Wasch Raines LLP: Franchise Litigation Update
Under the amended FTC Franchise Rule, certain lawsuits falling into four broad categories must be disclosed by a franchisor in Item 3 of the Franchise Disclosure Document (FDD): pending lawsuits, lawsuits involving the franchise relationship, prior lawsuits, and current government injunctive or restrictive actions. This includes federal and state courts and arbitrations.
Franchise litigation is complex. In Florida, franchise lawsuits brought by franchisees often involve the Florida Deceptive and Unfair Trade Practices Act (FDUTPA) which specifically incorporates federal statute 16 C.F.R. 436.9. Section 436.9, for example, in subsection (e), states that it is an unfair and deceptive trade practice to fail to furnish a copy of the franchisor’s disclosure document (FDD) to a prospective franchisee at least 14 calendar days before the prospective franchisee signs a binding agreement with, or makes any payment to, a franchisor in connection with the proposed franchise sale.
Florida has its own franchise act in Section 817.416 which provides that a franchisee has a private right of act when a person, namely a franchisor, misrepresents in selling a franchise the following: (1) the prospects or chances of success of a proposed or existing franchise or distributorship; (2) the known required total investment for such franchise or distributorship; or (3) efforts to sell or establish more franchises or distributorships than is reasonable to expect the market area to sustain. Damages under the Florida Franchise Act include the return of all moneys invested by a franchisee in the franchise system.
Franchisors should take a pragmatic approach to litigation, especially startup and emerging franchise systems, which may be impacted more heavily in losing prospects by disclosing lawsuits against them in Item 3 of the FDD. Some prospective franchisees may also be turned off to a particular franchise system if the franchisor is litigious and sues franchisees regularly.
Franchisors often bring actions against franchisees for failing to pay royalties or other monthly fees; failing to open in time; and breaching non-compete and post-termination clauses that often invoke trademark infringement and unfair competition under the Lanham Act and common law. Franchisors will often sue master franchisors or area developers under similar causes of action but the hot button issue against master franchisors and area developers is usually failure to meet the development schedule. More aggressive franchisors might take the stance that they are “defending their franchise agreement” in bringing lawsuits against franchisees while others look to resolve disputes in a mutual termination agreement.
Wasch Raines LLP franchise attorneys represent franchisors and franchisees. Within the past year, Wasch Raines has filed federal and state lawsuits against franchisees on behalf of established franchisor clients for, among other things, breach of the franchise agreement in failing to pay royalties and necessary monthly payments to continue operating a franchise in the system. One of our firm’s franchisor clients found that a prior employee was infringing on the franchise system’s trademark and trade name. The decision was made by the franchisor to protect the franchise brand and sue under the Lanham Act and common law for damages. Another franchisor client is pursuing a case against an area representative in a foreign country in federal court for, among other things, breach of the development schedule and breach of post-termination covenants including infringement of the trademark, trade dress and the franchise’s brand.
Wasch Raines LLP’s experience representing franchisors lends itself to counseling franchisees and representing franchisees in litigation disputes and alternative dispute resolution. In fact, many franchisees contact us to discuss their dispute and determine their rights under the federal and state franchise laws and the specific franchise agreement and FDD. Franchisees invest hundreds of thousands of dollars into franchise businesses. Unfortunately, some less-than-reputable franchisors think that selling more and more franchises is the goal and not providing the support necessary to ensure that franchisees which follow the “system” are successful and make money. This leads to a fragile system of unhappy franchisees that will ultimately could crumble the franchise business. The work we do for franchisees sometimes ends up in court or arbitration but many of the discussions with franchisors is attempting to negotiate a mutual termination agreement outside of a formal judicial proceeding. This benefits franchisors from having to disclose the dispute in Item 3.
Much of the work that Wasch Raines LLP does for franchisees is to educate them before the franchise agreement is signed. For a flat fee, we review our franchisee clients’ franchise agreement and FDD and point out the negotiating points and red flags to arm the franchisee in negotiations; we draft addendums to the franchise agreement with terms that benefit our clients; and we review and negotiate commercial leases. We counsel our franchisee clients on how to best conduct due diligence into the system including making contact with as many current franchisees as possible.
If you are a franchisee about to sign a franchise agreement and a commercial lease (where you will likely be a personal guarantor), we recommend hiring a franchise lawyer that charges a flat fee for review of the franchise documents or contact our firm for a free consultation. If you own and are operating a franchise unit or multiple units but you are struggling to make it, you should look to retain franchise counsel with dispute resolution experience to determine the best plan of attack. There are alternatives to litigation such as the negotiation of an addendum with fairer terms to allow the franchisee, negotiation of a mutual termination agreement and release of liability, and the transfer and sale of assets to another willing franchise purchaser approved by the franchisor. Each of these options should be considered.
Startup, emerging and established franchisors should have a legal partner with experience in both transactional work to assist with updating the FDD and ensuring compliance with federal and state franchise laws. But it is equally important for a franchisor to have a go-to lawyer with experience in franchise litigation and dispute resolution. Otherwise, you, as the franchisor, will need to retain outside litigation counsel. There ends up being an additional cost to catch up outside counsel on the state of the franchise system and the dispute with the franchisee. Your franchise counsel should be equipped to nip disputes in the bud and minimize risks of being sued by an unhappy franchisee.
At the end of the day, franchisors should be wary of Item 3 of the FDD but sometimes they need to be proactive against a breaching franchisee or area representative to protect the overall viability of their franchise system. Franchisees need to review Item 3 of the FDD, and we recommend franchisees retain counsel to assist with due diligence and reviewing the franchise documents.
About Wasch Raines LLP
Wasch Raines LLP is a franchise and business law firm providing a comprehensive range of services to emerging and established businesses and franchise companies in a variety of industries. Through its unique business model, the firm offers its clients the benefits of having a cost-efficient in-house general counsel and a full service litigation team. For more information, click here to contact us or call franchise attorney Adam G. Wasch directly at (561) 693-3234.
Wasch Raines LLP has has provided this article for general informational purposes only. It is not intended as professional counsel and should not be used as such. You should contact your attorney to obtain advice with respect to any particular issue or problem. Read our full disclaimer at http://www.waschraines.com/terms-of-use/.