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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
40
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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
Chapter 40
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
