978-1285770178 Lecture Note BL ComLaw 1e IM-Ch01 Part 1

2 INSTRUCTOR’S MANUAL FOR BUSINESS LAW: COMMERCIAL LAW FOR ACCOUNTANTS

Sole proprietors pay only personal income taxes on business profits.

B. DISADVANTAGES OF THE SOLE PROPRIETORSHIP

The proprietor bears all of the financial risk of losses and liability, however, and the ability to raise capital

is limited.

CHAPTER 1: SOLE PROPRIETORSHIPS AND FRANCHISES 3

the Sarks might have filed for bankruptcy. Under some parts of the Bankruptcy Code, they might have been

able to continue in business while paying down as much of the debt as possible. Or, if that were not possible,

they might have retained all or at least some of the value of their home.

ANSWER TO “THE ETHICAL DIMENSION”

QUESTION IN CASE 1.1

Why did the Sarks take the unethical step of fraudulently conveying their home to their son? What

should they have done instead? The Sarks may have taken the steps that led to the dispute in this case to

save their home and its value for themselves and their son. They may have been motivated by

embarrassment or humiliation for their predicament.

Instead of the unethical step of fraudulently conveying their home to their son, the Sarks might have

attempted to downsize to a smaller residence. Or they might have attempted to renegotiate the terms of their

mortgage, or obtain a second mortgage or initiate a home equity line of credit. Or they might have simply sold

the house themselves and applied the proceeds against their debt. If none of these options were possible,

they might have tried to renegotiate their debts and the terms with Quality and their other creditors..

2. Lack of Continuity

A sole proprietorship ends when the owner dies.

II. Franchises

Franchises can take the form of distributorships, in which a manufacturer licenses a dealer to sell

its product, often in an exclusive territory.

2. Chain-Style Business Operation

A franchise can take the form of a chain-style business operation. Here, the franchise operates

product, which is marketed according to the franchisor’s standards.

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whole or in part.

B. LAWS GOVERNING FRANCHISING

There is not a solid body of appellate decisions from federal or state courts relating to franchises. Courts

tend to apply general common law principles and appropriate statutory definitions and rules.

1. Federal Regulation of Franchises

a. Industry-Specific Standards

• The Automobile Dealers’ Franchise Act of 1965 protects auto dealership franchisees from

26).

b. The Franchise Rule

The Federal Trade Commission’s Franchise Rule requires—

• Reasonable basis for representations at the time they are made.

• Projected earnings. If these are provided, it must be indicated whether the figures are

based on actual or hypothetical examples.

ANSWER TO CRITICAL THINKING QUESTION IN THE FEATURE—

INSIGHT INTO THE BUSINESS ENVIRONMENT

If the law required franchisors to provide estimates of potential earnings, would there be more or

less growth in the number of franchises? Explain your answer. All franchisors under such a new law

would have to provide some type of estimate of potential earnings. As a consequence, we will probably see a

lower growth in franchises because franchisors will wish to avoid potential prosecution for providing inflated

earnings estimates. Franchisors will therefore provide “low–ball” estimates. These “low–ball” future earnings

estimates will induce fewer individuals to become franchisees.

2. State Protection of Franchising

CHAPTER 1: SOLE PROPRIETORSHIPS AND FRANCHISES 5

State legislation tends to be similar to federal statutes and regulations (to protect prospective

franchisees from dishonest franchisors and prohibit franchisors from bad faith termination).

a. State Disclosures

Many states require—

• Franchise Disclosure Document (FDD). This must be registered with a state official.

• State approval. Advertising aimed at prospective franchisees must be approved.

b. May Require Good Cause to Terminate the Franchise

State law may prohibit termination without “good cause” or require that certain procedures.

ENHANCING YOUR LECTURE—

 FRANCHISING IN FOREIGN NATIONS 

In the last twenty years, many U.S. companies (particularly fast-food chains and coffeehouses) have

successfully expanded through franchising in nations around the globe. Franchises offer businesses a way to

expand internationally without violating the legal restrictions that many nations impose on foreign ownership

of businesses. Although Canada has been the most popular location for franchises in the past, during the last

few years, franchisors have expanded their target locations to Asia, South America, Central America, and

Mexico.

