To paraphrase Benjamin Franklin, “Those who fail to plan, plan to fail.” That is true in any business, but particularly so in franchising.  Planning is more important in franchising because franchising leverages a business–expanding the horizon of the brand more than a single owner or operator could. Decisions on branding need to balance the effects on employees, franchisees, prospective franchisees and customers. Without proper planning, the brand will grow randomly, without alignment, and will never achieve the momentum necessary to grow exponentially.

Is the Business Qualified to Franchise?

When asking whether a business is qualified to franchise, the question seeks to answer whether there is a sustainable business that could be operated by others through proper training. The business concept needs to be on an upward trend and projector. If the business is merely a fad, it is not worth the investment of time, money and opportunity costs to expand a novelty which will soon evaporate.

The business needs to be capable of being converted into a systematic and replicable business. A franchise business needs to be taught to others so that they can expand and replicate it. The know how needs to be recorded and encapsulated. It cannot be readily copied merely by someone looking at the business from the outside. The business operation needs to have a little mystery and magic. At the same time, the magic, secret sauce or formula for success needs to be carefully guarded from competitors and will require legal protection.

Does the business have operating units which are profitable?

The more profitable and the more units which are operating profitably, the better the franchise system will be. A single location can be franchised successfully, but multiple profitable locations demonstrate that, while location is a variable, the formula for success can work in multiple places, with multiple crews, and much of the problems–which exist in any system–have been identified and fixed. Moreover, the higher the number of successful locations, the higher the probability that franchises will be established without unexpected obstacles.

Does the company have the staff to launch a franchise system?

Running a franchise system requires a sales function to qualify and process prospective franchisees. The franchisees will need some handholding and will need training. Some may be investing their life savings and need franchisor leadership to make the investment. After the investment is made, the franchisee needs to be motivated. The franchisor needs to be a leader and must instill confidence. If the staff or people cannot fulfill these needs, then the franchisor needs to hire or contract for these people to run the franchise company.

Does the company have the money and energy to invest in franchising?

Franchising costs money, but the money is a good investment because franchising has so many positive attributes. Franchising allows franchisees to share in the brand success and provides rapid growth, faster brand recognition with less oversight over the franchisees. The legal foundation for the franchise business structure needs to be properly prepared and that requires an investment in legal work. But wholly aside of the monetary investment is management’s time commitment in establishing the franchise structure, qualifying, training and supporting the franchisees. It requires an investment in legal infrastructure and investment in the people necessary to support and grow the franchise system.

How Big is the Market?

Many franchised business do well by having a narrow niche, but the best companies find ways to broaden the interest. Think about how a mere name change can broaden the business. “Boston Chicken” changed to “Boston Market” to capture customers whose meal preferences did not include chicken.

Write and Test the Business Plan.

Answer all of the questions that someone critiquing your business might ask. Contemplate various sources of grants, investment and funding. Each has positives and negatives, but all should be considered because your franchised business will not be static. Consider various avenues of growth, and the effect of competition. Commit it to writing it down so that you are disciplined and deliberate about it. See if anyone else is doing it the same–or differently–in another geographic area.

Test the business concept with a feasibility study, formal or informal. You can hire a consultant inexpensively. Ask a variety of people what they would be concerned about if it were their company. Business schools often offer counselling or review by students of new concepts. As these students may be your customers, take the opportunity for feedback. One of the main questions to ask is how can your franchisees make a reasonable return on investment.

Planning means anticipating problems and solutions. Planning and feasibility testing can be the difference in a successful franchise system and a failed dream. Good counsel, good accounting and good foresight help to avoid bad outcomes.

On December 28, 2018, the D.C. Circuit Court of Appeals issued an opinion in the Browning-Ferris case. In this much anticipated decision, the Court of Appeals concluded that the National Labor Relations Board’s decision to enumerate a new joint employer test was a valid exercise of its authority. The Court of Appeals held, however, the NLRB failed to properly apply the newly created test. Consequently, while the Court of Appeals didn’t completely abrogate the NLRB’s ruling, the opinion frankly raises many questions respecting the future of the Browning-Ferris standard.

In the Browning-Ferris decision, the NLRB generally outlined a new joint employer test where two entities would be considered to be a joint employer if a common law employment relationship exists and if the joint employer possesses “sufficient control” over the “essential terms and conditions” of employment to permit “meaningful bargaining”. This test eliminated the long-standing precedent requiring an employer to have direct and immediate control over the subject employee. For a more detailed analysis of the original decision, and its various twists and turns, please see our previous blogs posts here, here and here.

