Recently by Matthew Kreutzer

If you follow my blog, you know that one of the issues I've been writing about for a couple of years now is the problem that certain franchisors have faced in being deemed "employers" of their franchisees.

The most well-publicized of the "franchisees are really employees" cases is Awuah v. Coverall, a case I blogged about here,here, and here.

The trend that has seen franchisees filing lawsuits seeking a determination that they are actually employees of their franchisors has continued to grow.

The case discussed below, Roosevelt Kairy, v. Supershuttle International, Inc., Bus. Franchise Guide (CCH) (N.D. Cal. Sept. 20, 2012), is a good example of what these cases typically look like. The decision I report on does not deal directly with the "franchisees as employees" issue, which will likely be decided upon by an arbitrator (for the reasons discussed below). This decision in particular deals with a challenge by the franchisees to the arbitration clause that was in their respective franchise agreements, which they claimed were unconscionable.

Plaintiffs, individuals who drive passenger vehicles for SuperShuttle, were franchisees of the company. Plaintiffs sued to challenge SuperShuttle's "unlawful misclassification of its airport shuttle drivers as 'franchisees' and independent contractors," alleging that they had not been paid minimum wages and overtime compensation pursuant to the Fair Labor Standards Act ("FLSA") and under California law.

Each franchisee signed a franchise agreement with SuperShuttle that contained a mandatory arbitration clause." Most of the franchise agreements also provided that "[a]ny arbitration, suit, action or other legal proceeding shall be conducted and resolved on an individual basis only and not on a class-wide, multiple plaintiff or similar basis."

Supershuttle moved to compel arbitration and to stay the action pursuant to Section 3 of the Federal Arbitration Act. The only issue was whether the arbitration agreements were valid and enforceable. Plaintiffs made three challenges to arbitrability: (1) that Supershuttle waived arbitration by pursuing litigation; (2) that the arbitration agreements were unconscionable and therefore invalid; and (3) that Plaintiffs should not be compelled to arbitrate their statutory claims.

The Court began its analysis by discussing the Supreme Court's decision in AT&T v. Concepcion, 563 U.S. __, 131 S. Ct. 1740 (2011). Under Concepcion, the Court stated, agreements to arbitrate may be "invalidated by generally applicable contract defenses, such as fraud, duress, or unconscionability, but not by defenses that apply only to arbitration or derive their meaning from the fact that an agreement to arbitrate is at issue." (quotingConcepcion, 131 S. Ct. at 1742-43.

The Court first considered the waiver argument. In essence, the plaintiffs claimed that SuperShuttle waived its right to enforce arbitration because it did not seek to compel that process after plaintiffs first filed suit (which occurred prior to the ruling in Concepcion). In disposing of that argument, the Court found that it would have been futile for SuperShuttle to attempt to compel arbitration because, prior to Concepcion, California and Ninth Circuit law held that similar arbitration agreements with class action waivers were unconscionable and unenforceable.[1]

Because SuperShuttle had no right to waive prior to Concepcion, the Court held that no such waiver occurred. The Court also found that the plaintiffs had not been prejudiced by SuperShuttle's delay in seeking to compel arbitration.

The Court then turned to plaintiffs' argument that they should not be compelled to arbitrate their statutory claims. The Court observed the rule that, where statutory claims are involved and an arbitration agreement exists, the agreement should be enforced if the litigant can "effectively vindicate his or her statutory claim for relief in arbitration, unless Congress itself has evinced an intention to preclude waiver of judicial remedies for the statutory rights at issue." (internal citation omitted).

Finding that plaintiffs had not shown any such intention by Congress to preclude arbitration of claims under the FLSA, the Court disposed on plaintiffs' argument on statutory grounds as well.

Finally, the Court considered plaintiffs' argument that the arbitration provision was unconscionable. To demonstrate procedural unconscionability, the plaintiffs claimed that the arbitration provision was "hidden in a prolix of printed matter," and that SuperShuttle had failed to provide them with copies of the AAA's commercial arbitration rules before the plaintiffs signed the franchise agreement.

The Court found that there was no procedural unconscionability because the plaintiffs: (1) were given franchise disclosure documents that described the arbitration provisions; (2) had a fourteen-day period to review the franchise agreements and disclosure documents; and (3) were given copies of the franchise agreement with a table of contents that clearly identified the arbitration provision.

Interestingly, the Court did agree with plaintiffs that the fee-splitting provisions (providing that the parties would equally share the arbitrator's fees and costs) were substantively unconscionable.

In this regard, the Court observed that "fee splitting can be unconscionable where fees and costs are so prohibitively expensive as to deter arbitration" and that the Court should consider "whether the arbitral forum in a particular case is an adequate and accessible substitute to litigation."

The Court reasoned that, based on the plaintiffs' cost projections, it appeared that the individual plaintiffs would not be able to afford arbitration.

Instead of refusing to enforce the arbitration provision, however, the Court severed the fee-splitting provisions of the arbitration agreements as unenforceable.

[1] The Court observed Concepcion specifically found that the FAA preempts the rule announced by the California Supreme Court in Discover Bank v. Superior Court, 36 Cal. 4th 148, 1b62 (2005), aff'd Discover Bank, Laster v. AT&T Mobility LLC, 584 F.3d 849, 855 (2009), which found class action waivers in arbitration clauses to be unconscionable.

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Last night I reviewed a franchise agreement and found a surprising, and illegal, provision buried deep in the contract. If ever there was a compelling case for being careful when you are choosing legal counsel, I just found the provision that makes it.

But first, some background. My law practice involves representing both franchisors and prospective franchisees. For franchisors, I primarily draft franchise disclosure documents ("FDDs") and franchise agreements; I assist my clients in obtaining franchise state registrations; and I assist them with day-to-day issues that arise in running their businesses. For prospective franchisees, I will review their proposed franchise agreements and FDDs and help them understand what they will be committing to do if they decide to buy the franchise. If the franchise company is willing to negotiate, I help prospective franchisees through that process.

I find that reviewing other companies' FDDs and franchise agreements also helps me in my practice for franchisors; it's always instructive to see what other industry leaders are doing. I have noticed that, in a small minority of systems, some franchisors go well beyond what is legally permitted to be included in the franchise agreement and include provisions that unquestionably violate the FTC Franchise Rule (the "Franchise Rule") as well as various state franchise laws.

The Provision

If you're on either side of the franchise relationship, you should know if your contract has a provision like this one. Pull out your franchise agreement now. Go ahead, I'll wait.

You have it now? Good. Here's the provision we're looking for:

Release of Prior Claims. By executing this Franchise Agreement, Franchisee, and each successor of Franchisee under this Franchise Agreement forever releases and discharges Franchisor and its Affiliates, Its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors. representatives, employees and agents, from any and all claims of any kind, in law or In equity, which may exist as of the date of this Franchise Agreement relating to, in connection with, or arising under this Franchise Agreement or any other agreement between the parties, or relating In any other way to the conduct of Franchisor, its Affiliates, its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors, representatives, employees and agents prior to the date of this Franchise Agreement, including any and all claims, whether presently known or unknown, suspected or unsuspected, arising under the franchise, business opportunity, securities, antitrust or other laws of the United States, any stale or locality.

In plain English: "you, the franchisee acknowledge that we, the franchisor, may have lied to you and might be lying to you right now. Our entire FDD might be one of the greatest works of fiction sinceMoby Dick. You agree, however, that you waive all your legal rights to take action against us based on those lies, even if you have invested hundreds of thousands of dollars of your hard-earned money in this phony business." Wow.

