Restaurant operators and their financiers often need to predict the future. The operators, mostly from franchised brands, need to adapt to changing tastes and fashion. The financiers need to assess risk before making commitments or investments. Experts in these fields met together in November 2017 to test their assumptions.

Kevin Burke, Managing Director of Trinity Capital LLC, delivered a report which he summarized the economy for restaurants “As Good as it Gets.” The formal title was a very analytical “A Reversion to the Mean: What Happens When Industry Tailwinds End?” Burke’s basic conclusion is that things are great now, but the analytics show eventually the metrics will return to baseline, and this reversion to the mean predicts a slowdown of business and a tightening of credit.

You should in no way conclude that the credit punch bowl will be removed soon. Bankers are still enthusiastic about restaurants, and the chains are doing well. Current valuations of multiples of cash flow for merger and acquisitions average near historical highs of 10.6, and growing franchisors have multiples of double that. Leverage is at near historical highs of 5.3. These are multiples not seen nor sustained since 2007.  Private equity investment has slowed this year, and so have exits from their investments. Everyone looks fat and happy.

While there is still room for growth, current market conditions cannot last forever, and changes are coming via changing demographics. The discretionary spenders driving the restaurant renaissance are now the millennials. Millennials constitute the majority of the U.S. population. Their student loan debt is at all time highs. Less than half of the millennials make as much or more than their parents at the same age. The maturity cycle of millennials will have profound effects on the economy.

Millennials dine-in on delivery, according to Andrew Charles, Senior Analyst, Cowen & Co. Millennials are driving 30% of restaurant industry sales growth based on their delivery predilections. The largest demographic with the most demand for delivery is the 18-34 year-old, living in a major metropolitan area earning in excess of $100,000.00. Demand for delivery is less frequent in the suburbs and mid-size metro areas among 35-44 year-olds earning over $50,000 a year. Demand for delivery is lowest among those in small metro areas or small cities over the age of 45 years old earning less than $50,000.00 per year. Delivery users clearly prioritize convenience and time over the specific restaurant’s food. Based on the data, Charles predicts that the better a restaurant can meet the delivery demands of its customers, the more delivery will drive sales.

Looking at the data alone, this would suggest that restaurants have a great opportunity to expand their business by catering to millennials and providing delivery. However, the world is not that simple. When looking at the buying habits of millennials, they are now saving for houses and having children. For the past two years their restaurant spending as a group has trended down, and is predicted to fall as they invest in housing and their families. This will put a cap on growth and an emphasis on catering more to the millennial lifestyle of automation, convenience, delivery, healthful choices, as well as “foodie” choices.

Expect new entries in the artisan breads, foods and pizza categories. The “better pizza” will follow the “better burger” trend, with state of the art menu, delivery and payment systems. Expect menu changes in the casual dining sector to accommodate millennial tastes and the tastes of their children. Look for brands to tout their autonomous car, drone and other novel promises of delivery. Look for slumps in steak houses and casual dining as these brands need to adjust. Because of these trends, we are seeing a lot of activity in the mergers and acquisitions by strategic buyers ready to upgrade the brands to millennial friendly.

The millennials are the future, and the rest of us are merely tenants.

Yesterday afternoon, the NLRB issued a decision in Hy-Brand Industrial Contractors that caused a collective sigh among employers.  The decision rolls back the joint employer standard to what it was before Browning-Ferris Industries, 362 NLRB No 186.

The Browning-Ferris decision was greeted with alarm by most employers, especially franchisers and franchisees, as it made it easier for employees to claim that two entities were joint employers.

Specifically, Browning-Ferris held that two entities could be joint employers even where they never exercised joint control over essential terms and conditions of employment.  It was enough that there was an agreement between the parties where they reserved the right to exercise joint control.

The Hy-Brand decision explicitly overrules Browning-Ferris.  Interestingly, the decision discusses in some detail the negative impact Browning-Ferris had on franchisers.

Now the test for determining whether an employer has exercised joint control goes back to what it was before Browning-Ferris was decided in 2015.  Two entities will be found to be joint employers where:

  • joint control is exercised;
  • the control has a “direct and immediate” impact on employment terms; and
  • where such control is not merely “limited and routine.”

