Franchise Lawyer Blog

This morning we received an email blast from Field Fisher Waterhouse, a UK firm, reporting on a recent Kentucky case (Doctors' Associates, Inc. v. Uninsured Employers' Fund, 2011 WL 5878145) on the subject of franchisor vicarious liability. The Kentucky Supreme Court found that Doctors' Associates, Inc., which owns the "Subway" trademark and franchises the right to operate Subway sandwich shops worldwide, was not liable for a franchisee's employees' worker's compensation benefits for a work-related injury.

In deciding the case, the court held that the franchisor was not an "up-the-ladder" employer under Kentucky law and that Doctors' Associates, Inc. did not control the day to day activities of the franchisee, a critical element if vicarious liability was to be found. The court noted that despite retaining certain rights such as the right to be named an additional insured, receipt of notice of cancellation of insurance, the right to inspect the franchisee's premises and business records, nevertheless Doctors' Associates, Inc. was not considered to control the franchisee's activities.

In reviewing the Doctors' Associates, Inc. case, it occurred to us to review and highlight the law on this issue in our state, New York. We have written on this topic previously in this franchise law blog. Generally, a franchisor in New York will not be held vicariously liable for the actions of its franchisees if the franchisor did not retain control over the franchisee's day to day actions. These cases are decided on a case by case basis and are heavily dependent on the particular set of facts at hand.

As a practical matter and as stated in Rupert M. Barkoff's November 30, 2011 article in the New York Law Journal, Vicarious Liability: Interplay of Franchise and Trademark Laws, franchisors should: (1) avoid controlling their franchisees' day to day activities; (2) require that the franchisees hold themselves out to the public as an independent operator of their respective franchised businesses; (3) avoid making employee hiring/firing decisions for its franchisees; and (4) offer suggestions and recommendations for franchisees to follow in connection with the operations of their franchised businesses rather than a prescribed set of requirements.

These nuances can be fully addressed in the franchise agreement. Our franchise agreements have developed over time to provide franchisors with sufficient control over essential elements, such as trademark and system integrity, while trying not to get bogged down in day to day operations, always considering potential vicarious liability issues.

In the January 12 Wall Street Journal, Stephanie Simon, in her article entitled Franchises, on a Smaller Scale, highlights the growing trend of franchisors (especially food franchisors) offering multi-tiered franchise concepts (meaning offering multiple price/size entry points to a franchise). As noted in an article in Entrepreneur magazine's website by Jason Daley, Franchises Hop on the Food-Truck Trend, certain fast food and casual food franchises are looking into expanding their franchise systems through mobile food trucks, which would present a less expensive tier to their systems.

According to Ms. Simon, multi-tiered franchise concepts appeal to potential franchisees because it allows them to buy into a franchise system at varying price points that fit their budget. For example, a full restaurant franchise could cost $300,000 to build out, an express restaurant franchise could cost $200,000 to build out, a mobile truck franchise could cost $125,000 and a food cart franchise could cost $65,000.Ms. Simon attributes the growth of the multi-tiered franchise concept to the tightening of the credit markets. With fewer funds available to develop full restaurant franchises or other standard-size franchise stores, franchisees have been able to obtain financing to develop less expensive express locations, mobile trucks, kiosks and other types of franchises.

In determining whether to offer multi-tiered franchises, franchisors consider whether their standard franchise system translates well into the smaller scale business models. As Ms. Simon pointed out, franchisors should ensure that their products, design specifications, signage and other aspects of their standard franchise system are either suitable for the other business models or can be altered in some fashion to better suit those business models.

In our practice, we have already discussed and assisted our clients with implementing a multi-tiered approach. One of our clients, Chinese Mirch, Inc., a franchisor of Chinese food restaurants influenced by Indian flavors and spices, has begun offering an express restaurant franchise in addition to its full-sized restaurant. We have also discussed expanding another client's frozen-yogurt retail business through mobile trucks and stand-alone kiosks. Although there are some concerns about diluting the value of the brand by offering smaller outlets, this approach is enabling brands to make themselves available to more candidates in a tighter economic environment.

By Richard Bayer

Over the past few years, the slowdown in the American economy has inspired many franchisors to consider expanding their businesses overseas. Even putting the recession aside, international franchising can be a profitable alternative to trying to expand in an already saturated American market. As we noted in our September 22 blog, Yum! Brands recently sold 2 American systems (A&W and Long John Silver's) to focus on brands more suited for growth in China.

