On demand 1h 12m 29s Basic

Evaluating a Franchise Agreement

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Evaluating a Franchise Agreement

This course is designed for counsel representing a franchisee in evaluating their decision to purchase a franchise business. We will discuss the role of franchisee counsel, practical considerations for deciding whether to acquire a franchise and how to prepare for reviewing a franchise opportunity. We will also cover how to determine which laws apply and why this matters to the review, the top 13 risk analysis issues, key tips for negotiating an addendum, and additional resources for franchisee counsel.

Transcript

Welcome. We're so glad that you decided to join us for this continuing education course, evaluating a franchise for a franchisee. My name is Mary Clapp and I am the CEO of and an attorney for Delafran LLC, where I focus my practice exclusively on franchising, licensing and distribution law. Okay, so let's get going. This morning, we have a tight schedule. We're going to talk about the role of franchisee counsel, practical considerations in choosing a franchise, some initial considerations when you start the review process. And then we're going to look through the top 12 issues in evaluating a franchise relationship. Of course, a franchise disclosure document that your client receives will sometimes be 250 pages ish. And so we can't possibly cover everything that you might need to convey to your clients as a part of that review process. But we're going to hit sort of the top 12 issues. Then we're going to talk about some negotiation keys in terms of if you find things that you would like to try to negotiate with the franchisor, and I'm going to provide you with some resources at the end to assist you in this type of representation. Okay. So the role of franchisee council, this is the best analogy that I could come up with is sort of a race. And, you know, the race car drivers have a spotter in the stands who is looking from far distance, you know, kind of keeping them apprised of everything that's going on and telling them about things that might be coming that the driver can't see yet. And so that's you as the franchisee counsel are the spotter. Your job is to point out the flags, the risks, the major obstacles and the paths that appear clear to assist your driver or franchisee client in making decisions. You want to make sure that you're clear and concise, that you take that 250 page document and you turn it into bite sized information that your client can understand and and that you help your client look at some of the long range implications and things that might be applicable much later down the line with a big picture view in mind and and keeping the franchise laws in mind. Ultimately, the driver or the franchisee, your client is the one who's going to make the decisions. So you're not going to tell your client this is a good franchise or a bad franchise or buy this or don't buy this. You're just going to provide your client with the facts and the client is going to decide whether to slow down, step on the gas, take the high side or take the low side. You do, of course, as a part of the process, want to make sure that you provide due diligence, recommendations to your client and things that your client might need to to do some additional digging or get some additional information from other sources about. So the first part of the process is helping your client assess whether he or she would be a good franchisee at all in any franchise system. And so really what you're looking at is is talking to your client about how to assess. And again, the client's going to do the assessment. You're not going to decide whether franchising is right for the client. You're just going to help them sort of ask the questions. So you really are looking at the two big categories that you're balancing are an entrepreneurial, entrepreneurial spirit and the ability to take direction. And your client has to have a little bit of both of those things, both of those personality traits in order to be a good franchisee. From the entrepreneurial spirit perspective, of course, your client's going to be investing significant time and dollars into this business venture. You need to have a client who wants to own and operate a business, who's willing to train and direct staff, who accepts risk and who can support themselves while developing the franchise. On the other side, you are looking at having a client who can take direction because a franchise is going to have system rules and system standards. You're going to want to make sure your client has a personality where he or she doesn't have to always be right, but is more of a team player or a collaborator that they're willing to be inspected and share information. Because most good franchise systems, the ones who are going to provide the most value to your clients, are going to be collecting information from your clients in order to further develop the franchise system. So there's going to be a lot of interaction between the franchisor and franchisee, which can, for some personalities, come off as contentious. So most good franchise systems, for example, have a system of inspection where they are going to periodically inspect the the franchise operations and provide the franchisee with things to change or improve in order to better meet the system standards. That is a really good thing. But if if your client doesn't have the right personality, that can be seen as a negative thing. So you do want your client to be able to follow a system and follow the advertising requirements. And so if you have a client who goes through this assessment process and heavily leans one way or another, so maybe they're a little bit more entrepreneurial, for example, and they are really super creative, they may want to consider starting their own business from scratch, or they may want to find a really dig in and find a franchise system that's going to give them more flexibility or appreciate the creativity and the skill sets that the franchisee is bringing to the operation. So it's really kind of important as a starting place that your clients go through that exercise to evaluate whether franchising at all is appropriate for them and whether they need to be looking for a different type of franchise. In terms of the relationship between the franchisor and the franchisee. And so some practical considerations as you start to evaluate a particular franchise that your your client has brought to you. Keep in mind that there are thousands of franchise brands and more than a thousand of those franchise brands are very good brands. And so you want to advise your client not to settle. If the