Recently by Michael Webster

You are a young cartoon writer, starting your career after returning from World War II.

You don't know it, but you are going to gross over 1 billion dollars from your cartoons, during the next 1/2 century.

You start off with a fight with the syndicate, and cannot get this satirical cartoon printed.

So, over the next 50 years, you get even by publishing every Thanksgiving the famous gag between Lucy and Charlie Brown.

Now, everyone knows who you were really satirizing, in 1951.

Not much has changed, sorry to report.

This is well known negotiation game - the Confidential Information Game.

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Rory Sutherland tries to explain the unilateral gift giving on Valentine's day as a show of commitment.

Do you think he succeeds?

"Do this for me, which I like and you hate, to prove your commitment." says the women to the man.

This article is about how to create a modern franchise owner's group.  An owner's group that benefits the brand, maintains and enhances franchise owner's equity & is not born after a bitter legal struggle.

A modern franchise owner's group is required in all franchise systems - especially when the franchisor seeks both the benefits of controlling franchisees as if employees, but resiles from the legal and tax liabililty that attaches to such control.

The Coverall case illustrates the disaster which befalls a franchisor who becomes - in the eyes of the state- an employer. It provides a good case study of what a  modern franchise owner's group can do to benefit the franchise system.

Coverall required its franchisees to perform cleaning for the franchisee's customer, but have that customer pay Coverall directly for the job. Coverall would then remit to the franchisee payment, less deductions for royalties and other charges.

Not surprisingly, the arrangement caught the eye of the Attorney General in Massachusetts. It looked liked an employer/employee relationship with the employer making illegal deductions from the employees salary. [The case is currently under appeal, but the finding of an employer/employee relationship looks not to be overturned, and the penalties for wrongly treating employees as franchisees are increasing.]

It is not hard to imagine that there is a beneficial reason for centralized billing that is also in the franchisee's self interest. Cleaning crews are composed from an irregular work force. Relability is not easy to maintain, so a centralized billing scheme may provide better customer service. The customer can pay in advance knowing that the payments for substandard jobs will be refunded. A simple cleaning crew could not achieve this reputation.

The reason is simple. The cleaning crew I employ today and pay at the end of the day may not be the crew I have to dock pay for a job poorly done but discovered tomorrow.

Centralized billing is a reputational device, functioning in a manner similar to a cash register. The customer makes the payment directly to Coverall, and if the work is satisfactory, the payment is sent to the local operator. Because the customer no longer cares if the local operator can refund the substandard cleaning jobs -their relationship is with Coverall- the local operator has a reputational advantage over even the same crew operating outside the franchise system.

In summary, each party, franchisor and franchisee, would like the benefit of centralized billing, but the franchisor dare not provide it. There exists a gap between services needed by the system and what can be legitimately provided by the franchisor - the services/goods gap. The services/goods gap follows directly from the fact that the franchisor is not an employer of its franchisees.

The services/goods gap is what provides the the economic imperative for the  modern franchise owner's group - it can create the benefit as a condition of membership. More accurately, the  modern franchise owner's group can serve as a catalyst by creating a critical mass or tipping points for providers of services/goods to the franchise community.

In the Coverall case, their franchisee advisory council, or if they had an independent franchisee association, could have taken on the role of communicating, educating, and advocating the benefits to the franchise owners of having an neutral, trusted third party to do the invoicing, remittance, and customer service.

The communication, education and advocacy by the  modern franchise owner's group for the voluntary benefit stands in contrast to Coverall's risky decision to require the delivery of the benefit by contract.

It is of course possible that the  modern franchise owner's group proves not to be capable of being such a catalyst, and the effort fizzles without reaching critical mass.

But imagine the benefits to the system once even a small effort is successful - perhaps two or three vendors are selected to provide both billing and customer service. (The franchisor would retain control over the standards that these service providers would have to meet, but would not have a contract with them.)

Franchise owners using this reputational device get more cleaning jobs, while others would flounder. It becomes in the franchise owners self interest to join the invoicing network. As more join, the network begins to fund more communication, education, and advocacy about the benefit - which causes or drives more owners to join, bringing about increased funding.

(This mechanism is similar to how many QSR independent franchisee trade associations tax their members to fund the association's convention. The beverage company in the QSR may put aside, say 1/2 cent per gallon of syrup ordered, and remit the collected amount back to the association.)

Virtually, any  modern franchise owner's group can be started or grown in this manner.

1. Find a mission critical service or good required by the franchisor which cannot be provided by the franchisor because of legal problems.

2. Pick one or more platforms which can deliver these services or goods to franchisees.

3. Pick the right catalyst or catalyst methods which set in motion a critical mass - communicate, educate, advocate and self fund.

4. If the project enjoys systemic acceptance, then consider collaborating with the franchisor on standards for such service providers.

Each step depends upon the actual system, and there is room for all sorts of things to go wrong. But, this is a good blue print for any new franchisee association who wishes to grow and contribute to the brand's overall success in the marketplace.

The relationship between a franchisee and its employees is a now massive headache for the franchisor. 

The reason is simple: Joint Employer status.

If the franchisor overreaches and actively controls the employee relationship between franchisee and it's employee, then the franchisor might be liable under the legal theory of joint employer.

 "In Myers v. Garfield & Johnson Enterprises, Inc., et al., 2010 U.S. Dist. LEXIS 3468 (E.D. Pa. January 14, 2010), a federal district court in Pennsylvania held that defendant Jackson Hewitt, Inc., the franchisor of co-defendant Garfield & Johnson, was potentially liable under Title VII of the Civil Rights Act of 1964for sexual harassment allegedly committed by Garfield & Johnson managers. 

Rejecting the franchisor's motion to dismiss for failure to state a claim, the court held that plaintiff's joint-liability theory was plausible enough to proceed to discovery. 

 

What is particularly bracing about the court's analysis is its recognition that these factors could trigger potential employer liability for the franchisor even though they were, in many cases, typical of the control exercised in any franchisor/franchisee relationship. 

 

The court said that if the standards for control and authority derived from common law principles for application in the Title VII context were met, the fact that they arose between a franchisor and franchisee and reflected the type of control that almost all franchisors exercise would not insulate the franchisor from liability.

 

Because the joint employer and agency tests involve multiple considerations with no single factor dispositive, it is not clear that any single contractual or operational step (short of drastically limiting the degree of control over franchisee operations that most franchisorsfeel is essential) could foreclose the potential for liability under this court's view of the law. 

 

Taking the decision at face value, it could be argued that, under Myers, franchisors find themselves between a rock and a hard place: 

 

The more closely they monitor franchisee employment practices, the greater the risk of their being subject to Title VII liability for the franchisee's wrongful behavior.

 

If they eschew monitoring of that behavior, they may be subject to Title VII liability anyway under other elements of the applicable tests, and will not be in a position effectively to regulate conduct that could result in statutory violations. 

 

On the other hand, if they do monitor the behavior and then take draconian measures in response to franchisee violations, they may trigger liability under state dealership or franchise protection statutes."

Connie Gentry of FSR has written a short blurb on the popular Maryland franchise The Green Turtle Sports Bar & Grille.

It is not clear whether this is an advertorial, a press release, or simply a small news piece.  It matters because if this was an advertorial, it would have to comply with the FTC's Rules on Testimonials and Endorsements.

It is further unclear as to what the * is supposed to refer to - I expect the author thought that this was sufficient notice that some disclaimer was being made about these numbers.  But no such disclaimer was in the article.

Since, it was not clear what reliance one could reasonably place on these AUV's, I decided to get the Green Turtle's 2012 FDD and look at the Item 19, directly.

This is the middle of 2013, and the 2012 Item 19 was calculated for the end of 2011, we do need to get some up to date data if we were going to make a buying decision.

But, instead I want to highlight something I have seen a number of times.

First, this is a gross sales only Item 19.  There is not enough data here to make a reliable cash on cash return estimate - important basic costs line rent, cost of goods solds, and labor are not disclosed.

Second, and I have seen this a number of times, is the insertion of a median annual gross sales.  In this case, 11 locations  had gross sales above the median and 11 had gross sales below the median.

The natural question is:  what was the average gross sales for the 11 locations under the median?  Could be $500k, $1million, or even up to $2.24million. Makes a big difference.

But, we don't get any more useful data - just some disclaimers.

So, what you should you do?  After all, it is important to know what the gross sales of those units below the median.

It is a flip of the coin whether your location will be above or below the median.

The answer is to ask: ask for the back-up, look at those 11 units and calculate yourself their average gross sales.  Because if you don't ask, nobody is going to tell you.

One of the important findings in behavioral economics is the discovery of "anchoring".  Anchoring is responsible many poor financial decisions and this is how it works in franchise sales.