The controversy surrounding what the Dickens the initial decision in Browning-Ferris means has festered since that time, with the concern from employers being particularly vocal. Specifically, employers have argued that the NLRB failed to establish what the “essential terms and conditions” of employment are, calling the language impermissibly vague and impractical. It didn’t help matters that the NLRB’s response to such concerns had been, essentially, “we’ll know an employment relationship when we see one.”

The Court of Appeals, in reviewing prior jurisprudence, concluded that the right-to-control standard is an established aspect of common-law interpretations of agency and that the analysis is not limited to the direct and immediate control an employer exerts over the employee. In analyzing this new standard versus long-held common-law agency decisions, the Court of Appeals found that cases of common-law agency focused not only on actual control over the employee but the “right to control” the employee as well. Thus, according to the Court of Appeals, the NLRB properly considered not only direct control but also control which is reserved and unexercised.

However, in remanding the case to the NLRB, the Court of Appeals held that the NLRB failed to reserve its application of the indirect control factor to those “essential terms and conditions” of employment. The Court of Appeals stated that the NLRB failed to differentiate between those aspects of indirect control relevant to status as an employer, and those aspects which are simply the by-product of common-law third-party contractual relationships.

The Court of Appeals further guided the NLRB in future actions by stating that, if it again finds Browning-Ferris to be a joint employer, it could “not neglect to (a) apply the second half of its announced test; (b) explain which terms and conditions are ‘essential’ to permit ‘meaningful collective bargaining’; and (c) clarify what ‘meaningful collective bargaining’ entails and how it works in this setting.” In the view of these commentators, the Court of Appeals’ guidance highlights the concerns raised by employer groups and provides hope that the NLRB will dedicate itself to further fleshing out the standards so as to provide meaningful guidance.

Unfortunately, one important question that the Court of Appeals failed to answer is whether indirect control, in and of itself, can establish joint employer liability. Given this continuing ambiguity, the franchise community will continue to be left with many questions as to whether franchisors will be considered the joint employer of their franchisees’ employees.

But this is not the only open question.

Perhaps the more important question is what will the NLRB do now? As is noted in our blog post here, the NLRB is currently in the midst of a rulemaking process to further develop and define the joint employer standard. The deadline for comments on this proposed rulemaking has been extended multiple times, suggesting both a large number of comments and disparate views. It is unclear whether the NLRB will rule on the remanded Browning-Ferris case prior to implementation of a new rule or wait for the completion of the rulemaking process. Either way, grab your popcorn, candy and pop, and settle in for more excitement and fireworks, NLRB-style.

Submitted by Odia Kagan, Partner & Chair of GDPR Compliance and International Privacy.

Does the EU General Data Protection Regulation (GDPR) apply to my brand? This is a question with which many U.S.-based franchisors have been grappling since the GDPR took effect on May 25th. Six months later, the European Data Protection Board (EDPB) has issued, for public comment, guidelines on the territorial scope of GDPR.

Below is a breakdown of the major questions and takeaways for US-based franchisors:

1. Do you have an ‘establishment in the Union’?

●  You could be deemed to have an establishment in the Union (and subject to GDPR) even if you do not have a branch, subsidiary or franchisee in an EU member state.
●  Any real and effective activity, even a minimal one, could satisfy the notion of establishment for the purpose of Article 3(1) jurisdiction, even, in some cases, the presence of a single employee.
●  However, just having a website accessible from Europe is not enough.

2. (If you have an EU establishment) Is your data processing carried out ‘in the context of its activities’?

●  GDPR will apply to your data processing if there is an inextricable link between the activities of an EU establishment and the processing of data carried out by you (a non-EU entity).
●  As non-EU controller, you will not become subject to GDPR simply because you chose to use a processor (a service provider carrying out the data controller’s instructions) in the Union.
●  If you are a controller subject to GDPR and you choose to use a processor located outside the Union and not subject to the GDPR, you will need to ensure by contract that the processor processes your data in accordance with the GDPR.

3. If you do not have an establishment in the EU ̶ do you offer products or services to individuals in the EU? (Art 3(2))?

a)  “In the EU” means physically located in the EU at the time of the offering of goods or services (or the monitoring of behavior, see below). Not citizenship. Not residence.
b)   Does the processing relate to (1) the offering of goods or services or (2) to the monitoring of data subjects’ behavior in the Union?

(1) Do you offer Goods or Services?

●  In order to fall in scope, you need to manifest your intention to establish commercial relations with consumers in the EU. For this, the EDPB uses the concept of “directing an activity” to the EU market, developed in case law by the Court of Justice of the EU (CJEU) with respect to jurisdictional matters. Payment for the services, however, is not required.
●  Some non-exhaustive factors, taken possibly in combination with one another, include:

 mentioning dedicated addresses or phone numbers to be reached from an EU country
 marketing and advertisement campaigns directed at an EU country audience
 using an EU or member state top-level domain name
 mentioning customers domiciled in various EU member states, including client testimonials
 using an EU language or a currency
 offering the delivery of goods in EU member states.

