In our last post, we examined some of the types of risk that come with growth. In this post, we discuss some forms of diligence that may be used to better manage that risk.

Diligence on Legal Matters

Are there operating hour ordinances that might affect the business? How about limitations on operating hours or days by the landlord? For foreign expansion, the inquiry is whether it is even legal to sell the goods and services in the foreign market. In the Middle East, not every country allows pork or alcohol products to be sold.

Tradenames and trademark protection are essential, but do you know if there are similar names or businesses already in the market that will confuse your customers? Do prior users exist which could create a threat to your brand? In foreign countries, you need to know whether the name is available for protection and whether it must be registered before selling a franchise.

Does the new territory have different rules on regulation or disclosure? Are there local laws which require disclosures, require registrations, require preapproval of advertising, or permit rescission in the absence of compliance?  U.S. franchisors probably know the national rules, or can acquaint themselves easily with local counsel to learn the rules, but going cross-border requires local knowledge. One needs to know whether the local country franchise laws require or exempt registration, or approval, prior to offering a franchise. Jurisdictions which have special franchise laws often will require mandatory disclosures, or a “quiet period” between offer and acceptance.

The local rules on termination and renewal need to be explored. Some jurisdictions require franchises to be “evergreen” such that they never expire under the law until the franchisee commit a material breach. Some jurisdictions allow termination but require buy backs from the franchisee of inventory, or some type of compensation. Some jurisdictions allow enforcement of restrictive covenants and others invalidate the restrictions as anticompetitive. In some foreign countries, preregistration of intellectual property is required, and the property reverts to the franchisee after a period of operation. Mitigation of these risks need to be baked into the deal from the outset.

Reputational Due Diligence

A frequently overlooked aspect to development is whether the addition of this geography and operator (that is, franchisee) improve the reputation of the brand. One might first start by measuring a baseline of the reputation of the brand, then examining the reputation of the folks who are intended to help you expand the brand. News sources, media and social media sites associated with the shareholders, principals and officers should be reviewed. References should be requested and should be checked. In foreign countries, that might require the use of a translator and/or local investigator. Again, care needs to be taken that even the investigator complies with local laws–including privacy laws, which can be much more restrictive than at home in the U.S.

Financial Due Diligence

In the U.S., we can rely on credit reports, criminal records searches, and electronic searches. Cross-border, data and privacy laws create barriers to common search methods used in the US. The foreign search tasks will take longer and will require more cooperation from the prospect. Foreign data is difficult to assemble and may not be as robust even when it is available.

In conclusion, expansion always requires acceptance of risk, with its many considerations such as taxes, dispute resolution, the cost of compliance and serious consideration of governing law. Expert advice should also be sought when traveling into the unknown.

Growth can be expensive, but it is always more expensive when the expansion is taken without risk assessment. Whether domestic or foreign, many risks can be reduced or avoided by proper consideration of differences between where you are now, and where you want to go.

For illustration, the examples here will be for foreign expansion, but the same issues confront domestic expansion as well.

Many factors need to be taken into account in new territories. National chains offer localized products in particular territories. A hamburger franchisor offers biscuits in the South, and lobster rolls in the Northeast, and chili peppers on everything in New Mexico, even with all of its hamburger options. What are the consumer preferences in the new frontier or for Generation Z–which is bigger than either the Boomers or the Millennials?

Now imagine going global. In India, the hamburger giants need to remake their signature sandwiches because cows are sacred. In addition, the packaging must reflect at a distance whether the contents are vegetarian. Church’s Chicken is understandably called Texas Chicken in the Middle East to avoid offending the majority populations.

Logistics must insure that the quality and availability of the products is reliable, and the look and feel of the retail outlet reflects the brand. Brands need to insure the availability of products, fixtures, supplies and equipment. The goal is instant recognition of the brand. Freshness and quality is essential. You do not need headline risk if your food is not wholesome. Think of the baby formula scandals in China that resulted in global headlines.

In comparing risks to rewards, your ultimate goal is to generate more revenue and promote awareness of the brand. But what sort of investment do you need to incur before those goals are realized. Growth is never cheap and cheap growth is never good. You need to know the growth is suitable and sustainable.

What are the critical the legal and business issues you should be considering?  We’ll discuss those in our next post.