Science has discovered that when we are presented with an estimate or percentage measure from a population that we know nothing about, we tend to anchor on the estimate and act as if it was true -even though we understand that we have no real knowledge.

Here is an example, from a QSR interview and Teriyaki Madness, which states how much you can make with Teriyaki Madness.

"He says that not only are potential franchisees attracted to the impressive numbers operators are pulling off--including an average 23 percent same-store sales increase; AUVs of $855,000; and profitability of 16-21 percent--but also to the uniqueness of the concept, which combines Asian flavors with healthy items."

Now you and I have no idea whether the AUV is correct, what the average is based upon, or how "profitability" was calculated.  However, the science says that you will anchor on these numbers and act is if they were true - despite not knowing what the Item 19 actually stated.

You will also notice that this claim made in an interview could not be compliant if it were an ad - the required disclaimer about how many units achieved that AUV is not present.  QSR can make this claim on behalf of Teriyaki Madness only if the interview is not a paid advertorial.

So for fun, let's take a look at the numbers behind the claim.

This is from Terriyaki Madnesses' 2012 FDD - and things could have changed by then.  Even so, the real numbers are revealing.

Teriyaki Madness Item 19 (2012)

We have provided the following information: the high and low annual gross revenue information for each year that the franchised locations were open; the average same store sales percentage increases for each year; the average unit volume of the group for each year; and the  number and percentages of franchisees that met or exceeded the average unit volume for each year.

For 2011, four (4) Teriyaki Madness restaurants were in operation for the entire year and for the years 2008 to 2010 only three (3) Teriyaki Madness restaurants were open for the entire year.

The financial picture disclosed in the Item 19 looks very different from the rosy picture described in the QSR article.  We find out that we have reporting only from 4 units, and two of those units had an AUV between $380,000  and $615,000 for the three years 2008-2010.

A new store would likely face a similar ramp up period.

Even the reported high is less than the AUV reported in the QSR story, compare $796,000 to an AUV of $855,000.

Further, the profitability story is taken not from a franchisee store but a company or affiliate store.

All of the reporting is designed in the writers minds to paint the glossiest story that he or she can tell - but, a smart reader like you knows to go beyond the anchoring effect, read for youself the Item 19, request the back-up for the Item 19,  and then come to a more realistic conclusion.

To Read more of Michael Webster's articles, Please Click Here.

The information provided to franchisee candidates is meant to be read, understood and acted upon.

Some franchise sales processes are designed to run around this information, minimize its import or in some cases to blatantly contradict this information.

Consider this marketing piece put out for Mooyah Burgers.

The advertising clearly states & makes a financial performance claim: 2 to 1 sales/investment ratio.  

Now, let's check what the franchisor actually says in their FDD. 

Item 19 from Mooyah Burgers 2013 FDD

The FTC's Franchise Rule permits a franchisor to provide information about the actual or potential financial performance of its franchisedand/or franchisor-owned outlets, if there is a reasonable basis for the information, and the information is included in the disclosure document.

Financial performance information that differs from that included in ftem 19 may be given only if:

(1) a franchisor provides the actual records of an existing outlet you are considering buying; or

(2) a franchisor supplements the information provided in this ftem 19, for example, by providing information about  performance at a particular location or under particular circumstances.

This franchisor does not make any representations about a franchisee's future financial  performance or the past financial performance of company-owned or franchised outlets.

We also do not authorize our employees or representatives to make any such representations either orally or in writing.

If you are purchasing an existing outlet, however, we may provide you with the actual records of that outlet.

If you receive any other financial performance information or projections of your future income, 

you  should report it to the franchisor's management by contacting Michael Mabry or our Franchise Sales  Department at:

6100 Preston Road.

5212 Tennvson Parkwav Suite 240.

Frisco 120.

Piano. Texas

7503475024 or f2141 872 4313 310-0768.

the Federal Trade Commission, and the appropriate state regulatory agencies.

This is a clear case in which the sales process & the marketing materials are at odds with the 2013 Franchise Disclosure Document.  The presentation of this contradictory information likely harms the franchisor's sales process.

The  SB 610 Fair Franchisee Bill passed via a 5 to 2 vote yesterday at Senate Judiciary Committee.

It is will now go the Senate floor for full Senate vote.  If it passes, then it must pass the Assembly and be signed into law by the Governor.

"This bill would modify the California Franchise Relations Act (CFRA) to enhance the protections for and rights of franchisees in the performance and enforcement of the franchise agreement. 

As noted in the Background, the CFRA governs the ongoing relationships between franchisors (including subfranchisors) andfranchisees to generally prevent unfair practices in the termination, renewal, or transfer of a franchise.

Consistent with the general goal of the CFRA, this bill would require franchisors, subfranchisors and franchisees to deal with each other in good faith in the performance and enforcement of the franchise agreement. The bill would define good faith for these purposes to mean honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade.

A franchisor or subfranchisor who violates this provision could be sued by the franchisee for specified damages.

In opposition to the bill, a coalition comprised of the International Franchise Association, California Chamber of Commerce, Civil Justice Association of California, California Grocers Association, and California Retailers Association, raise concerns with the good faith requirement, arguing that it is an "amorphous term . . . to be applied to the franchisor in its relationship with the franchisee.

The concept of 'good faith' was created in the Uniform Commercial Code to fill in the blankson short form contracts for the sale of goods. However, it provides no benefit in the context of detailed franchise contracts which govern complex and ongoing business relationships."

In response, co-sponsor American Association of Franchisees and Dealers states that "modern franchise relationships are most always governed by one-sided 'take it or leave it' adhesion contracts that elicit substantial monetary investment from franchise owners, provide substantial protection for 
franchisors, but severely limit a franchisee's rights in the franchise relationship.

Creating a statutory affirmative duty of good faith in franchise relationships will inhibit the enforcement of one-sided franchise agreements in an abusive 
manner."  (Other details of the California Bill, click here.)

The British Columbia Law Institute (BCLI) has an announcement, relevant to all those in the franchise industry, with special focus on the legal profession.

British Columbia does not have franchise legislation, being one of the last provinces in Canada to look at the problem. Here is the announcement.

"The British Columbia Law Institute (BCLI) has begun a new project on franchise legislation for British Columbia. The project will examine whether there is a need for franchise legislation in British Columbia and, if so, what features it should have.

There is typically an inequality in bargaining power between franchisees and franchisors in negotiating complex legal agreements, with franchisees at a significant disadvantage in terms of disclosure of information and control of business decisions.

"Unlike some other provinces in Canada, BC does not have any legislation to regulate franchises and provide legal protections for franchisees," noted BCLI executive director Jim Emmerton. "Through this project we hope to address this concern by reviewing the Uniform Franchises Act and making recommendations on whether this Act is an appropriate model for BC".

Key features of the Uniform Franchises Act, a prototype statute developed by the Uniform Law Conference of Canada, are provisions dealing with disclosure, the duty of fair dealing, rights to rescission, damages for misrepresentation, and dispute resolution.

BCLI aims to promote and contribute extensively to an informed discussion on the question of franchise regulation in BC. BCLI will publish a consultation paper with tentative recommendations, which will be used to consult broadly with the public. BCLI will then produce a report with final recommendations and draft legislation. A backgrounder on the project is available on the BCLI website

BCLI strives to be a leader in law reform by carrying out the best in scholarly law reform research and writing and the best in outreach relating to law reform."

For Further Information, Please Contact:

Greg Blue, Q.C., Senior Staff Lawyer
British Columbia Law Institute
Email: [email protected]
Tel: (604) 827-5337

YUM! and its irrepressible CEO David Novak have set sail from the shores of America to find fame and fortune overseas.

I hope that they have taken several copies of Andrew Hupert's admirable book on negotiating with the Chinese, The Fragile Bridge: Conflict Management in Chinese Business.

Here are 3 lessons Novak and his team are going to have to learn, especially when the first bird flu wipes out 1/2 the intangible value associated with KFC in China.

1. Conflict is seen differently.

Hupert claims:  "The Chinese will tell you that harmony is the way to go and that disputes are unnecessary - and they may well believe it. Conflict, however, actually serves an important role in relationship-oriented Chinese business.

It is often the fastest and most efficient way of terminating a partnership that is not paying off or has already served its purpose."

"Already served its purpose."  

Think about that, for one moment.  YUM! is expanding to China, a country with a long memory of having been disrespected and ill-used by foreign devils.  YUM! is bringing to China a trademark, some proprietary equipment, and a marketing fund.

How long will it be before their Chinese partners decide that the association with YUM! brands is no longer worth the royalty payment - precisely because they have copied everything of value?

And how will their Chinese partner achieve this?  

Hupert states: "While neither Chinese law nor tradition give the weaker side too many options, the local partner will resort to a tried and true method for disposing of a partner that is no longer needed.

