New York Franchise Law Blog

Intellectual Property: A Two Sided Coin for Franchisors and Entrepreneurs

Charles Internicola — Tue, 02 Mar 2010 14:02:54 -0500

If you are a successful franchisor or entrepreneur (of a non-franchised business), chances are that you place great priority on the development of your "intellectual property" such as your trademarks, trade designs and innovations that may be the subject of a patent. While successful business owners and entrepreneurs are great at innovating and creating "intellectual property", sometimes, mistakes are unnecessarily made respecting the protection of your "intellectual property.

When evaluating the development and protection of your intellectual property, the following are some factors that you should be aware of and considering as you manage your critical intellectual property assets:

Intellectual property is a "Two-Sided Coin" and is not limited to just "One Thing". That is, your view toward your intellectual property assets should be expansive and involve the recognition that you are not just limited to "trademarks" or "patents". Many of the key intellectual property assets that comprise your business may be afforded an array of protections involving trademarks, patents and a broad array of "common law" protections associated with "trade secrets", "customer lists", "production sources" and other confidential components that drive your business. The key is to properly structure your legal approach to these assets and afford them the maximum protection possible. For example:

- Have your key employees with access to confidential information about customers and production sources signed limited but enforceable confidentiality agreements;

- Do you review with your corporate counsel the current usage of your trademarks to ensure that your trademark registrations are current and that supplemental applications are not warranted;

- Have your production sources signed off on confidentiality agreements respecting key components or processes involved in the production of your proprietary products and supplies;

-Have you evaluated key product designs to determine whether or not your product may benefit from a "design patent.

As you are certainly aware there are many more issues and considerations concerning the protection of your intellectual property assets. However, the basic and extremely limited point I wish to convey that the creativity that you put into developing the unique intangible assets that drive your business should also be applied toward the active management and protection of these assets. Set a plan and actively discuss the protection of these critical assets with your corporate counsel.

The "Franchisor's Mindset": Some Factors that Franchisors and Franchisees should Consider

Charles Internicola — Mon, 15 Feb 2010 16:31:15 -0500

For both (a) franchisees deciding on the right franchise investment and (b) franchisors establishing a solid franchise system, the right "mindset" is critical. That is, it is critical that your understanding of franchise opportunities and franchise systems go beyond the generalized and involve a detailed understanding and evaluation of the overall mindset that a successful franchisor brings to the table. Reflecting on "some" of the critical points that my clients have raised over the years, the following is my take on some of the factors that you (whether a prospective franchisee or franchisor) should be considering in evaluating a "franchisor's mindset":

Focus on Franchisee Training is Paramount - Smart franchisors, that is franchisors that are focused on the "long-term" are focused franchisee training. That is, the long-term road to franchise growth and the development of a valuable franchise system must be premised on the consistent development and training of its franchisees and not just a quick sale of a franchise unit. Is the franchisor focused on evaluating franchisee qualifications and and developing systems for for both initial and on-going training?

Franchise Growth Must be Planned and Controlled - Somewhat related toward a franchisor's "training mindset" is the franchisors "mindset toward growth". Franchise systems that grow to "fast" (i.e., at a rate that is not readily supported by expanded training, system development and market evaluation) are bound to fail. Is the franchisor focused on controlled growth and growth that takes place only after developing the necessary support and brand development systems?

Product Development must be Ongoing - One of the primary advantages of becoming a franchisee (in the right franchise system) is leveraging off of the franchisors centralized efforts in constantly developing, refining and improving the products and services that its franchisees offer. Product and brand development is a constant and on-going process and is critical to the continuing success of a franchise system. Is the franchisor focused on systems and a process that continuously reinforces and refines its brand and the products and services offered to its customers.

There are many, many more points and steps that successful franchisors follow. However, key to every franchise is a franchisor and franchise management team that approaches each day with a "mindset" focused on controlled growth, franchisee development and product development.

Franchisors: How do you Reduce your "Litigation Exposure" and "Legal Fees"?

Charles Internicola — Tue, 02 Feb 2010 09:57:00 -0500

Short Answer: Avoid lawsuits. That is, work on and establish with your legal counsel "legal systems and procedures" that is designed to avoid unnecessary litigation. (Slightly longer answer follows)

While the advice that I am offering here may sound obvious and, possibly, even a little self-serving, it is nevertheless an honest and critical point that far too many franchisors and business owners overlook. That is, in most (but not all) litigation once your are involved (either as a plaintiff or defendant) the advantages and benefits that may or may not stem from the outcome of the litigation will, many times, be outweighed by:

(a) the legal fees that you will incur,

(b) lost productivity associated with your focus on the lawsuit (as opposed to building your franchise systems), and

