Franchising

Chapter 3: Navigating the Paper Trail

WHAT ARE THE KEY SUBJECTS IN THE FRANCHISE AGREEMENT?

The franchise agreement is more specific than the UFOC about the terms of the relationship between the franchisor and franchisee

Use of trademarks.

One of the main benefits you receive when purchasing a franchise is the use of well-known trademarks.
This section lists the trade- marks, service marks or logos the franchisee is entitled to use

Location of the franchise.

This section describes the exclusive area or territory granted to the franchisee.

Franchisee’s fees and other payments.

In this section, all the mandatory fees are described
Initial fee and what the franchise receive for that fee
Royal payments, what is based on and when it is due

Obligations and duties of the franchisor.

This section describes, in detail, all the services which the franchisor will provide:

• training

• operations support

• advertising

Obligations and duties of the franchisee.

This section describes the franchisee’s responsibilities:
requirements for training
requirements for keeping and submitting adequate records

Restriction on goods and services offered.

This section describes any restrictions placed on the goods and services offered:
required quality standards
Approved suppliers
Approved advertising
Hours of operation
Pricing

Renewal, termination and transfer of franchise agreement.

This section includes:
the right and obligation of the franchisee upon termination
Descriptions about the transfer of the franchise agreement
Description about the renewal of the franchise agreement

WHAT INFORMATION IS FOUND IN THE DISCLOSURE DOCUMENT (UFOC)?

-The purpose of the UFOC is to provide prospective franchisees with information about the franchisor, the franchise system and the agreements they will need to sign so that they can make an informed decision.

The franchisor, its predecessor and affiliate.

This section provides a description of the company

Business experience.

This section provides biographical and professional information about the franchisors and its officers, directors and executives.

Litigation.

This section provides relevant current and past criminal and civil litigation for the franchisor and its management.

Bankruptcy.

This section provides information about the franchisor and any management who have gone through a bankruptcy.

Initial franchise fee.

This section provides information about the initial fees and the range and factors that determine the amount of the fees.

Other fees.

This item provides a description of all other recurring fees or payments that must be made.

Initial investment.

This item is presented in table format and includes all the expendi- tures required by the franchisee to make to establish the franchise.

Restriction on sources of products and services.

This section includes the restrictions that franchisor has established regarding the source of products or services.

Franchisee’s obligations.

This item provides a reference table that indicates where in the franchise agreement franchisees can find the obligations they have agreed to

Financing Available.

This item describes the terms and conditions of any financing arrangements offered by the franchisor.

Franchisor’s Obligations.

This section describes the services that the franchisor will pro- vide to the franchisee.

Territory.

This section provides the description of any exclusive territory and whether ter- ritories will be modified.

Trademarks.

This section provides information about the franchisor’s trademarks, service marks and trade names.

Patents, copyrights and proprietary information.

This section gives information about how the patents and copyrights can be used by the franchisee.

Obligations to participate in the actual operation of the franchise business.

This sec- tion describes the obligation of the franchisee to participate in the actual operation of the business.

Restrictions on what the franchisee may sell.

This sections deals with any restrictions on the goods and services that the franchisee may offer its customers.

Renewal, termination, transfers and dispute resolution.

This section tells you when and whether your franchise can be renewed or terminated and what your rights and restrictions are when you have disagreements with your franchisor.

Public Figures.

If the franchisor uses public figures (celebrities or public persons), the amount the person is paid is revealed in this section.

Earnings claims

Here the franchisor provides information that a franchisee can use to estimate what can be earned from the business.

List of franchise outlets.

This section provides locations and contact information of existing franchises.

Financial statements.

Audited financial statements for the past three years are included in this section.

Contracts.

This item provides of all the agreements that the franchisee will be required to sign.

Receipt

Prospective franchisees are required to sign a receipt that they received the UFOC.

WHAT ARE THE KEY ITEMS IN THE

DISCLOSURE DOCUMENT?

Initial investment.

Some of these costs are averages or estimates and may vary in your area.
Talk to other franchisees who have been in the system for a year or more to see:

Franchisor’s obligations

Be sure you understand the services you will get before you open:
site selection
training
development assistance

Be sure you know what services you will receive for your grand opening:
marketing
advertising
field support
Be sure you know what services you will receive after you begin operating your business:
Training
advertising
operations

Renewal,termination,transfers and dispute resolution.

Take your time to understand what rights you will have and what rights you are giving up.
Pay particular attention to any non-compete provisions and your obligations when the franchise rela-

tionship ends.

Earnings Claims.

Only 20 to 25 percent of all franchisors provide prospective franchisees with information about earn- ings claims. The next best thing to do is to talk to existing franchisees about earnings potential.

List of franchise outlets.

Examine how many units the franchisor has taken back and resold. If this number is high, this could indicate churning (when the franchisor takes back failed locations and remarkets them over and over.)
Pay attention to the contact information of the franchisees who have left the system. These are people you definitely want to talk to.

Financial statements.

Financial statements are the track record of the franchisor. You should be given copies of the fran- chisor’s last two or three years financial statements. Take them to an accountant who specializes in franchising to evaluate

Contracts.

Make sure that all the agreements listed are attached to the UFOC—and read every one of them.