All they have to do is start a fight and let it spin out of control. They lose face, their culture is insulted, and traditions are disrespected - all due to the arrogance and ignorance of the Western side."

They must walk away from the arrogant Western partner.

2.  The long term relationship may be over quickly.   

Hubert claims: "Westerners are frequently surprised at how often Chinese negotiators seem to destroy value by scuttling the potential for a long-term relationship. [However], it may be that the Chinese have already met their objectives when they learned about your business model or new product design. To them, there is no conflict to be resolved. They never planned to follow through with the deal in the first place."

YUM! is going to turn over confidential information to its Chinese business partners.  But, why should those partners having seen how to fry chicken 8 pots at a time care to carry the YUM! brand and pay royalties for a 20 year term?  YUM! turns over confidential its information; what else can the Chinese do, but use it to put YUM! out of business.  

Anything else would not be fair.

3.  IP wants to be free in China.  

"The Chinese are always trying to help foreigners by showing them how they can turn their ideas (which are supposed to be free) into products (which can be sold).

Westerners are always trying to outsource production (which is cheap) so they can focus on marketing, IP and services (which are expensive).

The Chinese think that making use of other people's IP is a common sense shortcut to success.

Obviously, you don't - and this is a major source of dispute and hostility."

Hupert is making a straightfoward cultural observation.  Not every country treats the same ideas as a source of intellectual property to be protected by laws and enforced by the state.  

The formation of intellectual property law in the US and Britain was a reaction to the secretive trade guilds who refused to publish their trade secrets to outsiders.  

You don't have the same history of trade guilds in China, and so there is a completely legitimate basis for their attitude to "borrowing" IP.

May YUM! live in interesting times.

California is rightly the envy of all for its commitment to public education, consumer protection and sophisticated agribusiness.

However, the current legal franchise model allows franchisors to either deliberately or inadvertently skirt their civic responsibilities.

First, Franchising needs to return to its roots, in which the franchisor set quality control standards for a reason and not just to trap the franchisee into paying for high fees to the preferred suppliers, who then kickback  money to the franchisors.

The standards which protect the food supply chain are too important to leave to the federal government to enforce.  We need the unintended good consequences of brands maintaining quality control and funding the appropriate training and education.  

We don't need, however, a kickback economy.

Second, the current legal franchise model has an unbalanced picture when it comes to information: there is no legal balance between what the franchisor markets the benefits of the system and what the franchisor is contractually obligated to perform.

Private Brand Standards and Public Safety

To understand the first benefit of Bill AB 2305, we have to return to 1950-1970, when McDonald's enforcement of private brand standards were of assistance to the public good and helped maintained a safe food supply chain.

Ray Kroc's franchise model - complete with Hamburger University and passing on volume pricing rebates to the operators- had quality control standard which had a beneficial and unintended good consequence. Kroc's enforcement of private standards produced a safer food supply chain for the public. Sadly, Kroc's vision is not upheld by many modern franchisors.

To see how Kroc's system worked, we have to pay attention to some details.

In the 1970's, Kroc and McDonald's set quality control standards and operating standards. But, the operators purchased food from local sources.

Here is just one clever example of how the private brand's standards had a public benefit. Kroc shipped hamburger buns in package containing enough to make 100 hamburgers. The operating standard was that an operator should go through 100 patties for each package of buns. If the operator went through more, say 110 patties, then:

"Either his meat man was shorting him or someone else was stealing from him."

A meat man who would cheat on weights and measurements is a risk to public safety.  Kroc would have the meat man dead to rights, if he was found to be cheating.  

Today, we have more difficult contamination problems to detect and solve.

But, today many brands set standards for a different reason.  They require the operators to purchase from preferred vendors. Many of these preferred vendors are simply competing on cost - how much money they can rebate to the franchisor? There is no legal requirement for the vendors to compete on value and safety.

To understand why the modern franchise standards don't produce a public good, we have to understand how legal kickbacks work in the franchise industry.

Current Brands - The Kickback Problem

The franchisors you hear from today will tell you how strong their standards are. But, what they will not tell you is is the reason for these strong standards.

Many franchisors have used the current legal model to primarily obtain kickbacks or commercial bribes from their suppliers. The franchisor mandates that the franchisees purchase supplies, at an artificially high price.  The supplier then splits all or some of this extra price with the franchisor. This is perfectly legal as long as it is adequately disclosed.

The franchisor may elect, and many do, to report these kickbacks as essentially royalty income on their intellectual property and transfer the money out of state without paying California state income tax.

But, you will rightly feel uncomfortable with this arrangement, whether or not legal. Kroc was appalled by it.

A supplier who was being richly reward by his business relationship asked Kroc what he might like in return.

"Let's get this straight. I want nothing from you but a good [safe] product. Don't wine me. Don't dine me. If there are cost breaks, pass them on to the operators."

Promises to the Small Business Operator and Consumer

The second benefit of Bill AB 2305 is to protect the consumer, the consumer of information seeking to purchase a franchise. If the brand markets to prospective purchasers by making promises about volume rebates, quality standards, or continuous training, then their legal obligations in the franchise contract will have to match these promises.

Currently, most brands are only contractually required to provide sufficient training to open a location.

Further, the brands are only required to disclose somewhere in the fine print of a 500 page plus "Disclosure" document in legalese that the operator can only expect sufficient training to open a location and there are no price discounts.

But, of course these truths make hard marketing. Bill AB 2305 simply requires the brands balance their marketing hype with what the franchise document delivers by not allowing the brands to disclaim or ignore its marketing promises by disclaiming them in the franchise agreement.

The Benefits of Balance

A return to a balance in which quality standards are used to strengthen a brand, and indirectly contribute to public safety, franchisors who live up to their marketing promises will protect the small business operator and consumer.  We can do no better to reflect upon Kroc's view of franchising.

"We are an organization of small business [operators].  As long as we give them a square deal and help them make money, we will be amply rewarded."

Bill AB 2305 provides that square deal for franchisees, and the franchisors, consumers and public will be amply rewarded by its passage.

Californians need jobs.  Franchising has historically provided those jobs in the hotel, restaurant and service industry. Without a change which rewards franchisees as owners, risk capital will not be attracted to California. California will lose out on job creation, and its budget woes will be worsened if the Level Playing Field for Small Business Act of 2012 is not passed, Bill AB 2305. 

California, the spiritual home of franchising

California and San Bernadino are the spiritual home of franchising.  In the late 50's, the McDonald brother's restaurant routinely recreated the secular miracle of feeding the hungry with a nutritious and delicious 15 cent Hamburger Meal -burger, fries and a milk-shake.

But, it took the owner of a franchised business, franchisee Ray Kroc from Chicago, to export California's golden miracle. Ray Kroc formalized the McDonald's brother's system. Ray Kroc created the scalable restaurant system - as a franchisee.

Before he bought out the McDonald's brothers, Ray was a master franchisee, a company that was granted a master license. Ray was a supply chain genius, and had an operator's understanding of what made a restaurant profitable. He was constantly challenging the supply system to scale and grow the franchise system.

In the 1950's, Ray broke every rule in his license or franchise agreement, and ended up paying a penalty of some $5 million to the McDonald brothers. He was brilliant, ungovernable, yet made many of his operators millionaires — enriching the middle class and contributing to many state's coffers.

Ray could attract a variety of operators in the 1950's and 1960's because he could legitimately offer them the prospect of real wealth. 

Passing Bill 2305 will stimulate job growth

The current franchise legal model allows the franchisor to exercise so much control over the franchisee as to be an employer. This legal model creates employees where there should be owners. This is the fairness issue is being addressed by Bill AB 2305:  the problem of too much control and not enough sharing. Such a model does not attract risk capital.

Today many franchisees are nothing more than employees who pay good cash money to obtain jobs. No serious minded entrepreneur is attracted to this business model. The growth of franchising is largely fueled by those who are seeking to buy a job.

Without AB 2305 being passed, franchising will stagnant because it will not and cannot attract the Ray Kroc's as franchisees - the operators with boots on the ground who have the experience and capital to implement systems that scale and deliver value to the consumer.

It is not merely a matter of downloading these payments to the franchisee/employees.  It is a matter of making the franchisee nothing more than an employee who pays for the right to work.

The California example, United Parcel Service franchises

The widely and rightly praised United Parcel Service Company (UPS) has used the current franchise legal model in this manner.

Prior to acquiring the franchising firm Mailboxes Etc. in San Diego, Atlanta-based UPS had a series of depots and unmanned drop-off boxes to process returns. UPS makes money when more packages are shipped, and their business model is to increase this volume.  Some packages must be returned from where they were shipped to: the part is defective, the address is wrong, or the customer has lost interest in the product.