The Fox Rothschild associate team of Megan Center and Alex Radus recently gave a presentation at the International Franchise Expo in New York City on the “Top Ten Provisions to ‘Never’ Negotiate in a Franchise Agreement”.  We have prepared a summary of this presentation in four separate blog posts.  The first post focused on central themes of franchise negotiation, the second post addressed protecting the confidentiality of franchise negotiations, and the third post addressed the first five of our top ten provisions.

This last installment details the second set of our top ten provisions to “never” negotiate.

1)  Changing Marks/Renovations/Upgrades

  • Typical Provision:  Franchisors can require franchisees to update and renovate their units, as well as upgrade furniture, fixtures and equipment, at any time during the franchise relationship. This also includes franchisors’ rights to change their marks.
  • Franchisee Argument:  Franchisees want to limit uncertainty in their financial obligations.  Depending on the circumstances, they may request a spending cap, reimbursement from the franchisor, and a grace period while they ramp up when they will not be obligated to spend more.  Franchisees may request additional concessions with respect to new marks, because they will be helping build goodwill from day one.
  • Franchisor Argument:  Franchisors have weighed the liabilities they may incur in connection with the franchise agreement and priced the initial franchise fee because of that analysis. Shifting any additional liabilities on franchisors skews this analysis. This practice can be extremely expensive even if granted this for one franchisee. Renovations and upgrades will likely benefit the unit by modernizing the unit and keeping up with customer preferences. Customers could be turned off by a stagnant brand. Franchisors need to ensure consistent experience from the brand across the board.
  • Compromise:  Franchisors can agree to a maximum expenditure during the term of the franchise agreement. Franchisors can agree to not impose this requirement during the first few years of the term of the franchise agreement. Franchisors can also agree to provide franchisees with a certain credit against its local advertising requirement depending upon the expenditure.

2)  Termination/Cure Period

  • Typical Provision:  Franchisors can terminate the franchise relationship for a whole host of reasons. These reasons, or defaults, commonly fall into curable defaults and non-curable defaults.
  • Franchisee Argument:  Franchisees will seek to de-risk their investment by requiring notice of violations and period in which to cure, with extensions if they are attempting to cure.  Franchisees will be especially sensitive to the possibility of losing their business due to “technical violations” or cross-defaults (i.e., breach of agreements other than the franchise agreement).
  • Franchisor Argument:  Some defaults of the Franchise Agreement are so egregious that they cannot be cured. These types of defaults attack the heart of the franchise relationship and are likely irreparable. While there may be required revisions based on state law, these provisions are drafted with particular precision and attention.
  • Compromise: Our first bit of advice to lighten the situation is to blame the lawyer! Termination rights are impactful and drive franchisor outcomes. Franchisor counsel understandably spends significant time and energy focusing on this section of the franchise agreement and that is why it can be so voluminous. If a franchisee has concerns about a specific event of default, the franchisee and franchisor can deal with each in turn.

3)  Indemnification

  • Typical Provision:  Franchisees are required to indemnify franchisors for any claims or losses that franchisors incur in connection with that franchisee’s operation of its franchised unit.
  • Franchisee Argument:  Franchisees seeking parity will ask for the franchisor to indemnify them.  They will argue this is fair due to the risk that they could face litigation based on the franchisor’s acts and omissions.
  • Franchisor Argument:  This practice can be extremely expensive even if granted for one franchisee. Franchisors’ time and resources are better spent further developing the franchise system instead of reimbursing franchisees for or defending lawsuits against franchisees, many of which can be frivolous.
  • Compromise:  Franchisors can agree to indemnify a franchisee for any suits related to trademark infringement if the franchisee was using the trademarks in accordance with the franchisor’s standards and specifications. Additionally, franchisors can agree to indemnify their franchisees if such claims are directly caused by franchisors’ willful misconduct or gross negligence. That way, franchisees will get a bit of comfort that they will not have to pay for claims arising from certain of franchisors’ actions.

