978-1285428222 Chapter 12 Lecture Note Part 3

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The FTC Franchise Rule—It requires the franchisor to give prospective franchisees a detailed

disclosure at least 10 days before the buyer is legally committed to a purchase. The document

must include:

– Names, addresses, and telephone numbers of other franchisees

– An audited financial statement of the franchisor

– The background and experience of the business’s key executives

– The responsibilities the franchisor and franchisee will have to each other once the purchase is

made.

If the information presented is not true, a legal action can be brought by either the party or the

FTC.

State Regulation—The California Franchise Investment Law of 1971 was first. It requires

franchisors to register the franchise with a state agency and provide prospective franchisees with

a prospectus-disclosure document before a franchise is sold. The prospectus must detail all of the

material facts about the franchise sales transaction. A minority of states have laws similar to

those imposed by California. Their requirements imposed go beyond those of the FTC Franchise

Rule. Most state AGs (or securities commissioner) can monitor franchises after the sale. If there

is fraud, there may be a civil lawsuit seeking damages, injunctions, and fines. In some cases,

criminal liability may be imposed.

Add. Case: Chrysler v. Kolosso Auto Sales (7th Cir., 1998)–Chrysler’s 1988 franchise contract

with a dealer prohibited it from changing locations without approval from Chrysler. A 1993

Wisconsin statute allows a state agency to determine if such moves should be allowed, regardless

of the wishes of the parent company. In 1995, the dealer asked Chrysler if it could move to

another address in the same town. Chrysler refused; the dealer appealed to the state agency.

Chrysler sued to enjoin the dealer from moving and challenged the statute as invalid under the

Contracts Clause of the Constitution, which prohibits states from impairing the obligation of

contracts. District court held for the dealer; Chrysler appealed.

Decision: Affirmed. The Wisconsin law does not violate the Contracts Clause, which cannot be

Add. Case: Continental Basketball Assn. v. Ellenstein Ent. (Sup. Ct., Ind., 1996)–Ellenstein

paid $300,000 for a CBA franchise (the Evansville Thunder) that allowed him to operate a pro

basketball team to compete with other CBA teams and use the CBA logo and marketing system.

The parties ended up in court, with Ellenstein claiming that the CBA failed to disclose sufficient

information under the Indiana Deceptive Franchise Practices Act and that termination of the

Ellenstein franchise was improper under the Act.

Decision: The contract between the parties was a franchise subject to the Act. The Act “creates a

private right of action only for acts which constitute fraud, deceit or misrepresentation.”

Ellenstein failed to show any of those conditions. “There is a clear failure to identify the

substance of the so-called fraudulent statements. Ellenstein instead offers a very general

Issue Spotter: The Road to Riches?

This is based on an actual incident–the promoter took in hundreds of thousands, the franchisees

bought something worth nothing and ended up with nothing since the promoter blew all the

money by the time there was legal action. The franchise promoter is supposed to comply with the

FTC rule about providing information. Don’t believe what is written–who knows if it is true?

The government does not guarantee the information. You are supposed to have names of existing

franchisees–get on the phone to them. Call the BBB and other offices to try to determine if this is

on the up and up. But for new operations, there will not be much information. The old standbys,

such as McDonald’s cost a lot because they are almost surefire to work–new enterprises must sell

for a low price because they are new. So evaluation requires digging into the background of the

promoters–not just believing their sales pitch. Buyers are very much on their own.

The Franchise Agreement—Sets forth in detail the rights, duties, and obligations of the

franchisor and franchisee. As applied to a business format franchise, the key elements would

include, among other things, the rights and duties associated with the use of the franchise

trademarks or tradenames, the use of the franchise operating manual, the location and designated

territory of operation, fee and royalty payments, the advertising commitment, and termination.

Add. Case: Servpro Industries v. Pizzillo (Ct. App., Tenn., 2001)– Servpro is a franchise

operation with over 900 franchisees who operate under the Servpro name. Pizzillo signed an

agreement to operate a Servpro cleaning business; he operated under the name “Servpro of Fort

Lauderdale.” He paid $36,000 for the franchise. He paid Servpro a royalty fee based on a

percent of gross revenues. The agreement said he would not divert any customers to a competitor

and he would not work with a competitor within 25 miles of his service area for up to two years

after termination of the franchise. He ended the agreement after 4 years, owing Servpro $4,000,

and went to work for his wife, who started a competing business. Servpro sued for $4,000 and

for breach of the non-compete clause. The court agreed with Servpro, ordering Pizzillo to pay

the money due and to stop working for the competition. He appealed.

Decision: Affirmed. Covenants not to compete are not favored by the law, but they are not invalid

per se. They may be enforced when deemed reasonable under the circumstances. Servpro has an

interest in protecting the value of the basic product it has to sell: its franchises. If it could not

Add. Case: Rochester Lincoln-Mercury v. Ford Motor (1st Cir., 2001)–Casaccio owned a

Lincoln-Mercury dealership in New Hampshire, to sell and service Lincoln and Mercury cars.