United Parcel Service would need to recruit employees to man and manage the returns and could have done so by expanding their depots. They did not hire more employees. Instead, they acquired an existing franchise system, Mailboxes Etc. out of bankruptcy. They changed the franchise agreement, giving the franchisor more control. They put their signage in front and the public now believes that they are dealing with UPS employees.

UPS achieved their business goals: they effectively turned these franchisees into employees who will not be a payroll expense to the franchising firm. All of this is currently legal —as many court filings in California's courts show.  It was also a very shrewd business decision.

But it is time to end this overreaching and return balance and fairness to franchising.  

Franchisors avoid taxes due to California

Now, you will hear from franchisors about how important franchising is as an industry. But what you will not hear from the franchisor corporatist apologists is this secret: the current franchise legal model is detrimental to California's public interest.

The current legal model allows the franchisor, which is the company who grants a franchise license to a local business, to escape or evade paying state taxes compared to other firms trading in California.

This is how it is done. A franchisor incorporates a company in Delaware and that company owns the franchisor's trademarks and other intellectual property.  Delaware does not tax royalty payments made to the holders of intellectual property.  A franchisor funnels the royalty payments made by its California franchisees to Delaware - minimizing or sometimes eliminating the correct amount to remit to California for income tax.

This tax issue is not addressed by Bill AB 2305.  But, you need to be aware of it when the franchisor apologist  urges upon you the value of the great economic engine of franchising.  Such industry does exist - what benefit is it to California if the surplus is untaxed and moved out of state?

Proper risk and reward between franchisor and franchisee will create wealth

California, in particular Silicon Valley, creates great immediate weatlh. For that wealth to become capital, it makes sense to woo those individuals into investing into a restaurant, hotel or service franchise — creating permanent jobs in the restaurant, hotel and service industries in California.  

But the current franchise legal model is not hospitable to risk capital. Proper balance between control and reward must be restored.

Bill AB 2305 is aimed at correcting or restoring this imbalance. By returning the franchise legal model model to the correct balance, where the franchisor creates and mantains brand standards, while the franchisee executes those standards and everyone shares in the surplus value as owners, Bill AB 2305 creates a hospitable environment for operator and supply chain geniuses like Ray Kroc.

Jobs and growth will follow.

One fine day, a franchisor, a preferred vendor, and some franchisees decided to build a franchise system together.

They found many good locations and built a number of great units.

The franchisor asked the preferred vendor to divide up what they had accomplished together.

So, the preferred vendor made up three roughly equal parts and let the franchisor chose.

Angered by the vendor's lack of grace, the franchisor revoked the preferred vendor's status for cause- bankrupting the vendor and acquired all the vendor's confidential information.

After that, the franchisor told the franchisees to propose a division of all that they had accomplished together.

The franchisees put together the vastly greater part of all they had accomplished together in one pile and in the other they put only scraps. When they had prepared the two parts, they called the franchisor and invited him to choose.

The franchisor, quite delighted with this arrangement, took the vastly greater part of all they had accomplished together and said to the franchisees:

"My esteemed colleagues, who taught you to divide things up so well?"

The franchisees answered through clenched teeth:

"None other than the preferred vendor and what happened to him, sir!"

With the scraps, the franchisees rushed off, tails between their legs, to bitterly complain in some small, far off location where the franchisor could pretend not to hear them.

This fable or wisdom story dates back to what Cialdini calls the First Era of Persuasion - which ended badly for the persuaders. It is known as the fable of the Lion, the Donkey and the Fox.

Moral: A partnership with the economically powerful is untrustworthy. If you want to partner with your franchisor, create an modern Independent Franchisee Association working for all of you.

It pays to be a member, both as franchise owner and supplier.

Are you a supplier that wants to get increased exposure to franchise owners?

Do you have a product or service that solves a problem for some, even if not all, franchisees in a system?

And would it help if Franchise-Info made franchise owners more acutely aware that they have this problem?

Then, you need to market directly to franchise owners. Connect me directly on LinkedIn. Ask about "Preferred Vendor Marketing"

Franchisees have long term contracts, sometimes as long as 20 years. Franchisor executives in C suite might not last more than 5 years.

The franchisor may be sold, merged, or go into a reorganization. How does this time difference effect their views?

View this highly informative and short video and find out the difference between franchisee and franchisor time.

Steve Ellerhorst was a firm believer in the value and necessity of franchisee associations.  Steve's entire working life was spent in franchising: franchisor executive, franchisee operator and as a franchisee association leader. 

Steve, along with others in the Hardee's system, was instrumental in forming the Independent Hardee's  Franchisee Association. 

The  Independent Hardee's Franchisee Association exists today because of the foresight of Steve, his deep appreciation of the three different views and needs of the franchisee, franchisor, and supplier -and how to reconcile those needs within the business framework.

Steve was a master of finding great ideas, presenting them to the right person in the franchise system - then stepping out of the way so that person could get their necessary credit and applause.  He created the best audience for great ideas, which then got implemented because of the audience's enthusiasm.

Steve was also instrumental in the growth of a number of franchisee associations: the Meineke Dealers Association, the American Association of Franchisees and Dealers,  the Curves Association,  and the Coalition of Franchisee Associations.

Steve was also one of  the founders of the International Association of Franchisees and Dealers.

The IAFD is a testimonial to Steve Ellerhorst's grand vision of how franchisee associations exist to strengthen, help and promote the franchise brand through member benefits, communication, advocacy and education.

A great organizer, with a keen and penetrating mind peering out of a loveable soul, Steve will be dearly missed by all his family, friends,  franchisees, suppliers, and franchisors.

Please feel free to add your own remembrances of Steve in the comments section.   (You will have to register by providing your name and email.)

Memorial Notice

Beloved husband of Lisa Krummen Ellerhorst; loving father of Elizabeth 

(Matt) Yingling and Katie Ellerhorst

Loving grandfather of Micah Yingling;  dear son of Margie and the late 

Jack Ellerhorst;  dear brother of John (Julie), Dan (Lucy), Tom (Vicki), 

Scott and Patti;  dear uncle of many nieces and nephews.

Died May 30, 2011 in Indianapolis, Indiana.  Graduated from Purcell High 

School in 1975; was CEO/Executive Director at International Association 

of Franchisees and Dealers;  


Memorial service to be held Saturday, June 

4 at 11:00 am at Holy Trinity Church, 201 Clark Street, Middletown, Ohio 

45042.  

If sending flowers, please send by Friday, June 3, 2011 to Holy 

Trinity Church;  In lieu of flowers, family asks that donations be made 

to the American Cancer Society.

Steve Lubet kindly sent me his new book entitled "Lawyers' Poker: 52 Lessons that Lawyers Can Learn from Card Players", after we had a lively exchange about the:

a) the value of slow play at poker, and;

b) what trial advocacy lessons can be learned from a sophisticated analysis of poker play.

I was pleasantly surprised with well how this book worked.

My concern was that I would find two interesting books: a) one on trial advocacy, and b) another on poker analysis; and that the two parts would wear out each other like sandpaper and wood, contributing only a fine dust.

Prior to reading the book, I thought it unlikely that an analysis of poker strategies would provide insightful analogies to trial advocacy skills, skills that could not be obtained direct inspection.

What do poker players have in common with trial lawyers, anyways?

Succinctly, each has to solve the game theoretic question:

"if he knows, that I know that he knows ...".

The poker player has to solve this problem in connection with what the other players believe they know about his hand, what he believes they know about what he believes about their hands, and other various permutations.

(You could try your luck here, playing Texas Hold 'Em)

The trial lawyer has to solve this problem in connection with what the cross-examination witness believes what the lawyer knows about the facts, what the lawyer believes the cross-examination witness knows about the facts, and what the cross-examination witness believes about what the lawyer believes that the cross-examination witness knows about the facts, and other various permutations.

The poker player is at advantage since there is a set of facts which will soon be revealed: at trial, there are no sets of facts to be revealed until the Judge determines what facts there were.

If analogical explanations work, as a opposed to direct explanations, then the analogy must provide a quicker access to the problem.

One might complain, and this would be a superficial complaint, that the trial examples must be easier to understand than the poker examples because we are all potential jurors, but few of us are potential poker champions.

For example, in the beginning of the chapter on "Controlling the Opposition", Lubet describes the Johnny Cochrane gambit at the O.J. trial and the infamous glove scene and compares it with an example of "slow play".

After reading the two together, I was intially puzzled.

I understood Cochrane's move, but I really had to work hard at understanding the poker gambit.

How as a lawyer could I learn a trial advocacy point from a difficult poker problem, when I comprehended the trial example directly?

But, after working through the poker example, I realized that I had only superficially understood the trial advocacy gambit, and not appreciated all of the elements and what Christopher Draden should have been wary of.

Let me first review the poker example on slow play on pages 86 to 87, hardcover version.  

WARNING- THIS NEXT BIT IS HARD.