However, expanding overseas isn't the same as selling franchises in the United States. You, the franchisor, will need to take special considerations and make some adjustments to your business model before entering the international market.

Understand Local Regulations

You will likely need to follow different franchise, business opportunity, tax and reporting rules in international markets than you do in the United States. Some countries will require your company to operate profitable locations in the country before you are allowed to sell franchises. No matter where you operate, you will probably need to tailor your franchise agreement and offering documents to meet local rules.

Revamp Your Product

You will probably need to tailor your product to adapt to any particular country's culture and preferences while keeping the soul of your business intact. For example, if you are in the restaurant business, you might need to add more vegetarian options to the menu or substitute unpopular or hard-to-source ingredients with local favorites.

You may also want to take a look at your brand image. Could your business name or logo be unintentionally humorous or offensive when translated in the local language?

You need to understand the culture of the country in which you will be operating. Figure these issues out early, so you don't lose money by making an unwitting mistake.

Consider Local Residents' Purchasing Power

Can the residents of the country where you are expanding afford to buy your product? Do you need to alter your product so that it is accessible to more people? These are a couple of considerations worth thinking about.

For example, although China and India are both densely populated and quickly growing countries, many residents still cannot afford to purchase Western-style products.

Get Qualified Help

International expansion can be tricky, but also a rewarding way to grow your business. If you think operating a franchise overseas sounds promising, assisting the help of an experienced and knowledgeable team is vital. Local franchise attorneys, accountants and franchisee recruiters who understand the regulations and culture in the target country are a few examples. Let your domestic franchise attorney assist you in this process.

We continually search the "world wide internet," as my Dad calls it, for signs that the skies are brightening (or not) for the franchising world.

If you are looking for brightening, look no further than the IFA Smartbrief, the email blast from the International Franchise Association, which offers well-organized selections from the media world attesting to the premise that the franchising glass is half full. Yesterday's offering lead off with an article from The Street, an online source which offered five reasons why franchising would be on the upswing in this moribund economy. The reasons: (i) loosening credit; (ii) more ways to finance a franchise; (iii) commercial space is available; (iv) franchisors are more willing to help with expenses; and (v) more talent is available.

These theories have been in circulation for some time. We wrote on this blog in May 2009 that franchised businesses might weather these economic storms more easily because of franchisor support, qualified refugees from unemployment, imaginative financing, cheaper real estate and just because historically they supposedly have. Whether that is proving to be the case remains to be seen. There are success stories and there are just as many failures.

One thing that does consistently emerge in any examination of the economic landscape is evidence of the resiliency of the American worker. One franchising model that seems to have caught on is the one man (or woman) franchise: franchises that do not need employees. Some of these are mobile franchises, about which we have just written.

According to The Economist, Americans started an average of 555,000 businesses every month from 1994 through 2004. Some individuals, however, are afraid of taking that step to self-employment because they do not want to deal with the personnel issues that come in tandem with owning a business. Luckily, there are franchise opportunities available that do not even need employees.

Business News Daily--an online website that provides information for startups and small business owners-- recently offered as examples several franchises that do not require employees, including:  

1. America's Swimming Pool Company: Franchisees can operate their own professional pool and spa maintenance business through this franchise, and can do so alone--even without having any background in pool service.

2. Stroller Strides: This franchise offers franchisees the opportunity to provide fitness programs and motivation services to moms--all in just a few hours work a day. 

3. Lawn Doctor: Through this franchise, solo franchisees can offer lawn and maintenance service on a flexible schedule.

4. Safeguard: This franchise provides business management solutions to small business owners including check, form, filing and printing services. And, through Safeguard, franchisees can work alone.

5. Mom Corps: This staffing franchise helps experienced individuals looking for flexible work and low overhead costs find employers with short-term staffing needs.

 6. Sir Grout: This franchise operates mobile businesses for grout, tile, stone and wood restoration.

Running a franchise without the need to oversee employees can be extremely beneficial. Franchisees do not have to deal with the responsibilities that accompany hiring and managing others, nor do they have to worry about complying with employer payroll laws or worker's compensation. A first-time business owner can focus all of his or her energy on making the business grow, rather than getting bogged down in managerial details.

So, as things continue to be tough going, one discernible trend is a simplification of the approach to business, the above representing perhaps the most basic evidence of that.

The Wall Street Journal online Small Business section posted a piece yesterday on mobile franchises, described as franchised businesses in which owner/operators work out of van, truck or trailer. Low start up costs are the chief attraction, since these businesses avoid the hefty expense of lease and build-out costs for a retail or wholesale location. The piece also mentions some of the drawbacks to the model, such as fierce competition in the areas that are conducive to mobile businesses and some difficulties in marketing and promotion, partially tied to the lack of a storefront presence.