Franchisers should still be careful when setting up controls over payroll processes or scheduling of employees of franchisees or when they have reserved the right to address discipline with the franchisee’s employees.  The mere fact that an employer reserves the right to weigh in on disciplinary issues will no longer mean that they could be a joint employer.  However, if that right to weigh in on discipline is frequently exercised, then there might be a finding of joint employment.  In other words, wade carefully.

If your franchise–or your franchisees–operate a website that accepts user-generated content, NOW is the time to contact the Copyright Office.

Whether you realize it or not, your website probably accepts accept user-generated content. Examples of such content include e-commerce websites that accept product reviews, franchise-sponsored blogs that publish user comments on posted articles, and brand fandom sites that permit users to share photos or videos.

It can be very difficult for you to determine whether user-generated content posted to your brand’s website was created by the user who posted it, or whether the content infringes someone else’s copyright.

To protect your brand from being liable for copyright infringement resulting from user-generated content, since 1988 the Digital Millennium Copyright Act (DMCA) has provided a “safe harbor” from liability so long as you follow certain procedures, including:

  • not actually knowing about the infringement;
  • not financially benefiting from the infringement;
  • when gaining knowledge of infringement, acting quickly to remove or disable access to the infringing material; and
  • designating an agent to receive notifications of claimed copyright infringement, and providing the agent’s contact information to the Copyright Office.

As of December 2016, the procedures for designating a DMCA agent changed. Previously, DMCA agent designation was handled by completing a form and filing the form with the Copyright Office with a required filing fee.

Under the new DMCA agent designation procedure, all DMCA agent designations must be done online. Even entities that previously designated an agent must file an online designation to maintain their DMCA designations. Any entity that previously designated an agent with the Office will have until December 31, 2017 to use the online system to update their agent designation. You must create an account on the Copyright Office website and complete the agent designation form online.

The Copyright Office has published several video tutorials to help you understand how to use the new online designation system. Those tutorials are available on the Copyright Office website.

This lightly-edited post was drafted by my partner Jim Singer and originally appeared, in a slightly different form, on the IP Spotlight blog.

A recent decision in the United States District Court of Arizona (“Court”) could have far-reaching consequences to many franchisors based on the broad-sweeping principles the Court used in its reasoning. In Zounds Hearing Franchising, LLC et. al. v. Bower et. al., the Court answered the question of whether the Ohio Business Opportunity Purchasers Protection Act (BOPPA) trumps a choice of law and venue provision that provides for the application of law other than the State of Ohio.

Here, four franchisees filed suit against Zounds Hearing Franchising, LLC and Zounds Hearing, Inc. (collectively, “Zounds”) in the state court of Ohio for failure to comply with the five-day cancellation requirement under the BOPPA. Further, the aggrieved franchisees claim that Zounds made false, misleading and/or inconsistent representations than that contained in its FDD in connection with the sale of its franchises in violation of the BOPPA. Each Franchise Agreement provides that Arizona law governs the interpretation and enforcement of the Franchise Agreement and all disputes are subject to pre-suit mediation (at Zounds’ option) and venue in Arizona. As such, Zounds moved to remove the suits to Ohio federal court, which then transferred the suits to the instant Court.

In analyzing whether BOPPA should trump the provisions of the Franchise Agreement, the Court relied on the rules of the Restatement of Conflict of Laws. Specifically, the law of the state with the “most significant relationship” to the parties shall govern the agreement or, if the parties chose the law of another state, that state’s law shall govern. However, if the choice of law is contrary to a fundamental policy of the state with the most significant relationship, that state will presume to have the materially greater interest in its state law governing the agreement. In holding that Ohio has the most significant relationship to the parties, the Court noted that all of the franchises and franchisees were located in Ohio and it has a strong interest in protecting its residents, particularly where the underlying statute is designed to protect franchisees that are in an inferior bargaining position. Further, Arizona lacks a statute that protects purchasers of franchises, while BOPPA is directly on point to address the franchisees’ purported harm. Essentially, the franchisees would be left with little recourse against Zounds if Arizona law applied.

Further, the Court held that it is difficult to imagine that a statute that makes certain conduct a crime as being anything but the fundamental policy of the state. Additionally, the Ohio legislature amended the BOPPA in 2012 to explicitly state that any venue or choice of law provision that deprives an Ohio resident of protection thereunder is contrary to public policy, void and unenforceable further evidencing its intent. Lastly, the Court went so far as to say that even if a statute does not explicitly outline that it is fundamental policy of that state, a court still could deem it so by its very nature. Further, the lack of a non-waivability term does not doom the statute under this analysis. These principles may open the door to seemingly endless arguments about what constitutes the fundamental policy of a state.

