Correcting an Accidental Franchisor Violation

Young woman making a mistakeWhat’s a franchise?  Franchise registration and disclosure laws define a “franchise” more broadly than people generally realize.  A company may be franchising without knowing it.  The “license” agreement may have been drafted, for example, by an attorney who has limited knowledge about franchise law.  Hence the popular topic (at least among franchise lawyers) of the “inadvertent” or “accidental” franchisor.

A business owner who has run a successful “test” of licensing its business may decide that the next step is to set up a franchise system, not realizing that the test was already a franchise sold in violation of one or more franchise laws.  The violation would consist of the licensor’s failure to prepare a franchise disclosure document (“FDD”) as required by the Federal Trade Commission’s trade regulation rule on franchising (the “FTC Rule”) and to deliver the FDD to the prospective franchise buyer at least two weeks before the franchise buyer signs an agreement or makes a payment to the franchisor.  If a state franchise law applies, the violation may also consist of the licensor’s failure to register the offering with the state.


Suspending Franchise Sales

In several states that require franchise registration, franchisors should suspend franchise sales while an amendment or renewal application is pending with the state.  Franchisors commonly suspend franchise sales pending registration in most states that require franchise registration.  But California and New York each offers a unique and very different approach than a blackout or suspension of sales.

California takes an approach that is eminently practical.  In California, a franchisor may deliver to a prospect the franchise disclosure document (“FDD”) as filed with state for renewal or amendment together with a written statement that the filing has been made but it has not been reviewed by the examiner and is not effective, and that the franchisor will deliver to the prospect an effective FDD showing any further revisions at least 14 days before any agreement is signed or any consideration is paid. (Cal. Corp. Code §31107.) This approach seems to be one that would not be objectionable in any registration state even if it is not part of the laws of the other state.  How could anyone object to a disclosure of filed materials while the actual sale is being suspended until the registration is effective and the franchisor makes a new disclosure after the amendment or renewal is effective and waits the required 14 days?

New York also does not require franchisors to completely stop all sales while an amendment to the franchise registration is pending.  But New York’s approach is impractical, leading franchisors generally to suspend sales during the time that an amendment is pending.


What Does Brexit Mean for Franchisors?

The coming negotiation over the specifics of the UK’s departure from the EU is an unfortunate necessity that follows from the UK’s unfortunate “leave” vote on June 23, 2016.  It is too early to know what the relationship between the UK and the EU will be once the UK actually leaves the EU, or indeed, whether there might be a way to reverse the vote.  For now, the laws remain unchanged.  The actual changes may take two years or more to work out, depending on when the UK notifies the EU of its departure pursuant to Article 50 of the Lisbon Treaty.

If those in the UK who are expressing regret today work to maintain a close relationship with the EU without actually reversing the Brexit vote, the approach might be similar to that of Iceland, Liechtenstein and Norway.  Those countries are not EU members.  They are members of the European Free Trade Association (EFTA) and European Economic Area Agreement (EEA). The UK could join these countries and continue its participation in the EU single market.  But it would require the UK to make large payments into the EU budget and to allow for the free movement of labor.  At this point, the UK may not be ready to accept those conditions.  Switzerland is also an EFTA member, but has its own agreement with the EU on trade instead of the EEA Agreement.


Notice of Rights Enhances Trade Secret Protection

trade secretsIn order to access the full range of remedies the Defending Trade Secrets Act of 2016 (DTSA) offers, a trade secret owner must notify employees and contractors of certain rights they have under the DTSA.

The DTSA allows a trade secret owner to seek damages and injunctive relief in federal court against someone who misappropriates the company’s trade secrets. The trade secret must be related to a product or service used or intended for use in interstate or foreign commerce. The action must be brought within three years after the misappropriation was discovered or reasonably should have been discovered. And the misappropriation must have occurred after the date of the DTSA enactment, May 11, 2016.

If trade secrets are misappropriated willfully and maliciously, the court may award (i) exemplary damages equal to twice the amount of the actual loss and (ii) attorneys’ fees.

But a trade secret owner can forfeit the right to recover exemplary damages and attorneys’ fees by neglecting to follow one simple requirement. The trade secret owner must notify employees and contractors that they are protected against liability for disclosing trade secrets in certain circumstances. This notice applies to agreements entered into or updated after the date the DTSA went into effect. In other words, franchisors and other trade secret owners should update their documents now.


New Tool to Protect Franchisors’ Trade Secrets

Obama Signing CeremonyOn May 11, 2016, President Obama signed into law the Defending Trade Secrets Act of 2016 (the Act). The Act amends the Economic Espionage Act of 1996 to create a federal private right of action for the misappropriation of trade secrets.

The Act offers to all companies with trade secrets new tools to protect against their misappropriation in interstate commerce as well as foreign commerce. Trade secret owners can use the Act in defending against both domestic and foreign threats.


