March 2015 Archives

The top stories in the franchise world continue to be about efforts by the cities of Seattle, Chicago, and others in raising the minimum wage with laws that discriminate against small business owners who own franchises. For the full story, see some of my previous blog posts on the issue. These laws are a serious concern for franchisees and franchisors alike.

In brief, these laws (which are written substantially the same way in the different cities that have adopted them) require small businesses to raise the minimum wage of their workers from the current level to $15 an hour. Under these new ordinances, businesses with more than 500 employees have 3 to 4 years to increase the minimum wage to the new $15/hour level, while "small businesses," defined as businesses with fewer than 500 employees, have up to 7 years to reach the new level.

The problem? For the purpose of calculating the "500 employees" number, all franchises in the same system are counted together. The net result of this is that these locally-owned small businesses with a few employees, which also happen to be franchises, are being discriminated against as compared to their non-franchised counterparts.

After reading some of my blog posts on the subject, another franchise attorney (one who exclusively represents franchisees) commented to me that these laws, which treat franchises differently than similarly situated non-franchise small businesses, could arguably be viewed as "industry specific" laws for the purposes of Item 1 of a franchisor's Franchise Disclosure Document (FDD). I can see the argument on both sides of that point.

The Federal Trade Commission's (FTC) Franchise Rule requires a franchisor to state in Item 1 of its FDD "any laws or regulations specific to the industry in which the franchise business operates." The FTC has elaborated on this requirement by saying that laws applying to all businesses generally do not need to be disclosed; instead, "only laws that pertain solely and directly to the industry in which the franchised business is a part must be disclosed in Item 1."

The minimum wage laws adopted by some cities like Seattle target franchises by treating them differently from other similarly-situated small businesses; laws that are specific to a certain "industry" are the types of laws that need to be disclosed in Item 1.

So, the question then becomes: is franchising as a whole an "industry?" Are these the types of laws the FTC was contemplating when creating the Item 1 disclosure requirement? Should Item 1 of a franchisor's FDD should disclose these laws?

I can see the arguments on both sides. On the one hand, franchising itself isn't really an "industry." Merriam-Webster defines "industry" as "a department or branch of a craft, art, business, or manufacture; especially: one that employs a large personnel and capital especially in manufacturing." In that sense, franchise systems are not part of the same "industry" because they are diverse, representing businesses in a multitude of different streams of commerce (like retail, food service, personal services, and business services just to name a few).

However, Merriam-Webster does recognize an alternative definition. "Industry" can also be defined as "a distinct group of productive or profit-making enterprises <ex: the banking industry>." In that sense, franchising could be considered an industry because franchise companies are in a distinct group that has its own set of goals, concerns, and issues. It is in this sense that the International Franchise Association and business periodicals regularly refer to franchising as an "industry."

In its guidance, the FTC hasn't specified which of these definitions it meant when it created the Item 1 disclosure requirement. The better argument, in my view, is that the FTC didn't intend to single out franchising as a whole as its own "industry" when it created the Item 1 disclosure requirement. That is because the FTC itself, in its rulemaking process, used the word "industry" a number of times, but used it in different contexts. Specifically, the FTC repeatedly referred to franchising itself as an "industry," and then in other contexts that are clearly different, it talked about the franchisor's duty to disclose certain information unique to "industry" in which the franchisee's business will operate. It is clear from the context of the FTC's guidance that the two uses of the word are different from one another.

Based on the contextual distinction between the two uses and definitions of the word "industry" by the FTC in its rulemaking, I think the more convincing legal argument is that a franchisor does not have to disclose minimum wage laws that discriminate against the franchise "industry" as a whole.

But, from a practical and informational perspective (and considering the purpose of the Franchise Rule), I think a good argument can be made that these laws should be disclosed anyway (even if disclosure is not legally required). That a franchisee may be required to pay its employees a higher minimum wage than his or her similarly situated non-franchise competitors is something that she or he would certainly want to know.

As a result, I am recommending to my franchisor clients that, when they update their FDDs for 2015, they include a disclosure in Item 1 that says:

Some jurisdictions have passed laws that require businesses to pay their employees a higher minimum wage than what is required under federal law, which laws may disproportionately affect franchised businesses.

It's a simple enough disclosure to include. Moreover, it would certainly help a franchisor in later defending against a legal claim by a franchisee that the franchisor knew about, but didn't disclose, the existence of these laws prior to the franchisee committing to buy the business.

