IFA s 45th Annual LEGAL SYMPOSIUM

Transcription

1 IFA s 45th Annual LEGAL SYMPOSIUM

2 Franchise Under FTC Rule A Franchise is a commercial relationship with three elements: The right to operate a business associated with the franchisor's trademark The franchisor has authority to exert a significant degree of control or provide significant assistance in the franchisee's method of operation The franchisee makes or commits to make a payment of $500 or more to the franchisor or its affiliate.

3 Franchise Under FTC Rule The Control or Assistance Element Amount of reliance by franchisee on the franchisor s provided level of control or assistance can also impact the analysis The greater the reliance, the more likely control or assistance will be deemed to be significant

4 Franchise Under FTC Rule The Control or Assistance Element Must relate to the franchisee s overall method of operating its business Site approval, design or appearance requirements Hours of operation Personnel policies, management or advice Furnishing a detailed operations manual Sales or business training

5 Franchise Under FTC Rule The Fee Element $500 or more to franchisor or affiliate Includes amounts required by contract or practical necessity paid as an initial fee, a training fee, a deposit, rent, equipment purchases and continuing royalties Excludes the payment for a reasonable amount of inventory at bona fide wholesale prices

6 Franchise Under FTC Rule The Fee Element During the first 6 months of operating the business Promissory note payable after 6 months will not satisfy the FTC Rule, but no acceleration clause, no waiver of defenses, and franchisor cannot negotiate the note to a Holder in Due Course

7 Franchise Under State Rules Prescribed Marketing Plan States California, Illinois, Indiana, Maryland, Michigan, North Dakota, Rhode Island, South Dakota, Virginia and Washington Community of Interest States Hawaii, Minnesota and Wisconsin

8 Franchise Under State Rules Prescribed Marketing Plan Definition Franchisee is granted the right to operate a business that is associated with the franchisor s trademark Franchisor substantially prescribes a marketing plan or system Franchisee pays a fee

9 Franchise Under State Rules Prescribed Marketing Plan Association with the franchisor s mark must be substantial (generally measured in terms of the totality of the goods or services offered under the franchisor s mark) In California, the presentation of the business to customers is important (whether there is an appearance of a unified operation)

10 Franchise Under State Rules Community of Interest Definition A fee Franchisee is granted the right to sell goods or services under a trademark Franchisor and franchisee share a community of interest in the operation of that business

11 Franchise Under State Rules When is a community of interest present? When there is a continuing financial interest between the parties; and When there is interdependence between the parties, such as cooperation and coordination of activities and shared common goals Wisconsin Supreme Court 10 factor test

12 Franchise Under State Rules New York Definition A fee is paid for the right to engage in a business of offering goods or services substantially associated with the franchisor s trademark; or A fee is paid for the right to engage in a business of offering goods or services under a marketing plan or system prescribed in substantial part by the franchisor

13 Business Opportunities FTC Business Opportunity Definition A seller solicits a prospective purchaser to enter into a new business The prospective purchaser makes a required payment (bona fide wholesale excluded) The seller makes certain representations to the buyer

14 Business Opportunities 26 State Business Opportunity Laws A product sale element A fee element (most states do not have a bona fide wholesale price exclusion) A representation element

15 Avoiding Franchise Laws Using Exemptions Where avoiding the definition of a franchise is not possible or desirable, look for an exemption Must be exempt from disclosure under the FTC Rule, and exempt from registration and disclosure in any applicable states

16 Risk of erroneously relying on an exemption falls solely to the franchisor Potential for rescission, damages, injunctions, fines, other civil and criminal penalties

17 Exemptions from the FTC Rule Sophisticated Franchisee and Fractional Franchisee Particularly useful because at least one of these exemptions exists in the majority of registration states

18 Sophisticated Franchisee Exemption Franchisee (or its parents or any affiliates) is an entity that: Has been in business for at least 5 years, and Has a net worth of at least $5 million

19 Sophisticated Franchisee Exemption Practical considerations: How do you document qualification? Balance sheet Inter-corporate org chart and ownership structure Public records Are they a fit from a business perspective? Suitability for operating the business to be franchised Understanding of franchise relationship

20 Fractional Franchise Exemption The franchisee (or directors or officers of franchisee or parent or affiliate), has more than 2 years experience in the same type of business, and The parties reasonably anticipate that sales from the franchise business will be less than 20% of franchisee s total sales during first year of operation

21 Fractional Franchise Exemption What type of experience is required? same type of business Same business selling competitive goods Business that would be ordinarily expected to sell the type of goods considered Judgment call? Practical considerations? Involvement in the business?

