Liquidated Damages - Friend or Foe? (Part One)

This topic has only been mentioned tangentially in this blog some time ago -- Franchisees - Damages Warning: Lost Future Royalties (see the last paragraph of that post)

In my experience, Liquidated Damages are most commonly found in construction contracts, where damages can be imposed for delays in completion or other material breaches. But we jump the gun. What are Liquidated Damages and what the heck do they have to do with franchising?

Simply stated, Liquidated Damages is the amount of money that both parties in a contract agree upon if a breach of contract occurs or legal action arises as a result of a contract breach. That is, if there is a breach by one party, instead of arguing about the potential actual damages that may result, the parties agree in advance at the time of the contract is signed  that the damages will be predetermined. Sounds simple enough ...

But, Liquidated Damages has a checkered past and, if applied in a punitive or excessive manner, can be challenged as an unenforceable "penalty," even though the parties "agreed" in advance. Therein lies the rub: agreed? Oftentimes Liquidated Damage provisions are imposed by one party and, when that occurs, the "penalty" argument ensues. Although there is more legal nuance to how Liquidated Damages work, let's turn to how Liquidated Damages are used in franchising.

The post mentioned above Franchisees - Damages Warning: Lost Future Royalties summarizes the hazards that can ensue when a franchise agreement is terminated by a franchisee prematurely (i.e. before the full contractual term is fulfilled) and the franchise company seeks damages in the form of "lost future royalties" and other lost fees the company expected. If there is no Liquidated Damages clause, some franchise companies believe they are entitled to the lost royalties and fees for the entire remaining balance of the contract term (think: a 20-year term with 10 years left to go). This can be a hefty amount! And some courts have granted these types of damages. Very bad for franchisees.

Of course, the higher the amount sought, the greater the likelihood that a franchisee will fight or perhaps seek the shelter of a bankruptcy court. This increases the franchise company's legal fees and may leave the company holding an empty bag. Very bad for a franchise company.

So there are risks on both sides.

Stayed tuned for Part Two of this post where we will discuss how some companies may use Liquidated Damages to their advantage and why franchisees may want to negotiate for a Liquidated Damages clause (even though this may sound counter-intuitive).

Marijuana - Pot - Cannabis ...the Bud Turns

Some of the MOST popular posts on this blog have concerned franchising and marijuana. (See "Franchising Marijuana" Part One, Part Two, Part Three and Part Four)

Franchise lawyers have been nipping around issues concerning the ultimate franchising of cannabis-related businesses. With the passage of more and more state laws legalizing medical and recreational pot, franchising and marijuana is a hot topic. (Illinois is a recent entrant)

In 2016, an article appeared in the American Bar Association's Franchise Law Journal that I mentioned in this blog: Franchising a Marijuana Business: It's not Quite Mission Impossible. Shannon McCarthy (a partner with Miller Nash Graham & Dunn, LLP in Seattle, Washington) and Dawn Newton (a partner with Donahue Fitzgerald, LLP in Oakland, California) provided a comprehensive treatment of the legal issues and challenges.

This month, Rochelle "Shelley" Spandorf  added to the legal literature with "Cannabis Entrepreneurs: Know the Perils of 'Accidental Franchising."  

Shelley is a franchise-colleague of mine from the American Bar Association’s Forum on Franchising. She is a partner in the Los Angeles office of Davis Wright Tremaine. A certified specialist in franchise and distribution law in California, she has dedicated her legal practice to representing primarily franchisors, suppliers and other brand owners expand through trademark licensing. She is the first woman to chair the American Bar Association’s Forum on Franchising, the nation’s preeminent association of franchise attorneys, and has twice chaired the Franchise Law Committee of the California Lawyers Association.

In other words, Shelley knows what she is talking about! Her article shines a bright spotlight on the subject and it is worth a read. Thanks Shelley!

Franchise Purchasers Entitled to Written Substantiation

Hey Franchise Purchasers here's a tip for you.

The Franchise Disclosure Document contains 23 items of information for your benefit and should be provided to you by all franchisors before a sale is consummated.

