April 2013 Archives

When you finally figure out that you have been had, that you bought a bozo franchise and that you are going to be cheated even more by the scoundrels who sold you the deal, the first things that you will do will be the wrong things. It never fails.

People who won't spend money to obtain competent help on deal due diligence before they invest, who only want to spend a few hundred bucks to have some bozo lawyer "read the contract", usually - in fact almost always in the case of the newer franchises these days - wake up one morning realizing that they have been royally screwed.

Before continuing, I think I need to explain the term "bozo lawyer", as I know I will get a lot of angry feedback from certain circles in the legal profession if I don't explain it.

A bozo lawyer is a lawyer who wants so much to make a few hundred dollars doing something inadequately and incompetently, that a small fee will be accepted rather than honestly saying to the client that the scope of the project is beyond their ability and helping the client find a resource who knows what to do.

A bozo lawyer will take the small "read 'em the contract" fee rather than tell the client that the project requires business and financial and franchise, as well as legal due diligence and experience with how representations are skewed in the franchise industry.

Any lawyer who will "read you the contract" and not do the other things I have suggested in the Franchise Fraud Symposium Tutorial articles is a bozo lawyer. And, as I have said in those Tutorials, even that is sometimes not enough.

Fraud is sometimes blatant and often subtle. If you don't have the training or experience to do the job right, you have a fiduciary duty to the client to direct them elsewhere and help them get what is needed to do the job competently.

If you don't do this you are a bozo lawyer and deserve to be sued for malpractice.

It breaks my heart when I realize that almost everyone who comes to me after they have already been cheated hired a lawyer before they bought the franchise who only told them that the franchise contract is very one sided and that usually there is no opportunity to negotiate individual terms, and maybe also that it looks like a good deal if all the claims are true.

I just want to scream that there are not militant seminars to teach so-called business lawyers about how to do franchise purchase due diligence in a hot zone of intense franchise investment fraud.

The due diligence on a new franchise has to be as intense, if not more so, than the due diligence on the acquisition of an up and operating business. There is less actual information available on the new franchise proposition, because there is no actual operating history for the store that the client will operate.

This makes it easier to fabricate the appearance of financially positive prospects. Ferreting out that scenario's warts calls for more intense cynicism.

Because the work is more complex and costs substantially more to do it properly, prospective clients are often reluctant to spring for The Full Monty. The client is presold and, at the moment of your first meeting, the job will be to disabuse him of the enthusiasm for the proposal.

But if, after you have told him the risks of skullduggery, there is still unwillingness to pay for doing the job right, taking the smaller version of counseling is simply an invitation to disaster.

If the client won't pay for doing the job right, the only intelligent course is to show him the door. Oh, you can write a fee agreement that limits what you will do for the small fee, but if you have ever heard that kind of fee agreement dealt with in trial of a malpractice case, you probably will never do it that way.

You're not a professional if you lack the ethical substance to tell a prospective client that you can't help them. Usually those resources have to be multi disciplined.

They have to be capable of spotting fraud, spotting "tricks" always used by franchise sales people, knowing where to look for the "stuff" that isn't obvious on the surface, parsing the financial substance of how the proposed business relationship will really work, and differentiating between what is communicated in the sales and marketing process and how - if at all - that is reflected in the franchise agreement and accompanying disclosure documents.

You have to be capable of graphic portrayals of the defects that the client has no idea are hidden within the documents provided by the franchisor. The client believes that the people that are on the opposite side of the proposed transaction are really trying to help out rather than fleece him.

If the prospective client doesn't want to pay for that level of assistance, the only smart thing to do is to decline the retention and let the victim go take his lumps. That way the victim won't have you to blame/sue when the worst happens after the sale is closed.

Filled with anger, loathing and hatred, these victimized franchisees initiate a campaign of name calling, send emails and letters and make telephone calls whining about something that they thought they had a right to that is not being performed by your franchisor, or about something the franchisor is doing that they said they would never do in the sales pitch - but not in the franchise agreement itself.

They also get on the phone and discuss it angrily with their fellow franchisees, some of whom will - of course - report to the franchisor that you are calling around bad mouthing the organization, hoping that by ratting you out they can suck up and maybe avoid the same treatment.

Then the victim will spend the next two years whining and complaining, and usually making no money or far less than he was led to believe - almost no one makes the projections - even if they make the sales they don't make the profit numbers.

All this time the victim will be miserable. His net worth will decrease. His ability to handle financial obligations will get steadily worse.

