Annual Franchise Legal Update
In our courtrooms last year we saw a multitude of decisions that reflect the state of our economy – “Uncertainty”.
 1.        Taxation
            Perhaps the biggest uncertainty franchisors face today is their growing exposure to state taxes as states struggle to find new sources to replace lost revenue. Franchisors are being exposed to more and more states which are re-defining “Nexus” to by-pass the old requirement that franchisors had to have a physical presence in a state to be subject to the state tax laws. The most dramatic change last year occurred in New York, requiring franchisors to act as tax auditors for their New York franchisees (New York Tax Law, § 1136 (i) (1) (B) Subpart G, Part V-1 of Chapter 57, L. 2009). California has also joined the state tax feast and recently mandated that all franchisees “withhold” if their franchisors do not file.Â
            In Surters v. Ventures, Inc., 8 So. 3d 950 (Ala. Civ. App.), aff’d, 8 So. 3d 983 (Ala 2008), cert denied, 129 S. Ct. 2051 (2009) the Court of Civil Appeals upheld the Alabama Department of Revenue’s assessment that royalty payments had to be added back to the taxpayer’s income under Alabama’s version of an add–back state. See also Decision Nos. 506 – 544N & 06 – 545 FN, West Virginia Office of Tax Appeals, January 6, 2010.
 2.        Disclosure
            In the matter of the California Corporations Commissioner v. Play N Trade Franchise, Inc., No’s. 99 3 – 5595 and 993 – 5596 (April 14, 2009), the California commissioner found that the franchisor failed to file the required notice when the franchisor openly negotiated different sales terms with prospective franchisees. The Commissioner found a willful disregard for disclosure requirements and material misstatements in the Franchise Application. As a result, the unit registration was revoked and the area application denied. The franchisor was also fined $132,500 and Ordered to pay Complainant’s attorney fees and the franchisor was also required to offer California franchisees the right of rescission.
            As we all know, franchising is a very specialized area of the law. When an attorney who is not knowledgeable about franchise law steps out of his normal practice areas he can find the road very bumpy. In State ex. Rel. Counsel for Discipline of the Nebraska Supreme Court v. Orr, 759 N.W. 2d 702 (Neb. 2009), a veteran business lawyer drafted a disclosure document. The franchisor was sued by several franchisees claiming the disclosure document did not comply with applicable law. Formal charges were filed against the attorney for violating several ethic rules, one of which states that a lawyer shall not handle a legal matter “which the lawyer knows or should know that he or she is not competent to handle, without associating with a lawyer who is competent to handle it or without preparation adequate in the circumstances.”
 3.        Wrongful Termination
           A wrongfully terminated franchisee turned an initial franchise fee into almost $350,000 plus interest and attorney fees. Quiznos Franchising, LLC v. Zig Zag Restaurant Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,046 (D. Colo. Dec. 31, 2008). The Court lambasted the franchisor’s termination based upon a mystery shopper program which was flawed and inconsistent. This case emphasizes that franchisors which retain discretion in deciding whether facts exist to warrant termination are under an implied duty to exercise their discretion reasonably and justifiably. It is a very good case for franchisors to read and learn what not to do.
            In Emergency Accessories & Installation, Inc. v. Whelen Engineering Co., 2009 U.S. Dist. LEXIS 40956 (D. N.J. 2009) the Court noted that the 60-day notice of termination required by statute was required even though the Franchise Agreement chose the law of another state and provided for an at–will termination by either party. As always, franchisors must comply with the termination laws of the franchisee’s state.
 4.        Unconscionability
            California continues to lead the challenge on arbitration provisions being unconscionable. In the case of Bridge Fund Capital Corp. v. Fastbucks Franchise Corp., 2008 U.S. Distr. LEXIS 83724 (E.D. Cal. Aug. 19, 2008) the franchisor contended the franchisees were contractually bound to submit their claims to arbitration in Texas pursuant to their Franchise Agreement. The California court found the arbitration provision to be unconscionable and thus unenforceable. Part of the finding focused on provisions of the Franchise Agreement which were so one-sided that the Court found them to tilt the scales of unconsciousness. The Court stated that the limitation of damages to actual damages, shortening of the statute of limitations, the place of arbitration and banning class actions was enough to find against the enforcement of an arbitration clause in the Franchise Agreement. Similar issues were presented in Ben Charsky v. Cottman Transmission Sys., LLC, 2008 U.S. Dist. LEXIS 105 689 (N.D. Cal. Dec. 29, 2008). The Court severed the unconscionable provisions that violated the California Franchise Investment Law and upheld arbitration but required the application of California rather than Pennsylvania law.
 5.        International
            a.        Australia
                        In January, 2009, the Australian Competition and Consumer Commission published its Franchisee Manual, available at:
 www.accc.gov.au/content/index.phtml/itemId/795322
            b.        Canada
                        In April, 2009, the provincial Department of Justice and Consumer Affairs published its Consultation on Proposed Regulations that will give effect to the New Brunswick Franchise Act. It is expected that the disclosure regulations will be introduced in the next two months followed by implementation six months after introduction.
            c.        South Africa
                        On April 30, 2009, The President of South Africa signed into law a sweeping consumer protection bill that includes a regulatory regime for franchising.Â
 6.        Conclusion
            It is my hope that our Annual Legal Update will assist your company in analyzing the sufficiency of existing safeguards in your franchise program and help you decide whether to modify or implement new procedures in your franchise system. As part of your Annual Review make certain to include a legal review with your counsel. I am a firm believer that an “ounce of prevention is worth a pound of cure”.
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About the Author
Mr. Hunt’s primary areas of practice include franchising, intellectual property law (copyright and trademark), entertainment law, corporate transactions and real estate law. He has represented clients in trademark registrations and dispute resolutions. Mr. Hunt consults clients in copyright issues related to music and the performing arts, publishing, computer and internet content, and various other issues that arise for clients under copyright law.Â
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