Wanting to sell Fords, he applied to Ford to takeover an existing franchise, which he agreed to

buy from the owner, subject to approval from Ford. His request was rejected. He was told that

his franchise was not a good performer, so they would not allow him to take over another

franchise. Casaccio sued Ford, contending that it violated New Hampshire’s statute regulating

“business practices between motor vehicle manufacturers, distributors, and dealers.” The law

prohibits acts of bad faith. The court dismissed the suit; Casaccio appealed.

Decision: Affirmed. The statute protecting franchisees against acts of bad faith does not apply to

applications to obtain a new franchise, even if the application is from an existing franchisee who

Trade Name and Procedure—The agreement will provide the franchisee with the right to use the

franchisor’s name and identifying trademarks or trade names. As a condition for the use, the

franchisee normally undergoes training and is given the use of the franchisor’s confidential

operating manual. The franchisor specifies the franchise’s requirements regarding record keeping

systems, advertising, hours of operation, hiring and training practices, and other details of the

franchise’s operations.

Territorial Rights—The agreement imposes limits on the territorial rights of the franchisee and

the franchisor. It usually specifies whether the franchisee is limited to operating only one unit

within the territory. The agreement also dictates which party has the responsibility to select the

site and to construct or establish the physical facility in the territory.

Add. Case: Imperial Motors v. Chrysler (D. Mass., 1983)–Imperial agreed to have Plymouth

and Chrysler dealerships. The Chrysler district manager orally assured Imperial that it would

have the only Plymouth dealership in a four-city area, but Chrysler allowed another dealer to be

established 7 miles from Imperial. Imperial sued, asserting that Chrysler had violated the

Automobile Dealers’ Franchise Act by approving the other dealer. Chrysler moved for summary

judgment, claiming the Act covered only written franchise agreements. That Act is a federal

statute that provides an auto dealer with a federal cause of action against a manufacturer who

fails to act in good faith in complying with the terms of the franchise or when terminating the

franchise.

Decision: The court upheld Chrysler’s motion for summary judgment because it had not violated

the Act by allowing another franchise in the area. The Act covers franchisor actions that are a

“failure … to act in good faith in performing or complying with any of the terms or provisions of

the franchise, or in terminating, canceling, or not renewing the franchise with a dealer.” Good

Franchise Fees and Royalties—Franchisors often require an initial franchise fee and a royalty,

generally a percent of the sales of the business. The franchisor may require the franchise to pay

an annual fee for advertising that depend upon whether the franchisor does local, regional, or

national advertising on behalf of its franchises. To protect the tradename, many franchise

agreements prohibit franchisees from engaging in any advertising or promotional programs not

approved by the franchisor.

CASE: Dunkin’ Donuts Franchised Restaurants v. Sandlip (N.D., Ga., 2010)—Three people

owned Sandlip, which owned two Dunkin’ shops. Dunkin’ sued, contending they failed to

remodel their stores, failed to attend mandatory meetings, and failed to prepare proper

immigration papers for employees. Dunkin’ also claimed Sanlip transferred some ownership

interests without Dunkin’ permission. Sanlip offered a new buyer for the operation, but Dunkin’

refused the party offered. Sunkin’ moved to force Sanlip out of the two operations; Sanlip

countersued that Dunkin’ must let them sell to the party who had made them an offer to take

over.

Decision: The agreement required Dunkin’ to not “unreasonably” reject a proposed sale.

Dunkin’s standard analysis projected losses for the stores, which means it will not approve a sale.

Questions: 1. If Sanlip had a willing buyer with sufficient cash to finance the operation, why

would Dunkin’ Donuts reject the buyer?

Franchise operations are often sued for selling franchises that fail, contending that a market

analysis should have shown likely failure. A way to head off such litigation is to not sell

2. Aren’t the terms of the franchise agreement favorable to Dunkin’ Donuts?

This was a tight contract, but that is true of most large, successful chains. There is a method that

works, so the franchisor insists the franchisees stick by it. The main reason for the termination

Add. Case: Coffee Beanery v. Albert (Ct. App., Mich., 2006)—Yurick, Shaw and Albert formed

an LLC to operate a Coffee Beanery franchise. When they signed the agreement, they falsely

claimed they had seen disclosure agreements that they had not. Later, they fought; Albert and

Yurick bought out Shaw. Trouble continues and they tried to back out of the franchise, claiming

the agreement was void. Beanery sued for payment. Trial court held for Beanery. The partners

appealed.

Decision: Affirmed. Under the Michigan Franchise Investment Law, they were supposed to get

disclosures. The fact that they did not does not make the agreement invalid, since they were the

Termination—Franchise agreements are usually explicit about events that can bring about

termination. Typically, the franchisor may terminate in case of bankruptcy of the franchisee or

the failure of the franchisee to submit to inspection by the franchisor. Termination notice must be

given to the franchisee. In some states, the franchisor must provide the franchisee with

reasonable time to correct the problem. Some states restrict a franchisor’s ability to terminate a

franchise unless there is “good cause.” Upon termination, the franchisee loses all rights to the

franchisor’s tradename and know-how.

Add. Case: Garnett v. McDonald’s (Super. Ct., Conn., 1993)–The Speros were McDonald’s

franchisees. Garnett went into the Speros’ McDonald’s, slipped on a wet floor and was injured.