We have seen success with a mobile franchise concept first hand. We have written previously about our franchise client Sir Grout, who are grout, tile, stone and wood restoration specialists and are ranked in Entrepreneur Magazine's Franchise 500. Sir Grout has shown steady growth from its first franchise in 2008, with 17 franchises operating as of the end of 2010. 

The key is to find entrepreneurs who do not want to be trapped behind a desk or counter and thrive on their feet, interacting with people on a regular basis. It is a perfect set-up for a person with a skilled handyman or installation backround. The International Franchise Association recorded growth across the board this past year in the mobile segment, with a 26% jump in franchise sales in the mobile bathroom remodeling business, with similar jumps in mobile handymen, electric and plumbing.

From a franchisor's point of view, the appeal is very strong. Numerous busineses lend themselves to the mobile model, particularly in the housing segment, and there is a healthy supply of willing and experienced workers left over from the housing boom who can fill the spots. The limited upfront capital necessary is still achievable for many people. Also, the mobile model is flexible, with the ability to expand into other sources of revenue with minimal capital outlay. Once you are in the door, opportunities abound.

As Jeff Gill, one of the founders of Sir Grout, says, "In today's economy, potential franchise owners can ill afford to take risks when investing in a new business. To be attractive to a prospective franchise owner, you must show them a lot of value with a low cost to start and maintain the business. We have gone to great lengths to create an opportunity that provides multiple streams of revenue that mimics owning 3 different franchises for the price of one."

Just like in the stock market, franchise investors are looking to make value investments with little speculation. Hitting the road with your own business fits that aim nicely.

Many franchising lawyers evolved into that practice from other more traditional areas of practice: intellectual property, licensing, business development. In my case it was real estate law. It is a logical connection. As we have noted in prior posts, the vast majority of franchisors need to have reliable counsel with respect to real estate matters; the exception being "franchises on wheels," such as Sir Grout, a franchising client about whom we have written in the past.

If you are a typical franchisor, your franchisees will open a physical location somewhere. You want to have oversight and approval of where the site is located and the ability to veto any site that does not meet your criteria for a franchise location. The franchisor should develop a model of an ideal site and an acceptable site, using identifiable and verifiable criteria. The FDD and franchise agreement should contain detailed provisions for how sites are located and presented for approval, with ample opportunities to inspect and specific time frames that will govern the parameters within which this must be accomplished. The successful location of a site and completion of a lease agreement are the primary factors that will determine how quickly the franchise can open. The more specific these requirements are, the more predictable your schedule of franchise openings will become.

As franchisor you will want to make sure that the lease contains specific provisions that will enable monitoring of the franchisee's operations and, if necessary, the ability to step in and take over. Your FDD and franchise agreement should contain a list of required lease provisions or, as an alternative, an actual lease rider as an exhibit that must be attached to and executed as part of any lease. You will need a collateral assignment of lease executed in advance by the franchisee and the landlord, so that in the event of a franchisee default, there is no question about your right to step in and take possession. And if you do step in, the lease must be clear that you are not assuming any of the franchisee's past due or defaulted liabilities and obligations.

Will you as franchisor provide a guaranty of the franchisee's lease obligations? You may be asked to. That decision depends on the site, of course, and the likelihood that you would want to continue to operate even if the franchisee folds. And if the site is attractive enough so that your continued operation of the site in the event of the franchisee's failure is a real possibility, then you as franchisor have to look at the lease as a tenant would. Everything is potentially relevant to your ability to make money in a "company-owned store:" common area maintenance charges, tax escalations, electric and other energy charges, renewal rates and all other financial terms.

You must understand your franchisee as well. Even the most attractive site may be too much for a prospective franchisee: too much rent, too much space, too much of a challenge for an inexperienced operator.

We find that we discuss these matters with our prospective franchisor clients as we are assembling the data needed to put together their FDD. Most of them have a business model for the ideal store. We start exploring with them how many different types of places their franchisees may end up being situated in and crafting FDD disclosure and franchise agreement clauses that protect them in each of those cases.

The experience of opening a franchise unit is rife with rewards, risks and challenges. Traditionally, even highly successful franchisees stuck to a single brand when expanding to multiple locations. But some entrepreneurs are exploring the unique possibilities offered by multi-concept franchising.

