ICLG - Franchise Laws and Regulations - USA Chapter covers common issues in franchise laws and regulations including competition law, real estate and protecting the brand and other intellectual property.
1.1 What is the legal definition of a franchise?
The U.S. Federal Trade Commission (“FTC”) promulgated 16 C.F.R. Part 436 (the “FTC Franchise Rule”) to regulate the offer and sale of franchises in the U.S. Under the FTC Franchise Rule, a commercial business arrangement or relationship will be deemed a “franchise” if the terms of the contract (whether oral or written) satisfies the following three elements:
While many states have franchise-related laws, there is no uniform legal definition of a “franchise”. Various states’ laws mirror the FTC Franchise Rule’s definition of a franchise. For example, the laws of California, Illinois, Indiana, Iowa, Maryland, Michigan, North Dakota, Oregon, Rhode Island, Virginia, Washington, and Wisconsin provide that a “franchise” exists if, under the terms of the contract:
The laws of Hawaii, Minnesota, Mississippi, Nebraska and South Dakota vary from the FTC Franchise Rule model by identifying a “community of interest” rather than a “marketing plan” as an element of a “franchise”. A “community of interest” means a continuing financial interest between the franchisor and a franchisee in the operation of the franchised business.
Connecticut, Missouri, New York and New Jersey provide a “two-pronged” definition of a “franchise”. For example, New Jersey law provides that a franchise exists where:
The New York’s Franchise Sales Act’s (“NYFSA”) “two-pronged” approach provides for a more expansive definition of a franchise. A franchise exists under the NYFSA where: (i) the franchisee pays a franchise fee (the “First Prong”); and (ii) the franchisee either: (a) operates under a marketing plan; or (b) is granted the use of a trademark (the “Second Prong”).
1.2 What laws regulate the offer and sale of franchises?
The FTC Franchise Rule imposes a pre-sale disclosure requirement that applies to all states, obligating franchisors to furnish prospective franchisees with information and data regarding the material terms of the franchise relationship prior to consummating the sale of a franchise. Franchisors disclose this material information in a prescribed format commonly referred to as a Franchise Disclosure Document (“FDD”). In addition, 15 states have registration and/or disclosure requirements that must be met before a franchise can be offered and sold in that state. 11 of these states require that, before franchisors may commence franchise sales activities in their states: (i) there must be a state agency review and approval of the FDD; and (ii) the franchisor must register its franchise programme with the state. 25 states have Business Opportunity Laws, which extend the disclosure protections afforded to franchisees as well as to consumers who purchase business opportunities, including franchises. Under Business Opportunity Laws, franchise sellers are typically obligated to prepare and disclose certain information to prospective franchisees prior to the consummation of a sale of a franchise. Typically, the information required to be disclosed by franchise sellers under Business Opportunity Laws is less extensive than what is required to be disclosed under the FTC Franchise Rule or applicable state franchise laws. Franchisors may be provided with an “exemption” or “exclusion” from Business Opportunity Laws, provided that they are in compliance with the FTC Franchise Rule. Obtaining the exemption or exclusion, in some cases, may require the filing of a notice to qualify for the exemption (e.g., Florida, Kentucky, Nebraska, Texas and Utah).
1.3 If a franchisor is proposing to appoint only one franchisee/licensee in your jurisdiction, will this person be treated as a “franchisee” for purposes of any franchise disclosure or registration laws?
Yes. Business format franchising is the primary method by which franchisors elect to expand their brand in different domestic consumer markets. However, “direct franchising” is not the typical method of franchising for U.S.-based franchisors looking to establish their presence internationally. Franchisors seeking global expansion of their brand are more likely to partner with a single franchisee/licensee (“Master Franchisee/Sub-Franchisor”) to develop, market and operate units under the franchisor’s brand within a specified geographic region outside of the U.S. Notwithstanding this approach, this form of expansion is more commonly referred to as “master franchising”. A Master Franchisee/Sub-Franchisor is treated as a franchisee for the purposes of franchise disclosure and registration laws. The Master Franchisee/Sub-Franchisor is afforded the same franchise disclosure and registration protections as if it was a “typical” franchisee for various reasons, including the fact that it makes a substantial investment in the franchisor’s system. However, because the Master Franchisee/Sub-Franchisor typically “steps into the shoes” of the Franchisor and assumes many of the duties of the franchisor by selling and offering franchises in its territory, the Master Franchisee/Sub-Franchisor will be required to provide appropriate disclosure to its “Sub-Franchisees”.
1.4 Are there any registration requirements relating to the franchise system?
The FTC Franchise Rule does not require franchisors to register their FDDs with a federal administrative or governmental agency. It only imposes a pre-sale disclosure requirement on franchisors. However, as noted in the response to question 1.2 above, there are 15 states that require a franchisor to either: (i) register their FDD; or (ii) file a notice of intent with the appropriate regulatory authority prior to commencing the offer or sale of franchise or multi-unit development rights within the state. Notwithstanding this lack of requirement under the FTC Franchise Rule, most franchisors will require their franchisees or Master Franchisees/Sub-Franchisors to comply with all local laws.
1.5 Are there mandatory pre-sale disclosure obligations?
Any violation of the FTC Franchise Rule’s disclosure requirement is a violation of the U.S. Federal Trade Commission Act, and grants the FTC the right to sue franchisors in federal court and to seek any or all of the following remedies: (i) civil penalties of up to $11,000 per violation; (ii) injunctive relief with respect to violations of the FTC Franchise Rule, including barring franchise sales in the U.S.; and (iii) restitution, rescission, or damages on behalf of the affected franchisees. While the FTC can bring an action against franchisors who violate the FTC Franchise Rule, no such private right of action is granted to aggrieved franchisees. Although franchisees do not have a private right of action under federal law, state franchise disclosure laws permit an aggrieved franchisee to bring an action against the franchisor for violations of state registration and disclosure laws. These claims typically include actions for rescission of the franchise agreement and/or actions for actual damages (including reasonable attorneys’ fees and expenses). There has been a great deal of criticism over the lack of a private right of action under the FTC Franchise Rule and, as of February 1, 2022, a bill was introduced in the United States Congress (H.R. 6551) to introduce a private right of action under the FTC Franchise Rule.
With respect to pre-sale disclosure requirements, franchisors may look to the Franchise Registration and Disclosure Guidelines (the “Guidelines”) promulgated by the North American Securities Administrators Association, Inc. (“NASAA”) as a resource (along with other NASAA publications). NASAA is a voluntary association with a membership consisting of 67 state and territorial securities administrators in the 50 U.S. states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada and Mexico. NASAA facilitates multi-state enforcement actions, information sharing and education (including the publication of new materials). The Guidelines provide an item-by-item breakdown of the information required to be disclosed in FDDs.
On May 19, 2019, NASAA adopted three new cover pages that were to be incorporated into FDDs as of on January 1, 2020. These new pages include: “How to Use this Franchise Disclosure Document”, “What You Need to Know About Franchising” and “Special Risks to Consider about This Franchise”. The NASAA website provides instructions for use of the new cover pages ( [Hyperlink] ). On June 10, 2020, NASAA’s Franchise Project Group circulated guidelines to state franchise administrators for the review of Financial Representations after most businesses had been significantly impacted by the COVID-19 pandemic (see the response to question 1.7 below).
On September 18, 2022, NASAA adopted a Statement of Policy regarding the use of Franchise Questionnaires and Acknowledgments, generally finding them to run against public policy regarding the protection of franchisees and, at times, violative of state anti-waiver provisions. Several registration states, including Maryland and California, have adopted NASAA’s Statement of Policy into law, thereby requiring Franchisors to delete questionnaires and acknowledges which contravene the Statement of Policy.
In addition to the above, franchisors may also consult the FTC’s Franchise Rule Compliance Guide for an interpretation of the various disclosure requirements of the FTC Franchise Rule ([Hyperlink] ).
1.6 Do pre-sale disclosure obligations apply to sales to sub-franchisees? Who is required to make the necessary disclosures?
The FTC Franchise Rule imposes a pre-sale disclosure requirement on franchisors selling franchises, but no such pre-sale disclosure requirement applies to sub-franchisees. While the FTC Franchise Rule does not directly address master franchising, NASAA has adopted a Multi-Unit Commentary (as of September 16, 2014) that provides franchisors with practical guidance concerning their disclosure obligations with respect to certain multi-unit franchising arrangements, including master franchising. Under the NASAA guidelines, Master Franchisors are required to prepare a separate FDD (from the FDD the franchisor provides to area developers and unit franchisees) for offering and selling sub-franchise rights to prospective franchisees, because the relationships and agreements for sub-franchise rights are very different than those offered in a unit franchisee’s FDD; combining them in the same FDD would lead to confusion. This pre-sale disclosure requirement is not only imposed on Master Franchisees offering and selling sub-franchise rights to prospective franchisees and multi-unit developers, but also upon Master Franchisees/Sub-Franchisors who “step-into” the franchisor’s shoes and engage in franchise sales activities and provide training and support to sub-franchisees. Therefore, under the NASAA guidelines, Master Franchisees/Sub-Franchisors are responsible for preparing and providing their own FDD in connection with their offer and sale of sub-franchises and, where applicable, complying with state registration requirements.
1.7 Is the format of disclosures prescribed by law or other regulation, and how often must disclosures be updated? Is there an obligation to make continuing disclosure to existing franchisees?
Under the FTC Franchise Rule, franchisors are obligated to furnish prospective franchisees and multi-unit developers with certain material information through the prescribed format of an FDD. The purpose of the FDD is to provide prospective franchisees and multi-unit developers with the information they need to make an informed decision about investing in the franchisor’s franchise system. The FDDs, which are the most essential component of the pre-sale due diligence process, are uniform in structure and are comprised of 23 categories (“Items”) (which are laid out in the FTC Franchise Rule) of detailed information and accompanying exhibits regarding, among other things: (i) the history of the franchisor (and any parent or affiliate), including any history of bankruptcy or litigation; (ii) the business experience of the franchisor’s principals; (iii) the recurring or occasional fees associated with operating the franchised business; (iv) an estimate of the franchisee’s initial investment in order to commence operations; (v) the products (and sources for those products) that the franchisor requires the franchisee to use and/or purchase in connection with the operation of the franchised business; (vi) any direct or indirect financing (along with the terms of such financing) being offered by the franchisor; (vii) a list of all of the franchisor’s word marks, service marks, trademarks, slogans, designs, and patents that will be used in connection with the operation of the franchised business; (viii) the territory in which the franchisee will operate, along with any rights retained by the franchisor to operate or cause a third party to operate in such territory; (ix) the exit strategies available to the franchisee and franchisor; (x) a description of how disputes are resolved; and (xi) the franchisor’s financial performance, etc.
One of the Items that prospective franchisees and multi-unit developers usually deem to be amongst the most vital in analysing the franchise opportunity are financial performance representations concerning existing franchised and company-owned units. Such financial performance representations reflect past or projected revenues or sales, gross income and net income or profits. Franchisors are not required by federal or state law to provide prospective franchisees with this information. However, if they choose to do so, they may provide the information in FDD Item 19, provided that there is a reasonable basis for the information and such information is properly and accurately disclosed. Improper or misleading financial performance representations can (and have, in many instances) give rise to a governmental or private cause of action under federal, state and/or common law (although there is no private right of action under the FTC Franchise Rule although there has been significant public interest in providing for a private right of action under the FTC Rule. The NASAA provides commentary (adopted May 2017) on certain aspects of the financial performance representations that may be disclosed under Item 19.
The FTC Franchise Rule requires new annual information (including updated audited financial information) to be made within 120 days of the end of each fiscal year. In addition, at the end of each fiscal quarter, a franchisor must prepare and include in “Item 22” an attachment reflecting any “material” changes to its FDD (e.g., bankruptcy filings or pending litigation filed against the franchisor).
In addition to the federal requirement to update an FDD, certain states require the franchisor to update the FDD and submit amendment filings (e.g., in New York, California, Maryland, Michigan, North Dakota and Rhode Island, a franchisor must “promptly” update its FDD and file an amendment with the state agency whenever there is a material change to the disclosed information).
Notably, in the aftermath of the COVID-19 pandemic and in an effort to streamline franchise filing generally, various states have begun to require the online filing of franchise registrations and renewals (e.g., the New York State Attorney General’s Office and several other state agencies have recently adopted NASAA’s Electronic Filing System; California’s Department of Financial Protection and Innovation maintains its own system).
1.8 What are the consequences of not complying with mandatory pre-sale disclosure obligations?
Non-compliance with either federal or state disclosure laws, can result in very significant consequences. Because of the overlapping federal and state regulatory frameworks, each with its own set of repercussions for non-compliance, franchisors are strongly cautioned to engage competent franchise counsel to guide them through the sales process.
Under federal law, violations of the FTC Franchise Rule are deemed “unfair or deceptive acts or practices” in violation of Section 5 of the FTC Act. When such a violation occurs, the FTC can initiate enforcement actions against franchisors using its broad investigatory powers, including the ability to take testimony, examine witnesses, issue civil investigatory demands (“CIDs”), and issue federal subpoenas. See, e.g., 15 USC 46, 49, 57, and 16 CFR Sec. 2.5. If a violation is found, the FTC may seek an administrative enforcement proceeding before an administrative law judge (“ALJ”), whose decision is enforceable in federal court. Consequences of franchisor’s violation of the disclosure rule can include civil penalties, restitution of aggrieved parties, preliminary and permanent injunctive relief, including potentially barring a franchisor from conducting business or engaging in certain conduct (15 USC Sec. 56(b)), and other equitable relief. Enforcement actions by the FTC are relatively uncommon in the franchise context, although recently regulators have shown interest in enhancing enforcement. The federal FTC Act does not provide for a private right of action (although there has been recent discussion that Congress may re-address that issue).
Many states also have their own independent franchise sales and disclosure regulatory enforcement guidelines, typically through a state’s Attorney General’s (“AG”) office. These state statutes, depending upon the state, independently allow state regulators a variety of remedies, including the ability to impose fines, obtain preliminary and permanent injunctive relief, including potentially barring a franchisor from conducting business within the state, along with providing relief for aggrieved parties, such as damages, restitution, or rescission. Some state violations are independently punishable as crimes. Since a state’s regulatory authority generally operates independently from federal regulatory schemes, state law, and its requirements must be independently reviewed, and complied with, in addition to any federal requirements. State regulatory actions are also relatively rare.
Perhaps the most commonplace risk to franchisors for non-compliance with disclosure and sales regulations, presently comes from private actions. Under state law, franchisors may be directly civilly liable to franchisees, and franchisees may bring their own private actions in court directly against the franchisor. As discussed herein, many states have unfair trade practices and consumer protection acts (often called “Little FTC Acts”), which provide franchisees with private rights of action for violations of the federal FTC Act’s Franchise Rule. Many of these state acts grant significantly augmented damages, including in some cases, multiples of damages, punitive damages, and attorney fee-shifting.
In addition to state Little FTC Acts, there are currently 13 states that have their own state-specific franchise registration or disclosure obligations that require a franchisor to register a FDD (or similar state document). Other states require some form of registration or notice, and many states have general Business Opportunity Laws, which apply to franchise transactions. Each of these state laws not only provide state regulators with enforcement powers, but many also often permit aggrieved parties to maintain private rights of action for disclosure violations (See, e.g., N.Y. GBL 691; CA Corp Code. 31300). Further, even where disclosure requirements don’t give rise to a right of action, disclosure violations can lead to a greater risk of liability for common law claims, including fraud and misrepresentation, or even for violations of the implied covenant of good faith and fair dealing.
Importantly, some of these state statutes allow actions against not just the franchisor, but also impose individual liability on officers, directors, control persons, or principals of franchisors engaging in prohibited activity, including sales agents who were involved in the sale (See, e.g., NY GBL 681(13), 691(3); CA 31302). See also Sea Tow Servs. Int.l, Inc. v. Tampa Bay Marine Recovery, Inc., 2022 U.S. Dist. LEXIS 181658, *38–39, __ F.Supp.3d __ ; 2022 WL 5122728 (U.S.D.C. E.D.N.Y. Sept. 30, 2022) (NY Franchise Sales Act can impose joint and severable liability directly upon the General Counsel and the President of a franchisor as “persons” covered under the act). Franchisors should engage knowledgeable counsel that are aware of these liability risks, and ensure compliance, as liability can reach not just the corporate entity, but also individuals in certain states.
Therefore, an FDD (with its many protective disclosures and disclaimers) is really a tool to protect a franchisor, and franchisors should take care to show that a prospective franchisee properly received a compliant FDD. In ensuring that an FDD is compliant, franchisors should be mindful of the potential need to update their disclosures, as both federal and state law often require franchisors to provide interim disclosures or amendments if circumstances have materially changed. “Material changes” to a franchised system’s operations may be triggered by material changes to financial conditions, or a franchised business model. These issues have been brought to the forefront in recent years, as the COVID-19 pandemic (and related government shut-downs and re-openings) caused material changes in operations in many franchised systems. More recently, global and regional disruptions in supply chains, the War in Ukraine, and the availability of energy, fuel, required goods and services (or lack thereof), all have the potential to cause material impacts upon disclosures, and how accurate they are. Conflict-related sanctions, like those imposed because of the War in Ukraine, may also significantly impact overseas operations, particularly for international franchise systems operating in, or relying upon, targeted regions. All this should be potentially “disclosed” as being caused by unusual external factors, or changes as a result of price swings, significant fuel costs or supply chain issues, and these changes can occur even in the middle of a disclosure cycle. Franchisors should also be mindful that external factors can also cause financial disclosures to be misleading, as significant changes in revenues, or closures of units and abnormal financial declines, or conversely, abnormal growth in a “rebound” following a steep decline, can be aberrations and unrepresentative without additional information. All these may all call for amendments (e.g., FTC Act; Item 8: Restrictions on Sources of Products and Services), and franchisors should be flexible and reasonable under the circumstances, and protectively provide augmented disclosures with the assistance of knowledgeable counsel. These types of adverse changes may require a franchisor to amend and redisclose the amendment to an FDD to prospective franchisees (or even recently disclosed franchisees), under federal law and state law (as applicable) and the failure to do so may result in a violation that could lead to substantial civil liability. Here, even where it may not be technically required, amended and up to date, disclosure certainly may be advisable to avoid litigation, and provide a full picture of a franchisor’s operations and financial situation.
1.9 Are there any other requirements that must be met before a franchise may be offered or sold?
In addition to franchisors’ obligations to comply with the aforementioned franchise disclosure and registration laws, there are other business and legal elements of franchising that the franchisor must address prior to engaging in franchise sales activities.
Trademark registration
As noted in the response to question 1.1 above, the definition of a franchise includes the franchisee’s operation of its business under the franchisor’s trademark. Therefore, franchisors should pursue the federal registration of all trademarks, service marks, trade names, logos, domain names, and other commercial symbols that will be used in connection with the franchise programme with the United States Patent and Trademark Office. Federal trademark registration confers many benefits on the Franchisor, including but without limitation: (i) protection against infringement in the federal courts; (ii) a presumption of the trademark’s validity; (iii) a valuable, transferrable asset; (iv) notice to potential infringers of the Franchisor’s ownership of the trademark; and (v) prevention of the registration of similar trademarks.