Lubet recounts the story of Monty, a player who played hands only on their expected value, against a fellow named Solcum, a wealthy banker's son.

They were playing 5 card draw, one hidden card and four exposed cards, with four rounds of betting.

Round 1: M: Shows 7 S: Shows 7

M bets $5

Round 2: M: Shows 7 7 S: Shows 7 A

M bets $10, S raises $20,

and M calls.

Round 3: M: Shows 7 7 5 S: Shows 7 A 10

M checks, S bets $50, and

M calls.

Round 4: M: Shows 7 7 5 Q S: Shows 7 A 10 10

S bets $100, but M raises $1500.

What would you think that if you were S and your hidden or hole card was an A, giving you the highest possible two pair?

How would you analyze what M's bet was telling you? Assume that M and S know that it is not possible for S's hole card to be a 10, since the two other tens had shown.

Think carefully.

Well, I would react, and not think, that M had picked up his queen and had queens and sevens, which would lose to my aces and tens.

I would rationalize that M bet small and didn't raise because he feared but didn't know I had an Ace, but when M hit his big cards, he beat big.

I would call the raise and rake in the pot.

And, I would lose, because M had the last 7.

I lost because I looked only at the last round of betting to see what "information" it revealed.

I probably heavily discounted the possibility that M had the last 7, and so "knew" I had a lock. (In case it isn't obvious, I am dead poor average player in a good game.)

What did the betting in round 2 show, given that M only plays on with hands that he has an advantage with?

If S knew that M knew that S's hole card was an A, should S believe that M would fold? Yes.

And M didn't fold or bark in the night.

Therefore, M had a hand that beat a pair of Aces, in round 2.

The only hand possible was three sevens.

But would you have been disciplined enough to fold your hidden pair of Aces? Not me.

Turn to the trial problem. Should have Christopher Draden known that Johnny Cochrane knew that glove wasn't going to fit?

Don't know - but the point of the poker example, having worked it through, is this: did Christopher Draden ever stop to question whether Johnny Cochrane could know that the glove wasn't going to fit?

Not such a stretch, when you ask the question. What did Cochran know about the glove, given his daily interactions with accused? Darden should have stopped to think about the relative asymmetry in knowledge, made a few deductions, before forcing the play on.

That knowledge is worth the price of buying the book, Lawyers' Poker: 52 Lessons that Lawyers Can Learn from Card Players

"The state franchise registration process, virtually unchanged for nearly forty years, is archaic, time-consuming, and extremely costly for franchisors; offers little protection for prospective franchisees; and fails to take advantage of current computer technology. 

The time has come for a twenty-first-century solution." wrote franchisee attorney Keith Kanouse in the ABA's Franchise Law Journal, Summer 2009.

Keith argues that when the FTC changed their franchise disclosure documents, effectively bringing the federal disclosure in line with the state disclosure requirements, the FTC missed a golden opportunity to require federal registration.

Think about the possible advantages that franchisors would have enjoyed, had the FTC required federal registration:

1. Franchisors would have effectively had one registration process, at the national level. This would lower their filing costs.

2. The renewal dates for registration would be uniform, making it less likely that franchisors would inadvertently miss a registration date, which has resulted in at least one successful legal malpractice suit by a franchisor against its attorneys.

3. There would be an end to the practice of selling in franchises in the unregistered states, as precursor to selling in the registrant states. Less money would flow to more speculative franchise systems, which would benefit the better systems.

4. Prospective franchisees would be able to obtain the FDD from the federal registry, read and comprehend it long before they did their pre-sale investigation.

5. Finally, with the many of state's in dire financial condition, the number of people needed to review the registration has been cut back - leaving these franchise systems without the ability to sell in a registrant state.

On the later point, Keith notes: "The states don't want to give up their power even though they complain about being understaffed and underfunded. There have been cutbacks and furloughs as you know.

With most franchisors on a calendar year fiscal year, most renewal filings are made in April/May creating an enormous backlog.

For existing franchisors in states where there is no automatic effectiveness of the renewal application, it causes them to cease selling until these until the states get around to reviewing the renewal.

There is no urgency on the examiners."

This is an issue that all franchisee associations should agree on, with the franchisors, it just makes sense to have one single registry system which minimizes costs, delay and increases proper pre-sales research.

Michael Millerick, correctly in my opinion, notes that the passage of the Fair Arbitration Act which bans mandatory arbitration in franchise agreements is more likely to pass because of the Supreme Court (US) decision in Rent-Center v Jackson, which allowed the arbitrator to take jurisdiction over the question whether there was an agreement to arbitrate or not.



"Two significant events have, and are occurring, which will change the entire landscape concerning how franchise disputes are going to be resolved. 

ARMSTRONG J.A.:

INTRODUCTION

[1]               Quizno's Canada Restaurant Corporation, Quiz-Can LLC, The Quizno's Master LLC (collectively "Quiznos"), Gordon Food Service, Inc. and GFS Canada Company Inc. (collectively "GFS") appeal from the order of the Divisional Court dated April 27, 2009, which conditionally certified the within action as a class proceeding.

[2]               Quiznos is the franchisor of a chain of some 427 fast food restaurants located across Canada.  GFS is the distributor of food and other supplies to Quiznos restaurants.  GFS operates through five affiliated companies, which distribute products to Quiznos restaurants through eight distribution centres across the country.

[3]               The respondents are two former Quiznos franchisees in Ontario, who seek to represent a class of all Canadian Quiznos franchisees in business on or after May 12, 2006. 

[4]               The essence of the dispute between Quiznos and the franchisees is that the franchisees allege that they have been charged exorbitant prices for food and other supplies they purchase for use in their restaurants.  Against GFS, it is alleged that they have engaged in a civil conspiracy with Quiznos in which they aided and abetted a price maintenance scheme. 

[5]               In the Superior Court, Perell J. dismissed the motion for an order certifying the action as a class proceeding.  The Divisional Court reversed the motion court judge.

THE FACTS

[6]               The Quiznos franchise system was established in the United States 25 years ago and commenced operation in Canada in 2001.  The relationship between Quiznos and the franchisees is governed by a standard form franchise agreement.

[7]               The Quiznos system requires the franchisees to offer common menu items made from uniform supplies.  There is a common operating manual and common advertising.  The franchisees may not sell at prices which exceed prices mandated by Quiznos.  Franchisees pay royalties of 7 per cent on gross sales.

[8]               The franchisees are required to purchase all equipment, products, services, supplies and materials from common sources or from sources with common ownership, which are designated by Quiznos.  Quiznos has designated GFS to sell and distribute a full line of products including meats, produce, frozen foods, dairy goods, paper and cleaning chemicals to the franchisees in Ontario.  Quiznos has designated four companies affiliated with GFS to sell and distribute supplies to franchisees in the rest of Canada.

[9]               The franchisees allege that Quiznos, aided by GFS, has established a price maintenance scheme in which large sums of money are extracted from the franchisees from the sale of supplies.  It is alleged that prices paid by the franchisees pursuant to this scheme are inflated and commercially unreasonable.

[10]          As a result of the alleged price maintenance scheme, the franchisees further allege:

(a)         They have been denied the ability to negotiate lower prices of supplies with the GFS defendants and other suppliers.

(b)        They have been hindered, prevented or denied the opportunity to source identical supplies from other suppliers.

(c)        They have been hindered, prevented or denied the opportunity to compete equitably with competitors whose prices are not unlawfully enhanced, fixed and maintained.

(d)        They have experienced declining profitability, or are suffering losses, including unsustainable losses, which, if unabated, will result in irreparable harm including, inter alia, loss of total investment by some Class Members.

[11]          The franchisees assert three causes of action:

(i)       breach of the price maintenance provisions of the Competition Act, R.S.C. 1985, c. C-34;

(ii)      conspiracy among the defendants (appellants) to fix prices; and

(iii)     breach of contract

[12]          Section 61(1)(a) of the Competition Act provides:

(1)              No person who is engaged in the business of producing or supplying a product...shall, directly or indirectly...

(a)   by agreement, threat, promise or any like means, attempt to influence upward, or to discourage the reduction of, the price at which any other person engaged in business in Canada supplies or offers to supply or advertises a product within Canada...

[13]          The franchisees claim against the Quiznos defendants:

(a)              compensation and damages in the amount of $75 million for conduct that is contrary to s. 61(1) of theCompetition Act;

(b)             an interim, interlocutory and permanent injunction preventing Quiznos and GFS from engaging in the price maintenance scheme;

(c)             $75 million for breach of contract including breach of the common law duty of good faith; and

(d)             an amount equal to the full investigative costs of the plaintiffs and the plaintiff class, pursuant to s. 36 of theCompetition Act.

