Unlike some states’ franchise laws, the Missouri Franchise Act gives limited protection to franchisees. However, it does provide that if a franchisor fails to give 90 days’ notice of cancellation or termination, the franchisee may be awarded “damages sustained, to include loss of goodwill, costs of suit, and any equitable relief that the court deems proper.” A recent case provided much-needed clarification on how damages are measured if a franchisor fails to give a proper notice of termination.

In Sun Aviation v. L-3 Communications Avionics, No. SC 96280, 2017 WL 4930870 (Mo. Sup. Ct. Oct. 31, 2017), Sun Aviation, a distributor of L-3 Communications’ aircraft products, sued L-3 for, among other things, lost profits because of L-3’s failure to provide 90 days’ notice as required under the Missouri Franchise Act. In a non-jury case, the circuit court judge awarded Sun more than $7,600,000 in damages for 18 years of lost profits. After the appellate court affirmed, the Missouri Supreme Court reversed the judgment and held that the damages were limited to those sustained as a result of the failure to provide 90 days’ notice. The court sent the case back to the circuit court for a new trial on damages.

The Supreme Court noted that awarding profits in excess of those caused by the failure to provide the 90-day notice would give unintended breadth to the remedy. It reasoned that the limitation was justified because if a franchisor lawfully terminated a franchise by giving the proper notice, the franchise would not be entitled to any more than those sustained due to the franchisee’s reliance on the expectation that the relationship would continue for at least 90 more days, especially because the Missouri Franchise Act has no “good cause” requirement for termination.

The takeaways:

This case provides comfort and guidance to franchisors, particularly those who may fail to provide notice or who provide less than 90 days’ notice of termination of a franchise. However, it also highlights the importance of any franchisor, manufacturer, supplier or distributor carefully reviewing each state’s relationship laws before terminating or not renewing a franchise.

To avoid problems, franchisors should, of course, still provide 90 days’ notice as required by the statute and should recognize that the Missouri Franchise Act applies to many types of distributorships and dealerships, and not only traditional franchises. Furthermore, if the franchise agreement provides greater protection to the franchisee than the Missouri law, such as good cause prior to termination (which is not required under Missouri law), a franchisor must still comply with the terms of its contract.

Although not evident from the Supreme Court’s opinion, the ruling of the circuit judge is also instructive. According to the judge’s decision, prior to filing suit, Sun asked L-3 to buy back $250,000 of its unsold inventory, but L-3 refused to do so. We, of course, do not know all of the details of those negotiations, but one can only wonder if the lawsuit could have been avoided if L-3 had agreed to buy back the inventory in exchange for a full release. Even though L-3 may not have been legally required to buy back the inventory, in retrospect, it may have made a mistake by failing to do so.

SBA-backed loans have long been an important source of funding for many franchisees, but in the past several years, the system has been in flux. Changes will again be implemented on Jan. 1, 2018, and franchisors should ensure they are ready.

By way of background, franchisees seeking SBA-backed lending are at a disadvantage to other small businesses because of how the SBA views the “affiliation” between franchisors and franchisees. Certain provisions that are common in franchise agreements are viewed as overly restrictive on the franchisee’s right to independently reap a profit from its business and as creating an affiliation between franchisor and franchisee. The SBA then views the franchisor and franchisee as one economic entity, often disqualifying the franchisee from SBA-backed lending. The affiliation issue is typically overcome by amending the franchise agreement on the points that create “affiliation.”

For many years, to avoid the affiliation issue and to facilitate SBA-backed lending to its franchisees, franchisors went through an optional SBA registration process facilitated by a third-party vendor, FranData. That process included reviewing the franchise agreements, negotiating an addendum to waive any franchisor rights that would create affiliation, and registering the form of franchise agreement and addendum with the SBA. While not cheap, the process worked well with relatively quick turn-around times — until the past few years. More recently, the application process began to slow, with processing times frequently exceeding six months. The familiar SBA review process came to an abrupt halt when, effective Jan. 1, 2017, the SBA introduced a required, standard form of SBA addendum that the SBA required all franchisors to use for franchisees seeking SBA loans. The standard addendum was almost immediately criticized for being vague and for not fitting certain franchise systems. The SBA took the critique to heart, and already in mid-February this year permitted franchisors to revert to using previously negotiated SBA addenda, if they would certify that their current form of franchise agreement did not affect “affiliation” between franchisor and franchisee. This was a welcome change, but still left some uncertainty, for example, about how long the alternative would remain an option.

