978-0134004006 Chapter 40 Lecture Note

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“It has been uniformly laid down in this Court, as far back as we can remember,

that good faith is the basis of all mercantile transactions.”

Buller, Judge

I. Teacher to Teacher Dialogue

today’s most successful franchise operations. Under the franchise system, there is ample evidence

of the positive effects of good franchise planning. The original basic technology, patent, process,

or other trademarked service or product is allowed to reach many more users or consumers

through a franchise system. With intelligent planning and quality control, the original franchisor

concept allows the small businessperson to ride the coattails of the goodwill, advertising, and

technology developed by large multinational enterprises.

There are some down sides to franchising as well. The “get rich quick” mentality of

franchising has led to a number of abuses on the part of would-be franchisors. Many people have

In addition, the franchise device has not always served the third party well. Because a

franchisee is an independent contractor, the franchisor is not normally responsible to third parties

for torts or contracts that the franchisee has been involved with. That may sound well and good in

FRANCHISE AND SPECIAL FORMS OF

BUSINESS

Chapter 40

proceed.

II. Chapter Objectives

1. Define franchise and describe the various forms of franchises.

2. Describe the rights and duties of the parties to a franchise agreement.

3. Identify the contract tort liability of franchisors and franchisees.

III. Key Question Checklist

 What are the basic elements of a franchise agreement?

 What are the key terms in a franchise agreement?

IV. Text Materials

Introduction to Franchises and Special Forms of Business

Franchising is an important method for distributing goods and services to the public. Special

forms of business are used in domestic and international commerce. Licensing permits one

Franchise

A franchise is established when one party (the franchisor, or licensor) licenses another party (the

franchisee, or licensee) to use the franchisor’s trade name, trademarks, commercial symbols,

Types of Franchises – The four basic forms of franchises are:

 Distributorship Franchise – A distributorship franchise is when a franchisor manufactures

 Processing Plant Franchise – Processing plant franchises occur when the franchisor

 Chain-Style Franchise – In a chain-style franchise, the franchisor licenses the franchisee

Franchise and Special Forms of Business

 Area Franchise – In an area franchise, the franchisor authorizes the franchisee to

Franchise Disclosure Laws

The federal government and several state governments have adopted mandatory disclosure

FTC Franchise Rule – The FTC rule requires franchisors to make full presale disclosures

Disclosure of Sales or Earnings Projections Based on Actual Data – If a franchisor makes

sales or earnings projections for a potential franchise location that are based on some actual data,

Disclosure of Sales or Earnings Projections Based on Hypothetical Data – If a franchisor

makes sales or earnings projections based on hypothetical examples then, the franchisor must

FTC Franchise Notice – The FTC requires that the FTC franchise notice must appear in at least

State Disclosure Laws – State franchise administrators developed a uniform disclosure

Franchise Agreement

Prospective franchisees file an application with a franchisor that provides detailed information.

Business Environment: McDonald’s Franchise

McDonald’s Corporation is the largest chain of hamburger fast food restaurants. Approximately

70 percent of McDonald’s outlets are owned by franchisees. The company owns and operates the

rest. Because of its size, experience, and reputation, McDonald’s has one of the highest cost

structures for franchisees.

and other intellectual property.

 The initial franchise fee for a McDonald’s franchise is approximately $45,000.

 McDonald’s charges its franchisees a royalty fee for the use of McDonald’s name that is

approximately 12.5 percent of monthly gross sales.

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McDonald’s charges a franchisee rent.

 If a franchisee purchases the cups, wrappers, plastic tableware, and other items from

McDonald’s, the franchisee is responsible for paying McDonald’s for these supplies.

 McDonald’s does not grant exclusive geographical territories to its franchisees.

 McDonald’s requires that a new franchisee go through a rigorous nine– to twelve-month

training program before opening a franchise.

the franchisee meets certain conditions.

 The total investment by a franchisee to open a McDonald’s franchise ranges from about

$1 million to $2 million.

Liability of Franchisor and Franchisee

independent contractor.

Critical Legal Thinking – This is a control issue. The franchisee is to execute the operating plan

and the franchisor does not have day-to-day management control over the operations of each

franchise establishment. If the franchisor were liable for every wrongful act and omission in

Case 40.1 Franchise Liability: Rainey v. Domino’s Pizza, LLC

998 A.2d 342, 2010 Me. Lexis 56 (2010), Supreme Judicial Court of Maine

Facts: Domino’s granted a franchise to TDBO, Inc., to operate a franchise restaurant in Gorham,

Maine. The agreement expressly stated that TDBO was an independent contractor and that

negligence. Rainey appealed this judgment.

Issue: Under the facts of this case, can Domino’s be held vicariously liable for the alleged

negligence of its franchisee TDBO?

Decision: The court found that Domino’s was not vicariously liable for the alleged negligence of

necessary to impose vicarious liability.