Faced with the inherent costs in all litigation, the best course of action for both start-up and established franchisors is to establish with your legal counsel open channels of communication focused on cutting-down and mitigating your "litigation exposure". That is, in addition to the critically important task of managing your regulatory requirements and disclosures as a franchisor, you must discuss and establish with your legal counsel a fair and flexible relationship and system focused on the management and monitoring of your day-to-day legal activities. Some of these activities should include:

(a) The review of vendor agreements,

(b) The establishment of standardized franchisee communications and compliance notices;

(c) The quarterly evaluation and review of your trademarks and the filing of supplemental trademark applications and affidavits;

(d) The establishment and maintenance of a specified and well documented "encroachment policy" respecting the grant of additional franchises;

(e) The establishment of a clear and concise policy respecting the negotiated modification of your franchise agreements;

(f) The maintenance of strategic employment agreements with your key employees that are focused on the implementation "enforceable" restrictive covenants;

While establishing an on-going day-to-day working relationship with your legal counsel may be more expensive than "doing nothing", the value of this planning process will far outweigh the cost associated with unnecessary and avoidable litigation. Once tasks become standardized and well establish, my experience has been than many activities may be incorporated into the tasks of your "in-house" staff and, over time, serve to reduce your long-term legal fees.

Franchisee Profitability: 8 Days, 8 Months or 8 Years

Charles Internicola — Mon, 25 Jan 2010 17:58:45 -0500

This afternoon in consulting with a client who had recently signed a franchise agreement involving a substantial commitment of capital, I was reminded about the importance of maintaining "realistic" expectations when buying a franchise. When discussing his expectations about his franchise purchase and the business that he will be developing, he was extremely "realistic" as to his expectations and the work ahead of him. That is:

(a) He diligently evaluated the "franchise opportunity" that he was investing in and thoroughly understood that, as with many businesses, it would be a number of months and possibly years (hopefully not) before he achieved a level of profitability and acceptable return on his franchise investment; and

(b) He understood that the success of his franchise rested on the hard work, marketing and business development that he (and his family) would bring to this new business. Significantly, his approach is not one of "lets wait and see" what business comes through the door.

The most important lesson that I was reminded of by my client - a lesson that future franchisees and franchisors may also put to use - is that getting your expectations "right" is critical. When considering a business opportunity and setting your "expectations", franchisors and franchisees should consider:

Profitability will Take Some Time - Profitability is not guaranteed and, depending on your particular franchise opportunity, may take 8 days (unlikely), 8 months or 8 years (hopefully not). That is, you must plan ahead and account for the extremely realistic fact that you in selling a franchise or purchasing a franchise you must properly communicate and/or understand that reserve capital will be critical. Evaluate the opportunity thoroughly and ensure that you have developed the correct expectation about the future profitability of your business.

Franchisors Can't (and Shouldn't) do Everything - Buying a franchise does not mean you just pay money and then sit back and wait for business to "walk through the doors". You must be actively engaged in the marketing and "development" of your business. Look to your franchisor as your "partner" and not your "caretaker". Franchisors, be selective about the franchisees that you approve - look for franchisees that will contribute to the development of your franchise system.

Get your expectations right.

New York Seminar: How to Buy Your First Franchise

Charles Internicola — Tue, 19 Jan 2010 17:12:49 -0500

NYC Business Solutions (a division of NYC Small Business Services), the Manhattan Chamber of Commerce and the US Department of Commerce will be conducting and coordinating a seminar - "How to Buy Your First Franchise or Grow the One you Have" - for both prospective and current franchisees.

Seminar Date: February 17, 2010

Seminar Time: 8:00 AM - 10:00 AM

Seminar Location: 110 William Street, 4th Floor, New York, NY 10038

Seminar Registration Information

If you are considering the purchase of a franchise your best resource and asset will be "information". Information about the franchisor, information about your legal rights, information about your estimated start-up expenses and information about your rights and obligations as a franchisee. My point being attending a seminar such as the one offered by NYC Business Solutions can only be helpful in this important decision making process.

Hopefully, you will also find our articles about buying a franchise to be helpful. Good luck.

Franchisor Basics: Disclosure of Financial Statements

Charles Internicola — Mon, 11 Jan 2010 10:00:52 -0500

Part of the “Franchisor Basics” Series

Under the Federal Franchise Rule franchisors are required to disclose their “Financial Statements” in Item 21 of the Franchise Disclosure Document. All financial statements must be prepared in accordance with Generally Accepted Accounting Principals ("GAAP") and in all but an extremely limited number of situations involving a start-up franchisor, a franchisor’s financial statements must be “audited”. In the franchise regulations (16 CFR Parts 436 and 437) FTC provides detailed information respecting a franchisor's "Item 21" disclosure requirements, including:

Financial statements must be audited by an independent certified public accountant and prepared in accordance with GAAP;

Financial statements must be prepared in a "tabular" format providing for a comparison between current and prior fiscal years; and

Financial statements must include (a) Balance Sheet for the prior two (2) fiscal years and (b) Statement of Operations, Stockholders Equity and Cash Flows for each of the franchisor's prior three (3) fiscal years.

