February 2015 Archives

Just back from the wars, so to speak, I found that most folks are too socially emasculated through the process of institutionalized position sensitivity to even have an inkling about what to do when a dominant position person goes off the deep end and his actions threaten to destroy businesses if not brought to a screeching halt. Such was the war just concluded, in which we represented numerous franchisees of a franchisor who's point person thought and acted like a white bread Benito Mussolini.

This was a renewal issue in which the franchisees had the right to renew on the same terms they currently enjoyed unless the franchisor was then selling new franchises, in which instance they would have to sign the then current franchise agreement in order to renew.

Obviously, new franchise agreements are historically upon worse terms for franchisees than expiring agreements. At least that is the predominant experience in the franchising business.

Money, restrictions, franchisor prerogatives and other matters that impact the relative economics of a franchise relationship tend to move in favor of the franchisor with each new iteration of the agreement.

This franchisor was a more than over the hill operation and had not sold new franchises for about twenty years. It had seen the attrition of most of its franchisee population and did not even have an operations manual.

Peter the Point Man decided that the value of being his franchisee was far above then current relative economics and that he was not going to be so foolish as to honor renewal terms, no matter how clearly they may be stated in the soon to expire current agreements of my clients. They were the best performing franchisees, historically, in the system and had been there for about forty years. Had Old Pete been possessed of any good sense, he would have paid them to show him how to operate the company owned units which lost money while theirs prospered every year more and more.

Any econometrician would tell you that in these circumstances the relative value of the relationship among the parties were indeed skewed, but in favor of the franchisees rather than the franchisor. Had Old Pete simply gifted these franchisees with the entire company, he would have come out far better off economically compared to facing years upon years of continuing losses eventuating in the bankruptcy of his company.

These franchisees had been clients of mine for over thirty five years, having once before been confronted by an earlier edition of delusional point person. I sued the franchisor on their behalf then, and the results of that litigation was the ultimate cause of their having favorable contract terms now.

My clients believed that when renewal time came around this Bozo had plans to try to rip them off, and so we had almost a year head start in setting Him up for his comeuppance.

Franchisors love discussions. Discussions leave no tracks. Writings are tracks, and thus are despised by franchisors, especially if they have an agenda to be predatory and need deniability in case there is strong push back by the franchisees. Peter the Point Man, however, failed to recognize that our insistence upon having email confirmations and exchanges to prevent negotiations from being nothing more than conversations was providing us with a plainly visible trail of the development of his entire program to rip us off.

His arrogant lack of subtlety even went so far as to acknowledge his obligation to negotiate terms with us and then insist that the negotiations be restricted to only those issues raised by the franchisor.

He even went to the trouble to have his lawyers send us a proposed contract amendment saying just that.

No one signed that, on advice of counsel.

He then told us that business requirements prevented him from being able to negotiate the renewal terms right now and offered a one year extension of the same terms to accommodate his claimed business needs. In fact, what he did during that extension period was to have his lawyers create a spurious FDD, which he registered in Virginia so that he could claim that he was in reality engaged in selling new franchises and therefore exonerated from having to negotiate new terms with us or to offer renewal upon the same terms as before. He then imperiously insisted that we sign his new franchise agreement, which was full of incredibly stupid positions that no competent franchisor would ever put into his agreement.

To be sure, he also changed the economics drastically in his own favor (as if that needed to be said). The State of Virginia took one look at his company financial reports and immediately slapped him with an initial fee impound.

My clients had been successful business operators for over forty years, and had been in only one real battle royal in their entire lives, the earlier litigation with this same franchisor under other "leadership". They found it very out of character for me to insist that they seriously do things to bring about the entrapment of the present franchisor management. I had constantly to explain to them that if they didn't handle the situation as a prelude to a main battle they were going to lose their businesses.

They, like most folks, erroneously believed that they had obvious rights and that that was all that was necessary for the correct result to ensue.

They were initially incredulous when I explained to them that there is no right on earth that is self-executing, not even those in the Constitution. If you don't stand and defend your rights, they can easily be taken from you, and this was an obvious situation in which that was exactly what would happen unless we succeeded in entrapping the franchisor into revealing his hand in an evidentiarily usable manner.

