January 2015 Archives

There are in every segment of our economy, at every moment of the day companies/people who sense that some significant project for which they bear responsibility is starting to move in a bad direction.

Whether it is:

1. A franchise system filling with disenchantment due to market changes for which requisite adjustments have not been found and made-

2. A fashion house trying to cope with designer disputes and threatened license terminations-

3. Dealers that need to be terminated in order to more effectively aligning the company's direction with its marketing strategy or foreign trade issues -

4. How to build a more international network and mitigate exposure to foreign jurisdictions should things not go as planned -

The list is endless - that movement from well being to impending serious difficulty arises.

The people to whom you regularly turn for guidance in more normal circumstances are less helpful when life starts to get tougher.

They may have long tenure and vast company and specific industry knowledge as well as knowledge of the people involved. However, theirs is not responsibility for stepping away from the immediate picture and providing calibrated options that can with econometric reliability be sorted and prioritized.

Finally, let us assume that the situation/company/relationships now coming into higher risk are worth saving. Some are so desperate that the die has been cast.

Most of these relationships are founded upon written agreements containing clauses taught in law school or by long custom that are terrible impediments to braking as brinks are more closely approached. Feeling trapped by inopportune language, most law firms I have encountered advise the pulling of triggers, giving notice of claim or default, stated in those stilted lawyerese that so endears our profession to the rest of the world.

But contracts have other clauses, largely unwritten in the traditional sense. They have become incorporated into the business model of the agreement by the force of experience and change. Lawyers who can read often can't find these clauses due to lack of substantive insight. They may be legal scholars, but this isn't a law school final exam.

If pulling triggers for fear of being accused of not exercising one's rights and thereby losing them could without sacrifice of position be replaced, would you consider it?

And what factors would you have to take into account to decide to take a more unorthodox approach to dispute avoidance that could save the deal/relationship/realignment project that you really wish to implement?

Begin with the metrics. The metrics are not a set of likely numbers if one approach is chosen. The metrics are differentials between performance number sets when alternatives are not only netted against each other, but considered in series. Yes. You can do both. If you know you can still fight if the preferred approach doesn't work, with no loss of position, could you ever even think of not doing this as I suggest you should?

Obviously this is not addressed to scorched earth egoists who like fiddle music in the midst of conflagration. Most companies are rational. It is to those rational companies that our approach makes the most sense.

Few people are always or absolutely right. In most instances there is room for adjustment. The passage of time alone suggests market changes that make old agreements less suitable to modern issue resolution.

Lawyers who believe only in contract language can never accomplish what I am speaking of.

If you would like to explore this avenue to rational prosperous relationship preservation, give us a call 281-584-0519.

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My previous post described common disclosure errors that might be used to exit a franchise system. This article describes the process by which disclosure errors can produce this result. The process is by no means automatic, and it requires the involvement of an experienced franchise attorney. In some cases, even obvious and serious disclosure violations do not translate into a pass to leave a franchise system.

But where (a) significant disclosure law violations exist, and (b) applicable state law cooperates, disclosure law violations can be used to exit a system without any continuing obligation not to compete, and sometimes franchisors can also be made to refund fees or reimburse business losses.

There is no private right of action for violation of the FTC Rule under federal law, so the consequences of violation generally depend on applicable state law. If the franchisor and franchisee are located in different states, consequences of disclosure violations can be very different under the laws of their respective states.

The Franchise Agreement almost always specifies that the law of the franchisor's state applies. Frequently that controls which state's law applies.

But sometimes the franchisor is located in a state with a law that permits private actions for disclosure violations, so that the choice of law provision actually gives the franchisee rights it would not have had otherwise. In other cases the franchisee may be located in a state where either (a) state law requires a franchisor to provide a contract amendment invalidating such provisions, or (b) state law provides that contract terms applying a different state's law are not enforceable.

In some cases, the specified state may not have any law addressing FDD disclosure violations, and no lawsuit could therefore be brought for such violations, apart from the possibility of a lawsuit alleging fraud (for example, for issuing misleading financial performance representations).

In other cases, the state may have a law directed at disclosure violations, but the law may include an exemption for certain kinds of franchise sales, for example, where the franchisor is very large (think McDonalds), or the sale of the business involves a very large investment (such as a large hotel investment).

Ohio has a Business Opportunity Law which one commentator has referred to as "the Hidden Franchise Law". The law is complex, and generalizations are hazardous.

But in substance, the law requires a franchise seller to provide the purchaser with an FDD, and gives the purchaser a right to file suit if the FDD or disclosure process violate FTC regulations in significant respects. In such cases, the purchaser can bring a lawsuit and ask the court to "rescind" (or undo) the transaction, and also to award treble damages and attorney fees. In practice, many franchisors quickly offer to settle such claims once they are shown how the FTC regulations were violated.

Attorney Stanley Dub has handled many such cases, and would be pleased to discuss your situation without obligation.

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A colleague recently asked me this question:

"You've stated that defects in the FDD or disclosure process can sometimes be used by unhappy franchisees to exit their franchise systems, even if a significant amount of time has passed. What are the most common defects in the FDD or disclosure process that can be used in this way?"

This scenario is a focus of my practice and I've handled dozens of these situations for both franchisees and franchisors.

The question has two parts, which will be discussed in separate articles.

Part 1. What are some common significant disclosure violations?

Here are eight common disclosure violations which I regard as significant:

1. Failure to disclose sufficiently in advance of signing or taking payment (e.g., handing out the FDD at "Discovery Day" and then signing the contract without waiting the necessary 14-day period). In this scenario, the Receipts are typically not signed and dated, or they are signed later and backdated.

2. Making defective financial performance representations. Franchisors want to put their financial data in the best possible light, and sometimes they cherry pick data in violation of FTC guidelines.

3. Providing different or "updated" financial performance information after the FDD, but before contract signing, either verbally or in writing. Many franchisors decline to provide an Item 19 financial performance representation at all. That's the safest course legally for a franchisor, but it makes it hard to sell franchises. What do you tell a proposed franchise buyer when his bank asks him to prepare a budget for his loan application? If you give him some projections, that becomes an unlawful financial performance representation.

4. Failing to provide an updated FDD after the previous document expires. The documents have to be updated within 120 days after the end of a year.

5. Providing an updated FDD which does not include updated financial statements. The financial statement requirements can be confusing, but they are a fertile area to check for disclosure violations. Sometimes the footnotes contain information that conflicts with the disclosures in the FDD text.

6. Providing a parent company's financial statement in the FDD in lieu of franchisor financials, without also providing a guarantee of performance by the parent company.

7. Failing to address ownership of key trademarks by entities other than the franchisor. Check the trademark registrations to see if the trademark owner is the same as the franchisor. Often the business owner starts a new entity to operate the franchise, and sometimes the trademark will be shared between the franchised units and the preexisting company units. Is there an Agreement between the trademark owner and the franchise entity addressing this shared ownership? How is this relationship described in the FDD?

8. Failing to update a prior FDD before signing, where a material change requiring an updated version has occurred since FDD preparation.

If this material is relevant to YOUR situation,

please give me, Stan Dub, a call at: 216-991-4480