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Avoiding the Accidental Franchise When Structuring Licenses or Distribution Agreements

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THURSDAY, SEPTEMBER 13, 2018

Presenting a live 90-minute webinar with interactive Q&A Rochelle (Shelley) Spandorf, Partner, Davis Wright Tremaine, Los Angeles Craig R. Tractenberg, Partner, Fox Rothschild, New York

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Avoiding the Accidental Franchise When Structuring Licenses and Distribution Agreements

THURSDAY, SEPTEMBER 13, 2018

Rochelle Spandorf, Davis Wright Tremaine LLP Craig Tractenberg, Fox Rothschild LLP

Discussion Points:

◼

Why does Franchise status matter?

◼

So, what exactly is a Franchise?

◼

How and why do accidental Franchises happen?

◼

Examples of accidental Franchises

◼

Strategies for drafting licenses and distribution agreements to avoid inadvertent Franchises

◼

Common issues and stress points in Franchise relationships

◼

Q&A

6

Why does Franchise status matter?

7

Why do companies award licenses?

◼

Licensing overcomes the two chief barriers to expansion:

◼ Capital: Licensee invests its own money to own and develop a

licensed branded outlet/business

◼ Labor: Licensee (independent contractor) hires and supervises

its own employees to run licensed branded outlet/business

◼

Licensing lets brand owner leverage its TMs for $$$

◼ Licensee invests its own resources to create public awareness

for a brand that it has the right to use for a defined time period, but does not own.

◼ Licensing combines one party’s TMs + operating methods with

an another party’s entrepreneurial drive to “be in business for

• neself, but not by oneself”

◼ Sales by licensee-owned branded outlets and distribution of

branded products create revenue for TM owner

◼ Brands drive consumer decisions; a licensee hitches its future

to the licensor’s brand

8

License vs. Franchise

◼

By legal definition, every franchise is a trademark license. However, not every trademark license is a franchise! TM ≠ F F = F = TM TM

◼ A distribution agreement that gives a distributor or dealer a right to sell

branded goods is an implied trademark license (if not an express one)!

◼ Franchises” are creatures of statute. There is no such thing as a

common law franchise.

◼ Franchise status does not depend on what parties call their

arrangement; names are irrelevant.

9

Franchises = creatures of statute

• r
• r

+ + SIGNIFICANT ASSISTANCE/ CONTROL MARKETING PLAN COMMUNITY OF INTEREST REQUIRED FEE TRADEMARK

10

So why does Franchise status matter?

◼

Franchises are subject to extensive regulation that licensors of non-franchise trademark licenses are able to bypass

◼

Federal and state franchise sales laws – “front end” ▪ Regulates the sales process ▪ Public disclosure of financial statements ▪ Personal liability for top management

◼

State relationship laws - “back end” ▪ Must have “good cause” to end a franchise relationship ▪ Some relationship laws impose other substantive contract terms, e.g., transfer, unilateral changes imposed by the franchisor/supplier, and more

11

So why does Franchise status matter?

◼

Non-franchise trademark licenses are private, consensual

◼

Non-franchise trademark franchisors do not have to make any public disclosure about their financial condition or other sensitive information

◼

No “front end” or “back end” laws regulate how non-franchises trademark licenses are formed or may end

◼

“At will” arrangements that allow a non-franchise a trademark licensor to terminate on X days notice = enforceable

◼

No personal liability if a non-franchise trademark licensor breaches the contract

12

Complications of Being a Franchise - Overview

◼

Franchise Sales Laws (‘front end” laws)

◼ Federal: Amended FTC Rule: presale disclosure duty, but no

federal filing

◼ State: Presale disclosure + registration/filing duty

◼

Business Opportunity Laws (“front end” laws)

◼ Even if not a franchise, arrangement may be a “bus/op” ◼ More states with Bus/Op laws than franchise sales laws, but

various exemptions

◼ Most Bus/Op laws regulate only when buyer starts a business, not

when expanding into new line

◼ Federal and state Bus/Op laws exempt franchises that comply

with Amended FTC Rule; some states may require TM owner to make filing to qualify for exemption

◼

Franchise Relationship Laws (“back end” laws)

◼ Federal: none ◼ State laws: vary widely; override contract terms

13

State Laws Regulating Franchise Sales – “Front End”

Registration Filing - Full Agency Review Notice Filing for Bus/Op Exemption Notice Filing for State Franchise Sales Law Amended FTC Rule – Disclosure, but no filing req'd

14

More complications: which law applies?