Other provisions apply for "start-up" franchisors (a topic that will be discussed in future posts) and the disclosure of the financial statements of a franchisor's "affiliates".

Franchising Basics

Charles Internicola — Mon, 11 Jan 2010 08:48:14 -0500

In an effort to expand the information provided at the New York Franchise Law Blog and, hopefully, the timeliness and value of this information for our readers and subscribers, we will now be featuring a continuing series of succinct fact based articles (in addition to our commentary and reports) focused on the "basics of franchising", comprised of "Franchisor Basics" and "Franchisee Basics".

These articles will serve as a valuable reference tool to our readers and, as always, it is important that you discuss the specifics of your franchise system, disclosure obligations and franchise decisions with your franchise attorney.

As always, we appreciate and welcome the comments and suggestions that we have been fortunate to receive from our readers. Please let us know if there are any specific franchise topics that you like us to address. Thanks.

Buying an Existing Franchise: Is their Value in the "Franchise System"?

Charles Internicola — Thu, 03 Dec 2009 11:48:17 -0500

When purchasing an "existing business" (whether a franchised or independent operation) prospective purchasers are faced with the critically important task of conducting a "due diligence" evaluation/investigation of the business under consideration. While there are many steps to the "due diligence" process and while many of these steps are the same whether the business is a "franchised operation" or an "independent location", one critically important distinction and factor that should not be overlooked and must be evaluated by the prospective purchaser of an existing franchise is:

"whether or not there is value in the franchise system?".

That is, as a purchaser, you must evaluate and determine what added value (i.e., profits and cash flow), if any, that you will be afforded by purchasing and operating a "franchised business" (and becoming a franchisee) as compared to a competing but "non-franchised" independent operation. When making this "assessment" you must recognize that there is tremendous variation and value between franchises - that is, some franchise systems add real value and advantages while some poorly run "franchise systems" simply drain the profitability of its franchisees. When making this assessment, some of the factors that you should consider, include:

Higher Sales Do Not Necessarily Equate to Higher Profits. As a franchisee one substantial obligation that you will be undertaking will include the payment of "royalties" to the franchisor. Since royalties are typically based on a percentage of your "gross sales" the franchised business that you are evaluating will most likely have higher operating costs than the non-franchised business.

Not all Franchise Systems are Equal. Some "franchise systems" are simply poorly run and ill conceived business operations that afford little, if any, value to its franchisees. So, don't just "assume" that the franchise business that you are considering will be properly supported by the franchisor - ask questions, speak to other franchisees and evaluate the benefits of the franchise system that you are buying into.

Start-Up franchisors: What is the Right Franchise Fee and Royalty Structure for Your System?

Charles Internicola — Mon, 16 Nov 2009 17:23:15 -0500

For the "start-up franchisor" (and even established franchisors) determining the appropriate franchise fee and royalty structure for your franchise system is a critical task that will have long standing implications. The fee structure that you establish will serve as the primary source of revenue for your franchise system and will represent one of the most significant "expenses and obligations" on the part of your franchisees. Set the fees to high and you risk franchisee and, ultimately, franchise system failure. Set the fees too low and you risk "franchise system" failure resulting from your inability (as the franchisor) to properly support, develop and expand your system.

The process of establishing your franchise fee and royalty structure should not be based on a rigid formula or a formula that simply duplicates the fees charged by your "perceived" competitors. Rather, your franchise fee and royalty structure should reflect the unique characteristics of your business, the sophistication of your existing business systems, the strength of your trademarks and your future obligations to maintain, develop and refine your franchise system and the rights of your franchisees.

When establishing these fees, some of the critical factors/principals that you should be considering, include:

The Initial Franchise Fee Should Reflect the Value of Your Existing System(s). In many respects the initial upfront franchise fee that you will charge to your franchisees should reflect the value of the existing "system(s)" that you have already established. Higher franchise fees are usually predicated on valuable, well established and tested "systems" and intellectual property assets. In making this assessment, consider:

(a) The legal strength of your trademarks and their USPTO registration status;

(b) The strength and recognition of your trademarks and trade dress by consumers in the marketplace;

(c) The competitive advantage(s) that will be afforded to your franchisees by your "established" business systems, products and services, including unique products and sources of supply.

The Initial Franchise Fee Should Reflect Your Initial Training Obligations. The initial training of your franchisees will play a significant factor in the development of your franchise system and the success of your franchisees. Your initial franchise fee should reflect and give consideration to the initial training obligations that you will be undertaking as you add each franchisee. Your franchise fee must be sufficient to ensure that you possess the necessary financial resources and systems to properly train your franchisees.

