August 2015 Archives

When Can A Franchisee Continue

United States Court of Appeals for the Seventh Circuit, Decision of 9 July 2012, No. 11-3920, Sunbeam Products, Inc. v. Chicago AM. MFG. LLC, and United States Court of Appeals for the Eighth Circuit, Decision of 30 August 2012, No. 11-1850, In Re Interstate Bakeries Corp.

The U.S. Courts of Appeal for the Seventh and Eighth Circuits came to different conclusions in deciding the right of a trademark licensee to continue using the licensed mark after rejection or attempted rejection of the trademark license by a bankrupt licensor.

U.S. bankruptcy law allows a bankrupt licensor to reject an executory trademark license, i.e. where the parties have continuing, material obligations. Trademark licenses typically are considered executory due to the continuing obligations of the licensee to pay royalties and of the licensor to control the quality of the goods produced or services offered under the licensed mark.

Previously, courts followed a Fourth Circuit decision, Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. 756 F.2d 1043 (4th Circ. 1985), which held that after rejection, the former licensee would lose its right to use the mark and be left with only a damages claim.

Three years after the Lubrizol decision, Congress amended the bankruptcy Code to add Section 365(n) to protect the right of intellectual property licensees to continue using licensed copyrights and patents after rejection, but not trademarks.

In the Seventh Circuit's decision in Sunbeam Products, the court did not follow the Fourth Circuit's Lubrizol decision and found that the rejection of the agreement did not terminate the licensee's right to continue using the licensed mark, LAKEWOOD for ceiling fans.

The court determined that the rejection was a licensor breach, but that the breach should be treated as other breaches, with the licensee's rights not ending.

The decision did not address how and whether the licensor could continue to exert the quality control that is necessary to prevent abandonment of the licensed mark.

Shortly thereafter, the Eighth Circuit came to a contrary conclusion in In re Interstate Bakeries Corp. Even though the trademark license at issue, for use of the SUNBEAM BREAD and BUTTERNUT BREAD marks, was a prepaid, perpetual, exclusive license granted as part of the sale of the related business, the court agreed with the district court's determination that the license agreement was executory in light of the licensee's continuing standard of quality obligations. The court followed the Lubrizol rule and deemed the license terminated by the rejection of the license.

These decisions highlight the continuing risks of relying on a trademark license rather than ownership of a mark.

If a license must be used, a useful strategy is to structure the licensor-licensee relationship to maximize the likelihood that the license would be deemed fully performed (non-executory) and, thus, not subject to rejection.

In the context of a sale of a business, the closer the license grant is tied to the overall sale, the higher the likelihood that the overall arrangement will be deemed fully performed in material respects. In jurisdictions following In re Interstate Bakeries Corp., however, even that strategy does not assure the right to continue using a mark owned by a bankrupt licensor.

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

In Spina v. Shoppers Drug Mart Inc., 2012 ONSC 5563, Justice Perell for the Ontario Superior Court has given judgment in the first stage of a class action certification motion brought on behalf of franchisees of Shoppers Drug Mart. The decision addressed the threshold requirement for certification, namely whether the claim disclosed reasonable causes of action.

In the process, the Court reviewed and determined the legal validity of the varied and interrelated causes of action asserted by the representative plaintiffs.

While only a pleadings motion, Spina provides useful guidance to franchisors and franchisees in Ontario. Although the decision addressed numerous issues, this comment focuses on the following three lessons:

Franchisors should review their standard form franchise agreements to ensure that the key financial terms are absolutely clear and leave no doubt regarding the scope of the franchisor's rights to earn profits from the franchise system.

In Spina, the Court allowed the Franchisees' claim to proceed on the allegation that the Franchisor had improperly profited from certain services provided to the Franchisees. While the franchise agreement contained detailed provisions on these issues, it was not plain and obvious that the Franchisor could earn a profit on these services provided to the Franchisees.

The duty of good faith and fair dealing does not provide franchisees with the right to receive ongoing disclosure throughout the term of the franchise relationship. The Court struck the Franchisees' claim in this respect, rejecting the argument that such ongoing disclosure was necessary for the Franchisees to verify that the Franchisor was complying with its obligations under the franchise agreement. The Court held that imposing an ongoing disclosure obligation of this nature would be impossible to meet, would turn management of the franchise relationship over to the franchisees, and would encourage litigious fishing expeditions.

The Ontario Courts are demonstrating an increasing willingness to dispose of weak contractual arguments at the pleadings stage, even in class action proceedings. In Spina, the Franchisees -- ignoring an explicit clause that provided the Franchisor with the right to retain rebates earned from suppliers of merchandise -- asserted a contractual right to such rebates. The Franchisees relied on a general clause in the agreement that suggested they would benefit from the franchise system's use of "bulk purchasing". The Court struck the Franchisees' claim for rebates upholding the express language of the agreement over what Justice Perell deemed a "tortured interpretation of the contract".