[14]          The franchisees claim against Quiznos and GFS:

(a)              damages in the amount of $75 million for civil con-spiracy;

(b)              punitive, exemplary and/or aggravated damages in an amount to be determined by the court.

THE MOTION COURT DECISION

[15]          There were two motions before the motion court: a motion by the franchisees to certify the action as a class proceeding pursuant to theClass Proceedings Act, 1992, S.O. 1992, c. 6 and a motion by Quiznos to stay the action.  Only the certification motion is in issue in this appeal.

[16]          Section 5(1) of the Class Proceedings Act provides:

5. (1)   The Court shall certify a class proceeding on a motion under section 2, 3 or 4 if,

            (a) the pleadings or the notice of application discloses a cause of action;

            (b) there is an identifiable class of two or more persons that would be represented by the representative plaintiff or defendant;

            (c)  the claims or defences of the class members raise common issues;

            (d) a class proceeding would be the preferable proce-dure for the resolution of the common issues; and

            (e)  there is a representative plaintiff or defendant who,

                              (i) would fairly and adequately represent the interests of the class,

                       (ii) has produced a plan for the proceeding that sets out a workable method of advancing the proceeding on behalf of the class and of notifying class members of the proceeding, and

            (iii) does not have, on the common issues for the class, an interest in conflict with the interests of other class members.

[17]          In respect of s. 5(1)(a) of the Class Proceedings Act the motion judge concluded that the statement of claim disclosed causes of action for breach of s. 61 of the Competition Act, breach of contract and civil conspiracy.  The motion judge also found that "all persons, including firms and corporations, carrying on business in Canada under a Quiznos franchise agreement on or after May 12, 2006" with a slight alteration (the date for closure of the class membership) was an identifiable class as required by s. 5(1)(b) of the Class Proceedings Act. 

[18]          The motion judge's refusal to certify this case as a class proceeding turned on his analysis of the proposed common issues pursuant to s. 5(1)(c) of the Class Proceedings Act.  The franchisees proposed the following common issues before the motion judge:

(a)               Have the Quiznos defendants, or any of them, engaged in conduct contrary to Section 61(1) of theCompetition Act?

(b)              Have the defendants, or any of them, engaged in conduct that amounts to civil conspiracy?

(c)              (Issue deferred)

(d)              Have the Quiznos defendants, or any of them, engaged in conduct which constitutes a breach of their contractual obligations to the Class Members?

(e)              Have the Class Members suffered loss or damage as a result of any of the conduct referred to in issues a, b, c, or d?  If so, what is the appropriate measure or amount of such loss or damages?

(f)               Should the court award an aggregate assessment of monetary relief on behalf of some or all class members?  If so, what is the amount of the aggregate assessment and how should the class members share in the award?

(g)              Should the defendants pay punitive, exemplary or aggravated damages to the Class Members?  Should such damages be assessed in the aggregate?  If so, what is the amount of such damages including pre- and post-judgment interest thereon?

(h)              Are the Class Members entitled to recover from the Quiznos defendants the full costs of their investigations and the full costs of this proceeding, including contingent legal fees on a complete indemnity basis, under section 36(1) of the Competition Act?

[19]          As is often the case in certification motions, the problem for the franchisees before the motion judge was the issue of damages.  The appellants argued that because damages constitute an individual issue for each franchisee it was not appropriate to be treat them as a common issue.

[20]          The franchisees tendered the evidence of an economist, Dr. Andy Baziliauskas, in respect of the damages issue.  Dr. Baziliauskas testified that the quantum of the over-charge from the alleged price maintenance conspiracy could be calculated by taking the difference between the prices paid by the franchisees and the prices they would have paid but for the price maintenance conspiracy.  The economist testified that actual prices would be available from the financial records of the parties and the "but for" prices could be taken from industry data.  Thus, the difference between actual prices and "but for" prices could be applied on a class wide basis to prove damages. 

[21]          The appellants argued that actual prices would vary on a class wide basis because of a number of variables including: whether the supplies are purchased outside of the authorized distribution system, whether the franchisee qualifies for a rebate, individual credit terms, waste, employee theft and sharing among franchisees.

[22]          The appellants also argued that "but for" prices would vary on a class wide basis because of circumstances particular to individual franchisees such as location, financial capacity and purchasing power. 

[23]          The appellants relied on their own expert economist, Dr. Roger Ware, who testified that the impact of the alleged price maintenance scheme would have to be assessed on an individual franchise and product by product basis across the country.  The motion judge summarized the expert opinions as follows:

[112] Thus, relying on the critique of Dr. Ware, the Defendants disputed Dr. Baziliauskas' opinion that that (sic) there were three methodologies for extrapolating "but for" prices on a class-wide basis; namely: (1) by using "benchmark prices," which are prices paid for substantially similar products purchased by a comparator coalition of buyers where there is no price maintenance agreement between the franchisor and its distributor; (2) by using a "servicing fee" analysis, which is to take the difference between the sourcing and mark-ups charged under the distribution agreement under which GFS-Canada supplied goods and the fees charged by other franchisors in similar circumstances but where there is no price maintenance; and (3) by using a "before and after comparison," which is to compare the prices charged to the Quiznos franchises before and after the purported price maintenance began.

[113] I agree with the criticism of the Defendants that: (a) Dr. Baziliauskas has not shown that a comparator group of franchisees or a comparator franchisor can be identified; (b) he has not explained how it could be determined that a comparator group of franchisees was paying for product free of price maintenance by its franchisor; and (c) with respect to the before and after methodology, he has not shown that there was or that it could be determined that there was a time before price maintenance began.  In my opinion, these omissions make his three methodologies conceptually unsound and not feasible to measure a class-wide impact of price maintenance.

[24]          On the basis of the above, the motion judge concluded that it was not shown by the franchisees that their damages, if any, could be proven in the aggregate on a class wide basis. 

[25]          Having disposed of damages, the motion judge turned to the other common issues advanced by the franchisees in para. 115 of his reasons:

This conclusion removes proposed common issue (f) [aggregate assessment of damages] as a common issue and has the effect of an avalanche that buries the proposed common issues with an absence of commonality and a proliferation of individual issues.  Thus, for instance, pro-posed common issues (a) and (b) above (namely: (a) Have the Quiznos Defendants, or any of them, engaged in conduct contrary to section 61(1) of the Competition Act? And (b) Have the Defendants, or any of them, engaged in conduct that amounts to civil conspiracy?) depend upon showing: individual instances of price maintenance; individual instances of suffering loss in the "but for" world in order to measure the impact of losses; and individual claims of damages for the tort of conspiracy.  Similarly, proposed common issues (d), and (e) are individual not common issues.  Proposed common issues (g) and (h) have commonality but, standing alone, they would not sufficiently advance the litigation to qualify as common issues.

[26]          The franchisees relied on ss. 23(1) and 24(1) of the Class Proceedings Act, which they claimed assisted them in establishing a common issue in respect of damages.  Sections 23(1) and 24(1) provide:

Statistical evidence

23.(1) For the purposes of determining issues relating to the amount or distribution of a monetary award under this Act, the court may admit as evidence statistical information that would not otherwise be admissible as evidence, including information derived from sampling, if the information was compiled in accordance with principles that are generally accepted by experts in the field of statistics.

Aggregate assessment of monetary relief

24. (1)            The court may determine the aggregate or a part of a defendant's liability to class members and give judgment accordingly where,

(a)       monetary relief is claimed on behalf of some or all class members;

(b)       no questions of fact or law other than those relating to the assessment of monetary relief remain to be determined in order to establish the amount of the defendant's monetary liability; and

(c)       the aggregate or a part of the defendant's liability to some or all class members can reasonably be determined without proof by individual class members.

[27]          The motion judge found that neither section was of any help to the franchisees.  He was of the view that s. 23(1) related to the distribution of damages and had nothing to do with the determination of the entitlement to damages.  He further concluded that s. 24(1) "provides a method to assess the quantum of damages on a global or aggregate basis, but not the fact of damage".

[28]          Following from the above analysis, the motion judge concluded that a class proceeding would not be the preferable procedure for the resolution of the proposed common issues as required by s. 5(1)(d) of the Class Proceedings Act.

[29]          Finally, the motion judge concluded, in accordance with s. 5(1)(e) of the Class Proceedings Act, that the two named franchisees are satisfactory representative plaintiffs subject to the filing of a better litigation plan.

[30]          In the result, the motion for certification was dismissed.

THE DIVISIONAL COURT DECISION

[31]          Hennessy and Karakatsanis J.J., for the majority, would have allowed the appeal from the decision of the motion judge.  Swinton J., in dissent, would have dismissed the appeal.

