Franchisees - Damages Warning: Lost Future Royalties

As I mentioned a few posts back,  I was invited to co-present at this year's upcoming American Bar Association's Annual Forum on Franchising.  The title of the presentation is "Show Me the Money!" The presentation focuses on monetary damages in franchise disputes. The essence of this post was one of the subjects of that previous post BUT I wanted to emphasize the issue for franchisees.

When you sign a franchise agreement and things don't go well, you may be in for more trouble than just a failed business. Every franchise agreement contains a term of years that the relationship is expected to last (5 years, 10 years, 20 years). Franchisors "expect" that the franchisee will pay royalties and other recurring fees during the full term.

Unfortunately, not all franchisees succeed. Some stop paying royalties, some just close the door, and others tear down the signs and try to compete. (I strongly recommend against the last one) In these circumstances, the relationship ends ... and the franchisor may have the right to collect ALL lost future royalties that it was expecting. Fairness aside, courts have supported the recovery of these lost future profits and royalties.

While this is a complicated legal area that requires further explanation (visit with your franchise lawyer for more info), here, in a nutshell, is what I said in the previous post:

• Franchisor Recovery - Lost Profit - Lost Future Royalties: Although case law in this area is not completely settled, when there is a premature termination of a franchise agreement (not the full term), many franchisors seek the balance of the royalty payments due to the end of the contracted term as damages. A number of courts have permitted recovery of these "lost future royalties," especially when the franchisee abandons operation and simply closes. Some courts permit this recovery upon any "material" breach by the franchisee (i.e. failing to pay royalties). In this instance, from the franchisor's perspective, the worth of the franchise is the total amount of royalties to be paid. However, some courts have denied this type of recovery or have limited it, depending on whether the franchisor actually brought about the termination (instead of just suing for the past due royalties) or has not deducted its own service costs during the balance of the term.

So franchisees BE WARNED - you may have to pay more than you earn. An alternative is to seek a fixed amount of damages to be paid on any early termination - known as Liquidated Damages. Some franchisors already provide for this or are willing to negotiate to add it. BUT, you must reach this agreement in advance of signing the franchise agreement.

Franchising and the FMLA - Employer's Guide

Without arguing over whose workers they are, franchisors and franchisees have one thing in common: Employees! Yes those pesky people who greet the customers, turn on the grills and ovens, flip the burgers, clean the guest rooms, deliver the food and make the business run like a business.

As we know, dealing with employees is an integral part of any business and it grows more complicated and more important as time goes on. To assist employers in the United States, the Department of Labor has published a new guide for one of those areas that has grown more complex: The Family and Medical Leave Act.
You can download the Employer's Guide to The Family and Medical Leave Act here.

Having handled a few FMLA matters from both sides of the employment relationship, I can attest to the complexities and nuances that can arise. Take a few moments to download this guide and give it a read before your next HR crisis emerges.

Here is what the DOL says about its guide: "This Employer’s Guide to the Family and Medical Leave Act is designed to provide essential information about the FMLA, including information about employers’ obligations under the law and the options available to employers in administering leave under the FMLA. The Guide is organized to correspond to the order of events from an employee’s leave request to restoration of the employee to the same or equivalent job at the end of the employee’s FMLA leave. It also includes a topical index for ease of use."

Tip of the Hat to Jon Hyman at Ohio's Employer's Law Blog for bringing this Guide to my attention.

Franchising Marijuana - Part Four - New Article

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

And now, a recent article in the American Bar Association's Franchise Law Journal gives rise to Part Four - Franchising a Marijuana Business: It's not Quite Mission Impossible.

Thanks to 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) we now have the most comprehensive treatment of these subjects to date.

Shannon and Dawn both practice in states where some form of legalization has taken place - California has legalized medical marijuana and Washington has approved recreational use.

Their article is well done and thoroughly researched - and they are both experts in the area. But, despite the title (It's not Quite Mission Impossible), Shannon and Dawn outline so many current obstacles to franchising or licensing a marijuana business that it should have been titled "Mission Impossible 6."

The article pulls together in a much more complete fashion some of the posts that have appeared here  - Give it a read! Thank you Shannon and Dawn!

Franchising a Marijuana Business: It's not Quite Mission Impossible

Franchise Valuation through Damage Analysis

Recently I was invited to co-present at this year's upcoming American Bar Association's Annual Forum on Franchising (it is not until November but we get an early start on the materials that go into it). The general topic: monetary damages in franchise disputes; it got me thinking about my last post (How much is that franchise business worth?)

Why? Well many franchise disputes focus on the termination of the relationship and the damages to which one of the parties may be entitled. Central to this analysis is the value of the loss. But the real question is: which party is suffering the loss, the franchisor or the franchisee? Now this is a complicated area and far too complex to do justice here, but let's just touch on few damage remedies that may, when carried over to the "worth" of franchise, offer some guideposts.

Franchisor Recovery - Lost Profits - Lost Future Royalties: Although case law in this area is not completely settled, when there is a premature termination of a franchise agreement (not the full term), many franchisors seek the balance of the royalty payments due to the end of the contracted term as damages. A number of courts have permitted recovery of these "lost future royalties," especially when the franchisee abandons operation and simply closes. Some courts permit this recovery upon any "material" breach by the franchisee (i.e. failing to pay royalties). In this instance, from the franchisor's perspective, the worth of the franchise is the total amount of royalties to be paid. However, some courts have denied this type of recovery or have limited it, depending on whether the franchisor actually brought about the termination (instead of just suing for the past due royalties) or has not deducted its own service costs during the balance of the term.