They had never heard of such a thing, and their regular lawyers had no inkling or experience with this sort of confrontation technique. They were always fearful of giving offense and messing up their negotiating posture. They refused at first to believe that there was in this instance no such thing as negotiations and accordingly no such thing as a proper negotiating posture. Fearful of burning bridges and self-destructing, it required a lot of tough love quasi-military training to get them to go along with my urgings.

Only as the unfolding of the fact pattern revealed that I had absolutely correctly assessed the risk and danger profile did they come to accept the ancient truth that the only way to deal with a bully is to whip his ass half to death - or at least until he came to terms.

Peter the Point Man had no experience in working with a company that was actively selling franchises. His overlord had once before been with a franchising company that had, under his leadership, gone into bankruptcy. Between them both, they were playing with far less than a full deck - were several bricks short of a load.

Accordingly, they compounded mistake upon mistake. They failed totally to do what every real franchisor always does to market a franchise program. They even sent us a letter half way through the litigation saying that they hoped soon to have an operations manual ready for review. The list of bozo mistakes would provide a standup comic with at least fifteen minutes of material.

They informed the court that their position was that the issuance of the spurious FDD was all they needed to prove that they were indeed engaged in selling new franchises. They could not have posited a more ridiculous strategy. This was the easiest possible position for us to defeat. Four days before we were to take their depositions in anticipation of an immediate preliminary injunction hearing, they had an epiphany, and about a week later the case was resolved upon very favorable terms for my clients.

The lesson here is that while it is nice to have polished manners and live by reasonable rules of commercial civilization, there comes the moment when those rules do not apply. If you continue to live by those rules you will simply be eaten alive. In times like that you need representation that understands and understands how to execute battle plans that level any playing field.

When someone decides that a business relationship is there to serve the terms of an agreement rather than the agreement being there to serve the quality of the business relationship, the result will be calamity if not immediately changed. Usually that change can only be brought about by aggressive confrontation.

For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.

As always, you can call me, RIchard Solomon, at 281-584-0519.

The Vanishing Competent Franchisor

Franchise investors find, often too late, that the unique systems and concepts in which they have invested are neither unique nor have even competent execution by the franchisor.

The reasons for this are several. Some of them are the natural vicissitudes of living in any competitive marketplace over time, but others are fault ridden. Which is which? What are the identifiers? How early can they be spotted and what can be done to avoid or thwart them?

So far the courts have not seemed hospitable to the notion of going beyond the explicit wording of carefully drafted agreements entered into by seemingly sentient adults. From a macroeconomic perspective this is exactly what courts should be doing, as enforceable agreements are indispensable capital that underlie the value of enterprises.

But are the franchisees caught in an ever tightening noose of business contraction so constrained by contract language that the only diagnosis is: suffer a financially excruciating death? Should bankruptcy be the only resort/cure to being in contract with people who rely on legal enforceability?

How far can franchisees go without violating fundamental contract rights and thereby effectively changing franchisor inability into franchisee liability? Where is the line between act or die on the one hand and legal suicide on the other?

The Legal Framework

In today's franchise agreement one finds that the mission statement is not a term of the agreement. None of the hortatory rhetoric of the sales pitch/marketing materials is ever to be found anywhere in the actual contract language.

There is a bright line between all the positive reasons for investment and the machinery by which the investment, once made, is to be managed, performed and observed.

Investors seem not to notice that what convinced them to invest in the first place is nowhere to be found in the agreement itself. Franchise investors are in the main due diligence illiterate.

The agreement always provides that the goodwill of the business and the brands are all the sole and exclusive property of the franchisor and that the franchisor may change its configuration at any time, for any reason and without having to field test and performance prove any change before compliance with it is demanded of the franchisees.

The franchisees covenant to execute the business model as directed by the franchisor in the manual and otherwise, including participation in all programs mandated by the franchisor on the terms stated, all as may vary from time to time, and to guaranty the payment of royalties out to the end of the contract term regardless of termination or other reason for failure.

All fault for nonperformance is placed upon the franchisees while all decision making prerogatives belong exclusively to the franchisor.