Assumed business name registration
Franchisors should register any assumed or fictious business names under which they operate with the proper administrative agency, prior to offering and selling franchises, in order to protect their rights to use that particular assumed name.
Copyright protection
Under the 1976 Copyright Act (the “Copyright Act”) (17 U.S.C. §§101 et seq.) copyright protection is available for “original works of authorship fixed in any tangible medium of expression”. The Copyright Act broadly protects literary works, musical works, dramatic works, pictorial, graphic and sculptural works, sound recordings, motion pictures and audio-visual works, and architectural works. These categories may be viewed broadly, but also carefully. For example, software code may be registerable even if it is not a “literary work” in the literal sense. On the other hand, a recipe consisting of a mere list of ingredients is not protectable under the Copyright Act. Tradenames, slogans, phrases and logos, all of which are crucial to the franchise model, are generally protected under trademark law but not under the Copyright Act. It is advisable for franchisors to pursue copyright protection where appropriate, because of the relatively low cost of registering copyrights, and the valuable rights provided under the Act, including, but without limitation, the right to pursue statutory damages and attorneys’ fees in federal court.
Advertising materials related to the sale of franchises
Certain registration states, including New York and California, require franchisors to file any materials that advertise the sale of franchises (e.g., brochures and websites) prior to the advertisement’s first publication in that state. New York State in particular requires the franchisor to receive approval from the New York State Attorney General’s Office prior to publishing the advertisement.
Registration of franchise brokers and sellers
Certain states require franchisors to register their franchise sellers with the appropriate regulatory agency before that person is permitted to sell franchises or multi-unit development rights in that state. In these states, franchisors must file a Franchise Seller Disclosure Form for each franchise seller, which includes the seller’s name, business address and phone number, his or her employer, title, five-year employment history and information about certain relevant litigation and bankruptcy matters. Two states (e.g., New York and Washington) require franchise brokers to file a separate registration form that provides the state with more detailed information about the broker. A Franchise Seller Disclosure Form and/or Franchise Broker Registration Form must be submitted with each initial registration application, annual renewal application and any post-amendments to a franchisor’s FDD.
1.10 Is membership of any national franchise association mandatory or commercially advisable?
No. While membership in a national franchise association is not mandatory, it is strongly advisable. Many franchisors, individual franchisees and businesses that service the franchising industry are members of the International Franchise Association (“IFA”), which is the largest and oldest global franchising organisation. The IFA provides its members with a wealth of valuable information (including, but not limited to, the latest legal developments affecting the franchising industry, networking platforms and franchise opportunity information) relating to the franchising industry. For information about the IFA, visit their website at: [Hyperlink] . In addition to holding membership in the IFA, many franchisees and franchisee associations are members of the American Association of Franchisees and Dealers (“AAFD”). The AAFD has promulgated a code of Fair Franchising Standards, which sets forth the AAFD’s view of requirements for a more “level playing field” between franchisors and franchisees. Visit [Hyperlink] for more information about the AAFD. Both the IFA and the AAFD engage in “lobbying” activities before Congress, with respect to matters such as the FTC Franchise Rule and other franchise-related legislative matters.
1.11 Does membership of a national franchise association impose any additional obligations on franchisors?
The IFA has a Code of Ethics that can be found at [Hyperlink] . While it does not have the force or effect of law, this Code of Ethics provides IFA’s members with a framework for the manner in which they are to act in their franchise relationships. As mentioned in question 1.10 above, the AAFD has promulgated its code of Fair Franchising Standards, which addresses relationships between franchisors and franchisees and regarding franchising, generally.
1.12 Is there a requirement for franchise documents or disclosure documents to be translated into the local language?
No. Federal and state law only require that the FDD be written in “plain English”.
2.1 Are there any foreign investment laws that impose restrictions on non-nationals in respect of the ownership or control of a business in your jurisdiction?
Generally, there are no restrictions relating to foreign investment in a business in the United States. Such restrictions are contrary to the general approach to free trade. Typically, countries with developing markets are more likely to impose such “foreign investment” restrictions and regulations. However, the U.S. federal government imposes certain restrictions, including, for example, disclosure filing requirements and/or actual limits on foreign investment that may apply to certain highly regulated sectors and/or sensitive industries or businesses (e.g., communications and broadcasting), especially those which may have a potential impact on national security (e.g., banking, technology, weapons manufacture, maritime, aircraft, energy, etc.). As franchise opportunities in the United States do not typically involve these industries or businesses, it is not likely that franchisors will be affected by such restrictions.
2.2 What forms of business entity are typically used by franchisors?
As is frequently the case with other businesses, franchisors operating in the United States will typically utilise either a corporation or limited liability company (“LLC”) as their preferred form of business entity. While each of these entity types offers “limited liability” to its owners, choosing between the two will depend on the legal, financial and tax needs of the franchisor and its principals. If a franchisor chooses to use the corporate form of entity, typically a “C corporation” is used, as opposed to an “S corporation” which is most often used in connection with small, closely held businesses, such as those formed by franchisees. It is important to note that foreign investors are prohibited from being owners of S corporations. In a C corporation, income which is received by the company is taxed at the entity level. Then, the company’s profits are taxed (again), to the company’s shareholders when distributions are made. However, over the last 20 years many franchisors have chosen to use the LLC as their preferred type of business entity for their business structure, rather than utilising a corporate structure. LLCs offer franchisors greater flexibility in certain areas, including with respect to internal governance requirements (e.g., fewer “corporate” formalities in management structure and activities, and fewer ownership restrictions), income allocation and the ability to transfer assets out of the entity. Since LLCs are usually treated as “pass through” entities for tax purposes, the entity’s profits are not taxed at the business level. Rather, the profits typically flow through to the company’s owners in proportion to their ownership percentage so that the owners pay taxes on this income as part of their taxable income. An LLC may, however, elect to be treated as a C corporation for tax purposes.
While foreign franchisors are permitted to sell directly to prospective franchisees located within the United States, foreign franchisors typically use one or more affiliate or subsidiary entities to conduct their U.S. operations. However, if a U.S. franchisor is a wholly-owned subsidiary of a foreign parent, then certain financial disclosures regarding the foreign parent also have to be included in the U.S. franchisor’s “offering prospectus” (the FDD) which must be given to all prospective franchisees. Usually, franchisors (including foreign franchisors) find it useful to utilise a tiered “corporate” structure comprising a holding company or “parent” company at the “top” and several subsidiary operating entities, “below” the holding company. (This “corporate” structure approach may be used for LLCs as well as corporations.) For example, one subsidiary may own the intellectual property rights (typically, trademarks or service marks) associated with the franchise system; another subsidiary might be the “franchisor entity” which would enter into the franchise agreement (and other agreements) with franchisees; another subsidiary might be a management company which would provide the various “franchisor services” to the franchisees; and yet another subsidiary could purchase, sell or lease equipment to franchised or company owned units. Typically, separate entities are also formed in order to hold title to each parcel of real estate that is owned by the franchisor or its affiliates. Where the franchisor subleases the various premises to its franchisees, the franchisor may choose to form separate entities to enter into each “master-lease” with the landlord rather than have one real estate “leasing entity”. This provides the franchisor (and its affiliates) with greater asset protection and additional flexibility in the event that it wanted to sell or transfer a particular parcel of real estate.
Many franchisors, including foreign franchisors, do not rely solely on selling single unit franchises. In international franchising, franchisors typically establish a franchise network by utilising either (or sometimes both) the master franchise (or sub-franchisor) method and/or the area development method. The more common approach in international franchising in the United States is the master franchise method, where the master franchisee is granted the right to either develop the assigned territory itself or to sub-franchise the territory to other franchisees, with the master franchisee usually taking on “franchisor” obligations (e.g., providing initial training and ongoing support and guidance) and typically receiving a significant share of the initial franchise fees and ongoing royalty payments paid by the franchisees within the territory. Alternatively, some franchisors, who wish to retain greater control over their franchise network and do not wish to share their initial franchise fees and ongoing royalty fees with a master franchisee, will grant territories to “area developers” who obligate themselves to develop their territory, but have no rights to offer sub-franchises to other franchisees. Since the U.S. is a large country with varying demographics and diverse cultures, franchisors often utilise a combination of the master franchise and area development franchise arrangements to expand their franchise network. Another option is for the franchisor to enter into a “joint venture” with an independent company, presumably, a joint venture partner located in the U.S. Such a partner may have significant experience in operating franchises or the ability to provide significant financial resources to the franchise system, or perhaps both. However, the “joint venture” approach has not been frequently utilised by franchisors (including foreign franchisors) as they have potential disadvantages which include, among others: (i) the risk of ineffective management and/or disagreements with the partner; (ii) requiring a large investment; and (iii) the sharing of initial and ongoing fees, profits and other benefits.
Shifting away from franchisors for the moment, some franchise systems have franchisee associations (membership associations for franchisees that are independent from the franchisor). Franchisee associations offer a group of individual franchisees the ability to have a collective voice in their communications and interactions with the franchisor. Franchisee associations, like other entities, are formed and governed under state law, and are typically formed as “not for profit” corporations. This provides the entity with limited liability and ensures its compliance with the FTC’s Amended Franchise Rule’s requirement for inclusion in Item 20 of the franchisor’s FDD as an independent franchisee association.
2.3 Are there any registration requirements or other formalities applicable to a new business entity as a pre-condition to being able to trade in your jurisdiction?
In the United States, new business entities are formed under state law and their formation documents (e.g., for corporations: the Certificate of Incorporation; and for LLCs: the Articles of Organisation) are filed with the Secretary of State (or similar agency) in the state of formation. (In a small number of states, there are publication requirements for new business entities, most notably, in New York, with respect to LLCs, limited liability partnerships (“LLPs”) and limited partnerships (“LPs”).) Any new business entity formed in the United States is required to obtain a federal taxpayer identification number by filing Form SS-4 with the Internal Revenue Service. Pursuant to said form, a “responsible party” must be identified, who is required to be a natural person (and not another entity), who is the person that exercises ultimate effective control over the entity. If the new entity will be conducting business in multiple states, it will likely have to file an application in each state (other than the state of formation) in order to qualify to “do business”. In each state where the entity is authorised to “do business”, it must list a designated “registered agent” (who resides in the state, in the case of an individual; or which has a physical location in the state, in the case of a business entity), upon whom service of process (e.g., lawsuit documents) may be served.
New entities must also register as an employer with the department of labour of the formation state and must withhold proper amounts of certain taxes including, for example, income taxes and Federal Insurance Contribution Act (“FICA”) taxes (which include contributions to federal Social Security and Medicare programmes). A handful of states require the filing of initial reports and tax forms rather than waiting to file an annual report. Finally, entities which are involved in certain specific industries or types of businesses (e.g., education/school based, childcare based businesses, or businesses selling alcohol to the public) may have to obtain one or more licences or permits in order to comply with state or local laws.
3.1 Provide an overview of the competition laws that apply to the offer and sale of franchises.
In the United States the concept of “competition law” is generally referred to as “antitrust law”. In contrast to other jurisdictions like the European Union, “antitrust” laws do not directly regulate the offer and sale of franchises. The offer and sale of franchises are governed by the FTC Franchise Rule (16 C.F.R. 436 et seq.) and certain state statutes (e.g., N.Y. G.B.L. § 680 et seq.; CA Corp. Code §31000 et seq.). These State and Federal statutes directly regulate the required disclosures and sales practices with respect to the offer and sale of franchises (see Section 1 supra) and are not considered “antitrust” or “competition” laws. There may be circumstances where an offer or sale of a franchise constitutes an “unfair” or “deceptive” act or practice, under either federal law or an analogous state law. The FTC is responsible for consumer protection enforcement for over 70 different laws, including the FTC Act, which contains a broad prohibition against “unfair and deceptive acts or practices”. See, e.g., §15 U.S.C. 45. In addition, many states have also enacted similar statutory schemes prohibiting unfair or deceptive trade practices (sometimes called “Little FTC Acts”), many of which provide for a private right of action. However, these are not generally considered “competition” laws.
Nonetheless, in the U.S., “anti-trust” laws exist, which are analogous to “anticompetition” laws in the E.U., and they can impact the franchise relationship (even if franchise laws are not considered antitrust laws in and of themselves). At the federal level, the major antitrust statutes that may apply to franchising are the Sherman Act, (15 U.S.C. §1 et seq. generally prohibiting anti-competitive or monopolistic conduct) and the Robinson-Patman Act (at 15 U.S.C. §13 generally prohibiting anti-competitive price discrimination, exclusive dealing, and tying) which the Antitrust Division of the U.S. Dept. of Justice (“DOJ”) and the FTC cooperate to enforce, as well as the Clayton Antitrust Act (15 U.S.C. §§12 et seq.) that authorises private rights of action. At the state level, nearly all states have enacted antitrust laws, which are usually based upon, but may differ from, the federal antitrust statutes and usually look to federal law for guidance. As a result, practitioners need to examine both the federal and state laws in the applicable jurisdiction, particularly where an issue concerning potentially monopolistic conduct, or price-determination, exclusive dealing, or tying is involved.
Fortunately for franchisors, many state and federal courts have significantly limited the applicability of antitrust laws in the franchise context, recognising that franchising is generally a specialised industry, and one where mandated disclosure provided some level of protection to the public. Antitrust claims declined in the last two decades after court decisions curtailed the applicability of antitrust laws in the franchise context by narrowly restricting the definition of the applicable “market” for antitrust analysis in ways that effectively exclude franchise relationships and franchise related claims such as price-fixing (like franchisee complaints where franchisors set maximum or minimum prices), exclusive dealing requirements (like requiring franchisees to deal only with particular designated vendors or suppliers), or tying (like requiring franchisees to purchase products or services not directly related to the trademarked franchised product or service). Additionally, courts now generally employ the “rule of reason” test (if it results in an unreasonable restraint of trade concerning competitors, based upon economic factors) in circumstances that would once have been per se violations of antitrust laws. As such, in most franchise circumstances, a franchise agreement that clearly provides for (and an FDD that adequately discloses) contractual requirements to purchase certain goods or services, restraints on a franchisee’s ability to freely conduct business, or requirements that franchisees deal only with specific vendors, will defeat most antitrust claims. It currently remains the case that franchisors who comply with all applicable disclosure requirements, and properly detail any potentially anti-competitive aspects of the franchise relationship within the FDD (like specific suppliers that must be used), can significantly lessen any potential liability for antitrust issues with their franchisees in the context of the offer or sale of the franchise.
However, more recently there has been increased regulation and activity as federal regulators scrutinise “no-poach” provisions (see Section 3.6 infra), and now may be interested in regulating post-term restrictive covenants in franchise agreements generally. Additionally, several legislative initiatives could dramatically alter the antitrust landscape, including franchising. If one or more of the proposed federal bills aimed at competition and antitrust law enforcement reform pass, not only will that potentially provide additional funding for increased enforcement and regulatory resources (including the FTC and DOJ), but also potentially alter some of the factors considered by courts and add legislation to curb “exclusionary conduct” by “dominant companies”.
Simultaneously, State Attorneys General are also aggressively reviewing “anti-poach” provisions, and other post-term restrictive covenants, and state-specific antitrust legislative action could impact franchises. If such prospective legislation is not carefully crafted, or does not contain sufficient carve-outs for franchising, it could upset traditionally permitted contractual terms, including: (1) restrictive covenants and other employee restrictions, which arguably are actually protective of franchisees in many ways; (2) permissible and disclosed price setting; and (3) tying and the required use of approved vendors or suppliers, which is often necessary to maintain franchise system standards, or create uniformity in a franchise system.
The uncertainty regarding what type of legislation may pass makes it difficult to predict how franchised system models will be impacted. And, if consideration of the benefits of franchising are stripped from a court’s analysis, any prospective legislation could have a disproportionate impact on franchised businesses.
3.2 Is there a maximum permitted term for a franchise agreement?
There is no federal regulation of the maximum permitted term for a franchise agreement; however, some states may be reluctant to enforce franchise agreements without a limited term. Some states may limit franchise agreements without a specified duration, or automatic renewal agreements that continue in perpetuity, for example, an agreement that renews automatically every 10 years without any limit. Other states may require a franchisor to automatically renew a franchise agreement, regardless of the stated term in the agreement, so long as a franchisee is in substantial compliance with the franchise agreement.
3.3 Is there a maximum permitted term for any related product supply agreement?
As noted above, there is no antitrust federal statutory restriction but there are some states that may be hostile to enforcing agreements without any stated term. The FDD must adequately disclose, and the franchise agreement must clearly provide for any required related product supply agreements. In addition, there may be circumstances where, for example, a supply agreement becomes so onerous that it may excuse performance, violate a state statute, or give rise to a claim, so that its enforcement becomes unreasonable, for example, the New Jersey Franchise Practices Act, makes it unlawful “to impose unreasonable standards of performance upon a franchisee”. See NJ Stat. §56:10-7(e).
3.4 Are there restrictions on the ability of the franchisor to impose minimum resale prices?
Federal antitrust law prohibits a minimum resale price (“MRP”) if the MRP causes an adverse effect on inter-brand competition under a “rule of reason” test – if it results in an unreasonable restraint of trade concerning competitors, based upon economic factors. The “rule of reason” test is relatively permissive and, therefore, under federal law, courts have been reluctant to find violations where there is an economic justification, resulting in most cases being dismissed. However, some state statutes differ from the federal standard and prohibit the use of MRPs and may consider MRPs to be per se unreasonable restraints of trade.
In addition, while not an “antitrust” issue, MRPs may give rise to other claims by franchisees, such as common law claims for violation of the implied covenant of “good faith and fair dealing”, or prohibitions against imposing “unreasonable standards of performance” upon franchisees. See NJ Stat. §56:10-7(e). Federally, the Robinson-Patman Act can impact a franchisor’s ability to set pricing, causing a franchisor to be wary of differentiating between certain franchisees, or groups of franchisees, in its pricing of required goods or services, as favouritism to certain franchisees. See 15 U.S.C. §13 (anti-competitive price discrimination).
3.5 Encroachment – are there any minimum obligations that a franchisor must observe when offering franchises in adjoining territories?
Federal antitrust laws do not require a franchisor to observe any minimum obligations when offering franchises in adjoining territories (or when a franchisor itself operates in an adjoining territory). The antitrust laws will not consider the applicable “market” for antitrust analysis to be competing franchise locations, but the market for franchises more generally when the franchisee purchased the franchise. And under federal antitrust laws’ “rule of reason” analysis there will generally be sufficient justification for “territory” competition to avoid liability. Nonetheless, anti-competitive misconduct on the part of a franchisor that impacts inter-brand competitors could still result in liability under federal law and more restrictive state antitrust statutes may also impose liability for anti-competitive conduct.
