May 2014 Archives

As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents.

Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws. As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents ("FDDs").

Many of these mistakes, which can cause delays in a franchisor's ability to obtain registration, are easily avoided.

Make them, and state regulators will refuse to register your franchise offering - sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

The Disclosure Requirement

On the top of the list of these common FDD mistakes is the franchisor's failure to comply with the requirements for Item 2. Item 2, entitled "Business Experience," is where a franchisor must list employment history of certain of its key officers, managers, directors, and employees. The instruction for completing Item 2 is a simple one:

Disclose by name and position the franchisor's directors, trustees, general partners, principal officers, and any other individuals who will have management responsibility relating to the sale or operation of franchises offered by this document.

For each person listed in this section, state his or her principal positions and employers during the past five years, including each position's starting date, ending date, and location.

That's it - that is the entire instruction for Item 2. The instruction does not call for the franchisor to give the entire resume, or even a mini biography, for its key personnel. But that's exactly what many franchisors tend to do.

Common Mistakes in Item 2

The franchisor's natural tendency in Item 2 is to use it as a sales tool - explaining why and how its key people are well-qualified, outstanding individuals with a long history of leading successful companies, and why they are great human beings, to boot. Here's an example of how a non-compliant, overly-descriptive Item 2 might look:

Jules Winnifield, President

Jules has been the President of Jack Rabbit Slim's Franchising Company for six years, and has been the driving force behind growing our franchise system from two locations to seventy-five. Before coming to work for Jack Rabbit Slim's, Jules was the Chief Operating Officer of Red Apple Security, one of the largest private security companies in the world. During his eight years at Red Apple, Jules was responsible for a 22% increase in revenue company-wide. Jules earned his Ph.D in Behavioral Psychology from the University of Santa Cruz in 1992. In addition to his hobbies, which include walking the earth and memorizing passages from important works of literature, Jules enjoys spending time with his wife, Mia, and his children, Marsellus and Lance.

So what's wrong with the above description? A lot.

First, it provides only a small portion of the information called for by the instructions in Item 2. While it does at least describe where Jules has been employed for the last five years, it doesn't tell you the dates of employment or where those positions were located.

Second, the listing reads like a sales pitch, telling the prospective franchisee why Jules is so well-qualified for his current position. Nothing in the instructions for Item 2 asks the franchisor to provide that information.

Third, the franchisor has provided more than five years of work experience for Jules, going back more than thirteen years into Jules's prior employment.

Fourth, the Item 2 instructions do not call for educational experience - only work history. And in this situation, it's not even clear that Jules's doctoral degree is even relevant to his current line of business.

Fifth, nothing in the guidelines asks a franchisor to provide information regarding the hobbies or family members of its key personnel.

You might think I'm exaggerating non-compliance with Item 2 when I list Jules's hobbies, wife and children. I'm not. I've seen many franchisors provide exactly that type of information in Item 2 of their own FDDs. 

Here's how an Item 2 disclosure should look:

Vincent Vega, Chief Executive Officer

Vincent has been our Chief Executive Officer since March 2012. Prior to becoming our CEO, Vincent was President of Butch's Boxing Club in Inglewood, California, a position he held between December 2010 and March 2012. Before that, Vincent was the Vice President of Operations for McDonald's in Amsterdam, the Kingdom of the Netherlands, a position that he held between October 2006 and December 2010.

The above Item 2 description is correct because it provides all of the information called for by the instructions, and only that information. Vincent's work experience the location of each position he held is listed in the description, and his starting and ending dates with each employer (month and year are all that is necessary) are given. The disclosure gives enough information to cover his last five years of employment, and no more.

Conclusion

Avoid making these common mistakes in Item 2 of your own FDD, and you will have an easier time of getting registered in the registration states. While it may be tempting to include the extraneous information in Item 2, your doing so will increase the likelihood that you will obtain comment letters from those states, and that your registration will be delayed as a result.

The term "epithet" is most commonly thought of as just using cuss words.

The dimensions of epithet are many and diverse, and their applications materially adverse to those who use them when it comes to avoiding or managing disputes.

For example, everyone who can now look back on an adverse dispute resolution result will be able to remember that in the beginning there was a lot of emotional input.

Furthermore, that input was egged on overtly or subtly by their lawyers. The angrier your client can become and the longer you can help to keep him angry, the larger will be the fees earned by "helping" him through the event.

Epithetical approaches are the least positive result productive and the most expensive way to deal with tough situations. By way of sarcastic example, consider that the names we call those we dislike tend to make whatever the chasm is between us wider, impassible, outrageously costly. The obvious "son-of-a-bitch" is simple and mild. Think terrorist, gangster, communist, socialist, rabble rouser, shyster, dead beat, malcontent, ingrate, Hamas, Hezbollah, Nazi, bomb thrower, jihadist and so on.

How does identifying a potential adversary as one of these help to get through the rough process? It doesn't.