Many attempts to modify the absolutist right versus wrong, franchisee versus franchisor abrasive interface have been tried and they have all come to naught.

Most of them have been in the guise of an imaginary unwritten covenant of good faith and fair dealing and more recently in the form of a so called franchisee bill of rights that exists neither in statute, ordinance or other document having any legal force whatsoever.

Finding Operational Salvation

Where does that leave the franchisees who see themselves caught in abandonment of the brand by the franchisor and in the inability of the franchisor to respond effectively to changes in market conditions?

Litigation/confrontation seems not to provide a remedy. Self help so often leads to litigation/confrontation.

And yet no one can live at sword points.

The only present tense answer to this problem lies in effective but insistent relationship management that is initiated by the franchisees acting mostly in concert with organization and a high level of competence that seems at such moments to be available only from the franchisees themselves.

How does that work?

Up to now it doesn't work at all/yet. Commitment at any effective level seems not to be an ability of groups of franchisees. As their collective minds now work, they feel entitled to competence/protection as a matter of "right" (whatever that is) and because of that they are simply waiting for someone to provide it.

Since no "right" on earth is self executing, no matter what they taught you in political science class, attitudes of entitlement produce nothing useful. Why can't franchisees seem to recognize that obvious fact?

They didn't get what they bargained for - in their minds - and want "justice". Inasmuch as what they signed on to did not provide for what they thought they were getting, they, as adults, in law are getting what they bargained for. The correct analysis is that they failed to recognize that the agreements they signed never said that they get what the sales pitch/marketing materials said they were getting.

They are not a "family".

They are in business by themselves.

They are not their own boss.

Nor, have they invested in any commercial vehicle that has prospects for a successful future -without a lot of work being done.

The courts enforce what they signed, not what they later wish they had signed.

Where does that leave them? It leaves them with only self help and self help is fraught with liability risk. The choice in a franchise system that is draining away their resources is between slow financial death and taking the risk associated with a turnaround through self help. How in hell does one accomplish that?

The Road To Glory

The road to glory is paved with personalities. There are definable personalities who are running your franchisor company. Their characteristics are known, unfortunately not any more deeply that epithetically. The things that need to be fixed spring from what is happening in the market place and the fact that their abilities to guide the company through the happenings without hurting franchisee financial performance are inadequate.

A method of approach has to be configured. It is not realistic to expect collaboration from people if your opening gambit is to itemize in loudly proclaimed expressions all their perceived shortcomings.

There is, after all, a bit of sonofabitch in each of us. We aren't perfect either. At least tacit recognition needs to be given to the fact that a close evaluation of our own constituency would uncover some warts too.

I am good and you are awful will not yield a desired response or open that door through which you must walk. This is reality.

I have sat in too many franchisee association meetings listening to epithets hurled at franchisor managers by people who were chronically late with many obligations, to put it mildly - and the principal reason for not doing what was agreed to was always self serving opportunism.

In some instances the franchisor was aware of the defaults but tolerating them for later use as bargaining chips - something that every franchise agreement specifically allows the franchisor to do but not the franchisee.

When the pain in the ass franchisee wants consent to open additional stores there will always be this stuff in his file to justify a refusal of consent. The same goes for anything else a franchisee might want to do that requires franchisor consent. The uses of those seemingly small peccadillos are many and delicious, which I have elaborated elsewhere.

While the personality profile of the people we must deal with is configured, and we have devised a few plans for how best to make the approaches we want to make, a goals agenda should be made and ranked in order of priorities. There are several, time being one and cost efficient feasibility being another. Rank the goals. Some goals will be interrelated so that they may be presented and achieved as a package, while others may need spacing.

Goals and projects need responsible people to take charge of their execution. Within your group there will probably be more than one person with a special interest in particular goals as well as the skill sets necessary to accomplish them. Identify them and privately vet their suitability and willingness to put forth the effort in a timely manner.

Each goal must have its own business plan. The plan must be cross examined viciously before it is presented, because that is exactly what management is going to do. If you cannot defend your thesis you have just wasted a lot of time and your credibility. Debug the plan to the greatest extent possible. There is an inside track for the plan. Find the management person who controls the track and win his/her support.