Ethics Questions: Vicarious liability occurs where a principal is liable for an agent’s tortious

conduct because of the employment contract between the principal and agent, not because the

principal was personally at fault. The agreement between Dominos and TDBO expressly stated

that TDBO was an independent contractor and that Domino’s was not liable for TDBO’s debts

Franchise and Special Forms of Business

Case 40.2 Franchisor Liability: Martin v. McDonald’s Corp

572 N.E.2d 1073, 1991 Ill. App. Lexis 715, Court of Appeals of Illinois

Facts: One of McDonald’s franchises was located in Oak Forest, Illinois. A McDonald’s regional

security manager visited the Oak Forest franchise to inform the manager of security procedures.

ordered the crew to open the safe and get him the money and then ordered them into the

refrigerator. In the course of moving the crew into the refrigerator, Logan shot and killed Martin

and assaulted Dudek and Kincaid. Laura Martin’s parents claimed damages from McDonald’s

Corporation for the wrongful death of their daughter, and Therese Dudek and Maureen Kincaid

by obligating itself to inspect the restaurant to see that the required security measures were

implemented. The court held that McDonald’s was liable for its own negligence due to the failure

of security measures and the failure of its security manager to follow up to determine that the

security deficiencies at the Oak Forest franchise had been corrected.

it must be completed. The benefit is the safety of franchisee employees and the fact that if there

are no problems, there is no bad publicity. However, the detriment, as seen here, is that once the

franchisor assumes the responsibility, they must carry it through fully.

Critical Legal Thinking Case: Apparent Agency

Holiday Inns licensed Hospitality Venture to operate a franchised hotel in Fort Pierce, Florida.

The Rodeo Bar, which had a reputation as the “hottest bar in town,” was located in the hotel. Due

to the lack of sufficient space, security guards posted in the Holiday Inn parking lot required

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was usually a waiting line to enter. Fights were not uncommon. On the night in question, two

liability.

Critical Legal Thinking Questions: A franchisee is always liable for its own tortious conduct. A

franchisor may be held liable for the tortious conduct of a franchisee that is the “apparent agent”

of the franchisor. This occurs when the franchisor misleads the public into believing that the

franchise is really owned and operated by the franchisor even though it is not. Here, the court

Termination of a Franchise

Most franchise agreements permit a franchisor to terminate “for cause,” which cannot be

unreasonably applied. A termination-at–will clause is generally held to be void as unconscionable.

termination.

Breach of the Franchise Agreement – A lawful franchise agreement is an enforceable contract.

Licensing

considered a license.

Joint Venture

This arrangement allows two or more business entities to combine resources to pursue a single

Joint Venture Partnership – Joint ventures may be operated as partnerships, with each joint

Joint Venture Corporation – Joint ventures may form a third corporation to operate the joint

Strategic Alliance

A strategic alliance is an arrangement between two or more companies whereby they agree to ally

themselves and work together to accomplish a designated objective. A strategic alliance allows

Franchise and Special Forms of Business

Global Law: International Franchising

V. Key Terms and Concepts

 Apparent agency—Agency that arises when a franchisor creates the appearance that a

franchisee is its agent when in fact an actual agency does not exist.

within a geographical area.

 Assessment fee—A fee for such things as advertising and promotional campaigns and

administrative costs.

 Breach of a franchise agreement—If a franchise agreement is breached, the aggrieved

party can sue the breaching party for rescission of the agreement, restitution, and

damages.

territory.

 Consulting fees—Many franchisors charge a monthly or annual consulting fee for having

experts from the franchisor help the franchisee better conduct business.

 Cost of supplies—Involves payment for supplies purchased from the franchisor.

 Covenant not to compete—It prohibits franchisees from competing with the franchisor

franchisee.

 Federal Trade Commission (FTC)—Federal government agency empowered to enforce

federal franchising rules.

 Franchise agreement—An agreement that the franchisor and the franchisee enter into that

sets forth the terms and conditions of the franchise.

status, and so on.

 Franchisee (licensee)—The party who is granted the franchise and license by a franchisor

in a franchise arrangement.

 Franchisor (licensor)—The party who grants the franchise and license to a franchisee in a

franchise arrangement.

the franchisee.

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presale disclosures to prospective franchisees.

 FTC franchise notice—The FTC requires that the FTC franchise notice should appear in

at least 12-point boldface type on the cover of a franchisor’s required disclosure

statement to prospective franchisees.

 Initial license fee—A lump-sum payment for the privilege of being granted a franchise.

service marks, or trade secrets.

 Joint venture—An arrangement where two or more business entities combine their

resources to pursue a single project.

 Joint venture corporation—A corporation owned by two or more joint venturers that is

created to operate a joint venture.

formed to operate a joint venture.

 Joint venture—An arrangement in which two or more business entities combine their

resources to pursue a single project or transaction.

 Lease fees—Lease fees are payments for any land or equipment leased from the

franchisor, billed either as a flat monthly or an annual fee or as a percentage of gross

sales or other agreed-upon amount.

distribution of goods, services, or software.

 Licensee—The party to whom a license is granted.

 Licensing—A business arrangement that occurs when the owner of intellectual property

(the licensor) contracts to permit another party (the licensee) to use the intellectual

property.

 Licensor—The party who grants a license.

sales.

 Service mark—A distinctive mark, symbol, name, word, motto, or device that identifies

the services of a particular franchisor.

 Strategic alliance—An arrangement between two or more companies whereby they agree

subfranchisor.

 Termination-at-will clause—Termination-at–will clauses in franchise agreements are

generally held to be void on the grounds that they are unconscionable.

 Territory—Where a franchisee may operate.

 Trade secret—Ideas that make a franchise successful but that do not qualify for

goods of a particular franchisor.

Franchise and Special Forms of Business