Brief History and Overview of Franchise Relationship Laws

A. Abuses

In the 1950s and 1960s, the early period of modern business format franchising, abuses were common. These abuses were exacerbated by the retrenchment and vertical integration in the motor vehicle fuel industry following the OPEC oil embargo in 1973.

Unjust Terminations:

Either by contract or by economic or other pres- sures, the franchisor would attempt to terminate the franchise relation- ship, thereby depriving the franchisee of the fruits of his labor and investment.

No Renewal Rights:

The franchise agreement typically was for a time- limited, and often short, duration, with no renewal opportunity, or, contractual renewal opportunities would be unjustly frustrated, allowing the franchisor to capture the benefits of the business that the franchisee had developed once the stated term of the agreement had expired.

No Right to Assign:

The franchisor would prohibit the franchisee from transferring all or a portion of his or her interest in the franchise to a bona fide purchaser, or perhaps to a qualified family member, depriving the franchisee of the opportunity to liquidate the equity in the franchised business.

Other Abuses:

The franchisor would place another unit (either com- pany-owned or franchised) in close proximity to an existing franchised unit. This placement, known as encroachment, would result in the franchisee’s business being “cannibalized”—sales diverted to the new location. Franchisors also engaged in other practices objectionable to franchisees, such as restricting the right of free association among franchi- sees, discriminating in their treatment of franchisees, and imposing un- reasonable standards of performance on franchisees.

II. Definition of “Franchise” Under State Relationship Laws

A. Breadth of Definition

While the definition of a “franchise” varies widely among the state franchise relationship laws, most definitions require three elements

The relationship must involve the use of a trademark;
There must be either a “community of interest” between the franchisor and the franchisee, or the franchisor must provide the franchisee with a marketing plan”; and The franchisor must charge the franchisee a fee.

the Elements of a Franchise

Trademark

The trademark element of the state relationship laws will always be satisfied if the franchisee is licensed to do business under the franchisor’s name or mark.

Marketing Plan

The term “marketing plan” can refer to a grant of the right to engage in business of offering, selling, or distributing goods under a marketing plan or system pre- scribed in substantial part by the franchisor

This might be done, for example, through one of the following:

Advertising by the franchisor;
Requirements regarding site selection, appearance of the premises, uni-

forms, or hours of operation;

Limitations on products, services or customers;
Providing training;
Requiring approval of advertising and signage; and
The use of an operations manual.

Community of Interest

Some franchise laws include a requirement that the franchisor and franchisee have a “community of interest” in the marketing of the goods or services.

Fee

The fee element of the definition of a franchise generally means any fee or charge that the franchisee is required to pay for the right to do business under the franchise agreement.

“Good Cause” for Termination

A. Statutory “Good Cause” Requirements

Most franchise relationship laws require the franchisor to have “good cause” before terminating a franchise agreement. What good cause means may vary depending on the jurisdiction. For instance, “good cause” is defined in Con- necticut, Minnesota, Nebraska, New Jersey, Rhode Island, and Wisconsin as failure by the franchisee to substantially comply with the requirements imposed by the franchisor.

Failure to Maintain Standards and Other Contractual Requirements

Breach of system standards imposed under the franchise agreement usually sup- ports termination. An Illinois court found McDonald’s had good cause to termi- nate where the franchisee failed to maintain the required standards of cleanliness, quality, and service.

Failure to Meet Sales and Other Performance Requirements

Breach of minimum sales standards can justify termination under the good cause standard.

Sale of Competing Products

A commercial conflict of interest can justify termination if the franchise agree- ment so provides. The sale by a franchisee of a competing line was held to be good cause for termination under Illinois87 and Wisconsin law.

Damage to Franchisor’s Reputation

Egregious behavior by a franchisee that tarnishes the brand’s reputation some- times justifies termination. In Minnesota, termination was found to have been lawful where the franchisee had engaged in consumer fraud, damaging the franchisor’s reputation

Market Withdrawal by the Franchisor

When a franchisor discontinues business either entirely, in a particular line of products or in a particular geographic area, the question of whether ensuing terminations are for “good cause” requires careful and detailed analysis.

Unfair Actions by Franchisors

A franchisor may not terminate in Wisconsin if it intends to replace a franchised outlet with its own store in the same marketing area as that of the franchisee after the franchisee has helped establish the franchisor’s reputation or, apparently, for failure to maintain standards determined to be minor or ancillary.

Termination upon Transfer by the Franchisee

Incurable Conduct by the Franchisee

A franchisor in some instances may terminate without regard to the statutory procedural requirements for termination upon incurable conduct by the franchi- see.

Procedural Requirements for Termination

A. Statutory Procedural Requirements

In addition to requiring good cause to terminate, many state statutes set forth certain procedural requirements that also must be followed before a termination is effectuated. These requirements typically include a minimum notice period and an opportunity to cure. As a result, a franchisor often must do all of the following in connection with terminating a franchise:

give written notice of termination the required number of days in ad- vance;
include in the notice all of the reasons for termination;
include in the notice how much time, if any, the franchisee has to cure the default(s); and
continue to comply with the franchisor’s obligations during the notice

period.

The notice and cure periods vary from state to state, but are generally between 30 and 90 days.