One important item is Item 19 (Financial Performance Representation) -- under the FTC Rule -- Item 19 "permits a franchisor to provide information about the actual or potential financial performance of its franchised and/or franchisor-owned outlets, if there is a reasonable basis for the information, and if the information is included in the disclosure document." (See my prior post for more more background on Item 19 - Franchise Disclosure Document - Dissected - Part Four)

But the tip concerns some "hidden" information you are entitled to receive upon request.

If a franchise company makes a Financial Performance Representation in Item 19 (this used to be called an Earnings Claim) you are entitled to know more: a franchise company must have "written substantiation for the representation at the time the representation is made." The trick is though that the substantiation will be made available only upon reasonable request."  The FTC Compliance Guide notes that written substantiation means that the franchise company must have "supporting data underlying any representation..."

Now in my experience many franchise purchasers are reluctant to ask for this! You should ask for everything you are entitled to receive when making this large of a financial investment. Also, on a few occasions, when I do convince a purchaser to ask for the written substantiation, some franchise companies indicate that they DO NOT have the information. This is a violation of the FTC Rule and a major red flag. Would you buy a franchise from a company that does not comply with the law?

Franchisors: if you make an Item 19 Financial Performance Representation, be sure to inform franchise prospects that they are entitled to receive the "written substantiation for the representation at the time the representation is made" and make certain you are prepared to produce it.

Unintended Consequences - Joint Employment Revisited

The Contrarian is BACK! Sorry for the long absence but life intervenes and my posts require some motivation i.e. something interesting!

Well some of my franchise colleagues have delivered! In a recent article in the American Bar Association's Franchise Law Journal, "Drawing Lines in Franchisor Support--Is It Necessary and Where Are the Lines to Draw in Today's Joint-Employment Environment?," some of franchising's leading lights (Joyce Mazero, Karen Boring Satterlee, Eric H. Karp, Leonard H. MacPhee, Jess A. Dance & William W. Sentell), discuss the unintended consequences from the joint-employer debacle. 

(For some background check out these prior posts: NLRB Decision and Joint Employer Controversy...Trumped? There are updates generally available but we don't have the room here)

Most striking about the article is the reporting from a survey the authors and the International Franchise Association conducted. The results show that a "substantial majority of brands... report reducing or eliminating certain services." What does this have to do with joint employment? Well franchisors are trying to avoid being tagged as the "joint employer" of its franchisees' employees. So the reduction or elimination of  franchisor guidance and services that deal with "employees" is one way to say "Hey, we don't have anything to do with franchisees' employees, that's the franchisees' job!"

Now for the result of the survey (quoting from the article):

• Eighty-six percent of the franchisors and fifty-three percent of the franchisees indicated that training provided to franchisee employees had been reduced or eliminated.

• Sixty-six percent of the franchisors and sixty-seven percent of the franchisees indicated that the franchisor had reduced or eliminated providing operations and performance standard recommendations.

• Eighty percent of the franchisors and fifty-three percent of the franchisees indicated that franchisor-supplied advice/guidance regarding staffing and scheduling had been reduced or eliminated.

• Forty-six percent of the franchisors and fifty percent of the franchisees indicated that franchisor-supplied advice/guidance regarding personnel manuals and human resources had been reduced or eliminated.

• Seventy-three percent of the franchisors and sixty-seven percent of the franchisees indicated that franchisor-supplied advice/guidance regarding compensation to employees had been reduced or eliminated.

• Thirty-three percent of the franchisors and sixty percent of the franchisees indicated that franchisor-supplied advice/guidance regarding employee benefit programs had been reduced or eliminated.

• Fifty-three percent of the franchisors and forty-three percent of the franchisees indicated that franchisor-supplied advice/guidance regarding employee standards/performance or assessments had been reduced or eliminated.

Wow, the "joint employer" advocates caused some changes in the franchise world...but not the ones they intended!

Don't Forget about SBA Franchise Registry

The Franchise Registry is an important tool for franchisees and franchisors - eligibility information is available here with a click.

As noted on the Franchise Registry site (powered by FranData): "The Franchise Registry lists franchise systems whose franchisees enjoy the benefits of a streamlined review process for U.S. Small Business Administration (SBA) financing. Loan applications for franchises on the Franchise Registry can be reviewed and processed faster and more efficiently by the SBA and its lenders because the respective franchise agreements do not need to be reviewed in each individual franchisee situation." 