Do you have that one in your franchise agreement? You might have to do a bit of hunting for it. You would think something like that would be on the first page, bolded, in caps, with a box around it and perhaps accompanied by a self-lighting sparkler that draws your attention directly to the provision when you open the contract. But no, in the case of the contract in which I found this provision, it was buried on page 36 of a 39-page franchise agreement, with no particular emphasis placed upon it.

I will never include a provision like this in a franchise agreement I draft, nor will I ever recommend that a prospective franchise buyer sign a contract when it includes this provision. Why? It's not only unfair, but it's also illegal under the Franchise Rule and under various state franchise laws.

The Problem with Having the Provision

Now, I highly doubt that in most situations, the franchisor even knows this provision is in its franchise agreement. Most start-up franchise companies trust their franchise counsel to draft the agreement and don't necessarily carefully consider each provision in the contract. This sort of provision is typically created by counsel, who is seeking to protect his or her client. An admirable goal, to be sure.

The problem is that this provision is impossible to justify to a prospective franchisee that notices it and understands its implications. If you're a franchisor, imagine trying to explain that to a potential buyer: "we're not lying to you. But you have to agree as a condition of buying this franchise that we might be and that you won't ever do anything about it if we are.

A franchisor may be able to slip this one by a franchisee unnoticed, but a franchisee that notices and understands this provision is always going to have a problem with it. A franchisee that has experienced franchise legal counsel review the agreement for them will certainly flag the term and warn the franchisee against agreeing to it. That could cost you a sale.

To make matters worse for the franchisor, the types of franchisees that actually read the agreement before signing it and have legal counsel review it for them are exactly the type of franchisees the franchisor wants: franchisees that take their commitments seriously and are willing to put their time, effort, and money into understanding commitments before they make them.

Now, I have my doubts that this type of provision will be enforceable in any event because, as I said, including a provision like this one is an explicit violation of the Franchise Rule, which "prohibits franchise sellers from disclaiming or requiring a prospective franchisee to waive reliance on any representation made in the disclosure document or in its exhibits or amendments." This provision does exactly that - and, as a result, the franchisor that included it in its agreement is in violation of the Franchise Rule (and various state laws) just for having the term in the contract.

Violating the Franchise Rule and state franchise laws leaves the franchisor exposed to lawsuits by franchisees that may have a state law "unfair trade practices" cause of action against the franchisor because of it. When those legal claims exist, a franchisor could face claims for damages or rescission. Moreover, state franchise administrators could refuse to register the franchise offering with a provision like this one (if they notice it) or worse, later take administrative action against the franchisor based on its violation of franchise law.

The better practice for franchisors that want to protect themselves, but do so within the bounds of the law, is to use exculpatory provisions and "compliance questionnaires" as part of the agreement signing process. A well-drafted exculpatory provision will provide a measure of protection to franchisors for unauthorized statements made by a renegade sales person, but will not seek to disclaim statements made by the franchisor in its FDD (and therefore is permissible under the Franchise Rule and many state laws).

The Lesson for Franchisors and Franchisees

If you are a franchisor, inclusion of a provision like this in your franchise agreement should make you question your legal counsel. Ask yourself: are you willing to risk losing a potential sale to a qualified, savvy, and ideal franchisee because you have a provision in your franchise agreement that probably isn't enforceable anyway? Are franchisees that sign your contract without even reading or understanding it really the type of franchisees you want? And is "sneaking something past" your unwitting franchisees who don't review every term of your contract really the way you want to do business? As I explain above, there are better (and legally-enforceable) ways to protect yourself in your franchise agreement, anyway.

If you are a prospective franchise buyer, this situation highlights the importance of: (1) reading your franchise agreement, cover-to-cover; and (2) hiring legal counsel experienced in franchise law to review your contract before you sign it. Contrary to the opinion of some, franchise agreements aren't all boilerplate, and not all franchise contracts are created equally. Don't assume that your franchise agreement doesn't contain something objectionable just because other franchisees signed it.

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On Monday, June 29, 2015, California State Assembly Bill (AB) 525 was considered by the Senate Business, Professions and Economic Development Committee.

If passed by the Senate, AB 525 will amend the existing California Franchise Relations Act (Business and Professions Code §§ 20000 - 20010) ("CFRA") by expanding protections for existing franchisees. See my previous blog post for a discussion of the amendments to the CFRA that would be created by AB 525.

While the Senate has made some minor clean-up amendments to AB 525, none of them substantially change the character of the bill or the amendments that it would create to AB 525.

The International Franchise Association ("IFA") has mounted a significant challenge to AB 525, having sent to its California-based members an email urging them to contact their elected officials and voice opposition to the bill.

From the IFA's email:

This bill in its current form places the basic tenets of the franchise contract at risk, which ultimately would harm franchisees, franchisors and consumers in California. This is a dangerous precedent, as this legislation could damage the reputation of local franchise business owners by reducing their brand standards. The unintended consequences of this legislation will also drastically increase incentives for litigation.

As an interesting example of politics making strange bedfellows, one of the key sponsors to AB 525 is the Service Employees International Union (SEIU).

The SEIU is the driving force behind the National Labor Relations Board's (NLRB) push to hold franchisors liable for their franchisees' employees as "joint employers," which push is widely considered to be a significant threat to the franchise industry as a whole.

According to Catherine Monson, CEO of FASTSIGNS, AB 525 is part of the SEIU's "coordinated attack on the franchise business model."

To assist the IFA in its campaign to defeat AB 525, you can follow this link: https://www.votervoice.net/FRANCHISE/Campaigns/39986/Respond

On May 14, 2015, the California state Assembly passed AB 525, a bill that would amend the existing California Franchise Relations Act (Business and Professions Code §§ 20000 - 20010) ("CFRA") by expanding the protections for existing franchisees.

As currently written, AB 525 would amend the CFRA in the following ways:

• "Good Cause" Restricted to Substantial Compliance. Under the CFRA, a franchisor is permitted to terminate a franchise prior to the expiration of its term only for "good cause," which includes (but is not limited to) the failure of a franchisee to comply with any lawful requirement of the franchise agreement after being given notice and an opportunity to cure the failure. Under AB 525, "good cause" would be limited to the failure of the franchisee to substantially comply with the franchise agreement.
• 60 Day Cure Period. AB 525 would create a mandatory period of at least 60 days for the franchisee to cure a material default under the franchise agreement, which cure period would apply in all but a few defined circumstances.
• Right of Sale. A franchisor would be prohibited from withholding its consent to the sale of an existing franchise except where the buyer does not meet the franchisor's standards for new franchisees.
• Notification of Approval / Disapproval of Proposed Sale. A franchisor would be required to notify the requesting franchisee of its approval or disapproval of a contemplated sale of a franchise within 60 days of receiving from the franchisee certain mandated forms and information regarding the sale. If a franchisor does not provide its written approval or disapproval with the 60 day period, the sale will be deemed to have been approved.
• Reinstatement or Purchase of Franchise. In the event that a franchisor either terminates or fails to allow the franchisee to renew or sell its franchise in violation of the CFRA, the franchisor would be required to, at the election of the franchisee, either: (a) reinstate the franchise and pay the franchisee damages; or (b) pay the franchisee the fair market value of the franchise and the franchise assets.
• Monetization of Equity. A franchisee must have the opportunity to "monetize its equity" (obtain the fair market value of the franchise and its assets) prior to the franchise agreement being terminated or not renewed by the franchisor, except under certain limited circumstances.

