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CHAPTER 36
SMALL BUSINESSES AND FRANCHISES
ANSWER TO CRITICAL THINKING QUESTION
IN THE FEATURE
DIGITAL UPDATE—CRITICAL THINKING
Sole proprietorships, as well as other businesses, routinely seek funding for online
projects. How can the individuals involved avoid personal liability? One way to avoid
personal liability is to receive funding through the sale of an interest in the actual or proposed
ANSWERS TO QUESTIONS
AT THE ENDS OF THE CASES
CASE 36.1—LEGAL REASONING QUESTIONS
1. As is clear from the law applied in this case, and the result, the liability of a business
for unpaid taxes “follows the assets.” Why? The liability of a business for unpaid taxes
“follows the assets” on the sale of the business, rather than remaining with the seller, for
2 UNIT EIGHT: BUSINESS ORGANIZATIONS
2. What action can Gadley take now to avoid suffering the loss of the funds required to
cover Gresh’s unpaid taxes? After the result in the Gadley case, Gadley can file a breach of
contract action against Gresh for misrepresenting the liabilities of her business at the time of its
sale. Gresh operated her business Romper Room as a sole proprietor. As an employer, she
3. What action should a buyer take before purchasing the assets of a business to avoid
liability for the seller’s unpaid taxes? Before buying the assets of a business, a buyer should
obtain the seller’s assurance that all liability for taxes will be satisfied before the sale.
CHAPTER 36: SMALL BUSINESSES AND FRANCHISES 3
CASE 36.2—CRITICAL THINKING
ECONOMIC
What is the most likely reason that All Professional stopped paying the franchise fees
and making note payments, in addition to closing one of its offices? Why is this an
insufficient justification for breach of the franchisee’s agreements with Century 21? A
lack of funds—whether by undercapitalization or a failure to succeed—was the most likely
reason that All Professional stopped paying its franchise fees, making payments on the note,
CASE 36.3—CRITICAL THINKING
LEGAL ENVIRONMENT
Why should House and HAI have been advised of Holiday Inn’s plan to grant a franchise
to a different hotel in their territory? House and HAI should have been informed of Holiday
Inn’s plan to grant a franchise to a different local hotel in order to evaluate the economic risk of
4 UNIT EIGHT: BUSINESS ORGANIZATIONS
ECONOMIC
A jury awarded HAI $12 million in punitive damages. The state court reduced this to $1
million, but the appellate court reinstated the original award. What is the purpose of
punitive damages? Did Holiday Inn’s conduct warrant the $12 million punitive damages
award? Explain. The purpose of punitive damages is to punish a defendant and deter similar
future conduct. Yes, Holiday Inn’s conduct supported the increased amount of punitive
damages. The harm to HAI was substantial. Holiday Inn—which is a wealthy, a multi-national
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Type of franchise
This is a chain-style business operation. Taco Bell, Burger King, and McDonald’s restaurants
are other examples of chain-style business operations.
2A. Sole proprietorship
If Del Rey operated the restaurant as a sole proprietorship, the loss for the damaged kitchen
3A. Wrongful termination
4A. Good cause
If La Grande Enchilada attributes the termination of the franchise solely to Del Rey’s failure to
CHAPTER 36: SMALL BUSINESSES AND FRANCHISES 5
ANSWER TO DEBATE THIS QUESTION IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
All franchisors should be required by law to provide complete estimates of the
profitability of a prospective franchise based on the experiences of their existing
franchisees. Because many franchisors seem only to survive by selling more franchises—
rather than from current operations—they tend to exaggerate the potential profits than can be
made. Those seeking to buy a new franchise are therefore often provided with little hard
ANSWERS TO ISSUE SPOTTERS
AT THE END OF THE CHAPTER
1A. Frank plans to open a sporting goods store and to hire Gogi and Hap. Frank will
invest only his own funds. He expects that he will not make a profit for at least eighteen
months and will make only a small profit in the three years after that. He hopes to expand
eventually. Would a sole proprietorship be an appropriate form for Frank’s business?
2A. Anchor Bottling Company and U.S. Beverages, Inc. (USB), enter into a franchise
agreement that states the franchise may be terminated at any time “for cause.” Anchor
fails to meet USB’s specified sales quota. Does this constitute “cause” for termination?
6 UNIT EIGHT: BUSINESS ORGANIZATIONS
ANSWERS TO BUSINESS SCENARIOS
AT THE END OF THE CHAPTER
36-1A. Franchising
Factors that potential franchisees might want to consider before committing themselves to a
franchise include: how long the franchisor has been in business, how profitable the business is,
36-2A. Control of a franchise
The court would likely conclude that National Foods was responsible for the acts of harassment
by the manager at the franchised restaurant, on the ground that the employees were the agents
of National Foods. An agency relationship can be implied from the circumstances and conduct
ANSWERS TO BUSINESS CASE PROBLEMS
AT THE END OF THE CHAPTER
36–3A. SPOTLIGHT ON MCDONALD’S—Franchise termination
McDonald’s should prevail. J.C. failed to comply with the terms of the franchise agreement.
