The Reluctant Franchisor
By Susan E.
Wells, Esq., Jaburg &
Wilk, P.C.
Due to the heavily-regulated nature of franchising, clients
often tell their attorneys "I'm only going to do a license. I
don't want to do a franchise." Although a client may believe
what he says, he's most likely drawing a conclusion that disregards
the facts and/or the law.
What is a Franchise?
A "franchise" is defined differently under the federal franchise
rule from how it is defined under state laws. The definition
of a "franchise" also varies from state to state. Under the
federal franchise rule, if all of the following elements are
present, then the business relationship constitutes a
franchise:
• The
franchisee will obtain the right to operate a business (or to
offer, sell or distribute goods, services or commodities) that is
identified or associated with the franchisor's trademark
• The
franchisor will (or has the right to) exert significant control
over the franchisee's business or provide significant assistance in
the franchisee's business
• The
franchisee makes (or promises to make) a required payment to the
franchisor (or its affiliate)
However, if those three elements are present, the business
relationship constitutes a franchise regardless of whether the
franchisor calls it by another name or denies that it is a
franchise, regardless of whether the parties agree that it is not a
franchise and regardless of whether the parties attempt to have the
franchisee waive the application of the franchise laws. If it
walks like a duck and talks like a duck, it's a duck.
After I explain the three requisite elements to a client, we
typically discuss restructuring the business relationship in
various ways to avoid application of the franchise laws. What
if we eliminate the trademark license? What if there is no
significant control or assistance? What if there is no
required payment? Typically, none of those alternatives is
acceptable, as the resulting business relationship does not satisfy
the client's objectives.
What Must Franchisors Disclose to Prospective
Franchisees?
The purpose of the franchise laws is to provide certain required
information to a prospective investor so that he can make an
informed decision whether or not to invest in a franchised
business.
Under the federal franchise rule, a Franchise Disclosure
Document must be provided to a prospective franchisee at least 14
days before the franchisee signs the Franchise Agreement or gives
the franchisor any money or other consideration. The
Franchise Disclosure Document contains 23 specified categories of
information that must be included. The information falls into
two categories:
•
Information about the franchisor and the franchise system, such as
what business the franchisee will actually be conducting, the
biographical, litigation and bankruptcy background of the
franchisor and its management team and the financial condition of
the franchisor
• A
plain-English summary of the key provisions of the Franchise
Agreement, such as what the franchisor will be providing for the
franchisee (such as training), the fees the franchisee must pay to
the franchisor or its affiliates and what the franchisee must buy
from the franchisor or its affiliates or approved vendors and
suppliers.
The Franchise Disclosure Document also contains the Franchise
Agreement and all of the other agreements that franchisees must
sign in connection with becoming a franchisee.
Why Comply with the Law?
Compliance with the federal franchise rule is not as difficult
or burdensome as potential franchisors fear and offers certain
advantages. First, regardless of whether the franchisor
acknowledges that the business relationship is a franchise, the
franchisor should have a solid agreement that clearly states the
parties' respective rights and obligations and protects the
franchisor's interests. Second, business relationships that
do not comply with the federal franchise rule frequently constitute
business opportunities, which are perceived to be less legitimate
than franchises and must comply with the federal business
opportunity rule and a patchwork of 26 state business opportunity
laws.
The failure to comply with the federal franchise rule and state
franchise laws may subject the franchisor, its officers and
directors and other personnel to severe federal and state civil and
criminal penalties. In addition, it reflects poorly on the
franchisor, as the franchisee rightfully questions whether the
franchisor, in addition to disregarding its legal obligations, will
disregard its contractual obligations or otherwise cut corners in
business.
About the author: Susan E.
Wells is a partner at the Phoenix law firm of Jaburg Wilk. Her corporate
and business
practice encompasses all aspects of business transactions and
commercial relationships in numerous industries, including franchising. She
can be reached at 602.248.1034 or sew@jaburgwilk.com.
This article is not intended to provide legal advice.
Always consult an attorney for legal advice for your particular
situation.
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