And, for current FDDs and Franchise Agreements it is important to remember that a new Addendum to Franchise Agreements is available. Initially, the new Addendum (one-size fits all) was made mandatory by the Small Business Administration (SBA) but a recent change allows franchisors to use their previously-approved 2015 or 2016 SBA Addendum. You can find the updated policy here. It is important however to let FranData know which option you will use so lenders can be alerted to the choice.

After reviewing the new Addendum and comparing it to some of my clients' previously-approved 2015 or 2016 SBA Addenda, the Addendum seems far simpler with little-to-no downside. But, each franchise system needs to review this choice with franchise counsel.

Good luck with your SBA financing!

Goodbye 2016! Bonus Included for You

Well 2016 was certainly an interesting year ... most of my comments would likely cause some controversy (isn't that what a contrarian lives for?) but I will refrain and say only that 2017 could be even MORE interesting! And, it would be even better if I improve in Fantasy Football and the Eagles have a winning season.

Thank you readers ... for some unexplained reason visits to this blog have increased dramatically over the last few months (have I been discovered?) -- this month alone there were over 7,100 views and all-time visits just topped 19,000! Again thank you.

Some quick news: my ABA Forum on Franchising colleague and VERY good friend, Ken Milner, just reported a "Holiday Present for Franchisors in PA" via the ABA Forum List-Serv. This is another chink in the "joint-employer" stance. The Pennsylvania Supreme Court let a lower court's decision stand that held that a franchisor was NOT a joint employer of an employee of a Saladworks' franchisee, at least in regard to being liable for workers compensation payments. (lower court decision: Saladworks, LLC, et al v. WCAB (Gaudioso), et al, No. 1789 C.D. 2014, decided October 6, 2015) Thanks Ken! As noted in my last post (Joint Employer Controversy ... Trumped?) , perhaps 2017 will see the demise of this ill-begotten theory (at least in the franchise context).

And here is a "Holiday Present" for you -- this year I had the privilege of working with Bethany Appleby (Wiggin & Dana, LLP) in presenting our paper at the ABA Forum on Franchising's Annual Meeting in November - Show Me the Money! Maximizing Monetary Recovery in Franchise Cases. If you are interested in that sort of thing -- here's a copy for you. 

Wishing you a Successful 2017!

Joint Employer Controversy ... Trumped?

Wow ... I admit to falling off the blog wagon of late! No real excuse except ABA Forum on Franchising burn-out (as author/presenter), college football, pro football, and, oh yeah, a number of client-litigation matters!

First, thank you for visiting this blog ... there have been over 14,000 visits since starting this effort in January 2015 and over 4,000 visits last month - maybe I should post LESS frequently!

Many of my posts are stimulated by new franchise cases, striking client-experiences, and hot franchise topics. I think my "stimulation" has been dampened by the Trump-election and the litigation matters mentioned above (they become obsessions!) But let's talk Trump and the joint-employer controversy for a moment ...

I have posted on the joint-employer issue a few times (here and here) and have advocated to "relax" ... let the courts sort it out. In the meantime, franchisors have gone into protective-mode, changing their procedures, agreements, and manuals. Now even the Small Business Administration has gotten into the act - issuing a new mandatory Addendum to Franchise Agreements for franchisors seeking SBA financing for franchisees via the Franchise Registry that includes the following provision: EMPLOYMENT - Franchisor will not directly control (hire, fire or schedule) Franchisee’s employees. (tip of the hat to Edith Wiseman with FRANdata for passing it along) WOW, this certainly smacks of one government-agency feuding with other government-agencies (NLRB and DOL).

So what does this have to do with Trump? Since the election, a number of my ABA Forum on Franchising's colleagues have been commenting on the Forum List-Serv that Trump's election may derail the efforts to hold franchisors jointly liable for their franchisees’ employment law violations; noting that the NLRB will likely become Republican controlled and the leadership at DOL is destined to change as well. By the by, the joint-employer session at this year's Forum's Annual Meeting had one of the largest attendances. (Authors: Joe Fittante, Justin Klein, and Karen Marchiano, with "pinch-hitter" Shelly Spandorf).

So stay tuned ... Trump's election may have a silver-lining for some segments of our world.
PS - Ohio lost its favorite son last week - "Godspeed John Glenn."