Tag: franchisors
May 10th, 2013
David Cahn
In Long John Silver’s Inc. v. Nickleson, decided February 12, 2013, the U.S. District Court for the Western District of Kentucky issued another decision demonstrating the danger of franchisors relying on disclaimers in their contracts and the Franchise Disclosure Document (“FDD”) to defeat claims that it provided false financial performance information in selling a franchise. The court denied summary judgment for the franchisor of A&W Restaurants, Inc. (“A&W”) and will allow the franchisee’s claims of fraud and violation of franchise sales laws to be decided at trial. The case is particularly noteworthy because the franchise purchased was the claimant’s fourth from the same franchisor.
A&W’s FDD had what is known a “negative disclosure” in Item 19 concerning the provision of information about the sales or profits at existing franchises, specifically saying “[w]e do not make any representations about a franchisee’s future financial performance or past financial performance of company-owned or franchised outlets.” The Minnesota-based franchisee alleged that, in connection with considering purchase of a franchise to open a new “drive in” model A&W restaurant, the franchisor provided “information, including financial projections, which was laden with false data.” These allegations, if true, would mean that A & W provided a financial performance representation (“FPR”) outside of its FDD, in violation of federal and state franchise sales laws.
A&W followed the usual route of trying to get the franchisee’s claims thrown out before trial on the argument that, in light of the disclaimers in Item 19 of the FDD and in various parts of the franchise agreement, as a matter of law the franchisee could not “reasonably rely” on the information provided. The court rejected the argument that the disclaimers could be used to bar the franchisee’s claim that A&W provided misleading information in violation of the Minnesota Franchise Act, because that law (like the Maryland Franchise Registration & Disclosure Law) contains a provision making “void” any waivers of conduct contrary to the franchise sales law. The franchisor will be permitted to use the disclaimers in the contract and the FDD at trial as evidence to persuade the jury that the franchisee could not have reasonably relied on the “projections “.
The court also ruled that the disclaimers could not be used to deny the franchisee a trial on its claim of common law fraud (under Kentucky law) with regard to its claim that the projections provided were based on false data about other locations’ sales or earnings. In the words of the court, “A broadly-worded, strategically placed disclaimer should not negate reliance as a matter of law where A&W allegedly shared objectively false data to induce Defendant to enter into the Franchise Agreement.” Therefore summary judgment was denied and the franchisee’s fraud claim will proceed to trial, with A&W potentially liable for punitive damages if the franchisee prevails on that claim.
Given that the franchisee in this case already owned three (3) other A&W restaurants at the time it purchased the franchise at issue, it would hardly be surprising if it demanded and received specific financial performance information about the other “drive-in” models. A logical question is, if A&W had included sales and earnings data in Item 19 of the FDD that it provided to this franchisee, was it less likely to have faced the allegations made in this case? In this author’s opinion, based on more than fifteen (15) years of representing franchisors and franchisees, A&W would have been in a better position to defend against the allegations had it included such data in Item 19. The reason is that the data would have been reviewed by A&W’s attorneys and probably by upper management, who would be more likely to make sure that the presentation was accurate and not misleading. Once the presentation is in the FDD, most franchise salespeople will be less likely to “go off script” and provide information that is more optimistic than Item 19.
However, even if the franchise seller did provide information beyond the written FPR, at trial the franchisor will be able to point to the data provided in Item 19 and say, “Look, we gave the franchisee the data in the FDD and made it easy for him to investigate further, so it is ridiculous to believe he relied on something are franchise salesperson said.” In that situation it may be more likely than not that the jury would agree with the franchisor. By contrast, by denying its franchise seller use of an Item 19 FPR, A&W made it difficult to comply with the law and convince qualified candidates to purchase the franchise – setting up a scenario where a jury may believe that the franchise seller “went over the line.”
June 29th, 2012
David Cahn
For the first time the annual International Franchise Expo took place in New York City from June 15 until June 17, 2012, and it was a revitalized event worthy of The Big Apple. I visited on Friday, which has been the “slow day” of the Expo in the past during which suppliers could mingle and “network” with exhibitors. Accompanied by fellow Baltimoreans Jerry Blumenthal and Nick Courtalis of
Business and Commercial Ventures (business brokers) and Anne Paulus of
3D Signs (signmakers), I arrived at 11:30 to find a truly packed exhibit hall!