The FTC Franchise Rule mandates that an FDD includes a detailed disclosure of the rights conferred in any territorial grant, but there are no mandated obligations. Although there is no specific federal minimum obligation with respect to the territorial rights of franchisees, encroachment or the unfair allocation of territories could lead to liability outside of antitrust law (discussed infra), as for violation of the implied covenant of “good faith and fair dealing” and some state franchising statutes may restrict or prohibit unfair encroachment activity.
The provisions in the franchise agreement (and the disclosures in the FDD) that address and define the franchisor’s right to sell franchises (or operate so-called “company owned” units) in a franchisee’s “protected territory” must be crafted with great care not merely considering geographical limits, but also to the applicable “market” of customers to which a franchisee will be selling its goods and services. Encroachment issues also encompass non-traditional methods of providing products and services that may compete with a franchisee, like through e-commerce, or the use of non-traditional sales-points, including food trucks, kiosks, or promotional activity within a territory of a franchisee.
3.6 Are in-term and post-term non-compete and non-solicitation of customers covenants enforceable?
Under federal antitrust law, in-term and post-term non-compete clauses (with respect to franchisees) and non-solicitation of customer provisions are generally enforceable. However, the FTC and federal regulators have shown increased interest in potentially regulating post-term restrictive covenants within franchise agreements, are actively soliciting comment on the issue of restrictive covenants, and “no poach” provisions, and it remains to be seen if significant regulation may be forthcoming in the near future. The FTC has shown particular concern with in-term and post-term non-compete covenants “no-poach” agreements, which are non-compete clauses that apply to a franchisee’s employees, generally prohibiting one franchisee’s employees from being “recruited” to be employed by another franchisee. There are legislative efforts at both the federal and state levels to pass laws prohibiting restraints upon employment and poaching.
In April 2023, the FTC closed a comments period for a proposed rule, inter alia, banning non-compete clauses that would prevent employers from entering into non-compete clauses with their workers, require employers to rescind their existing non-compete provisions, and actively inform their employees that they were no longer bound by such provisions. The FTC’s proposed § 910.1(f) does not include the franchisor-franchisee relationship (since the franchisee is not an employee) but includes workers employed by the franchisee or franchisor, and non-compete clauses between franchisors and franchisees would remain subject to federal antitrust law (as well as all other applicable law). These laws include state laws that apply to non-compete clauses in the franchise context. As a potential window into the FTC’s thinking, the FTC sought comment on whether non-compete clauses between franchisors and franchisees should be included in the rule and why, and specifically cited matters involving franchises, including 7-Eleven’s acquisition of Speedway that violated federal antitrust laws with an order prohibiting 7-Eleven from “enforcing any non-compete clauses against any franchisees or employees working at or doing business with the divested assets”, and another franchise case where the FTC issued a final consent order in which a company and its subsidiary “agreed to roll back a sweeping non-compete clause they imposed on a company to which they sold 60 gas stations”. Regulations.Gov, [Hyperlink] (last visited July 10, 2023).
More broadly, in July 2021, the Biden Administration issued an Executive Order “Promoting Competition in the American Economy”, which, inter alia, targeted employment restrictive covenants, including anti-poaching clauses. And, prior to the Executive Order, in April 2018, the DOJ issued a policy update specifically warning the public of its intent to aggressively enforce antitrust laws in relation to labour markets and “no-poach” provisions and has been engaged in that activity under the Biden Administration. The DOJ is clearly engaged in increased resource allocation and scrutiny, as well as a policy shift as to the applicable legal standard (advocating for no-poach provisions to be considered “per se” violations as opposed to being analysed under a “rule of reason” analysis).
At present, the enforceability of these contract terms still depends largely on state law. Some states may prohibit or severely restrict post-termination non-competition clauses. In states that restrict non-solicitation and non-compete clauses, enforceability often depends on the reasonableness of the restriction, including factors like the scope of business activity being restricted, the duration of the restriction, whether it is necessary to protect legitimate business interests, whether the restriction is contrary to the public interest, and whether it is reasonable in geographic scope. And many states do not allow their non-competition statutory provisions to be waived regardless of what a “choice of law” clause may state in an agreement.
State statutes and state regulators vary in their approaches to this issue. More aggressive state regulators have been prosecuting cases under state law arguing a “per se” rule should be applied, independent of the federal anti-competition laws. Further, several states’ AG’s Offices have aggressively pursued state “no-poach” regulations under state anti-trust laws (notably CA under its Cartwright Act, and WA under its Consumer Protection Act), also generally seeking to take a “per se” violation approach. Indeed, there is a decided momentum to void such restrictive covenants. For example, in May 2023, Minnesota enacted amendments to its law to prohibit and void employment restrictive covenants in the franchise context, and requires all prior agreements to be voided and notice be provided to all franchises that such provisions are no longer effective (“no franchisor may restrict, restrain, or prohibit in any way a franchisee from soliciting or hiring an employee of a franchisee of the same franchisor. [or] an employee of the franchisor”) (See MN Stat. 181.99).
Most cases will depend on whether restraints are deemed to be “vertical” or “horizontal” and the standard utilised by the court. Within the context of franchises, “vertical” agreements are imposed by franchisors on franchisees to prohibit them from hiring employees of another franchisee within the system, while “horizontal” agreements are between franchisors within a single industry. “Horizonal” agreements are clearly violative of federal and state law and may even impose criminal penalties. A case is likely to turn upon whether under the circumstances, precedent, or statute involved, a strict “per se” standard, a “rule of reason” standard, or a “quick look” (a truncated “rule of reason” test) is used.
Previously, the use of broad restrictive covenants was relatively commonplace in franchise agreements. However, now, with the increased scrutiny of regulators, and more regulation potentially on the horizon, franchisors are well-advised to ask whether such clauses are necessary to protect their system. Many franchisors have decided that such restrictive covenants are not worth the risk. Franchisors should examine whether their systems really need to have such protections, whether they are justified, and consult with knowledgeable counsel prior to their inclusion in a standard franchise agreement.
4.1 How are trade marks protected?
At the international level, the United States is a party to the Paris Convention and Madrid Protocol (administered by the World Intellectual Property Organization (“WIPO”)), which allow a trademark to be registered internationally with member nations through a uniform process (an “International Application”). Generally, under the Madrid Protocol, a trademark must first be registered and approved “locally” in a member nation (the “Office of Origin”), and then submitted to the WIPO for international approval and registration (within 12 or 18 months). Once approved at the WIPO level, the mark may be submitted to the other member nations in which the mark holder seeks to obtain trademark protection. When an international mark holder seeks approval of an international trademark within the U.S. through the Madrid Protocol (often called a “Madrid application” or “Section 66(a) Application”), the application is submitted to the United States Patent and Trademark Office (“USPTO”). The application will then be examined by the USPTO, in the same manner, and subject to the same standards, as a mark seeking approval within the U.S., and must be approved by the USPTO before it is allowed to be registered within the U.S. Notably, the WIPO also provides for ADR through its WIPO “Arbitration and Mediation Center”, and franchisors are well-advised to consider that forum for dispute resolution, should a dispute arise.
At the federal level, the USPTO is the agency responsible for registering trademarks. Unique logos or designs, including “trade dress” that a franchisor wishes to use in connection with their mark can, and should, also be registered with the USPTO. The USPTO will initially determine if the application has met the minimum filing requirements. If it has, then the USPTO will assign an examining attorney to review the application and determine if any conflicting marks or other defects in the application prevent the application from being granted (this review by the examining attorney generally takes several months). If an issue with the application arises, and the examining attorney decides the mark should not be registered, the USPTO will issue a letter explaining the reason for refusal or deficiency (an “Office Action”), and the applicant must respond (a “Response to an Office Action”) within six months, or the mark will be deemed to have been “abandoned”. If the examining attorney approves the mark, or the application overcomes an Office Action, the USPTO will “publish” the mark in the USPTO’s weekly “Official Gazette”, and anyone wishing to challenge it will have 30 days from the date of publication to do so. Any objection will be heard by an administrative tribunal within the USPTO called the Trademark Trial and Appeal Board (“TTAB”). If an application is refused by the examining attorney, or fails to overcome any objections, there is an appeals process to the TTAB. If no objection is filed, or none are successful, the registration process (which differs slightly if the mark is currently “in use” or not) then continues to formal “registration”, which can take several more months. If the mark is not actively “in use”, the registrant must, after receiving a “notice of allowance”, use the mark in commerce and submit a “Statement of Use” to the USPTO (or request an extension). Franchisors should take care to avoid having another party cancel, and even acquire, the mark they wanted to use. Further, the issue of what constitutes “use” or “use in commerce”, for foreign trademark holders to qualify for protection, can be particularly tricky to navigate, and mere “spillover” of international business operations into the U.S., or occasional use, may not be sufficiently protective, if a properly registered mark is not being used actively in U.S.-based Operations (within the U.S.). After a federal trademark is registered, the registrant must, periodically, take steps to renew the mark, and file “maintenance” documents, or risk cancellation. Significantly, a “declaration of use” must be filed between five and six years after registration, and a renewal application must be filed 10 years after registration, and every 10 years thereafter (internationally filed marks under the Madrid Protocol follow a slightly different process). Specific acts or affirmative steps may need to be undertaken by an internationally-based franchisor to further protect that mark (such as to affirmatively utilise a U.S.-based agent to promote or provide services connected with a mark). Knowledgeable counsel should be consulted if this is a significant risk.
Recently, the Trademark Modernization Act (“TMA”) expedited and simplified the process for removal of unused (or abandoned) trademarks, even by ex parte practice (both for expungement, and for re-examination). The TMA further codified the “letter of protest practice” whereby interested third parties could challenge a registration, making it easier to challenge an unused mark. The TMA also expedites the registration process (e.g., by shortening the response period for office actions (effective since December 27, 2021). With the passage of the TMA, mark holders must remember to be vigilant, as the process for removal or expungement of an “unused” mark, has been simplified, and even well-intending franchisors who have suffered a delay in implementation of a new mark or system (e.g., due to COVID-19 or supply chain-related issues), may need to take steps to ensure timely “use” of their mark.
At the state level, individual states also have their own trademark registration offices (with their own registration process) that register trademarks within their individual states, which is better than no registration at all or relying on common law trademark rights (discussed infra) but inferior to federal registration that would protect their marks throughout the United States.
In the U.S., unlike in many jurisdictions, a party can also establish and acquire “common law” trademark rights through the usage of a mark in commerce. Common law rights to a mark may be superior to another party’s attempt to subsequently register the same or a similar mark, especially if the common law mark is in use before the other party files for registration, and the holder of the common law mark objects properly. However, common law rights are not well defined and are often limited by geographic scope and specific industries or markets. Indeed, recent decisions, as well as established jurisprudence, tend to significantly limit such common law marks to the specific geographic market in which they are known or “famous” – meaning that reliance on a common law mark may limit the first-in-time mark holder to a small geographic territory (such as a city), while a later, federal USPTO registrant, may have the rest of the country to operate in.
Therefore, while trademarks do not have to be registered to obtain “common law” rights, franchisors are well advised to proceed with, and complete, the federal trademark registration process with the USPTO (outlined above), as a federally registered trademark acts as a “notice to the public” of the franchisor’s claim on the mark and creates a legal presumption of nationwide ownership and the exclusive right to use the mark (in connection with the goods or services in the registration). Additionally, federal law grants significant legal remedies for federally registered marks (including, under certain circumstances, injunctive relief, treble damages and attorneys’ fees). Further, once registered, the federal mark holder has a presumptive argument that it was “first in time” as of its registration (since all objections will either have been rejected or deemed untimely). After federal trademark protection is granted, an adverse “common law” mark holder will be extremely unlikely to overcome the protection of the federal registration and the TMA resolved an unsettled trademark issue caused by the U.S. Supreme Court decision eBay Inc. v. MercExchange. 547 U.S. 388 (2006), by codifying that mark holders have been presumptively irreparably harmed by a violation, removing a significant barrier to obtaining an injunction. Trademark infringement actions can also be brought to address online violations, including unauthorised usage of a trademark in a domain name (or “cybersquatting”), by initiating actions under the Lanham Act (as amended by the Anti-Cybersquatting Piracy Act), or initiating an arbitration proceeding to seize the offending domain under the Internet Corporation for Assigned Names and Numbers (“ICANN”) Uniform Domain-Name Dispute-Resolution Policy (“UDRP”) procedure, or, if applicable, ICANN’s newly adopted Uniform Rapid Suspension (“URS”) domain name suspension procedure for “top down” domain names.
However, trademark holders in the U.S. are cautioned that they are generally required to “police” their marks, by actively monitoring the market in order to discover infringement, and then taking action against infringers so as to protect the mark. A franchisor who fails to take timely action against infringers may lose its right to obtain any relief (due to, inter alia, affirmative defences of laches, acquiescence or waiver, a finding of abandonment, or where usage of the mark by others causes the mark to lose its distinctive significance). Once it has been established that a franchisor has not properly policed its mark in one instance, subsequent attempts to enforce a mark may become much more difficult, or impossible.
Unfortunately, a franchisor must also constantly “police” its mark and brand reputation, not just to protect against infringement, but also to ensure that consumers see it in a positive light. The franchisor must remain appraised of online and social media commentary on the mark, and aggressively work with its franchisees to address negative comments and adverse online postings. The U.S. is culturally diverse, and regional and political differences vary significantly from market to market. It may be necessary for a franchisor to be flexible in its political positioning (or neutrality) to facilitate operations for individual franchisee’s local political environments, and Franchisors may need to tailor their approach on a regional level to avoid negative impacts upon brand image based on region. Franchisors must stay ahead of any potentially concerning situation with effective PR, so the brand can protect its marks from any negative social media, and such services are often relatively inexpensive compared to the potential costs of failing to properly handle a PR issue. Even smaller franchisors should have contingency plans and systems for addressing PR problems in place, so they will be able to identify any threat, respond properly, and recognise that regional differences may necessitate a nuanced approach. The ability for any negative situation to rapidly reach large segments of the population through non-traditional media, means that franchisors must be able to maintain a presence on a wide variety of social media platforms, and be prepared to react swiftly and adeptly to threats as they manifest.
4.2 Are know-how, trade secrets and other business-critical confidential information (e.g. the Operations Manual) protected by local law?
Confidential information, which can include know-how, trade secrets, and other business-critical information, may be protected by federal and state statutes, as well as common law.
At the federal level, the Defend Trade Secrets Act of 2016, 18 U.S.C. §1831 et seq. (the “DTSA”) provides a private civil right of action for theft or misappropriation of trade secrets (which may be brought in federal court), under which an aggrieved party can seek damages, and in instances of wilful and malicious violation, double damages and attorneys’ fees. To utilise the DTSA, a party must have provided “notice” (under 18 U.S.C. §1833(b)(3)) to any person it wishes to prohibit from disclosing the trade secret(s), including employees, agents, or franchisees. Therefore franchisors (and franchisees) should incorporate into their agreements, policy manuals, confidentiality agreements, and other confidentiality provisions, such “notice”. Additionally, the DTSA, provides for injunctive relief, including an ex parte expedited seizure of the trade secret under certain circumstances. See 18 U.S.C. §1836. Importantly for foreign parties (or in connection with agreements with foreign parties), the DTSA also may provide for extra-jurisdictional liability (reaching violators outside of the U.S.). See 18 U.S.C. §1837. Franchisors may use this legislation to restrain former franchisees from misappropriating trade secrets, and to protect the franchisor’s intellectual property. See, e.g., Panera, LLC v. Nettles and Papa John’s Int’l, Inc., 4:16-cv-1181-JAR, 2016 WL 4124144 (E.D. Mo. 2016) (franchisor successfully obtained a temporary restraining order against a former employee to prevent dissemination of trade secrets under the DTSA); Bambu Franchising v. Nguyen, 5:21-cv-00512-EJD, 2021 US Dist. LEXIS 88030 (ND Cal May 7, 2021) (franchisor granted injunctive relief for, inter alia, violation of the DTSA). However, simply stating in a franchise agreement that something is a trade secret does not make it one and courts will examine carefully whether a franchisor has taken reasonable measures to keep an alleged trade secret “confidential”, and whether the information really is a trade secret not readily ascertainable through independent means, or available as general knowledge in the industry. See, e.g., Oakwood Labs. LLC v. Thanoo, 999 F.3d 892 (3d Cir. 2021). However, overly protective contractual draftsmanship may lead to definitions of a “trade secret” or “confidential information” within a FA that exceeds what is actually protectable under the DTSA. And franchisors should be aware that contractual breaches for what constitutes protected information, does not necessarily equate to statutory violations of the DTSA, and they should only bring suit under the DTSA statue when there is a viable claim. Therefore, while utilising the DTSA may protect franchisors against former franchisees absconding with secrets, it may also harm franchisors by inadvertently having a court declare that its intellectual property is not sufficiently protected as a “trade secret” (which could have system-wide implications).
At the state level, almost every state (New York being a notable exception) has adopted some form of the Uniform Trade Secret Act (“UTSA”). Additionally, each state (including New York) has its own common law trade secret protection operating in tandem with the federal level protections. While there is variation between states, typically, a party must show that information it seeks to protect is “secret”, not in the public sphere or known by others. Furthermore, a party must also demonstrate that it has undertaken significant efforts to maintain the secrecy of its trade secrets to be afforded common law or statutory protection.
To protect themselves from the acts of franchisees, franchisors should implement policies and procedures designed to protect against the dissemination of confidential information. From the start of a relationship with a potential franchisee, franchisors should be wary in their sales processes (e.g., Zoom calls or even “discovery days”) to adequately define the line between a pitch to prospective franchisees, and inadvertently disclosing intellectual property that they want to protect, as prospective franchisees are generally not bound by NDAs, and such conduct by a franchisor will likely result in the information being unprotected. See, e.g., Smash Franchise Partners, LLC v. Kanda Holdings, Inc., 2020 Del. Ch. LEXIS 263, No. 2020-0302-JTL (Ch August 13, 2020) (information was freely shared with prospective franchisees, including on phone calls with prospective franchisees, in pitch-decks, in group calls (without security measures or non-disclosure agreements (“NDAs”)) and in the FDD, and therefore was not protectable as a “trade secret”, and was not properly protected as “confidential” information by the franchisor). Where applicable, franchisors should require franchisees to agree to non-disclosure agreements and should include strong and inclusive confidentiality provisions in their franchise agreements. Further, franchisors should mandate that their franchisees require that their own respective agents or employees agree to confidentiality prior to disseminating any of the franchisor’s trade secrets.