AB 525 is now in the Senate for consideration.

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FRANData, the company that operates the Franchise Registry for the U.S. Small Business Administration (SBA), announced last week that it adopted the standard franchise definitions used by the North American Securities Administrators Association (NASAA) in the Multi-Unit Commentary that was issued in Fall 2014.

This is important because it recognizes and implements some standardization in the franchise industry, which has historically been inconsistent when referring to certain types of franchise relationships.

Specifically, the NASAA Multi-Unit Commentary uses the following definitions, which will now be recognized by FRANData:

• Unit Franchisee: An owner of a single franchise unit.
• Area Developer: A person that is granted, for consideration paid to the franchisor, the right to open and operate multiple unit franchises, generally within a delineated geographic area. The area developer generally is a party to an "area development agreement" with the franchisor specifying the number of units to be developed and a development schedule, and the area developer or its affiliates generally are parties to separate unit franchise agreements with the franchisor. The area developer does not have the right to grant or sell unit franchises to third parties. This relationship is sometimes also referred to as a "multi-unit" or "area franchisee" relationship.
• Subfranchisor: A person with rights related to granting unit franchises to third parties, generally within a delineated geographic area("subfranchise rights"). The subfranchisor generally is a party to a subfranchisor agreement, aka master franchise agreement, with the franchisor specifying the territory in which the subfranchisor may operate and a minimum opening schedule, and the subfranchisor is a party to unit franchise agreements, aka subfranchisee agreements, with third parties for unit franchises. The subfranchisor is typically obligated to provide support services to those third parties.
• Subfranchisee: A third party that signs a subfranchisor's unit franchise agreement. The franchisor and the subfranchisor usually each receive a portion of the initial franchise fee and the continuing fees paid by each subfranchisee.
• Area Representative: A person that is granted, for consideration paid to the franchisor, the right to solicit or recruit third parties to enter into unit franchise agreements with the franchisor, and/or to provide support services to third parties entering into unit franchise agreements with the franchisor. The person granted these rights is a party to an "area representative agreement" but is not a party to the unit franchise agreements signed by the third parties. The area representative, like a subfranchisor, usually receives portions of the initial franchise fees and the continuing fees paid by unit franchisees, depending on the services the area representative provides. The area representative's payment of consideration to the franchisor for the right to recruit and/or provide support to unit franchisees is the element that makes the area representative different from a franchise broker or selling agent.

FRANData's adopting these standard definitions will help the company work with franchisors, state administrators, and the SBA in benchmarking performance across brands and industries. "When franchisors ask us to benchmark their performance against their peers, it's important that we all agree on the types of franchising programs being used and their relative historical results," said Edith Wiseman, President of FRANdata.

"Franchisors use single-unit franchising, multi-unit franchising, area representatives, sub-franchising, master franchisees, licensing and other growth channels. It is crucial that we are able to do apples-to-apples comparisons when gauging the relative success of their efforts."

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One of the most common provisions in franchise agreements is the "forum-selection" clause.

Under these provisions, the parties agree that any lawsuit filed by either one of the parties will be brought only in a court in a specified city and state. The chosen court will almost always be in the city where the franchisor has its home office.

A forum-selection clause is used as a cost-shifting tool in franchise contracts.

The franchisor, which presumably has a large number of franchisees in diverse geographic locations, would find it financially burdensome to have to hire different lawyers in a number of different states to defend or prosecute lawsuits against its franchisees. Using the forum-selection provision, it shifts the burden of traveling for a lawsuit (and obtaining counsel in a sometimes-remote forum) to the franchisee.

Some states have laws that consider forum-selection clauses in franchise agreements to be void - so that a franchisee protected by the state law will be able to sue and be sued in his or her home state.

Other states will stop short of voiding those provisions, but will permit a franchisee who sues the franchisor first to do so in his / her home jurisdiction.

Case Study: Maaco Franchising, Inc. v. Tainter

Even where these state laws do exist, they don't always carry the day. Take, for example, the recent case involving Maaco Franchising and two California-based franchisees. In 2004, Maaco entered into a franchise agreement with Richard and Diane Tainter for the operation of a Maaco automotive painting and repair shop located in Palo Alto, California.

The Franchise Agreement

The franchise agreement contained a Pennsylvania choice-of-law provision, as well as a forum-selection provision requiring that all litigation occur in Pennsylvania federal or state courts. Under the franchise agreement, the Tainters agreed that they would submit to the personal jurisdiction of Pennsylvania courts, and waived all objections to the jurisdiction or venue of any action brought in Pennsylvania. This type of language - requiring a franchisee to waive objections to the jurisdiction of the other state's courts - is common in franchise agreements.

Before signing the franchise agreement, the Tainters also received a franchise offering circular with a California-specific addendum. This type of addendum can be found in any franchise disclosure document where the franchisor is registered to sell franchises in a registration state like California.

The California addendum in the agreement stated that California has a statute that "might supersede" the franchise agreement, "including the areas of termination and renewal." Importantly, however, the franchise agreement itself did not have any state-specific addendum modifying the terms of the contract.

Maaco's lawsuit against the Tainters

In September 2012, Maaco sued the Tainters in September 2012, alleging that the Tainters failed to pay royalty and advertising fees, and for failing to comply with an audit. Maaco filed the lawsuit in Pennsylvania court (in accordance with the forum-selection clause).

Opposing Maaco's decision to sue them in Pennsylvania, the Tainters argued (among other things) that:

(1) the forum-selection clause was invalid because the parties did not reach a "meeting of the minds" agreeing to a forum outside California;

(2) the forum-selection clause should not be enforced because it is contrary to California's "strong public policy disfavoring the enforcement of out-of-state forum-selection clauses," citing California Business & Professions Code §20040.5; and

(3) that even if the forum-selection clause was valid and enforceable, other factors weighed in favor of transferring the case to the Northern District of California.

The Court analyzed the matter by referring to 28 U.S.C. §1404(a), which allows a court to transfer a case to any other district or division where the case could have been brought "for the convenience of parties and witnesses, and in the interests of justice." The Court recognized that the forum-selection clause in the contract was entitled to "substantial consideration," but that it would not be dispositive.

The Court noted that the Tainters, as the moving party, had the burden of showing why they should not be bound by the forum-selection clause and that a transfer was necessary in this case.

1. Meeting of the Minds

The Tainters argued that they did not "agree" to a forum outside of California based on the U.S. Court of Appeals for the Ninth Circuit's holding in Laxmi Investments, LLC v. Golf USA, 193 F.3d 1095, 1097 (9th Cir. 1999). In Laxmi, the court found that there was no "meeting of the minds" about the forum-selection clause because California Business & Professions Code §20040.5 prohibits franchise agreements from "restricting venue to a forum outside of California.

Based on the above statutory provision, the Tainters argued that they never agreed to a Pennsylvania forum for its dispute; in other words, that there was no "meeting of the minds" between the parties regarding the Pennsylvania forum-selection clause.

To support that argument, the Tainters pointed out language in the Franchise Disclosure Document (which said that California "might have statutes that supersede the Franchise Agreement") meant that Maaco could not insist on a forum outside of California.

Analyzing the Tainters' argument, the Court said that, "under federal law, forum-selection clauses are presumptively valid and enforceable unless enforcement is shown by the resisting party to be unreasonable under the circumstances."

To meet this burden, the resisting party must show:

(1) the clause was invalid for such reasons as fraud or overreaching;

(2) enforcement of the clause would contravene a strong public policy of the forum in which the suit is brought; or

(3) that enforcement of the clause would be so gravely difficult and inconvenient as to be unreasonable and unjust and that it would deprive the party of its day in court.