On Oct. 13, 2017, the SBA announced the most recent change to its approval process. It appears to be a mix of the old, familiar registration system, with the new standard SBA addendum. Some of the changes introduced in 2017 will remain in place: franchisors will still be able to choose between using the standard SBA addendum to their franchise agreements and their previously negotiated SBA addenda. However, there are also significant changes. The SBA is reintroducing a franchisor registry, though now it will be managed by the SBA itself. For franchisors, being on that registry will be a prerequisite for their franchisees being able to obtain SBA loans. The criteria for being on the registry are the same as under the old FranData registry: The franchisor must meet the eligibility criteria, and the agreements the franchisee will sign with the franchisor must not create “affiliation” between them. However, while being on the old registry signaled that the SBA had actually reviewed the franchisor’s agreements to confirm no franchisor-franchisee affiliation, that is no longer necessarily the case. For already registered franchisors, the SBA will no longer review their franchise agreement. Instead, franchisors that believe their agreements do not require an SBA addendum or who wish to use a previously negotiated addendum must annually certify that no changes to their franchise agreement have triggered the need for an addendum or triggered a need to revise the previously negotiated addendum.

At this time, franchisors whose franchisees are interested in SBA-backed lending need to take some steps to ensure that this resource will be available to their franchisees, come the new year. The first step is to ensure that the franchisor is listed on the SBA’s registry and that the registry correctly identifies the form of SBA addendum (if any) it will be using. Assuming no addendum is required or the franchisor wishes to use a negotiated addendum, the first annual certification will be due no later than April 30, 2018. A franchisor who wishes to use a negotiated addendum but that has changed or will be changing its franchise agreement will have to resubmit its franchise agreement to the SBA for review.

At first glance, the new approval process appears to strike a good balance for franchisors, but as with so many things, the proof is in the pudding. It is uncertain how long the SBA review process will take for franchisors getting their first negotiated addendum or for franchisors who may need a revised negotiated addendum. Especially for new franchisors who are new to SBA financing, it is possible that the requirement to be on the SBA addendum will cause hardship, unless the SBA will prove to be very swift in updating the new registry.

The enforceability of class action waivers in arbitration provisions has been debated for years in courts across the country, including in several cases before the United States Supreme Court. This week, Congress weighed in on the ongoing debate. 

In July, the Consumer Financial Protection Bureau (CFPB) announced a new rule that, among other things, prohibited contractual provisions that barred a consumer from asserting claims in a class action. The rule required that contracts include language to notify a consumer that they may file a class action. The CFPB’s new rule would apply to certain offerings of consumer financial products or services. For example, it was intended to apply to consumers’ credit card and bank account contracts. The prohibition on class action waivers applied to pre-dispute arbitration provisions, meaning agreements entered before any dispute arises. As a result, consumers would be free to file and participate in class actions for products and services covered by the rule.

Immediately the rule faced opposition, well before it went into effect. In July, the House voted to repeal the CFPB’s rule. On Oct. 25, 2017, the Senate voted to repeal the rule, with Vice President Mike Pence casting the tie-breaking vote in favor of repeal. The president is expected to sign the repeal. As a result, the CFPB’s rule will not take effect.

Although the CFPB’s rule was limited to particular types of contracts, it is unlikely this is the end of the debate over class action waivers. To avoid risks associated with class actions, many companies (including franchisors) include class action waiver provisions in their contracts—whether the contract includes an arbitration provision or not. 

A nearly 10-year-old Illinois privacy law that has sparked class action lawsuits against familiar tech companies such as Google, Facebook and Shutterfly has moved into the franchise industry.

Following in the footsteps of claims under the Americans with Disabilities Act and the Telephone Consumer Protection Act, class action lawyers are now filing lawsuits under Illinois’ Biometric Information Privacy Act (BIPA) alleging that companies are unlawfully collecting biometric information from customers and employees through devices such as fingerprint scanners. Plaintiffs are suing both franchisors and franchisees. Franchisors are being sued for collecting the information themselves for their own employees and also for the actions of their franchisees on theories of joint and several liability, vicarious liability, agency and alter ego. A recently filed case alleges that a franchisor mandates and controls virtually every aspect of its franchise locations, including the use of certain equipment that collects biometric information to track employees’ time and attendance and to monitor cash register systems for fraud. Other cases allege that franchisors and franchisees are using it to track health and fitness information and authenticate customers’ transactions.  

