Can They Really Do That? Expectations Meet Franchising Realities.
by Kat Tidd
A franchise is not a magic word, it is a legal definition: (1) license a trademark or permit substantial association with the trademark or trade name; (2) accept payment of consideration; and (3) provide significant assistance, control or other forms of ongoing support or a continuing relationship. If that definition is met, then the franchisor has certain obligations concerning the timing and manner of offering and selling a franchise, and the use of a Franchise Disclosure Document.
Keep in mind that a franchise is essentially a specialized form of business opportunity, with the additional element of a trademark or trade name license. And, generally, a franchisee has no special rights except those that the franchisor grants by contract or those accruing through reasonable reliance on franchisor promises. In some states, there are specific statutes that regulate relationships and/or termination, like Arkansas, New Jersey (Franchise Practices Act) and Wisconsin (Fair Dealership Law).
Pricing. While many antitrustissues have fallen into disfavor, pricing controls traditionally unquestioned as per se unlawful price-fixing practices were rehabilitated by the Supreme Court in Leegin Creative Leather Products Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007).
Since Leegin’s holding that vertical price restraints are to be evaluated under the rule of reason, Pandora’s Box has opened. Leegin offers franchisors some comfort in their ability to dictate at least the parameters of a franchisee’s pricing as a reasonable resale price maintenance program. Any challenge will now be scrutinized under a rule of reason analysis that calls for establishing several ambiguous and difficult-to-define factors (e.g., such as what is the relevant product market). This may make plaintiff's counsel more reluctant to challenge such practices.
Several states, however–Illinois, Michigan and California among them–have reacted negatively to Leegin and maintain that minimum resale price maintenance is still per se illegal. And with less certainty, friction seems inevitable.
Encroachment. Disputes over the proximity of competing franchisees, solicitation and diversion of customers, and sales of product within a franchisee’s trade area or exclusive territory are being litigated with more frequency. Some states like Iowa have passed protective legislation.
Franchisors have reacted by broadening the reservations of the rights to encompass everything not specifically granted to the franchisee.
With such clauses in place, more franchisors are exercising their contractual right to place franchises closer together and to sell products and services directly by “alternative distribution channels,” e.g. Internet sales and discount membership chains like Costco. Where the franchisor diverts–real or perceived–business and customers that would otherwise go to a franchisee, disputes and litigation ensue.
Duty or Implied Covenant of Good Faith and Fair Dealing.In franchising, this is typically asserted by a franchisee. Numerous states recognize this duty or implied covenant–sometimes by statute and sometimes by common law–including Oklahoma, Tennessee and Georgia. However, Texas courts have yet to find that a franchise creates a special relationship beyond that of a normal commercial contract and, so far, have not found that a franchisor owes its franchisees such a duty.
Breakaway Franchisees. Franchisors often assume they can keep franchisees from going into the same business or from competing with their franchisees. They often fail to grasp that there is a patchwork quilt of state laws affecting restrictions against competition. They must balance the scope of protection they want in the franchise agreement against what is most likely to be enforced in the greatest number of jurisdictions in which they will franchise.
In some states, like California, a post-termination restriction may not be enforceable at all. In Georgia covenants against competition in franchise agreements have long been disfavored and subjected to the difficult standard of strict scrutiny.
In Texas and several other states, the scope must be reasonable in duration and geography. What constitutes “reasonable” remains unpredictable and intensely fact-driven. Amerispec, Inc. v. Metro Inspection Services, Inc., 2001 US. Dist. LEXIS 9259 (N.D. Tex. 2001) had the odd result of finding the franchisee in the wrong, but refusing to apply the contractual provision prohibiting the franchisee from competing in the territories of other Amerispec franchisees in Texas.
Whose law? Franchising reaches across state borders. It is an industry regulated at both the federal and state level in a way much like securities are. Whether representing franchisees or franchisors, Texas counsel needs to be sensitive to the laws of other jurisdictions that may apply, such as state franchise registration laws, franchise relationship and protection laws, “little FTC” acts and, of course, the overriding umbrella of the Federal Trade Commission’s Franchise Rule, 16 CFR § 436.1 et seq. Much useful information and a copy of the Franchise Rule and the proposed new business opportunity regulations can be found at business.ftc.gov/legal-resources/13/33.
Kat Tidd, Law Offices of Kat Tidd, P.C., advises franchisors, franchisees, dealers, and entrepreneurs and advises other attorneys on franchise and business opportunity transactional and dispute resolution matters. Ms. Tidd may be reached at firstname.lastname@example.org (972) 247-6934.