Reasoning that the unambiguous language in the agreement clearly stated that the parties waived any objection to the jurisdiction or venue of Pennsylvania courts, the Court found that the language in the separate disclosure document was "insufficient to negate the Tainters' express agreement to litigate in a Pennsylvania forum."

In other words, the fact that the disclosure document said that California law "might supersede" the parties' choice of Pennsylvania as the proper forum for disputes wasn't good enough to overcome the clear language of the contract.

As a result, the Court found that there was a meeting of the minds between the parties regarding the forum-selection clause in the Franchise Agreement.

2. Strong Public Policy

Next, the Tainters argued that the forum-selection clause was unenforceable as it contravened California's "strong public policy," as embodied in California Business & Professions Code §20040.5.

Turning to this argument, the Court said that the question is not whether enforcing a forum-selection clause is contrary to any strong public policy, but whether it would "contravene a strong public policy of the forum in which the suit is brought."

Pennsylvania courts, the Court said, regularly enforce clauses electing a Pennsylvania choice of forum. As a result, the Court held that the Tainters' "strong public policy" argument could not override enforcement of the forum-selection clause.

3. Transfer for Convenience of Parties and Witnesses

Lastly, the Tainters argued that the Court should transfer the case for the convenience of the parties and witnesses, as permitted by 28 U.S.C. §1404(a). The interests that can be considered under this Section are "plaintiff's forum preference as manifested in the original choice; the defendant's preference; whether the claim arose elsewhere; the convenience of the parties as indicated by their relative physical and financial condition; the convenience of the witnesses -- but only to the extent that the witnesses may actually be unavailable for trial in one of the fora; and the location of books and records." Quoting Jumara v. State Farm Ins. Co., 55 F.3d 873, 879 (3d Cir. 1995).

The Court found that a California forum would certainly be more convenient for the Tainters, who live in the State.

Presumably, the Tainters' witnesses, books and records would all be located there.

On the other hand, the Court reasoned that Pennsylvania would be a more convenient forum to Maaco, which had its principal place of business in the State during its relationship with the Tainters and maintained offices there.

Noting that the function of a venue transfer is not to "shift inconvenience from one party to another," the Court held that a "plaintiffs' choice of venue should not be lightly disturbed," particularly in light of the contractual forum-selection clause.

Additionally, the Court said that Pennsylvania courts are more familiar with Pennsylvania law, which the parties had chosen as the law governing the franchise agreement. Therefore, the Court declined to order transfer of venue to California.

Maaco v. Tainter: Lessons Learned

Currently, many franchise registration states specifically require, as a condition to registration, that the franchise agreement have a state-specific addendum to the franchise agreement (as opposed to the disclosure document, as in the case of the Tainters) that says that the franchisee has the right to sue or be sued in her home state. Those provisions will usually be enforced.

The key takeaway for franchisors from Maaco v. Tainter is that forum-selection clauses are valuable tools that can help them shift some of the burden of litigation costs to its franchisees.

Courts in states that don't have special franchise laws will usually enforce forum-selection provisions, unless there is a clear reason not to do so. A state-specific addendum to a franchise agreement, which may be at play in certain franchise registration states, will usually be enough to require a court to transfer a case to the franchisee's home state.

For prospective franchisees, the lesson from Maaco v. Tainter is that it's important to read and understand the franchise agreement - and any state-specific addenda - before signing the contract. If your proposed franchise agreement contains a forum-selection clause, understand what that provision will mean to you if your relationship with the franchisor implodes.

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A couple of years ago, there was this fun little commercial from Domino's Pizza, which features a new product called "Bread Bites."

From the commercial, we learn that Bread Bites were created by a Domino's Pizza franchisee in Findlay, Ohio (watch the commercial below).

Franchisee innovation is nothing new. Franchisors often find that some of the best-selling products are created by franchisees.

For example, some of the most popular sandwiches (including the Big Mac, Filet-o-Fish, and Egg McMuffin) at McDonald's were created by franchisees. Indeed, the Big Mac is one of the all-time innovation success stories, having been created by franchisee Jim Delligatti in the 1960s and finally adopted by McDonalds in 1968 (the sandwich quickly became one of the chain's best sellers, accounting for 19 percent of all sales).

These success stories encourage franchising companies to carefully consider permitting franchisees to create new or different products.

That having been said, franchisors have to balance the idea of product innovation with the need to maintain system uniformity and system standards. Allowing franchisees free reign to create and sell new items can create customer confusion (when they can't find a particular item they liked at all locations) and an erosion of goodwill.

This is particularly true where the new item isn't up to the franchise company's brand and quality standards.

As a result, franchisors will ensure that their contract clearly prohibits a franchise from selling new or different products unless they are first approved by the franchisor. That was true in the case of the Big Mac, where franchisee Delligatti's creation was subjected to a rigorous approval process by McDonald's that took several years of evaluation and consumer testing before the sandwich was finally added to the menu.

Equally as important to a franchise company is that the ownership of products created by franchisees is undisputed. Where a new item has the potential to be successful and attractive to consumers, the franchisor wants to be sure that the product can be offered at all locations.

As a result, a careful franchisor will ensure that its franchise agreement clearly addresses the handling of innovations with a provision that explicitly states that any franchisee creations or breakthroughs will be considered the exclusive property of the franchisor.

I like to call this type of franchise agreement provision a "Big Mac" provision, in honor of the granddaddy of all franchisee innovations.

A well-written "Big Mac" provision will also require the franchisee who created the new item to assist the franchisor in obtaining and enforcing intellectual property rights to any such innovation, or, if the rights can't be secured by the franchisor, then to grant the company a fully-paid up and irrevocable license to use the product.

By controlling the ownership of such intellectual property, a franchise company can ensure that any improvements -- be they Bread Bites or Big Macs -- can be rolled out across all of its locations, thereby creating uniformity systemwide.

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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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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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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.

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The National Labor Relations Board's General Counsel, Richard Griffin, recently spoke to a group of law students at West Virginia University's College of Law. During the discussion, which was recorded and is available here,

Mr. Griffin offered the students some insight into his decision determining that McDonald's USA, LLC is a "joint employer" of its franchisees' employees.

Mr. Griffin's view is that the standard that has long been applied by the NLRB to evaluate employment in the franchise relationship context is wrong because it does not focus heavily enough on the control that franchisors actually exert over franchisee employees in their day-to-day operations.

Mr. Griffin believes that the level of control exerted by McDonald's over the employees of its franchisees is significant enough to change the character of the relationship, making McDonald's not only a franchisor, but also a "joint employer" of its franchisees' employees.

In particular, during the talk Mr. Griffin focused on the computer and software systems that McDonald's requires each of its franchisees to use. In this computer system, he says, McDonald's is able to monitor all activities at each franchise location on a minute-by-minute basis and uses this data to direct its franchisees when to schedule their employees for work, and when to send their employees home.

This control, which Mr. Griffin says is direct control over employee hours, is enough to make McDonald's a "joint employer" of those employees.

Of course, the franchisor's view is that the direction given by McDonald's to its franchisees is only guidance, which is given to help the franchisee operate its business more efficiently.

The long term effect that General Counsel's decision, which sent shockwaves around the franchise industry, will have on franchising is still unknown, but his comments during the WVU talk do offer a glimmer of hope to franchisors that they can avoid "joint employer" liability by not having McDonald's level of involvement in day-to-day franchisee operations and employee scheduling.

