California’s governor recently vetoed legislation that had intended to make it easier for franchisors and franchisees to do business in the state. While the vetoes came as no surprise, they are disappointing from a franchise perspective.

AB 1782 (Limited Trade Show Exception) and AB 2637 (Negotiated Sales) — which the State Bar of California’s Franchise Law Committee, the International Franchise Association and the Coalition of Franchisee Associations each supported — were vetoed Sept. 22, 2016, by California Gov. Jerry Brown.

AB 1782 would have allowed franchisors who are not registered with the Department of Business Oversight (DBO) an opportunity to advertise their franchises at trade shows in California. Passage of this law would have made it easier for unregistered franchisors to advertise to potential California-based prospective franchisees.

The governor vetoed this bill because he believed the lack of registration deprived the DBO of the ability to “review franchise disclosure documents to ensure franchisors were providing accurate information to potential customers.” In truth, franchisors cannot sell a franchise in California unless they first register with the state and submit the franchisor’s franchise disclosure document (FDD) for the DBO’s review in that process. If AB 1782 had become law, California would have joined New York as the only states that allow unregistered franchisors to advertise their franchise within the state.

AB 2637 would have brought California’s treatment of negotiated franchise sales in line with other states. No other state regulates the negotiation of franchise agreements like California does. Proponents of this bill thought the requirement that franchisors have to disclose negotiated changes to the registered FDD to the government and/or other prospective franchisees dissuaded franchisors from negotiating with prospective franchisees in California.

In California, negotiated franchise agreement terms that differ from the registered FDD are handled in one of two ways. If the new negotiated franchise agreement terms are to the prospective franchisee’s detriment as a whole, the franchisor is required to file the amended agreement for approval by the DBO and prepare a revised FDD to go with it. If franchisors and franchisees negotiate terms that are to the franchisee’s benefit, which is the usual case, the franchisor has to disclose these terms for the next 12 months to prospective franchises.

The governor vetoed AB 2637 on the basis that it “could be detrimental to potential franchisees” because the DBO would not be able to review contract changes to ensure that franchises are not disadvantaged in their final agreements. The governor’s reasoning appears to be based on a misunderstanding of current practices in the franchise industry. For example, most franchise agreement negotiations are done at the prospective franchisee’s request and result in better terms for the franchisee. As a result, franchisors are not required to submit the negotiated agreement for review to the DBO. Instead they can simply disclose a summary of the negotiated terms to future prospective franchisees without regulatory oversight. The restriction on negotiated sales in California also leads to franchisors being unwilling to negotiate their agreements at all, or seeking out some of the many exemptions available from the state franchise registration requirements.   

California franchise law has many exemptions, so the harder California makes franchise compliance, the more franchisors will look to available registration exemptions. Time will tell if California will take any additional steps to become a state more supportive of franchise opportunities. If you have questions about this topic or any other state laws that may affect your franchise, please contact Greensfelder’s Franchising & Distribution Group.

More and more franchise registration states are offering the option to submit franchise applications either electronically or in hard copy. As of June 30, 2016, Wisconsin franchise filers now find themselves required to e-file all future franchise applications. 

In an effort to avoid excessive mailing costs, the division staff will return mailed checks and cover letters while recycling all other hard copy documents they receive. There is no downside to electronically filing in Wisconsin, as it is instantaneous and immediately effective. 

We will hopefully see additional states following suit as we transition further into the franchise digital age. If you have questions about electronic filing, please contact Greensfelder’s Franchising & Distribution group.

Several of the exemptions available under the FTC Franchise Rule are tied to dollar thresholds. For example, when the current FTC Franchise Rule was adopted in 2007, a franchise sale was exempt from the disclosure requirements of the rule if the payments from the franchisee to the franchisor in the first six months of the franchisee’s operations did not exceed $500. Wary of inflation, the FTC Franchise Rule requires the FTC to adjust the nominal fee exemption and others every four years. The first such adjustment occurred in 2012, and the fees are being adjusted again effective July 1, 2016. 

Come July, the following fees are being adjusted:

• The nominal fee exemption threshold will be $570.
• The large investment exemption threshold will be $1,143,100.
• The large franchisee exemption threshold will be $5,715,500.