4)   Assignment

  • Typical Provision:  Franchisors can freely assign their rights under the franchise agreements without obtaining franchisees’ consent.
  • Franchisee Argument:  Franchising is a relationship-driven business model.  Franchisees invest not only on the strength of the system, but also because they believe in the management team’s ability to grow the system and support their franchisees.  Franchisees may seek to restrict founder’s and management’s ability to exit the system, including approval rights over assignment.
  • Franchisor Argument:  Franchisors are unable to predict every future business opportunity they may encounter. Franchisor founders need to ensure an exit strategy. Franchisors cannot restrict the sale of the entire franchise system because one franchisee objects. The ultimate acquisition by a larger franchise system, even if competing, could increase efficiencies and levels of support of the underlying brand.
  • Compromise:  Franchisors can agree to only assign the franchise agreement to third parties that agree to assume the responsibilities and obligations underlying the Franchise Agreement. Franchisors will be required to do this regardless and it will give franchisees a bit more comfort in a sale situation.

5)  Personal Guaranty

  • Typical Provision:  All of franchisee’s owners and each owner’s spouse must sign a personal guaranty making each individual personally liable for, and personally bound by, the terms and covenants in the Franchise Agreement.
  • Franchisee Argument:  More than nearly any other provision, the personal guarantee will keep franchisee’s up at night.  For obvious reasons, they will not want their or their spouse’s personal assets at stake.  They may argue that, like other investments and business ventures, their risk should be limited to their contributed capital.
  • Franchisor Argument:  Franchisors are entering into this relationship with the expectation for a relationship of a certain duration and the expectation of a royalty and advertising fund revenue stream. Franchisors expend significant costs and expenses in assisting a franchisee with opening its franchised unit. The use of the personal guaranty ensures that the franchisee has some skin in the game and franchisors are not left chasing shell entities. The personal guaranty risk is part of the analysis a franchisee has to take in connection with the operation of its independent business.
  • Compromise:  Generally, franchisors can agree to waive the requirement for a non-owner spouse to sign a personal guaranty so long as the spouse signs a confidentiality and non-compete agreement. If the franchisee candidate is someone a franchisor strongly desires to have in the system, the franchisor can impose limits on time and amount of money it can obtain against the franchisee. However, any concessions that are granted in connection with the initial franchise agreement should lapse with any renewal franchise agreement or purchase of additional units because the uncertainty of the relationship is removed from the equation.

We hope you have enjoyed this recap of our presentation and found the information helpful and insightful. Please do not hesitate to reach out to us with any questions about this series of blog posts.

My esteemed colleague Tami McKnew today filed the following comment on the NLRB proposed joint employer rulemaking, 83 FR 46681:

The proposed rule specifically acknowledges the effects of the 2015 shift in joint employer analysis evident in the Board’s decision in Browning-Ferris Industries, 362 NLRB No. 186 (“Browning-Ferris”). Following the Browning-Ferris decision, franchisors, temporary employment firms, contract employers and others whose businesses necessitate some degree of interaction with and arguable control over non-employed workers found themselves as joint employers, despite decades of precedent otherwise. The effect on such businesses was immediate and profound.

With this proposed rulemaking the NLRB more clearly defines the conditions under which joint employment may be evident, and largely restores the pre-Browning-Ferris analytical framework. This is entirely appropriate, given the decades of business relationships and industries whose very structure incorporated and depended upon the prior established analytical framework. As recognized in the Notice, the proposed rule also reflects the pre-Browning-Ferris well-established and long-standing joint employment analytical framework.

However, that the Notice fails to adequately address, by specific acknowledgement or by example, the concerns of licensors and licensees of intellectual property, in particular patent, trademark or service mark licensors. Owners of such intellectual property rights must police and protect those rights; failure to do so may render such rights unenforceable. In legal jurisprudence, a patent owner’s policing obligations have been whittled down, especially given the elimination of a laches defense in infringement actions, SGA Hygiene Products Aktiebolag v. First Quality Baby Products, 137 S.Ct. 954 (2017), but affirmative action must be undertaken by the licensor to protect against infringement. The policing obligation remains for trademark owners, however. 15 U.S.C. §1064(5)(A).

Patent and trademark owners may license rights to practice patented technology or use trademarks or service marks. Such licenses require the licensee to abide by standards and/or to adhere to particular practices. Certain types of patents, for instance, process or method patents, may dictate an entire process and all the operations required to perform the method or process; the licensee has little or no choice as to the operations governed by the patent license.