if there's something wrong in the the process where there's not a good fit, then it doesn't mean that that your client has to stop their dreams of becoming a franchisee or owning their own business. It just may mean that they need to shift gears and look at another opportunity. Keep in mind that this is going to be a long term relationship with a significant investment. There are typically going to be non-competition restrictions, and so you want to make sure that your client is really getting the best deal for the particular client and your client may want to look at competitors. You do want to be up front with your client that the evaluation process may indicate risk factors or red flags that warrant an addendum. And you would certainly want to offer to negotiate that addendum on behalf of your client. But keep in mind that not all franchisors will agree to an addendum. Many franchisors will take the position that they are not going to change anything for any franchisee ever. And so if that is the the if your client understands that up front and that you are going to point out risks and risk factors and you're going to try to assist them in negotiating an addendum, but that they they may ultimately not get an addendum and they may ultimately have to make a decision then, do I want this this franchise agreement, the way it stands, or do I want to look for something else? And so then your client also wants to you want to have your client assess whether they have a passion for the brand, because starting a business will even a business with a good set of system standards from the brand where lots of the thinking and discovering is sort of taken out of it, it's still going to be a lot of work and you don't want your client to find the work that he or she needs to put into the developing the brand in the market. You don't want that to become a drudgery for your client so that he or she is coming back to you in six months, in a year and saying, I want out of this. How do I get out? So you want your client to have some level of passion for the brand or respect for the brand. So that doesn't mean, for example, that if your client is purchasing a cleaning franchise, that your client personally loves to get down into the nitty gritty and clean. It just means that that your client has an appreciation and a and and a value values the particular brand and the the business. Something about the business that makes it unique. And you also want your client to assess whether they click with the people behind the brand and other franchisees. It doesn't mean that your client has to be best friends with everyone that he or she meets associated with the brand. But. The the benefit, the huge benefit of franchising is to have that set of people that that your client can go to and get answers to questions and have resources and have other people to share things and talk about unique circumstances and how to handle things. And so if there's not a comfort level, then it may mean that this particular brand doesn't mean that either the franchisee or the franchisor is bad, it just means it's not a good fit. And so you want your client to click with the people that are that he or she is going to be interacting with behind the brand. And at least some other franchisees are existing and former franchisees happy. So a big part of the due diligence process is making sure that your client this is not something that I typically do on behalf of my clients. I just give them the due diligence plan that your client has reached out to other franchisees. The franchise disclosure document will provide a list of all current franchisees in the brand and franchisees who left the brand in the last year. And so the there should be plenty of existing and former franchisees if it's an established brand for your franchisee to to reach out to and you want to make sure that they do take advantage of that and do that, your client wants to assess whether he or she will be able to earn a living with the brand. So does this brand is there the potential for this business to make money? For example, I had a client several years ago who was assessing purchasing a children's museum franchise, and the franchise was beautiful in many, many, many respects. The client was a parent of young children and thought this would be a perfect fit for their family. But working through the financials that were provided as a part of the franchise disclosure document, as well as financial information that she obtained from other franchisees, we just weren't given the real estate costs in the particular area where she was opening planning to open. We couldn't make it economically viable. We couldn't figure out how to make it not be a money pit. And so your client does want to do that assessment. Our other franchisees making money. Has your client built a forecast? Can the client earn a living after the franchise relationship ends? Keep in mind that there are likely to be non-competition restrictions of some kind, and the enforceability of those will vary from state to state, as we'll talk about in a few moments. So the next sort of initial consideration is you want to approach the review of the franchise with the franchise laws in mind. So we're going to just quickly sort of run through those laws. This is not a course that's designed to dig deep into the franchising laws, but I do want to give you sort of a quick overview. So of course, we have the Federal Trade Commission franchise rule, which is primarily a disclosure law, and then we have state registration and disclosure laws. And then we have state franchise relationship laws. So let's briefly take a look at those. The Federal Trade Commission Act franchise rule is found at 16 CFR parts 436 and 437. I've provided the link there to you to the FTC website where you can get the full text of the franchise rule, the franchise Rule Compliance Guide and amended franchise rule FAQs. And this federal rule, of course, applies in all 50 states. And then there will be some state laws that will provide additional protections that to the franchisee above and beyond those things that are provided in the federal rule. So first we have the state franchise registration laws. And in this chart I've provided the links to the websites for each of these franchise state franchise registration sites. Some of the sites let you obtain information online. Many of them do regarding the registration status of any particular franchise. Or you also will notice that certain of the states have dash next to them. And the that dash is an indicator that that state participates in the North American Securities Administrators Association franchise registry, which means that attorneys representing