And the statute of limitations will be running toward the extinction of any fraud and misrepresentation claims that he may have and does not assert in a proper forum.

Since he wouldn't spend money to get competent help with the due diligence before he bought the franchise, he resists spending money to get competent assistance on what to do about the situation now.

If he is really stupid, he will wait until his financial condition is so bad that he can't afford competent help anyway.

One thing is certain. If the franchise he bought is a fraud, one of the franchisor's goals is that when he figures out what happened to him, he will be too poor to do anything about it. He may already be beyond help. If he delays further, his chances of being beyond help increase rapidly and dramatically.

That's what most folks do in this situation.

There are two rational solutions to having just learnt that you've been had. And the earlier on that you chose one and get on with its execution, the better off you will be. Life is tough. You have to be tough or it will devour you.

The ability to sue the lawyer who failed to provide competent guidance in counseling you about doing the deal in the first place is probably subject to a two year statute of limitations.

The statute of limitations on any franchise fraud claim is probably going to run out in three or at the most four years from the date you signed the franchise agreement. There may be an even shorter contract limitations period.

YOU CAN NEVER ASSUME THAT STATUTES OF LIMITATIONS GIVE YOU THE AMOUNT OF TIME THAT I HAVE JUST SUGGESTED. YOU HAVE TO CHECK THE SPECIFIC STATE STATUTE FOR YOUR PARTICULAR SITUATION IN EVERY INSTANCE. YOU MAY NOT HAVE AS MUCH TIME IN YOUR SITUATION FOR ANY NUMBER OF REASONS.

You may stupidly have given away your right to jury trial and your right to collect most categories of damages when you singed the franchise agreement, and damn few courts are going to be willing to give those rights back to you under any kind of unconscionability rationale.

You need to get yourself into the hands of a competent business fraud trial lawyer as soon as you believe you have been cheated. You need also to avoid any communication whatsoever about your situation until you and your new lawyer have sorted out what you options are and in what priority you are going to exercise them.

Don't send the angry emails and letters. Don't make the angry phone calls. Don't talk about the situation with other franchisees. Shut up until you have a battle plan. Everything you say or write before you get the battle plan sorted out is more likely to hurt your real interests than help.

One of the first and most important options you will have is simply to get out of the business by putting your franchised business up for sale. It probably has some market value. If you think you would rather just sell the business than spend money fighting your franchisor and/or your original lawyer, you will need not to have created a difficult situation by bad mouthing anyone or anything.

You will have to deal within yourself with the question of how you will feel about dumping the deal you wish you had never bought onto someone else. That's your call, but the option is there and you need to consider it.

You may well not realize total recovery of your investment. What you can get has to be measured against what you would have to spend and to risk in order to go to war over having been cheated.

Contingent fee lawyers only get paid if they win something, so if you insist on a contingent fee arrangement for your new lawyer, expect a recommendation to fight.

Solutions that don't produce cash recoveries don't provide funds to pay contingent fees. If the contingent fee agreement states that it will apply to any sums you receive, expect the lawyer to claim a percentage of the price you get from selling your business.

Business brokers are cheaper in percentage of sales price than anything you will find in a contingent fee agreement. Contingent fee agreements frequently take 30 - 50 % of the recovery from any and all sources. Do you want to go that way? Probably not. If you want competent legal assistance and don't want to pay that kind of fee, you have to pay the lawyer by the hour and not on a contingency. If you pay by the hour you will also get more attention paid to alternatives that do not involve having to fight for a litigated recovery. There is no free lunch!

Do not expect that your fellow franchisees are going to come to your aid. They almost certainly will not. They will in all likelihood gossip amongst themselves about what you tell them.

Promises of confidentiality are totally useless. Some of these folks will tell the franchisor everything that is said in hopes of getting some favorable treatment for themselves.

Even if what happened to you also happened to them, do not expect assistance. They would rather lie in the weeds and see what you get on your own than stand with you and assist in the attainment of a better result for everyone. That's how the world works and how it has always worked.

See the Tutorial entitled "WHO DO I NEED? WHEN DO I NEED HIM? GETTING THE RIGHT LAWYER AT THE RIGHT TIME" in the roster of Specialized Tutorials on my web site.

