| Licensing, Technology Transfers, |
I wrote a tutorial on the nature and
manner of franchise compliance from the perspective of the franchisor a few
years back. Since then I have seen many situations in which franchisees have
incurred disastrous losses because they failed to appreciate the nuances of
compliance by a franchisee, and that failure presented opportunities for their
franchisor or a company that acquired their franchisor to take away their whole
business without compensation.
If you are a franchisee and don’t want to lose
everything, you need to read, understand and follow the principles outlined
below.
Your franchise agreement contains many provisions
in addition to those requiring you to do what you are told and pay money to your
franchisor on time. You probably never read them, and if you did, you didn’t
appreciate what they mean. There are many “boilerplate” (contained in every
franchise agreement) provisions that deal with financial transactions,
intellectual property protection, ownership and transfer, consents and rights of
refusal.
If you forget about these and do certain things
that seem perfectly normal in any non-franchise business context, without
following the requirements of the contract, your franchisor may declare you in
default, and the default will in some instances not have a cure opportunity. You
could simply be terminated and lose everything.
You may have done whatever you did that failed to
comply with your obligations under these provisions many years ago. They didn’t
affect the day to day operations of your franchise or relate to your normal
monthly reporting routines. The fact that the franchisor failed to discover the
failure to comply until many years later may not excuse what you did or failed
to do.
This particular agony arises normally and usually
in connection with your desire to renew the franchise for another term; sell the
franchise; buy another franchise; change the company form (Corp, LLC, etc); pass
the franchise ownership to your next generation. In each of these instances it
is customary for your franchisor to conduct an “audit” (not really an audit, but
an examination of the manner of your compliance with all the provisions of the
franchise agreement) to determine whether you could be held to have breached the
agreement.
Today we see some companies accused of
discrimination because of the franchisee perception that certain groups are
being targeted for termination. In one such lawsuit, the franchisor is accused
of trying to rid itself of its brown skinned franchisees in a scheme to enhance
its opportunity for a very successful IPO. While that seems ridiculous on its
face at first blush, it did signal that certain franchisees were being
inspected, “audited” and noticed for termination in an other than customary
manner.
Most franchisees think of an inspection as a
visit from a field rep looking for unauthorized products, adverse conditions in
the store, failure to comply with various daily operational requirements.
Inspection deficiencies usually are noted in written inspection reports that are
reviewed with the franchisee for purposes of getting the franchisee to spruce up
for another inspection to come shortly to see if the problems have been fixed.
If they are attended to, the franchisee is not at risk in most instances.
Most franchisees think of “audits” as examination
of their financial records to assure proper reporting and payment of what is
required by the franchise agreement. The contracts require that errors/under
reporting be corrected, with penalties and interest and payment for the expenses
of the “audit”. Repeated examination of financial records comes with an initial
finding of under reporting, and it is customary for the agreement to provide for
termination without cure if there are repeated financial defaults.
That accounts for the “performance” requirements
as understood by almost all franchisees. That is simply insufficient sensitivity
to franchisee obligations and may get you terminated or refused renewal rights,
or refused consent to sell the business and realize the full going concern value
you may have built up over the years.
Transactions in which you omit to think of the
more “boilerplate” provisions of the franchise agreement are often present in a
non franchised business. If you borrow money, what happens in the transaction is
just between you and your lender.
In franchising, if you borrow money and there is
a security agreement that is signed in connection with the loan, as there almost
always is with any commercial lender, the security agreement is written to
encumber every asset you have, to maximize the lender’s secured position. By
definition, that would include your rights under your franchise agreement.
However, your franchise agreement doesn’t allow that without the written consent
of the franchisor. A rational franchisor will be used to dealing with the
requirements of commercial lenders and either be willing to consent, or may have
a rider that exempts the franchise rights from the security agreement, that
banks will usually agree to if handled correctly.
That means that you start your loan arrangements
sooner to provide time to work out the consent of the franchisor. If you do the
loan without the franchisor’s consent, the franchisor may claim that you have
encumbered the franchise rights in violation of at least two covenants in your
franchise agreement. The first would be the covenant not to alienate or encumber
the franchise rights; and the second would be the covenant against attempting to
permit or license anyone other than the named franchisee to have rights to use
the name or other intellectual property of the franchisor.