franchisors can use the franchise Electronic Filing Depository to register in the particular states where participation is allowed. And so that link there to the the EFD site is in the gray box at the bottom of the table. And you can check franchise registrations there as well. And so the state franchise laws and this is we're going to start with the group that are that have the franchise registration laws. And then we're going to go into other states that have franchise laws but not registration requirements. And this is just for your use. We're not going to sort of dig into detail about these things, but I've provided you with the the the applicable code sections for each of the states and a quick summary of the types of things that are addressed in the franchise laws. And don't sort of take this summary list as gold. If you have an issue in a particular state, make sure that you go to the code and that you look at the laws. Because when I put this summary together for the CLI, I may have missed something. And so you just want to want to dig into the law yourself and make sure that the types of things that may be covered in the law are actually listed. And so, again, there's this is we're starting with the franchise registration states here and then we have additional state franchise laws. So some of the these following states that are listed in red with the state names are not franchise registration states, but states that do have franchise relationship laws. And so some of these laws may be applicable to the particular issues that your client is having with respect to the franchise. And so, again, those are just for your use and you can dig into them as appropriate in each particular circumstance. So the next initial consideration is figuring out which of those array of laws is applicable. And so why do we want to know? We want to look at are there state law protections that may be applicable to the client down the road for misrepresentation, renewal rights, term rights and termination mechanisms for termination, discrimination and transfer issues? And that's knowing what laws apply is going to color the review process as you are presenting information to your clients. You're going to look at the registration and state addenda requirements. So if your client, for example, is located in one of those franchise registration states, you're going to want to make sure that the franchisor is actually registered in that registration state and has provided a a state addenda page for that registration state. Each of the franchise registration states does have particular requirements that that they require franchisors to provide to franchisees about a multitude of issues and citing to the state laws so that your client has some additional information about protections that may be available to him or her in the state. There also may be initial fee deferral requirements. So many of the registration states, particularly with younger or less well funded franchise systems, will impose an initial fee deferral requirement, meaning that your client may not have any obligation to pay anything until the franchise unit is up and running. Um, so we want to make sure that you know what those are and that your client has. If those fee deferrals are applicable to your client, that your client understands that and doesn't pay things that he or she doesn't need to pay before the franchisor meets its obligations. And you also want to keep in mind non-competition restrictions and their enforceability vary from state to state. So typically in a franchise system, what we will see, both the franchise owners are going to have some non-competition restrictions and there may be requirements that certain types of employees of the franchise are going to have to to enter into to certain non-disclosure or non-competition agreements. And the in the current climate non-competition the enforceability of employee in particular employee non-competition covenants is up in the air. The Federal Trade Commission has recently proposed a rule alteration which would make most employee non-compete covenants and unfair and deceptive trade practice. There are variations from state to state about what businesses, what types of non-competition restrictions businesses can enforce with their employees. And so you do want to make sure that your client understands what is being asked of from the franchisor to the franchisee, what the franchisee is going to be asked to do with respect to employees, and that the franchisee isn't going to be in trouble for that. Um, statute of limitations issues can also vary from state to state. For example, many franchise agreements include a clause that says something like The franchisee agrees that the statute of limitations for any breach of or anything in connection with the franchise agreement is one year or 18 months from the date the facts arose, something like that. There are states such as the state of Florida which automatically void those kind of changes to the statute of limitations in a contract case. And so you do want to know which laws are applicable. Um, so first, of course, you're looking at the provisions in the franchise disclosure document and the franchise agreement, the franchise disclosure document is going to on the first risk factor page, which is typically the second page in the FTD. It's going to, to typically have a risk factor that lists the applicable state laws. So if, for example, it says, you know, the the laws of Wisconsin apply to to this franchise and these laws may impose different rights or obligations than those rights in available in your state. And so you you want to know what the franchise disclosure document says with respect to the franchise agreement itself, the choice of law provisions are typically provided towards the end of the agreement in the the sections that are closest to the signature block at the end of of the franchise agreement itself. You also want to know. Where your clients are located. Where are the franchise will be located and what franchise territory will be granted and where the franchise is located. And so those factors may bring in the applicability of other laws other than the the the law that is dictated in the franchise agreement itself. And some of those laws may provide protections to your client regardless of the choice of law provision in the franchise agreement. You also want to know if any of these states are registration states and if the franchisor is indeed registered in any of these registration states. Okay, So here's just a quick example. So let's say your client is interested in an ABC commercial cleaning franchise and has formed XYZ Clean LLC, a limited liability company registered in