The Franchisor's Ability to Profit on Fees Charged to Franchisees

The Plaintiffs in this case claimed that, contrary to the terms of the franchise agreement, the Franchisor had improperly earned profits in respect of certain services that it provided to the Franchisees.

The franchise agreement contained several, interrelated provisions that addressed the financial aspects of the franchisor-franchisee relationship. These included a profit-sharing provision, under which the Franchisor was entitled to receive a percentage of all of the Franchisees' gross sales. This, according to the Franchisees, was the sole mechanism through which the Franchisor was permitted to earn a profit from the Franchisees. In addition to this profit-sharing provision, there were additional clauses that obligated the Franchisees to contribute to a national advertising fund and marketing in initiatives, as well as additional fees for ancillary services provided by the Franchisor. The additional fees provision in the franchise agreement explicitly stated that the quantum of fees was to be set by the Franchisor "in the good faith exercise of its judgment".

The Franchisees claimed that the Franchisor had improperly earned a profit from the additional fees that it charged to Franchisees, and that this was a breach of the franchise agreement and contrary to the statutory and common law duties of good faith and fair dealing.

The Franchisor countered that it was perfectly entitled to include margin and return-on-investment in the additional fees it charged to its Franchisees, and that such fees were subject only to the obligation that it exercise good faith judgment.

Unlike other claims of improper profits raised by the Plaintiffs the Court was not prepared to strike this claim, holding that it had "sufficient traction" under the franchise agreement. As it was ambiguous whether the Franchisor's obligation to exercise good faith judgment permitted it to establish the fees at such a level that would allow it to derive a profit, it was not plain and obvious whether such claims would fail.

Although we do not know whether the Franchisees' claims will ultimately prevail, this holding should serve as a cautionary tale to franchisors. These financial aspects of the franchise relationship are foundational and lie at the heart of the business model. As such, financial clauses that address profit sharing should be explicit and drafted with clarity. Where they are absent or ambiguously crafted, franchisors may be vulnerable to the argument that their ability to make profits from certain aspects of the franchise system are limited by more general clauses in the franchise agreement or the duties of good faith and fair dealing.

The Right to Share in Rebates

Another element of the Franchisees' claim relied on a provision in the franchise agreement which obligated the Franchisor to provide each Franchisee with the "advantages of bulk purchasing". The Franchisees asserted that, pursuant to this provision, the Franchisor was obliged to provide them with any rebates that were received from product suppliers.

The Court held that it was plain and obvious that this claim would fail. The franchise agreement at issue contained a specific provision that expressly held that the Franchisor was "entitled to the benefit of any and all discounts, rebates, advertising or other allowances, concessions, or other similar advantages" received from a supplier of merchandise. Given this clear, specific provision, it was plain and obvious that the principles of contractual interpretation did not support the Franchisees' position. The Court also held that it was plain and obvious that the statutory and common law duty of good faith and fair dealing did not modify the contract by establishing a right for the Franchisees to share in the rebates.

By contrast, the Court was not willing to strike out a related claim by the Franchisees for "professional allowances" provided by pharmaceutical suppliers to pharmacists under the Ontario Drug Benefit Act. The Court held that it was ambiguous whether "professional allowances" fell within the definition of "rebate" in the franchise agreement and thus would not determine whether they were governed by this clause.

The Right to Continuous Disclosure Throughout the Franchise Relationship

In part related to their two previous claims regarding profit-sharing and access to rebates, the Franchisees also asserted that the common law and statutory duties of good faith and fair dealing obligated the Franchisor to provide ongoing disclosure of information that would permit the Franchisees to verify whether the Franchisor was complying with its financial obligations. For example, the Franchisees claimed that they had a right to disclosure of the costs that the Franchisor incurs for the programs it provides to Franchisees, in order for the Franchisees to know whether the Franchisee was improperly profiting from those programs.

The Court rejected this argument and held that it was plain and obvious that the duties of good faith and fair dealing did not impose an obligation for intra-term disclosure in this circumstance. Justice Perell distinguished the circumstances of this case from the situation where a Franchisor is in possession of material information that could reasonably influence a Franchisee's decision with regard to the franchise. The Court emphasized that imposing this obligation would effectively "turn over design, supervision, and management of the franchise system to each franchisee, who gets to fish for grounds to sue the franchisor".

Sometimes business owners want to exercise their First Amendment right and publicly express their religious beliefs. While this is admirable in a free society, it has potential to be costly to franchisees who are directly affected by the perception of their franchisor's brand. Franchise systems are usually organized to protect the franchisor from a number of potential liabilities.

One of the most important assets to be protected is the company's brand or trademark. Thus, trademarks are often held within a namesake holding company, only to be licensed to a similarly named franchising enterprise. The franchising enterprise then sub-licenses the trademarks to franchisees through a franchise agreement.