As such, even though the parties agreed to the Arizona choice of law and venue provisions, the application of Arizona law would be contrary to the public policy of Ohio because Arizona does not have a statute that protects the rights of franchisee purchasers as does Ohio. Further, Ohio has a materially greater interest in the enforcement of its law because the franchisees are Ohio residents and the franchises are located therein.

In the alternative, Zounds filed a motion to compel mediation pursuant to the requirement for pre-suit mediation in Arizona in the Franchise Agreement. Here, the Court determined that the pre-suit mediation requirement violated the franchisees’ rights to Ohio venue because the mediation is “intimately bound up” with the franchisees’ right to sue under the BOPPA. Lastly, the Court determined that the mediations for all four franchisees could be joint despite the Franchise Agreement requiring that all proceedings arising out of the Franchise Agreement be decided on an individual basis. Here, the Court held that because pre-suit mediation was a “proceeding” (as argued by Zounds’ counsel), then the BOPPA prohibitions apply to the mediation requirement and the BOPPA specifically prohibits class action waivers. As such, the requirement to conduct pre-suit mediation was void in violation of the BOPPA. However, the parties conceded to conduct mediation during the course of the suit. As such, the Court required that the parties conduct joint pre-suit mediation. To take it a step further, the Court awarded the franchisees their attorneys’ fees because Zounds burdened the franchisees with a multiplicity of actions in a distant forum. Further, the Court cited the unequal provision in the Franchise Agreement that stated Zounds could recover attorneys’ fees upon a successful claim against a franchisee but did not afford franchisees with a reciprocal right. The Court noted that it would be a presumptive abuse of discretion not to award attorneys’ fees against an unsuccessful party who “used its superior bargaining position to impose such a term”.

Overall, this result could have substantial effects to any franchisor that currently has franchises in Ohio or has Arizona law as its choice of law. This decision suggests courts have wide latitude to determine whether another state has a substantial interest in the transaction and whether that state’s law should govern the agreement. Further, it is important to take note of the consequences this has on a franchisor’s ability to enforce non-binding mediation as a preliminary form of dispute resolution (and on an individual basis) and to collect attorneys’ fees (without a corresponding right afforded to the franchisee). Lastly, it would be prudent for all franchisors to review their franchise agreements in light of this decision.

A federal court in Colorado recently upheld a franchisor’s non-competition provision despite that state’s strong public policy against non-competes. The franchisor prevailed due to its thoughtful contract drafting and ability to effectively communicate the unique nature of franchising to the court.

In-home care franchisor Homewatch International, Inc. and its franchisee, Prominent Home Care, Inc., signed a franchise agreement that terminated on June 30, 2016. The next day, Prominent’s sole shareholder and officer (the “Defendant”), started a competing company. Homewatch sued the Defendant for breach of contract, seeking to enforce the non-competition provisions in their agreements.

The Defendant made two arguments in her defense (i) the franchise agreement’s non-competition provision did not bind her because she signed the franchise agreement only in her executive capacity on behalf of Prominent; and (ii) the non-competition provision was unenforceable under Colorado law.

Argument 1:  Parties Bound
The franchise agreement stated that, after the term of the franchise agreement, Prominent and its officers and shareholders could not own or operate a competing business within a twenty-five mile radius of a Homewatch location. Only Prominent (not the Defendant) signed the franchise agreement. However, the franchisor had also required the Defendant to sign a personal guaranty. The guaranty stated that the Defendant would be bound by the non-competition covenant in the franchise agreement.

The court ruled in the franchisor’s favor. It held that the guaranty unambiguously stated that the Defendant—in her individual capacity—would be bound by the franchise agreement’s non-competition provisions.

Argument 2:  Colorado Policy
Colorado law generally disfavors non-competition provisions. One exception to this rule is for a contract for the purchase and sale of a business. This exception promotes the purchase and sale of businesses by protecting the good will of the business being sold (i.e., a purchaser may be less likely to buy a business if it cannot obtain an enforceable non-compete from the prior owner).