An Intellectual Property Primer for Franchisors

Franchise IP LawIntellectual property is a core asset of any franchisor. In fact, intellectual property is important to virtually all businesses. For some companies, it’s their most valuable asset. A basic knowledge of intellectual property law enables an owner or manager to facilitate the development, protection and commercialization of the company’s intellectual property and to engage in productive discussions with the company’s legal counsel.

Intellectual property falls into four categories – trademarks, copyrights, patents and trade secrets.

  • A trademark is a brand. It’s the words or designs that identify your company when it sells anything.
  • Copyright law protects creative works. In the business context, this includes items like advertisements and operations manuals.
  • Patents protect inventions.
  • Trade secrecy law protects confidential information that is valuable to your business.

One crucial initial step for any startup company is determining the brand name of the products or services it will sell. The trademark may be one or more words or a logo design.

A lack of planning before investing marketing dollars can lead to expensive problems. For example, you may have to rebrand your products or your services if your trademark infringes the rights of a prior owner. Or the mark may not be registrable or protectable because it is too descriptive of the products or services you sell. Or it may be protectable, but so similar to the mark of other companies that its scope of protection will be narrow.


Improving Franchise Laws

California Franchise LawsWill California’s recent overhaul of its franchise relationship law lead to a proliferation of state franchise relationship laws? I doubt it. As I’ve written elsewhere, my guess is that the California law represents a specific congruence of interests that is unlikely to be repeated in other states.

Outside of California, the new franchise laws being enacted today have nothing to do with termination and non-renewal or good faith in franchise relationships. Instead, we are seeing new state laws declaring that franchisors are not joint employers of the franchisee’s employees. Such laws were passed in recent months in Texas (S.B. 652), Louisiana (HB 464), Tennessee (SB 475), Wisconsin (SB 422) and Michigan (SB 492). They are a reaction to the NLRB’s radical new joint employment standard in franchising.


Rulings Pose Obstacles to Franchisors Seeking to Stop Wrongful Trademark Use

Trademark infringementA series of recent Circuit Court decisions has made it more difficult for a franchisor to enjoin a former franchisee from using the franchisor’s federally registered trademarks after the franchise agreement has been terminated. I recently authored an article for the New Jersey Lawyer entitled, “Will New Court Rulings Make it Harder for Franchisors to Rescue a Hostage Trademark?“, discussing the impact of these decisions. Since its publication, I have received a number of comments from practitioners in the area, most of whom represent franchisors. All are completely frustrated with the new hurdles imposed by these decisions on efforts to obtain injunctive relief for trademark infringement.

Most jurisdictions require a franchisor plaintiff to establish some combination of the following elements:

  1. a likelihood of success on the merits,
  2. a likelihood of irreparable harm in the absence of an injunction,
  3. the balance of equities favors plaintiff, and
  4. a preliminary injunction is in the public interest.

Historically, once a franchisor demonstrated that it was likely to succeed on the merits of the case, a relatively easy task in a holdover usage case, irreparable harm was presumed.


What’s an FPR?

financial performance representationsEvery franchise buyer wants to know how much money he or she can make from the franchised business.  Franchise sellers naturally want to answer that question in order to make the sale.  But many say that they cannot give figures to prospective franchisees, and they suggest that the prospects talk to other franchisees whose contact information is typically listed in an exhibit to the franchise disclosure document (FDD).

The fact is that franchise sellers may indeed provide information regarding earnings, but only if the franchisor discloses “financial performance representations” (or FPRs) in Item 19 of the FDD.  If no FPRs appear in Item 19, then the seller must say nothing about prospective sales or earnings.  To do so would violate the Federal Trade Commission’s Franchise Rule and potentially give rise to liability under Section 5 of the FTC Act as false or deceptive advertising.  This requirement applies to franchise brokers as well as franchisors.

The term “financial performance representations” includes essentially any indication of “a specific level or range of actual or potential sales, income, gross profits, or net profits.”  Item 19 may state (using the required language) that the franchisor does not provide any financial performance representation.  But the FTC encourages franchisors to make FPRs in Item 19.


State Regulation of Biz Ops

breach-notification-laws26 states in the U.S. have laws that govern the sale of business opportunities, or “biz ops”. California and some other states use the term “seller assisted marketing plan” instead of business opportunity, but the substance is the same. At the federal level, the Federal Trade Commission (FTC) regulates the sale of biz ops, as explained in an earlier post. The FTC biz op rule does not preempt the state biz op laws, but allows the states to impose their own requirements.

Like the franchise laws, the business opportunity laws contain disclosure requirements and many require a filing. Unlike in franchising, though, there is no uniformity among the various biz op laws. These laws define a business opportunity in various ways and impose differing obligations on biz op sellers. Moreover, if a biz op offering subject to the FTC rule is also subject to the disclosure requirements of a prospective buyer’s state, the seller may be required to deliver to the buyer both the federal and state disclosure documents.