◼

Amended FTC Rule applies to all franchise sales in US even when franchisor, franchisee + franchise location/territory are in same state

◼ No private right of action ◼ However, in many states, plaintiffs may bring a state “baby FTC

Act” claim and rely on Amended FTC Rule violation as predicate unfair or illegal act or practice

◼

State law jurisdiction varies according to:

◼ Assigned territory; distributor or licensee’s residence/domicile;

where offer/acceptance take place

◼ New York approach to jurisdiction

◼

Some state laws require that distributor/licensee maintain “place of business” in state; a warehouse or office may suffice

◼

No uniformity across states re: jurisdiction, exemptions, exclusions

◼

No federal preemption. A transaction may be exempt from the federal franchise law, but, if no counterpart state law exemption, must comply with state franchise sales law; and vice-versa.

15

Key Points About Franchise Sales Laws

◼

FEDERAL: Amended FTC Rule

◼

Pre-sale disclosure via uniform form of franchise disclosure document (“FDD”)

◼ 14 day “waiting period” before signing any contract or paying

any money (even refundable deposit or option to buy franchise)

◼ No federal filing requirement or FTC review

◼

FDD must include audited financial statements for last 3 years

◼

FDD must be updated annually w/in 120 days after each FYE

◼

Material change amendments = quarterly

◼

Record keeping duties (varies by state law)

◼

No financial performance representations (FPR) without complying with FDD Item 19 disclosure rules

◼

STATE: franchise sales laws

◼

Same pre-sale disclosure duty + 14 day delivery requirement

◼

Must register with state franchise agency before offering or selling franchises to state resident or for location/territory in the state; full review registration vs. notice filing registration

16

States Regulating Franchise Sales

Franchise registration ▪ California ▪ Hawaii ▪ Illinois ▪ Indiana** ▪ Maryland ▪ Michigan** ▪ Minnesota ▪ New York ▪ North Dakota ▪ Rhode Island ▪ South Dakota ▪ Virginia ▪ Washington ▪ Wisconsin** ** = notice filing states States with bus/op laws that exempt franchise sales if filing is made: ▪ Florida ▪ Kentucky (one time) ▪ Nebraska (one time) ▪ Texas (one time) ▪ Utah

17

Business Opportunity (Bus/Op) Laws “Front End” only; no relationship regulation

Goods/ Services $$$ to promoter (minimum amount varies) Start a business (some, maintain

• r operate a

Business) Triggering Representations

+ + + +

18

States Regulating “Business Opportunity” Sales

Alabama Kentucky** North Carolina Alaska Louisiana Ohio California Maine Oklahoma Connecticut Maryland South Carolina Florida** Michigan Texas** Georgia Minnesota Utah** Illinois Nebraska** Virginia Indiana New Hampshire Washington Iowa

19

** exemption available for franchisors that comply with FTC Rule and make a simple notice filing with state agency

State “Relationship Laws” – “Back End” Laws

GC for termination + payment of a required fee besides cost of product (“3 prong states”) GC for termination, but no required fee (“2 prong states”)

PR & VI 20

◼

No federal franchise relationship law

◼

State franchise relationship laws

◼ ◼

◼

Dealer termination laws

◼

◼

Special industry laws “3-prong” - “2-prong” -

Key Points About Franchise Relationship Laws

“2-prong” -

21

Alaska Maryland South Dakota Arkansas Michigan Virginia California Minnesota Washington Connecticut** Mississippi** Wisconsin** Delaware** Missouri** Puerto Rico** Hawaii Nebraska** U.S. Virgin Islands** Illinois New Jersey** Indiana North Dakota Iowa Rhode Island**

States with a “Relationship” Law (not industry-specific)

22

** denotes 2 prong definition; franchise fee not required

Legal Consequences: Statutory Remedies – Franchise Sales Laws (“Front End Laws”) Franchise