He sued the Speros and McDonald’s. McDonald’s filed a motion for summary judgment on the

ground that there is no genuine issue regarding its liability. It filed copies of the franchise

agreement, arguing that it did not have possession or control. It argued that the Speros are liable

for accidents because they had the duty to maintain the premises, including the floor. Garnett

claims that the Speros were required to follow the “McDonald’s System” in its business

procedure under the terms of the agreements. This included practices relating to cleanliness such

as mopping the floor. Therefore, Garnett argued, the court should deny McDonald’s motion for

summary judgment.

Decision: McDonald’s motion denied. There were issues regarding the liability of each defendant

based on who had control of the premises. The agreements between the parties do not provide

Cyberlaw: Franchise Information on the Internet

FTC regulations state that there is to be no particular difference in traditional ways of offering

franchises and those offered via the Internet. The informational requirements are the same; so

long as those are followed, the entire transaction can occur over the Internet.

Discussion Question

A partnership is a business organization made up of two or more people who have entered into an

agreement, formally or informally, to carry on a business venture for a profit. Four people who

own a summer cottage jointly and use it only for their personal enjoyment would not be a

partnership, since they are not in the venture for a profit. (They would all be liable, however, for

any tort claims against the cottage owners). If they purchased the cottage with the intent to rent

(or restore and sell) it for a profit, they would be a partnership. All partnership rules would then

apply to their activities related to the cottage. The situation becomes more complex if we assume

that while two of the doctors view the relationship as a personal undertaking–say, for example,

they bring their families to the cabin once a year for two weeks of vacation–the other two rent

the cottage with the intent to make a profit.

Case Questions

1. No they were not partners. The fact that Mehta used Citrin’s office and billed patients in

Citrin’s name did not form a partnership. “The indicia of the existence of a partnership

relationship among several individuals are a pro rata sharing of profits and losses of the

2. (answer on Internet for students) Covalt and High were still both shareholders of CSI and

partners in the building they rented to CSI. Hence, even though Covalt was working for a

competitor, he had a fiduciary duty both the CSI and the partnership. When there is a dispute

between two equal partners, neither has the power to force a change; that is, in case of

3. Generally, a corporate officer is not considered the employer responsible for creating the

contractual employment relationship and is not personally liable for a breach of that relationship.

Under Nevada corporate law, individual liability does not extend to officers, directors, or

4. (answer on Internet for students) The partners were under a fiduciary duty of full disclosure to

all partners involved in the business venture: “Appellants owed a fiduciary duty to plaintiff as the

widow and executrix of their deceased partner in purchasing from her their deceased partner’s

5. Sheehan could not hold former partners, who were not partners at the time the lease was

signed, liable. However, every general partner who signed the lease became jointly and severally

liable for the lease. The liability of any of the partners who signed the lease was not ended when

6. (answer on Internet for students) No piercing the corporate shield was not warranted; Haff

was due protection from personal liability. To win the case, plaintiff must show that Haff

7. The guarantors must all pay judgments on the guaranties—Emprise collects first. The four

guarantors have no claim for contribution from their co-guarantors without having first paid the

8. Reversed. Domino’s gave the franchise owners longer than they had to under the agreement to

get things right, so the termination was proper under the franchise agreement. Failure to pay

taxes was grounds for terminating the franchise. It was not interference with prospective business

9. Summary judgment for Burger King upheld. The termination agreement was clear and

reasonable as to its meaning. If a franchisee can own a competitor franchise, it allows them

access to proprietary materials that are of possible interest to the other and dilutes their interest in

Ethics Question

In undertaking the business transaction, Cook needed to evaluate both his required

duty-of-loyalty to his partner Smith in Trinity, and his ethical concerns toward the good faith

seller, McCade. Cook has a legal duty-of-loyalty to Trinity and Smith under partnership law. The

On the other hand, Cook could argue that the property was sold to a third party because McCade

did not like Smith, and therefore refused to sell it to him in any fashion. However, unless the

property sale contained a restriction on resale by Cook to Trinity, and hence Smith, Cook does

not have a good excuse for not selling the property for its purchase price plus expenses to his

Essay Question from Case

Beracha, CEO of Campbell, which operated a bread plant in North Carolina, told the employees

in a meeting in August that the plant was profitable and their jobs were secure. In December, the

employees were told that the plant would be closed in February and their jobs lost. Some

employees sued Beracha and the company for negligent misrepresentation. The trial court

dismissed the suit; the employees appealed. Do they have a claim? [Jordan v. Earthgrains, 576

S.E.2d 336, Ct. App., N.C. (2003)]

Answer: Affirmed. Beracha did not owe a duty to report accurate information about the plant’s

financial status to the employees. He owed a duty of care to the corporation. The employees “fail

Internet Assignment

Jurist Legal Intelligence, Business Associations: http://jurist.law.pitt.edu/sg_bus.htm

This website is devoted to materials on business associations. For an overview of the most

famous franchisee training facility in the country, search “Hamburger University” to read about

McDonald’s management program.