Ask the tough questions of the lawyer you are thinking of hiring for due diligence work. How many of these proposed transactions have you vetted? Have you followed up on any of them regarding how well or poorly they did? What were the main problems that contributed to the difficulties of those franchisees who had difficulties? Can you identify the point at which the due diligence work may require the participation of a financial advisor in addition to a legal advisor? If so, do you have someone who is available to assist with that work, and what should I expect that to cost?

And don't forget that a reality mode appreciation of the terms of the franchise agreement is also part of the mix. You really do have to understand what the contract says and, more importantly, how that works when it comes into play and why it is configured the way it is.

If you the lawyer can't appreciate the intertwining of Integration and Acknowledgement clauses, and the intertwining of covenants not to compete and liquidated damages clauses, and you are unable to portray to the prospective client how those work together and why they are in the contract, you aren't ready for this work at any level.

If you lack sensitivity for the differences between the sales and marketing brochures and the substance of the Duties Of The Franchisor provisions of the franchise contract, and how to go about accounting for them, plus the oral statements made by franchisor representatives, you may be a RedNeck, as Jeff Foxworthy says, but you aren't ready for prime time when it comes to counseling about franchise purchases.

The  SB 610 Fair Franchisee Bill passed via a 5 to 2 vote yesterday at Senate Judiciary Committee.

It is will now go the Senate floor for full Senate vote.  If it passes, then it must pass the Assembly and be signed into law by the Governor.

"This bill would modify the California Franchise Relations Act (CFRA) to enhance the protections for and rights of franchisees in the performance and enforcement of the franchise agreement. 

As noted in the Background, the CFRA governs the ongoing relationships between franchisors (including subfranchisors) andfranchisees to generally prevent unfair practices in the termination, renewal, or transfer of a franchise.

Consistent with the general goal of the CFRA, this bill would require franchisors, subfranchisors and franchisees to deal with each other in good faith in the performance and enforcement of the franchise agreement. The bill would define good faith for these purposes to mean honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade.

A franchisor or subfranchisor who violates this provision could be sued by the franchisee for specified damages.

In opposition to the bill, a coalition comprised of the International Franchise Association, California Chamber of Commerce, Civil Justice Association of California, California Grocers Association, and California Retailers Association, raise concerns with the good faith requirement, arguing that it is an "amorphous term . . . to be applied to the franchisor in its relationship with the franchisee.

The concept of 'good faith' was created in the Uniform Commercial Code to fill in the blankson short form contracts for the sale of goods. However, it provides no benefit in the context of detailed franchise contracts which govern complex and ongoing business relationships."

In response, co-sponsor American Association of Franchisees and Dealers states that "modern franchise relationships are most always governed by one-sided 'take it or leave it' adhesion contracts that elicit substantial monetary investment from franchise owners, provide substantial protection for 
franchisors, but severely limit a franchisee's rights in the franchise relationship.

Creating a statutory affirmative duty of good faith in franchise relationships will inhibit the enforcement of one-sided franchise agreements in an abusive 
manner."  (Other details of the California Bill, click here.)

The Senate Judiciary Committee of California is scheduled to consider a franchising bill at a hearing scheduled for Tuesday, April 16, 2013, at 1:30 p.m.  

If passed by California's legislature (the State Assembly and Senate), SB 610 would amend the California Franchise Relations Act ("CFRA") as follows:

• The parties to a franchise relationship would be required to deal with one another in good faith (essentially, making the implied covenant of good faith and fair dealing an express statutory requirement); and 
• Franchisors (or subfranchisors) would be prohibited from restricting a franchisee from joining or participating in an association of franchisees.

SB 610 would also amend the CFRA by permitting a franchisee to sue a franchisor or subfranchisor who violates the CFRA for damages, rescission, or other relief deemed appropriate by a court. 

Moreover, SB 610 would authorize a court in its discretion to award treble (3 times) damages to the suing franchisee, as well as reasonable costs and attorney's fees. 

For more information about SB 610 and a copy of the full text of the bill, visit www.leginfo.ca.gov. 

A live audio / video feed may be available during the hearing at http://www.calchannel.com/. 

If the franchisor makes a financial performance representation - also called an FPR - in Item 19 of its FDD, you or the franchisor may furnish to a prospect a supplemental FPR about a particular location or variation.

For example, if the FPR in the FDD gives average sales and cost information for all outlets in a system and the prospect is considering an urban location, the supplemental FPR could focus on the sales and costs of just urban outlets in the system.

The supplemental FPR may be a document separate from the FDD, but must:

• be in writing

• explain the departure from the FPR in the FDD

• be prepared in the same manner as a standard FPR

• be furnished to the prospect.