Damages Injunctive Relief Rescission Potential personal liability Criminal prosecution - felony Administrative agency remedies including restitution, asset freeze, C&D Attorneys fees

23

Franchise Legal Consequences: Statutory Remedies – Franchise Termination Laws – “Back End Laws”

Damages for wrongful termination or other statutory violation (some states treble damages or award a multiple of lost profits, some 5-10X) California offers remedies to a lawfully terminated franchisee if the franchisor assumes

• peration of former franchise location

Potential personal liability Inventory repurchase Injunctive relief Attorneys fees

24

Franchise Law + Legal Malpractice

◼ Beverly Hills Concepts v. Schatz, 717 A.2d 724 (1998)

◼

Attorney who fails to advise his or her client that a licensing program is a franchise may be guilty of malpractice. Here, a junior associate failed to seek appropriate supervision and her negligent advice went unchecked resulting in the firm’s liability to the ex- client.

◼ Courtney v. Waring, 237 Cal. Rptr. 233 (Ct. App. 1987)

◼

Attorney who negligently prepares a franchise disclosure document for its client may be held liable to non-clients, franchisees.

◼ State of Nebraska v. Orr, 277 Neb. 102 (2009)

◼

Attorney who negligently prepares FDD w/o researching applicable disclosure rules/law and by copying work product of other franchise programs was disciplined by state bar for incompetent

• representation. In this case, the disciplined attorney had an

unblemished record over an o/w exemplary 40-year career.

25

So, what exactly is a Franchise?

26

A Franchise = 3 legged stool (if any leg is missing ≠ F)

• r
• r

+ +

SIGNIFICANT ASSISTANCE/ CONTROL MARKETING PLAN COMMUNITY OF INTEREST REQUIRED FEE TRADEMARK

27

◼

Definitional variations

◼ “substantial association” with a licensor’s TM ◼ TM license

◼

Defacto or implied licenses

◼ “Smith’s Appliances, an authorized Brand X Service Center” ◼ ABC, a member of the Oracle Partner Network

(displayed with logo)

◼ Branded products or services account for a significant % of the

licensee/operator’s overall sales/revenue (generally > 20%)

◼

Trademark leg is essential to franchise status, but not bus/op status

◼

Licensor’s quandary

Trademark

28

SIGNIFICANT ASSISTANCE/ CONTROL MARKETING PLAN COMMUNITY OF INTEREST

◼

Definitional variations depend on jurisdiction

◼ Substantial assistance/significant control ◼ “Marketing plan prescribed in substantial part” ◼ Community of interest

◼

No minimum number of facts must co-exist

◼

Most subjective definitional element

◼

Licensor’s dilemma

29

SIGNIFICANT ASSISTANCE/ CONTROL MARKETING PLAN COMMUNITY OF INTEREST ◼ Similar tests for “substantial assistance/significant control” and “marketing plan prescribed in substantial part” ◼ Focus on training; marketing support; purchasing requirements; licensor prior approval of 3P suppliers, restrictions on licensee competitive activities; limits on collateral services to customers, lead generation support, assignment of exclusive territory; uniformity of design and appearance; operating protocols; network-wide activities ◼ “Normal” routines ≠ marketing plan ◼ Distinguish technical training vs. training and support that covers core aspects of operations and marketing ◼ Focus on whether network members operate in a manner that suggests centralized rules/management

30

SIGNIFICANT ASSISTANCE/ CONTROL MARKETING PLAN COMMUNITY OF INTEREST ◼ “Community of interest” in marketing goods/services = broader ▪ Licensor/licensee: common source of revenue ▪ Licensor has a “continuing financial interest” in franchisee ▪ Interdependence of parties: if arrangement ends, licensee is “over a barrel”

31

◼

Captures all sources of revenue to licensor or licensor’s affiliate for the award of distribution or licensing rights

◼ Nominal minimum threshold (> $500) ◼ Lump sum, installment or recurring; fixed, fluctuating or

percentage fee

◼ Springing franchises (no payment at inception; payments

start/stop)

◼ Bona fide wholesale price exception for goods bought for resale

(inventory); but excessive purchasing obligations = fee

◼

Optional vs. required payments (truly optional vs. nominally optional)

◼

Ordinary business expenses paid to 3P

◼

Direct and indirect fees

◼

Money flow (licensee to licensor, not vice-versa)

Required Fee

32

Example

◼

In To-Am Equip. Co., Inc. v. Mitsubishi Caterpillar Forklift America, Inc., a jury awarded $1.5M in damages for wrongful termination of a distributorship agreement found to violate Illinois Franchise Disclosure Act.