Your Royalty Structure Should Reflect Your Business and be Geared toward Franchisee Success. The relationship between franchisor and franchisee is one of interdependence. That is, to be a truly successful franchisor, you need successful franchisees. When structuring the ongoing royalty obligations of your franchisees, consider:

(a) Successful franchise systems require successful franchisees, so ensure that the ongoing royalty rate reflects the economics of your individual franchise units and does not inhibit franchisee "profitability";

(b) Royalties must be sufficient to support and pay the expenses associated with your current and ongoing efforts and obligations to continuously refine, develop, recreate and protect the core components of your franchise system. As a franchisor you will possess some serious and necessary obligations respecting the continued development and refinement of your franchise system. this is a serious obligation and your royalty structure must be sufficient to properly fund these activities;

(c) Your royalty structure should reflect your business. Although the typical or predominant royalty structure is based on a fixed percentage of gross sales, start-up (and even current) franchisors should consider possible alternatives that may better reflect the "unit economics" of their franchisees.

Starting a Franchise: How should You Approach the Development of Your Disclosure Documents

Charles Internicola — Fri, 06 Nov 2009 08:32:21 -0500

For the successful business owner considering the franchised expansion of his or her business one critical question that must be answered is "how do you approach the preparation and development of your franchise agreement." That is, do you "approach" the preparation and development of your franchise agreement (and franchise disclosure documents) as:

(a) A "legal obstacle" that requires the preparation of "generic" agreements and disclosure documents;

(b) A collaborative process focused on the development of a critical "asset" that uniquely reflects, identifies and protects the components of your business (that is what has made your business successful), franchise, and franchise system.

Why do I ask? Because your approach will determine the ultimate outcome of this important process.

Approach "(a)" - the "legal obstacle approach" will typically lead to generic agreements and disclosure documents that, by all accounts, result in little (if any) value to a developing franchise system. While this approach may satisfy (or appear to satisfy) your regulatory disclosure requirements they do nothing to advance the development of your "franchise system". That is, approach "(a)" typically leads to "form over substance" and not much else. When speaking with start-up franchisors that have followed this approach - an approach that they followed with the best of intentions but based on what may be poor advice - I am typically advised that their franchise agreements simply do not work for their business and franchise system.

For the start-up franchisor, approach "(b)" is the only true option. By following this approach your franchise agreement and disclosure documents will serve as core business "assets: that will reflect and protect the unique and critical components of your business and your newly established franchise system.

When starting a franchise keep in mind that all agreements are not the same and and that your input will be critical to insuring that your agreements and disclosure documensts reflect the unique nature of your business. This is no easy task and is not one that is not simply delegated - an indepth working relationship with your franchise lawyer is required.

Can you Find Success in "Re-Opening" a Previously Failed Franchise Location?

Charles Internicola — Fri, 30 Oct 2009 06:00:58 -0500

Recently on satellite radio I listened to a radio advertisement, allegedly, by a national franchisor promoting the resale of what I believe to be previously closed franchise locations. The franchisor is allegedly Quiznos and this morning I checked out their website relating to their promotion and sale of opportunities relating to the "re-opening" of closed Quiznos locations. Basically, the website is promoting and offering prospective franchisees the opportunity to acquire rights to own or operate closed Quiznos locations. Presented as a "low start-up cost" opportunity, the website operator makes the following "promotional" statments about this Quiznos "re-open" opportunity:

Own a Big Brand without a Big Investment.

Jump into a proven business system for as little as $12,500 down.

Own your own business in as little as 90 days.

Quinos has a limited inventory of stores available through this program.

While I readily admit that I have not reviewed Quiznos disclosure documents respecting this alleged "reopen opportunity", here is my take on this advertisement and potential opportunity:

Understand Why the "Closed Location" Originally Failed. Franchise failure resulting in closed stores may be attributed to many factors and may not necessarily be attributed to the the Franchisor, i.e., failure could be attributed to a deficient and non-performing franchisee. However, when a franchisor possesses an "inventory of closed stores" and is looking to resell these opportunities you must question whether or not the closed stores (and especially the particular store that you are considering) may be attributed to failings or deficiencies on the part of the franchisor, the franchise system or the business location, i.e., Is the continuing royalty too high? Is the food cost too high? Is the rent reasonable? Is the advertising program insufficient? Does the location generate enough traffic? You must understand what contributed the original "store closing" and insure that the facts and legal obligations that you are undertaking are different. That is, learn from the mistakes of others.

Your Investment Goes Far Beyond your Initial Out of Pocket Expense. When buying a franchise your investment goes far beyond "out of pocket" expenses. Although this opportunity is presented as one with limited start up costs, you must also consider the loan obligations that you will be agreeing to and assuming. While your "out of pocket" may be nominal you could be acquiring substantial debt obligations. Also, always remember that your time has value and in and of itself represents a substantial investment - especially if your store is not generating a profit.