Similarly, trademark or service mark licenses may dictate extensive quality control standards, processes and procedures. The most obvious example is the central role that trademark and service mark licensing have in a franchise system. But such licenses are not limited to the franchise industry. A dealer or distributor may sell products bearing the trademarks of one or more licensors; it may service products pursuant to licenses from different licensors; and it may lease products under license from yet a third licensor. The scenario is not unlikely. A tire dealer may be licensed to sell multiple brands; it may be licensed to provide recapping services, as directed in the license, by a different licensor; it may lease products under the service marks of yet a third licensor. Each of the licenses will include mandated procedures and operations over which the dealer has no control.

In each of these cases, control over significant operations in the licensee’s business is dictated by the licensor. Will the efforts of the licensors to police and enforce the licensed rights expose them to the risk of being considered the joint employer of the licensee’s employees whose employment is to perform such operations? And for a licensee who holds licenses from multiple licensors, as in the distribution example above, are multiple licensors potential joint employers? In each situation, the licensor can be said to offer “direct and immediate” control over the licensee’s employees, in that the licensor dictates the operations that form the central part of their employment. The ability of an owner of intellectual property to reap the potential financial benefits of a patent or trademark/service mark is ephemeral at best if enforcing those rights exposes one to the risk of becoming a joint employer of the licensee’s employees. More importantly in the context of the NLRB’s proposed rulemaking, it makes little sense to include such licensors at the bargaining table. Absent specific recognition in the proposed rule of the unique position of intellectual property licensors and licensees, the application of the joint employer analysis is unclear.

I respectfully suggest amending the proposed rule to include language which provides that the status of joint employment is inappropriate based solely on a licensor’s policing or enforcement of its patent, trademark or service mark requirements and standards. Intellectual property owners should not be dissuaded from enforcing their rights to control, police and enforce their patent, trademark or service mark rights.

Note:  Comments were originally due November 14th, but that deadline has been extended to December 13, 2018. See 83 FR 55329.

The Fox Rothschild associate team of Megan Center and Alex Radus recently gave a presentation at the International Franchise Expo in New York City on the “Top Ten Provisions to ‘Never’ Negotiate in a Franchise Agreement”. A summary of this presentation will be prepared in four separate blog posts. The first post focused on central themes of franchise negotiation, and the second post addressed protecting the confidentiality of franchise negotiations.

This installment details the first five of our top ten provisions to “never” negotiate.

1)           Signing “then-current” franchise agreement

  • Typical Provision: Upon transfer, renewal or purchase of an additional unit, the franchisee must sign the franchisor’s then-current form of franchise agreement.
  • Franchisee Argument: Franchisees want the same terms for the entire franchise relationship. Uncertainty increases investment risk and hinders growth.
  • Franchisor Argument: Franchisors spend time and money on continually developing and refining their form of franchise agreements. Franchisors need to rely on the uniform use and enforceability of their then-current franchise agreements. Franchisors cannot predict the future and, given that a renewal franchise agreement will be signed many years after the initial franchise agreement, franchisors need the flexibility to use their then-current form of franchise agreements at that time.
  • Compromise: Parties often agree not to change fees, territory and terms they initially negotiated. If any terms were negotiated due to the “newness” of the relationship, these generally lapse as the relationship matures.

2)           Reservation of Rights – Competitive Units or Brands

  • Typical Provision: Except for the franchisee’s right to operate in the territory, the franchisor reserves all other rights, including to open units in non-traditional venues (stadiums, shopping malls, etc.) and to operate competitive brands in the franchisee’s territory.
  • Franchisee Argument: Franchisees won’t want to compete with company units, which may have greater resources, preferred pricing from suppliers, and may not pay royalties. They may also seek locations near non-traditional venues to capitalize on that market.
  • Franchisor Argument: Franchisors are unable to predict every future business opportunity they may encounter and need flexibility for future growth. Franchisors cannot restrict the sale of the entire franchise system because one franchisee objects. Franchisors need to reach customers through every avenue possible, including non-traditional venues, which may increase brand exposure and visitation of a franchisee’s unit.
  • Compromise: Parties can mitigate competition risk by carving out venues near the franchisee’s location, or granting the franchisee a ROFR to purchase units in non-traditional venues.