The number of exhibitors was much larger than the sessions the past several years in Washington, D.C., and also included large franchisors such as Choice Hotels and 7-Eleven that I don’t remember seeing in D.C. However, as a counselor for emerging franchisors and for many franchisees of emerging systems, I always find innovative newer brands to be interesting. Here are a few that intrigued me, with the proviso that none of the descriptions are an endorsement of the franchise:
America’s Taco Shop: an authentic Mexican fast casual restaurant founded by America Corrales Bortin, who is originally from Culiachán, Sinaloa, Mexico. I met her husband Terry, who told me that America was named after the local soccer team in her Mexican town and not as any plan to immigrate, start a business or other ulterior motive. Nice coincidence! But seriously, their food is great.
Interpreters Unlimited: the first franchise system for the provision of interpretation services, including in-person, over the telephone, and by video conference, as well as document translation services. The company has some U.S. government contracts that the franchisee could fulfill in local markets. This “work from home” opportunity could be perfect for a good salesperson.
Joshua’s Shoarma Grill: founded by Israelis living in Europe, they have had some success there and are now seeking to grow here through area developers and masters. Have an interesting Middle Eastern fusion and healthy menu in a fast casual setting.
Team Makers: an education concept with group programs for children ages 5 to 12 to prevent bullying and other inappropriate behavior. The franchisee organizes and provides in-school workshops, after-school programs, birthday parties and carnivals or special events. This company is addressing an important societal need, and could be wonderful for a parent seeking to “re-enter the workforce” after focusing on child rearing.
Boneheads: A fast casual restaurant chain with a focus on fresh fish and Piri Piri spices, which are from Mozambique, Africa, were made popular by the Portuguese, and are now “all the rage” in Europe.
Gyu-Kaku: Japanese restaurant with a twist – the customers grill their own meat at the table! Sort of like Hibachi crossed with Fondue.
CRAL: home services with layers – mold remediation, duct cleaning, ventilation, and lead abatement, with the telephone number 1-888-KIL-MOLD. Seems to indicate strong cross-selling possibilities, although also some operational complexity. Could be good for a veteran with strong operations skills – like a sergeant!
Cool De Sac: A “family entertainment center” with a modern healthy menu, “play stations” and birthday parties programs. Sort of like an upscale “Chucky Cheeses”.
The Expo included many educational seminars and other resources for prospective franchisees and those considering the franchising of their own business methods. The same company also has events in Los Angeles in October (West Coast Franchise Expo) and in Miami in January (Franchise Expo South). For more information, visit http://mfvexpo.com/.
August 30th, 2010
David Cahn
(This is the conclusion of the August 23, 2010 post on this Blog.)
Franchising vs. Other Methods of Expansion
The main advantage that franchising has over expanding a business on your own is that you get to invest other people’s time, skills, and money to growing the business instead of borrowing against your business and personal assets or granting stock to outside investors. Having franchisees allow a business to play off of a diverse pool of talent that may attract different types of people to the business.
Many businesses have found that, by granting franchises, they can recruit talented individuals who will be driven to tremendous lengths to make their business a success. While incentives to the managers of company-owned remote locations can drive good short-term results, franchisees who risk their net worth on the enterprise have the ultimate incentive to develop the businesses for long-term profitability.
As the franchisor, your business will be less likely to be held liable for any claims of personal injury or employment discrimination that that may happen on the premises of a franchised unit, as opposed to one opened with borrowed or equity capital. Making sure that this liability shield is effective takes careful planning, but when properly executed it is a substantial benefit of franchising.
It’s not all good news however. After outside lenders or investors are repaid, company units may yield more profit to the brand founder than franchises. It can be more difficult and costly to terminate a misbehaving franchisee than a location manager. Finally, company owned units located near franchises could suffer revenue losses through competition with the franchises.
So You’ve Decided to Franchise…
With all of that in mind, and you’ve decided that your business is ready to franchise, there are a few things you should do before looking for your first franchisee.
- Develop the operating manual and training plan. Owners often create these items with the help of a consultant and with overall legal guidance.
- Put money aside. A thoughtful and responsible business owner should have at least $100,000 available for franchising purposes, including legal, development of training programs and operations manuals, and advertising for franchisees (both creative and placement). Also, a shrewd businessman might put away that money, spend half on the aforementioned items, and keep the rest on hand to show sufficient capitalization to obtain state franchise registration on favorable terms.
- Be prepared to do some hand-holding. Business owners that are looking to franchise need to be realistic when they look at the additional operating costs of getting a franchise up and running. They must spend money and time recruiting and supporting the new franchisees. Time away from the core-business means money for managerial costs for the original businesses that form the “prototype” for the franchises.