Franchise agreements are very detailed in nature, particularly when discussing the franchisee's obligation to uphold the franchisor's brand or trademark. Between the mandatory adherence to the franchise agreement and the franchisor's operating manual, franchisees are required to remain in lockstep with orders that may be as detailed as the size, color, and exact placement of the company's logo. These top down rules also may delineate other specific guidelines such as approved advertising, company promotions, store design, uniforms, or even where supplies can be purchased.

This corporate exercise is perpetually performed by franchisors to insulate their core brand from future risks. Meanwhile, consumers are oblivious about the myriad of corporate entities and rigid structure comprising a franchising system. The silent and seamless cooperation between franchisors and franchisees is the back bone to rapid growth and success of a franchising system.

Nevertheless, as history has shown, great strengths have the potential to become great weaknesses. The silent nature of the franchise partnership is precisely what places franchisees in grave danger when their franchisors go off script. If an owner or executive of a franchising business makes controversial statements in public, those statements can have a ripple effect across the franchise system, as angry consumers who wish to boycott the particular brand do not discriminate between franchisor and franchisee operated enterprises.

Chick-fil-A experienced this after its president Dan Cathy stated the company strongly supports the biblical definition of the traditional family, thereby being in opposition of same-sex marriage.

Naturally, given today's hypersensitive socio-political climate, controversy ensued, embroiling Chick-fil-A in one of society's most contentious issues. The immediate negative effect to the Chick-fil-A brand was obvious. A New York based market research firm estimated that Chick-fil-A's perception rating declined by 25 percent soon after the story broke. Supporters of the LGBT movement picketed Chick-fil-A restaurants. The company lost some of its marketing deals and business partners. Chicago mayor Rahm Emanuel, Boston mayor Thomas Menino, and other politicians pounced on the opportunity to speak out in opposition to the restaurant.

And, of course, many news organizations covered all of the juicy, flame broiled Chick-fil-A controversy in primetime.

While it is clear that any corporation could be negatively affected by the public actions of its leadership, the potential damage to investors in a franchise system is unique from that of shareholders in publicly traded companies. In publicly held corporations, shareholders are chiefly concerned about the overall health of the enterprise, as risks are diversified and gains and losses are shared proportionately.

Whereas, when franchisees invest their life's savings into a franchise, they are heavily dependent on both the success of their individual store and the perceived goodwill of the franchisor's brand within the franchisee's individual market. This phenomenon explains the contrast between the reactions of investors in large, non-franchising companies such as Starbucks, Microsoft, and Amazon, to that of franchisees in Chick-fil-A regarding publicly expressed positions on same-sex marriage made by executives of their respective companies.

Starbucks is a quick service restaurant perfectly akin to Chick-fil-A, and Starbucks's leadership has made a number of statements that openly express the company's support of same-sex marriage. During a shareholder meeting, investors in the coffee giant merely posed questions as to the economic consequences of such statements, but there were no reports of Starbucks shareholders actively contradicting the company's stance or expressing fear of possible repercussions.

In the Chick-fil-A scenario, some franchisees were eagerly giving interviews to local and national media, and posting ads on social media websites disassociating themselves from the beliefs of Dan Cathy. One franchisee even enrolled his Chick-fil-A as a sponsor of a pride fest in New Hampshire.

Meanwhile, other franchisees refrained from distancing themselves from Cathy, likely because their customer demographics dictated that their restaurant would be better suited if it were tacitly aligned with his comments. These contrasting responses demonstrate the divergent interests of franchisee business owners operating underneath the same brand.

Amidst the controversy there was some reprieve from the storm provided by former Arkansas Governor Mike Huckabee's Chick-fil-A Appreciation Day. Huckabee and other conservative politicians encouraged people who stood for the biblical definition of marriage to patronize Chick-fil-A in support of their cause. The company stated that it achieved record sales during the event but did not release any store or region specific information.

Although Chick-fil-A has over 1,600 locations throughout America, the restaurant chain is deeply rooted in traditionally conservative states; therefore, it is not hard to determine by location which franchisees likely benefited from the Chick-fil-A Appreciation Day wave of conservative support and which franchisees did not. In fact, if the company tracked the locations that did not receive a boost in sales during the Chick-fil-A Appreciation Day, that list would likely encompass the franchisees that were most negatively affected by Dan Cathy's statements, because the respective markets are probably split along the same socio-political fault lines.

On the face of this situation, it appears that some franchisees legitimately could argue that they suffered financial damages due to Dan Cathy's public, religious statements, and that Chick-fil-A should compensate them because Cathy knew he had a reasonable duty to protect their business interest when acting on the company's behalf. However, in law and in life, there are always exceptions to the rule. Here, the notable exception is notice.