3)           Right of First Refusal

  • Typical Provision: Except for the right to operate in the territory, the franchisee has no other rights to operate additional units (within or outside the territory).
  • Franchisee Argument: From the franchisee’s perspective, a right of first refusal (“ROFR”) to purchase additional units is optimal: if the investment is successful, the franchisee can double down, while avoiding the obligation to open additional units under a development agreement.
  • Franchisor Argument: Franchisors need to protect their right to make additional sales without having to check with franchisees. Franchisors will likely be starting out a relationship with a new franchisee and may be unsure as to whether this franchisee would be a good fit as a multi-unit owner.
  • Compromise: The parties can agree to a ROFR subject to certain stipulations. First, the ROFR should lapse if a franchisee refuses it more than a certain number of times. Second, the ROFR will only be available after the franchisee has been successfully operating a unit for a certain period of time. Lastly, it’s important to outline a process for how a franchisee can exercise this right, including a time period on the response.

4)           Marketing Fund

  • Typical Provision: The franchisee must contribute to a national marketing fund. The franchisor can spend the funds as it sees fit.
  • Franchisee Argument: Franchisees want assurances that marketing funds will be spent in their territories. They may also seek to limit the franchisor’s discretion via restrictions on the use of proceeds or oversight (including audits or formation of a franchisee advisory committee).
  • Franchisor Argument: Franchisors are in the best position to determine the most effective way to advertise the franchise system on a national basis. Franchisors need flexibility to promote the franchise systems, including ability to spend in any geographical region. The purpose of the marketing fund is to promote the brand on a national basis and the franchisee should focus its efforts on local advertising in its territory.
  • Compromise: If franchisors have an internal marketing team, they can offer franchisees additional marketing assistance free of charge. Alternatively, franchisors can waive a franchisee’s requirement to contribute to the marketing fund only after a certain number of units are open and operating. In exchange, the franchisee must expend the amount it would have contributed to the marketing fund on local advertising. That way, the funds are still being utilized to promote the brand.

5)           Renewal

  • Typical Provision: Franchisee has the right to renew the franchise agreement a limited number of times (1-2) if certain conditions are satisfied.
  • Franchisee Argument: Franchisees want unlimited renewals. They will argue that as long as they are in compliance with the franchise agreement, they should not lose their business, which is often a franchisee’s livelihood.
  • Franchisor Argument: Franchisors want to avoid creating an evergreen contract. An evergreen contract has an indefinite duration and is difficult to terminate. Franchisors need the ability to evaluate franchisees on a semi-regular basis to determine whether they are still a good fit for the franchise system.
  • Compromise: The parties may agree to longer renewal terms (e.g., one 10-year renewal term instead of two 5-year renewal terms). Clear renewal conditions and a cap on renewal costs will also help franchisees budget and prepare.

In the next installment, we’ll launch into the remaining top 10 provisions to “never” negotiate:

  1. Changing Marks/Renovations/Upgrades
  2. Termination/Cure Period
  3. Indemnification
  4. Assignment
  5. Personal Guaranty

Renewed Efforts to End No Poaching Provisions

Franchisors need to review their franchise agreements and take immediate action in response to the recent onslaught of legal action over “naked no poaching” provisions in franchise agreements.

In a typical franchise agreement, a franchisor will prohibit a franchisee from poaching its or its other franchisees’ employees during the term of the franchise agreement and for a period of time after the franchise agreement ends. Until now, these provisions were fairly commonplace. Franchisors argue these provisions are protect each franchisee’s investment of time and money in its employees, including general managers who sometimes participate in extensive training programs.

Critics of such provisions argue that the practice keeps wages for these employees low and that this is a manipulation of the market. Worker advocacy groups have long pushed for an end to this alleged “anti-competitive” practice. Economists generally agree that no poaching provisions have a negative impact on low-level employee wages.

Moreover, in October 2016, the U.S. Department of Justice (“DOJ”) and the FTC issued guidance that naked no poaching agreements are “per se” illegal–meaning that their very existence violates the law and sets companies up for criminal charges.  The DOJ further stated that it intended to criminally prosecute companies employing naked no poaching agreements. While most observers expected that the DOJ under Attorney General Jeff Sessions would retreat from this position, it has not, citing pro-competitive concerns. In fact, in April 2018, the DOJ initiated a criminal complaint against a number of companies respecting naked no poaching agreements. While the case settled with only civil penalties imposed, the DOJ expressly stated that it was reserving the criminal question and planned to “zealously enforce” the law.

Major Brands Settle After Attorney General Files Suit

In July, seven international brands agreed to no longer enforce the no poaching provisions in response to a lawsuit being led by the State of Washington Attorney General’s Office.