Courts will generally enforce confidentiality agreements and grant injunctive relief in appropriate circumstances to prevent the theft or misuse of confidential information. Well-crafted franchise agreements will often include injunctive relief provisions designed to facilitate the protection of confidential information in court. New or prospective franchisors should be extremely mindful of confidentiality issues before discussing their “new concept”, their “secret sauce”, or other intellectual property with anyone (including potential investors or prospective business partners). Non-disclosure agreements should be entered into prior to having discussions in which a prospective franchisor has disclosed a trade secret or idea that is unique and worth protecting. In addition, a well-crafted franchise agreement will ensure any “inventions” by a franchisee belong to the franchisor. This may be a trap for the unwary in some states, as for example, in New York, franchisors may not require execution of an NDA prior to providing a prospective franchisee with an approved and registered prospectus (See NY GBL 693(8) (no “other agreement” concerning the franchise may be entered into prior to disclosure and a 10 business-day period). While each situation is different, it may be the prudent course of action to avoid any disclosure of truly confidential information prior to execution of a FA.
Franchisors often employ restrictive covenants within their franchise agreements to prevent a former franchisee (after termination or execution of the franchise agreement) or any person who had access to confidential information or trade secrets from subsequently competing with the franchise (e.g., working for a competitor). However, restrictive covenants may not be enforceable, or the extent of enforceability may be limited. Some states will find them void or unenforceable as a matter of law, and many will not enforce them unless they are truly necessary to protect IP or a brand, and the person(s) being restrained have been adequately compensated. Recently, federal and state regulators have been “cracking down” on over-reaching franchisor’s post-employment restrictive covenants as violating anti-competition laws or restraints of trade. Therefore, franchisors should be cautious when relying upon restrictive covenants to protect their IP.
Publications by the franchisor, including operations manuals and policy and procedure manuals, may also be protected by federal copyright law (discussed below). In addition, a franchisor might consider applying for a federal patent with the USPTO if a franchisor has a unique invention or product, process, or design. However, confidential trade secrets can be kept in perpetuity, while patents expire. Further, in applying for a patent, a company risks publication of its intellectual property, as patents are public; and, if a patent application is rejected, it is typically publicly available within 18 months. Therefore, it may be better to protect certain IP as a “trade secret”, depending upon the nature of the IP. If an operations manual or other publication is to contain “trade secrets”, franchisors are well advised to so state on the document itself and require their franchisees to take steps to guard it (and its employees), such as insisting that only certain of the franchisees’ employees have access to it, and that each franchisee maintains it in a secure place with limited access to others.
Furthermore, franchisors should consider utilising other security measures, including password-protected computer systems, to maintain the “confidentiality” of information (such as client or customer lists and information) that the franchisor may wish to keep “confidential”.
Franchisors should also be vigilant after termination of a franchise and ensure that not only physical (paper) manuals and trade secrets are returned or destroyed, but also all online access to trade secrets or confidential information is terminated. See, e.g. Neighborhood Networks Publishing, Inc. v. Lyles, 19-cv-89-BO (EDNC January 31, 2021) (franchisor failed to take reasonable steps to protect trade secrets by continuing to allow terminated franchisee access to web-portal months after termination, making misappropriation claim unviable).
Additionally, as artificial intelligence continues to develop and be utilised by different actors in different ways, franchisors need to take steps to protect their intellectual property and themselves from infringing on others’ IP. First, franchisors need to be vigilant about the dissemination of their protected materials and remain aware of the various ways in which it might be used both to train AI and to create new content that may infringe on their rights. Second, in using AI themselves (as in creating marketing campaigns), franchisors must be sure to review all materials produced before dissemination to ensure that they are not infringing on another company’s protected IP, or as discussed herein, ensure that they are not generating erroneous, improper, or potentially damaging content. Human involvement is necessary in both situations.
Finally, as discussed supra, the reputation associated with a brand must be protected from (increasingly all-too-common) online assaults. Franchisors must not only remain vigilant in protecting their trademark or intellectual property from being stolen or usurped, but also from unfairly disparaging commentary or defamatory material on online social media, third-party product or service reviews, or other online commentary or postings. Traditional common law defamation, based upon the relevant state law, may be utilised when false claims are made concerning a brand or service. In addition, the Lanham Act may also be utilised to protect a federal trademark from statements that might be misleading to consumers, even if such statements are not literally false (which may open the door to bringing claims under the Lanham Act to protect a mark from statements that might not be literally false, but which may be misleading).
Furthermore, the FTC Act may allow a franchisor to seek assistance from the FTC due to a third-party utilising “unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce…”. 15 U.S.C. §45(a)(1). States’ “Little FTC Acts” may also apply, including what are often called unfair and deceptive trade practices acts allowing a franchisor to bring an action to protect its branding from unfair online competition or commentary. Finally, most online service providers have terms of service that prohibit defamatory or unfairly disparaging speech. Often, it may be sufficient (and cost effective) to directly contact a service provider and attempt to have the offending material removed under the terms of service, at least in the first instance, rather than resort to litigation. However, prior to bringing any action, a franchisor should be mindful that the U.S. has particularly strong public policy rights associated with freedom of speech. The franchisor should consider whether the potentially offending content is protected opinion, or otherwise qualifies for protection as free speech. There are implications (such as “Anti-SLAPP” statutes) that may punish overly litigious franchisors who bring lawsuits that improperly infringe upon someone’s right to freedom of speech. If a franchisor wishes to engage in litigation to address potentially defamatory misconduct, it is highly recommended that knowledgeable counsel be retained, as ill-advised litigation can backfire.
4.3 Is copyright (in the Operations Manual or in proprietary software developed by the franchisor and licensed to the franchisee under the franchise agreement) protected by local law?
As detailed above, the United States is a signatory to many treaties and conventions concerning copyrights, including those overseen by the WIPO. Within the U.S., federal law protects both registered and unregistered copyrighted material. Furthermore, common law rights and statutory rights conferred by states, such as claims for misappropriation or unfair competition, may overlap with copyright law to protect information within publications. Nonetheless, there are exceptions to copyright (such as “Fair Usage”), and a franchisor should carefully consider which exceptions it may encounter before it seeks to protect its copyright through litigation.
A wide variety of publications and media, including operations manuals, websites and online content, social media pages and content, advertisements, menus, or computer programs may be protectable by copyright. In distributing such materials, franchisors should be careful to draft clear agreements covering employees, agents or vendors that designate “work for hire” copyright ownership to the franchisor for materials that are created for the franchisor to ensure that it does not inadvertently grant “ownership” of expensive, custom resources to outside parties.
The culture of the U.S. tilts decidedly towards protecting intellectual property rights and punishing those who would misappropriate or engage in unauthorised usage or plagiarism of another’s intellectual property. For example, the Federal Digital Millennium Copyright Act (“DMCA”) also provides a mechanism whereby copyright holders can directly notify third-party online service providers that an infringement is occurring (like a user posting a confidential portion of an operations manual) and ask that the provider remove or disable access to the infringing material. Most third-party internet service providers also have terms of service that prohibit infringement and will remove offending material on that basis once notified of unauthorised use of copyrighted material. And federal law often provides for the assessment of additional damages, including exemplary (sometimes treble) damages, and attorney fees, against those who violate the law through unauthorised usage or plagiarism. Many of these protections are now in tension with the greatly accelerated usage of AI to cull available information, process it, and generate similar content. While material and content may be available online, and therefore available for AI to emulate and process, the legality of then utilising copyrighted or protected content to generate output is murky at best. Courts will need to adapt to this emerging technology, and the legal landscape here is likely to develop and change rapidly in the coming years. Franchisors should think twice about allowing public or online access to copyrighted or protected work if they fear emulation through AI usage by competitors.
In addition, generic and commonly known information may not be protectable. Copyrighted materials that courts may characterise as basic, common, and generic, including those in “confidential” proprietary franchise operation manuals, even if copied verbatim, may not necessarily qualify for protection. See, e.g., Civility Experts Worldwide v. Molly Manners, LLC, 15-cv-0521-WJM-MJW, 2016 WL 865689 (D. Colo. 2016). Practically, even if a copyrighted work is protected, a franchisor must be prepared to explain to a court how its unauthorised use truly harms the franchisor. Franchisors must diligently police any information that they want to protect as confidential or as trade secrets, regardless of what is set forth in its contracts, or what statutory remedies may or may not apply. Therefore, it is not prudent for a franchisor to rely upon statutory protection alone to protect its IP and should have clear and enforceable provisions within its franchise agreements protecting the IP and declaring it a material breach for any failure to do so (in addition to any regulatory or statutory protections). Such provisions should make it clear that any IP or manuals are the property of the franchisor and are only being temporarily licensed. Furthermore, the dispute resolution provisions should provide a “carve out” for a franchisor to go to court to obtain injunctive or other relief to protect its IP. And, upon termination of a franchise, a franchisor should require destruction or return of any and all property and IP that a franchisor wishes to protect, so at the minimum, breach of contract may be employed in addition to statutory or other rights. In these matters, it is essential to act quickly, and a well-timed “cease and desist” letter may not only serve to avoid litigation, but also evince to a court that a franchisor is taking its rights seriously, and diligently acting to protect its intellectual property.
5.1 What remedies can be enforced against a franchisor for failing to comply with mandatory disclosure obligations? Is a franchisee entitled to rescind the franchise agreement and/or claim damages?
Under federal law, the FTC’s Franchise Rule does not provide a private right of action for franchisees to sue their franchisors for disclosure violations. As such, a franchisee’s only recourse is to refer disclosure violations to the FTC for enforcement. Such a referral was, historically speaking, unlikely to yield any results for the wronged franchisees because, until recently, the FTC rarely directly sued franchisors for violating the FTC Franchise Rule, perhaps due to the lack of the allocation of resources to enforcement personnel. However, in a dramatic shift from past decades of lax enforcement policy, the FTC filed an enforcement action against a certain burger franchisor in February 2022 for alleged pre-contract misrepresentations, and appears to be increasing its activity in this area. Additionally, the FTC launched a new fraud reporting tool in 2022, in an effort to further hold franchisors accountable for FTC Franchise Rule violations. Whether the FTC will maintain this increase in enforcement, and increased scrutiny and potential additional regulation of business practices in the franchise arena, remains to be seen.
Like the FTC, state enforcement agencies can seek to impose civil and criminal penalties or obtain an injunction against a non-compliant franchisor. Unlike the FTC, individual states allow for a private right of action for a franchisee to sue its franchisor under applicable statutes that afford protection to franchisees, including, inter alia, under a state’s unfair trade practices act (“Little FTC Act”), franchise statute, and/or business opportunity law.
In some states, a franchisee may even be able to directly sue not just a franchisor entity, but also potentially a franchisor’s owners, directors, agents, or other “persons” covered under a statutory definition of those liable for violations. Such individual liability may come as a surprise to unwary franchisors, their owners, officers, key personnel, and even salespersons, and it highlights the need to have competent counsel advise franchisors concerning their sales process. It also behoves franchisors and salespersons to have appropriate insurance to cover individual liability if sales are potentially covered by such statues. For example, recently the Eastern District of New York ruled that a Chief Executive Officer and a General Counsel could individually qualify as “persons” jointly and severally liable under two independent sections of the New York franchise Sales Act. The court found these “persons” could be liable under NY GBL 681(13) (definition of “person” liable), or alternatively, as a “control person” that “materially aids in the act or transaction constituting the violation” under NY GBL 691(3). See Sea Tow Servs. Int’l, Inc. v. Tampa Bay Marine Recovery, Inc., 2022 WL 5122728 at 27–28*; 38–39*, __ F.Supp.3d __ (S.D.N.Y. Dist. 2022). It is a cautionary tale. In states with broad definitions of “person(s)” that may be liable, franchisors, and key personnel, including individuals in the sales process, should be mindful of the need to navigate the applicable state statues. Fortunately, most state statutes are not overly burdensome to comply with, particularly if a franchisor is already complying with federal law, and competent counsel is timely sought.
If a franchisee prevails in an action, the franchisee may be entitled to various forms of relief, including recission, damages, costs, reasonable attorneys’ fees, and statutory interest. Recission, which restores the parties to the “status quo ante” (the condition they were in before the violations occurred), provides for the restitution of any money previously paid by the franchisee to the franchisor, including the franchise fee and royalty payments. Additionally, in some states, it may also entitle a franchisee to recover its initial investment costs and operational losses. However, recission may only be available under limited circumstances (e.g., for wilful and material violations). Some states allow for the recovery of treble damages for plaintiffs that prevail on their franchise claims. However, what is important to keep in mind is that the rights and potential remedies available to a franchisee will vary by state. As such, it is generally advisable for a franchisee to retain counsel knowledgeable in the applicable state’s franchise law.
5.2 In the case of sub-franchising, how is liability for disclosure non-compliance or for pre-contractual misrepresentation allocated between franchisor and master franchisee? If the franchisor takes an indemnity from the master franchisee in the Master Franchise Agreement, are there any limitations on such an indemnity being enforceable against the master franchisee?
To sub-franchise a franchise, the franchisee must be considered a “Master Franchisee”. In other words, a Master Franchisee must: (a) enter into unit or sub-franchise agreements with franchisees; and (b) provide ongoing business support to the franchisees after signing in accordance with those sub-franchise agreements. Master Franchisees are considered “Sub-Franchisors” and, as such, must comply with its disclosure obligations under the FTC’s Franchise Rule and any applicable state disclosure laws. Franchisors and franchisees should be mindful that these “master franchise” agreements have their own, often independent, disclosure and sales requirements.
In an action against a Master Franchisee, the FTC’s Franchise Rule and most state franchise statutes consider the Master Franchisee and the franchisor to be jointly and severally liable for their violation(s) of the disclosure laws. As such, it is common for a Master Franchisee and franchisor to include a mutual indemnification clause in the Master Franchise Agreement. Such clauses are generally enforceable, except, in states where an indemnification clause covering the intentional misconduct of the indemnitee is void as a matter of public policy.
5.3 Can a franchisor successfully avoid liability for pre-contractual misrepresentation by including a disclaimer in the franchise agreement?
Under the FTC’s Franchise Rule, a franchisor cannot disclaim, or require a prospective franchisee to waive reliance on representations contained within the FDD. Such actions are deemed as unfair or deceptive trade practices. Therefore, disclaimers are ineffective with respect to representations within the FDD. Disclaimers are also ineffective against protecting a franchisor from liability for material omissions in the pre-contract disclosures. Disclaimers are only an effective form of protection with respect to misrepresentations that are extraneous to the FDD, and still may not fully inoculate a franchisor from liability.
In addition to the FTC’s Franchise Rule, several states’ franchise laws contain anti-waiver provisions. In other words, some states protect franchisees by voiding any contractual term that attempts to waive a franchisee’s right to sue under the statute for, inter alia, pre-contractual misrepresentations. In other jurisdictions, merger and integration clauses may not be able to defeat a claim for fraudulent inducement based on the theory that fraud is extraneous to the contract.
Typically, specific disclaimers are more effective than broad disclaimers or integration clauses. Such disclaimers can be effective against common law claims, and undermine a franchisee’s “reliance” upon extra-contractual representations. It still is relatively commonplace for franchisors to require a franchisee to sign a separate questionnaire detailing what representations were, and were not made, prior to execution of the franchise agreement, although the efficacy and propriety of such questionnaires are increasingly being challenged by courts and regulators. As such, disclaimers generally still have some utility, depending upon the jurisdiction, but are not going to function as liability shields, particularly where franchise statutory remedies are present that operate independently of contractual language.
While disclaimers do not wholly protect a franchisor from claims of pre-contract misrepresentations, at the very least a franchisor can point to the disclaimer clauses as evidence that the franchisee did not reasonably rely on the misrepresentation.
5.4 Does local law permit class actions to be brought by a number of aggrieved franchisees and, if so, are class action waiver clauses enforceable?
Yes, franchisees can join together to file a class action lawsuit so long as the designated class meets the applicable federal or state law requirements for class certification. Generally, separate franchisees may be able to sue the same franchisor within the same action or arbitration (or join multiple claims together), depending upon the jurisdiction or forum. Additionally, franchisee associations can sue on behalf of their members if the associations can show they have standing to sue, which is available in certain jurisdictions. Alternatively, a franchisee association can create a litigation fund, and sponsor a lawsuit by one of its franchisee members. Therefore, there are a variety of mechanisms that multiple franchisees can employ to bring a joint, class, or collective action, and potentially pool their resources.
Although franchisees can join together for a class action lawsuit, it is common practice for franchisors to include both general class action waiver provisions within franchise agreements as well as waiver clauses in the arbitration provisions preventing class or group arbitrations. The U.S. Supreme Court has long held that such provisions are generally enforceable. In addition, where arbitration forums are utilised, such class or collective action waivers tend to be more effective, depending upon the jurisdiction. Notably, general class action waivers within a franchise agreement are still subject to normal contractual defences, and still may not be enforced under certain state laws (e.g. if they are found to be against public policy, unconscionable, or not a knowing and voluntary waiver of a right).
6.1 Is there a requirement for franchise documents to be governed by local law? If not, is there any generally accepted norm relating to choice of governing law, if it is not local law?
There is no requirement for a franchise to be governed by local law, except for non-waivable state statutory provisions, or when there are statutes mandating that the local law overrides any choice of law provision. Choice-of-law provisions are generally enforceable if: (1) there is a substantial nexus between the selected state and the parties or the transaction, or some other reasonable basis for the parties’ choice exists; and (2) the selection does not violate the public policy of the state having the predominant interest. Choice of law provisions will likely be ineffective in avoiding liability under a state franchise law that is otherwise applicable. Indeed, most state franchise statutes contain non-waiver provisions.
Typically, franchisors include in their franchise agreements a choice of law provision preventing their non-applicability that requires application of the law of the franchisor’s home state to the contract, and to any related disputes. This allows for uniformity in application of the forum state’s law across the franchised system, at least as far as the interpretation of the franchise agreement is concerned, and to the extent that common law claims are asserted in connection with any disputes that arise. While, as noted above, choice of law provisions are generally unable to override a local statue, they can do much to ensure that a more advantageous forum state’s substantive contract law, and potentially its tort and common law, will apply to any potential dispute.
6.2 Do the local courts provide a remedy, or will they enforce orders granted by other countries’ courts, for interlocutory relief (injunction) against a franchisee to prevent damage to the brand or misuse of business-critical confidential information?
A franchisor has the right under federal and state law to seek an injunction against a franchisee. To obtain such an injunction, the franchisor will typically seek recourse by filing a court action. Even franchise agreements with arbitration provisions will typically preserve or “carve out” the right to seek injunctive relief in court. Even where there is no such carve out, injunctive relief may be available under the rules of certain arbitration organisations (including the American Arbitration Association (“AAA”) and JAMS), arbitrators have the authority to grant interim relief is sought in an arbitration proceeding.
The U.S. is not a signatory to any treaty or convention that specifically requires its courts to recognise or enforce injunctive orders or judgments issued by any foreign courts. However, out of “international comity”, U.S. courts typically recognise and enforce final and valid foreign judgments. While some U.S. courts have enforced foreign court orders for permanent injunctive relief, they have been less willing to enforce preliminary injunctions (as they are not final and conclusive judgments).