Most of the time the accusation is also simply wrong. Your adversary may have a sincere belief that he is right - that his position lies upon solid ground. A good many times - as I have found in the last 52 years of dispute resolution practice, when you first call him that name, you will not yet have total command of all the facts and you will later find out (when all the facts are martialed and assessed by someone without passion) that you are not in as perfect a position as you assumed when you sent that first email; let out that first press release or took other first step actions that angry people tend to take when they are accused of doing something wrong or when they think someone is fudging on obligations.

Think, for example, of the campaign against Ralph Nader that General Motors waged when Nader challenged the safety of the Corvair.

Just the cash that GM paid to Nader when the lawsuit was resolved over GM having his hotel room bugged sufficed to finance the establishment of the Center for Automotive Safety.

The additional costs incurred by GM's insisting that it could do no wrong include not only expenses directly related to the Corvair, but market injury suffered by GM generally resulting from the enormous blunder; being inattentive when Ford developed the Mustang and when Honda came into the United States market. The accumulated injury came from arrogantly insisting that there was something called the General Motors Way and that no other approach was either correct or to be tolerated.

To this very day with its scandalous behavior regarding recalls and faulty electronics, we can see that the General Motors attitude has not changed in the least.

They still advertise that they are "professional grade" people - nothing could be further from the truth and they are the only ones who don't know that. GM has turned itself into an excellent case study in how not to deal with risk and confrontation. General Bullmoose is long dead, and that is true for GM as it is for any other company with similar inclinations.

General Motors is an extreme example of epithetical thinking, but not even they can afford what they are now caught doing.

Even if your company is publicly held and you are playing with shareholder money rather than your own, epithetical thinking, assessment, analysis of the essence of any dispute makes its resolution much more costly in dollar terms and in market position/reputational injury.

Never let your PR people or your lawyers cheer you on to be overly adversarial. There are always less costly and quicker ways to get beyond any dispute.

And no matter what you may think at that first moment, you may not be in the enviable position you thought you were in then. Ultimately you will receive greater respect and accolades for a more mature manner of dealing with adversity than you will get from being just another corporate loudmouth later proven wrong, or at least not right.

What is required to head off confrontation is that you step back from what your training and your instincts have conditioned you to do in the face of perceived adversity.

If you were an elite unit military person you were told never to hesitate to shoot or you will end up dead. You normally would think that you must present an intensely adversarial front or be consumed by a more aggressive opponent.

In dispute avoidance management and in dispute resolution management you must take another approach while keeping open the option to shoot if the more reasoned, outside the box techniques do not produce at least positive movement.

How that is accomplished differs somewhat with the particular facts of the situation and with the chemistry that has resulted from what has already happened that cannot be taken back. That is the point of differentiation between the template following traditional law firm and PR group and the expert crisis avoidance/management resource.

I am not supposed to be blunt here, but I would rather risk being politically incorrect that fail to get my point across.

I want you to think of how I do things as handling it so that you do not have to attempt the burden of stuffing the shit back into the horse.

In its best mode that is more likely to be the positive result if I am consulted very early on, before you have made any move or response to anything that falls within my definition of being epithetical. You can deal with an adversary being epithetical if you can contain yourself - keep your head when all about you are losing theirs, as Kipling put it.

When your normal professional resources are telling you to follow your instincts and your former training, it is very hard not to go in that direction.

But when you disregard the adversaries and act/speak as though you have command authority when in fact you may not have command authority, you always get the General Motors result.

You usually do not know for sure whether you have command authority that early on.

All too often what comes out later makes you look dishonest or out of touch. You don't have to do that to yourself.

Execution of Agreements

The franchise sales process does not end until final agreements are executed by the parties. When you receive back the final agreements signed by the prospect, they are not executed. The franchisor must countersign the agreements for them to be executed. Only when the franchisor countersigns the agreements does the franchise sale occur and the prospect become a franchisee.

If a "material change" occurs, or if a state registration expires, before the franchisor countersigns the agreements, obligations to re-disclose the prospect and re-observe all waiting periods may be triggered. So, if the franchisor wants the prospect as a franchisee, you should arrange for the franchisor to countersign the agreements as soon as possible.

Post-Sale Obligations

The franchisor must retain a copy of each materially different version of its FDD for 3 years after the close of the fiscal year when it was last used. Some states require longer retention periods.

If the prospect signs a franchise agreement, during the entire life of the franchise and for several years beyond, the franchisor should retain copies of all communications from and to the prospect during the franchise sales process, and copies of all signed FDD receipts and all executed final agreements.

By law, signed FDD receipts must be retained at least 3 years, or even longer for sales in some states.

Even if the prospect does not sign a franchise agreement, the franchisor should retain copies of all signed FDD receipts, and of all communications from and to the prospect during the franchise sales process, for at least 3 years, or even longer for offers in some states.

(This was the last post in a series of 11 posts on making compliant franchise sales. )

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