Contributed by Elizabeth Sigety

Throughout my travels as a franchise attorney, I am often asked by potential clients who want to expand their business how to avoid the franchise laws. They don’t want to be a franchise, but want to license their trademark, control the actions or have uniformity of behavior from their licensees.  And, of course, they want to be paid. The only honest answer is that, unless the client is willing to omit one of the conditions above from their business model, compliance with the franchise laws is required.

Nonetheless, many of these potential clients cite an example of a similar business they know is expanding in accordance with the three conditions above, but not complying with these expensive and painful franchise regulations!! How can this be?!?

I do hate to be the bearer of bad news, but it is probably because the similar business is, for the time being, flying under the regulators’ radar. With the reductions in governmental budgets, this is inevitable. However, as a business grows, the likelihood that the regulator’s radar will detect it also grows. One disgruntled licensee is enough to tip off a regulator. Fraud and illegal financial performance representations (formerly earning claims) are well-known reasons for enforcement actions, but more technical violations of regulations can also result in repercussions which can cause serious damages to a business.

For example, in 2009, California brought an enforcement action against Play N Trade Franchise, Inc. and its affiliate, Yakety Yak Wireless. They were accused of not disclosing to new franchisees that they are affiliates, that Yakety Yak had initially sold franchises without registration in California, that a suit had been filed by a former employee, that they had terminated three area developers and they had sold franchises for reduced fees without the proper filings required by California. The Department of Corporations imposed heavy fines, revoked their right to sell franchises in California and demanded they send rescission notices to all their franchisees, whether or not the franchisees had relied on the defective disclosure document.

In early 2010, the DOC and these franchisors entered into a stipulation providing, among other items, for payments and concessions to franchisees but enabling these franchisors to begin to reoffer franchises upon full compliance with franchise laws. The costs and the damage to the business resulting from this enforcement action have been very significant. So, the moral of the story is…. follow the rules.