6.3 Is arbitration recognised as a viable means of dispute resolution and is your country a signatory to the New York Arbitration Convention on the Recognition and Enforcement of Foreign Arbitral Awards? Do businesses that accept arbitration as a form of dispute resolution procedure generally favour any particular set of arbitral rules?
Arbitration is clearly a favoured means of dispute resolution under federal law, as codified in the Federal Arbitration Act (“FAA”). Furthermore, the FAA pre-empts any state law that attempts to deny or even limit the right of contracting parties to arbitrate disputes involving interstate commerce.
The U.S. adopted the New York Convention and ratified the Inter-American Convention on International Commercial Arbitration (Panama Convention), which requires the U.S. and most South American nations to enforce arbitration agreements and awards originating in members’ countries. The New York Convention and Panama Convention have been codified as U.S. law in Chapters 2 and 3, respectively, of the FAA.
Ad hoc (self-administered) arbitrations often proceed in accordance with the UNCITRAL Arbitration Rules or the CPR’s Non-Administered Arbitration Rules. The International Centre for Dispute Resolution (“ICDR”) (the AAA’s international division) and the International Institute for Conflict Prevention & Resolution (“CPR”) are two of the most well-established international arbitration forums located in the U.S. Additionally, the International Chamber of Commerce (“ICC”) administers arbitrations from its New York City office and some international organisations, like the London Court of International Arbitration (“LCIA”), can conduct U.S.-seated arbitrations from their foreign offices.
7.1 Generally speaking, is there a typical length of term for a commercial property lease?
The U.S. represents a huge real estate market with urban, suburban and rural areas. It is not one homogenous market, but rather it is comprised of diverse areas within which there are wide differences with respect to commercial leasing conditions. As such, there is no typical length of term for a commercial lease in the U.S. The term may vary depending on a variety of factors including, for example, the area type and specifics of the local market, the premises (e.g., retail, office or industrial), general economic and market conditions, the landlord, lender requirements, franchisor requirements, etc. In major metropolitan areas and in shopping centres, it is common to have leases for retail spaces that are for 10 years or more. While, perhaps, this may not be as prevalent in smaller communities, even there, leases of 10 years (or more) can usually be negotiated for well-known franchise brands. (While there is no standard length of franchise agreement in the U.S., many franchise agreements have an initial term of 10 years.) Some landlords offer “specialty leasing” arrangements in which tenants are offered the option of leasing retail spaces in malls, shopping centres, and storefronts on a short-term basis. This option is especially advantageous for businesses that sell merchandise that is either seasonal or related to a specific holiday. Tenants often seek to incorporate one or more option terms into their leases. Some franchisors, and franchisees (if they are represented by knowledgeable counsel) will prefer to have the term of the franchise agreement (with any renewals) coincide with or be “coterminous” with the term of the lease being entered into (including any options). Generally, there are no statutory rights regarding a commercial tenant’s or franchisee’s right to “hold over” at the end of the lease’s contractual term. In most instances, commercial leases contain provisions requiring the tenant to pay anywhere between 125% and 200% of the Base Rent and Additional Rent during any holdover period(s), although the amount of the overage, as is the case with most lease provisions, is usually subject to negotiation.
7.2 Is the concept of an option/conditional lease assignment over the lease (under which a franchisor has the right to step into the franchisee/tenant’s shoes under the lease, or direct that a third party (often a replacement franchisee) may do so upon the failure of the original tenant or the termination of the franchise agreement) understood and enforceable?
Yes, this is a well-established concept that serves to protect both the franchisor’s brand and revenue stream derived from a particular location and is often addressed by contractual agreement, both in the franchise agreement and, if properly negotiated, in the lease, as well. Sophisticated landlords are generally aware that franchisors often reserve rights in their franchise agreements which will enable the franchisor, an affiliated entity or another approved franchisee, to “step-into” the franchisee/tenant’s shoes, either to temporarily operate the franchisee’s business (see commentary at question 16.2), or to take an assignment of the lease if either of two events occur: (i) the franchisee’s lease is terminated by the landlord; or (ii) the franchisee’s franchise agreement is terminated by the franchisor. Some landlords will consent to such a requested lease term by so providing in a three-party rider or addendum to the lease, which is executed by the franchisor, franchisee/tenant and the landlord. Landlords will usually require that the franchisor (or other assignee) must cure any defaults (including the payment of any outstanding rent/additional rent, etc.) before the franchisor or another franchisee can take over the lease. Savvy franchisors or franchisees may negotiate a lease term providing that, under such circumstances, the landlord’s consent will be “deemed” to have been given and that the only requirement is that proper notice and disclosure be provided to the landlord. Other landlords may resist agreeing to such a provision outright, while others may seek to obtain financial concessions from the franchisor in return for agreeing to such a provision. For example, where landlords have required the franchisor or franchisee to provide either a full or partial guaranty of the lease (e.g., a “good guy” guaranty where the guarantor is responsible for the rent, or even for all of the obligations under the lease, for only so long as the tenant remains in possession of the premises), the landlord may require that a comparable guarantor be added (or substituted) as part of the transaction. Whether or not the franchisee/tenant, as well as any guarantor(s), will be released from liability under the lease upon such a sale is also a key issue to be negotiated.
7.3 Are there any restrictions on non-national entities holding any interest in real estate, or being able to sub-lease property?
Typically, not in the franchise context, in which franchisees and/or franchisors commonly hold leasehold interests in real property. While U.S. federal law restricts foreign ownership of certain federal oil, gas and mineral leases, and authorises the blocking of certain foreign acquisitions of U.S. companies with respect to particular industries which potentially impact on national security, energy resources and critical infrastructure, such restrictions are generally inapplicable to franchising opportunities in the U.S. Rather, federal laws generally impose reporting or disclosure requirements in which foreign investors report the real estate transaction to the appropriate federal agency. Under federal law, foreign owners or investors in U.S. real estate are subject to U.S. tax to the same extent as domestic owners are. In most instances, foreign investors would acquire U.S. real estate interests, including leases, by utilising single purpose U.S. entities which are created specifically in order to acquire or lease the real property.
7.4 Give a general overview of the commercial real estate market. To what extent has the real estate market been affected by the Coronavirus pandemic? Specifically, can a tenant expect to secure an initial rent free period when entering into a new lease (and if so, for how long, generally), or are landlords demanding “key money” (a premium for a lease in a flagship location)?
The U.S. commercial real estate market is large and varied. Prior to the emergence of the COVID-19 crisis (“COVID-19 Crisis”) the commercial real estate market was in the process of recovering from the “great recession” of 2008 through 2012. In certain metropolitan areas, the real estate market recovered fairly well and it was not uncommon for landlords to charge premium rents for “Class A” and other desirable retail locations. Prior to the COVID-19 Crisis, certain events had been negatively impacting the retail section of the U.S. commercial real estate market, including, in significant part, the impact that the purchase of products on the internet has had on retail sales generally, and inevitably, on the sale of products from franchised (or franchisor-owned) retail locations. According to an article published in Forbes, in 2022, digital commerce surpassed the $1 trillion dollar threshold for the first time. Further, almost 80% of Americans make purchases via the internet. This trend will likely continue and is likely to have an increasingly negative impact on “brick and mortar” retail purchases generally, and on franchised retail outlets, specifically. Until the last recession (e.g., 2008–2012), malls and shopping centres in the U.S. had experienced explosive growth since the 1950s. However, based on the internet’s continuing negative impact on retail locations (including franchised outlets), malls and shopping centres may well become smaller and rents may have to be reduced in order to induce retailers to make long-term commitments that both landlords and lenders desire or require. It is unlikely that we will see, in the foreseeable future, the kind of explosive growth that malls and shopping centres had previously experienced. We are starting to see retail space undergoing a major transformation, where the trend generally speaking, has been that “low-quality” retail premises have been struggling and “high-quality” retail premises are more likely to be successful (especially where consumers enjoy services and entertainment as opposed to buying durable goods which can easily be purchased “online”). This recent trend has helped to keep retail rents at more reasonable levels.
Partly as a result of these factors, reasonable construction periods (which vary depending on the location and type of work to be done), landlord contributions to tenant “work letters” and some “free rent” periods, continue to be frequently available in metropolitan areas. In other areas of the country, including more suburban and rural areas, where the real estate market (and the local economies generally) have been, perhaps, more “hard hit”, it is even more common for tenants to obtain a period of free rent and/or tenant improvement allowances.
The specific work that the landlord agrees to do in order to prepare the premises for the franchisee/tenant’s occupancy is memorialised in a “work letter” which is almost always subject to negotiation. It will be influenced by such factors as the length of the lease term, the tenant’s credit worthiness and overall “desirability” and, of course, the rent to be paid. The time needed to perform both landlord’s and tenant’s work will vary according to the nature of the work to be performed but will typically range from 60 days to six months and, sometimes, may be even longer where it is anticipated that particular zoning or “permitting” issues will apply. While no rent will be charged during the construction period, tenants frequently seek out an additional “free rent” period after the premises opens for business while still within the construction period and, in some cases, even after the construction period has ended. In certain areas, such as where a free-standing building is being constructed for the franchised unit, or for larger construction projects, such as hotels, even longer construction periods, and “free rent” periods, may come into play.
In certain metropolitan areas where the real estate market had recovered well, landlords would sometimes charge commercial tenants so-called “key money” as a premium for the tenant’s right to secure the lease. The pressure from internet sales has had a negative impact on this practice. In most cases, where key money is a factor, the deals usually involve transactions where an existing lease and infrastructure (e.g., built-in furniture, specialty plumbing or electrical work) are transferred to a new tenant and the landlord requests a one-time payment in recognition of the extra facilities and the convenience that the tenant is inheriting. Examples of this situation may include a restaurant having a recently upgraded infrastructure in place, or where a petrol station having substantial equipment improvements is being transferred to a new tenant (petrol distributor). Unlike the residential context where tenants are sometimes asked to pay “key money” to superintendents or building managers in order to secure a flat (such “off the books” practices are illegal), in the commercial real estate market context, requests may be presented so long as the money is requested by the landlord and is paid by the tenant and set forth in the lease.
Impact of the COVID-19 Crisis
Beginning in the spring of 2020, millions of American employees were unable to travel to their workplaces because state and local government authorities issued “stay at home” orders and ordered all “non-essential businesses” to “shut down”. As a result of the COVID-19 Crisis, many retail locations and other businesses (including franchises) defaulted on their leases in 2020 and 2021 and attempted to negotiate with their landlords as to the waiving or deferring of rent and additional rent, and to avoid being evicted from their premises (when existing eviction moratoriums were eventually lifted). Further, as many larger businesses have been reluctant to require their employees to return to their offices, especially in urban areas, the commercial office market in metropolitan areas has continued to struggle, and this has caused some “brick and mortar” franchises to suffer, which rely on foot traffic by customers. Even though the COVID-19 Crisis is under control, the commercial real estate market in the U.S., especially with respect to “Class A” retail and office space, both in urban and suburban areas, is still struggling to fill vacant retail and office space. There is generally less demand for office space as many employers continue to offer remote work policies and also seek to save money to help offset increased costs due to inflation.
8.1 If an online order for products or request for services is received from a potential customer located outside the franchisee’s exclusive territory, can the franchise agreement impose a binding requirement for the request to be re-directed to the franchisee for the territory from which the sales request originated?
Yes. The franchise agreement can, and should, where applicable, regulate how online orders are allocated. Online commerce has exploded in the past few years, and even service-based franchisors and brick and mortar dependent franchise systems have had to incorporate increased online orders and services. Franchisors should take great care to adequately define in the franchise agreement, and similarly, to disclose in the FDD (along with required state disclosure documents), how such online orders will be handled. Franchisors should take advantage of the protective nature of a well-crafted FA and FDD, so they can put a prospective franchisee on notice of what is, and what is not, part of the market or territory they are purchasing the rights to, including digital commerce rights. Unless a territory is truly “exclusive”, franchisors should avoid words like “exclusive” territory in order to avoid confusion, and make sure that prospective franchisees are put on notice as to the manner in which online orders are handled within a franchisee’s territory. Item 12 of the FTC Rule requires that if a franchisor does not grant “exclusive” territories to its franchisees, the franchisor’s FDD must include a disclaimer underscoring that fact. The FTC Rule also requires that the FDD include separate detailed disclosures regarding whether a franchisor reserves the right to sell its products through “alternative channels of distribution” in the franchisee’s territory, including e-commerce. That means that franchisees must be made aware of whether or not a franchisor is granting them rights to engage in online commerce, and what limitations are placed upon those rights. Notice is key, and making sure a franchisee’s rights are well-defined will do much to prevent costly litigation in the long run. A franchisor’s failure to clearly define a franchisee’s rights with respect to online sales, especially in its required disclosure documents and franchise agreements, may result in litigation, including claims by aggrieved franchisees that a franchisor has committed “disclosure” violations (including violations of both federal and applicable state law), and common law claims for fraudulent or negligent omission, breach of contract, and/or breach of the implied covenant of good faith and fair dealing.
As e-commerce continues to mature, prospective franchisees who are purchasing a franchise should carefully review the territorial protections and online market provisions described in the FDD and provided for in the franchise agreement with great care. Access to the online market can significantly impact the profitability of a franchise, and both franchisor and franchisee should be clear about their respective rights.
Given the speed at which the economy in the United States has embraced remote services, online commerce, and digital orders, many franchised systems, particularly those with “evergreen” franchise agreements that may span decades, could find that their standard franchise agreements do not specifically address online commerce. Indeed, entire franchise system models have had to adapt within the past several years to incorporate and adjust to these disruptive changes in how people shop and expect services to be provided. Franchisors who find that their agreements no longer reflect the new economic reality, need to take steps with knowledgeable counsel to update their agreements and disclosure documents.
Further, franchisors should be cautious about employing new methods of online purchasing, or implementing requirements that online business be conducted through a national website, where existing franchise agreements may not have fully contemplated or delineated the rights of the parties with respect to online sales. Where online sales divert enough business away from a franchisee’s exclusive territory, or the franchisor has not specifically reserved its rights to compete with franchisees online, such changes could violate implied covenants of good faith and fair dealing, or potentially even state-specific franchise laws (see, e.g., Wis. Stat. §1365.03 (franchisor may not substantially change the competitive circumstances of a dealership without good cause); IN Code §23-2-2.7-1(2) (prohibitions against franchisor competing unfairly with franchisee, or within franchisee’s designated protected territory); NJ Stat. §56:10-7I (franchisor may not impose unreasonable standards of performance)).
Franchise systems must continue to be flexible, and franchisors and franchisees should work together in this new increasingly digital landscape. In this regard, individual franchisees and franchisee associations can provide valuable input and innovation for a franchisor, as system-wide adjustments may be necessary, which will likely include significant re-working of online sales platforms and associated arrangements between franchisors and franchisees concerning online rights and restrictions affecting online sales. Systems that do not adapt and work together may suffer the loss of many of their franchised units. Customers now expect online services and sales, and franchisees need to be part of a system’s online business in order to survive. It is often no longer realistic or prudent for a franchisor to reserve digital commerce entirely to itself. Further, the failure of a franchisor to fairly and adequately address their franchisees’ needs in this new marketplace, may subject themselves to claims by franchisees for refusing to reasonably accommodate them in these new circumstances, including for breach of the implied covenant, impossibility, and frustration of purpose, despite what the FDD or franchise agreement may say.
8.2 Are there any limitations on a franchisor being able to require a former franchisee to assign local domain names to the franchisor on the termination or expiry of the franchise agreement?
No. A franchisor may require (in its franchise agreement) that a franchisee utilise a specific domain name, and return usage of that domain to the franchisor after expiration of the franchise. It is advisable that a franchisor disclose domain name requirements within the FDD, and that the franchise agreement clearly set forth any post-termination requirements with respect to domain names. The ICANN regulates the usage of domain names, and franchisors may seek transfer of a domain name under ICANN’s UDRP proceedings to effectuate the transfer of a domain name. Where a franchisee’s domain utilises a franchisor’s protected trademark within the domain name, the UDRP is far more likely to require transfer back to the franchisor, even if a dispute arises (and the usage of a protected trademark in the domain name may give a franchisor additional Lanham Act claims). If the infringement involves a generic top-level domain (“gTLD”) and in clear-cut trademark infringement matters, ICANN’s newly adopted URS domain name suspension procedure can be used to suspend infringing domain usage (but suspension of the infringing domain is the only remedy in a URS matter).
Franchisors should incorporate domain-specific provisions in their FDDs and franchise agreements with care and take steps to ensure they maintain control over their domain names. Franchisors may consider having franchisees agree in writing to transfer their domain rights to a specific domain at the time of termination of the franchise, or alternatively, control the rights to a specific domain themselves, and grant the franchisee a licence to utilise the sub-domain during the franchise relationship. Notably, if a franchisor does not take steps to timely effectuate the transfer of a domain name, or object to a former franchisee’s continued use of a domain in violation of an agreement, it opens itself up to laches, acquiescence and waiver arguments (see, e.g., American Express Marketing and Development Corp v. Planet Amex et ano., NAF UDRP Proceeding, Claim No. FA1106001395159 (January 6, 2012) (the domain would properly stay with the franchisee, as the franchisor “acquiesced to the use of its mark in the Respondent’s domain name for at least a period of several years”)).
Franchisees should be aware that if a domain name is the property of a franchisor, any systems reliant upon that domain name, including any e-mail accounts, internal data and communications, associated online media content and contacts, and any other identifiers tied to that domain name may be abruptly discontinued at the end of a franchise agreement’s term. Indeed, intellectual property rights may also attach to such communications and content, and as owner of the domain, the franchisor may retain such rights in the content. A termination could therefore result in significant business disruption, including the loss of client contacts, and potentially years of e-mails and other domain-dependent communications and information. Where content matters, such content may also be retained by the franchisor (particularly where the franchisor has made clear in its franchise agreements and disclosures that any IP is theirs). However, in other instances, content rights may be retained by the franchsiee or its agents or employees, while the domain remains the property of the franchisor, creating complications and potential litigation. One example where such issues arise is in the realm of real estate franchises, where property listings, properly pictures, and individual agent’s online portfolios and prior deals might be on a franchisor’s domain or “portal”, but the content may be subject to differing rights, and even local laws regarding who controls the rights to property listings.
Also of importance is the longevity of a domain, and its value as a highly-listed domain in major search engines. In the realm of digital commerce, it is crucial where a search engine (such as Google) lists a particular domain. The value of a long-standing and high-listed domain, with carefully cultivated links and online presence, can be substantial. Counsel should examine relevant provisions in an FDD or franchise agreement carefully, so clients are fully aware of the implications of termination of the franchise upon domain-name usage, and potentially the ability of a business to continue functioning after de-identification. Indeed, large portions of a customer base may be easily transferred to a new owner of a franchised territory if the domain remains with the franchisor, despite a former franchisee’s efforts in fostering that customer good-will and usage, and boosting the “listing” of a domain. All these issues need to be examined at the outset of a franchise relationship, so that the parties understand the implications of domain names on their business.