Each of these exemptions is multi-faceted and complex, and franchisors should carefully consider the specific facts of any sale before relying on an exemption. They should also be mindful that state franchise laws have different exemptions and compliance with both federal and state laws may be required. Please contact Greensfelder’s Franchising & Distribution group for more information on exemption-based franchising.

Think twice before requiring at-will, low-wage workers to sign noncompetes

On June 8, the Illinois attorney general filed a lawsuit in Cook County (Illinois) Circuit Court against two Jimmy John’s entities: franchisor Jimmy John’s Franchise LLC and an LLC owning eight Jimmy John’s sandwich shops, Jimmy John’s Enterprises LLC. The lawsuit alleges the sandwich chain engaged in unfair and deceptive acts or practices unlawful under the Consumer Fraud and Deceptive Practices Act. The lawsuit seeks to stop the allegedly unlawful use of noncompetition agreements on at-will, low-wage employees and to ensure that current and former employees are informed that the noncompetition agreements they signed are unenforceable. 

The suit alleges that the Jimmy John’s operations manual provides franchisees with expectations and recommendations for the operations of the stores, including a recommended noncompetition agreement for all store employees, regardless of title or job function.

Jimmy John’s Enterprises, as well as many franchisees using the recommended Jimmy John’s form, require all employees to sign the noncompetition agreements as a condition of employment. The requirement extends to sandwich makers, bike delivery drivers and assistant managers. The noncompetition agreements prohibit the employee — during his or her employment and for the two years following— from having any role, including manager, owner, or employee, in any business that earns more than 10 percent of its revenue from selling sandwiches. The limitation applied to any business within either two or three miles of the store where the employee worked or any other Jimmy John’s sandwich shop in the country. There were over 2,400 Jimmy John’s sandwich shops at the end of 2015.  

Although Jimmy John’s Enterprises purportedly changed its policy in April 2015 to no longer require store employees to sign non-competition agreements after that date, and represented it no longer included the non-competition agreement in its new hire packets, it subsequently advised the attorney general that it never implemented the change in policy. As a result, many employees hired after April 2015 continued to sign noncompetition agreements. Jimmy John’s also represented to the attorney general that it had no intention of enforcing the noncompetition agreements. However, those non-binding intentions were never communicated to current or former employees.

‘No legitimate business interest’

The attorney general seeks a declaratory judgment that the noncompetition agreements are unenforceable. She alleges that Jimmy John’s has no legitimate business interest to justify the use of noncompetition agreements against store employees.

The suit further alleges that the noncompetition agreements contain unfair and onerous terms because the temporal restrictions of two years post-employment is not objectively reasonable, and the geographic scope is unreasonable, unconscionable, unenforceable and an improper restraint of trade under Illinois laws. The attorney general seeks to assess the maximum applicable civil penalty, including a penalty of $50,000 per violation if the court determines that Jimmy John’s has engaged in acts or practices declared unlawful with the intent to defraud.

The lawsuit follows an April 2015 dismissal by the U.S. District Court for the Northern District of Illinois of claims for injunctive and declaratory relief against Jimmy John’s to determine the validity and enforceability of confidentiality and noncompetition agreements. The court held that plaintiffs had not alleged a sufficient injury and did not have standing to bring suit and, even if they had alleged a sufficient injury to confer standing, they could not overcome Jimmy John’s and the franchisee defendants’ sworn intention not to enforce the agreements, thus mooting the claim. These claims were part of the allegations in a putative national class action against Jimmy’s John’s and some franchisees for alleged violations of the Fair Labor Standards Act and Illinois Minimum Wage Law, raising joint employer issues. (Brunner v. Liautaud, N.D. Ill. April 8, 2015).

Illinois is not the first state to investigate Jimmy John’s noncompetition agreements. CNBC reported that, in 2014, U.S. Congressional Democrats asked the U.S. Department of Labor and other agencies to investigate Jimmy John’s noncompetition agreements. In late 2014, news reports stated the New York Attorney General Eric Schneiderman initiated an investigation into, and requested information from, Jimmy John’s and a number of its New York franchisees regarding the noncompetition agreements. He has not yet announced any action.

What this means for franchisors

While most franchisors likely do not require all employees of their franchisees to enter into noncompetition agreements, protecting the trade secrets and confidential information of the franchise system is at the heart of each system. That said, franchisors should be aware that the forms of agreements they recommend to their franchisees could result in liability to the franchisor. 