Don't Just "Jump In". I think that you probably know this already, but we all need to be reminded of this critical point. So, "don't, do not just jump in". Due diligence is key.

Disclaimer: Michael Webster of BizOp makes a great comment about this alleged Quiznos website and the possibility that it may not be directly affiliated with Quiznos. Michael's comment is instructive for prospective franchisees and a reminder as to why prospective franchisees must engage in a detailed due diligence process. Thanks Michael.

License Agreements, Franchise Agreements and Unintended Consequences in the State of New Jersey

Charles Internicola — Wed, 21 Oct 2009 16:27:24 -0500

Can you expand your business in the State of New Jersey through a "license agreement" without triggering New Jersey's franchise relationship laws? (This is not a simple question and, unfortunately, the answer involves an evaluation of both "objective" and "subjective" factors.)

Short Answer:

Yes, however you must discuss and evaluate the substance of your license agreement, including your degree of control over your "licensees" operations and your economic influence over your "licensees" business.

Long Answer :

The New Jersey Franchise Practices Act contains extensive prohibitions and restrictions governing (and in many cases modifying) the contractual relationship between franchisors and franchisees within the state. Under New Jersey law the following criteria give rise to a franchise relationship and the potential imposition of franchise regulation:

The existence of a written agreement for a definite or indefinite period;
Providing for a license to use a trade name, trademark, service mark or related characteristic is granted; and
The existence of a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement, or otherwise.

With New Jersey's definition of a "franchise" heavily dependent on the existence of a "trademark license", your contemplated "license agreement" may have the unintended consequence of creating a regulated "franchise relationship". To determine if your (1) written (2) trademark license agreement "crosses the line into franchise territory" you must evaluate the (3) community of interest criteria and determine whether or not your written license agreement "creates a community of interest [between you and your licensee] in the marketing of goods or services..."

This "community of interest" criteria is not defined by the New Jersey statute, involves a subjective determination and has been expansively evaluated by New Jersey courts in favor of finding a franchise relationship. To make this determination the courts look to the relationship between the parties and, among other things, the extent to which the licensee (franchisee) is economically dependent on the licensor (franchisor). That is, where a licensee invests in a business that is largely dependent on a licensor's trademarks, products and/or services and where the licensor possesses significant influence over the licensees business, a "community of interest" (and thereby a franchise relationship) may exist. Some of the factors that the courts have found to be relevant, include:

The extent and nature of the licensees /franchisees business investment;
The bargaining power between the parties;
The licensees/franchisees economic dependence on the licensor's/franchisor's goods or services;
The licensor's/franchisor's control over the goods and services offered by the licensee/franchisee; and
The licensees/franchisees ability to procure and/or offer goods supplied by a third-party.

Ultimately, any determination as to whether or not your New Jersey license agreement "crosses the line" into franchise territory will require a detailed evaluation of your written agreement and the economic relationship and legal rights that you create. If your "license agreement" gives rise to a "franchise relationship", your licensee (and now franchisee) will be granted substantial protections and rights granted by the New Jersey Franchise Practices Act. The key is to be aware of this "unintended consequence" when structuring and planning your "license" agreements and business relationships

You Can't Blame Franchisors for Everything: You Do Have Options before Signing a Franchise Agreement

Charles Internicola — Thu, 08 Oct 2009 20:44:06 -0500

Recently I received some interesting and insightful comments from an individual commenting on issues involving franchisee rights. Her main point of contention appears to be the disparity of bargaining power and legal rights between franchisors and franchisees. While this is certainly an issue of concern, I believe that her comments may be giving a "free pass" to franchisees who don't take the time to conduct the appropriate pre-purchase franchise due diligence. The following are some of the commentators insightful points:

On Franchise Agreement Liquidated Damages:

Isn't it true that most franchisees don't understand that the "optional" liquidated damages terms in the contract are premeditated to give the franchisor the advantage when the franchisee fails to thrive? The failure fee is hidden within the contract from the view of franchisees.

Do attorneys point this "failure fee" out to their clients?

My Take on this Serious Issue: As I have previously discussed, "liquidated damage" provisions in franchise agreements - especially those that kick-in when a franchisee "closes his or her doors" have the potential to inflict serious financial harm on a franchisee who already may have lost a substantial investment. However, these provisions may be negotiated by franchise attorneys and are exactly the types of "legal issues" that a franchisee should be discussing with a franchise attorney before signing a franchise agreement. Liquidated damage clauses can be negotiated.