Conclusion
Potential franchisors need to accept that franchising successfully will require some short term sacrifices in terms of time and money. Done correctly and thoroughly can mean the growth of your business to larger regional or national markets. Improperly, underfunded, and rushed could mean the loss of the business entirely. Early investment in franchise resources and assistance will give the business a better chance at success and growth within your industry.
August 23rd, 2010
David Cahn
Do you think you’re ready to make your business a franchise? Ready to become the next Subway or Jiffy Lube?
In this column, I’ll outline some key factors to consider as you make the important decision of whether and when to franchise your business methods. Part 1 focuses on signs that a business is “franchisable”. Part 2 will focus on franchising vs. other methods of expansion, and steps necessary to franchise.
One thing is for sure – given the number of jobs lost over the past two years, there are many potential franchise owners “out there” who are eager to find their next opportunity. Becoming the owner of a franchised business (as the “franchisee”) can be a great option for someone who has entrepreneurial skills and motivation but doesn’t want to start a business “from scratch.” But before you take the plunge and dive headlong into becoming their franchisor, it’s important to keep in mind the most important factors that will determine your success.
Signs That Your Business Is Ready To Franchise
The first hurtle to “franchise-ability” is whether your business has been consistently profitable over a substantial period of time. Typically, if your business is in a mature industry, such as food service or printing, you need to have been in business at least three years and have a steady record of profits. You should also have multiple separate locations to disprove that notion that it’s only a local success.
A different rule applies to “new” industry or niche businesses. If a business presents a truly unique and innovative operating method, and has shown some profitability, then it may be in the business’ best interests to franchise quickly to gain regional recognition as the leader for that niche. For example, a fitness company that offers a new type of program and that has been developed locally should try to get into the market quickly and establish themselves as the dominant brand for that niche.
The second hurtle is having developed a business system that you can teach to franchisees and can be easily replicated in other locations. Disclosures that must be given to prospective franchisees under U.S. and state laws have essentially mandated that a franchisor prepare some sort of “Operations Manual” to loan to active franchisees, and also that it plan out a new franchisee training program in advance of offering franchises. Therefore, before franchising you need to carefully document both how to develop and operate the business you want to franchise, and also plan how you will train others to replicate your methods.
Another important question is whether you have a business name and/or logo that can obtain and maintain trademark protection. Having a “strong Mark” for both marketing and legal purposes is very important to the long-term success of a franchise system, and if that factor is not present then you should carefully consider whether to re-brand and obtain trademark registration in advance of franchising.
Last but not least, will your prospective franchisees be able to obtain the capital that they need to open and operate franchises? A prospective franchisor needs to talk with its bankers to develop a profile for a suitable franchisee that will have sufficient net worth (both total and liquid) to be able to personally qualify for financing. You should then obtain informal commitments from financial institutions to finance candidates who have meet those qualifications and secure suitable locations or geographic territories from which to operate the franchise.
August 13th, 2010
The final installment in this series focusses on the Franchisor’s selection of franchisees.
Evaluation of Franchise Prospects by Franchisors
In the recent economic climate, franchisors have been tempted to ease their qualifications for new franchise prospects. However, franchisors need to remember that they are investing in their franchisees just as much as their franchisees are investing in them, and must resist compromising their brand’s long-term growth for short-term cash flow.
The following considerations are frequently cited by industry experts as fundamental criteria for evaluating prospective franchisees. Regardless of the economic conditions a franchisor may be facing, it should remain loyal to these fundamental principles for determining the viability of candidates:
- Ability to learn and follow the franchisor’s system;
- Fitting with the franchise system’s “culture”;
- Having relevant business experience or general business acumen;
- Being located in a geographic and demographic area that favors the franchise concept;
- Having access to capital; and
- Having grounded and realistic expectations.
While the specific traits and skills needed to succeed in any particular franchise system obviously will vary, these fundamental requirements can generally be applied broadly across all franchise systems, regardless of the industry they are in.
The need to select quality prospects as franchisees is particularly important for new and early-stage franchisors, though it obviously remains critical for highly-developed franchise systems as well. While one “bad apple” may not be as detrimental to the brand image or the ability to sell franchises for larger systems, unsuccessful franchisees can cause significant administrative burdens, and quite possibly legal fees, for franchisors of all sizes. Signing an under-qualified franchisee as one of the first non-affiliated representatives of a franchise system may have dire effects on a new system’s ability to attract qualified franchisees. When counseling prospective franchisees, we recommend that they speak with as many existing and former franchisees as possible when performing their due diligence, and one or a few franchisees who are unhappy or unsuccessful, or who are simply unimpressive as people, can impact a prospect’s view of the franchise system as a whole.