The operation of a notice exception is most easily illustrated in the homeowner liability context. For example, virtually every state in the U.S. has laws governing injuries to visitors in the homes of its residents. Homeowners have a legal duty to protect their visitors from reasonably known dangers within the home. But homeowner liability can be nullified in virtually every situation where the visitor is given proper notice of a potential danger in advance of any incidents. The reasoning behind the notice exception is that once a visitor becomes reasonably aware of the risk, they can freely decide how to proceed and should no longer be able to look to the homeowner for damages from any resulting injury.

The same holds true in the Chick-fil-A situation. It would be understandable if franchisees were totally blindsided by Dan Cathy's comments, but nothing could be further from the truth. Before they purchase a franchise, Chick-fil-A franchisees receive ample notice that the company is and always has been rooted in the Christian faith and operates on biblical principles.

S. Truett Cathy, founder of Chick-fil-A, maintains that franchisees don't have to be Christians to work at Chick-fil-A, but he asks that they base their business on biblical principles because those principles work. A Forbes.com article even playfully described Chick-fil-A as a cult because it found its practices to be a little odd and extreme vis-a-vis its competitors.

Chick-fil-A's corporate mission, as stated on a plaque at company headquarters and often by S. Truett Cathy, is to glorify God. It is the only national fast-food chain that requires all of its locations to remain closed on Sundays. Company meetings and retreats include prayers, and the company encourages franchisees to market their restaurants through church groups. They screen prospective operators for their loyalty, wholesome values, and willingness to buy into Chick-fil-A's Christian credo.

The company requires applicants for operator licenses to disclose marital status, number of dependents, and involvement in social, church, and professional organizations. S. Truett Cathy believes that if a man can't manage his own life he can't manage a business, and thus family members of prospective operators are often interviewed so the company can learn more about the candidates and their relationships at home. Fifty employees and one franchisee grew up in one of 13 Christian foster homes in the U.S. and Brazil run by a nonprofit organization Chick-fil-A funds, the WinShape Foundation. Sixteen others were in Sunday-school classes Cathy teaches at First Baptist Church in Jonesboro, Ga.

From a business standpoint, the most obvious of Chick-fil-A's Christian practices is the company's mandate for all locations to be closed for rest on Sundays. It does not take a certified forensic accountant to understand that Chick-fil-A and its franchisees have foregone millions of dollars over the years in observance of this blatantly Christian tradition. Yet, franchisees made the decision that it was well worth investing in a Chick-fil-A franchise nonetheless. This is likely because even withstanding the "short week" disadvantage, Chick-fil-A remains the second largest quick-service restaurant chain in the nation based on annual sales, operating at an average of $2,500,000 in sales per unit.

Looking back on all that has taken place since Dan Cathy's comments on same-sex marriage somehow created a firestorm, it is likely that Chick-fil-A conducted a cost-benefit analysis of the situation and made some determinations. The company has since stated that its tradition is to treat every person with honor and respect regardless of their belief and sexual orientation, and that going forward they intend to leave the policy debate over same-sex marriage to the government.

It has been reported that the company has also decided to discontinue its donations to anti-gay marriage activists groups, but that has yet to be confirmed.

Nevertheless, given that Chick-fil-A has no real reason for concern about its ability to weather this socio-political storm due to its proliferation in conservative regions, and that the Cathy family will obviously maintain its biblically based views and corresponding activism, it is reasonable to conclude that while the company might not make many more socio-political statements, it will definitely continue mixing religion with the foundation of its franchise system because it works.

And any franchisees that do not share that vision cannot cry foul in times of tribulation, as they had full notice of Chick-fil-A's Christian tradition from the moment each franchisee arrived on the scene.

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

I was given a recent dilemma from a new franchisor whose management could not agree on whether or not to provide exclusive territories.

I provided this analysis:

Generally when you have a product or service that the franchisee's customers will be drawn only from local areas around physical location, then exclusive territories make the most sense, because your franchisee believes he has no way to "keep the competition" from taking his customers, and that there is no way to draw replacement potential customers from afar.

This is generally WHY franchises buy a franchise, because of the perceived benefit from competition the exclusive territory gives. I say "perceived" because honestly the success of a particular franchisee really depends on his business acumen and marketing efforts, not on the fact he has an exclusive territory.

But the franchisee perceives he has an advantage, so he is willing to buy the franchise that gives the exclusive territory, over the competing franchise he is looking at that does NOT give an exclusive territory. (If all franchises in a particular industry do not give an exclusive territory then there is no issue).

But if your competitors all have exclusive territories, you will want to offer the same OR some other more attractive benefit that your franchisor competitors do not offer, such as better pricing or lower fees or different services your competitors charge for, etc.

Having said that clearly there are problems with having territories, such as encroachment claims (which some states entertain even when the encroachment is outside the actual territory lines). If you have no territories, you have no encroachment claims. Period.