Biometric information is information based on an individual’s biometric identifier, such as eye, hand, face or fingerprint scans. Generally, BIPA prohibits private companies and individuals from obtaining biometric information unless they obtain prior, informed written consent. BIPA also requires companies to publish publicly-available written retention schedules and guidelines for permanently destroying biometric information. Potential damages are steep: liquidated damages of $5,000 for each intentional or reckless violation or $1,000 for each negligent violation, or actual damages, whichever is greater, plus attorneys’ fees and costs. The first reported settlement of a class action under BIPA was $1.5 million against a tan company franchise in December 2016 that involved a class of people who provided their fingerprints to access Illinois tan franchise salons for a nearly three-year period. The plaintiff alleged that the company obtained customers’ fingerprints without obtaining their informed written consent.

Thus, businesses that use fingerprint scans or facial-recognition technology to identify and track customers or employees may find themselves the subject of a costly class action lawsuit. In addition, storing this type of information can subject companies to litigation risk if a breach occurs. BIPA notes that, unlike a Social Security number, for example, a person has no recourse if their biometric data is compromised. BIPA also prohibits companies from selling or otherwise profiting from a person’s biometric data, which may come into play in the sale or transfer of ownership interests in a franchise or franchise system.

The big tech companies have challenged these lawsuits, with mixed results. Legal arguments at the motion to dismiss stage have included lack of personal jurisdiction over defendants, their actions fall outside the scope of the law, and plaintiffs’ failure to allege that they had suffered any harm other than mere procedural violations, although a court concluded recently that alleging an invasion of privacy was sufficient at the early stages of the lawsuit.  

Although the biometric privacy compliance and litigation focus has been in Illinois, other states are enacting laws to address these issues. Texas regulates the collection and use of biometric data but does not allow a person to sue, instead giving the state attorney general the power to recover civil penalties up to $25,000 for each violation. Washington recently passed a law that appears more limited than BIPA. New Hampshire is currently considering a biometrics law. Other states have considered similar laws this year, so others will likely follow.  

The takeaway: Franchisors should be careful about mandating franchisee use of biometric procedures and devices without first checking applicable law and also making sure that their own policies and procedures are in compliance with those laws.

 Greensfelder attorneys are knowledgeable in the franchise, privacy and employment laws of multiple jurisdictions. If you have any questions about this article or issues raised in it, please contact the authors of this article or Greensfelder’s Franchising & Distribution Group attorneys.

While state and national efforts are underway to clarify the issue of joint employment, plaintiffs continue to allege the theory against franchisors in hopes of getting past a motion to dismiss. The lesson in one such recent case was that franchisors that give product discounts to their franchisees’ employees may find their generosity backfires if they are sued for being a joint employer in certain states. A federal district court in Michigan recently found that food service managers working at Marriott franchises had alleged enough facts to survive a motion to dismiss a lawsuit claiming that the franchisor, Marriott International, Inc., exercises control over them and is their joint employer. Among the allegations that the court cited in denying Marriott’s motion to dismiss was that Marriott treated plaintiffs like Marriott employees by giving them discount room rates at Marriott hotels worldwide, which the court said could be viewed as the ability to affect compensation and benefits similar to an employment relationship.

Plaintiffs filed a putative class action lawsuit on behalf of current and former food and beverage managers who worked more than 40 hours a week at Courtyard by Marriott hotels. They alleged that Marriott, as their joint employer, violated federal wage and hour law by misclassifying the food service managers as executives so that they were exempt from overtime pay protections. In evaluating Marriott’s motion to dismiss, the court pointed to other allegations that are typical of a franchisor-franchisee relationship, such as auditing and compliance oversight. The court also cited Marriott’s right to terminate the franchise agreement, which would necessarily terminate the employees’ employment, thus amounting to control over employees. The court rejected Marriott’s attempt to rely on a case from an Illinois federal court finding that the right to terminate a franchise agreement and to have control over uniformity and brand standards do not support a finding of joint employer status. Therefore, the final outcome of this case likely will be determined at the summary judgment or trial stage.