the District of Columbia, which will have a commercial office located at one, two, three DuPont Circle, Washington, DC, and will provide commercial cleaning services in a territory that covers parts of Virginia and parts of Maryland. Joe, Bob and Bill are the owners of the entity. Joe and Bob live in Virginia, but Bill lives in Maryland. Which laws are at issue? So, of course, the District of Columbia is at issue. And then Virginia is at issue and Maryland is at issue. The District of Columbia does not have any franchise registration requirements, but both Virginia and Maryland do. And both Virginia and Maryland may impose fee deferral obligations on a franchise or. Okay. So we talked about in our initial considerations that even if your client is really set on a particular brand, even if your review of a particular brand ultimately turns out to be very positive, it may be beneficial to your client to review competitor brand franchise disclosure documents. So like back to that example we were talking about, about, um, ABC cleaning the ABC cleaning franchise. If your client reviews franchise disclosure documents of other franchise brands who operate in the area, your client, for example, might see what their advertising requirements are. So if Brand A imposes an advertising obligation of, you know, let's say $5,000 a month that franchisees are going to spend in advertiser raising and the brand you're looking your client is evaluating only has a $500 a month advertising requirement. And there may be a big disparity there in your your client may need to adjust his or her budget to meet the um, advertising or to scale up the advertising so that he or she has has enough recognition to to get some of the market share from that competitor. So some of those things can be really helpful. You can look at the item 19 disclosures in other competitor brands to give your client a sense for what other competitors are doing in terms of profitability or gross revenues, whatever may be disclosed in those disclosure documents. So so some quick ways that you can find disclosure documents online for free without your client having to apply to the competitor brand. Um, you can go to that NASA electronic filing depository site that we talked about. And check there. You can check with the state of California, Indiana, Minnesota and Wisconsin. So all of these registration states, if a client is if a franchise brand is registered in one of these registration states, then they the states make the franchise disclosure documents publicly available online. So you can click the links here provided in the slide and go and check it out. Do keep in mind that in searching in the state of California, you do have to search by the franchisors legal entity name, which may not be the same as the brand name. So, for example, the the brand name may be 1 to 3 Holdings LLC and mean the the legal name may be 1 to 3 Holdings LLC, while that brand name is ABC Cleaning. So you may need to look at the competitor brands trademark registrations with the USPTO and find out the Or at their their website and find out the legal entity name of the franchise or. Okay, so let's dive into those 12 considerations that are the primary issues we are going to evaluate for our franchisee. So the first thing, of course, is we are going to assess the franchisor and the brand and the reputation of the franchisor and the brand. So item one of the franchise disclosure document is going to give us the legal name, the parents and any affiliates who are providing sales or services to franchisees. And so we're going to run those all of those entities and names and affiliates and parents through our legal research provider system and and sort of see what's out there. We're going to look at I always send a request to the American Bar Association forum on Franchising list serve. The other attorneys who participate in the forum on franchising are amazing in terms of the camaraderie that they provide to other franchise attorneys and information that they will share. And so if I'm assessing a brand that I haven't evaluated before or haven't evaluated in a while, I will send out a request to the Forum on Franchising Listserv and ask about the brand. If the brand is part of a, you know, a private equity group that owns a number of brands, I might ask about the group and the other brands that are are sort of sister or brother brands to the brand our client is considering and see what information that we get. Because even if there isn't anything. In the franchise disclosure document itself. So there's no litigation that's required to be disclosed in item three or bankruptcy information required to be disclosed in item four. There may be other things or issues that exist out there in the nethersphere. So we want to look at evaluating all of the the folks that are listed sort of behind the brand, the officers and directors of the franchisor, as well as the entities that are associated with the brand as well. You want to look at are the officers and directors that are listed. Have they been with the brand for a long term? Do they have industry experience? Does it look like there is adequate support for the franchise system? So I'll give you an example. I evaluated a brand a number of years ago for a client who was looking to purchase a microbrewery franchise and the the particular client had some experience sort of operating as a brewer, had studied in that area. And I forget what their their degrees or education are called, but had worked in the area and studied in the area and really wanted to acquire this franchise. But when we dug into the brand, there were no persons listed in the disclosure document with any experience in brewing. And so this was a microbrewery franchise, but there was no no experience depth at the franchise or because the franchise brand had recently been acquired by a private equity group and they were just running it. So so ultimately that coupled with some other things, led my client to make a decision not to invest in the franchise brand, but to put the same amount of money into getting a restaurant consultant and developing his own concept since he had a background in brewing beer. And so it could be, you know, doing that assessment of who who's listed in the franchise disclosure document is more than just have these people been involved in litigation. But what is it that they are doing for the brand and what is their experience base? You want to, of course, also assess the litigation and bankruptcy item three and item four, require all of those entities and person individuals that we have talked about in item one and item two, they if any of those folks have been involved in litigation that includes