On Franchisees Reading and Negotiating their Franchise Agreement:

While it may be true that franchise agreements may be legally negotiated with the franchisor by individual prospective franchisees, isn't it true that most of the mature franchisors don't or won't negotiate changes and will acknowledge that pre-sale, their contracts are not negotiable. Don't they acknowledge this to the courts, when asked?

My Take on this Serious Issue: Franchise agreements are negotiable and even "mature" franchisors are willing to make reasonable modifications. However, even if we assume that a particular franchisor will not make changes why would a prospective franchisee invest his or her livelihood in a franchise and sign a franchise agreement without first reviewing, understanding and evaluating each and every right and obligation contained in the franchise agreement. Look, there are many times where I believe that franchisees need an advocate but franchisees cannot get a "free pass" when they neglect to conduct even the most basic due diligence.

In the end, you do not have to sign a franchise agreement and, sometimes, even with successful franchise systems, not signing the agreement might be the best course of action for you. No one is forcing you to sign the agreement. Likewise you must know that no matter how many other franchisees may have signed the franchise agreement you - personally - must understand and evaluate what you are signing. Your livelihood depends on it.

For franchisors, a policy that permits limited but targeted franchise agreement modifications may actually strengthen the enforceability of your franchise agreements when faced with litigation.

My thanks to Ms. Cross for some really insightful comments.

Myth: It is Illegal for a Franchisor to Negotiate and Modify the Terms of its Franchise Agreement?

Charles Internicola — Thu, 01 Oct 2009 17:33:25 -0500

In certain "franchise sales settings" franchisees are sometimes led to believe that modifications cannot be legally made to their franchise agreement. That is, to induce a franchisee to sign the franchise agreement - without the benefit of any negotiations or review by a franchise attorney - the franchisee is led to believe that the franchise agreement is a "standard agreement" (signed by everyone) and that legally the franchisor is not allowed to make any changes. The implication: you might as well just sign the agreement and not waste time or money since "we can't change the franchise agreement even if we wanted to".

Sadly this misstatement / "myth" leads to a false sense of security and sometimes some big mistakes by prospective franchisees. To be clear:

Franchise agreements are negotiable;
It is not illegal for a franchisor to modify its franchise agreement; and
It is extremely common for franchisees to negotiate certain aspects of the franchise agreement.

Understanding these facts keep in mind that the extent to which a franchisor may be willing to negotiate the terms of its agreement varies depending on the negotiating power of the parties - one major factor includes the financial resources of the franchisee. Also, certain core provisions of a franchise agreement - such as the royalty rate, methods of operation and use of proprietary products - usually are not and should not be subject to change.

Some of the critically important franchise agreement terms that you should be evaluating and potentially negotiating, include:

Scope of your protected territory;
Grace periods regarding the commencement of royalty obligations;
Liquidated damages and liability for early termination;
Renewal rights;
Transfer rights;
Cure periods for alleged defaults; and
Potential "rights of first refusal".

Depending on your circumstances and concerns there are many other issues that, as a prospective franchisee, you should be considering. However, it is critical that, as a prospective franchisee, you recognize that you have the "right" to negotiate the terms of your franchise agreement. This "right" must be taken seriously.

"Low Start-Up Costs High Returns"?

Charles Internicola — Fri, 25 Sep 2009 16:23:24 -0500

Recently, in my article "Avoid the Hype when Buying a Franchise: Focus on Specifics and Not Overall Industry Trends" I discussed what I believe to be the improper and harmful methods for promoting franchise sales, i.e., generic statements and promises that may lead to inaccurate and unrealistic expectations by a franchisee. These statements are bad for both franchisors and franchisees and my advice, basically, was to disregard and avoid this type of promotion.

This afternoon after speaking with a client about a franchise that he was evaluating - a franchise that he explained would provide him with a great "return" - I took a look at the franchisor's website and, there it was, the pitch:

[_________________] is a proven franchise system with low start-up costs and high returns.

While I readily admit that I am a franchise lawyer and not an accountant, if I were a prospective franchisee or even legal counsel to the franchisor making this pitch, I would have the following questions:

How High of a Return? 2%, 5%, 10%...?;

A "Return" Based on What? Start-up costs, overall investment?

Is the Return Measured / Based on Gross Sales or Net Income? Before Royalties or after Royalties? Before debt service or after debt service? and;

What type of return should I expect?

The reality is that this franchisor probably does not (and cannot - without subjecting itself to potential litigation exposure) offer an answer to these questions and even if it did there would (I hope) be an extensive number of disclaimers. For the prospective franchisee recognize that franchisors cannot guarantee success (that is not their job), so before you make an investment decision based on "vague" statements about "profits" and "returns", start asking questions.