What do you think? Do you think these discriminatory minimum wage laws must be, or should be, disclosed in Item 1?

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It seems to me, looking at this phenomenon over the 53 year history of my practice as a conflicts specialist/litigator, that most of what I have to try (or where I have had to be sufficiently aggressive to cause my adversaries to lower their demands to an acceptable level) could have been remedied in one tenth the time & for one tenth the expense.

The introductory phase of conflict presents rather similarly across the range of dispute causes/subjects.

They begin and develop in the same manner. There is a grain of dissatisfaction over some subject/event/program or other that is either not identified as it first begins to sprout or is given almost no weight.

Ignore Some Irritations

Many times, ignoring that first flicker of annoyance is the sensible thing to do, judging by hindsight because it never developed into fulminating melee.

Sensible people appreciate that no relationship, business or personal, is without occasional inconvenience.

Sensible people absorb the minor shocks/vicissitudes of ongoing relationships because the value of the relationship itself is an overall positive. With quality control relationship management the difference between the ebb and flow of normal relationships and problem development is much more discernible.

But that is relative, not an absolute, and the value morphs as the relationship develops over years - sometimes becoming more valuable and sometimes less.

There is a dependent relationship that is expressible quantitatively between length of relationship/severity and frequency of difficulties/quality of reward for staying in the relationship. An econometrician could assign values to each of these factors and the passage of time would cause them to move along lines that diverge and intersect in trends to provide a mean scale within which, given a large enough sample, one could posit relative satisfaction generalities and, by measuring deviations from the mean, posit the potential for eruptions. I promise that at this point I will stop all this econometric mumbo jumbo and get down to brass tacks.

The major target of this discussion is distributive systems, vertical in the instance of managing franchise and dealer relationships. The application is the same in all business relationships that endure over a significant period of time, but I am going to use the vertical distributive relationship as the focus of this article.

Frequently people enter commercial relationships with unrealistic expectations. This is sometimes the product of hype and sometimes worse than that. If there is no enforceable agreement providing for a term of years, the situation is easily remedied.

The remedy is not always cheap as investments in infrastructure may have been made in expectation of success.

If there is an agreement for a period of years the exit cost is often extremely high, both in terms of cash and other non cash elements (think move out/covenant not to compete/transfer of customer loyalties). Often the deal is as expected but does not succeed for other reasons, some economic and some just a failure of relationship management skill.

Those involved can sense when the tension begins to rise and can also appreciate when the tensions increase. They suppress the angst for as long as possible because they simply dislike confrontation and don't want to waste money lawyering up every time there is a pissing contest. Somehow they never just sit down and try to find a path to YES. Maybe even if they did that path would not be available for one or both. Why is that so frequently the case?

The process of a relationship becoming disputatious is similar to that of an illness progressing from a sneeze or cough to pneumonia. The issue is when to intervene and how to arrest this progression. There is no magic point. How that point is identified is affected by attitudes of caring or not caring; of follow up quality control communication or simply leaving the strategic health to the care of the tactical functionaries. But everyone reports to upstairs, and dissatisfaction where the rubber meets the road becomes amplified as it effervesces upward.

Large institutional companies operate upon the assumption that all is automatically normal and positive because in some sense the belief is that anything but utter calamity is affordable and someone down below may always be thrown under the bus in the process of cosmetic accountability.

But most of us aren't General Motors and most of us can't afford the General Motors attitude - nothing matters because we are professional grade people. Sadly, even calamity failed to alleviate the kind of arrogance that persists even today in that company - and in more like it.

In many companies there is official doctrine. One must agree with the official proclamation of what and where and how or be moved out of the organization. This reduces the potential value of internally generated relationship quality control.

In short, people are afraid of speaking up when their doing so could be extremely helpful if only there were open minds.

Where the game is to "make it" through your assignment and move on, leaving problems to the poor bastard who will take over from you in this position, effective trigger point spotting will simply not occur. In so many companies there is the middle management belief that upstairs never wants to hear anything except positive reports and will punish in one way or another those who raise "issues". They really don't give a damn, won't bother monitoring what is going on until it is lawyer up time.

Even at the General Motors level of wealth that system doesn't work. What then for the rest of the rational commercial world?

But, When Is It Just Too Much To Take?

Real people managing real companies that have to face real vicissitudes of relationship quality fluctuations have to be alert to trigger points that, if left unattended to, may sour important ongoing transactional success. Left unmonitored, even the best commercial relationship tends eventually to unravel.