(Of course there is always unfair business practices claims, which is what we call it in Calif, when someone does something you don't like!).

Another negative about giving territories, is that, generally in new systems, the first set of franchisees are given territories, that are later are clearly recognized to be, way to large.

The problem then becomes that the franchisee simply does nothing to develop the client base when he becomes satisfied at some lower than expected level of customers, knowing there can never be any competition from a neighboring franchisee.

This results in low market penetration for your product/service, and there is nothing you can do about it since you are locked into the territory. (Hint about what to put in your FDDs and franchise agreements to avoid this problem--either minimum sales quote to maintain territory, OR minimum royalty amount).

Can you sell franchises, some with territories, some without? Well, if everything is the same, no. If you have a way to differentiate why one franchisee would receive an exclusive territory and one would not, perfect!

For example, in the printing franchise world where I came from, franchisees would not receive territories when their location was in a high density metropolitan area such as Washington D.C., since their potential customers (small businesses) were all bunched up in a very tight geographic configuration, as opposed to the the more rural or suburban less metropolitan areas, where the franchisees did receive territories.

That was a legitimate distinction which did not promote discourse among those franchise owners...and of course this was clearly disclosed in the FDD.

Another approach is to offer two separate and distinct franchises with a few differentiating features; one with an exclusive territory higher priced, and the other with less features, no exclusive territory, lower priced. Both versions can even be identified in the same FDD offering, so as not to double the registration costs.

Another approach, is make small contiguous territories, selling only one, yet giving a franchisee the right of first refusal to purchase perhaps at a discount any number of contiguous territories based on some level of penetration (sales level) within his existing territory, or within a certain time-frame, some other parameter.

This way the franchisee does receive both a small, but exclusive territory AND the right to expand his exclusive territory if he is working the system well; and, you as Franchisor receive both a benefit in keeping a contiguous territory "open" for purchase and development by a new franchisee, while at the same time, if you have a very good existing franchisee who wants the continuous territory, you receive another franchise fee plus the expanded development from a good player.

SO if you are going to give territories, my suggestion is to keep them fairly small either based on population, zip code, city, or a certain radius around the physical location, rather than several counties....

Remember the goal is market penetration of your product/service, and the larger the territory, the less incentive for the franchisee to quickly develop the entire territory, and the less system wide sales you will achieve, from which you are to receive royalties and other payments.

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

1. Western negotiating tactics can have unforeseen - and unfortunate - results when employed with Chinese counterparties.

China's macro-economy is certainly slowing, but the frequency of Chinese-Western negotiation has been on the upswing as more and more Mainlanders with Money (MWMs) start investing, spending and relocating to North America and Europe. Western negotiators may be eager to transact with a new set of potential buyers and partners from China, but American and European sellers have to be aware of cultural barriers that can drive away business before they even know there is a problem.

Good Cop- Bad Cop (GCBC) is a common bargaining tactic that can drive an otherwise promising international deal off the rails. GCBC can be a very effective technique both for buyers and sellers, and is a standard part of the American business repertoire (it shows up often in the UK as "Mutt and Jeff").

For those unfamiliar with the tactic, a negotiating team takes on opposing roles - one person is the aggressive, irrational and vaguely threatening "bad cop" while the partner takes on the role of reasonable and rationale "good cop". The problem is that the tactic is loaded with social and cultural meanings that don't translate well - particularly when the counterparty is from China.

2. "Good Cop - Bad Cop" is Not Universal

The general pattern of GCBC is to split the negotiating team and deploy the bad cop - Terrible Ted in our case - against Bud the Buyer. A typical scenario is for the GCBC team to make their initial contact together and then for Nice Ned (good cop) to excuse himself or be called away.

Once Terrible Ted is alone with Bud the Buyer, the bad cop's aggressive and menacing nature surfaces. Nice Ned's role is to provide relief - and he returns to the negotiation just in time to rescue Bud and act as the voice of calm rationality. In many instances, Ned will physically restrain or block Ted and send him away. In the Western scenario, Good Cops are the savior, the protector, the rescuer in times of distress - and the tactic often conjures up at least vague notions of verbal threats or even physical harm.

Bud the Buyer is expected to team up with Nice Ned to neutralize and escape the attack of Terrible Ted. Bud gets relief and protection from a recurrence or continuation assault of bad cop Ted - who has already attacked once and behaves irrationally and threating. Bud is relieved and forms a bond of trust and gratitude with Ned - and the two friends quickly agree to deal terms.

3. Chinese Don't Find "Bad Cop" Amusing

Chinese negotiators don't use Good Cop - Bad Cop. The threat of violence (even if it is verbal) deployed directly against counterparty outside the organization isn't considered funny or light-hearted. If a Chinese person is menaced or intimidated it tends to trigger cultural responses different from those in the West.