◼

Mitsubishi ended relationship per contract’s “at will” termination provision in order to take distribution in house; no good cause for termination.

◼

Relationship not a franchise at inception; morphed into one years later when cumulative payments for sales manuals > $500

◼

7th Circuit Ct. of Appeals affirmed stating:

◼ “Like many manufacturers, MCFA simply did not appreciate how

vigorously Illinois law protects "franchisees." … While we understand MCFA's concern that dealerships in Illinois are too easily categorized as statutory franchises, that is a concern appropriately raised to either the Illinois legislature or Illinois Attorney General, not to this court.”

33

What Parties Call the Arrangement is … Irrelevant

◼

License

◼

Dealership

◼

Distributorship

◼

Strategic alliance

◼

Marketing affiliation

◼

Joint Venture

◼

Affiliate Program

◼

Co-Branding Program

◼

Membership Agreement

◼

Partner (any title using “partner” is not a good idea for other reasons)

34

No Defense to Statutory Violations if …

◼

Violation is inadvertent

◼

Violation is unintentional

◼

Seller lacks knowledge of the law

◼

Competitors don’t comply

◼

Buyer agreed to waive compliance

35

Top 10 Excuses Why a License or Distribution Agreement Can’t be a Franchise

10. “Everyone else in our industry does it this way” 9. “We grant licenses, not franchises” 8. “We’ll just call it something else” 7. “We’re partners, really …” 6. “We don’t tell them how to operate their business”

 2009 Rochelle Spandorf, Davis Wright Tremaine LLP 36

Top 10 Excuses Why a License or Distribution Agreement Can’t be a Franchise

5. “They use their own trade name, not ours” 4. “They buy products from our affiliate, not us” 3. “They sell other products/services besides ours” 2. “We never intended it to be a franchise” 1. “We didn’t know about the law when we signed the contract”

 2009 Rochelle Spandorf, Davis Wright Tremaine LLP 37

How and Why Do Accidental Franchises Happen?

38

Accidents Really Happen! Why?

◼

Ubiquitous branding – businesses want to affiliate with another person’s brand for “halo effect”

◼

TM owner unaware why TM license is not a F tacks on fees for training, sales tools,

• r more -“nickels and dimes” - causes TM

license to be a F when wrongful termination claim is raised

◼

Fees paid to TM owner may be called “optional” but are essential in order to

• perate profitably (e.g., training,

marketing)

◼

Joint venture with TM owner assumed not to be F because of brand owner’s equity stake = wrong!

39

When Do “Accidental” Franchises Typically Get Discovered?

◼

Licensee, distributor or dealer fails to achieve business goals

◼ Buyer’s remorse ◼ Loss of investment

◼

Termination, non-renewal or cancellation of rights

◼ Parties may dispute if “good cause” exists ◼ Licensor/supplier may want to change its business model for its

• wn business reasons; take distribution in-house; phase out

product line (e.g., Oldsmobile)

◼ Parties contract may give both parties the same right to

terminate on X days notice for any reason without good cause:

◼

Relationship law supersedes contract

◼

The fact the licensor/supplier complies with contract in ending relationship is no defense to statutory claim

◼

The fact the licensee has the same right to terminate the contract on X days’ notice without good cause is no defense to statutory claim

40

Is a Dealership, Distributorship Or License Really a Franchise?

◼

Examine contract terms (oral and written)

◼

Examine parties’ course of dealing

◼

Are so-called “optional” requirements truly optional?

◼

Examine representations by seller (help with finding outlets, accounts or buy-back inventory; income from distribution rights > initial investment; representations about future results)

◼

Are mandatory purchases of inventory excessive?

◼

Examine price of branded goods (is there a surcharge above bona fide wholesale price?)