Until you have actually proved your ability to create and execute brand enhancing new concepts it is a hard sell. Once you have made your bones life will become easier unless you get cocky or careless.

You save up reputational wampum just like you save money. Don't spend your credibility before you make your bones on the next projects. Winners know how to share credit and shut the hell up about how great they think they are.

The road to franchisee primary participation in brand enhancement is not easy at first.

There will always be detours. It has to be managed and counseled by people who understand the process. Find such people and bring them on board to help guide you.

Theirs will be the job to ask the tough questions that members of your group will not want to ask for reasons of political correctness.

They pull their weight.

For the 5 Most Fascinating Stories, a weekly report, click here & sign up.

Tamerlane group's purpose is to prevent you from shooting yourself in the foot when you see a bad event threaten to develop.

Our focused expertise in crisis management can prevent these situations from developing if we are called before someone makes self-humiliating public statements/files absurd lawsuits.

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.

To read my other "common mistakes in the FDD" blog posts, click here.

The Disclosure Requirement

A common FDD mistake is failure to list all "Initial Fees" in Item 5.

Item 5, entitled "Initial Fees," is where a franchisor must disclose all initial fees paid by the franchisee, and the conditions under which the fees are refundable.

Initial Fees" are defined as "all fees and payments, or commitments to pay, for services or goods received from the franchisor or any affiliate before the franchisee's business opens, whether payable in lump sum or installments." A franchisor must also disclose whether the initial fees can be paid in installments, and what those payment terms are.

Many franchisors do not follow instructions and fail to list all initial fees in Item 5. There are two types of common mistakes.

1. Common Mistake #1: Failure to List All Initial Fees Paid to the Franchisor

The first type of mistake is that the franchisor or its counsel assumes that "Initial Fees" means only the initial franchise fee paid by the franchisee (the fee franchisors charge franchisees for the right to enter into a franchise agreement). This is wrong because it ignores the other types of fees that are paid (or that the franchisee is committed to pay) to the franchisor prior to the franchisee's business opening.

In some franchise systems, there can be a multitude of initial fees charged that need to be disclosed in Item 5. Some examples:

• In connection with processing the franchisee's application (running credit, doing a background check, etc.), the franchisor requires a deposit or "application fee."

• The franchisor charges a fee for the franchisee to attend initial training.

• The franchisor requires (or has the right to require) the franchisee to pay a fixed amount directly to the franchisor so that the franchisor can conduct grand opening advertising for the franchisee.

• The franchisor charges a technology start-up or other type of fee relating to the franchisee's use of the franchisor's point of sale or other software system.

This is only a partial list of the types of fees that can fall under the category of "initial fees." I have seen many FDDs where franchisors will clearly charge these fees, but fail to list or disclose them in Item 5.

2. Common Mistake #2: Failure to List All Initial Fees Paid to the Franchisor's Affiliates

The second type of common mistake is the franchisor lists only initial fees paid by the franchisee directly to the franchisor, but ignores the fees paid to the franchisor's affiliates. The instructions for Item 5 clearly call for these fees to be disclosed, too. Remember, an "affiliate" is defined as "an entity controlled by, controlling, or under common control with, another entity."

Some examples of fees paid to a franchisor's affiliates:

• The franchisee must purchase an initial stock of inventory from the franchisor's affiliate.

• The franchisor's affiliate builds out the store for the franchisee (often referred to as a "turn key" franchise), and the franchisee pays the affiliate for the build-out.

• The franchisee is required to pay the franchisor's affiliate to buy or obtain the right to use the franchisor's proprietary software system.

• The franchisee buys an initial supply of marketing materials from the franchisor's affiliate.

Again, these are just some examples of the types of fees that are paid to affiliates. If these fees are paid before the franchisee opens for business, they are "initial fees" and must be disclosed in Item 5.

Conclusion

Avoid making these common mistakes in Item 5 of your own FDD, and you will have an easier time of getting registered in the registration states.

For the 5 Most Fascinating Stories in Franchising, a weekly report, click here & sign up.