At the mild end of the spectrum, Chinese will feel embarrassed or disturbed (loss of face or mianzi) but the specter of institutional force can have far greater repercussions in China - where "Bad Cop" has a much deeper and more sinister meaning. A Chinese negotiator who is confronted by an aggressive and menacing counterparty is likely to withdraw from the negotiation completely and cut off all future contact with the organization that employs the bad cop.

Good organizations don't deploy Bad Cops in China - where harmony and surface appearances are valued highly.

4. Henpecked Husband and Tough Lihai Wife

But, China does have its own version of a negotiating team, but the function is completely different from Western versions. Anyone who has ever spent time shopping in Chinese family businesses is familiar with the henpecked husband and the tough (lihai) wife. Poor Paul and Lee Hai the Tai Tai (the tough wife) seem to mirror the Western Good Cop - Bad Cop, but there is a significant difference.

In China, the violent, aggressive behavior is not directed at the counterparty, but rather gets directed within the team or organization. Lee Hai terrorizes Poor Paul - and Bud the Buyer has the role of savior and rescuer who must protect Paul from mistreatment within his own house. Lee Hai is only a threat to Poor Paul - and Bud is expected to make concessions and compromise on deal terms in his role as benevolent, powerful buyer.

The Chinese side is elevating Bud's stature, giving face - and appealing to his sense of noblesse oblige to persuade him to buy more, faster or at higher prices. Poor Paul is an object of pity whom Bud has the power - and duty - to protect.

Larger Chinese corporations have co-opted the Henpecked Husband - Lihai Wife dynamic by substituting the absentee owner or overscheduled boss as the internal threat. The Chinese salesman or purchasing agent will blanch at your offer, shaking his head and confiding that his boss would punish him mercilessly if he even takes that offer back to the office.

Once again, you are given face and status - but are being pressured to make concessions due to your position of power and security.

5. Chinese Negotiators React to GCBC Well

Not only do the tactics have different goals, but the impact on the counterparty is completely different.

In CGBC the outside counterparty is facing the high pressure, aggressive actor right away. To Americans with experience and relatively high tolerance to pressure tactics, the entry of the Good Cop is a relief and a return to balance. We view the Good Cop as "normal" and equal to us in terms of temperament, power and outlook, while Bad Cop is the aberration and outlier. We are accustomed to institutional give and take. We view organizations as manageable, malleable to some degree, and transparent. Otherwise we have the choice of walking way.

If the counterparty is Chinese, then once the Bad Cop makes his appearance the damage is permanent and the game is over. In China, face and guanxi undermine the whole GCBC scenario. Aggressive, irrational behavior is not a cultural norm among harmony-conscious Chinese, and once the Bad Cop starts making threats the negotiation is lost and withdrawal is the only reasonable option.

Chinese institutions are a law unto themselves, opaque and ultimately unmanageable.

Those with power and connections never encounter the Bad Cop. Successful negotiation in China is not about relief or being saved - it's about avoidance. Once Bad Cop starts shouting and threatening, the Chinese side has already lost face and been humiliated.

Poor Paul instead appeals to the Bud the Buyer to rescue HIM from Lee Hai - the Tough Wife / Bad Cop. It's a passive aggressive manipulation - Poor Paul is giving face and placing himself in a subordinate role. This pressures you to make concessions in your role as the high-power actor. You gain face - but lose deal points. As a result you are speared any contact with Lee Hai.

6. Western Negotiating Tactics: Too Muscle-Bound for Chinese?

Westerners believe that strength and success go hand in hand when negotiating, but Chinese are adept at negotiating from positions of weakness . As more Chinese buyers and partners start knocking on American and European doors, Western negotiators might want to re-think some of their tried & true tactics. Bluffing, posturing, and positioning work well with local counterparties, but may have unintended consequences with Chinese negotiators.

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

One of the greatest personal debates we often face centers on character.

Do you believe that it's possible for a person to possess both a public and a private character, even if the two are very different? What you do in private is your own business, as long as it doesn't affect your public performance, right?

Not necessarily - especially when your individual personal performance impacts your business performance. Once you divide your personality and your actions into two or more categories, you deviate from the very definition of the word "character." At its root, one's character is defined by one's integrity - "The quality or state of being complete, unbroken condition, unimpaired, of sound moral principle, uprightness, honesty and sincerity." - (Defined by Webster)

Therefore, if your character - which defines who you are - is broken into two or more entities, you no longer have integrity because you are no longer "whole." Without integrity, you don't have much character. Unfortunately, without integrity it is still possible to run a successful business. However, the chance of your being successful is greatly minimized, and while certain people may do business with you, it's most likely going to be out of necessity. When your integrity is low, "people know it."

How many times have you heard a franchisor or franchisee claim to operate with integrity? In the hospitality environment, integrity is achieved by walking the talk and doing for your franchisees, employees or guests what you say you are going to do.