By carefully screening and interviewing franchise prospects, franchisors can protect the quality and value of their franchise systems, enhance their ability to sell additional franchises, and avoid the headaches of franchise terminations and legal disputes. We regularly counsel our new franchisor clients that selecting quality franchisees must be a top priority for their long-term success.
Individual franchised outlets and franchise systems as a whole stand a greater chance of success if they are built around committed franchise owners who trust and believe in the franchisor and everything it has to offer. Franchisees and franchisors both benefit substantially when they carefully evaluate each other during the pre-sale courting process.
June 16th, 2010
Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees’ business operations. Where a franchisor imposes and exercises substantial controls over its franchisees’ operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor’s exercise of control makes it liable for its franchisees’ negligence or misconduct.
Two recent cases involving employee and customer claims against Jackson Hewitt shed light on this issue. In one case, a customer of a Jackson Hewitt franchised tax center in Louisiana filed suit against the franchisor based upon a privacy breach committed by the franchisee. In the other, an employee of a Jackson Hewitt franchise in Pennsylvania sued the franchisor for sexual harassment based upon the alleged actions of certain owners and managers of the franchise. In asserting their claims against the franchisor, both plaintiffs relied heavily upon language in Jackson Hewitt’s franchise operations manual and other documentation, and also the direct involvement of Jackson Hewitt representatives in the operations of its franchisees. The courts in both cases were willing to consider the plaintiffs’ claims against Jackson Hewitt despite clear admonitions in the Franchise Agreement and Operations Manual that the franchisee and its employees “shall not be considered or represented [by the franchisee] as [Jackson Hewitt’s] employees or agents” and that franchisee has exclusive responsibility over hiring and matters relating to personnel.
Jackson Hewitt provided its franchisees with detailed mandatory policies and procedures for center operations. It required all franchisees to provide customers with a copy of the “Jackson Hewitt Privacy Policy” promising that the confidentiality of personally identifying information (e.g., social security numbers) would be safeguarded. It also provided franchisees’ employees with a Code of Conduct, which made no reference to the existence of franchises, and which included numerous references to the reader as an “employee” of Jackson Hewitt. Jackson Hewitt also operated an Intranet site through which franchise employees could apply for employment positions with other Jackson Hewitt offices, could obtain Jackson Hewitt policies, and could communicate with Jackson Hewitt representatives. In addition, franchise employees were directed to call Jackson Hewitt’s corporate office to resolve issues with tax returns. All of these factors weighed in favor of establishing a sufficient level of control over franchisees’ operations to impose liability on Jackson Hewitt. The court also found significant control in the Jackson Hewitt system relating to training and termination of employees of the franchises.
The conclusion to be drawn from the Jackson Hewitt litigation is that franchisors are essentially presented with two options when drafting their franchise agreements and operations manuals. The first option is to impose significant operational controls over their franchisees’ operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates. The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications.
The first approach allows franchisors to impose greater control over, and have more say in, their franchisees’ operations—which is an attractive proposition for many franchisors. In addition, franchisees may perceive greater value in a franchise system that provides strict operating standards and procedures, which may help to distinguish the franchisor from competing brands. If the franchisor chooses this approach, it should consider increasing the minimum policy limits required for franchisees’ insurance policies and the types of required policies. It may also want to explore direct insurance coverage for the franchisor for all claims arising from franchised operations.
The advantages of the second option are demonstrated by a recent court decision from Illinois, Braucher v. Swagat Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,355 (Mar. 19, 2010), in which Choice Hotels International, Inc. avoided liability in a wrongful death claim for the alleged negligence of one of its franchisees in maintaining its indoor swimming pool and whirlpool. Choice provided very limited operational guidance and controls with regard to swimming areas, and this approach allows a franchisor to avoid potential liability associated with imposing mandatory operational controls over franchises. However, it also carries the potentially negative business implications of allowing franchisees a measured level of discretion in running their businesses under the franchised brand. The term “measured” is important, because the franchise agreement should still include rights of termination or other remedies for acts or omissions that have the potential to cause material detriment to the franchise system’s goodwill. In addition, franchisees may view a franchisor that employs this approach as providing very little in terms of affirmative guidance and support, not acknowledging that the information and non-binding recommendations of a franchisor can provide value in and of themselves, irrespective of whether compliance is deemed mandatory.