an allegation of fraud, misrepresentation or a violation of the franchise laws in the last ten years, then that has to be disclosed, disclosed in the franchise disclosure document. Additionally, if any of those entities or folks have been have filed bankruptcy in the last ten years, that has to be disclosed in the disclosure document. So of course, you want to look at those things and you also want to look at the experience of the franchisor. So again, we're looking at item one tells us when this franchisor started franchising, Item 20 is going to give us sort of how many franchises, how many units are operating under the brand, both franchise units and units affiliated with the franchisor? And what is the growth history or loss of unit history over the last three years within the brand? So we really want to look at the experience of the franchisor. Have they been growing steadily? Have they been involved in this area for a significant amount of time? Um, and then I always like to look at the International Franchise Association and the link there is available to [email protected]. And most serious franchise systems belong to the International Franchise Association. It is a voluntary organization. It is expensive. Franchise owners have to pay several thousand dollars a year to participate in it, but those who are willing to invest in that are typically investing in the franchise system. They're looking for ways to do things better and to grow the brand rather than just sort of put franchise fees in their pockets. I also always want to look at who represents the franchisor. So I typically look up the franchise registrations and figure out who's representing the brand so I can have an understanding about whether they have good franchise counsel. If the the the franchise brand is represented by competent franchise counsel, then we are much more likely to have a good relationship long term than if you have a franchisor who doesn't have a full grasp of the franchise laws. I also like to run a separate litigation search separate from the information that's disclosed in item three and check the web. I check the unhappy franchisee. I just look at what comes up in search engine results then. And of course, we've already talked about making sure that you check with the the other franchise counsel on the forum on franchising and Listserv. Um, okay, so issue number two, assessing the marks. So typically the marks, you know, the the the primary mark for the brand is going to be disclosed on the on the cover page of the franchise disclosure document. And then any trademark registrations are going to be identified in item 13. And of course also your franchisors website is going to display the the franchise marks. So what are the marks? And then, of course, we want to look at are the marks unique or are they merely descriptive? So if we go back to that example that we talked about with the evaluation of the Microbrewery franchise, um, and I'm just going to sort of tweak this slightly because I don't want to talk about a brand directly, but so this franchise was had a very descriptive trademark. Um, so let's say it was like, um, Microbrew America. Um, and so you can't really own the word microbrew and you can't really own the word America. So there wasn't a lot of trademark protection there at all for this client as they're sort of developing. And if this client had bought the brand and developed a Microbrew America location and I opened right next door to them with Sarasota microbrew. Um, you couldn't make me change my name. So, you know, the, the, um, or if opened right next to them with USA microbrew, you couldn't make me change my name. And so the if the trademark protection, if the trade if the mark at issue is merely a descriptive, a descriptive mark, then your client's not getting a lot in terms of brand recognition or brand protection. Um, so I do typically, even if the item 13 indicates that there are in fact trademark registrations and that they are in fact in good standing, I always do a separate check because I cannot tell you the number of times I have found that that is incorrect. So you go to the Uspto.gov. I have a screenshot on here showing you if you just sort of hover over the second tab, the trademark tab, then you'll get that dropdown menu and then you can click you see in the second line of items, the searching trademark is the top blue link. If you click there, you can type in the word mark and see what comes up. What other marks are out there that have similar names? For example, if I type if we go back to that Microbrew America and I type in microbrew, I can see what else comes up with that in the terminology. In terms of registrations. You also can go over if you look at all the way over to the right hand side and the white box, there is a link there that says check application status. Tsr If you click that link, you can that will take you right to the the section of the USPTO site where you can enter the registration number listed in item 13 and you can check to see what the registration status is. I have had cases where the FTC says there is a registered trademark, but the number that's listed there is not in fact a registration number, but is rather a serial number for an application. And upon review of that TSR, the application for that particular mark found that the USPTO had in fact entered a final, final office action refusing to grant registration because of the likelihood of confusing confusion with an existing trademark. So you really do want to double check those things so you can give your client some assessment of the the brand itself. Um, you want to look at what other marks are similar, both here at the USPTO and doing a just a, you know, an online search. Um, and of course you want to check the Secretary of State website for your client's area because trademark rights in the United States are established by use in commerce, not necessarily by registration. So if, for example, I have a franchise brand that I obtain a registration in 2023 and it appears like it's a a valid registration, the mark appears like it's a strong mark. Um, but. There's someone operating maybe way far away from me, let's say on the West Coast. I'm on the East Coast and they're operating in a particular area with a business of the same name. And maybe they're not franchising, so they haven't thought, you know, or aren't looking to expand. So they haven't thought to obtain a trademark registration. But they've been operating for 20 years with the same name. So even though my brand looks to be like it has trademark protections, if your client is going to open a franchise location in the market where that other brand has been operating for 20 years, we