As we move into 2015, most franchisors will be re-evaluating their franchise documents (including their Franchise Disclosure Documents and Franchise Agreements) as part of the annual update, registration, and renewal process.

This is a good time to talk with counsel about ways that those documents can be amended to offer additional elements of protection against being found to be a "joint employer" of franchisees' employees.

If you want to discuss how you may be able to improve your franchise documents to respond to these and other new threats heading into 2015, please feel free to contact me or connect with me on LinkedIn.

I wrote this in 2013, and it seems appropriate to revisit the topic, today.

Following on the heels of similar strikes in recent weeks in New York and Chicago, hundreds of St. Louis area fast food restaurant employees walked off the job May 9, which affected more than 30 area businesses including a number of fast food franchise businesses. The strikes spread to Detroit on May 10.

These employees joined a growing wave of protests over wages and other terms and conditions of employment in what is one of the fastest-growing segments in the U.S. labor market.

You may even remember similar actions by Wal-Mart employees on Black Friday in 2012.

Although strikes are often associated with labor unions, the workers involved in these impromptu strikes are not unionized.

Instead, the efforts are being supported by a coalition of organizations, including labor groups, nominally coined "alt-labor," that are not legally unions.

But this does not mean that their activities are not protected by U.S. labor laws, specifically the National Labor Relations Act ("NLRA"). Enacted in 1935, the NLRA protects the right of workers to join together to bargain collectively with their employer and engage in other concerted activities for the purpose of collective bargaining or other mutual aid or protection.

The NLRA also protects the right of workers to refrain from any and all such activities.

Among other things, employees covered by the NLRA (which includes most, but not all, private sector employees) have the right to walk out or strike, even if they are not in a union. Many employers who are unfamiliar with unions or do not regularly deal with unionized workforces, can sometimes fall into a trap for the unwary by disciplining or discharging employees who are engaged in protected, concerted activities such as a strike.

Even though failing to report for work or even walking out during the middle of a shift impacts an employer's operations and may, in fact, violate an attendance policy, depending on the circumstances, an employer may actually be prohibited from disciplining them or questioning them about such protected activities.

In some cases, however, striking and picketing may not be protected. One such circumstance involves what is known as "recognitional picketing." This occurs when employees, and perhaps non-employees, picket an employer with the goal of obtaining recognition. When employees (and non-employees) picketed Wal-Mart on Black Friday, Wal-Mart filed a charge with the National Labor Relations Board. This charge was ultimately resolved when the union involved agreed to cease organizing the employees.

For franchisors and franchisees, an ounce of prevention is truly worth a pound of cure. To lawfully confront the potential for such activities, wise and savvy employers need to train their supervisors and managers now, before any such activity begins. Trained managers and supervisors not only have the tools to respond effectively and lawfully should such an incident occur, but are vital to warding off such activities in the first place.

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On November 25, 2014, the City of San Francisco unanimously passed a new law called the "Retail Workers Bill of Rights." If it is signed by Mayor Edwin Lee, it would go into effect next summer.

Among other things, the law would require retailers to give schedules to workers at least two weeks in advance, and penalize companies for noncompliance. Further, if a company is sold, workers with at least six months of tenure would be guaranteed work with the new owner for at least 90 days.

The problem with the law is, like the minimum wage laws in Seattle and Chicago, it disproportionately targets franchise companies. The law would apply to any retailer with at least 20 locations worldwide that also have at least 20 workers. This would put independent franchise owners at a disadvantage vis-a-vis other small businesses, because even a franchisee with a single location could be considered to fall under the law's criteria if the franchisee's entire franchise system counts more than 20 locations, worldwide. This is fundamentally unfair to franchises.

To illustrate the point: consider mom-and-pop business owners, the Smiths, who own a single Quizno's sub shop in San Francisco. The Smiths compete with the Joneses, who own an independent (non-franchise) sub shop one block away from the Smiths. The Smiths, whose annual sales are about the same as the Joneses (but also have to pay royalty, marketing, and other fees to their franchisor), would be required to comply with the new law because they are part of a large franchise system, while the Joneses are free to continue operating their business as usual. This inequity makes it difficult for franchise operators to compete.

The International Franchise Association has responded to this inherent inequity by writing a letter (available here) to Mayor Lee urging him to veto the new law. We will follow this story as it develops.

Earlier this year, the California Department of Business Oversight (DBO) launched a new electronic filing portal that franchisors and other companies can use to file franchise, securities, and other business documents for California.

Having personally used it for a number of franchise-related filings, I can tell you that the portal was difficult to use and full of flaws. In fact, because of problems with uploading documents and managing filings for my franchisor clients, in some instances I was forced to send paper copies of documents to the DBO -- even though I had already e-filed them through the portal.

The good news is that the DBO has been listening to our complaints and making changes to the portal -- just in time for franchise renewal season.

The latest update now makes it possible for a single law firm to register and file documents for multiple franchise companies.

This is a vast improvement from the prior version, which required outside franchise counsel (like me) to register a different account for each franchisor I represent. Now, a franchise attorney will be able to manage multiple California franchise registrations through one account.

Here is the text of the DBO's press release (dated November 14, 2014) on the latest updates to DOCQNET:

DBO Self-Service Portal Users:

Based on feedback the Department of Business Oversight (DBO) received from DBO self-service portal users like you, the DBO will modify the portal to make the Franchise or Securities notice filing process more convenient and user-friendly. 

Beginning on Monday, November 17, 2014 firms that file multiple franchise or securities notices, such as the Limited Offering Exemption Filing under Corporations Code Section 25102(f), will have the option to submit multiple filings under a single registered account.  The notice filing history and payment history for 25102(f) filings will be available to you in the online portal.  

However, please note that the notice filing history and payment history for any other notice filing is not available.

When you register (sign up) on the portal, you'll be given the option to select from one of two registration links:

1) To register as a Financial Services Licensee, as a securities issuer or franchisor filing on your own behalf, or a firm submitting Franchise registration applications or securities permit applications, you will go through the same registration process that exists currently, where both contact information and information about the Issuer/Licensee are required for registration.

2) To register a law firm seeking to file franchise and securities notices for multiple issuers, you will be asked to provide only your law firm's information and desired username.  You will provide Issuer information with each individual filing.

More information on which registration form is appropriate for your user needs can be found on the self-service portal.  You can also contact [email protected] with any questions. 

If you have previously registered and filed multiple times (and therefore have multiple accounts), the Department will be combining your previous filings under a single account.  We will send you a follow up email by Monday, November 17 with the username of the account that has been retained.  If you choose not to continue to use that username, you can still create a new single user account to submit all future filings.

Other features and changes include:

•  The filing summary preview page for 25102(f) notices will now have a button to select a printer-friendly version of the page
•  Issuer Representative information will be auto-populated using the information you provided at the time of registration

We hope these changes further improve your experience using the DBO self-service portal.  For more information, please visit the Frequently Asked Questions page.

A franchisee who sued his franchisor for fraud learned the hard way why it's important to read the Franchise Disclosure Document, cover to cover, before buying a franchise.

A California franchisee of Big O Tires sued the company in California court, alleging that Big O defrauded him when it sold him a franchise.

The California Court of Appeals ruled against him because the disclosure document Big O gave to the franchisee before he bought contradicted each and every one of his claims.

Mr. Hailemariam purchased his Big O Tires franchise in February 2008. Before he bought the franchise, he received Big O's Uniform Franchise Offering Circular ("UFOC"). The UFOC was similar in content and structure to the Franchise Disclosure Document that franchisors are now legally required to give prospective franchisees.