22 Fractional Franchise Exemption 20% of sales component? Revenue of the franchise entity only [?] Can include revenue from business activities in any location (but not in CA)

23 Other Exemptions from FTC Rule Large Initial Investment Insider Exemption Leased Departments Petroleum Marketers Oral Agreements

24 Exemptions from State Franchise Laws Must be exempt at a state level too. Consider applicability of state laws Where will the franchise be located, franchisee s state of incorporation, franchisee headquarters Availability of Exemptions vary widely state to state

25 Exemptions from State Franchise Laws Fractional Franchise Exemption: CA, MI, MN, NY, OR, SD, WI Sophisticated Franchisee Exemption CA, IN, MD, RI, SD, WA, WI

26 Exemptions From State Franchise Laws Many of these exemptions are only exemptions from registration, not disclosure or relationship rules Exemption by Order May be most practical if you do not have or want to prepare an FDD

27 Practical Considerations A nationwide system based on exemption is administratively complex Discipline and due diligence to evaluate each deal and each jurisdictions available exemptions Recurring filings

28 Converting Licenses or Distributors to Franchises

29 Advantages to Conversion Channel Ownership and Long Term Control Operational Control and Exclusivity Branding Collect Fees and Offset Support Costs

30 Challenges of Conversion Change is never well received Independence vs. Control Fees Emotional attachment the name on the door Perception of failure Impact on existing channels Dealer defections Selecting Dealers to Convert

31 Disposition of the Existing Channel What will you do with non-converting dealers? Multi-channel approach Allow channel to remain but stop offering new Gradual transition using attrition Planned transition using franchise sales

32 Branding Issues Is the current channel branded? If so, how do you differentiate the new channel? New brand Premier Brand If not, how do you get past the re-branding issue? Advantages of national branding v. father s name Costs of rebranding Impact on remaining channel

33 Incremental Value Ultimately, two ways to gain acceptance The Gun-to-the-Head approach Incremental Value Unless you are willing to take away value, must find ways to add value Win-win approach not margin reduction Can only be determined by existing channel

34 Incremental Value Elements Branding Territory Exclusive (or first access) to product lines Best Practices Improved support National accounts Purchasing discounts Equity ability to transfer Concept specific pieces of the value proposition

35 Exclusivity Restricting the Value to the Franchise Channel Channel bleed Employees of the franchisor motivated to make channel remnants more profitable Revenue growth will motivate ownership Loss of exclusivity will destroy the future of the channel How to keep it exclusive Separate support organizations Compensation structure

36 The Importance of Dealer Input Ultimately, we need to sell it Top down v. bottom up Without involvement in development process, dealers will lawyer up If dealers believe it is their program from day one, they will sell other dealers on their program

37 Soliciting Dealer Input Opinion Leaders approach Selectivity Controlled and structured environment If you cannot sell it there You do not need to cede control Understand structure first Win-win program a team approach Take the decision-maker out of the room Third-Party facilitators Can keep meeting on track where others cannot Use a lightening rod for sensitive issues Can be the fall guy Allow yourself an escape hatch can afford to lose money, not face

38 Facilitating Channel Conversion Planning Dealer Involvement Assess current distribution system Determine desired relationship changes Establish Boundaries for Acceptable Structure Financial Projections and Plan Prepared Develop Change Management Plan Develop survey of existing channel Review Survey Results & Develop Opinion Leader Presentation Document Revised Structure Develop Value Proposition and U.S.P. Finalize Revised Structure Survey select dealers and all Opinion Leaders Hold Opinion Leader Meetings Review Revised Structure Develop Opinion Leader consensus support for structure Review new contract(s) with Opinion Leaders Documentation Draft Contract(s) as needed/appropriate Complete other legal requirements, if any Copyright, The ifranchise Group, All Rights Reserved. Use Opinion Leaders to introduce new program at the regional level Sales Launch new program at the national level with deadlines for preferred status

39 The Importance of Trust Older organizations will have baggage Must take into account Strong relationships make the process easier By involving dealers throughout the process, you will have a substantially greater likelihood of program acceptance