can't make them change their name. And the other brand may be able to stop your client from coming in and using the brand in that area. So I do always want to make sure that I've double checked the Secretary of State website for any key terms that are similar to the trademark at issue. Okay. Assisting the client in assessing the potential for profit. Issue number three. And we're going to have to sort of speed up here a little bit because I'm kind of behind schedule. But if you look at item 19, the general rule under those franchise laws that we talked about is that unless a financial performance representation, that's information about the profit profitability of any unit in the brand or the potential for profit of a franchise applicant, unless that financial performance representation is included in item 19 of the franchise disclosure document, the franchisor cannot make the financial performance representation even if it's true and accurate. There are some exceptions to that. Of course, if a franchisee is, for example, purchasing an existing unit, then information about that existing unit can be provided. But in general, when a client is purchasing a franchise, the first place to look for information about gross revenues or profits is the item 19. There. The franchisor does not have to provide a financial performance representation in item 19. And what can be included in item 19 can mean there are no there are rules on. If you include certain things, then you and must include these other things or you must present it in this manner. But there's no requirement that a franchisor present certain information. So for example, if I have the franchise brand, I as the franchisor could present just gross revenues or I could present average and median gross revenues telling you how many franchisees met or exceeded these revenue numbers. And then you would have your client would have no information on costs and how those gross revenues translate down into dollars ultimately in the pocket book. So you want to check item 19 first for financial information and then some tricky things with item 19. You want to double check it against the franchisor audited financial statements. So the audited financial statements should tell you from the auditor's perspective how many franchise units were in the the the franchise at the close of the last fiscal year? And so if that number is different from what's presented in item 19, what the information you know, the franchisor is going to be required if they include a financial performance representation to tell you what that representation is based upon. So you want to to look at are there. Are there differences? So, for example, does item 19 say this is based on 50 franchise units? But the franchise audit said there were 100 franchise units. What's the difference? You also want to check it against the numbers in item 20. So what I have had happen, particularly in service based franchises that don't operate from a fixed location, is that you might have a franchisee. Who has or a lot of franchisees who have multiple franchises. And then the information in item 19 is presented based on the franchisee, not on the location. So item 20 says, for example, we've got 100 franchise units and item 19 says that the the information is based on 50 the 50 franchisees. Well, if most of those franchisees are own three or 4 or 5 units and your client is purchasing one unit, then the numbers may mean nothing. They may not be applicable at all. So you do want to double check the information in that manner. You also want to again refer to competitor franchise disclosure documents and see what kind of financial information they are given. And then, of course, you want to reach out, have your client reach out. Two other franchisees. There is nothing that prevents a franchisee with sharing information that is not included in the franchise laws. Item 19. So check item 20 or an exhibit to the franchise disclosure document for information about those other franchisees. You also want to double check when we're talking about potential for profit. You want to double check item 16 restrictions on what the franchisee can sell. So, for example, if I am purchasing a. Let's say a, um, cleaning franchise for residential cleaning. And I have some experience also doing, um, doing deck resurfacing. And I anticipate that I want to sort of add that as an add on, um, that some clients, you know, if we go to their home to do their cleaning, we may see that their deck needs to be resurfaced or re stained. And I want to offer that I may not be able to offer that service if it's not a part of the system standards. And so if your client has some expectation of additional revenue coming in from an ancillary service, the client needs to make sure that the the franchise agreement is going to allow for that ancillary service. Um, okay, so again, you're looking at the initial cost. Um, you want to check item five? These are the costs that are paid to the franchisor or affiliate and item seven, the initial startup costs. And then of course, we want to look at ongoing costs in item six, items eight and item 11. A lot of times I see in that in a franchise disclosure document, there is no reference in item 6 or 7. Those initial tables with cost information to third party software costs. But then we get down to item eight where we're looking at the computer system and there's a requirement that, you know, maybe the client is going to be expected to pay $500 a month for software to a third party software provider. So you do want to double check all of those places and make sure that the Item 11 also has some computer information included in it. And so you want to make sure that you you get go dig through that franchise disclosure document and dig out all the costs to make sure your client has included them in their forecast or financial evaluation. Okay. Issue for territory considerations. We want to look at item 12 of the franchise disclosure document is generally going to tell us how a territory is granted and whether the franchise is being awarded on a Territory basis. For example, I have the right to service this particular territory or a location basis, meaning that I am only going to be granted the right to operate from a particular approved location and then I may have some protected territory rights around that location. Keep in mind that an exclusive territory is very rare in today's world because the franchisor typically makes several sort of hold back reservations. These are typically common. For example, if you have a restaurant that has a particular secret sauce, your franchisor may reserve the right to sell that secret sauce in bottles at your local grocery