Prior to Homewatch, the courts had not definitively decided whether the sale of a franchise qualified for this exception under Colorado law. The Defendant argued that the exception did not apply because the sale of a franchise is not a sale of a business—instead it is the sale of a license to the franchisor’s methods and intellectual property for a certain term.

The court rejected this argument, holding that the exception applied and the non-compete was enforceable. The court concluded that the “good will” rationale was just as important in the franchise context, noting that a significant portion of the value of a franchise system is its good will. (It should be noted, however, that Homewatch is a federal court opinion. A Colorado state court could come to a different conclusion; however, the state court would likely consider the Homewatch rationale in its decision.)

The Takeaways
Franchisors should take note of the Homewatch decision and ensure that their franchisees’ owners and key employees, especially those with access to confidential materials and training, sign non-competes in their individual capacities. This is often addressed in the personal guaranty, as it was in Homewatch. Franchise systems in states that frown upon non-competition provisions should be aware of the Homewatch rationale in the event they need to enforce their non-competes. Franchisors should also make sure to use experienced franchise counsel. In Homewatch, counsel was able to communicate the unique franchise model to the court and to persuasively argue why the court should apply a law that was probably not drafted with franchising in mind. The result was a win for the franchisor and also franchising, which relies on non-competes to mitigate risks inherent in the franchise model.

 

Menu and chef
Copyright: yarruta / 123RF Stock Photo

The Trump administration is moving forward with an Obama-era initiative requiring certain food establishments to list calorie information on menus and menu boards, including food on display and self-service food. The FDA recently released new draft recommendations to help affected businesses comply with the menu labeling rule.

The rule implements the nutrition labeling provisions of the Patient Protection and Affordable Care Act of 2010, which are intended to give consumers direct, point-of-purchase access to nutritional information, including the calorie content of foods. When the rule was originally published, we blogged about its impact on restaurants and followed up with a report on the Small Entity Compliance Guide, which explains the rule’s requirements in a question/answer format.

The rule has met stiff opposition and enforcement has been delayed multiple times. Most recently, just four days shy of implementation, the deadline for compliance was extended to May 7, 2018. The extension was intended to give the FDA time to consider how to reduce the rule’s regulatory burden and increase flexibility, while providing consumers with nutritional information.

The FDA’s recent guidance is non-binding and addresses stakeholder concerns regarding implementation of the rule, including:

  • Clarifying calorie disclosure requirements for self-service food, including buffets and grab-and-go food;
  • Addressing the need for flexible methods to provide calorie disclosure information;
  • Explaining the criteria for distinguishing between menus and marketing materials;
  • Addressing how the FDA will assist covered establishments to comply with the rule, and how it will enforce compliance;
  • Expanding upon the “reasonable basis” standard that covered establishments must meet when disclosing nutritional information; and
  • Explaining the criteria for determining whether establishments (including franchises) and menu items are subject to the rule.

The FDA invites public comment on the draft guidelines through January 8, 2018.  We will continue to monitor developments and the rule’s effect on franchise systems.

The intersection of franchise law and general corporate law is extensive. A recent decision in the Michigan Court of Appeals (Court) highlights the importance of thoroughly understanding and considering the ramifications of transactions involving both spheres of law.

In Retail Works Funding LLC v. Tubby’s Sub Shops Inc. and JB Development LLC, the plaintiff (Plaintiff) brought suit against each defendant (Tubby’s and JBD or collectively, the Defendants) after JBD purchased the rights and goodwill to the service mark JUST BAKED (Mark) from Just Baked Shop LLC (JBS). Prior to that, Plaintiff obtained a judgment against JBS for over $184,000.

In this suit, Plaintiff claims that JBD should be liable for Plaintiff’s judgment under a successor liability theory because JBD is a mere continuation of the Just Baked system by carrying Just Baked products in its stores and offering franchises. Further, Plaintiff argued that JBD held itself out to the public in news articles as having merged with JBS. Defendants argued that JBD only purchased the rights to one asset of the Just Baked business, the Mark, and did not agree to take on any its liabilities as supported by the language of the Service Mark Purchase Agreement.