J.C. might argue that McDonald’s previous exercises of discretion, in regards to late payments,
36–4A. Franchise disclosure
No, because a disclaimer would undercut the purpose for the requirement of disclosure. Yes,
because parties to agreements might discuss any number of issues during negotiation, and they
CHAPTER 36: SMALL BUSINESSES AND FRANCHISES 7
should not be held to oral statements that are later refuted or replaced by more formal, written
terms. This case was vacated and remanded. Exculpatory clauses in the franchisor’s franchise
36–5A. The franchise contract
In most franchise relationships, the franchisor determines the territory to be served. A franchise
contract may give a franchisee exclusive rights to an area—“territorial rights.” But typically
Here, under Kubota’s franchise contracts with its dealers, Kubota reserved the right to
enter into a dealership agreement with “others at any location.” Regardless of what might
constitute a franchisee’s market or how close one franchise location might be to another, the
franchisor has the right, under this contract, to enter into a dealer agreement with “others at any
location.” Arguably, a significant loss of profits may be a ground for a court to hold that the
establishment of close, competitive franchisees violates the implied covenant of good faith and
fair dealing. But when a contract expressly allows a franchisor to enter into dealership
agreements “ay any location,” a franchisor who exercises that right does not change the
competitive circumstances of its franchisees—such events are contemplated by the contract.
A franchisee might argue that the placement of franchisees nearby is constructive,
wrongful termination of at least one of the franchisees. Sometimes, however, the nearness of
8 UNIT EIGHT: BUSINESS ORGANIZATIONS
36-6A. BUSINESS CASE PROBLEM WITH SAMPLE ANSWER—Franchise termination
Oshana and GTO have stated a claim for wrongful termination of their franchise. A franchisor
36–7A. Quality control
Yes, Liberty can be held liable for the statements in its franchisees’ ads. The validity of a
provision permitting the franchisor to establish and enforce certain quality standards is
unquestioned. The franchisor has a legitimate interest in maintaining the quality of the product
or service to protect its name and reputation. If a franchisor exercises too much control over the
operations of its franchisees, however, the franchisor risks potential liability. A franchisor may
occasionally be held liable under the doctrine of respondeat superior for the tortious acts of a
franchisee or the franchisees’ employees.
36–8A. Quality control
No, Domino’s Pizza, L.L.C., is not liable for negligence in the circumstances of this problem. The
operation of a franchise normally is left to the franchisee. When a franchise involves the
preparation of food, however, the franchise agreement often establishes certain standards for
the franchisee to follow. If the agreement gives a franchisor a significant degree of control over
CHAPTER 36: SMALL BUSINESSES AND FRANCHISES 9
36–9A. Franchise termination
No, Executive Care is not entitled to an injunction against the Marshals and their new company.
An injunction is an extraordinary remedy. To obtain an injunction before a suit is resolved, or
arbitration or other alternative dispute resolution procedure is undertaken and completed, a
party must establish that he or she will suffer irreparable harm if the injunction is denied.
36-10A. A QUESTION OF ETHICS—Sole proprietorship
(a) The court granted a summary judgment in Vilardo’s favor against Sheets and a
default judgment against Travel Center. The court awarded damages in the amount of
$8,277.35, which was trebled to $24,832.05 under the state consumer protection statute. On
Sheets’s appeal, a state intermediate appellate court affirmed the lower court’s judgments.
10 UNIT EIGHT: BUSINESS ORGANIZATIONS
(b) The appellate court ruled against Sheets on this argument “[i]n view of the fact that
Sheets admitted that Travel Center, Inc. was a sole proprietorship . . . . A sole proprietorship
has no legal identity separate from that of the individual who owns it. Thus Sheets, the lone
ANSWERS TO LEGAL REASONING GROUP ACTIVITY QUESTIONS
AT THE END OF THE CHAPTER
36–11A. Franchise termination
(a) Elkhatib’s refusal to offer breakfast sandwiches containing pork at his franchise
locations was based on his religious beliefs. When he sought to relocate one of the franchises,
(b) Dunkin’ Doughnuts (the franchisor) has a right to require franchisees to offer a
uniform menu to protect its name and reputation. Quality standards are particularly important in
reasons were not arbitrary. The court should issue a judgment in the defendants’ favor.
(c) Elkhatib’s obligations under his current franchise agreement presumably requires
all franchisees to carry the full food product line of Dunkin’ Donuts. Because Elkhatib failed to
carry the full line of food products, the franchisor would not extend his current franchise
agreement or allow the relocation of his store. In determining whether a franchisor has acted in
CHAPTER 36: SMALL BUSINESSES AND FRANCHISES 11