store or to sell products online. And your franchisor typically reserves rights to non-traditional venues like stadiums or airports and may reserve rights to non-national accounts. You also want to look at the territory restrictions. And keep in mind a couple of things that are particular to territory. First, in today's world, particularly in the restaurant industry, when we had all of the restrictions in response to Covid 19. You had restaurants who are allowed to do nothing but delivery. And so we really had an increase in the popularity of third party applications and delivery services like DoorDash, Uber Eats, GrubHub. And that the the service areas for those apps may differ significantly from the territory that is at that your client has at issue. And so we want to make sure that in today's world that your client has the ability. To do everything that we anticipate this business doing in a territory. So let's say, for example, we have an entertainment franchise of some kind that's going to operate from an approved location, but they're also going to do outside events like maybe where they go to a corporate location or a home and do the same sort of entertainment service of some kind. So the we want to make sure that the territory granted is large enough that your client can go to everywhere he or she anticipates going to. For those outside event operations, we want to make sure your client has marketing rights in a marketing territory that is large enough to actually support the franchise unit. And of course, we want to make sure that the. Uh, franchisors rights to service or assign service inside the territory are very, very limited. And assessing renewal rights. This is another area where you do want to make sure you understand the state franchise law protections. Some states, even non-registration states, have some particular renewal protections, meaning when a franchisor has rights to refuse to grant your client a renewed franchise. So we want to look at those state law issues for renewal. We want to know what the renewal fee is, what the conditions of renewal are and obligations that your client will have on renewal. Typically, a renewal fee is very small in comparison to the franchise fee. So, for example, if you have an initial franchise fee of $50,000, I would expect that the renewal fee would be less than $7,000. So maybe five, maybe two. But it typically would not expect a renewal fee to be anywhere near the same as the initial franchise fee. The franchisor is not retraining anyone. The business is just going to continue as usual, as usual. But you do want to know what what obligations your franchisee client may have on renewal. Are they going to be required to rebrand the entire location? So these are I have some examples down here of some problems that I have recently seen with respect to territory, with respect to renewal rights. One was I saw a provision recently that says you agree to our redefinition of the primary area, which will apply during the term of the successor franchise. If my client is purchasing a territory, my client is purchasing the territory. We are not going to agree that a renewal that the franchisor has the right to take away, that some of that territory. Um. You paid to us a successor franchise fee in the amount of our then current franchise fee. That is just crazy. It's not industry standard, and I wouldn't agree to it. Um, you may be entitled to up to two successor terms. That is a really common provision because a franchisor doesn't want to be, doesn't want to be seen as being obligated to continue operating franchise or offering franchises. But I typically ask for. Um, a revision of something that says as long as the franchisor is continuing to offer franchises and the franchisee meets the, the franchisors standards, that the franchisee would have a right to a successor term. Okay, So those state laws that have some renewal rights are provided here for you and they are color coded. The orange ones are registration states, the red ones are non registration states. And the the particularities vary from state to state. But in general, in these states, a franchisor must have good cause not to renew and must provide notice of non renewal. Um, issue number six, Assessing transfer rights. Your franchise, you're going to look at rights of first refusal that the franchisor has. What are the transfer fees? What are their conditions of approval? Franchisee obligations on transfer. You want to watch for a requirement that the franchisee may be required to guarantee the successor or the the buyer's franchise for the balance of the term. Sometimes those terms are included and don't generally like them. Does the buyer get a new term or is the buyer only going to get the balance of the franchisees term? This can affect when your client wants to plan to sell. Does the buyer inherit the franchisees requirements like performance requirements? Is there a requirement to pay brokerage fees? And of course, again, we want to look at any of those state law protections for transfers. Here again is a quick summary of the states that have some transfer law protections. Again. Registration states are orange, Non-registration states are red. You want to look at the typically these laws provide notice requirements for franchisees that your client may have an obligation to tell the franchisor when a certain amount of time about the transfer or the potential transfer that the franchisor has response times and must provide reasons for approval or disapproval. And then some of these states restrict releases as a condition of transfer. And some of these states include things that the franchisor can't refuse. If the franchise if the transferee meets the requirements and we'll assume assume the obligations of the exiting franchisee. Indemnification. This is a big area. So typically a key provision in most franchise agreements is indemnification. It's standard. I've never seen a franchise agreement that didn't require the franchisee to provide some indemnification to the franchise or that's absolutely commercially reasonable that if I have a hole in the middle of my entryway to my store, I am sure that is not part of the system standards. And if a customer trips on that hole, I am going to be obligated to indemnify the franchisor. So we get that sort of premises liability concept. But there are some things that in a broadly worded indemnification provision, your franchisee may have obligations related to indemnification, but no control over what happens. So a big thing right now is the website. Typically in most franchise agreements, the franchisor controls the website. There is a lot of litigation right now in two areas. One is. And that