The takeaway: This court sits within the jurisdiction of the U.S. Court of Appeals for the Sixth Circuit, which includes Michigan, Kentucky, Ohio and Tennessee. The court noted that the issue of joint employment depends on all of the facts and circumstances in a particular case and is largely an issue of control. Given the fact-intensive nature of the analysis, lawsuits alleging joint employer liability are often difficult to win before discovery, so franchisors should be aware of the applicable law in their jurisdiction and avoid exercising control, when possible, over non-employees.

Greensfelder attorneys are knowledgeable in the franchise and employment laws of multiple jurisdictions. If you have any questions about this article or issues raised in it, please contact the authors of this article or Greensfelder’s Franchising & Distribution Group attorneys.

The decision can be found here.

A recent federal appeals court decision overturning a $6.5 million jury verdict for a franchisee on a state franchise law discrimination claim demonstrates once again the difficulty that franchisees face in such challenges, even when the court finds that the franchisor treated some franchisees differently than others in some instances and could not explain why.

The Indiana Deceptive Franchise Practices Act (IDFPA) prohibits a franchisor from “[d]iscriminating unfairly among its franchisees” … “in relation to the [franchise] agreement.” Ind. Code § 23-2-2.7-2(5). In Andy Mohr Truck Center, Inc. v. Volvo Trucks North America, No. 16-2788, 2017 WL 3695355 (7th Cir. August 28, 2017), the U.S. Court of Appeals for the Seventh Circuit addressed what it means to “discriminate unfairly” under the IDFPA in a case where the franchisee claimed that the franchisor provided more favorable discounts on truck pricing to other franchise dealerships. In addition to standard discounts given to all dealers, the dealer could apply for additional concessions under the Retail Sales Assistance program that the dealer then used to negotiate a price quote with the customer.

Although the franchisee could show similarly situated franchisees were treated better in some cases, the appeals court held that the franchisee could not show that those differences were unfair discrimination. “At most, the evidence showed that Volvo offered no reasoned explanation for giving Mohr a relatively worse concession than it gave to a sample set of franchisees on similar transactions. But it did not show that such treatment was unfair or discriminatory (i.e., that it was not the norm among franchisees).” The court reasoned that the franchise agreement gave all dealers access to the Retail Sales Assistance program but it gave the franchisor discretion to grant different discounts for each transaction, although Volvo agreed to and did give the same discount to dealers bidding on the same transaction (a customer shopping for the best price among multiple dealers). Under a normal bidding process, the court said there is bound to be some variation between similar transactions.

So, under what circumstances could a franchisee make a showing of unfair discrimination under the IDFPA? The decision obviously is limited to the wording of this statute and these facts, but the court acknowledged that a franchisee might be able to show that it never received better discounts than allegedly favored franchisees. Or, a franchisee could show that a franchisor violated the franchise agreement, offered the franchisee worse agreement terms than other franchisees, or discriminated against it by offering less favorable terms for the same purchase by the same customer. Here, the evidence showed only that sometimes the franchisee received the better discount and sometimes the competitor did, such that the franchisee benefitted from the alleged discrimination. More is needed to show “unfair” discrimination, according to the court. 

The takeaway: As courts in other states have found in analyzing similar franchisee discrimination statutes, mere variations in dealings between franchisors and franchisees do not necessarily show discrimination that rises to the level of a legal violation. However, this case demonstrates the complexity and expense of defending these claims. Franchisors implementing discretionary sales assistance or other similar programs should carefully review the applicable state statutes, with the assistance of legal counsel, to evaluate their risks.

The decision can be found here.

Despite arguably conflicting terms in a franchise agreement, a franchisor could enforce a non-compete provision whenever the agreement ended, whether by termination or expiration. An arbitrator reached that conclusion by harmonizing two provisions in the franchise agreement that referenced a non-compete obligation — one that referenced termination and one that referenced both termination and expiration. This was a reasonable interpretation of the contract, according to the Maryland federal district court that found no basis to upset the arbitration award.