If you would like to know if you can franchise your business, connect with me on LinkedIn and give me a call.

Disturbing trends have emerged recently in both South Korea and Indonesia as governments move to place restrictions on the number of stores large franchise companies can develop.

I believe that these policies are misguided and the government officials involved lack a basic understanding of the industry and its impact on self-employment and entrepreneurship.

Indonesia is still a developing country and many large scale conglomerates do exist with sizable control over retail, mining and the agricultural sector. Some of these conglomerates are close to the government and license brands in the country such as Starbucks.

However, there are also local coffee house chains like EXCELSO that cater to a growing Indonesian middle class and are doing well. There are also chains like Hoka Hoka Bento with over 200 stores and growing offering affordable meals for US$ 2-3, primarily located in food courts.

Indonesia is not developed sufficiently to support single unit franchising successfully so even if the big chains are pressured to sub-franchise or sell off stores they are likely to be purchased by other large groups and defeat the government's purpose entirely.

No one can say that the franchise industry in South Korea lacks competition or that there is limited choice. One only needs to look at the coffee house or chicken sector to see the highly fragmented nature of the industry.

Of course some of the chaebol do have ownership positions in certain local chains, but there are many growing chains founded by local entrepreneurs as well.

Famous brands such as BBQ, Kyochon, Mister Pizza, Bonjuk, and Nolboo, for example, were all founded by local individuals, and while they all have strong positions in the marketplace, it is easy to find alternative concepts to visit as well.

Franchising in South Korea offers new opportunities to retirees looking to extend their business lives or to younger people seeking self-employment. This has a positive effect on the overall economy and restricting the number of successful franchise chain stores will likely have a negative effect as these potential franchisees may be forced to invest in less proven concepts with higher risk.

Government does have an important role to play to ensure that the franchiser provides clear and honest documentation to a potential franchisee in a manner that represents the business model fairly. The franchisee in turn is expected to do his own due diligence by meeting with the management of the franchiser and speaking with other franchisees operating the concept. Once this relationship is established it is in the mutual interest of both parties to ensure that the business is successful.

I hope that both the Indonesian and Korean politicians will study this issue more carefully before trying to solve a problem that probably does not exist.

The Fourth Circuit issued a bold new arbitration decision last week, sending a putative class of shuttle drivers to arbitration while expanding its application of SCOTUS' Concepcion decision beyond cases involving federal preemption of state arbitration law.  Muriithi v. Shuttle Express, Inc., __ F.3d __, 2013 WL 1287859 (4^thCir. 2013).

Muriithi was a driver for an airport shuttle service who signed a franchise agreement containing an arbitration clause.  The franchise agreement required arbitration of "any controversy arising out of this Agreement," required that arbitration proceed "on an individual basis only," and required each party to bear half the "fees and costs of the arbitrator." 

Muriithi later brought employment claims as a representative of a putative class of drivers, arguing they should have been treated as employees entitled to minimum wage and overtime pay instead of labeled as franchisees.

Shuttle Express moved to compel arbitration.  The district court denied the motion, finding the arbitration clause was unconscionable, because plaintiffs could not effectively vindicate their statutory rights due to the class action waiver and fee-splitting provision (and a one year statute of limitation).

The Fourth Circuit reversed the district court, and ordered it to compel arbitration of the drivers' claims.  The Fourth Circuit could have accomplished that in a fairly simple fashion - by finding that Muriithi did not meet his burden to prove the costs of arbitration would be prohibitive (under the same line of decisions at issue in the AmEx case currently pending before SCOTUS) because he did not present evidence about relevant arbitration fees or the value of his employment claims.  [It could not have hurt that Shuttle Express volunteered during oral argument to pay all arbitration costs if the court compelled arbitration.]

Instead, the Fourth Circuit did that, and then also went out of its way to discuss arguments about whether Concepcion had any application to the case.  The driver argued it did not, because he was not arguing for the application of any state common law that precludes class action waivers in arbitration. 

The court disagreed, finding Concepcion applies to any unconscionability argument directed to waivers of class arbitration.  "[T]he Supreme Court's holding was not merely an assertion of federal preemption, but also plainly prohibited application of the general contract defense of unconscionability to invalidate an otherwise valid arbitration agreement under these circumstances."