◼

Multi-line licensee/distributor/dealer: does 20% rule apply?

◼

What state law applies based on the location of the dealer?

◼

What law applies under the written contract?

◼

Ignore contract disclaimers and waivers

41

Examples of Accidental Franchises

42

Everyday Accidental Franchises in Commerce?

◼

Product dealerships and distributorships

◼

Certification programs, especially in the fitness industry

◼

Apparel/retail stores independently owned

◼

Joint ventures between “brand owner” and “operating partner

◼

Management arrangements – medical, dental and hotel

◼

Driver networks and “last mile” delivery services fulfilled by independent contractors

◼

Arrangements among non-profit organizations (“federation” of non-profits)

◼

Independent consultants providing training in branded software applications or other subjects

◼

Patent and “know-how” licenses

43

Product Distributorships

◼

Typical structuring

◼ No express trademark license ◼ Payments for reasonable quantities of inventory sold at a bona

fide wholesale price

◼ Marketing support, assigned territory, restrictions on sales of

competing goods, sales quotas, merchandising requirements

◼

Traps to fall into a “franchise”

◼ Extensive use of marks and branding ◼ Add-on fees (truly optional vs. nominally optional) ◼ Minimum purchasing requirements – excessive?

◼

Multi-line distributors – fractional franchise? Substantial association with trademark?

◼

2-prong state relationship laws may still apply

44

Certification Programs

◼

Exercise programs: e.g., CrossFit, Zumba

◼ Certification on how to teach particular type of fitness classes

◼

Traps to fall into a “franchise”

◼ TM license vs true “certification” trademark ◼ Common branding elements, marketing plan ◼ Location approval; curriculum control; restrictions on scope of

services

◼ Fees for trademark use ◼ Minimize controls? Minimize assistance?

45

Apparel / Retail Stores

◼

Licensee’s retail location is identified by supplier’s brand (“Benetton” or “Gap”)

◼

Typical structuring to avoid a “franchise” under U.S. laws:

◼ No upfront or continuing fee ◼ Inventory sold at a bona fide wholesale price ◼ May have minimal control ◼ Highly fact-specific

◼

Traps to fall into a “franchise”

◼ Add-on fees ◼ Significant control or assistance ◼ Branding

◼

International issues

46

Joint Ventures

◼

Varying structures: C corp, S corp, LLC, limited partnership, general partnership

◼

TM/Brand owner wears 2 hats: JV member + TM licensor

◼

Analyze:

◼ TM owner as minority vs. majority equity owner of JV ◼ Outsider may contribute just “sweat equity” or sweat equity +

$, but actively operates JV

◼ Brand is licensed to JV; TM ownership remains with brand owner ◼ Financial distributions to JV owners = hidden franchise fee ◼ Setting up a series of JVs is a tell-tale sign of a hidden franchise

47

Management Agreements (Dental, medical, hotel)

◼

Licensee engages professional management company and assigns significant day-to-day control to management company

◼

Management company or its affiliate owns TM which licensee may use while management agreement is in place

◼

Traps

◼ Through management agreement, TM owner provides significant

assistance or imposes business plan on licensee

◼ Extensive use of marks and branding ◼ Fees paid by licensee to TM owner for affiliation rights

◼

Hotel franchises: licensee owns the land/building. Signs franchise agreement for right to identify hotel with TM and engages TM owner

• r its affiliate to handle day-to-day operations, reservation services.

◼

Health care franchises: MD/DDS signs agreement permitting use of TM to identify professional practice. Engages franchisor’s management company to provide office facility, hire non- professional staff, and delivery “back office” management services including patient scheduling and billing.