Franchisee Recovery - Lost Profits or Fair Market Value: When a franchisee is wrongfully terminated, two approaches may be available: Lost Profits and Fair Market Value. In the most simplistic terms, future Lost Profits for a franchisee is the reasonable amount of profit (revenue less all expenses) the franchisee could expect to earn over the balance of the term based on reliable PAST sales and expenses date; while Fair Market Value is more complicated to calculate, think of it as "market" value - what would an arm's length buyer be willing to pay and a reasonable seller willing to take? Courts have approved both methods when solid evidence is presented. But franchisees cannot recover both and must elect one approach or the other.

So, as you can see, the "value or worth" of a franchised business may be in the eye of the beholder! But keep in mind that there are many NUANCES involved in these approaches - we can't cover them all here - and franchise owners and franchisors need to heed the advice found in the last post (How much is that franchise business worth?)

How much is that franchise business worth?

Happy March! The warm weather is just around the corner ... spring and summer are times when homeowners think it may be a good time to list their homes for sale or to jump to that new home. (Is this a real estate blog? ...wait for it ... I'll make the connection to franchising in a minute)

Usually, home buyers and sellers have a good idea of the VALUE of what they are buying or selling due to the very active and public real estate market. But what is the VALUE of that franchise business I want to buy or sell?

Of course the answer depends on whether it is being sold by the franchisor as a new franchise or by a franchisee who is cashing out after establishing and operating the business over a period of years. Either way wouldn't it be helpful to know the "market value"?

Now this type of analysis is above my pay grade but here are a few suggestions (in no particular order):

• Contact a Business Broker to see if they can help, especially for franchisees planning to list and sell. There are plenty of franchise brokers out there who are eager to give you a listing price;
• Visit with your Certified Public Accountant, especially if they have been handling your business affairs;
• Get a copy of the Business Reference Guide - a bit pricey at $155.00 but it has a wealth of information about business valuations, including popular franchises, and provides Rules of Thumb that will at least give you a starting point;
• Hire an appraiser - check out the Institute of Business Appraisers and the American Society of Appraisers for more information and to find a qualified appraiser;
• Ask franchisees who recently sold their business or ask a recent buyer from an established former franchisee - they may be listed in Item 20 of the Franchise Disclosure Document if the sale was within the last year before the date of the FDD;
• Finally, although the franchisor may be reluctant to provide historical re-sale info (due to various franchise laws and regs), you may want to ask anyway and see what you get.

These are just a few ideas - the important point is to get some idea of VALUE before you leap!

Quality Important in Selecting Franchise System

So I have not posted much lately because I was in Paris for a family vacation. OK I know that is not a good excuse but we all need some down time! As a consolation for my absence from the blogosphere, here is one of my best photos from Paris!

But we are back to business and I came across an article published by BlueMauMau that reports on a study conducted by FranchiseGrade.com: Study: Bottom Quintile of Franchisors Churn Franchises Three Times More than the Top.

"Churn" is the turnover rate for terminated franchisees - and the article indicates that: "The bottom 10 percent of bad franchisors have more than triple the churn of franchised stores from franchisor terminations of stores and ceased operations by franchisees than the top 10 percent, according to a 5 year research of Franchise Disclosure Documents by FranchiseGrade.com." This is a significant difference and one that all potential franchise buyers should take into account when deciding on a franchise system.

As a franchise attorney, I see many questionable franchise offering and implore clients to conduct thorough due diligence! There are too many ways to lose your money out there ... and while many systems ride the wave of "franchising is great," not all of them are successful and some do quite poorly.

Protect yourself - get a Franchise Disclosure Document, work with knowledgeable counsel, read some books about buying a franchise (like mine), and check out grading services like The Franchise Grade® Top 500 list - these are all low cost ways to conduct due diligence. Do not make up your mind until you have ALL the information.

Quality is important.

DIY Rant - Your Money or Your Life

Sorry but I have to rant - but my rant is at least related to my last post: Why Structuring Your Business Relationship is Important.

The "Do It Yourself" approach to forming a business entity (and, to some degree, in analyzing Franchise Disclosure Documents) is all the rage these days. I just file something online with the Secretary of State or State Corporation Commission and I am done. Easy, no legal fees involved, and I just saved a "ton of money."

So here is the rant: in the last five years, I have seen more incomplete, screwed-up, improperly formed entities than in my previous 35 years-plus combined. Why? Folks think they can DIY-it! And, this is a prevalent practice among franchise-operators trying to save a buck. Ladies and Gentlemen, this is not a home improvement project you can pull off the shelf at The Home Depot.

Why do you want an entity to begin with? To protect your personal assets and, in some instances, to enjoy certain tax benefits. If you screw-up the formation - by not creating the proper internal governing documents, not issuing share or membership certificates, not establishing the correct accounting procedures and the like - you may have just placed your personal assets at risk. In other words, your money or your life!

So do yourself a favor. That "ton of money" you think you saved could be peanuts if your personal liability is at risk for a major business reversal, personal injury or other business liability. If you are just forming an entity get yourself a good business lawyer; and do it right; if you formed an entity without a lawyer, get yourself a review by a good business lawyer. Gaining protection from a properly formed entity is your best "life" insurance policy that has a one-time premium payment! Get one.

See you at The Home Depot.