As was the case here, when assets of a business are purchased with cash and not stock, the successor is generally not liable for the predecessor’s liabilities unless an exception to the rule applies. In holding for the Defendants, the Court determined that none of the three exceptions to successor liability argued by Plaintiff applied to the case at hand. First, the instant case did not constitute a “de facto merger” because JBD purchased the Mark for cash. Second, JBD was not a “mere continuation” of the former Just Baked business because Plaintiff failed to provide any evidence of common ownership between the entities or that JBD acquired substantially all of the assets of JBS. Lastly, the “continuity of enterprise” exception did not apply because judgment creditors cannot rely upon it. As such, the Court held that the Defendants were not liable for the judgment against JBS.

If the deal to purchase the Mark had been structured in a different way, there is a chance that the Defendants would have been held liable for the Plaintiff’s judgment against JBS. As such, a franchisor (and its counsel) must evaluate how a transaction will effect multiple areas of law and ensure adequate protection from adverse consequences in each area.

As cyber scams become more widespread and sophisticated, social engineering fraud is quickly turning into one of the most popular way for a thief to rip-off a company using computers.  Every franchise system should be asking itself and its franchisees “do we/you have insurance coverage to protect against these losses?” In most cases, the answer is No!

43609592 – online scammer reaching to steal money out of a pocket of a naive internet user, vector illustration

Social Engineering Fraud” are schemes that mislead and deceive victims (typically a company employee) into transferring funds or divulging confidential information to a fraudster.   The difference between social engineering theft techniques and other types of cyber attacks is that the victim voluntarily performs the acts of transferring the funds or providing the information. For example, a fraudster may send an email to someone in a human resource department posing as the company’s accountant and request social security numbers and tax information of employees. The unwitting HR employee does not think twice and quickly compiles the information and hits reply.  In other cases, an employee in accounting is tricked into sending a payment to a “vendor” of the company which turns out to be a scammer.

Many companies incorrectly assume that these types of losses are covered under a standard cyber liability policy or crime policy. However, most crime and cyber policies require a computer hack or active invasion of a computer system by a criminal to trigger coverage under a policy.   Insurance carriers argue that there was no “direct” fraud.  This is becoming a huge gap in coverage for franchisors and franchisees as insurance carriers are denying coverage for these claims and winning coverage disputes.

All hope is not lost. Many insurance carriers offer endorsements to either a company’s crime policy and/or cyber policy for social engineering theft losses. The coverage under the endorsement is often sub-limited and may have a higher deductible but it is better than no coverage at all.  Before a loss effects your system, franchisors should do the following:

  1. Ensure that social engineering fraud coverage is clearly part of the franchise system’s crime or cyber policy.
  2. Modify insurance requirements for franchisees to mandate coverage for social engineering fraud claims.
  3. Keep in touch regularly with your broker and insurance counsel to make sure your insurance is covering new risks as they arise.
  4. Educate your employees on spotting potential scams. Many brokers and insurance counsels even offer data security training for clients at reasonable rates.  It is a good place to start.

The U.S. House Committee on Education and the Workforce recently approved the “Save Local Business Act” (HR 3441 – Byrne).  If enacted, the Act would limit joint employer liability by reversing the rule announced by the NLRB in Browning-Ferris Industries, 362 NLRB No. 186.  The Browning-Ferris decision departed from 30 years of precedent by issuing a new joint employer test with significant ramifications for the franchise model.  Under Browning-Ferris, a company (e.g., a franchisor) that has “indirect” or “potential” control over the employees of another company (e.g., a franchisee) may be considered a joint employer of those employees. The decision significantly expanded franchisors’ potential liability for matters related to their franchisees’ employees (including collective bargaining and employment torts).  Browning-Ferris is currently on appeal before the D.C. Circuit Court of Appeals.

The Save Local Business Act would amend the National Labor Relations Act and Fair Labor Standards Act to clarify that a person or company is a joint employer only if it “directly, actually, and immediately, and not in a limited and routine manner, exercises significant control over the essential terms and conditions of employment.” Essential terms and conditions include hiring employees, discharging employees, determining individual employee rates of pay and benefits, day-to-day supervision of employees, assigning individual work schedules, positions, and tasks, and administering employee discipline.

During its hearings, the Committee heard from franchise owners who described the impact of the Browning-Ferris rule on their business operations. Many legislators have specifically cited the franchise industry in announcing their support for the Act.  The Act’s passage would be a major win for the franchise model, which has been plagued with uncertainty over joint employer liability since the Browning-Ferris decision.