Business Law 101

By Albert L. Kelley, Esq.

Franchising

A hybrid of starting a business from scratch and buying an existing business is the franchise. Here you are in essence starting the business, but you are licensing a name, trademark and know-how from someone else.

In a franchise situation, the business owner, called the franchisee, pays an upfront fee to the entity offering the franchise, called the franchisor. This upfront fee, called the franchise fee gives the franchisee the right to use the franchisor’s business name, logo, business secrets, and know-how. It usually does not include the building, the equipment or inventory, although some franchisors will assist with finding a location, can lease equipment, and can provide inventory at a discount.

To start a franchise, each franchisor must create a document called a Uniform Franchise Offering Circular (UFOC). This document includes the names of the primary officers and directors of the franchisor, the history of the franchise, including all litigation and bankruptcies, a breakdown of all fees, including the initial franchise fee and any continuing fees, an estimate of the total initial investment, restrictions on merchandise/inventory-including what the franchisee may sell and where they may get their merchandise/inventory from, obligations of the franchisor and franchisee, a list of all of the franchisor’s trademarks, patents and copyrights, renewal rights, and financial statements. This is a document that the franchisee must review carefully. Information in the UFOC can give the franchisee an idea if the franchise is a positive move.

Most franchise agreements provide an area of exclusivity where the franchisor will not allow any other franchises. For example, a franchisor may state that the franchisee has the exclusive right to operate that brand of store within a city. Or it may only limit the area to a square mile.

The start-up cost of a franchise runs anywhere between $20,000 to over $1,000,000. Many franchisors offer financing for these expenses. In addition to the start-up costs, most franchisors require the franchisees to pay a continuing monthly royalty, usually a percentage of sales. Some franchisors require the franchisees to also pay a monthly advertising fee to allow the franchisor to create national or regional ads.

While owning a franchise lets the franchisor own their own business, they still have to answer to the franchisor. This means they may have to follow instructions on how the store must look, what merchandise to sell, even how to display their merchandise. In addition, the franchisee cannot simply sell the business whenever they want. Franchisors have the right to approve or reject potential buyers, require the potential buyers to meet certain preconditions before a sale is allowed, or prevent the sale of the franchise outright. If the franchisor fails to protect their trademarks, they run the risk of losing them; if they fail to protect the franchise reputation they risk lawsuits by their franchisees.

At the same time, they must be careful not to exert too much control over the franchisee, lest they be deemed to be overreaching. If the franchisor puts too many controls on a franchisee, the courts can deem them to be partners, subjecting the franchisor to liability for the actions of the franchisee, even though the franchise agreement will clearly state the franchisee is an independent contractor. As an example, in a case from California, Patterson v Domino’s, the appellate court held that Domino’s Pizza was liable for it’s franchisee’s actions in sexually harassing and wrongfully terminating an employee, when the franchise agreement put restrictions on the franchisee’s hiring standards and involved themselves in firing issues. The California Supreme Court reversed saying: “A franchisor enters this arena, and becomes potentially liable for actions of the franchisee‘s employees, only if it has retained or assumed a general right of control over factors such as hiring, direction, supervision, discipline, discharge, and relevant day-to-day aspects of the workplace behavior of the franchisee‘s employees. Any other guiding principle would disrupt the franchise relationship.”

Al Kelley is a Florida business law attorney located in Key West and previously taught business law, personnel law and labor law at St. Leo University. He is also the author of “Basics of Business Law” “Basics of Florida’s Small Claims Court” and “Basics of Florida’s Landlord-Tenant Law” (Absolutely Amazing e-Books). This article is being offered as a public service and is not intended to provide specific legal advice. If you have any questions about legal issues, you should confer with a licensed Florida attorney.

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