Domain name ownership also has significant consequences in the event of litigation, as the abrupt cessation of communications may lead to additional claims. Transfer of a domain without consideration for the preservation of data (or electronically stored information that may be relevant evidence in a litigation), particularly with cloud-based storage and services, and the consequences of who has (or takes) possession of that data, or who even has access to that data, can be significant if litigation ensues. As a cautionary note, franchisors who terminate a franchisee, and take possession of a domain used by the terminated franchisee (along with any “Electronically Stored Information” (“ESI”) attendant thereto), but that do not take steps to preserve electronic evidence (such as ESI, including e-mails, that may reside on a domain that they control), may find themselves the target of motions for discovery preservation sanctions. Franchisors should be careful to preserve evidence if litigation is reasonably anticipated. Franchisees should be aware that if they are terminated, they may not have access to ESI that is critical to day-to-day functionality, which now may be in the exclusive possession custody or control of a franchisor. Therefore, given the ever-increasing importance of this issue with the expansion of e-commerce, it is imperative that at the outset of a franchise relationship, both franchisee and franchisor should be aware of what the relevant FA states with regard to ESI and domain names, and be guided accordingly.
9.1 Are there any mandatory local laws that might override the termination rights one might typically expect to see in a franchise agreement?
Yes. While federal law in the United States, e.g., the Amended Federal Trade Commission Franchise Rule, governs the requirements with respect to how franchisors must provide proper disclosure to prospective franchisees in the U.S., federal law does not govern any aspect of the franchisor-franchisee relationship after the parties enter into a franchise agreement. However, almost half of all states in the United States (and U.S. territories of Puerto Rico and the U.S. Virgin Islands) have so-called “relationship laws” which govern one or more substantive aspects of the franchisor-franchisee relationship. Common examples include: restrictions on termination (which is discussed further in the next paragraph), non-renewal and/or transfer; limitations on the franchisor’s ability to open a new company owned or franchised unit in the vicinity of the franchisee’s location (encroachment); limits on post-term restrictive covenants including non-competition and non-solicitation agreements; permitting “free association” among franchisees; requiring that a franchisor act in good faith or with reasonableness when dealing with its franchisees; and the inclusion of “non-waiver” provisions with respect to the state statute’s protections. Beginning in the 1970s, these relationship statutes were enacted by state legislatures in an attempt to correct some of the significant perceived abuses that franchisors were committing against prospective and current franchisees. State relationship laws vary considerably, both in terms of the breadth of the issues that are addressed, and with respect to the specific provisions and restrictions which are contained within them. Some relationship laws are made part of the state’s franchise registration or disclosure statute, while others are set forth in a statute which is separate from the state’s disclosure/registration laws. Some states, however, have relationship laws but have enacted no franchise disclosure/registration law.
State relationship laws typically address (e.g., restrict) the franchisor’s ability to terminate or fail to renew the franchise. Most of them require a franchisor to have “good cause” (or “reasonable cause”) before it is permitted to either terminate or not renew a franchisee’s franchise. (Where applicable, such laws will override and make unenforceable, inconsistent provisions contained in the franchise agreement. For example, a provision stating that the agreement will expire at the end of a particular term if the franchisee has no right to renew, may be unenforceable, and the franchisor may be required to renew the franchise agreement.) While some relationship laws define “good cause” (or “reasonable cause”), others do not, leaving this determination to the courts. However, good cause generally exists if the franchisee has breached a material obligation of the franchise agreement. Typically, under relationship laws, which vary significantly, the franchisor is required to provide the franchisee with written notice of termination or cancellation (with such notice often being 60 days, which is often significantly longer in duration than what is typically provided for in the franchise agreement), within which the franchisee may cure the alleged default and avoid termination. However, in instances where the default involves the franchisee’s failure to pay monies owed to the franchisor, the permitted notice/cure period under relationship laws is often considerably shorter. Additionally, for certain defaults which are perceived to be egregious and/or which pose a threat to the well-being of the public or which are damaging to the franchisor’s brand, including, for example, posing a threat to the public’s health and safety (often, for example, in a food-related franchise), and/or are otherwise “uncurable” (for example, unauthorised use of the franchisor’s registered trademarks, or voluntary abandonment of the franchise), or where certain exigent circumstances are present (for example, the franchisee’s insolvency or bankruptcy or the franchisee’s loss of its right to occupy its premises), the franchisor is usually statutorily permitted to terminate the franchisee’s franchise agreement, either immediately, or with a much shorter notice/cure period than what might otherwise be required. As applicable relationship laws supersede whatever inconsistent provisions are contained in the franchise agreement, franchisors, and their counsel, need to be aware of any applicable relationship law when evaluating how to handle a franchisee’s default and/or potential termination. Of course, as relationship laws are meant to provide franchisees with additional protections which may not be included in their franchise agreement, such relationship law provisions may increase, but may not decrease or “take away” any of franchisee’s rights that are contained in the franchise agreement.
Almost all franchise agreements provide that the franchisor may terminate the franchise if the franchisee becomes insolvent or files for bankruptcy. However, under the U.S. Bankruptcy Code, a contractual provision permitting the franchisor to terminate the franchise agreement in the event of the franchisee’s bankruptcy may not be enforceable (see 11 U.S.C §365(e)(1)(A)). If a franchisee files for bankruptcy before its franchise agreement and/or its lease has expired or has been properly terminated, such agreement(s) become(s) part of the debtor-franchisee’s (“debtor”) “bankruptcy estate”. However, the franchise agreement and/or lease may be terminated relatively quickly if the debtor (franchisee) files either a Chapter 7 “liquidation” or a Chapter 11 “reorganisation” but “rejects” the agreement(s) (e.g., consents to their cancellation). In the event that a debtor in a Chapter 11 reorganisation wishes to “assume” its franchise agreement or lease (i.e., keep it/them “in place”), it is unlikely that the franchisor will be able to quickly terminate these agreements provided that the debtor/franchisee was not in default of these agreements at the time the bankruptcy petition was filed. It is likely that the Bankruptcy court will approve the assumption of these agreements if the debtor/franchisee is able to otherwise perform their respective terms, the agreement(s) appear(s) to be in the best interests of the debtor’s bankruptcy estate and the assumption of the agreement(s) is supported by reasonable business judgment. However, if the debtor/franchisee was in default of its agreement(s) at the time that the bankruptcy petition was filed, it is more difficult for it to assume them. In this situation, the debtor will likely have to: (i) cure, or provide adequate assurance that the trustee will promptly cure such defaults; (ii) compensate, or provide adequate assurance that it will promptly compensate another party for any actual pecuniary loss that the party may suffer as a result of such default; and (iii) provide adequate assurance with respect to the future performance of such agreement(s).
9.2 Are there local rules that impose a minimum notice period that must be given to bring a business relationship that has existed for a number of years to an end, which will apply irrespective of the length of the notice period set out in the franchise agreement?
Yes. As was discussed above in question 9.1, almost half of all states in the United States (and U.S. territories of Puerto Rico and the U.S. Virgin Islands) have so-called “relationship laws” which govern one or more substantive aspects of the franchisor-franchisee relationship, such as the franchisor’s ability to terminate or fail to renew the franchise. In addition to typically requiring the franchisor to have “good cause” (or “reasonable cause”) before it is permitted to either terminate or not renew a franchisee’s franchise, most relationship laws require the franchisor to provide the franchisee with written notice (with such notice often being 60 days, which is often significantly longer in duration than what is typically provided for in the franchise agreement), within which the franchisee may cure the alleged default and avoid termination. The reason for such provisions is to protect franchisees from having their livelihood (and often a large financial investment) taken away from them on short notice. Where applicable, such relationship laws will apply irrespective of the express notice provisions (and/or governing law and jurisdiction provisions) contained in the franchise agreement, and any such inconsistent provisions will be deemed unenforceable. While U.S. courts generally cannot “revive” or reinstate a franchise after the franchisor has terminated the franchise agreement, a franchisee who successfully asserts a claim that the franchisor violated an applicable relationship law and improperly terminated the franchisee’s franchise agreement, will be awarded appropriate damages, prejudgment and post-judgment interest as well as court (or arbitration) costs, including reasonable attorneys’ fees which were incurred by the franchisee in connection with the litigation or arbitration. Franchisors, and their counsel, need to be aware of any applicable relationship law when evaluating how to handle a franchisee’s default and/or potential termination.
10.1 Is there a risk that a franchisor may be regarded as a joint employer with the franchisee in respect of the franchisee’s employees? If so, can anything be done to mitigate this risk?
The “joint employer” doctrine is a concept in employment law. It expands the definition of “employer” to include additional persons or entities that exert sufficient influence or control over the “terms and conditions” of employment (directly, or sometimes, even indirectly) in such a way that they will be considered a “joint” employer, and therefore jointly liable for a statutory violation. Notably, the joint employer doctrine only applies in connection with, and is therefore limited to, violations of employment law (like the Fair Labor Standards Act, 29 U.S.C. 201 et seq., or National Labor Relations Act, 29 U.S.C. §151 et seq.).
Applying the “joint-employer” standard in the franchise context is troublesome because the franchisor-franchisee relationship, by its very nature, requires a franchisee (and its employees) to follow certain designated procedures. The hallmark of liability under the “joint-employer” standard is the exercise of sufficient control over employees to be considered an employer. A franchisor in trying to keep the franchise system uniform, may discover that by regulating what the franchisee’s employees do too closely, it will be considered liable for employment law violations.
Recently, in Browning-Ferris Industries, the NLRB utilised the joint employer doctrine and concluded that a franchisor could be considered a joint employer – even it if only exercised “indirect” control over a franchisee’s employees, or even if it sufficiently reserved the “ability to exercise such control”. Subsequently, the U.S. Dept. of Labor (“DOL”), and the “EEOC” among others adopted similar rules. However, during the Trump Administration, on February 20, 2020, the NLRB issued a new joint employer rule under the National Labor Relations Act (“NLRA”), which removed the prior “indirect” control language, and in relevant part states “the entity must possess and exercise such substantial direct and immediate control over one or more essential terms or conditions of their employment…”. More recently, the Biden administration rescinded the 2020 rule, reverting to the Browning-Ferris “joint-employer” standard. See DOL Notice for 29 CFR Part 791, RIN 1235-AA37 (July 29, 2021). (“This action finalises the Department’s proposal to rescind the final rule titled “Joint Employer Status Under the Fair Labor Standards Act”, which was published on January 16,2020 and took effect on March 16, 2020.) This rescission removes the regulations established by that rule. With the Biden Administration adopting the Browning-Ferris “joint-employer” standard, and the recent passage of the Protecting the Right to Organize (“PRO”) Act (S. 567) passed in the Senate Health, Education, Labor and Pensions Committee that proposes to codify that standard, franchisors should assume “indirect” control over a franchisees’ terms and conditions of employment will subject it to liability in the employment context. Therefore, franchisors must be aware of the extent of the control they exert over their franchisee’s employees, as even “indirect” control may result in liability.
In addition, at the state level, many laws maintained the Browning-Ferris “joint-employer” standard throughout or had distinct state statutes with broader interpretations of “joint-employer”, and the cases brought by multiple Attorneys General’s offices challenging the Trump Administration standard have been working their way through the courts. Each state may have its own laws and standards, some of which may be more permissive with respect to claims against the franchisor. Outcomes will largely depend on the franchise system and the jurisdiction involved, and Franchisors should consult with knowledgeable franchise counsel, and exercise caution where some control over a franchisees’ employees may occur, particularly within the realms of wage and hour, labour relations, or other terms and conditions of their employment.
However, this is a problem with a solution, and franchisors should remember that the application of a “joint-employer” standard is limited to issues within the employment context and only has the potential to impact franchisors who directly – or indirectly (depending on the standard) – exert control over the terms and conditions of their franchisees’ employment relationships, or specifically became involved in opposition to unionisation or collective bargaining with respect to their franchisees’ employees. Franchisors that do not seek to impose any significant control over the employees of their franchisees, especially in the labour relations arena, or wage and hour concerns, and who distance themselves from controlling the details and methods of franchisees’ operations, involvement in working conditions, setting “required” work hours, mandating and controlling employee time-tracking software, becoming involved in employees’ wage and salary levels, training “line” employees, becoming involved in hiring or firing, setting employment practices and policies, and management or even the training of a franchisee’s managers with respect to employment issues, will significantly reduce their risk of being considered joint employers, or subject to NLRB scrutiny or NLRA liability.
Nonetheless, concerns about “joint-employer” liability has led industry groups to lobby for “carve-outs” that would exempt franchise systems from the new regulations, for example, the IFA is advocating for legislative action to avoid subjecting franchised systems to increased liability (and costs associated with it). See, e.g., [Hyperlink] . Another front in the franchise employer liability battle is in California, which has enacted legislation (Assembly Bill 5, Labor Law) that utilises a more permissive “ABC test”, which makes it easier for a court to consider someone an employer than more traditional “independent contractor” tests. Lobbyists are also actively working to get legislatures to recognise the unique ramifications of enacting legislation designed to protect employees that may have an unintended impact upon the franchising industry and exposing franchisors to significant liability and court costs in defending “joint-employer” allegations.
While the dire predictions of an avalanche of litigation ensuing from “joint-employer” rules have yet to materialise, this may be because the issue is confined to employment law or it may be because of the continually fluctuating legal standards on the topic. And it is exceedingly difficult to assemble a class that should afforded class-wide certification across multiple locations that unless a franchisor has flagrantly engaged in system-wide malfeasance directly impacting the terms and conditions of its franchisee’s employees, it is often difficult for plaintiffs to connect the alleged misconduct to system-wide malfeasance committed (or even known to) a franchisor. It is also likely that the utilisation of the “joint-employer” doctrine in litigation has been blunted by prudent steps that franchisors have proactively taken the steps advised above to properly distance themselves from active involvement in their franchisees’ employment issues, and providing franchise agreements, operations manuals and other franchise guidance that would have the effect of avoiding joint employer liability.
Nonetheless, to reiterate, franchisors should wisely balance the need to avoid exerting excessive control over the terms and conditions of employment of their franchisees’ employees, as the need to maintain system standards. As a rule, franchisors should not only continue to maintain system standards and employee practices that have to do with the end product or service (sometimes called “control of outcomes”), while distancing themselves from directly engaging in setting policies or procedures regarding how a franchisee’s employees are managed in order to produce the end product or service (sometimes called “control of means”). For example, a franchisor of a sandwich shop can dictate in its operations manual precisely how a franchisee’s employees must assemble and produce its sandwiches, but should not dictate training, hiring, filing, or setting hours and pay rates for the low-level employees producing those sandwiches and, this limitation must also include point of sale (“POS”) systems, and mandated electronic software by a franchisor. As Franchisors are increasingly utilising such system-wide POS systems, accounting software, and centralised franchise intranet portals for franchisees, they should carefully consider whether such systems can exert too much control over franchisees, or even violate state and local law, and it is often prudent to not only allow franchisees access, but also to provide the option to utilise their own employee management, time tracking, payroll, and employment-related software systems. See, e.g., People v. Domino’s Pizza, Inc., Index No. 450627/2016; 2020 N.Y. Misc. LEXIS 2349 (Sup. Ct. May 27, 2020) (Dominos avoided regulatory action for, inter alia, wage violations, by showing that franchisee usage of its PULSE software system, which if used for time tracking and payroll miscalculated wages due under NY law, was not mandated, other franchisees often used their own software, and it was ultimately a franchisee’s burden to ensure compliance with all wage and hour laws). To conclude, reflecting such delineations in writing, in franchise agreements and operations manuals, and keeping away from direct involvement in a franchisee’s affairs with its employees, will significantly assist franchisors in avoiding “joint-employer” pitfalls.
10.2 Is there a risk that a franchisor may be held to be vicariously liable for the acts or omissions of a franchisee’s employees in the performance of the franchisee’s franchised business? If so, can anything be done to mitigate this risk?
Franchisors have been found to be vicariously liable for the acts or omissions of their franchisees and their franchisees’ employees. However, vicarious liability, generally, will only attach where a franchisor exerts so much control over the franchisee’s performance of the process or activity that is being complained of, that courts will find that the franchisor should be held responsible. For example, if a franchisor specifically mandates that coffee be served at a scalding hot temperature, it may be vicariously liable if a franchisee’s customer burns themselves. Where a franchisor has mandated a particular practice or policy that is directly responsible for the harm, there is a significant risk that vicarious liability will attach. However, almost every jurisdiction has found that general operations manuals or enforcement of a franchisor’s general franchise system will not, by themselves, create vicarious liability. Where detailed specific controls over the day-to-day operations of franchisees are not necessary to maintain quality control of the franchised system, they should be avoided.
Traditional agency liability remains a basis for vicarious liability. The problem is that it is often used to justify negligence liability where agency liability is premised upon controls that are largely unavoidable in a franchise business context. See, e.g., Domino’s Pizza, LLC v. Wiederlhold, No. 5D19-2343 (Fla Dis. Ct. App. October 23 2020) (9 million jury verdict affirmed against franchisor based upon agency factors inherent in most franchise relationships); but see Dissent (noting issues in franchising and “day-to-day” operations not provided in jury instruction). There is no absolute shield, and a lawsuit can always be filed, however, the degree of control exerted over franchisees is within a franchisor’s decision-making power.
Franchisors can also minimise potential damages, even where vicarious liability is found, by including an appropriate indemnity provision in their franchise agreement, and by requiring that franchisees maintain adequate insurance coverage, and naming the franchisor as an insured party, especially where necessary to protect against known liability concerns. Furthermore, franchisors should take care that their system standards and operations manuals do not conflict with any federal and local laws, and make clear that the burden of assessing, and complying, with all local laws, rests upon the franchisee, since if the two conflict, then the law will override any system standards or requirements.
One problematic area where a franchisor is often named in lawsuits (or class actions) alongside a local franchisee, is for joint violations of the Americans with Disabilities Act (“ADA”). Specific to this area (in addition to the precautions discussed above), franchisors should avoid such over-involvement in the construction or “build-out” of a location, particularly where it concerns compliance with ADA access. Similarly, franchisors should avoid the training of managers or employees with respect to how accommodations are to be given to disabled persons. Operations Manuals and FAs should state that compliance with all disability laws is the franchisee’s burden. Guidance can be given in Operations Manuals, but it should always be tempered with language that makes it clear that ultimately it is the franchisee’s responsibility to ensure its own compliance with federal and local disability laws. It should be noted that where the guidance in a manual is in conflict with a law or rule, the law or rule should control.