In some cases a confidentiality agreement may be more appropriate than a noncompetition agreement. Franchisors and franchisees should review their noncompetition agreements to ensure they are reasonable both in time and geographic scope. Furthermore, they should ensure that only those managerial or other employees with access to proprietary information and/or who maintain customer relationships are required to sign the noncompetition agreements.

The case is People v. Jimmy John’s Enterprises, No. 2016-CH-07746 (Ill. Cir. Ct. Jun. 8, 2016). 

The International Franchise Association’s annual Legal Symposium took place May 15-17, 2016. Greensfelder, Hemker & Gale attorneys Dawn Johnson, Beata Krakus, Kim Myers, Abby Risner and Leonard Vines attended the program in Washington, D.C, where industry speakers presented programs on important topics in franchising.

Vines moderated one of the roundtables on “Effective Use of Franchise Advisory Councils.”

Some key takeaways from this year’s sessions include:

Managing risk when implementing systemwide change

• Get franchisee buy-in: The quote “People don’t resist change, they resist being changed” set the tone for this presentation. Anchoring changes with franchisees before the changes are announced can make a tremendous difference to how franchisees will receive the news. It may be the difference between whether the changes will be embraced or rejected.
• Think through the contractual implications: How change is implemented will depend on the agreements in place between the franchisor and its franchisees. The approach that will have to be taken will differ depending on whether the franchise agreements permit the franchisor to introduce the change.

Financial performance representations

• FPRs, formerly called “earnings claims,” continue to be a hot topic for franchisors as they want to avoid litigation over unauthorized representations in the franchise sales process, yet still attract prospective franchisees who want to know how much money they can make. Despite the fear of litigation, the recurring question of whether a franchisor should make a financial performance representation in Item 19 of the Franchise Disclosure Document took a surprising turn this year, as the trend appears to be that more franchisors are making them.
• Franchisors that choose to make FPRs must be certain they have documentation to support the FPRs at the time the representation is made. Often, such documentation is lacking or has not been updated in several years. In-house and outside counsel should always ask to review the underlying documentation for FPRs.
• As always, training your franchise sales staff is key, as they often want to make the sale and can easily go beyond statements that are in the FDD.
• The rules on how to make FPRs could be clarified soon, as the North American Securities Administrators Association has issued a proposed commentary on FPRs to try to assist franchisors in making Item 19 disclosures. A final commentary has not yet been issued.

Updates on important franchise cases

• Brand protection: Franchisors may want to consider including in their franchise agreements the right to withdraw from a market and express terms limiting their obligation to protect the brand against competition
• Data privacy: Franchisors will have more risk of being held accountable for a breach the more connected they are to the franchisee’s system. Franchisors may want to consider including data security compliance requirements in their franchise agreements. Cybersecurity continues to be a big concern for all businesses, both franchised and non-franchised.  Franchisors should consider insurance and a review of procedures.
• Class action waivers: If not already included in your franchise agreement, franchisors should consider including class action waivers.
• Advertising: Franchisors need to be aware of the risks that increase because of social media. Of course, franchisors want to continue to ensure that they are giving the consumer what is actually being advertised.

Joint Employer

• Be sure a franchisee’s employees know they are working for the franchisee, and ensure there are no indications that could arguably cause them to think they are working for the franchisor, such as names on paychecks and employment applications.

The American Bar Association is accepting applications for a Forum on Franchising scholarship established in memory of the late Greensfelder, Hemker & Gale partner John Baer.

In October 2015, the ABA Forum on Franchising established the John R. F. Baer Scholarship for International Civility and Professionalism. The scholarship will be awarded to an attorney who demonstrates Baer’s tradition of exceptional leadership and civility in franchise law, with an emphasis on international law. Baer, who was a member of Greensfelder’s Chicago office, died in 2015. He was the first recipient of the Forum’s prestigious Lewis G. Rudnick Award in 2009 and was a member of the Forum’s governing committee from 2003 to 2006.