That is a bold statement from the Fourth Circuit, not only because the question presented and ultimate holding inConcepcion were both specific to federal preemption, but also because it adopts the position of the Petitioner in the AmExcase, before SCOTUS has even issued a ruling.

Here's an interesting case I recently came across.  It features a franchisee based in Italy suing its California-based franchisor in California, alleging violations of California's franchise laws.

If you've ever bought a diamond ring, you are doubtlessly familiar with GIA, or the Gemological Institute of America, Inc. GIA, which was the defendant in the case, is a precious gem grading company with a principal place of business in Carlsbad, California. 

The plaintiffs were longtime employees of GIA who, in December 1991, entered into an employment agreement with the company to relocate to Vicenza, Italy to open what would be GIA's first European location.  Plaintiffs did relocate from the U.S. to Italy in 1992, and opened and operated a gem grading school on behalf of GIA there.  GIA Italy became the hub of all of GIA's activities in Europe, graduating around 60 gemologists per year. 

In 2007, GIA entered into an agreement with the Florence Chamber of Commerce to relocate GIA Italy to Florence and construct a GIA lab and gem drop-off service there.  In exchange, the Chamber would provide GIA Italy with substantial financial support. 

Later in 2007, GIA ended plaintiffs' employment agreement and entered into a franchise agreement with them, giving them ownership of GIA Italy as franchisees.  The franchise agreement included the following provision:

3.6 No Gem Grading or Identification Services. Licensee, its affiliates, owners, managers, members, agents, and employees will not operate any trade-service laboratory for the purpose of diamond grading, colored stone grading, or gem identification, without the prior written consent of GIA in each instance.

In March 2011, GIA sent the Florence Chamber of Commerce a letter indicating that GIA would no longer allow the construction of the lab and drop-off facility in Florence.  Later that year, the Chamber informed the franchisees that it would no longer support GIA Italy because the Florence lab had not been opened despite the passage of several years. 

Plaintiffs filed suit, contending (among other things) that GIA had defrauded them into signing the franchise agreement based on its representations in 2007 that it would continue to support the Florence gem lab, which representations were false.   Plaintiffs argued that one of the key reasons they signed the franchise agreement was because of their understanding that they would be able to open the Florence lab (based on oral representations from GIA's President).  Plaintiffs also claimed that GIA violated the California Franchise Investment Law ("CFIL") (California Corporations Code §31119) by failing to provide them with a franchise disclosure document and register its franchise offering as required by law.

GIA moved to dismiss. As to the fraud claim, GIA contended that plaintiffs could not claim reliance on GIA's representations as to the Florence gem lab because (based on the above-quoted language) the franchise agreement expressly prohibited plaintiffs from operating a lab or drop-off location without GIA's prior written consent.  The Court agreed with GIA, holding that "it is not plausible for Plaintiffs to have reasonably relied on any prior representations of continued support for such a laboratory when they signed the License Agreement."

As to the CFIL claim, GIA argued that: (a) the law did not apply to extraterritorial franchise sales; and (b) the claim was not brought within the four year statutory limitations period as required by California Corporations Code §31303. Plaintiffs countered by arguing that GIA Italy's student enrollment included students from the U.S. and California, and that the statute of limitations had not expired because the claim was brought within one year of their discovery of GIA's breach.

The Court dismissed the CFIL claim, finding that the statutory limitations period had expired.  In support of this, the Court considered the language of California Corporations Code §31303, which provides:

No action shall be maintained to enforce any liability created under Section 31300 unless brought before the expiration of four years after the act or transaction constituting the violation, [or] the expiration of one year after the discovery by the plaintiff of the fact constituting the violation... whichever shall first expire.

The Court held that the CFIL's four-year limitations period is an absolute bar, and that belated discovery cannot serve to extend the statute (citing People ex rel. Dep't of Corps. v. Speedee Oil Change Systems, Inc., 95 Cal.App.4th 709, 727, 116 Cal.Rptr.2d 497 (Cal.Ct.App.2002).  Because plaintiffs' complaint was brought over four years and five months after the franchise agreement was signed, the Court dismissed their CFIL claim.  As a result, the Court did not reach the issue of whether the CFIL applied to the transaction.

The moral of the story: be aware of statutes of limitation and how they work.  Don't assume that a provision tolling the statute from the date of "discovery" trumps all other time periods in the statute.  Also, if you're a franchisee, don't assume that the franchise laws of your franchisor's home state will apply to you if you're not also based in that state.  Non molto bene for the franchisee!