48

Driver Networks and Delivery Services

◼ Contractors may wear uniforms for company they drive for (e.g.,

Sears), but not always (e.g., Lyft, restaurant delivery services)

◼ Contractors deliver packages w/brand owner’s name (e.g., Sears;

restaurant delivery services)

◼ Drivers are assigned delivery territory ◼ Mandatory reporting requirements, but not always ◼ Minimal requirements for appearance/condition of vehicle ◼ Nominal training for drivers on how to interact with customers and

complete any reporting requirements

◼ Money flow is often the key to franchise status

◼

Driver collects money upon pickup and remits % to TM owner (franchise fee)

◼

All money is paid to TM owner or delivery service and driver receives a % commission of revenue per pickup (no franchise franchise fee)

49

Non-profits

◼

Both TM licensor and licensee are non-profit entities

◼

Federal franchise law vs. state franchise law

◼

Federal = F is a continuing commercial relationship; excludes arrangements between non-profits

◼

State law = may apply to non-profits

◼

Girl Scouts of Manitou Council, Inc. v. Girl Scouts of the United States of America: trademark license between 2 non-profits

◼

7th Circuit Court of Appeals ruled that the Wisconsin Fair Dealership Law (WFDL) prohibited the national council from realigning local council’s territory

◼

Local girl scout council was held to be a “dealer”

◼

WFDL forbids TM pwmer from making substantial changes to the competitive circumstances of a dealership w/o good cause

◼

The national council’s own economic reasons for realigning territory ≠ good cause

50

Independent Consulting / Training Programs

◼

Typical structuring to avoid a “franchise”

◼

Trademark license?

◼

Control over the method of operating the business?

◼

Traps to fall into a “franchise”

◼

Likely brand affiliation; right to use marks and branding

◼

Software owner promotes fleet of qualified trainers

◼

Software owner’s website identifies local trainers by geography

◼

Control or assistance “creep”

◼

Trainers pay software developer various fees for training and maybe on sales

51

Accidents Really Happen …

◼ Sales agency: Gentis v. Safeguard Business Systems, 60 Cal.

• App. 4th 1294 (1998)

◼ Sports team/league: Continental Basketball Ass’n v.

Ellenstein, 669 N.E. 136 (Indiana Sup. Ct. 1996).

◼ Baked goods supplier & distributor: Petereit v. S.B.

Thomas, Inc., 63 F.3d 1169 (2d Cir. 1995); Atchley v. Pepperidge Farm, Inc., 2012 U.S. Dist. LEXIS 173974 (E.D.

• Wash. Dec. 6, 2012) (after 8 years & numerous reported

episodes and bench trial before defendant finally won)

◼ Appliance manufacturer & distributor: Cooper Distrib. Co. v.

Amana Refrigeration, Inc., 63 F.3d 262 (3rd Cir. 1995)

◼ Arrangement between non-profits: Girl Scouts of Manitou

Council, Inc. v. Girl Scouts of the United States of America, 549 F.3d 1079 (7th Cir. 2008)

52

Accidents Really Happen …

◼

Car dealership: JJCO, Inc. v. Isuzu Motors America, Inc., 2009 U.S.

• Dist. LEXIS 47128 (D. Haw. 2009) (case took 4 years and 12

separate reported episodes before defendant finally won)

◼

Golf pros at public golf course (dealership under Wisconsin 2-prong law): Benson v. City of Madison, 2017 WI 65 (2017)

◼

Value-added reseller of technology products: Oracle America v. Innovative Technology Distributors, 2012 U.S. Dist. LEXIS 134343 (N.D. Cal. 2012) (Oracle lost MSJ on franchise status claim)

◼

Furniture dealer: Bly & Sons v. Ethan Allen Interiors, 2006 WL 2547202 (S.D. Ill. 2006)

◼

Regional airline carrier: In re Northeast Express Regional Airlines, 1998 Bankr. LEXIS 1659 (Bkrtcy D. Me. 1998)

53

Strategies for drafting licenses and distribution agreements to avoid inadvertent Franchises

54

Structuring to Avoid “Accidental” Franchises

◼

Eliminate one leg of the stool (if any one leg is missing it does not matter how prominent the other two legs are)

◼

Trademark

◼

Fee

◼

Control, Assistance, Marketing Plan

◼

Not all jurisdictions define protected arrangement as a 3-legged stool

◼

NY franchise sales law

◼

2-prong state relationship laws

◼

Structuring solutions vs. sacrificing business goals

55

Naked Trademark Licenses

Lanham ACT, 15 U.S.C. §1127: “A mark shall be deemed ‘abandoned’ . . . [w]hen any course of conduct of the owner, including acts of