The Baer scholarship covers tuition and a travel stipend of $1,000 for attendance at the Forum’s annual meeting Nov. 2-4, 2016, in Miami, Florida. Applications should include:

1. A personal statement of interest and experience in the international practice of franchise and distribution law (which may include through writing or speaking);
2. A description of ways in which the applicant has demonstrated professionalism and civility across geographic borders; and
3. At least two letters of recommendation, which must include letters from practicing lawyers in least two countries. 

The Forum will give particular consideration to applicants who would not be able to attend without financial assistance. Submissions are due July 1, 2016, and should be directed to Forum chair Karen Satterlee at Karen.Satterlee@Hilton.com.

Although it was enacted almost 20 years ago, California’s Proposition 65 is continuing to expand and affect the operations of new companies with its far-reaching legal requirements. It is increasingly important for any retailer, manufacturer or business owner whose products could possibly be sold in California or be used by a California user to comply with the warning requirements of the law. 

Proposition 65 requires clear and reasonable warnings to be placed on products that contain specific chemicals that have been “listed” by California’s Office of Environmental Health Hazard Assessment (OEHHA). Chemicals are listed that have a potential to cause cancer or reproductive toxicity in certain levels of exposure. While many of the listed chemicals have long scientific names, many are found in various consumer products such as furniture, purses, bottles and cans.

One of the most recently listed high-profile chemicals is Bisphenol A (BPA), which can be contained in canned and bottled food products. The one-year grace period for companies with products containing a regulated amount of BPA ends this month, and lawsuits or enforcement actions for failure to warn could be filed shortly.

While Proposition 65 provides for enforcement by the California attorney general, it more importantly allows private citizens (and plaintiff lawyers) to file lawsuits to privately police whether the law is being complied with. The number of these lawsuits and settlement amounts to resolve them have continued to rise, with the California attorney general reporting that approximately $29.4 million was paid to settle 663 lawsuits in 2014. The defendants in these lawsuits were from every facet of the distribution chain including, for example, retailers (Bed Bath & Beyond, Forever 21 and Costco), consumer product manufacturers (Britax, which makes car seats, and Dooney & Bourke, which makes purses) and home direct sales companies (Arbonne and Stella & Dot).

Lumber Liquidators saw a huge impact to its business when its stock price decreased to less than half after a TV investigative report noted levels of formaldehyde in a floor product that was being distributed. Lumber Liquidators faced a California attorney general enforcement action as well as more than 20 separate lawsuits alleging failure to comply with Proposition 65 and other causes of action for failure to warn of the formaldehyde levels in certain flooring.

It is important for any company doing business in California or distributing products into California to evaluate the chemical makeup of their process and whether any listed chemicals are present or could be present such that a Proposition 65 warning is necessary.

Greensfelder has assisted clients in evaluating compliance with the legal requirements of Proposition 65. If you have questions about how this affects your business, please contact the attorneys in our Franchising & Distribution or Environmental practice groups. 

The American Bar Association’s annual Petroleum Marketing Attorneys’ Meeting took place on April 14 and 15, 2016. Greensfelder, Hemker & Gale attorneys Dan Garner, David Harris, Dawn Johnson, John Petite and Abby Risner attended the program in Washington, D.C, where industry speakers presented programs on important topics and emerging trends in the petroleum marketing industry. Click here to see a copy of the conference brochure.

As program chair, John Petite presided over the two-day event. Petite has been named to serve as program chair for the 2017 Petroleum Marketing Attorneys’ Meeting as well. He has served on the PMA Planning Committee for the past three years and also for the past three years has authored the Petroleum Marketing Committee Report Environment, Energy, and Resources Law: The Year in Review (YIR). The YIR is an annual summary of important developments in environmental, energy and resources law and is published online by the American Bar Association.

Abby Risner spoke at one of the program’s sessions, in a presentation titled “Commercial Litigation and PMPA Update.” Her presentation discussed developments in Petroleum Marketing Practices Act cases, as well as other cases impacting the petroleum marketing industry. Among other cases, Risner’s presentation included a discussion of the Hogan v. BP West Coast Products LLC case, handled by Greensfelder attorneys. She also addressed the recent developments in class action cases before the U.S. Supreme Court. Click here to see the PowerPoint presentation.