Avoid the Hype when Buying a Franchise: Focus on Specifics and Not Overall Industry Trends

Charles Internicola — Thu, 17 Sep 2009 08:20:32 -0500

Driving into the office this morning I listened to a radio commercial that I found to be repulsive . The commercial was not political, did not contain any profane language and, quite possibly, did not contain any false statements. Nevertheless, the information conveyed in this commercial (really just a bunch of self-serving platitudes) could do harm to the unprepared.

So what was this commercial about? The sale of franchises for a national mall based / strip-center consumer video game franchise. You see, the commercial was not promoting the operations of their retail stores or franchisee operations but rather the sale of "franchise opportunities". Since I don't have the actual text of the commercial (I am basing this post on my memory of 5 minutes ago) I will not disclose the name of the franchise.

What Do I think is So Wrong about this Commercial? the fact that rather than promoting existing franchisee sales and informing consumers about the advantages of their stores (compared to competitors) they offered a generic pitch about buying their franchise. Their "franchise sales" pitch followed the following formula:

Make a generic statement about "becomming your own boss";
Offer generic information about "industry growth trends"; and
Imply, with even more generic information, that you - as a franchisee - can benefit from this opportunity by utilizing their "proven and powerful" systems.

Basically, alot of hype and platitudes - many words but little, if any, information.

Points for Prospective Franchisees: (1) Just buying a franchise does not make you your own boss; (2) Just because an overall "industry" is growing and profitable does not mean that as a "retail franchisee" your business will also be profitable; (3) Before buying a franchise give serious thought about what makes them "unique" and the "added value" that they bring to the table. Most importantly, when you hear a franchisor brag about "proven and powerful systems" ask specific questions about those "systems" and what makes them "proven" and "powerful". Don't wait until after you pay a franchise fee and invest in build-out.

Some of the many internet resources to consider include: The Franchise King, Franchise Essentials, Blue MauMau, Franchise Pick, WSJ Small Business.

Points for Franchisors: Advertising franchise sales is no a bad thing and, in fact, may be a key component to overall system development and growth. However, the ads should be based on the unique and fundamental characteristics of your particular system and the advantages that you offer. If these "unique characteristics" are not readily identifiable then you are doing something wrong and you should be focusing on true "system development" and not unit sales. Significantly, the witnessed success of existing franchisees is the best source of growth for a franchise system.

When Buying a Franchise Your "Investment" Involves Much More than Franchise Fees and Start-Up Expenses

Charles Internicola — Thu, 10 Sep 2009 07:05:52 -0500

If you are considering the purchase of a franchise it is critical to recognize that your "investment" goes beyond - well beyond - initial franchise fees and startup expenses. While franchise fees and start-up expenses (such as equipment purchases and "build-out") are critical expenses that must be evaluated, they only tell half the story. That is, when signing a franchise agreement you will be committing yourself to a serious of legal obligations that will involve the commitment of your time, future financial resources and legal obligations for many years to come.

So when evaluating the "cost" of a franchise, in addition to franchise fees and initial start-up costs, give some serious consideration to:

(a) Reserve Capital. Additional funds that you may be required to invest in your business/franchise during periods of unprofitability and negative cash flow. As with any business you may very well encounter periods of unprofitability and losses. When faced with losses and cash flow shortages you will be required to invest additional assets and resources to sustain the operations of your franchise;

(b) Your Time. The extensive time that your will be devoting to operating and managing your new franchise. Your time is valuable and when operating your franchise you will be foregoing income and opportunities from other sources of employment. Although obvious, this expense / opportunity cost is commonly overlooked. If your franchised business does not work out remember that your losses include missed opportunity costs and income that you would have otherwise earned.

(c) Post-Termination Restrictive Covenants and Fees. As a franchisee in most instances you will be committing yourself to long-term obligations and restrictive covenants. These covenants and obligations have a cost, especially when they restrict what you can and cannot do if you elect to shut down your franchise. This is of special concern to current business owners with established reputations within a community who - for legitimate reasons - decide to become a franchisee of a national company.

For Example - If you are a carpenter with a long established reputation within a community and you elect to purchase and become a franchisee of a national "repair" or "handyman" franchise what happens if your franchise relationship does not work out and you cancel your franchise agreement? Will you be precluded from operating your own repair business - a business that you operated many years before becoming a franchisee? The answer is that it all depends on the restrictive covenants contained in your franchise agreement - covenants and obligations that you should review and discuss in detail with your franchise lawyer "before" signing a franchise agreement.

So when considering the "cost" of your franchise investment you must go beyond "out of pocket" expenses and fees and evaluate the substantive impact of the long-term legal obligations that you will be committing to.

New Jersey Franchise Practices Act: Franchisee Protection extended to "Constructive" Termination

Charles Internicola — Tue, 01 Sep 2009 07:37:18 -0500

In the recent decision of Maintainco, Inc. v. Mitsubishi Caterpillar Forklift America, Inc., the Appellate Division for the Superior Court of the State of New Jersey affirmed the application of the New Jersey Franchise Practices Act ("NJFPA") to the "constructive" termination of franchisee rights. That is, actual termination is not required for a franchisee to invoke the protections of the NJFPA.