[32]          The majority concluded that the motion judge erred in focusing solely on the damages issue and failed to consider the other proposed common issues.  The majority said at paragraph 45 of their reasons:

In our view, whether one of the proposed common issues is overwhelmed or buried by the individual issues is part of the analysis for the preferable procedure criterion, but is not necessarily determinative of the common issues requirement.  The remaining proposed common issues ought to have been analysed.

The majority stated further at para. 47 of their reasons:

We are satisfied that the motions judge erred in principle by focusing on proof of damages and failing to consider and identify other common issues.  Even if the motions judge made no reversible error with respect to his assessment that the expert evidence provided no basis in fact to prove damages on a class wide basis, he erred in failing to consider whether there was some other basis in fact to find that breach of s. 61 of the Competition Act, breach of contract, and the existence of loss on a class wide basis were common issues.

[33]          The majority proceeded to a detailed analysis of the proposed common issues, (a), (b), (d), (e) and (f).  The majority concluded that these issues had a sufficient number of common elements to provide the basis for the certification of the class proceeding.

[34]          The majority also concluded that the motion judge erred in finding that s. 24 of the Class Proceedings Act would not be available to determine aggregate damages at trial and he erred in finding that a class proceeding would not be the preferable procedure for the resolution of the common issues.

[35]          The dissenting judge concluded that the motion judge came to the right result.  In her overview of the case she said at paras. 155 and 156:

[155]   I agree with the majority that a motions judge hearing a certification motion must ask whether there are any common issues, and then determine whether they are a substantial part of each class member's claims.  In my view, that is what the motions judge did here, although his reasons might have been more detailed in order to illustrate his reasoning process more clearly.

[156]   However, even if he erred in the way in which he approached the common issues as the majority finds, I see no basis to interfere with his conclusion that a class proceeding is not the preferable procedure.  He applied the correct legal principles, made no palpable and overriding errors of fact, and exercised his discretion based on the pleadings and evidence before him.  Therefore, I would dismiss the appeal.

THIS APPEAL

[36]          The appellants raise the following grounds of appeal:

(i)                The Divisional Court majority applied the wrong standard of review.

(ii)      The majority erred in finding that s. 61(1) of the Competition Act is a common issue.

(iii)     The majority erred in finding that the conspiracy claim is a common issue.

(iv)      The majority erred in finding that the breach of contract claim is a common issue.

(v)       The majority erred in finding that ss. 23 and 24 of the Class Proceedings Act can be used to determine the damages.

(vi)      The majority erred in interfering with the motion judge's discretionary decision that a class action is not the preferable procedure for this case.

ANALYSIS

(i)        The Standard of Review

[37]          It is clear from the majority's reasons that they understood their role as an appellate court.  The majority recognized that a decision of a motion judge on certification is entitled to considerable deference.  See Anderson v. Wilson (1999), 44 O.R. (3d) 673 (C.A.) at 677 andCassano v. The Toronto Dominion Bank (2007), 87 O.R. (3d) 401 (C.A.).  However, as stated by Winkler C.J.O. in Cassano at para 23, "[L]egal errors by the motion judge on matters central to a proper application of s. 5 of the CPA displace the deference usually owed to the certification motion decision..."

[38]          The appellants submit that the Divisional Court majority erred in concluding that the motion judge failed to consider all the proposed common issues and then further erred in assuming original jurisdiction to decide those issues.  I disagree.  In my view, the majority correctly concluded that the focus of the motion judge's reasons was on the issue of damages, which he found overwhelmed the remaining proposed common issues.  While he referred to the other issues in passing, there was effectively no independent analysis of those issues by the motion judge, which constitutes the kind of error that attracts the intervention of an appellate court.

(ii)      The Competition Act Claim

[39]          The relevant sections of the Competition Act are:

Section 36

(1)              Any person who has suffered loss or damage as a result of

(a)     conduct that is contrary to any provision of Part VI, or

(b)    the failure of any person to comply with an order of the Tribunal or another court under this Act,

may, in any court of competent jurisdiction, sue for and recover from the person who engaged in the conduct or failed to comply with the order an amount equal to the loss or damage proved to have been suffered by him, together with any additional amount that the court may allow not exceeding the full cost to him of any investigation in connection with the matter and of proceedings under this section.

Section 61

(1)              No person who is engaged in the business of producing or supplying a product, who extends credit by way of credit cards or is otherwise engaged in a business that relates to credit cards, or who has the exclusive rights and privileges conferred by a patent, trade-mark, copyright, registered industrial design or registered integrated circuit topography, shall, directly or indirectly,

(a)   By agreement, threat, promise or any like means, attempt to influence upward, or to discourage the reduction of, the price at which any other person engaged in business in Canada supplies or offers to supply or advertises a product within Canada; or

(b)  Refuse to supply a product to or otherwise discriminate against any other person engaged in business in Canada because of the low pricing policy of that other person.

I should note that s. 61 of the Competition Act was repealed on July 13, 2009.

[40]          As indicated, the majority in the Divisional Court was critical of the motion judge for his focus on the problems associated with the proof of damages.  The majority concluded that the appropriate common issue was the breach of s. 61(1) of the Competition Act and that such breach "may be approached in a number of ways". 

[41]          The majority's detailed analysis of s. 61(1) of the Competition Act issue is found at paras. 51 - 75 of their reasons.  I find it unnecessary to repeat that analysis here. 

[42]          The Divisional Court correctly concluded that breach of s. 61(1) of the Competition Act does not require proof of loss or damage. Likewise it does not, as alleged by the appellants, require detailed analysis of the prices paid for each product by each franchisee and the prices each franchisee would have paid but for the alleged maintenance agreements.  The section is aimed at attempts to maintain prices.  Loss of profit or damages is not a constituent element. 

[43]          I accept the submission of the appellants that for the franchisees to succeed in their Competition Act claim, s. 61(1) must operate in combination with s. 36(1) of the act, which requires proof of loss or damage.  That said, it does not detract from the conclusion that a breach of s. 61 is itself an appropriate common issue, which advances the litigation.

[44]          I am in agreement with the majority's conclusions in the following paragraphs from their reasons for judgment:

[67]     We agree with the appellants' submission that a 'top down' approach focusing on the arrangement between the franchisor, the distributor and the suppliers, and the nature and amounts of the sourcing fees and mark-ups, may allow the court to determine whether the mark-ups and sourcing fees resulted in maintaining prices contrary to s. 61(1).  This may ultimately allow the court to determine whether s. 61(1) was breached without the need to establish what each individual franchisee, acting alone, would pay for each product from an alternate supplier.

[68]     Whether or not evidence is available of prices before and after the distribution agreement or comparable industry practices need not be shown at the certification stage.  The requirement that there be some basis in fact to support the common issues does not require the plaintiffs to indicate the evidence to be advanced at the certification stage, nor does it determine the admissibility of evidence.

[70]     If the court is satisfied that the Quiznos respondents imposed sourcing fees and mark-ups by way of the distribution agreement in an attempt to influence upwards the prices paid by the appellant franchisees, and that the pricing scheme resulted in a breach of s. 61(1), a substantial ingredient of liability under s. 36 of the Competition Actcan be proven on a class wide basis.  This will advance the claim of each member of the class, and avoids the duplication of the legal analysis involved in determining this question.  Alternatively, a finding that the distribution agreement did not amount to price maintenance will resolve the litigation relating to both the Competition Act and the civil conspiracy claim.

[Emphasis in the original.]

[45]          To the above, I would add that it is unnecessary at this stage to engage in the debate about the relative strengths and weaknesses of the expert evidence.

(iii)     The Conspiracy Claim

[46]          As already noted, apart from the claims for punitive and exemplary damages, the conspiracy claim is the only claim that includes GFS.  The franchisees allege that price maintenance agreements pleaded in respect of the claim advanced under s. 61(1) and 36(1) of the Competition Actsupport a claim for the tort of civil conspiracy.  Paragraphs 62 and 63 of the Amended Amended Statement of Claim provide:

62.       By entering into the Price Maintenance Agreements, and acting in furtherance of such agreements, each of the defendants entered into unlawful and tortious conspiracies to use unlawful means directed at the Class Members, knowing fully that their agreements and actions would cause injury to the Class Members, which injury has in fact resulted to the Class Members.

63.       Furthermore, pursuant to the Price Maintenance Agreements and the acts particularized in paragraphs 31 to 42 hereof, the GFS companies have knowingly aided, abetted and counselled the Quiznos defendants in maintaining the prices at which the GFS companies have supplied or offered to supply products and supplies to the Class Members, which price maintenance is contrary to section 61(1) of the Competition Act and which aiding, abetting and counselling is contrary to sections 21 and 22 of the Criminal Code, R.S.C. 1985, c. C-46.

[47]          As in the case of the s. 61(1) claim, the motion judge dismissed the conspiracy claim as a proposed common issue on the basis that it would be overwhelmed by the damages issue, which could not be established on a class wide basis.