Sounds pretty simple. . . and a great formula for a successful partnership, right? Partnership is achieved by accomplishing goals together and by teaming for the good of all parties. Unfortunately, just as in personal relationships, business partnerships sometimes fail because one of the parties takes his or her eyes off the original goal, or somewhere down the road loses integrity because of a flaw in his or her character (dishonesty perhaps, impaired judgment or in many cases the person "just doesn't care.")

Sink or Swim?

In the movie "Titanic," one of the primary reasons the ship was considered unsinkable was because of the way the compartments in its hull were designed. The theory was that flooding in one compartment due to a breach in the hull wouldn't affect other compartments because of the high walls between them.

What the ship's designers didn't consider, however, was that if the breach was big enough, water could spill over the walls from one compartment to the other, until the ship sank.

The same theory can be applied to the franchisor/franchisee relationship. If there is breach in the contract by either party, the negative impact on the relationship will begin to spill over from one area of your business into the next until eventually, the partnership crumbles, and the weaker of the two businesses possibly could sink.

How do you avoid such a tragedy? Franchisees looking to assure themselves of a solid, equitable franchise contract must first find a franchise company that is led by hoteliers with character and that is built on integrity. They will want to select a franchise based on the company's ability to provide them with the tools necessary to run a successful business, such as knowledgeable senior management, great marketing efforts, field support, an effective franchise board that has a voice in what goes on within the company, along with various other areas of support.

Likewise franchisors must be certain that they are building partnerships with owners who are willing to follow the standards and guidelines set by the franchise company to be successful. If a franchisee has done everything possible to make his or her businesses successful - even requesting the assistance and consultation of the franchisor when the first signs of trouble arise - and the business is still sinking, then it is up to the franchise company to provide equitable franchise termination and exit strategies.

If the mutual goals of the franchisor and franchisee are not being met, then there is cause to terminate the partnership. As long as both parties keep their integrity in check, and maintain their character in the true spirit of hospitality - taking each other's business and financial goals into consideration - then there should be an equitable separation.

Actually, sometimes it is just a prospective hotel owner, but whatever the case, it is always someone who has found frustration and confusion. The source of their problems is the contracts already entered into (or about to be entered) between them and the hotel franchise company. Whether I am in my office or attending a hotel-industry event, the conversation invariably is about problems that crop up between a hotel franchise company and a hotel owner.

Inference should not be drawn here that the problem in these matters has anything at all to do with devious franchise companies. While all of them are in the business of making money, none would survive for very long if they engaged in practices that are dishonest, unfair or morally bankrupt. So, it is clear that the problem is not that franchise companies are out to cheat potential and current franchisees. Precisely, the problem is that the franchise agreement is an intricate document designed to deal with as many situations as possible in favor of the side that draws up the contract--namely, the franchise company.

Besides, the franchisors and the executives they have hired are in possession of decades of experience, not only in the franchising arena, but also the hotel industry or other areas of hospitality. They have an ingrown advantage in dealings with hotel owners and that is something that will never change for as long as business is done.

The obvious solution is for the hotel owner to come as close as possible to simulating for himself the vast wealth of experience working in the favor of the franchise company. Knowledge must be drawn on wherever it is available, but it must be knowledge gathered with a critical eye and the realization that it is seldom the case that any two hotels' circumstances are exactly alike. Thus, what the potential hotel franchisee learns from a current franchisee must be taken with a grain of salt. No two businesspeople do business in exactly the same way, and no two hotels' properties can be run in an identical manner.

Hotel franchisors are already aware of this truth, and will go to great pains to prepare franchise contracts that are specific to the nature of the property involved. These companies have expertise in information gathering, historical data and travel-and-tourism patterns (to name a few items), and they know how to put all that data to very good use.

All of this is also pertinent to those hotel owners who are already in franchise agreements, and who now seek to be relieved of those agreements. There is an axiom about it being far more difficult to get out of a business contract than it is to enter one, and it seems that in all fairness the opposite should be true. But facts are facts, and whether entering a franchise agreement or seeking exit from one, the hotel owner must be as prepared and informed as is the franchise company.

Historically there has been only two ways of dealing with a franchise agreement, and liquidation or termination. You could endeavor to do it yourself or you could go out and hire a lawyer, who perhaps may be even more uninformed than you might be about the substance of hotel franchise agreements. The problem is that unless you are very knowledgeable about hotel franchise agreements or the varying atmosphere within the different franchise companies, you are probably not going to do an effective job entering or exiting a contract.

The franchisor/franchisee relationship is truly the ultimate in power sharing and character building. In the true spirit of hospitality, we as hoteliers need to look inwardly to see if our character is being defined by our business integrity.

Verbally trashing the franchisor if your business is doing poorly is not the way to seek an equitable resolution or to build your character in the eyes of your fellow hoteliers. Howling at the moon won't put more heads in beds or improve your integrity in the eyes of the franchisor, which most likely is able to help you get back on your feet.