In August, eight more large brands followed this trend. Additionally, several state attorneys general, led by  Massachusetts Attorney General Martha Healy but including the AGs of California, Illinois, Maryland, Minnesota, New Jersey, New York, Oregon and Pennsylvania, have sent investigation letters to eight large international franchisors regarding each of their no poaching agreements.

This is only the beginning of the attack on no poaching provisions. In the past year, civil antitrust actions have been filed by employees of franchisees of several large international franchisors.

The potential liability under these actions could be substantial because the class sizes could be immense with treble damages and attorneys’ fees potentially being awarded in any franchisee employee victory.

McDonald’s Loses Bid to Dismiss

McDonald’s’ recent motion to dismiss was denied so the case against that company will proceed. The outcome of this case will be closely watched as a test case for this issue overall. The need to act is further supported by the fact that Senator Elizabeth Warren (MA) and Senator Cory Booker (NJ) are strong advocates of removing the “no poaching” provisions and have introduced legislation to make these acts illegal.

And the DOJ is bringing a criminal antitrust complaint against franchisors for what they call vertically assisted, horizontal conspiracies to fix labor rates, allegedly in violation of Section 1 of the Sherman Anti-Trust Act.

The time to address naked no poaching provisions is now. Franchisors should not wait until the update of your franchise disclosure document in 2019. If you need any assistance navigating through this process, the franchise team at Fox Rothschild is more than happy to assist.

In a major policy announcement, on Friday, September 14, 2018, the National Labor Relations Board (the “Board”) proposed a new regulation establishing the standard for determining whether two employers, as defined in Section 2(2) of the National Labor Relations Act (the “NLRA”), are a joint employer of a group of employees under the NLRA.

Under the regulation proposed by the Board, an employer may be considered a joint employer of a separate employer’s employees only if the two employers share or codetermine the employees’ essential terms and conditions of employment, such as hiring, firing, discipline, supervision, and direction. More specifically, to be deemed a joint employer under the proposed regulation, an employer must possess and actually exercise substantial direct and immediate control over the essential terms and conditions of employment of another employer’s employees in a manner that is not limited and routine.

This proposed rule will overrule the Browning-Ferris decision, under which a company could be deemed a joint employer even if its “control” over the essential working conditions of another business’s employees was indirect and limited, or contractually reserved but never exercised. The Board, in its proposed rule, explains that Browning-Ferris’ relaxation of the concept that both of the putative employers of an employee must have “direct and immediate” control over the employee to be particularly troubling.  In what it calls an attempt to “clarify” the proposed standard, the proposed rule also includes a number of examples.

There was a dissent from one member of the Board.  The dissent essentially argues that the proposed standard of “direct and immediate” is no more clear that the Browning-Ferris standard, and that the Board is interfering with the natural development of the NLRA through the common law.  I think it is fair to criticize the proposed rule due to the the proposed standard of “direct and immediate” being less than clear, and I expect that it will be further developed in the rulemaking process.  Any proposed rule, however, is intended to short circuit the common law, and so I find that criticism to be extremely weak.

Comments, of course, are a key element of the rulemaking process. They must be received by no later than November 13, 2018.  Reply comments to initial comments must be received by November 20, 2018.  Comments may be submitted electronically through http://www.regulations.go or sent by mail or hand delivery to: Roxanne Rothschild, Associate Executive Secretary, National Labor Relations Board, 1015 Half Street SE, Washington, DC 20570-0001.  The Board cautions that comments sent via mail are often delayed due to security concerns.

This is THE time for the franchising community to be heard on the joint employer question. Comment now. Let your voice be heard.

I attended the International Franchise Association’s Franchise Action Network (“FAN”) Annual Meeting last week in Washington D. C. Basically, this is an educational event culminating in the participants being sent out to the “Hill” to lobby their senators and representatives on issues effecting small businesses – and especially franchised businesses. Speakers from the Hill, this year including Donna Brazile, Michael Steele and Senator Rand Paul, spoke to the delegations about the state of politics and the issues we were presenting to our representatives. I was part of the Pennsylvania delegation and most of the attendees in my district were franchisees.

