should consider the expanded application of the Act as part of the franchisor’s analysis of consumer protection requirements in connection with developing uniform system standards to keep franchisees operating within the bounds of the law.

State Specific Franchise Information: A New Resource Added to NYFLB

Charles Internicola — Tue, 15 Feb 2011 18:33:04 -0500

As franchise counsel, like many of my colleagues and clients, maintaining an updated and current database of state specific franchise laws, registration requirements and regulatory entities is a critical task that we continuously work on and improve. After recently launching our internal client accessed database - and receiving some extremely positive feed back - we thought that starting a "public" database of "state specific franchise links and information" would be a helpful resource for our readers and the franchise community. At the very least, it could serve as a time-saver.

So, we are pleased to announce that we have added the "State Franchise Resources Map" to our site. The map is somewhat interactive: By "Clicking" on a particular state you will be linked/taken (willingly, of course) to our resource page for the selected state. Presently, our state specific resources include: (i) registration status, (ii) relevant franchise laws, (iii) applicable regulatory agencies, and (iv) useful links. Click here to access the State Franchise Resources Map.

The resources available for each particular state varies and, presently, our launch is at its "beta" stage. We intend to further refine and supplement our state specific information and we would appreciate any comments, criticisms or input that you may have.

Prospective Franchisors and Franchises: Prosperity when Faced with Economic Uncertainty

Charles Internicola — Mon, 17 Jan 2011 12:10:15 -0500

In 2010 two trends have become abundantly clear: With the ever accelerating "shift" in the United States economy a substantial number of successful business owners and qualified individuals have and continue to consider and explore"franchising" as an avenue for growth and income stability. That is, (1) successful business owners are considering the prospects and benefits of "franchising their business and becoming a franchisor" and (2) certain exceptionally qualified individuals are evaluating the prospect of "buying a franchise and becoming a franchisee" as a potential opportunity for income stability and growth.

The interesting thing about these "trends" is that they do not relate to and are not evidenced by franchise system development or franchise unit sales (in fact these "metrics" are, markedly, down with declining growth levels) but, rather, the "intensity levels" by which certain "exceptionally qualified" individuals and business owners have and continue to - for the first time - seriously consider the "franchising business model" . Faced with economic declines and economic uncertainty comes, what I believe to be, an exceptional "filtering process" and opportunity whereby a select number of exceptional prospective franchisees and franchisors will be presented with the economic incentive to create successful franchise relationships and, quite possibly, help redefine the franchisor/ franchisee relationship.

So, for both prospective franchisors and franchisees, my advice for 2012 is to evaluate opportunities thoroughly, understand that franchising is not right for everyone (in fact it is not right for "most" business owners and individuals), and, recognize that for a select few - who get it right - with our current state of economic uncertainty also exists a substantial opportunity for growth through franchising. However this "opportunity" requires precise planning and commitment - do not rush into the purchase of a franchise or the development of a franchise system.

FDD Disclosure Exemptions for Franchisors: Capitalized Facilities and Large Franchisee Investments

Charles Internicola — Fri, 31 Dec 2010 11:21:32 -0500

As franchise counsel I am a strong proponent of “disclosure” – the more of it, the better. Quality disclosures contained in your FDD serve a critical role in mitigating future litigation risk and expense. So, when it comes to FDD disclosure exemptions, we typically proceed with extreme caution. Nevertheless, in the appropriate circumstance, franchisors should consider or at least be aware of potential tools available to them when it comes to potential disclosure exemptions to the Federal Franchise Rule.

One such exemption relates to “Large Franchisees”. The “Large Franchisee Exemption” was incorporated into the federal franchise rule to alleviate and lessen disclosure requirements when dealing with “sophisticated” franchisees. The criteria established by the federal rule are related to “high net-worth” franchisees and certain qualified insiders. The “large franchisee exemption” may be applicable – subject to qualification – to the following individuals / entities / institutions:

Franchise sales involving ongoing entities such as airports, hospitals and universities with at least $5 million net worth and five years of prior business experience;

Franchise sales where the initial investment is at least $1 million exclusive of unimproved land and franchisor financing; and

Franchise sales with “insider” franchise purchases involving owners or officers of the franchise sytem, or managers with at least two years’ management experience in the franchise system.

Before adopting and relying on a disclosure exemption, careful analysis should be given to (a) satisfaction of federal and state law, and (b) a cost-benefit analysis as to the extra burden and cost that disclosure would require. From a litigation standpoint legal counsel for franchisors must be aware of these disclosure exemptions as potential defenses in litigation involving alleged disclosure violations.

Franchise Litigation: Preserving Your "Start-Up" Franchise System

Charles Internicola — Fri, 19 Nov 2010 14:48:39 -0500

An on-going and, almost, unavoidable reality that franchisors must continuously monitor, anticipate and evaluate relates to the prospect and threat of "franchisee litigation". Established franchisors, typically, are well aware of this risk and understand the necessity of implementing and following a strict franchisee compliance program designed to mitigate "litigation exposure" and keep legal fees in check. However, many times, start-up franchisors are unaware of the "litigation risks" associated with franchising and the consequences for failing to implement the appropriate litigation procedures.

During the start-up phase of a franchise system (i.e., one, two or five years into selling franchises) start-up franchisors are extremely susceptible to the legal and financial risks associated with franchisees attempting to "break away" from the franchise system. That is, where your initial group of franchisees attempt to "save money" by attempting to terminate their franchise agreements (and their obligation to pay royalties) and invalidate their non-compete covenants under the pretext of an alleged default and fraud associated with the franchise relationship (i.e., where the franchisees claim that you have failed to meet your obligations as a franchisor and fraudulently induced them into becoming franchisees). From a tactical standpoint, this franchisee "break away" type litigation is typically funded by wealthy franchisees who have experienced success with their franchises and are looking to establish a competing business and/or franchise system. Some factors that start-up franchisors should consider, include:

Be Aware of Economic Imbalances with Franchisees - Although franchises should only be sold to competent and responsible individuals with sufficient assets and capital, be aware of "millionaire" franchisees who are looking to become your "partner". These individuals have typically experienced success in other industries, may be experienced with the "business advantages" that litigation sometimes affords and possess the capital to overwhelm a start-up franchisor with limited funds.

Be Diligent about the Enforcement of your Franchise Agreements - From day one of the franchisor-franchisee relationship you must enforce each and every provision of your franchise agreement. Franchisee non-compliance must be immediatly addressed and remedied.

Uniformly Enforce your Franchise Agreements - Ensure that you uniformly enforce your franchise agreement. If there is disparity in the treatment of your franchisees (i.e., where you excuse one franchisee from performing a obligation performed by and enforced against other franchisees) , you will be exposing your franchise system to unnecessary franchisee claims.

Act Promptly to Enforce Non-Competition Covenants Contained in Your Franchise Agreement. When faced with "rogue" franchisees who attempt to operate a competing business (under the pretext that they terminated their franchise relationship) you must immediatly review with your franchise lawyer the necessity of commencing litigation and filing an emergency motion for injunctive relief.

The "best litigation" is the litigation that is avoided. Ensure that you implement franchisee compliance programs focused on the diligent enforcement of well defined procedures and obligations both on your part as the franchisor and on the part of your franchisees.