• mission as well as commission, causes the mark to become the

generic name for the goods or services or in connection with which it is used or otherwise to lose its significance as a mark.” Uncontrolled or “naked” licensing:

◼

Trademark ceases to function as a symbol of quality and controlled source

◼

Inherently deceptive and constitutes abandonment

◼

No need to show that owner had subjective intent to abandon the mark

◼

Can result in forfeiture of owner’s rights in the mark and cancellation of registration

56

Franchise Risk Assessment Depends on Which Law Applies

◼

Federal law – evaluate viability of a state “baby FTC” Act

◼

State Franchise law jurisdiction varies – look at:

◼ Assigned territory ◼ Location ◼ Distributor/licensee’s residence/domicile ◼ Where offer/acceptance take place ◼ New York connection? ◼ “Place of business” requirement? ◼ Other jurisdictional prerequisites

◼ Franchise agency administrative claim? ◼ Statute of limitations period

57

Reducing Franchise Risks by Taking Advantage

• f Exclusions from Federal Amended FTC Rule

◼

Employment Relationships

◼

General Partnerships

◼

Cooperatives

◼

Bona fide certification and testing services (AAA, Good Housekeeping)

◼

Bona fide single trademark licenses

◼

HOWEVER, unless you can find a state law exemption or exclusion (which need not be the same as the Amended FTC Rule exclusion), state franchise laws still apply!

58

Reducing Franchise Risks by Taking Advantage of Exemptions

◼

Federal + state dual regulation. Depending on jurisdictional factors, brand owner will need federal + state exemption (but they need not be the same)

◼

Frequently used Amended FTC Rule exemptions:

◼

Large franchisee (>$5.715M net worth)

◼

Large transaction (invest >$1.143M to launch)

◼

Defer collecting > $570 within first 6 months of operation (signing a promissory note is OK)

◼

Fractional franchise (<20% total revenue/brand)

◼

Starbucks is one of the few companies that engages in exemption- based franchising in the U.S. With deep pockets, it can

• wn/operate locations in states with franchise sales laws if no state

exemption is available.

◼

Some franchisors confine expansion to non-registration states to avoid needing an exemption from a state franchise sales law.

59

Reducing Franchise Risks by Taking Advantage of Exemptions

◼

OK to piece together different types of exemptions/exclusions by jurisdiction according to facts

◼

Most states have a large franchisor exemption based on net worth + units + time in business. No federal large franchisor exemption.

◼

FTC Rule + most states exempt “fractional franchises” (2 years experience + expected branded sales < 20% of a franchisee’s total revenue; but variations in exemption requirements across states. Example = Airport and universities – concession contracts

◼

FTC Rule + a few states exempt franchise sales to large or experienced franchisees

◼

FTC Rule + a few states exempt franchise sales to “insiders”

◼

Federal and state franchise sales laws do not regulate the sale of a franchise business by a franchisee for own account if franchisor’s involvement is limited to approving buyer

◼

In some states, an exemption may excuse franchisor from registration, but not pre-sale disclosure

◼

No uniformity!

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Common issues and stress points in Franchise relationships

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Common issues and stress points in franchise relationships today

◼

Insisting on TM uniformity to enhance consumer awareness & brand identification despite regional consumer preferences

◼

Implementing system-wide changes applicable to existing franchisees

◼ Long term contracts vs. keeping system competitive

◼

Enforcing post-termination covenants not to compete

◼ Policing against “break-aways”

◼

Enforcing system standards

◼ Dangers of being joined at the hip: the franchise network is only as

strong/competitive as the weakest link

◼ Carrot vs. stick; duty to disclose litigation

◼

Vicarious liability

◼ Is the franchisor liable to 3Ps for the franchisee’s acts/omissions? ◼ Is the franchisor liable to 3Ps for the franchisee’s employee’s

acts/omissions?

◼ Is the franchisor a joint employer with the franchisee of the

franchisee’s employees?

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Q&A

◼

Rochelle Spandorf

◼ Davis Wright Tremaine LLP ◼ 213/633-6898 ◼ rochellespandorf@dwt.com

◼

Craig Tractenberg

◼ Fox Rothschild LLP ◼ 646-601-7639 / 215-444-7161 ◼ ctractenberg@foxrothschild.com

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