Another area of concern for franchisors, is in the franchised Hotel Industry under the Trafficking Victims Protection Reauthorization Act (“TVPRA”). In recent litigation, victims of sex trafficking have tried to hold franchisors of hotel chains responsible for their purported indirect participation in, or benefit from, sex trafficking and related illegal conduct. Here, the risk can be mitigated by showing that the franchisor was unaware of the issue, or otherwise made clear that it would not tolerate such conduct within their franchises. A hotel franchisor will often defeat such claims at the summary disposition stage of litigation if the franchisor can demonstrate that it did not directly “participate” in such an illegal venture, was not directly involved in such conduct, and had no reasonable awareness of the illegal acts. See, e.g. A.B. v. Hilton Worldwide Holdings, Inc., 484 F.Supp.3d 921 (D.Or.Mar.31 2021); H.G. v. Inter-Continental Hotels Corp., 484 F.Supp.3d (ED Mi. 2020).
Franchisors can greatly reduce their risk of vicarious liability, regardless of legal theory, by taking care to only become involved in operational issues critical to the day-to-day management of the system and maintaining its standards, avoid employment issues, and, with the aid of knowledgeable counsel, properly memorialise the responsibilities of franchisees.
11.1 Are there any restrictions (for example exchange control restrictions) on the payment of royalties to an overseas franchisor?
Foreign franchisors that expand their reach into the United States usually set up a U.S.-based subsidiary or Master Franchisee, which is granted a licence to the trademark and the right to sell franchises in the U.S. So, most often, U.S. franchisees pay their royalties to the U.S.-based subsidiary or Master Franchisee.
While U.S. law does not impose any restrictions on a U.S. franchisee’s ability to pay royalties to an overseas franchisor, it is far more typical for foreign franchisors to set up a U.S.-based subsidiary or Master Franchisee within the U.S. As such, any franchisees (or sub-franchisees) would most often pay their royalties to the subsidiary or Master Franchisee. However, absent a U.S.-based subsidiary or Master Franchisee, the only restriction based on U.S. law would be if the franchisor’s home country is subject to economic sanctions.
Notably, while there are no specific franchise exchange control restrictions, a foreign based franchisor must still comply with all other laws. This includes standing U.S. foreign embargos and sanctions. In such circumstances, knowledgeable counsel should be sought, as the potential consequences for violating such embargos and sanctions can be significant.
11.2 Are there any mandatory withholding tax requirements applicable to the payment of royalties under a trade mark licence or in respect of the transfer of technology? Can any withholding tax be avoided by structuring payments due from the franchisee to the franchisor as a management services fee rather than a royalty for the use of a trade mark or technology?
The royalties paid by a U.S. franchisee to a foreign franchisor are considered U.S. sourced income. Therefore, a 30% tax is typically withheld from the royalty payments made to the franchisor (and paid directly to the IRS). If the U.S. has an income tax treaty with the franchisor’s home country, the royalties may be taxed at a reduced rate. There is no advantage to structuring the royalties as management service fees since such fees are also subject to the 30% withholding tax. However, the franchisor may try to negotiate a “gross-up” provision in the franchise agreement that requires a U.S. franchisee to make up the difference and pay at, or close to, the full royalty rate.
11.3 Are there any requirements for financial transactions, including the payment of franchise fees or royalties, to be conducted in local currency?
No, it is standard for a U.S. franchisee to operate its business using the local currency. Major banks can wire franchise fees or royalties on behalf of a U.S. franchisee to the foreign franchisor using the franchisor’s foreign currency. However, this is not usually necessary since a foreign franchisor typically conducts its franchise business in the U.S. through a U.S. subsidiary or a master franchisee.
12.1 Is there a risk that a franchisee might be treated as the franchisor’s commercial agent? If so, is there anything that can be done to help mitigate this risk?
Yes, a theory of agency can be used to hold a franchisor responsible for the acts of its franchisees. If a franchisee is found to be an actual or apparent agent of the franchisor, the franchisor may be held vicariously liable for certain harm caused by the franchisee’s actions (or failures to act).
Unfortunately, contractual language alone is not likely to be dispositive on the issue of agency. A franchisor therefore cannot summarily eliminate agency risk by inserting a clause in the franchise agreement providing that the franchisee is an “independent contractor” (and not an agent), although such language in a franchise agreement can be helpful factual evidence.
If a franchisor retains the right to exercise control over the day-to-day business operations of its franchisee, or in a particular area that becomes the subject of liability or dispute, then it may inadvertently create an “actual” agency relationship, regardless of what disclaimers within the franchise agreement may call for. In addition, courts may also find that a franchisor is liable for the acts or omissions of a franchisee who has “apparent authority” to act on behalf of the franchisor. Generally, this theory of liability will only apply if an innocent third party: (a) reasonably believes, based on the franchisor’s representation, that the subject franchisee is an agent of the franchisor; and (b) reasonably relies upon that belief to its detriment. Other theories of agency and vicarious liability, some statutory in nature, also may apply, depending upon the situation and jurisdiction. See also Section 10, Joint Employer Risk and Vicarious Liability, supra.
To minimise risk, the franchisor should only do what is necessary to maintain brand integrity and ensure uniformity and consistency throughout the franchised system. The more areas in which a franchisor exerts control, particularly where such control is outside of what is required to ensure system standards, the more likely it is that agency liability may arise. The franchisor should include in its franchise agreement: (a) a clause making it clear that the franchise relationship is one of an independent contractor, not an agent; (b) an indemnification provision, obliging the franchisee to indemnify the franchisor; and (c) a provision requiring that the franchisee list the franchisor as an additional named insured under the franchisee’s insurance policy. Where training of a franchsiee’s managers or employees by a franchisor is involved, the training should be specific and cover only franchised system standards (what is necessary to ensure brand and system integrity and uniformity). The Operations Manual or Franchise Agreement should be clear that the franchisee is ultimately responsible for all other general training and employee supervision. The franchisor should also require franchisees to hold themselves out to the public as independent owners in their marketing and advertising materials. While such steps are not foolproof, they will do a great deal to minimise the risk and impact of the franchisor incurring agency liability for the acts or omissions of its franchisees.
13.1 Is there any overriding requirement for a franchisor to deal with a franchisee in good faith and to act fairly in its dealings with franchisees according to some objective test of fairness and reasonableness?
The answer to this question is dependent upon the jurisdiction. Most (but not all) states, through common law, enforce an implied covenant of good faith and fair dealing into every contract within their jurisdictions, including franchise agreements. In other words, in states that enforce the implied covenant, a party may be free to exercise its discretion, but it should not do so unfairly, or in bad faith, to deny the other party the benefit of the contract. This covenant does not act as an objective test of fairness or reasonableness, but rather one that prevents one party from acting in a way that deprives the other of the benefit of the bargain. A few states do not enforce this implied covenant, and a few only do so in limited non-franchise contexts. As such, it is important to know which state’s law applies given the situation.
The implied covenant of good faith and fair dealing, generally, cannot conflict with an express term of a contract. As such, well-drafted franchise agreements address most issues with sufficient particularity to minimise the application of the implied covenant. However, when a party exercises discretion and a franchise agreement is silent on the point in questions, issues can arise. When they do, courts employ a fact-driven analysis, and even well-drawn contracts may not anticipate every contingency. Therefore, if a franchisor wants to retain absolute discretion with respect to important decisions that may be to a franchisee’s detriment, it is important to address that specific circumstance as an express term in the franchise agreement in order to avoid the inadvertent application of the implied covenant of good faith and fair dealing.
When exercising discretion under a particular term of a contract, a franchisor must also ensure that the term itself is enforceable. Even if an express contractual term grants a franchisor absolute discretion, a franchisee may still argue a breach of the implied covenant of good faith and fair dealing, particularly if the term is so one-sided that it would be prohibited by statute, deemed unconscionable, or otherwise void. For example, a franchisor may retain the right to open new franchise locations but, in exercising that discretion, if existing franchisees are negatively impacted, it could constitute a breach of the implied covenant. See, e.g., Michael D. Bryman, et al. v. El Pollo Coco, Inc., MC026045 (Cal. Super. Ct., L.A. Cty., August 1, 2018) (jury verdict of 8.8 million against franchisor for violating implied covenant of good faith and fair dealing when franchisor placed competing units near franchisee, despite terms in franchise agreement that gave the franchisor that right) (settled on appeal); Kazi v. KFC US LLC, 19-cv-3300-RBJ (D. Colo., May 17, 2021) (jury awarded damages of $792,239 for breach of implied covenant of good faith and fair dealing due to bad faith exercise of discretion in locating new outlet too close to existing franchise, and failing to perform legitimate impact study in good faith). As such, franchisors must remember that contract law and well drafted franchise agreements are not an absolute defence, and many jurisdictions will prevent the abuse of a party’s discretion by applying the implied covenant of good faith and fair dealing.
However, while a franchisor is required to act in “good faith” and “deal fairly”, that does not mean that they have to sacrifice their own economic interests in favour of the franchisee. Generally, parties are free to include provisions in their contracts as they wish, especially if the parties are sophisticated and represented by counsel. As such, a franchisor or franchisee may knowingly enter into an unfavourable economic agreement and, if the contract is clear, the implied covenant of good faith and fair dealing typically cannot be used to contradict the express terms of the contract. See, e.g., ReBath LLC v. Foothills Service Solutions Company, No. 21-cv-00870-PHX-DWL, 2021 WL 2352426 (D. Ariz. June 9, 2021) (the court acknowledged the “harsh” result, but refused to apply the implied covenant of good faith and fair dealing over the express terms of the FA and allowed termination after three defaults in a year, even if the defaults were cured); SAT Agivara, LLC v. 7-Eleven, Inc., No. 19-19994 (MAS) (ZNQ), 2021 US Dist. LEXIS 8617 (DNJ January 15, 2021) (the franchisee’s implied covenant argument rejected where parties had specifically amended FA to address change in ordinance prohibiting certain hours of operation).
In the context of franchises specifically, some states go beyond the common law good faith requirement. Those states have franchise “relationship” statutes, as discussed in question 9.1, supra, and question 14.1 below. These statutes are powerful tools for franchisees that have the ability to override or void provisions, or even the entirety of, a contract. These relationship statutes prohibit, inter alia, unfair or inequitable conduct of a franchisor. Some even require “good” reasons for terminating a franchise agreement regardless of the express terms of the contract. See, e.g., NJ Stat. §56:10-5 (making it a violation to “terminate, cancel, or fail to renew a franchise without good cause”), §56:10-7 (e) (prohibiting the imposition of “unreasonable” standards of performance on franchisees); MN Stat. §80C.14 (prohibiting unfair or inequitable conduct); CA Stat. BPC §20020 (requiring a “good faith” reason for termination). Many of these “relationship” statutes also contain “anti-waiver” provisions, which prohibit any attempt to waive or nullify their statutory protections through contractual language. See NJ Stat. §56:10-7(a) (anti-waiver provision). Conduct by a franchisor in violation of a state’s “relationship” statutes may rise to the level of an “unfair and deceptive” act under other statutes such as the FTC Franchise Rule or a state’s “Little FTC Acts”.
Separate and apart from the legal consequences of acting in bad faith or dealing unfairly, franchisors also face serious economic consequences of taking advantage of their franchisees. The U.S. franchise marketplace is highly competitive. As such, negative reviews of a franchise system by its franchisees can dissuade potential franchisees from buying into the system – especially because a franchisor must disclose (in the FDD) when their units close or fail. Franchisors must also disclose litigations against franchisees. As such, franchisors should tread carefully before placing their immediate economic interests ahead of those of franchised units.
Franchisors should be especially cautious in the current climate. Normally, requiring a franchisee to comply with certain provisions, or to strictly maintain system standards, would be well within the orbit of a franchisor’s rights. However, many franchisees in the past few years may have been required to conduct business in accordance with emergency rules and regulations (e.g., governmental action regarding COVID-19 requiring deviation from system standards, hours of operation, staffing requirements, etc.), or to navigate unprecedented economic pressure and supply chain issues (making it impossible to timely pay fees, utilise only approved products or suppliers, or strictly comply with contractual obligations). Therefore, the blind use of a discretionary right by a franchisor to default or terminate a non-compliant franchisee, may give rise to potent claims under the implied covenant of good faith and fair dealing, particularly where a jury or finder of fact may feel especially sympathetic towards an aggrieved franchisee. Franchisees facing COVID-19 and supply chain disruption-related issues may have much better arguments excusing non-compliance, and will likely appear very sympathetic to a finder of fact if they were treated unfairly during these disruptive times. Franchisors may find the best course of action is to try and work with a franchisee, rather than default or terminate a franchisee, and risk a claim of breach of the implied covenant of good faith and fair dealing. Indeed, in states such as New Jersey (with the New Jersey Franchise Practices Act mandating “good cause” for termination, and prohibiting holding franchisees to an “unreasonable standard of performance”) the franchisees are regardless of the express terms of the franchise agreement and should consider the potential legal and economic consequences.
13.2 Is there any limitation on a good faith obligation being unenforceable if it only applies from franchisee to franchisor, rather than being mutual?
In jurisdictions where the implied covenant of good faith and fair dealing exists, the obligation is mutual, automatically incorporated by law, and generally cannot overcome an express contractual term that establishes the parties’ respective rights and obligations on a particular issue. However, there is no rule that overrides an express term of a contract that instils a good faith obligation by only one party. Therefore, the implied covenant acts more as a “gap filler” where a contract is silent to a particular issue, or when one party’s exercise of discretion is questioned, and limits of that discretion are absent from the contract. The implied covenant will limit that discretion to be performed in good faith.
In jurisdictions that apply the implied covenant of good faith and fair dealing, express waivers of its application are prohibited. Additionally, the affirmative defence of “unclean hands” is often available in these jurisdictions. This means that a party that has acted in bad faith to the detriment of the other party will often be barred from arguing that the other party breached the obligation of good faith and fair dealing.
In jurisdictions where the implied covenant does not exist, it may be useful to require “good faith” with respect to a party’s obligation, particularly where the specifics of the performance are not specified in, or anticipated by, the terms of the contract, or where discretion is reserved by the performing party. However, this practice may not be beneficial to a franchisor that wishes to expand a uniformed franchise system across multiple jurisdictions. Instead, well-drafted franchise agreements should properly delineate a party’s actual obligations, rather than leave them up to interpretation. If a franchisor wants to avoid a “good faith” obligation, or wants it to only work “one way” in a specific circumstance, it should expressly set forth the parties’ rights and obligations in the contract.
14.1 Are there any specific laws regulating the relationship between franchisor and franchisee once the franchise agreement has been entered into?
The FTC Franchise Rule’s disclosure laws do not regulate the conduct of the franchisor after a franchise relationship has been established. However, 21 states, D.C., Puerto Rico and the U.S. Virgin Islands have enacted “relationship laws” that govern the substantive aspects of the franchise relationship after the offer and sale of the franchise is completed. Relationship laws generally address: (i) regulating the franchisors’ ability to terminate or refuse renewal of the franchise agreement; (ii) the imposition of restrictions on transfer; (iii) granting franchisees the right to form an association with other system franchisees; (iv) prohibiting franchisors from discriminating against similarly situated franchisees without cause, including selective contract enforcement; (v) restrictions or prohibitions on the franchisor from directly or indirectly (for example, through another franchisee) encroaching upon a franchisee’s territory; and (vi) obligations of the franchisor to repurchase inventory upon termination or non-renewal of the franchise. While the specifics of each states’ franchise relationship laws vary, their common goal is to protect franchisees for the duration of the business relationship from the unequal bargaining power that typically favours franchisors. (Alaska, Arkansas, California, Connecticut, Delaware, Hawaii, Illinois, Indiana, Iowa, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, North Dakota, Rhode Island, Virginia, Washington and Wisconsin currently have Relationship Laws.)
While there is no generally applicable federal franchise relationship law, there are both federal and state laws that govern franchise business relationships in specific industries, including: gas station operations; automobile dealerships; hardware distributors; real estate brokerage firms; farm equipment machinery dealerships; recreational vehicle dealerships; and liquor, beer and/or wine distributorship. For example, under the Federal Petroleum Marketing Practices Act, gas station franchisors or refiners cannot terminate the relationship with franchisees without first having “good cause”. Good cause in relationship laws generally means that the franchisee has not “substantially complied” with the material terms of the agreement or has engaged in acts that have damaged the franchisor. Such acts, include, but are not limited to the franchisee: (i) voluntarily abandoning the franchised business; (ii) becoming insolvent; or (iii) selling competing goods. If sufficient grounds for termination exist, some states may additionally require the franchisor to provide the franchisee with notice of termination (60 days advance notice is a common requirement) and give the franchisee an opportunity to cure such violations (cure periods typically range from 30 to 90 days). If a franchisor elects not to renew a franchise agreement, the franchisor (under certain circumstances) may be required to either: (i) offer to buy the franchise, if the franchisee owns the gas station; or (ii) give the franchisee the opportunity to purchase the premises from the franchisor, if the franchisor owns the gas station.
There are also 28 states that have enacted unfair trade practice acts (typically referred to as “Little FTC Acts”) that grant “consumers” a private right of action under state law if a franchisor engages in unfair trade practices in violation of corresponding federal law (for example, a little FTC act would provide a private right of action where there is a violation of the Federal FTC Act of FTC Franchise Rule). Alabama, Alaska, Arizona, Connecticut, Florida, Georgia, Hawaii, Illinois, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Montana, New Hampshire, New Mexico, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah, Vermont, Washington and West Virginia each have Little FTC Acts.
Furthermore, U.S. courts have generally upheld applying the implied covenant of good faith and fair dealing (typically used to interpret commercial contracts) to franchise agreements. The Implied Covenant of Good Faith and Fair Dealing requires each of the contracting parties to perform their contractual obligations in a way that is not inconsistent with the other party’s reasonable business expectations or that would prevent the other party from enjoying the “benefit of the bargain”.
Since relationship laws vary, it is essential to determine which state’s relationship laws apply. Most states, though not all, address jurisdiction in their relationship laws. Among the states that address the jurisdictional application, some apply jurisdiction more broadly than others. Some states, such as New Jersey, require the franchised unit to be located in its state for its relationship laws to apply. Other states apply a broader scope, allowing its relationship laws to apply if the franchisee is a resident of or is domiciled in the state, while others apply an even broader scope.
15.1 What disclosure obligations apply in relation to a renewal of an existing franchise at the end of the franchise agreement term?
The FTC Franchise Rule requires franchisors to furnish all prospective franchisees with an FDD prior to consummating the sale of a franchise (see question 1.2 regarding disclosure obligations). However, the franchisor is not required to provide disclosure to a franchisee who is either: (i) exercising its rights under the existing franchise relationship to establish new outlets; or (ii) renewing or extending its franchise relationship by extending the term of its present franchise agreement or entering into a new franchise agreement, unless the terms and conditions of the new (or extended) franchise agreement are materially different from those under the previous franchise agreement, or if the circumstances surrounding the franchisor and its business have materially changed (e.g., there are changes: in ownership, to financial disclosures, the number of outlets opened and closed, the royalty and marketing fund contribution rates, etc.), in which case disclosure of the FDD is required.