The issues we discussed with our representatives focused in the joint employer issue and tax reform. Though some headway has been made regarding the joint employer issue, there is still work to be done for those wishing to reverse the standard set forth in 2015 by the National Labor Relations Board (NLRB) in the Browning-Ferris Industries decision, which replaced the “direct and immediate control” standard with a test based on “indirect” and “potential” control. Many feel this shift will cause franchisors to be “joint employers” with their franchisees which could invalidate the franchise model’s goal of providing opportunities for small business owners to run their own independent business.

Recent headway on the joint employer issue has been the passage in 2017 by the US House of Representatives of the Save Local Business Act (HR 3441) to simplify the joint employer standard for franchised businesses. However, that legislation has stalled in the Senate. In addition, the NLRB has announced plans for rulemaking relating to the joint employer standards.

Our first task on the Hill was to ask our congress to sign onto letters written by their fellow congressmen and senators to ask Labor Secretary Alexander Acosta to begin rulemaking on the joint employer issue under the Fair Labor Standards Act, under which franchises have seen many joint employer lawsuits as it allows individuals to file private actions. The hope is that this would help standardize the varied rulings that are coming out of the different federal circuit courts on the issue.

The second issue on our list to discuss with our congressional representatives was also related to the joint employer issue. The Trademark Licensing Protection Act was recently introduced into the House of Representatives by Rep. Steve Chabot (R-OH) and Rep. Henry Cuellar (D-TX) to help resolve the conflict between federal trademark law and the rationale supporting claims of joint employment. Federal trademark law requires the owners of trademarks, in this case the franchisor, to maintain control over its trademark and to monitor its use. Franchisors do this by controlling the use of the mark, which could be wearing standard uniforms, use in advertisement or otherwise, and the quality of the products supported by the mark, as well as other controls. However, this control supports the claim that a franchisor is a joint employer of the franchisee, thus catching the franchisor in the middle of these two laws. The Trademark Licensing Protection Act is being proposed to clarify that franchisors who control the actions of franchised businesses to maintain their brand will not be considered “joint employers” as a result under federal law.

The last issue for discussion was tax reform, particularly focused on aspects impacting pass-through entities, like limited liability companies which is the dominant form of company franchisees employ. First, we asked to make the individual tax cuts permanent as they effect owners of pass-through entities. Second was to clarify the exemption relating to professional service entities from those tax cuts. Certain professions, such as attorneys, are exempt from the tax cuts, but due to the vagueness of the wording, other unintended businesses may be covered by the exemption such as home health services. The IFA has requested that the Department of the Treasury fix this so this may go forward without the need for congressional action. Finally, because of a purported error in the tax bill, the ability to depreciate certain property and capital expenses at an accelerated rate has been eliminated so that these assets depreciate over an extremely long period of time. This causes a great disincentive for businesses to renovate and buy new equipment. The final ask was to fix that error and allow bonus depreciation.

I have gone to the Hill to lobby for similar issues before. I enjoy the meetings with the Representatives because the groups are smaller and the Representatives and their staff seem to be more responsive. I have always met with staff members for the Senators, but it is important to communicate with the staff as they are the ears of the Senators. Of course, for issues that are not bipartisan, if the congressman or senator is of the other party, they are less likely to act. But this is an important part of our democracy and I encourage all to go to the Hill or your state capital to meet with your representatives on issues important to you.

The Fox Rothschild team of Megan Center and Alex Radus recently gave a presentation at the International Franchise Expo in New York City on the “Top Ten Provisions to ‘Never’ Negotiate in a Franchise Agreement.” A summary of this presentation is being presented in four separate blog posts.  The first post focused on the central theme of franchise negotiation from the perspective of the franchisor and franchisee.

This installment highlights a few practice pointers that can save time and money during the negotiation process and protect the confidentiality of your negotiations.  Installments three and four will examine the top ten things never to negotiate in in detail, including typical franchisee requests, franchisor counter-arguments, and common compromises.

When negotiating a franchise agreement, the franchisee should provide a memorandum of the terms he or she proposes to revise.  This can take many forms, from a formal letter of intent to an informal email.  The level of detail will vary, but at a minimum it should cover all of the franchisee’s requests and be thorough enough for the parties to begin negotiations and understand what they are agreeing to.  This process focuses the parties on the most impactful terms and identifies potential deal breakers early in the process, saving time and money.