Having the ability to diversify their business capital, just like any other investor, allows franchisees the potential to increase both business and profit growth, while hedging against possible downturns in a particular industry.

Franchisors have expressed concerns about the distractions multiple franchise operations may create, such as a failing concept stealing attention from a franchisee's other business. For their part, multi-concept franchisees have to exercise caution to avoid violating franchise agreements or comingling business records, not to mention the fact that effectively navigating two different franchise systems can be very difficult.

Nevertheless, for some entrepreneurs the benefits outweigh the risks. There are many different strategies to choosing the right franchise operations. The main idea, however, is to make sure each business compliments the other in a way that creates some kind of synergy for the main goals of the franchisee.

Seasonal Cycles

A prime example involves franchises that are at the mercy of seasonal changes. A lawn care franchise operating in a geographical area of the country where there are winter months, for example, may only provide lucrative paybacks during a few months out of the year. So, to balance out incoming profits more consistently, a franchisee may opt to invest in another business that provides income during the winter months such as a coffee house or specialty bread or soup shop.

Different Cash Flow Cycles

Another example involves franchises that, when initially commenced, do not bring in any real money. Franchising.com provides an excellent example and details an instance where a franchisee had decided to open an Aaron's, a sales and leasing company of furniture, electronics, and appliances. Initially, the franchisee didn't see profits from the company right away. The amount of money the franchisor needed to first invest in expensive merchandise to stock up the store was not immediately returned via monthly rental fees from customers.

To balance out the illiquid period, that same franchisee invested in several operational Applebee's restaurants. The income from the restaurant franchise operations provided enough money to support the franchisee until the Aaron's franchise turned a profit.

Whatever the approach, some New York franchise attorneys say that many franchisees who opt to diversify and invest in multi-concept franchising today have become-and will most likely continue to be-profitable.

We first noted in June of 2010 that the tightening credit environment was creating development difficulties for franchisors and franchisees. At that time, franchisors were beginning to step in to create credit opportunities for prospective franchisees.

With the national and global economy still in recession, the franchise industry is caught in the grips of a vise-like credit squeeze. According to the New York Times, the current credit crunch is the worst the industry has seen since the franchise model first caught on after World War II.

Where an individual with good credit would have once had the luxury of choosing from a large number of eager lenders, now a prospective franchise owner may be lucky to find one or two willing lenders-and often at very unattractive terms.

First-time franchisors have been hit the hardest, as banks are less willing to take risks on individuals without a proven track record. To make matters worse, first-time business owners are often less able than their more seasoned counterparts to make large up-front equity investments or provide suitable collateral.

However, with this bad news comes a silver lining: Faced with the widespread lack of available credit, many franchisors are looking for ways to sweeten the deal for potential franchisees by taking an active role in making funds available.

Some franchisors have gone so far as to join the financing business themselves, creating their own lending and leasing programs that cater directly to franchisees. Others have initiated "credit enhancement" plans in which the franchisor guarantees a portion of the loans that franchisees take out with third party lenders, thereby reducing the risk to the lending institution.

In addition to providing loans directly, some franchisors have taken other measures to make the start-up process more affordable. For instance, many franchisors have lowered or waived fees and royalties, or reduced costs by relaxing the physical requirement of the franchise site itself.

The New York Times recently profiled a couple of instances where franchisors are offering some form of lending or leasing assistance to potential franchisees.

Marco's Pizza

One such example involves a prospective restaurateur who wished to open a Marco's Pizza franchise. The man visited several banks to help secure a $250,000 loan for the franchise, but was either rejected or offered loan options with unattractive terms. Instead of giving up hope, the man found help through a leasing program offered by the pizza franchisor.

Marco's Pizza chain understood all too well the roadblocks this man and other potential franchisees were encountering. To help, they created a few financing programs to assist new franchisees. Because of the financing opportunities offered through the pizza chain, the man was able to secure his $250,000 start-up costs and become a franchisee.

Wireless Zone

Sean Fitzgerald, vice president for franchise development at Wireless Zone-a cellphone company-also understands the predicaments potential franchisees face today. The Times reported that Wireless Zone currently provides financing to franchisee hopefuls to help with fees and start-up costs.

According to the International Franchise Association, a leader in franchising education and advocacy for over 50 years, franchisees are expected to seek over $10 billion in funding this year. However, banks and lending institutions are only expected to lend just over $6 billion.

Some New York franchise attorneys say that it's likely more and more franchisors will be stepping in to fill that gap and lend a hand to help franchisees kick-start their operations.