Some key takeaways from this year’s PMA sessions include:

Recent Petroleum Marketing Practices Act Cases

• Where a franchisor is terminating under 15 U.S.C. § 2804(c) for loss of the underlying ground lease, the franchisee’s right to assignment of the underlying ground lease can be limited by an ability to secure from the landlord a release of the franchisor, and it is irrelevant that if a franchisor provides notice to the landlord that it would not renew before offering to assign the option to the franchisee. Amphora Oil & Gas Corp. v. Cumberland Farms, Inc. (E.D.N.Y. 2015).
• A shorter period of notice of a termination is reasonable where a franchisee fails to operate a motor fuel station and fails to pay the franchisor for fuel and rent. Wynn v. Lukoil N.A., LLC (E.D. Pa. 2015); Hillmen, Inc. v. Lukoil N.A., LLC (E.D. Pa. 2015).

Customer Loyalty Programs

• Remember that the terms and conditions for any loyalty program will constitute the contract between you and the retail consumer. If you promise something or say the program works a certain way but don’t deliver, you risk serious liability, including potential class actions. Thus, a reservation of rights clause allowing you to change the terms and conditions of the loyalty program becomes important.
• For franchisors, it is key to be aware of all marketing and advertising materials for the loyalty program. Franchisees may want to develop their own advertising for a loyalty program. That can often be effective, but the franchisor must first ensure that such advertising is consistent with the terms and conditions for the program as well as the franchisor’s overall strategic direction for the marketing of the program. A franchisor should never allow a franchisee to advertise a loyalty program unilaterally unless the franchisor has first reviewed and approved the materials.
• Always consider whether a loyalty program poses any “below cost” sales risk, particularly if the program provides any kind of cent-per-gallon discount off the pump price. State law varies widely on what constitutes a below-cost sale, so the sponsor of the program needs to analyze the laws of each state where any program will run.
• The marketing/business team developing the program needs to be in touch with the site operators. Ultimately, the program won’t be successful if it doesn’t connect with the retail consumer at the site, and no one knows those retail consumers better than the people working at the site every day.

Antitrust Issues in the Petroleum Marketing Industry

• Motor fuel pricing continues to be a source of private litigation, focusing on the now-blurred lines in the supply chains: a traditional refiner-dealer model (now representing less than 10 percent of current retail sites), jobber model of supply (which is now well over 50 percent of retail sites) and the emergence of hybrid commercial contracts for supply principally to large end users such as hypermarketers (representing over 15 percent of retail sites).
• Traditional legal doctrines built up around older models of distribution are giving way to a new round of litigation brought by consumers, dealers and wholesalers challenging the distinctions between sales of branded and unbranded fuel, rack and dealer pricing, spot formula pricing and rack and dealer pricing, and the traditional distributive models.
• Whether it is under the Robinson-Patman Act, UCC Section 2-305 or state motor fuel laws, motor fuel sellers must now scrutinize their pricing practices against the new paradigm of a market that is unbundled, rather than relying on traditional defenses such as branded and unbranded fuels not being comparable, and spot, rack and dealer prices as separate points of reference. 

Joint Employer Issues

The issue of “joint employment” liability has been a continuing hot topic since decisions by the Department of Labor and the NLRB that expanded the standard for joint employment. (Click here and here for previous coverage on this topic.) In January, the DOL’s Wage and Hour Division Administrator issued an interpretation for new standards for joint employment under the Fair Labor Standards Act and the Migrant and Seasonal Agricultural Worker Protection Act. 

One of the most interesting developments is that the DOL appears to be trying to catch up with growth in the sharing economy, also known as the “gig” economy, where consumers request online and on-demand services through their cellphones or online. The DOL is considering whether to create a new classification of “dependent” employee that would capture this type of worker that is not included in employee or independent contractor categories. On Thursday, it was announced that Uber has settled the class action lawsuits brought against it by its drivers who wanted to be treated more like traditional employees. If the settlements are approved by the courts, the question of classifying app-based on-demand workers remains an open question. For more detail on the settlements, find news coverage here and here.

In addition to liabilities petroleum marketers face under the Petroleum Marketing Practices Act and federal and state laws, areas that may be impacted by the new standards are training, hiring and screening employees, and mystery shopping and non-compliance reviews and audits of retail outlets. Potential considerations include indemnity clauses that allocate costs if the franchisor is found liable, or requiring insurance coverage for actions in which the franchisor may be found liable.