40 IV. Legal Issues in Converting Licensee or Dealer to Franchisee Frequently dealers and licensees are not forced to convert, so the franchisor must make them an offer that they can t refuse. Exceptions: e.g. dealer agreement expires with a covenant not to compete

41 Read the Dealer Agreement, Franchise Agreement, FDD, Relevant Statutes: Exclusive territory clauses; make territories do not conflict, or that there are carve-outs Covenant of good faith and fair dealing; do no harm Dealer laws in specific industries (e.g. motor vehicles) protect territories FDD disclosures in Item 1, 12, 20 are tricky

42 I sold 20 licenses, but now I want to comply with the franchise laws. Assess risks of coverage, claims, exemptions Possible defenses, including laches to rescission, statute of limitations Possible damages; are licensees successful? Likelihood of claims; what will licensees tell the regulators and their lawyers

43 Should Client Fess Up ; Self- Report a Violation to Regulators If the violation is clear, inform the client that regulators in registration states need to be told, and that fines, rescission, consent orders that have to be disclosed may result If there is no violation or there is good defense, disclose licenses or dealerships What if grey area; risks of non-disclosure

44 De-Franchising Pros and Cons Dealers or Distributors Con: For supplier, no initial fees or royalties to fund training and support. Pro: For expensive or high margin products, e.g. cars or gasoline; or if training e.g. multi-line dealer supplier can still make adequate profit without fees other than a bona fide wholesale price for goods.

45 De-Franchising Pros and Cons of Licensing Con: No significant control or assistance or (in some states) a marketing plan or (in some states) a community of interest. Pro: If the licensee is large, sophisticated and experienced, it may not need or expect control or assistance, e.g. a clothing or technology manufacturer that licenses from a developer

46 De-Franchising Pros and Cons of Agency Con: No initial fees or royalties to fund initial and ongoing training and support. Pro: For goods or services normally provided directly to the customer by the principal, e.g. insurance or real estate listings, the principal can make adequate revenue from the customer, less agent commission

47 De-Franchising Pros and Cons of Business Opportunities Con: Purchasers may not use a unified trademarks, so no unified branding Pro: For businesses that do not rely on a unified trademark, e.g. direct sales, multi-line dealers, reduced legal compliance costs if no marketing plan Warning: dealerships may be regulated business opportunities

48 Conversion of Existing Franchisees Does franchise agreement permit defranchising: By eliminating fees and royalties (but will support be reduced); By eliminating trademark license (probably a breach of contract); At renewal or expiration, if there is a specific right to do so or to buy back option

49 Conversion of Existing Franchisees In agreement, Franchisor normally must license trademark and provide significant assistance or marketing plan, unless: Upon renewal, Franchisor s right to change the agreement, or renewal conditioned on franchisor still franchising in the state Option to buy out a franchisee at predetermined price and time

50 Conversion of Existing Franchisees Even assuming conversion affects only new licensees (dealers), as to affect on existing franchisees, consider: Duty of Good Faith. As with conversion the other direction, do no harm Obligation of Franchisor to Grow and Support? Territory and Exclusivity Provisions in Agreement?

51 Carve-Outs to Exclusive Territories Franchisor or its agents or licensees may: Purchase or be purchased by, or merge with, competing businesses; Establish or license a business outside the territory; Sell dissimilar goods or services; Serve dissimilar customers, such as national accounts; Sell in other distribution channels, e.g. Internet, wholesale, etc; Use different trademarks for goods and services that are similar but at different quality or price levels; Distribute to different dealers or licensees that may be exempt from franchise laws, such as large or sophisticated entities, schools and colleges, entertainment and sports complexes, airports, military bases and government facilities, a licensed department retail and hotel chains, etc.

52 In sum, if it quacks like a duck... If the structure involves all the elements of a franchise and exemptions are not available, franchise compliance is required, unless the business model is changed, in reality as well as in the contracts. Consider also the business and legal issues in running a dual system (e.g. franchisee and dealer), and the conversion process of one to the other

53 Thank you! Gary R. Duvall, Dorsey & Whitney LLP Mark Siebert, CEO, The ifranchise Group, Inc Christopher T. Feldmeir, Greensfelder, Hemker & Gale, P.C. Adam Ekberg, Director, Corporate Counsel Starbucks Corp, Seattle's Best Coffee Division