After operating a store for little more than a year, Mr. Hailemariam closed it down due to financial difficulties. 'In August 2009, Mr. Hailemariam sued Big O in California state court alleging that the franchisor fraudulently induced him into purchasing a franchise.

Specifically, the franchisee alleged that Big O:

(1) told him (falsely) that he did not need experience to operate a tire store;

(2) provided exaggerated earnings claims;

(3) concealed from him that many of its franchisees had failed;

(4) told him that it would sell him tires at competitive prices, when the same tires were often available for less money from other sources;

(5) falsely stated that it develops new products and services; and

(6) had expertise in locating and outfitting stores.

Big O moved for summary judgment on the franchisee's claims. Based on a Colorado choice-of-law provision in the franchise agreement, the trial court held that Colorado law (and not California law) applied.

Reasonable Reliance

Under Colorado law, the Court said that a plaintiff claiming that he was defrauded must be able to show that he reasonably relied on the defendant's misrepresentation (or on the material facts that the defendant purposefully concealed).

Courts in Colorado apply the concept of "inquiry notice" when considering whether a plaintiff's reliance on alleged fraudulent statements was reasonable.

Quoting the Colorado Supreme Court, the Court summarized the doctrine as follows:

[W]hatever is notice enough to excite attention, and put the party upon his guard, and call for inquiry, is notice of everything to which such inquiry might have led. . . .

When a person has sufficient information to lead him to a fact, he shall be deemed conversant of it. . . . . The presumption is that, if the party affected by any fraudulent transaction or management might, with ordinary care and attention, have reasonably detected it, he reasonably had actual knowledge of it.

[As a result] [w]here the means of knowledge are at hand and equally available to both parties, and the subject of purchase is alike open to their inspection, if the purchaser does not avail himself of these means and opportunities, he will not be heard to say that he has been deceived by the vendor's representations.

Quoting Cherrington v. Woods 290 P.2d 226, 228 (Colo. 1955).

In other words, a person who receives a franchise disclosure document is supposed to read it. If he doesn't read the document, he can't later complain that he didn't know what was in it when he signed the franchise agreement. Moreover, if there was enough information in the disclosure document to allow the person to investigate the truth of the other party's claims, he can't later complain if he failed to do so.

The Franchisee's Fraud Claims

The Court held that statements made in the UFOC received by Mr. Hailemariam before he bought his Big O Tires franchise should be considered when determining whether he had access to those facts. Applying Colorado law to the facts, the Court examined each of the franchisee's fraud claims.

1. Exaggerated Earnings Claims

Regarding Mr. Hailemariam's claim that Big O exaggerated earnings claims in Item 19 of the UFOC, the Court examined Big O's UFOC, which stated: "BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER."

Big O also pointed to the actual language of Item 19, which included data from 211 stores. The data from the 211 stores supported Big O's own estimate of the average sales per store.

In Item 19 of the UFOC, Big O stated that it would provide substantiation for the data upon the franchisee's request, and stated that a franchisee should conduct an independent investigation of the information by contacting existing and former franchisees of the system that were listed in Item 20 of the UFOC.

But Mr. Hailemariam did neither of those things, and the Court found it significant that he failed to make those inquiries.

2. Concealing Failed Franchises

Regarding the franchisee's claim that Big O concealed from him the failure rate of its franchisees, Big O again pointed out that Item 20 of the UFOC contradicted Mr. Hailemariam's claim.

Specifically, Big O showed that the UFOC specifically listed the number of transferred, cancelled, and terminated franchises during the periods specified in the UFOC - and that if Mr. Hailemariam had bothered to read the UFOC, he would have known exactly what the failure rate was.

3. Tire Sale Prices

Turning to the allegation that Big O misrepresented to Mr. Hailemariam that it would sell him tires at competitive prices, Big O again referred to the UFOC. Big O argued, and the Court found it significant that, Big O did not guarantee any specific supply of tires, and the franchise agreement did not contain any provision obligating Big O to supply tires to franchisees at competitive prices.

What the franchise agreement did say is that Big O was only required to provide tires to franchisees "to the extent available," and that Big O could set the recommended prices for the tires.

So again, the clear language of the UFOC rebutted Mr. Hailemariam's claims.

4. Store Location

Mr. Hailemariam claimed that Big O misrepresented that it had certain expertise in locating and outfitting stores, when in actuality the site he selected with Big O was not a profitable or good location. In response, Big O noted that the UFOC specifically told Mr. Hailemariam that the "final decision" regarding a store's location was left to him, and that Big O disclaimed any liability for that decision.

Because the UFOC stated that selection of a location was entirely the franchisee's responsibility, and not Big O's, the Court gave no credence to that claim, either.

5. Need For Experience

Considering Mr. Hailemariam's claim that Big O (falsely) told him that a franchisee did not need experience in the tire business, the Court found it significant that the UFOC contained this disclaimer:

BIG O DOES NOT GUARANTEE THE SUCCESS OR PROFITABILITY OF YOUR STORE IN ANY MANNER.

Mr. Hailemariam acknowledged this disclaimer in his Franchise Agreement, which the Court found significant in overcoming the fraud claim.

Failure To Read The UFOC

With regard to all of the franchisee's fraud claims, the Court found it significant that, on the cover page of the UFOC, Mr. Hailemariam was admonished to read the circular carefully and show it to an accountant. The franchisee admitted that he did neither.

The franchisee's failure to read the UFOC was especially significant because he negotiated with Big O for three years (since 2005) before executing the franchise agreement and consulted with an attorney in obtaining the lease for his store.

Despite this long period of time - and his having sought legal counsel to obtain a lease -- he paid little attention to Big O's franchise offering circular and franchise agreement, and never sought legal advice regarding them.

Under the doctrine of inquiry notice, the Court found that Mr. Hailemariam should be charged with knowing all of the information in those franchise documents.

Last, the Court gave considerable weight to an integration clause in the franchise agreement, where the franchisee acknowledged that he was "not relying on any promises of Big O which are not contained in the Big O franchise agreement . . . [or the] accompanying Franchise Offering Circular."

Based on the disclosures, statements, and disclaimers made in Big O's franchise offering circular and franchise agreement, the Court held that Mr. Hailemariam could not have reasonably relied on any of Big O's alleged misrepresentations or concealed material facts. As a result, the Court granted summary judgment in favor of Big O and against the franchisee. The Court of Appeals affirmed the trial Court's judgment in all respects.

Lessons For Franchisees and Franchisors

If you are considering buying a franchise, this case is a warning of the importance of actually reading your Franchise Disclosure Document before you sign on the dotted line. It also illustrates the importance of hiring an experienced franchise attorney to help you understand your legal obligations before committing to a franchise.

If you are a franchisor, this case shows why it's important to have a well-written and legally compliant Franchise Disclosure Document. Big O was able to win this lawsuit because its UFOC specifically contradicted each one of the franchisee's claims.

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To read more of Matthew's articles on Franchising Law, please click here.

If you are a businessperson, sooner or later you will have to deal with a lawyer. In the franchise world, it helps - tremendously - to deal with attorneys who understand franchising and franchise law. It doesn't matter whether you are a franchisor or a franchisee; no matter which side of the transaction you happen to be on, you will want an experienced franchise attorney to be on the other side.

Surprisingly, the level of franchise law knowledge among attorneys who actually get involved in franchise transactions varies considerably. The majority of the time, lawyers who are knowledgeable in franchise law are on both sides of the transaction. But that is not always the case. Sometimes, the attorney on the other side is inexperienced, and "dabbling," in franchise law.