The franchisee had argued that the limitation on competition “for a period of 24 months after termination of this Agreement” was triggered only if a party terminated the franchise agreement and did not apply if the franchise agreement simply expired by its own terms, as was the case here. The arbitrator, however, found that another provision that outlined the franchisee’s post-termination obligations — regardless of the paragraph’s title “Effect of Termination” — stated that in the event of termination or expiration of the agreement, the franchisee was required to comply with the non-compete provision. The arbitrator then enforced the non-competition agreement for 24 months after the franchisee first complied with it rather than the date that the franchise agreement expired because the franchisee had continued to operate the franchise for 20 months after the agreement expired. This ensured that the franchisee was subject to the 24-month non-compete the parties had originally agreed to, rather than only four months left from the original date of the agreement’s expiration.

This opinion demonstrates the importance of careful drafting of non-compete clauses to avoid legal challenges and to ensure that former franchisees do not benefit immediately from the knowledge and clientele they acquired during the franchise relationship. A non-compete provision must be drafted to comply with state laws and contemplate potential ways a franchise relationship might end. The opinion also demonstrates the difficulty of overturning an arbitrator’s decision, which is usually entitled to great deference.

The decision is Frye v. Wild Bird Centers of America, Inc., No. CV TDC-16-3216, 2017 WL 605285 (D. Md. February 14, 2017), which can be found here.

Greensfelder attorneys are knowledgeable in the franchise and employment laws of multiple jurisdictions. If you have any questions about this article or issues surrounding a non-compete provision, please contact the authors of this article or Greensfelder’s Franchising & Distribution Group attorneys.

On May 8, 2017, the North American Securities Administrators Association (NASAA) released its final commentary on financial performance representations (FPRs), providing franchisors with additional clarification and guidance on how to prepare one of the most important parts of their franchise disclosure documents (FDDs).

Preparing and sharing FPRs (formerly known as earnings claims) has long been a challenge for franchisors. Although franchisors are not required to prepare FPRs, information about earnings is often what a prospective franchisee wants the most. In recognition of that desire, it is estimated that 60 percent of franchisors include FPRs in their FDDs.

Before the commentary, the general rules have been just that – general – and there have been relatively few restrictions on how franchisors can shape and mold FPRs. At a basic level, the general rule is that franchisors cannot share FPRs with prospective franchisees outside of the franchisor’s franchise disclosure document. Also, a franchisor must have a “reasonable basis” for any FPR. Some guidance has been available from the FTC and NASAA, but it has been limited.

The new guidance in some ways restricts a franchisor’s ability to make FPRs, but it is intended to provide guidelines to help franchisors prepare FPRs that have a reasonable basis and are clear. For example, in an effort to clarify what constitutes a reasonable basis, the new commentary requires franchisors that choose to disclose top performers in the system to also disclose the worst performers. If a franchisor provides an average or mean number, they must also provide the median figure and vice versa. And, franchisors with operating franchisees will typically not be able to limit disclosure to the franchisor’s performance data. To make sure that relevant information isn’t lost, franchisors will also have to clarify what they mean by terms such as gross sales or net profits.

In some respects, having limited regulations of FPRs has been a good thing for franchisors. Franchises exist in a multitude of industries, and with each industry the financial model is a little different, as are key metrics of importance to prospective franchisees. Trying to fit FPRs for very different industries into one mold would be difficult, and franchisors have had (and will continue to have) some flexibility to express FPRs in a way that makes sense to their particular system.  On the other hand, with FDDs subject to state registrations, this relative freedom has also meant freedom for state regulators to comment on franchisors’ FPRs. Comments from states often post-date approval orders from other states, sometimes making it hard for franchisors to have a uniform multi-state FDD. From that perspective, the additional guidance from NASAA is welcome. The hope is that, with more specific rules, franchisors that carefully follow them will be able to avoid or minimize comments from state regulators. While it will likely take a little bit longer to prepare the FPR, it will hopefully cut back on the administrative difficulties with managing multiple FDDs or amending the FDD to make it consistent in all states. Of course, there is no definition of what constitutes a “reasonable basis,” and answering that question will remain subject to interpretation.

The new NASAA commentary becomes effective on the later of 180 days after the adoption by NASAA (Nov.4, 2017), and 120 days after the franchisor’s next fiscal year end, if the franchisor had an effective FDD as of May 8, 2017.