In the Maintainco decision, utilizing fundamental principals contract law, the Appellate Division held that that the franchisor / manufacturer's actions including (a) the threatened termination of the franchisee / dealer's rights, (b) the failure to disclose customary annual business plans to the franchisee, and (c) the grant of competing rights to a third party franchisee within the plaintiff franchisee's territory, constituted "constructive" acts of termination actionable under the NJFPA. In the court's well reasoned decision, the following points are instructive:

Franchisee's faced with the "constructive" termination of their franchise rights possess a claim for violation of the NJFPA;

"Sound and non-discriminatory" business decisions are insufficient to justify the "non-renewal" of a New Jersey franchise. The failure to renew a franchise must be based on the franchisee's failure to "substantially meet the performance requirements of the franchisor";

Performance requirements imposed on franchisees must be "reasonable;

Attorney fees are recoverable by a franchisee who successfully prosecutes a NJFPA claim; and

Expert fees are not recoverable under the NJFPA.

New York's Expansive Definition of a "Franchise": Trademarks Not Required

Charles Internicola — Wed, 26 Aug 2009 06:22:55 -0500

The definition of a franchise and the factors utilized to evaluate the existence of a franchise have important implications. That is, does the business arrangement providing for the multi-unit expansion of your business qualify as a franchise and thereby subject you to franchise regulations and disclosure requirements? The answer to this question depends on the "substance" of the business relationship and an evaluation of both federal and state law.

For the "New York franchisor" (comprised of any business - based in any state - seeking to offer or sell a franchise in the State of New York) the definition of what constitutes a "franchise" is more expansive that the federal definition. Under the Federal Franchise Rule "trademarks" and "trademark licenses" are primary and critical components of a franchise system. Without the license of a trademark, under federal law, a "franchise" does not exist. Under New York law however, the existence of a franchise is not dependent upon the existence of a trademark license. That is, although your "business arrangement" does not involve a trademark license and therefore does not qualify as a "franchise" under federal law, you may nevertheless be subject to New York's franchise regulations and disclosure requirements if your "business arrangement" is based on a written or oral agreement providing for:

(i) A Proscribed Marketing Plan or System: The offer, sale or distribution of goods or services under a proscribed marketing plan or system; and

(ii) Payment of a Franchise Fee: The direct or indirect payment of a "franchise fee". What qualifies as a "franchise fee" is also expansively defined and may include license fees and other charges associated with the business transaction.

Additionally, New York offers an alternative definition of a franchise replacing the "proscribed marketing plan" requirement (point (i) , above) with a "trademark license".

So, under New York law, unlike federal law, although the existence of a "trademark license" may give rise to a "franchise relationship" it is not mandatory. In the State of New York franchises and franchise relationships are not dependent upon the existence of trademarks and trademark licenses.

A Powerful Tool for Franchisors: "Liquidated Damages"

Charles Internicola — Wed, 12 Aug 2009 18:18:19 -0500

The typical franchise agreement is representative of the disproportionate bargaining power between the franchisor and franchisee. That is, franchise agreements favor franchisors. One such favorable clause contained in franchise and license agreements relates to "liquidated damages".

The typical franchise agreement will contain a "liquidated damages" provision whereby the franchisee agrees to pay, as damages, a fixed sum or a sum based on a fixed formula in the event of a court's finding of a breach of the franchise agreement. If the franchisor is successful in a lawsuit against a franchisee, the liquidated damages provision may clear a path for a Court (without any further detailed inquiry) to award substantial monetary damages. Similarly, when dealing with trademark license agreements, licensees may be subject to severe damages based on the liquidated damages clause contained in the license agreement.

Although presumptively valid in most jurisdictions, the enforcement of liquidated damage clauses is not universal and courts in states such as New York and New Jersey will make an inquiry as to the "reasonableness" of the liquidated damages and the "bargaining power" between the parties at the time of contracting.

So what do franchisors, franchisees and licensees need to know:

Franchisors: For franchisors, liquidated damage provisions are critical components to your franchise agreement and serve as a significant tool when faced with franchisee litigation. When drafting liquidated damages into your franchise agreement insure that the method of calculating damages is not arbitrary, based on tangible factors and is not inconsistent with your royalty structure.

Franchisees: recognize that a possible "liquidated damage" clause in your franchise agreement may expose you to substantial liability should the franchisor prevail. When negotiating your franchise agreement discuss the liquidated damage clauses with your franchise lawyer and try to cap your financial obligations and the accrual of royalties and other fees after any alleged event of default and the termination of the franchise agreement.