Franchisors must also pay close attention to state disclosure laws that contain provisions addressing disclosure requirements in connection with renewals (i.e., California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, and Virginia). For example, most state laws require re-disclosure where there is an interruption in the business by the franchisee, whereas others state laws require disclosure if the terms of the franchise relationship under the renewal agreement are materially different from those provided for in the previous agreement.
15.2 Is there any overriding right for a franchisee to be automatically entitled to a renewal or extension of the franchise agreement at the end of the initial term irrespective of the wishes of the franchisor not to renew or extend?
States generally acknowledge parties’ freedom to negotiate the terms for renewal or extension of the franchise agreement. However, some states have franchise “relationship laws” that restrict the franchisor’s right or ability to refuse to renew a franchise agreement. The restrictions imposed by these relationship laws vary from state to state. Several states require that the franchisor: (i) have “good cause” or “just cause” to refuse renewal of a franchise agreement (e.g., California, Connecticut, Hawaii, Illinois, Indiana, Michigan, Minnesota, Nebraska, New Jersey, Rhode Island and Washington); (ii) provide franchisees with at least 90 days’ (e.g., Delaware, Mississippi and Missouri), and in some cases, six months’ (e.g., in Connecticut where the non-renewal is based on a determination to not continue to lease property to the franchisee), prior notice of the franchisor’s intent to not renew the franchise agreement; (iii) repurchase the franchisee’s assets (e.g., Arkansas, California, Connecticut, Hawaii, Maryland, Rhode Island, Washington and Wisconsin); and/or (iv) waive any post-term non-competition restrictions (e.g., California). While the goal of these relationship laws is to protect franchisees from the arbitrary termination or non-renewal of the franchise relationship, such relationship laws often have the side effect of creating perpetual franchises. However, in each case, a franchisee may choose not to renew its franchise agreement. Savvy franchisors and franchisees may take the varying state laws and the protections afforded by them into account when deciding where they wish to sell and/or buy franchises.
15.3 Is a franchisee that is refused a renewal or extension of its franchise agreement entitled to any compensation or damages as a result of the non-renewal or refusal to extend?
Franchisors typically offer franchisees the right to renew their franchise agreements provided that any conditions for renewal have been satisfied. However, if: (i) a franchise agreement is for a defined term without any right of renewal and the franchisor is not in breach of the franchise agreement; and (ii) the franchisee and franchisor do not agree to renew the franchise agreement; then, typically, the franchisee will have no claim for damages relating to the non-renewal. However, there are circumstances under the law where a franchisee may seek damages if a franchisor fails or refuses to renew the franchise agreement, including, for example, where a franchisor: (i) breaches a contract provision pursuant to which the franchisee has a right to renew its agreement; or (ii) violates a state relationship law that restricts the franchisor’s right to fail or refuse to renew a franchise agreement.
Several state relationship laws provide for recovery of the fair market value of the business if the franchisor unlawfully fails or refuses to renew the franchise agreement. For example, in New Jersey, if a franchisor fails to renew or terminates a franchisee in violation of the New Jersey Franchise Practices Act, it must reimburse the franchisee for its loss and pay damages equal to “the actual or reasonable value of the franchisee’s business when the franchisor cuts off the franchise”. Westfield Ctr. Serv. v. Cities Serv. Oil Co., 86 NJ 453, 465-466 (1981). In addition, some state relationship laws require franchisors to repurchase the franchisee’s business assets (in whole or in part) when a franchise agreement is not renewed. For example, in Iowa, a franchisor must repurchase the franchisee’s assets at fair market value as a going concern. In Washington, franchisors are required to compensate franchisees for goodwill, unless the franchisor agrees (in writing) that it will not enforce the non-competition provision in the franchise agreement. In Arkansas, Hawaii and Washington, the franchisor is obligated to repurchase the franchisee’s inventory, supplies, equipment, and furnishings. In California, the franchisor is only required to repurchase the franchisor’s inventory, whereas Hawaii requires that the franchisor repurchase inventory from the franchisee upon termination of the franchise agreement, whether or not termination was for good cause. It is important for franchisees to know what their renewal rights, if any, are, so that they can make prudent business decisions concerning when and how much to invest in their franchised businesses.
16.1 Is a franchisor entitled to impose restrictions on a franchisee’s freedom to sell, transfer, assign or otherwise dispose of the franchised business?
Yes. Franchisors typically provide in their franchise agreement that franchisees are not permitted to transfer or assign any interest in the franchise agreement (or any interest in the ownership, direct or indirect, of the franchisee entity) without the prior written consent of the franchisor. Franchisors in the U.S. are permitted to impose reasonable restrictions or “conditions” in connection with a proposed transfer of the franchised business. Examples of such conditions typically include: (a) requirements imposed on the existing franchisee (e.g., being current on all of its financial obligations to the franchisor, not being in default of the franchise agreement, the payment of a transfer fee, and the delivery of a general release in favour of the franchisor); and (b) requirements imposed on the transferee franchisee (e.g., entering into the franchisor’s “then current” franchise agreement, meeting certain financial criteria qualifying as a franchisee under the franchisor’s normal standards, and completing the franchisor’s required initial training programme).
Many franchisors also provide in their franchise agreement that they will have a “right of first refusal” with respect to proposed transfers of the franchised business to third parties. This right is frequently waived by franchisors as they are not usually interested in “taking over” additional locations which are in their system by purchasing them at fair market value. However, as many franchisors will not waive their right of first refusal “up front” (e.g., before a deal between the franchisee and prospective transferee is negotiated), the fact that the franchisor has the “right of first refusal”, generally has a “chilling effect” on the franchisee’s ability to sell, because the proposed purchaser must spend considerable time, effort and money negotiating the deal with the franchisee and entering into an agreement, only to find that “its” deal has been usurped by the franchisor. If prospective purchasers are represented by knowledgeable franchise counsel, counsel may inquire as to whether the franchisor is willing to waive its right of first refusal “up-front” and if it is not, counsel may advise his or her client to move on to another deal.
Several state relationship laws impact on a franchisor’s ability to impose restrictions on the franchisee’s ability to transfer its business. For example, some relationship laws provide that it is an unfair or deceptive act for a franchisor to refuse to permit a transfer without having “good cause”. Others permit a franchisor to reject a proposed transfer if the transferee fails to satisfy the franchisor’s then-current requirements, as long as the franchisor’s refusal is not arbitrary. Other relationship laws require the franchisor to provide a timely response to a franchisee’s request to transfer, and if the franchisor denies the request, it must provide the franchisee with a “material” reason for the rejection, such as the proposed transferee’s failure to meet the franchisor’s “standard” requirements relating to financial ability, business experience or character. Some relationship laws provide that in the event of the death or disability of the franchisee (or franchisee’s principal, if franchisee is an entity), the franchisee’s spouse or heirs will have a reasonable amount of time and opportunity to elect to operate or own the franchised business, so long as the spouse or heir satisfies the franchisor’s various then-current standards and requirements for operating the franchise.
16.2 If a franchisee is in breach and the franchise agreement is terminated by the franchisor, will a “step-in” right in the franchise agreement (whereby the franchisor may take over the ownership and management of the franchised business) be recognised by local law, and are there any registration requirements or other formalities that must be complied with to ensure that such a right will be enforceable?
Many franchise agreements in the U.S. contain provisions which provide that the franchisor, under certain circumstances, has a right to “step-in” and take over the operations and management of the franchised business. This may be for a limited period of time, for example, where a principal owner passes away and the franchised business has no manager in place to properly manage the business, or where the business has been experiencing operational difficulties. If this occurs, and where the franchise agreement provides that the franchisor may take over the operations of the franchised business (for the benefit of the franchisee), the franchisor may do so and will typically have the right to retain an agreed upon “management fee” for its services. The franchisor may also have the right to “step-in” and take over the franchised business following its termination of the franchise agreement. If this occurs, it is common for the franchise agreement to grant the franchisor an option, but not necessarily an obligation, to purchase the assets of the franchised business pursuant to a defined formula, which formula may often provide for the purchase of assets for less than market value as a “going concern”. However, if a state relationship law is applicable, it may call for a more favourable result for the franchisee and would likely override any less favourable provision contained in the franchise agreement. Reasons for asserting such “step-in” rights, whether “short term” or as a result of termination, include where a franchisee is failing financially, has abandoned the franchised business, or where the franchisee (or its principal(s)) has engaged in egregious and/or criminal conduct which is likely to negatively affect the brand’s reputation or good will. This may include the franchisee knowingly defrauding the franchisor, using the brand’s trademarks for unauthorised purposes or being found guilty of a felony or crime of moral turpitude. Such “step-in” provisions, which must be disclosed in the franchisor’s offering prospectus (FDD) given to prospective franchisees, are typically provided for in the franchise agreement and are generally enforceable. Where the franchisee is going to be leasing the franchised business premises (as is frequently the case), the franchisor should require that the franchisee enter into a “Collateral Assignment of Lease” agreement (typically, a three-party agreement between franchisor, franchisee and the landlord) which will provide for the various circumstances in which the franchisor will be permitted to assert its “step-in” rights. If such an agreement is entered into (or the landlord otherwise consents in writing, such as in a lease rider or lease amendment), the franchisor will likely be able to enforce its “step-in” rights, including the right to take an assignment of the franchisee’s lease.
While there are no registration requirements or formalities that must be complied with in connection with a franchisor’s enforcing its “step-in” rights (other than complying with “notice” requirements contained in the franchise agreement), the franchisee and/or the landlord (if no “step-in” rights have been provided for in a lease rider or amendment) may object to or seek to frustrate the franchisor’s attempts to assert “step-in” rights. In such case, the franchisor would usually not be permitted to use any form of “self-help” (under governing state law) and it is likely that it would be forced to commence an action or proceeding in court to assert its rights. Where the franchisee files for federal bankruptcy protection before a franchisor tries to enforce its “step-in” rights, the bankruptcy filing typically results in the triggering of an “automatic stay” under bankruptcy law which will initially protect the debtor/franchisee. Under those circumstances, the franchisor would have to petition the bankruptcy court to seek to enforce its “step-in” rights. However, this process could take several weeks or even months.
16.3 If the franchise agreement contains a power of attorney in favour of the franchisor under which it may complete all necessary formalities required to complete a franchise migration under pre-emption or “step-in” rights, will such a power of attorney be recognised by the courts in the jurisdiction and be treated as valid? Are there any registration or other formalities that must be complied with to ensure that such a power of attorney will be valid and effective?
With some exceptions (see below), franchisors do not generally use basic powers of attorney in attempting to enforce “step-in” rights which are provided for in the franchise agreement. Rather, as explained above at question 16.2, franchisors often use a “collateral lease assignment” in order to protect and enforce their “step-in” rights. However, franchise agreements commonly include provisions which appoint the franchisor and perhaps “any officer or agent of franchisor” as attorney-in-fact (e.g., holder of a power of attorney), in connection with providing for the orderly (and peaceful) transfer of certain assets of the franchised business which franchisor believes that it has a right to retain after the franchisee no longer has the right to operate the franchised business. These include such assets as telephone numbers, fax numbers, and internet domain names, etc., used by the franchised business. These issues typically arise in the context of an involuntary transfer or termination of the franchised business (as opposed to an approved transfer of the franchised business, that is requested by the franchisee, where the approved transferee will continue operating the business). Such provisions authorising the franchisor to take such action as “attorney-in-fact” are generally enforced.
17.1 Are there any specific requirements for applying an electronic signature to a franchise agreement (rather than physically signing a “wet ink” version of the agreement), and are electronic signatures recognised as a valid way of creating a binding and enforceable agreement?
In 2000, the United States Congress passed the Electronic Signatures in Global and National Commerce Act (“ESIGN”), confirming that electronic signatures have the same legal status as “wet ink” signatures. In order to be a valid electronic signature, it is essential that, among other things: (i) each party intends to sign the document; (ii) the signature must be associated with the applicable document; and (iii) in certain consumer situations, the contracting parties must consent to do business electronically. ESIGN pre-empts state laws regarding electronic signatures whenever inconsistent to do so. ESIGN does not mandate the use of electronic signatures, but it affords parties the option.
If the franchise agreement is a deed (not frequently the case), further formalities such as needing to be executed in front of a witness are required. The witness must be present to witness the signing of the document, and there is no current authority on whether the requirement that the witness be present to see the signing can be satisfied by virtual means under normal circumstances. During the COVID-19 era, 46 states have passed laws or (temporarily) rules that allow the remote witnessing of deeds and counterpart signatures. As COVID-19 measures have subsided or expired, 38 states have enacted some form of permanent remote online notarisation (“RON”) law. In May 2021, the “Securing and Enabling Commerce Using Remote and Electronic Notarization Act of 2021 (the “SECURE Notarization Act”) was re-introduced in the U.S. Senate, with the aim of establishing standards for electronic and remote notarisations that affect interstate commerce. In June 2021, the same bill was introduced in the U.S. House. The bipartisan RON bill, if passed, would authorise every notary in the country to perform remote online notarisations for interstate commerce purposes. The bill remains stalled in committee.
While best practices would usually still suggest that the franchise agreement be signed in “wet ink”, so that the witnessing of the signature is less able to be challenged, it is vital to research each state’s current laws, to explore what options are available.
17.2 If a signed/executed franchise agreement is stored electronically (either having been signed using e-signatures or a “wet ink” version having been scanned and saved as an electronic file), can the paper version of the agreement be destroyed?
A franchise agreement that is currently in effect must be retained in either electronic or hard copy for the duration of the contractual term. Once expired, best practices and Internal Revenue Service guidelines recommend a retention period of 10 years. Franchisors also must retain a copy of each materially different version of their FDD and also a copy of the signed receipt, both for at least three years after the close of the fiscal year when the documents were last used. Many states impose similar, if not stricter, requirements.
Franchisors should also maintain e-signed or “wet ink” copies of executed franchise agreements even if they have been scanned and saved. While many states allow for such document retention to be digital rather than “wet ink”, and the FTC Franchise Rule does not specify a preference, it is prudent to keep “wet ink” versions of these important documents. From an evidentiary perspective, a “wet ink” version provides the best evidence in the event a dispute arises.
18.1 What is the biggest challenge franchising is facing in your jurisdiction and how are franchisors responding to that challenge?
Franchising continues to adapt to economic challenges caused, in part, by the COVID-19 pandemic and the fast and consequential shifts in consumer engagement patterns. In the U.S., over a short period of time, a significant portion of the workforce shifted to hybrid or completely remote work environments. As a result, many consumers have relocated, virtually eliminating their demand in some locations, or now seek to shop and access franchised business services where they reside, as opposed to where they once worked. Additionally, many former consumers embraced remote-access shopping and services once provided by local franchisees. Simultaneously, many other customers are yearning for more personal interaction, and have returned to in-person shopping and services, desiring interpersonal interactions with the sellers and service providers they know and trust. As a result of these shifts, both franchisees and franchisors must adapt and adopt creative, individualised approaches in response to how their customer base wishes to access franchised services and what impacts remain unaddressed within a system; particularly for commercial real-estate and brick-and-mortar-based franchises. Upheaval presents challenges and opportunities for franchises; many possibilities exist where markets are shifting or recovering. How franchise systems adapt to their customers is essential to success.
The regulation of restrictive covenants also represents a significant challenge. As discussed supra in question 3.6, in-term and post-term non-compete covenants “no-poach” agreements are the targets of increased legislation and regulation at both the federal and state levels, with legislators and regulators seeking to inhibit restraints upon employment and poaching. In addition, at the federal level, the Biden Administration issued an Executive Order “Promoting Competition in the American Economy”, which, inter alia, targeted employment restrictive covenants, including anti-poaching clauses with the DOJ aggressively enforcing labour and employment-related rules. And recently, the Protecting the Right to Organize (PRO) Act (S. 567) passed in the Senate Health, Education, Labor and Pensions Committee that codifies the Browning-Ferris “joint-employer” standard, under which an employer can be required to negotiate with a union over the wages and working conditions of workers it does not directly control, a standard that has already disrupted franchisor-franchisee, contracting, and other business relationships. At the state level, state statutes and regulators vary in their approaches to this issue. More aggressive state regulators have been prosecuting cases under state law seeking to, effectively, judicially prohibit such clauses on their face and several states’ AG’s Offices have aggressively pursued state “no-poach” regulations under state anti-trust laws notably CA under its Cartwright Act, and WA under its Consumer Protection Act.
It also appears that more regulatory challenges remain on the horizon, as the FTC appears ready to proceed with further regulation of the franchisor-franchisee relationship. In June 2023, the FTC closed a comment period in which it requested that the public comment and provide information on franchise agreements and franchisor business processes, with an apparent focus on the balance of power between franchisors and franchisees. This request alarmed franchisor associations and individual franchisors (and some franchisees) because of the possibility that increased FTC regulation would alter the environment surrounding franchise agreements and a wide array of issues that affect franchises, their workers, and the franchise business model overall. Counsel should remain vigilant and keep abreast of these developments.
Finally, it is impossible to ignore the significant upheaval that artificial intelligence (“AI”) may present across all industries, including franchising. Considerable investment and development in AI has already resulted in possibly game-changing AI tools appearing in the U.S. market that are being utilised by more financially robust franchise systems. Both franchisors and franchisees must recognise that AI is neither an omnibus threat, nor an all-encompassing solution. AI is a tool like any other, and, if properly used, can present tangible opportunities to improve franchised systems, including streamlining customer services, identifying potential customers and their needs, improving advertising, and automating previously laborious tasks. We anticipate that franchisors and franchisees who creatively imagine how AI can help their specific system models, and collaboratively explore how AI may be used to help their systems, to become early adopters, obtaining a significant competitive advantage. However, early adopters must remain cognisant that AI is still in its infancy, is prone to potentially significant errors (including those that could cause public-relations issues), is only appropriate for certain tasks and requires human supervision, proper programming, and training. AI will be a game-changer if used appropriately.
Acknowledgments:
The authors would like to thank Jeffrey Mailman, Elizabeth Zakheim, Dennison Marzocco and Brian Looser for their invaluable contributions to the writing of this chapter.
Dennison Marzocco and Jeffrey Mailman are Transactional Associates at the Firm, engaged in a diverse range of business transactions and franchise matters (including the structuring of franchise programmes, the drafting and negotiation of contracts, intellectual property, business formation and commercial leasing transactions. Dennison and Jeffrey are engaged in the formation and guidance of franchisee associations as well as the drafting of franchise documents and the registration of franchisors in various states. Dennison’s email address is dm@rosenlawpllc.com and Jeffrey’s email address is jm@rosenlawpllc.com.
Elizabeth Zakheim and Brian Looser are Associates at the Firm and members of our litigation team. They are engaged in litigation, in both state and federal courts, as well as in alternate dispute resolution, including both mediations and arbitrations. While both Brian and Elizabeth are primarily engaged in our franchise practice, each of them is familiar with general commercial matters and their areas of practice with the Firm includes these matters, as well. Brian’s email address is bl@rosenlawpllc.com and Elizabeth’s email address is ez@rosenlawpllc.com.
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