Another area in which franchisees tend to omit to
comply with franchise agreement consent obligations is the matter of changing
ownership of the franchisee’s company. This includes changing from a sole
proprietorship or LLC to a corporation without the franchisor’s prior written
consent; and bringing family members into the business. The franchise agreement
makes allowances for a tax planning or financial planning need to change the
form of your business, but prior written franchisor approval is required. Almost
no one thinks to do this because it seems so ordinary and simple a thing that
people do in business. But without prior approval, it is a breach of the
approval requirement; the intellectual property protection covenants; and the
franchisor’s right of first refusal of transfers or partial transfers provision.
Refugee franchisees seem always to be unaware in
any conscious sense that these standard contract provisions are involved in
matters that in any normal non franchised business would never be in play. They
tend to think that if they operate the business properly and pay what they owe
when it is due, they are home free. That simply is not true.
In many franchise agreements there are other
related agreements that are part of the overall franchise transaction. These
include lease agreements and financing agreements if the business is one in
which there is the use of floor plan financing.
In such situations, the franchise agreements
always provide that a default regarding any one of these other agreements will
also cause a default of the franchise agreement. That’s called cross default
amongst more than one agreement and is always the case in any competently
drafted franchise agreement.
Your store premises lease will usually have a
rider permitting the franchisor to take over the location and lease obligations
if you default. In these riders, the landlord usually consents in advance to the
takeover when there is a default of the lease. You can be evicted summarily
according to the agreement language. You may get a delay from a judge for
various reasons, but when you get right down to it, you are in default and the
cross default provisions are always enforceable. In the usual case you lose your
entire business, and you may have residual liability on the lease despite being
dispossessed, and breach of contract damages liability under the franchise
agreement. If you are very lucky and find some kind soul judge who pressures
your franchisor to allow you to cure the defaults, and you are able to do so,
you have spent many thousands of dollars just in your own legal fees, plus
whatever it costs to cure the defaults and pay the franchisor’s lawyers.
There is in every franchise agreement a provision
that requires the franchisee to operate the business in compliance with all
laws, statutes, ordinances and regulations that may pertain to the business. The
list of laws that you may violate and put your entire franchised business at
risk is a long list. Consider that if you file an improper income or sales tax
return, you are in default of the franchise agreement. That’s just one on many
possible examples.
There are also financial responsibility default
provisions in every franchise agreement. Under these provisions, insolvency,
bankruptcy and failure to satisfy or remove and judgment or lien within thirty
days puts you in default.
There are many more ways to lose your franchised
business than your are normally cognizant of. When you want anything from your
franchisor, it is quite customary for your franchisor to do an “audit” of your
compliance. The “auditors” they send out have check lists that tie into every
possible way in which you could have defaulted in some way under some provision
of your franchise agreement. If the “auditor” finds defaults, you may not
receive consents; you may not have a cure opportunity; you may not be allowed to
renew your franchise; you may not be permitted to sell your franchised business;
and you may be terminated.
When you contemplate any transaction that could
in any manner affect obligations under your franchise agreement that you may not
be aware of, you really must have it vetted in advance by a very competent
franchise attorney. A lawyer who is not a franchise lawyer may not – probably
won’t – have the experience and sensitivity to appreciate the interrelationships
of the various provisions of your franchise agreement.
You do yourself a grave injustice if you fail to
get this prior vetting of your proposed transactions by a franchise lawyer just
because you don’t want to spend money for the legal fees. Those legal fees will
save your business from ruin and save you from default liability under your
loans, your leases and your franchise agreement(s).
If there is no franchise lawyer in your
community, that makes no difference. Documents can be sent to any franchise
lawyer you may engage, and you may be advised by telephone and email. You can
find good franchise lawyer assistance on the Internet. Just Google up “franchise
lawyer” or “franchise lawyer in (name your city or state)”. There is no excuse
for putting yourself in danger by neglecting responsibilities.
Copyright 1997 - 2008 || Richard A. Solomon
|| Site Map
||
||
 | Licensing, Technology Transfers, |