For instance, your largest customer begins to believe that he is too important to you and that you will absorb all sorts of impositions in order to keep his business. This would include, stretching/exceeding credit terms, taking unauthorized discounts and allowances, making demands that you the seller, absorb the freight, seeking "gifts" and inclusion in perquisites that few others ever receive. The list goes on and on.

Many companies fail to recognize at an early point in this progression that some relationship discipline must be imposed to prevent this kind of malignancy from metastasizing. While the customer may be important to you, on these facts you are also important to him as a critical supplier on whose products or services he makes a lot of money downstream.

Doing nothing leads only to ultimate confrontation, because the more the customer gets away with these ploys the more he demands. Too much is never enough.

I start trial in such a case in three months. My client let this customer get away with far too much for too long, and when the axe finally had to fall, the customer sued. This particular scenario is one in which the customer has used similar tactics on others of his critical suppliers and has also ended up suing them.

The abusing customer should never win, but everything positive that might have been preserved is destroyed by failure to see the truth about the coming threat in time to defuse it.

Why The C-Suite Gets Bad Information

It is perhaps not fair to expect the people at the low end of the ladder to deal with their opposite numbers in client companies in handling potential problems. In an ideal environment they would report the issue upstream and a conscientious middle manager would take it to his boss for consideration. Then one of those people would take the initiative to contact his opposite number in the other company and deal with whatever it is that needs attention.

No one will say this, but making people fearful of expressing themselves in any way but the approved way for fear of infliction of punishment is precisely what Lenin and Stalin did following the Russian revolution. If you thought of how something may be working in your company to make it look like that, perhaps the failure of that method and the need to correct those impressions would be easier to recognize.

In a more advanced mode there could be a company ombudsman to whom people could go with identified oncoming issues, and the ombudsman would pull the laboring oar in getting upper management to address it positively. And if the ombudsman also had the authority to go consult with critical professional resources (legal, financial), including outside resources, the ability to head trouble off at the pass would indeed be enhanced.

Novel Retainer

I have my own way to handle this problem. I urge non litigation clients not to hire me on an hourly fee structure, but rather on a monthly or quarterly retainer that covers absolutely everything other than litigation/arbitration and out of pocket expenses.

That prevents people not calling me for assistance because they dislike knowing that when I pick up the phone the damn meter starts running. I am available 24/7 under that arrangement. The initial period of the retention is one of adjustment regarding whether the anticipated work turns out to be more or less than anticipated for the flat fee retainer, but as time passes the retainer gets adjusted up or down to keep it fair to everyone.

I urge consideration of this mode of relationship configuration upon my brother and sister attorneys. It may be less remunerative in the short term, but it builds a much better attorney-client relationship, so that in the longer term the economics are rather favorable.

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2014 was a challenging year for franchising. While franchising growth was strong (with growth through franchising outpacing growth in the economy overall), new labor-driven attacks targeted the franchise model with a vigor and force unseen in the long history of the industry.

These attacks, driven by unions like the Service Industry Employees Union, seek to drive new membership and increase dues through unionizing employees of specific franchise brands.

In 2014, these initiatives largely took two forms:

1. Drives to increase the minimum wage in specific jurisdictions. These laws target the franchise industry by classifying franchise owners differently from traditional small business owners. This is accomplished by aggregating the number of employees across all franchised locations in a brand to require franchisees to implement higher minimum wages more quickly than their independent competitors. This unfairly and disproportionately affects, and disadvantages, franchisees vis-a-vis their independent competitors.
2. Calling franchisors "joint employers" of their franchisees' employees. The National Labor Relations Board's General Counsel kicked off this anti-franchise campaign in July 2014 when he issued an opinion that McDonald's is a "joint employer" of its franchisees' employees. This position allows employees to attack both McDonald's and its franchisees collectively in asserting wage violations, and, if successful, would also support unionizing employees within a franchise brand.

The International Franchise Association has been vigorously combatting these initiatives through intense lobbying efforts and through grassroots educational outreach.

During the IFA's 2015 annual convention, the organization announced a new industry-wide effort to fight the minimum wage and joint-employer problems through its newly-formed group, the Coalition to Save Local Businesses.

Franchisees and franchisors alike should become educated about these efforts by the franchise industry to fight attacks on the franchise model. To learn more and to support the effort by the industry, go to www.savelocalbusinesses.com.

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