CULTURAL AND LEGAL DIFFERENCES ARE IMPORTANT

Businesspersons must exercise caution when entering international franchise relationships—perhaps

even more so than when entering other types of international contracts. Differences in language, culture,

laws, and business practices can seriously complicate the franchising relationship. If a U.S. franchisor has

quality control standards that do not mesh with local business practices, for example, how can the franchisor

maintain the quality of its product and protect its good reputation? If the law in China, for example, does not

provide for the same level of intellectual property protection, how can a U.S. franchisor protect its trademark

rights or prevent its “secret recipe or formula” from being copied?

THE NEED TO ADEQUATELY ASSESS THE MARKET

Because of the complexities of international franchising, successful franchisors recommend that a

company seeking to franchise overseas conduct thorough research to determine whether its particular type of

business will be well received in that location. It is important to know the political and cultural climate of the

target country, as well as the economic trends. Marketing surveys to assess the potential success of the

franchise location are crucial in international markets. Also, because complying with U.S. disclosure laws may

not satisfy the legal requirements of other nations, most successful franchisors retain counsel knowledgeable

in the laws of the target location. Competent counsel can draft dispute settlement provisions (such as an

arbitration clause) for international franchising contracts and advise the parties about the tax implications of

operating a foreign franchise (such as import taxes and customs duties).

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whole or in part.

FOR CRITICAL ANALYSIS

Should a U.S.-based franchisor be allowed to impose different contract terms and quality control

standards on franchisees in foreign nations that are different than those imposed on domestic

franchisees? Why or why not?

ENHANCING YOUR LECTURE—

 INDEPENDENT CONTRACTOR OR FRANCHISEE?



When Janet Isbell, a sales representative for Mary Kay cosmetics, lost her job, she sued Mary Kay, Inc.,

claiming that she was a franchisee and, as such, was entitled to the protections of the state franchising law.

Among other things, this law provided that a franchisor could terminate a franchising relationship only for

cause and required that the franchisee be given ninety days’ notice. Mary Kay responded that Isbell was not

a franchisee but an independent contractor. The case eventually reached the Arkansas Supreme Court, and

in deciding the issue, the court looked to the Arkansas Franchise Practices Act. At first, the letter of the law,

as spelled out in that act, was not very helpful. The act’s definition of a franchise, for example, did not shed

any light on the case at hand. The court did find one provision in the act, though, that could guide its decision.

According to that provision, the act applied only to a franchise that contemplated or required the franchisee “to

establish or maintain a place of business in the state.” Although Isbell had rented storefront space in a Little

Rock mall to use as a training center for Mary Kay representatives and to hold meetings, Isbell’s contract with

Mary Kay did not require her to do so. Therefore, under Arkansas law, she was an independent contractor,

not a franchisee.a

THE BOTTOM LINE

Businesspersons should realize that the law, and not an agreement between private parties, ultimately

determines whether a franchising relationship exists. In some cases, courts have held that even though

parties have signed a franchising agreement, the franchisees are in fact employees because of the degree of

control exercised over them by the franchisors. In other cases, courts have held that a franchising relationship

exists even in the absence of a franchising contract.

a. Mary Kay, Inc. v. Isbell, 338 Ark. 556, 999 S.W.2d 669 (1999).

ADDITIONAL BACKGROUND—

Law and the Franchisee

A franchise arrangement appeals to many prospective businesspersons who want to be financially in-

dependent and yet feel more comfortable working with an established product or service and a management

network that is regional or national in scope and that has been in place for some time. Although franchises

whole or in part.

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b. Degree of Control

franchisor may be responsible for the acts of the franchisee and his or her employees.

6. Pricing Arrangements

Franchisors may require the purchase of certain supplies at a set price and may set the price at

which a franchisee resells goods. This could violate antitrust laws, however.