(2) Do you monitor behavior of individuals in the EU?

●  Monitoring can be done both on the internet and through other types of networks or technology involving personal data processing, for example through wearable and other smart devices.
●  Monitoring activities include:

 geo-localization activities, in particular for marketing purposes
 online tracking through the use of cookies or other tracking techniques such as fingerprinting
 personalized diet and health analytics services online
 CCTV
 market surveys and other behavioral studies based on individual profiles, including behavioral advertising
 monitoring or regular reporting on an individual’s health status

4. Do you need to appoint a representative in the Union?

If you are a non-EU controller or processor that is subject to GDPR, you are required to appoint a representative in the Union, unless an exception applies. Local representatives may be held liable for the non-EU entity’s breaches and may be subject to administrative fines and penalties.

If you are not a public authority, you would be obligated to appoint a representative unless your processing is “occasional” and “does not include, on a large scale, processing of special categories of data….or processing of personal data relating to criminal convictions and offences…”, and such processing “is unlikely to result in a risk to the rights and freedoms of natural persons.” The EDPB does not elaborate on these and refers to criteria listed in the WP29 guidance on DPOs for the definition of “large scale processing” (e.g. factors like the number of data subjects concerned; the volume of data and/or the range of different data items being processed; the duration, or permanence, of the data processing activity; the geographical extent of the processing activity.

The appointed representative should be established in one of the member states where the data subjects, whose personal data are processed in relation to the offering of goods or services to them, or whose behavior is monitored, are located.

To speak about whether GDPR applies to you and what are the next top steps you should take on your road to GDPR compliance, please contact Odia Kagan, Partner, Chair of GDPR Compliance and International Privacy at Fox Rothschild, okagan@foxrothschild.com; 215-444-7313.

Copyright: vician / 123RF Stock Photo

With apologies (and props) to the great Yogi Berra, it’s deja vu all over again at the National Labor Relations Board.  The Board has extended the commenting period on its proposed joint employer rulemaking for a second time. Comments to the proposed rule may now be submitted until January 14, 2019. And the Board will accept replies to comments submitted in the original comment period through January 22, 2019.

We have blogged about this important issue to the franchise community twice before. The new rule would overrule the Browning-Ferris decision that eliminated the “direct and immediate” control requirement before an entity could be considered to be an employer. We have also noted, in comments submitted by our own Tami McKnew, that the proposed rule needs to be clarified so that the valid policing of licensed trademark rights would not be considered to be the act of an employer.

We encourage you, if you have not already, to make your voice be heard on this important proposed rulemaking by the NLRB.

Out-of-state franchisors beware of opening a franchise in New Mexico due to the recent decision in A&W Restaurants, Inc. v. Taxation and Revenue Department of the State of New Mexico and the potential for tax liability. The Taxation and Revenue Department of the State of New Mexico (“Dept.”) assessed over $29,000 in unpaid taxes against A&W Restaurants, Inc. (“A&W”) arising from its collection of royalty fees from several New Mexico franchisees.

In 2007, the New Mexico legislature amended the definition of “gross receipts” subject to the state gross receipts tax to include any money or value received from the grant of a franchise employed in New Mexico. Additionally, it removed from the definition of “gross receipts” any money or value received in connection with a trademark license agreement. Based on these definitions, A&W filed a protest seeking abatement of the gross receipts tax. During the course of the tax proceeding, A&W argued that the royalty fees were paid in connection with the trademark license provisions of the franchise agreements, omitting it from inclusion in the gross receipts tax. The hearing officer disagreed and upheld the Dept.’s assessment. A&W appealed the hearing officer’s decision.

The Court of Appeals in this case completed a thorough review of the amendments made by the New Mexico legislature and noted that the intent behind such revisions was to include royalty fees received in connection with franchise agreements subject to the gross receipts tax. Further, the New Mexico legislature wanted to exclude trademark license agreements but not franchise agreements that contain a trademark licensing provision. The Court noted, and A&W admitted, that a franchise agreement would not be entirely complete without a trademark license. With that, the Court upheld the hearing officer’s decision and held that A&W cannot separate out the trademark licensing provisions of the franchise agreement in order to avoid the gross receipts tax.

This decision serves as a reminder to ensure that your franchise agreement adequately protects you in this situation. It is important to keep your eye on similar legislative efforts in the future to appropriately plan for a franchisor’s potential tax liability.

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