Copyright: / 123RF Stock Photo

Once the negotiated terms are established, we suggest that they should preferably be included in an addendum to the franchise agreement, which will be attached to the franchisor’s standard form of franchise agreement.  We strongly encourage you to avoid revising the standard franchise agreement.  There are a few reasons for this.  First, it is generally easier and faster to draft and negotiate an addendum rather than redline the entire franchise agreement.  Second, sticking to an addendum will keep revisions focused and precise.  The franchisee’s attorney is likely to make more changes if he or she has the opportunity to redline the entire franchise agreement. Finally, when you need to review the negotiated terms of multiple franchise agreements, short addendums will be easier to review than redlined franchise agreements.

Finally, be sure to protect the confidentiality of your negotiations – but don’t go overboard.  Franchisees will talk to each other, which can be both good and bad.  You want your star franchisees to speak with new and prospective franchisees.  They’re in a great position to give advice that will boost performance, and to be a cheerleader for your system.  However, avoid permitting them to share negotiated terms, which can hurt morale and give new franchisees unreasonable expectations. For example, original or early franchisees may have obtain concessions that were appropriate for a startup system may no longer be appropriate at later stages of the brand’s development.  Moreover, you must be sure to understand the franchise laws of the states where you are offering franchises, which may require you to disclose negotiated terms in certain cases as briefly mentioned in our first post.  Also, as you probably know, disclosures and representations respecting financial performance are fraught with danger and should never be made by franchisees.

Your addendum should include a confidentiality provision that balances these considerations.  The negotiated terms, and the fact that you negotiated your franchise agreement, should be protected from disclosure.  After all, those are private terms between two business partners.  However, franchisors shouldn’t be so specific as to prevent franchisees from communicating in ways that benefit all members of the system.

In the next installment, we’ll launch into the first 5 of our top 10 provisions to “never” negotiate:

1.       Signing the “then-current” franchise agreement

2.       Reservation of Rights

3.       Right of First Refusal

4.       Marketing Fund

5.       Renewal

We, Megan Center and Alex Radus, recently gave a presentation at the International Franchise Expo in New York City on the “Top Ten Provisions to ‘Never’ Negotiate in a Franchise Agreement” and want to share the highlights of that presentation here.  This first of four blog posts will focus on central themes of franchise negotiation from the perspective of both the franchisor and franchisee.

With that, before we jump into the theme of negotiation, we want to briefly touch on the top ten provisions we will cover over the next few blog posts, which are as follows:

1.      “Then-current” form of Franchise Agreement

2.      Reservation of Rights

3.      Right of First Refusal

4.      Marketing Fund

5.      Renewal

6.      Changing Marks/Renovations/Upgrades

7.      Termination/Cure Period

8.      Indemnification

9.      Assignment

10.  Personal Guaranty

In each of the blog posts that follow, we will discuss the typical provision in a franchise agreement, the typical request by a franchisee, and how both a franchisee and franchisor may argue for its respective provision or revision.

By way of introduction, we want to briefly touch on why a franchisor may want to, or in certain circumstances be required to, negotiate provisions of its franchise agreement. First, economic factors may contribute to negotiation points. As the economy ebbs and flows, the sales of franchises often will follow. A franchisor may have to grant more concessions in a bad economy, or vice versa, in order to make a franchise sale.

Second, if an emerging brand, a franchisor may need to offer its original franchisees a more incentivized franchise package than an established franchisor would. Similarly, if a franchisor is trying to entice a multi-unit franchisee or a franchisee that has experience in operating other franchised businesses to join its franchise system, a franchisor may have to “sweeten the pot” and offer more concessions than it would a standard-single unit-franchisee.

Additionally, if a franchisor is expanding internationally, similarly to an emerging brand, a new franchisee will be developing the brand in an entirely different country, often with no brand recognition.  As such, it may need further incentives to take on this additional obligation.

Lastly, and perhaps most importantly, certain states require that a franchisor amend certain portions of its franchise agreement via a state law addendum. Generally, these changes relate to dispute resolution procedures, governing law, and termination procedures. Further, if you negotiate changes with franchisees in California, you are required to comply with the Negotiated Changes Law in California which mandates disclosure of all material revisions to the franchise documents granted to California franchisees to all California prospects for a year from the closing of the negotiated deal.

The next post in this series will focus on practice pointers if a franchisor chooses to, or is required to, negotiate a franchise agreement.