This is the second of a two-part piece on why attorneys who are inexperienced in franchise law can hinder a transaction, or worse, do harm to their clients. To read part one, discussing the problems that inexperienced franchisee counsel can cause for their clients, please click here.

This article explores the problem of inexperienced counsel from the point of view of the franchisor, which is using an attorney that has little or no familiarity with franchise law (or, even worse, the company is using a consultant who is not a lawyer).

Why Franchisors sometimes use Inexperienced Legal Counsel?

If a company is considering franchising its business (a "start-up" franchisor), one of the first things the company does is look for legal counsel. Finding an experienced franchise attorney is not a simple task; there are only a few hundred attorneys in the country that specialize in franchise law. A start-up franchisor may look to its local business attorney to help the company draft its franchise agreement and franchise disclosure document ("FDD"), and otherwise help the company comply with its legal obligations.

The business attorney may be tempted to do the work, instead of referring it to another lawyer. After all, form FDDs and franchise agreements are relatively easy to find, and many of them look similar to one another. But the problem is that franchise contracts and FDDs aren't "one size fits all" legal documents, and the franchise relationship isn't a typical business relationship. It is critical for attorneys who work in franchising to understand the documents they draft, the legal requirements for disclosure (both federal and state), and how the pieces of the documents need to fit together.

For example, an experienced franchise lawyer will understand the types of fees that are typically charged, and how those fees can be tailored to the client. The lawyer will know how fees can be used effectively to encourage compliance by the franchisee, and in what situations liquidated damages could be used effectively to decrease legal costs in the event of a dispute between the parties, and when those same fees should not be used. The experienced attorney will know where and how those fees must be disclosed in the FDD.

Counsel experienced in franchising will also understand the interplay between territorial protection (or territorial exclusivity) and the areas in which the franchisee will and won't be permitted to sell. Whether a franchisor offers exclusive or protected territories, and how those territories are defined, will depend on the type of franchise system, the franchisor's expansion plans, the nature of the business the franchisee will conduct, and the franchisor's internal franchise sales goals.

An attorney with little or no understanding of franchise law can inadvertently harm the client's business by failing to understand whether a protected territory even makes sense for the client and, if so, how the territory can or should be determined. Moreover, an inexperienced attorney may not understand the types of carve-outs from the scope of territorial protection that may be necessary or useful to protect the franchisor and its possible future expansion plans.

I could easily keep going - there are a multitude of areas that need to be addressed in the franchise agreement and FDD where the attorney must have a substantial background in franchising to adequately represent his or her client.

The Problems Caused by Inexperienced Franchisor Counsel

When an attorney who lacks franchise law experience drafts the start-up franchisor's FDD and franchise contracts, it can cause a number of substantial problems for the company.

First and most significantly, a poorly-drafted FDD can lead to significant liability for the franchisor. The form and content of the FDD is controlled by both federal and state law, and a franchisor can be held liable for an FDD that does not comply with those laws. A number of state laws give their regulators significant power to address franchisors' failure to comply with registration and disclosure requirements. These powers can include steep fines (that may be multiplied by each infraction or unlawful sale); the power to order a franchisor to rescind the franchise agreement of any franchisee who has been unlawfully sold a franchise; or, worst of all, the right to assess criminal penalties (including imprisonment) against the individuals who control or have decision-making power for the franchisor.

And that's just on the regulatory side. A franchisor can also face significant liability to its franchisees if it has sold them franchises without complying with federal or state law. Although the Federal Trade Commission's Franchise Rule does not give individual franchisees a private right of action against a franchisor for its failure to comply with the Rule, many state laws do create a separate cause of action that can be used by an aggrieved franchisee.

Even in the states where the franchisee does not have the right to sue based on a disclosure law violation, state common law will often provide a remedy to the franchisee through fraud claims. If the franchisee relied on a material representation made in the FDD that was false or misleading, and was reasonable in doing so, the franchisee can likely sustain a legal claim against the franchisor for that misrepresentation. Inexperienced counsel can lack the experience to provide his or her franchisor with the guidance needed to avoid inadvertently making a misrepresentation or false statement.

For example, an attorney who dabbles in franchise law may not have a full understanding of what is required of a franchisor who makes financial performance representations in Item 19 of its FDD. Without a full understanding of the guidelines for making an earnings claim, it is possible for a franchisor to make a misleading representation without intending to do so (by, for example, presenting an unreliable, misleading, or unreasonable subset or using numbers without a reasonable basis or written substantiation). This type of mistake could easily lead to significant liability for the franchisor - and, indirectly, for the dabbling attorney.

Even more troubling is the problem of franchise consultants - who are not attorneys - preparing FDDs and franchise agreements without the consultation or assistance of an experienced franchise lawyer. These individuals and companies risk substantial liability through an unauthorized practice of law claim in any jurisdiction where their documents are used.

Conclusion

These risks are not merely theoretical. There are a multitude of reported cases where a franchisor has been held liable for mistakes made in its FDD, with the imposition of significant damages. Often, liability could have been avoided with a more carefully-written FDD. Several other cases have also resulted in a lawyer or non-lawyer franchise consultant being held liable for malpractice or the unauthorized practice of law where material errors were made in the FDD that led to liability for the franchisor.

For these reasons, franchisors should avoid hiring attorneys who dabble in franchise law, and instead seek out experienced franchise counsel. Both franchisors and franchisees benefit when knowledgeable counsel is involved on both sides of the transaction.

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If you are a businessperson, sooner or later you will have to deal with a lawyer. In the franchise world, it helps - tremendously - to deal with attorneys who understand franchising and franchise law. It doesn't matter whether you are a franchisor or a franchisee; no matter which side of the transaction you happen to be on, you will want an experienced franchise attorney to be on the other side.

Surprisingly, the level of franchise law knowledge among attorneys who actually get involved in franchise transactions varies considerably. The majority of the time, lawyers who are knowledgeable in franchise law are on both sides of the transaction. But that is not always the case.

Sometimes, the attorney on the other side is inexperienced, and "dabbling," in franchise law.

This is the first of a two-part piece on why these dabbling attorneys can hinder a transaction, or worse, do harm to their clients.

This part one looks at it from the point of view of the franchisor, which is negotiating with a prospective franchise purchaser. Let's assume this prospective franchisee is the party represented by a lawyer without franchise law experience. This situation is much more common than the reverse - where it is the franchisor, and not the franchisee, that has inexperienced counsel.

Why Franchise Agreements are Different from other Business Contracts

Some, but not all, franchise agreements are negotiable. The most significant problem involving inexperienced counsel occurs when the franchisor is otherwise willing to negotiate with the prospective franchisee.

If a prospective franchisee seeks legal counsel, s/he will typically seek out that person's usual business attorney, if there is one. If the prospective franchisee doesn't have or know an attorney, that person will ask friends and family for referrals. Frequently, the referral is to a business attorney who has little or no experience in franchise law.

The business attorney may be tempted to do the work, instead of referring it to another lawyer. After all, the terms in franchise agreements look a lot like the ones you might find in other types of business contracts. But the problem is that the franchise relationship isn't a typical business relationship. It is critical for the attorneys on either side of a negotiation to understand what makes franchising different.

Specifically, franchise agreements are (on the whole) much more one-sided than other business contracts. This is for a good reason: the provisions are there (in one way or another) to protect the health and integrity of the system as a whole, including its intellectual property and goodwill. Protecting the system is paramount, because if the system fails, all of its franchisees lose.