Yes, owners should expect to get the very most - the highest return on investment - from the fees that they pay every month. But recognize that not all franchise companies are the same. Some operate with integrity and some may not. The one's that do will structure a fair franchise agreement that is equitable for both entities. If implemented correctly, there are ways to maximize the benefits provided by the franchise company to help increase guest satisfaction and improve overall asset performance.

True partners can weather any storm. Those who build a business relationship on integrity, looking inwardly at the character behind those building the partnership, will be those who swim upstream, even in the roughest waters.

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

The Bankruptcy Code in the United States is generally intended to give honest but unfortunate debtors the opportunity for a fresh start. This includes the honest but unfortunate franchisee who attempts to start a franchise but ultimately fails. Generally, if a franchisee files a personal bankruptcy case, the personal liability of the individual who filed bankruptcy is discharged and that individual has the opportunity for a fresh start.

However, there is an exception to discharge that can come into play. Section 523(a)(6) of the Bankruptcy Code provides that debts for a "willful and malicious injury by the debtor to another entity or to the property of another entity are not dischargeable."

In one recent case, the bankruptcy court found that the continued use of a trademark after the termination of the franchise agreement amounted to a willful and malicious injury under Section 523(a)(6). In In re Gharbi, 2011 WL 831706 (Bankr. W.D. Tex. Mar. 3, 2011) aff'd, 2011 WL 2181197 (W.D. Tex. June 3, 2011), the franchisee continued to use the "Century 21" mark after the termination of the franchise agreements. Specifically, the franchisee intentionally used websites with "Century21" in the domain name and intentionally used the "Century 21" mark on a website. The franchisee continued these infringing activities for a significant period of time after the termination of the franchise agreements.

As a result of the infringement on its trademark, Century 21 filed a lawsuit in the bankruptcy court against the franchisee. Century 21 prevailed on its infringement claims and was awarded damages of $75,000 and attorney's fees of $147,996. The bankruptcy court specifically found that the franchisee could not discharge these debts because they were the result of a willful and malicious injury by the franchisee against Century 21.

This case highlights the potential negative consequences of the continued use of a trademark following the termination of a franchise agreement. Although bankruptcy can generally provide a fresh start for individuals, that fresh start can be greatly hindered, or completely lost, if one of the debts is the result of a willful and malicious trademark infringement.

Mr. Carey's practice is focused in the area of bankruptcy and creditors' rights.

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

Franchise laws in California and several other states seek to protect both franchisors and franchisees in their investment in a new franchise business.

Franchisees are protected under these laws because franchisors must:

▪ Register with the state each year,

▪ Present a disclosure document about the investment, and

▪ Allow a cooling-off period before the new franchisee signs any agreement or pays any money to the franchisor.

These laws permit franchisees to bring a legal claim if the franchisor violates the law, such as by making a misrepresentation in offering or selling the franchise.

For the franchisor, the laws limit the time when franchisees can bring claims.

A franchisee's claim alleging violation of California's Franchise Investment Law, is barred if not brought within the earliest to occur, of:

▪ Four years from the act or transaction claimed to have violated the law, or

▪ One year after the franchisee discovers facts constituting the claimed violation.

Moreover, under an old California law (from the 1800s), anyone, including a franchisee, who knows circumstances that should cause him or her to investigate, is deemed to know the facts the investigation would have revealed. This rule can make the one year time limit start and end quickly.

Time limits differ in the various states that have franchise laws. Here are some of them:

Some Effects of Franchise Law Time Limits

▪ Sometimes they encourage litigation. They force franchisees to bring claims sooner, to reduce or avoid the risk of a claim being lost due to the statute of limitations.

▪ They also give franchisors a strong tool to defend and defeat some claims, because the franchisee waited too long to sue.

▪ These statutes also lead to some compromises and settlements, due to the complaining franchisee being uncertain if a statute of limitations may apply.

▪ In some cases, by the time a franchisee becomes suspicious of a problem, dissatisfied enough to consult a franchise lawyer, and then certain enough to make a claim, more time has passed than the statute of limitations allows.

▪ Sometimes, a franchisee knew the facts more than one year before bringing a claim.

As a business owner, actual or potential franchisor or franchisee, you should keep in mind the statutes of limitations under state franchise laws.

Franchisees should be aware to avoid losing or giving up a claim, by failing to bring it until after the time limit has passed.

Franchisors should be aware of statutes of limitations as a tool to bar or defeat an untimely claim, sometimes after only a relatively short time.

David Gurnick is the author of Distribution Law of the United States and Franchise Depositions (Juris Publishing) and is Certified by the State Bar of California as a Specialist in Franchise and Distribution Law.

Please reach him by calling 818.990.2120 or by e-mail: [email protected].

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