is a typo there. It should c add a. Americans with Disabilities Act, accessibility, accessibility. And then the second is intellectual property infringement. If the franchisor is controlling the website, your client, the franchisee, may be sued in relation to one of these claims, but not have any actual control over the website itself. So I would typically ask the franchisor to indemnify the franchisee for those issues. The next one is gift card programs, many franchisors. Have a gift card program where the franchisor controls the gift card funds in that. In such a case, the franchisee would have no ability to. Um. They may have responsibility for state. Escheat or abandoned property laws. And the the franchisee might not have an ability to comply with those. And so I would typically ask the franchisor to take that responsibility and customer liability for, for the gift cards. Um, so that's another area that would typically exclude from indemnification and ask for a reverse indemnification. The next is the point of sale system and credit card processing. If these systems and the credit card processing press processor are dictated by the franchisor, um, then and the franchisee is complying with the system standards and the vendor requirements, then if there is a breach of some kind, a breach of the privacy laws or liability for some sort of cyber breach, your franchisee could be liable but not actually have an ability to do anything about it. Okay. So some sample, um, indemnification modifications. These just are just a sample modification like we just talked about of those three issues, tax provisions. If your, your franchisee, you want to make sure is not responsible for the franchisors revenue taxes. So if the franchisor operates in the state of Florida, for example, that doesn't have income tax and then the the franchisee is operating in a state that does have income tax, there could be a possibility that the franchisee based state might claim entitlement to taxes on the royalties paid from the franchisee to the franchisor. But we certainly want that to be the franchisors responsibility, not the franchisees responsibility. Okay. Liens and encumbrances. Many times there are provisions that. Um, make blanket statements like you will not assign, pledge or encumber this agreement, the franchise or the franchise business. And those are are fine in terms of you. Your client should expect that he or she can't sell or transfer the business without the franchisors consent. But many times your franchisee is expecting to get commercial lending as a part of the startup process. And so we want to make sure that your client has rights to do that. So again, watch for those provisions against encumbering anything. And you also want to look for any provisions that grant a security interest to the franchisor when there is a security interest granted to the franchisor. We want to make sure if your client is going to have financing, that that happens in the correct priority so it doesn't interfere with that financing. Non-competition covenants. Again, this is an area that you really does vary from state to state. An excellent resource is the American Bar Association has a book, a publication called Covenants Against Competition in Franchise Agreements. I believe it's still in its fourth edition. And you want to double check, um, applicability of any of those non-competition covenants and the enforceability in your client's particular jurisdiction. I did did include an example here of a really broad problematic definition. So there was a. Covenant Against Competition, participating in a competitive business during the term of the franchise or after the franchise. And this particular franchise was like a coffee shop kind of franchise. But the competitive business was defined as any store coffee or tea shop or cafe or restaurant or cafe business or service that offers or sells coffee or tea or products and related merchandise for onsite on site consumption or retail sale. So you can see how. This this client, This was a very problematic clause because the client that I had was building an entire shopping center and was going to put this cafe in one location in his shopping center. But now he's restricted from having a restaurant that might sell coffee or tea. That's crazy. So it's drafted way too broadly, and you may need to work with the franchisor to negotiate a revised definition that makes more sense. Future royalties. The we have liquidated damages. Early termination fee and obligations on termination. Keep in mind that depending on the jurisdiction. Future royalties may be available even if there is not a liquidated damages or early termination fee clause. And so I typically ask in the event of closure of the franchise business and provided the franchisee complies with all other post termination obligations, franchisees shall not be obligated to pay any future royalties or minimum royalties from the date of closure for. Um, okay. And we've talked a little bit about item 20, so I'll just sort of rush through there because we're kind of out of time. Um, negotiation keys. If you are negotiating with the franchisor, keep in mind that some franchisors will not negotiate at all. Um, you have more negotiating power with new emerging to medium sized franchise systems. You have more negotiating power with systems who are losing units and or growing slowly. Um, you want to draft the proposed addendum before discussing with the franchisor? Because it's really easy for the franchisor to say, no, we're not going to negotiate versus looking at the language that you drafted and understanding, Okay, that's a really reasonable request. I understand the reason behind it. We'll get our legal counsel to look it over and approve it. You want to choose only a handful of the most critical issues to address. Do not attempt to change everything that's in the franchise agreement. It will only result in a big no, and you want to draft the modifications in a fair manner, recognizing the franchise owners concerns. Some resources to leave you with. Resources from the American Bar Association Forum on Franchising. I could not live without this group. Resources Sources from the International Franchise Association, the North American Securities Administrators Association that we talked about throughout the presentation. The United States Patent and Trademark Office. And then, of course, all of those federal and state statutes and regulations that we discussed. Thank you very much for your time today. And if you need to reach out to me regarding any questions, please feel free to do so. I am available through email, [email protected].

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