[48]          The Divisional Court in its analysis held that to succeed on the conspiracy claim, the appellants must prove the following elements:

1.       that the respondents entered into an agreement (to permit the Quiznos respondents to enhance, fix and maintain prices to be paid by the class members contrary to s. 61 of the Competition Act);

2.       that the GFS respondents' conduct (aiding and abetting price maintenance by the Quiznos respondents) is unlaw-ful;

3.       that the respondents acted in furtherance of the agree-ment;

4.       that the respondents should have known that the conspiracy would likely cause serious harm to the class members by forcing them to pay inflated prices for the goods; and

5.       that the conspiracy has caused damage to the class members.

[49]          The Divisional Court majority concluded at para. 81 of their reasons:

Given our conclusion that the fact of loss on a class wide basis is a common issue, we are satisfied that whether the respondents engaged in a civil conspiracy is a common issue.  However, even in the absence of proof of the fact of loss, the first four constituent elements of conspiracy are common issues that would advance each franchisee's claim and avoid duplication of fact finding and legal analysis.

I agree with the Divisional Court's conclusion.

(iv)      The Breach of Contract Claim

[50]          The motion judge also disposed of the breach of contract claim as a proposed common issue on the basis that the claim for damages of $75 million arising from the breach would not permit the claim to proceed on a class wide basis. 

[51]          The Divisional Court majority concluded that the Quiznos appellants "are alleged to have breached certain sections of the franchise agreements by failing to ensure that its franchisees are obtaining 'commercially reasonable prices' for supplies".

[52]          The Divisional Court majority was of the view that there were a number of contractual issues for determination on a class wide basis, which would advance the litigation including:

(a)               the meaning of the contract provisions;

(b)              the existence and nature of any common law duty of fairness; and

(c)              whether the Quiznos respondents have breached a contract provision in failing to provide specifications.

[53]          As in respect of the Competition Act claim and the conspiracy claim, the appellants argue that the contract claims are highly individualistic and are not conducive to a determination on a class wide basis.  I am not persuaded.  I accept the Divisional Court majority's conclusion at para. 93:

Based on the foregoing, we find that a significant number of factual and legal issues, integral to the breach of contract claim, are common issues.  These represent substantial ingredients of the breach of contract claim that could advance the claim of each class member and will avoid duplication of fact-finding or legal analysis.

(v)       Sections 23 and 24 of the Class Proceedings Act

[54]          The appellants submit that the Divisional Court majority employed s. 23 to alter the constituent elements of the alleged causes of action by permitting the franchisees to establish damages on statistical probabilities or percentages.  The appellants further submit that the court's right to make an aggregate assessment under s. 24(1) is only available after some liability and some entitlement are established - s. 24 merely provides a method to assess the quantum of damages on an aggregate basis.

[55]          In my view, the appellants have mischaracterized the approach that the majority of the Divisional Court took in the application of ss. 23 and 24.  The majority clearly recognized that s. 24 is procedural and cannot be used in proving liability.  However, they observe that a breach of s. 61(1) of the Competition Act and liability for breach of contract can be established without proof of loss.  The majority concluded at para. 123:

In this case, the appellants seek declaratory relief.  We have found that liability for breach of the Competition Act and liability for breach of contract are common issues.  Given our conclusions, ss. 23 and 24 of the CPA may be available at the common issues trial to determine damages on an aggregate basis.

[56]          The judgment of this court in Cassano is supportive of the approach taken by the majority.  Cassano involved an action against the TD Bank by the proposed class action plaintiff for alleged manipulation of exchange rates on charges to the plaintiff's Visa bill.  At para. 38, Winkler C.J.O., writing for the court, said:

In my view, this is a case where the common issues trial judge could find, based on a review of the evidence, that it is appropriate to conduct an aggregate assessment of monetary relief under s. 24 of the CPA, as was contemplated by this court in Markson, supra.  Alternatively, even if the trial judge were to conclude that an aggregate assessment of damages is inappropriate, the nature of the claim asserted is such that the provisions of the CPA might well be utilized so as to make a class proceeding under the statute the "preferable procedure for the resolution of the class members' claims": see Hollick v. Metropolitan Toronto (Municipality), [2001] 3 S.C.R. 158 at para. 29.

The expert evidence before the motion judge goes to the issue of whether the damages can be aggregated as indicated in the above passage, which is an issue to be decided by the common issues trial judge.

[57]          Winkler C.J.O. adopted the approach taken by Cullity J. in Vezina v. Loblaw Companies Ltd., [2005] O.J. No. 197 at para. 25 (S.C.J.) and cited by Rosenberg J.A. in Markson v. MBNA Canada Bank (2007), 85 O.R. (3d) 321 (C.A.) at para. 44 to the effect that on a certification motion, a plaintiff is only required to establish that "there is a reasonable likelihood that the preconditions in s. 24(1) of the CPA would be satisfied and an aggregate assessment made if the plaintiffs are otherwise successful at a trial for common issues."

[58]          Finally, Winkler C.J.O. at para. 52 of Cassano recognized that the ultimate decision of whether ss. 23 and 24 would be available rested with the trial judge:

Even in the event that a trial judge were not prepared to rely on ss. 24(2) and (3) to fashion a remedial order in this case, I note that the combined operation of ss. 24(4), (5) and (6) of the CPA authorize the court to require that class members submit individual claims in order to give effect to an aggregate award of damages.

[59]          I would add to the above that s. 25 of the Class Proceedings Act provides a procedural code for the determination of individual issues as an adjunct to a class proceeding.  It is clear that the intent of the act is to accommodate both common issues and individual issues that may arise in a class proceeding.

(vi)      The Preferable Procedure

[60]          The appellants rely on the reasoning of the motion judge that the proposed class proceeding would not be fair, efficient or manageable because the individual issues "overwhelm" the common issues and the resolution of the common issues would not significantly advance the litigation.  I do not agree.  If one accepts, as I do, that the motion judge erred in his treatment of the common issues then the rationale for his conclusion that a class proceeding is not the preferable procedure disappears.

[61]          In my view, the trial of the common issues in this case will significantly advance the litigation.  I agree with the conclusion of the Divisional Court majority that this is the case even if the damages issues cannot be dealt with on a class wide basis.

[62]          I am also of the view that a class proceeding in this case will satisfy at least two of the objectives of the Class Proceedings Act of judicial economy and access to justice.  It seems to me that this case involving a dispute between a franchisor and several hundred franchisees is exactly the kind of case for a class proceeding. 

DISPOSITION

[63]          For the above reasons, I would dismiss the appeal.

[64]          If the parties cannot agree on costs, we will receive written submissions from counsel for the respondents within 15 days of the release of these reasons limited to 5 pages double spaced.  Counsel for the appellants may respond with written submissions within 10 days of the receipt of the respondents' submissions limited to 5 pages double spaced.

RELEASED:

"RPA"                                                 "Robert P. Armstrong J.A."

"JUN 24 2010"                                              "I agree R. A. Blair J.A."

                                                                        "I agree R. G. Juriansz J.A."

Transcript Sheena Lyengar: What's interesting is that the way we go about finding our marriage partners today is quite different from the way it used to be in this culture.

When you look at... I've done a number of studies with speed dating and Match.com and what's interesting is that you know we still walk into a speed dating event, you know, thinking about what it is we're looking for in a mate and so you ask people, like women will say "I'm looking for somebody who is really kind and sincere and smart and funny."

And guys will say looks matter, but they'll also say things like "Well, she should be smart and kind."

And you know those are... so the typical responses and if you give them just a few options, like five or six, then they will rate them on the very characteristics that they said were really important to them.

You know if they said kindness or funniness was really most important to them then they will be more likely to say yes to the person that they thought was kind and funny.

Now if you expand their choice set-say you give them 20 different speed dates-everything goes out the window.

Everybody starts choosing in accordance with looks because that becomes the easiest criteria by which to weed out all the options and decide."

So who am I going to say yes to?

What does this suggest to you about how prospects choose franchise systems when "speed dating", attending a franchise trade show?

A senior executive franchisor, when reviewing the MWI/IAFD proposal made the following observation.

"Based on our conversation and the information contained on the link below I think that franchising could benefit from constructive problem resolution and I have a couple of suggestions for your consideration.

Set up a pre-negotiation matter review with a small fee ($195?) for franchisees/franchisors so either party can confidentially frame their problem or matter for review by an impartial third party in a secure online environment by using a thoughtful questionnaire with an impartial third party written summary and brief telephone consultation.

I think all too often people do not know what they are fighting about and this kind of pre-negotiation appraisal might frame the issue(s) within a logical and rational framework.

I like "constructive problem resolution"  People would buy into it sooner than they would a rehash of mediation or negotiation. If I'm human and either a franchisee or franchisor I want my problems resolved most of all."