A prospective franchisee can also glean guidance from the information provided above. When evaluating a franchise opportunity, a prospective franchisee should seek to review the franchisor’s operations manual, even if its table of contents is provided in the Franchise Disclosure Document (“FDD”). It is acceptable for a franchisor to require the prospect to sign a non-disclosure agreement with regard to the Manual. If the operations manual provides detailed mandatory specifications and procedures, the prospective franchisee should be wary of the likelihood that the franchisor will pursue rigorous enforcement, to account for the assumption of the significant liability risks described above. While the “deep pocket” franchisor’s potential “joint and several” liability for third-party claims may seem like a benefit to the franchisee, the prospect should be aware that indemnification and contribution provisions in the franchise agreement is likely to shift the ultimate financial burden back to the franchisee, unless it can prove that the franchisor’s actions caused the third party’s claim.
If the operations manual provides only examples and recommendations for franchisee policies and operational procedures, as opposed to detailed mandates, the franchisor may be attempting to avoid any direct performance obligations to its franchisees, or it may simply be attempting to limit its exposure. In performing its due diligence, a prospective franchisee should attempt to gain as much information as possible from the franchisor and its active franchisees to discern the quality and operational support the franchisor actually offers.
The operations manual and other forms and operational materials can be valuable tools for franchisors and franchisees alike. But, depending on how they are written, they can expose the franchisor to liability and raise serious questions in the minds of franchisees as to the benefit to be derived from subscribing to a particular franchise. Parties on both sides of the table should be sure to carefully evaluate these documents to ensure that they serve and meet their needs and expectations.
February 11th, 2009
From the Desk of David L. Cahn:, with assistance from Jeffrey S. Fabian
As we only begin to emerge from the nation’s most difficult economic times since the Great Depression, many franchisors (and their sales representatives) may be tempted to ease their qualifications for new franchise prospects. However, franchise agreements are long-term relationships, and franchisors are investing in their franchisees just as much as their franchisees are investing in them. Franchisors should remain cognizant of these facts and resist compromising long-term growth for short-term cash flow.
Franchisors should acknowledge and address this issue with their sales staff and independent franchise brokers. With regard to employees or independent contractor sales representatives, structuring compensation based on the performance of the franchisees they recruit should reduce the temptation to submit under-qualified prospects so as to increase the volume initial franchise fees.
The following considerations are frequently cited by industry experts as fundamental criteria for evaluating prospective franchisees. Regardless of the economic conditions a franchisor may be facing, it should remain loyal to these fundamental principles for determining the viability of candidates:
- Ability to learn and subscribe to the franchisor’s system;
- Fitting with the franchise system’s “culture”;
- Having relevant business experience or general business acumen;
- Being located in a geographic and demographic area that favors the franchise concept;
- Having access to capital; and
- Having grounded and realistic expectations.
While the specific traits and skills needed to succeed in any particular franchise system obviously will vary widely, these fundamental requirements can generally be applied broadly across all franchise systems, regardless of the industry they are in. One interesting article on franchisee selection by noted franchise consultant Mark Siebert can be found at: http://www.franchisetimes.com/content/story_result.php?article=00522
The need to select quality prospects as franchisees is particularly important for new and early-stage franchisors, though it obviously remains critical for highly-developed franchise systems as well. While one “bad apple” may not be as detrimental to the brand image or the ability to sell franchises for larger systems, unsuccessful franchisees can cause significant administrative burdens, and quite possibly legal fees, for franchisors of all sizes. As suggested above, signing an under-qualified franchisee as one of the first non-affiliated representatives of a franchise system may have dire effects on a new system’s ability to attract qualified franchisees. When counseling prospective franchisees, we recommend that they speak with as many existing and former franchisees as possible when performing their due diligence. If one or a few franchise owners are unhappy, have been unsuccessful or are simply unimpressive as people, this will impact a prospect’s view of the franchise system as a whole. Moreover, prospects may question the value of being associated with a franchisor’s brand if existing franchised outlets do not appear successful, regardless of the underlying reason for their lack of success.
By carefully screening and interviewing franchise prospects, franchisors can protect the quality and value of their franchise systems, enhance their ability to sell additional franchises, and avoid the headaches of franchise terminations and legal disputes. Selecting quality franchisees should be a top priority for any franchisor with a goal of long-term success.