An attorney representing either side of the franchise transaction needs to understand this basic truth at the core of franchising. When s/he has experience in franchise law, counsel will understand which provisions are typical or atypical. They will also understand which terms may be negotiable and whether, taken as a whole, the franchise contract is more or less one-sided than is typical for those agreements. Having this experience will make the negotiation more productive and efficient. A more efficient negotiation will typically result in lower attorney fees.

The Frustrations of Dealing with Inexperienced Franchisee Counsel

You might think that the franchisor would benefit if the lawyer on the other side is inexperienced. I can assure you that is not the case.

Here's the problem: when a franchisor is negotiating with a prospective franchisee's counsel, that attorney's lack of franchise law experience frustrates and needlessly complicates the process. Because the lawyer for the prospect doesn't understand franchising, s/he may try to negotiate items that simply can't be negotiated from a system protection perspective.

Again, the provisions in a franchise agreement are there to protect the system as a whole. An attorney who understands franchise law gets this, and will instead turn his/her attention to the contract terms that a franchisor may be willing to negotiate. The dabbling attorney, on the other hand, will often try to change these critical terms.

Here is how things usually shake out in those negotiations. The prospective franchisee's counsel issues a 30-page memo outlining each and every provision of the franchise agreement that s/he wants to have changed. Or even worse, the attorney submits a redlined version of the entire contract containing his or her requested changes or revisions to the contract, which are usually voluminous.

The franchisor is likely to give one of two responses in that situation, and neither of them is good for the prospective franchisee.

1. Refusal to negotiate

The franchisor's first possible response to the attorney's negotiating position is to simply refuse to negotiate, at all. A franchisor will react this way when it is overwhelmed and frustrated by the number of requests, which the company believes seek to change key provisions of the contract.

The franchisee is then presented with a choice: (1) walk away from the deal entirely, and lose out on what may have been a good business opportunity; or (2) accept the entire franchise agreement as written, without any changes, thereby missing the chance to negotiate for some critical changes. In either case, the inexperienced attorney did his/her client a disservice by impeding the deal. This is frustrating to both sides.

2. Agreeing to limited changes

The franchisor's second possible response to the attorney's negotiating position is to agree to some, but not all, of the proposed changes. Obviously, this is better for the prospective franchisee than under the first scenario. But even in this situation, inexperienced counsel can be an impediment to the prospective franchisee.

This is when experience really matters: an attorney who understands franchising will also know which provisions are worth negotiating, and which are not. The experienced attorney will know when the franchisor can be pushed, and when it cannot. As a result, the selection of specific provisions that are the subject of any negotiation becomes critically important.

In other words, the "shotgun" approach to negotiation -- asking for everything under the sun -- lacks focus. And it's this lack of focus that can result in a less effective negotiation process, when the different / changed provisions are not the ones that can make the biggest difference for the client. By taking the unfocused approach, the dabbling franchise attorney misses the opportunity to conduct an effective negotiation for his or her client.

Conclusion

When franchise contracts are negotiable, an attorney who dabbles in the area, lacking experience in franchising, can frustrate or impede the process. For this reason, franchisors tend to prefer that their prospective franchisees hire experienced franchise counsel, and those prospective franchise buyers should seek out lawyers who understand franchising. Plus, hiring an experienced franchise lawyer will typically save money, because the knowledgeable attorney will be more efficient than the dabbler.

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A recent decision from a federal court in California addresses the enforceability of a general release of claims signed by former franchisees. Quick tutorial: a "general release" is a document where the signing party (releasor) agrees to relinquish the right to enforce or pursue any and all legal claims against the non-signing party (releasee). While general releases in the franchise context are usually unilateral (given by the franchisee, or former franchisee, to the franchisor), they can be and sometimes are mutual.

The court decision deals with Grayson and McKenzie, who are former franchisees of 7-Eleven, Inc. Grayson and McKenzie are also the name plaintiffs in a class action lawsuit they filed against 7-Eleven relating to 7-Eleven's collection of a federal excise tax on pre-paid telephone cards they and other franchisees sold at their respective stores.

When those cards were sold, 7-Eleven collected excise taxes from the plaintiffs, and paid those taxes to the federal government.

In 2006, the federal government stopped collecting excise taxes on pre-paid phone cards. The government authorized a one-time refund of the tax for payments made between March 2003 and July 2006.

The federal government made refund payments to 7-Eleven for millions of dollars, but the franchisees in the lawsuit alleged that 7-Eleven did not return any portion of the payments to them, even though those franchisees believed they were entitled to a 50% share of the refunded money.

The reason the franchisees believed they were entitled to a portion of the tax refunds was because of the way the 7-Eleven system is structured. While most franchise systems are designed so that the franchisee will pay the franchisor a royalty fee (as well as other fees) based on the franchisee's gross sales, 7-Eleven's system is built differently.

In the 7-Eleven system, 7-Eleven and the franchisee will split the store's gross profit as well as the operating expenses.

Based on the "share and share alike" operating structure, the plaintiffs in the lawsuit alleged that they were entitled to a 50% pro rata share of the excise tax refunds received by 7-Eleven. The franchisees sued 7-Eleven for: (1) conversion; (2) money had and received; and (3) breach of implied contract.

7-Eleven moved for summary judgment on Grayson and McKenzie's claims, asking the court to dispose of the franchisees' claims. 7-Eleven based its request on general releases that the franchisees had each signed in 2004 and 2005, respectively, when they terminated their franchise agreements with the company.

In response, Plaintiffs argued that California Civil Code Sec. 1668 prevents the releases from excusing 7-Eleven from liability. That section states:

All contracts which have for their object, directly or indirectly, to exempt any one from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.

In essence, the franchisees argued that their general releases could not be used to dispose of their legal claims because 7-Eleven had engaged in intentional wrongdoing, and that California law does not permit 7-Eleven to obtain a release of those types of claims from the franchisees.

The Court began its analysis by recognizing the rule that "generally, California Civil Code Section 1668 invalidates contracts that purport to exempt an individual or entity from liability for future intentional wrongs, gross negligence, and violations of the law."

As to the franchisees' conversion claim, the Court stated that "[a]bsent a public interest, section 1668 does not invalidate a release from simple negligence or strict liability claims." The Court found that conversion is a strict liability tort, and because there is no "public interest" involved in a franchisee-franchisor relationship, the conversion claim was released by the franchisees.

As to the second claim, money had and received, the Court found that the essence of the claim does not require a plaintiff to show that the other party engaged in either gross negligence or intentional wrongdoing. As a result, the Court found that claim to be released as well.

Turning to the final claim, breach of implied contract, the Court found that the claim did not involve an intentional tort (which is the type of action that California law protects against), and that it was therefore also released by the franchisees.

Based on the foregoing, the Court held that the releases signed by Grayson and McKenzie released 7-Eleven from each of the claims asserted by them, and entered summary judgment in favor of 7-Eleven.

This case is a good reminder to franchisors of the value of obtaining a general release from a franchisee when it is possible (and legally permissible) to do so. A typical franchise agreement will require a franchisee to provide a general release upon the franchisee's sale of the business, or upon renewal. A prudent franchisor will be sure to collect a general release upon the occurrence of either event.

To franchisees, the decision is instructive. General releases, legitimately obtained, are enforceable in most circumstances and will usually result in nullifying any legal claims that may exist against the franchisor.

As a result, it's important to understand these documents -- and the requirement in most franchise agreements that they be signed under certain circumstances -- before entering into a franchise relationship.

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