Focused on Franchise Law - June 2012



When you think of franchise friendly states, do you think of Georgia? Starting July 1, 2012, franchised businesses and entrepreneurs considering a franchise model might want to take a closer look at that state.

The "misclassification" of employees as franchisees has been a hotly litigated issue of late. Classification matters because it determines whether the individual performing the work is entitled to employment related benefits such as worker's compensation, unemployment insurance and other wage protections.

Under the franchise model that has been under attack, the franchisor obtains and invoices the customers, deducts royalty fees from the amounts billed and pays the franchisee based on expected receipts. The franchisor later recoups any unpaid invoices from the franchisee. The Massachusetts Supreme Court recently held that Coverall franchisees in this type of system were "misclassified" employees and entitled to employee benefits and wages regardless of whether customers actually paid for the services rendered.

Georgia has gone the other way, though, and now recognizes this type of franchisor/franchisee system as a contractual arrangement by statute, not as an employment relationship. Georgia's House Bill No. 548 (HB 548), which becomes effective on July 1, 2012, amends the definition of "employee" in the state's workers' compensation statute to exclude individuals who are parties to a franchise agreement as defined by the FTC's Franchise Disclosure Rule to protect franchisors from workers' compensation claims made by their franchisees. Franchisors and their trade organizations have applauded Georgia's legislature and Governor for enacting HB 548. The International Franchise Association believes its passage will promote franchising in Georgia.

The business and litigation climate are important factors to consider when starting or expanding your business. So, if you are a franchisor looking to expand or an entrepreneur thinking of setting up a new franchised business, you might want to consider Georgia.


If a franchisee defaults on its obligations, most franchise agreements allow the franchisor to terminate the agreement. But what happens if the franchisor defaults on its obligations to creditors? This circumstance is rarely addressed in franchise agreements, but that doesn't mean it can't happen-it does. Franchisors are not immune from tough economic times. For example, Bennigan's filed for Chapter 7 liquidation in 2008, and Friendly's Restaurants, Sbarro and Marie Callender's all filed for Chapter 11 reorganization in 2011, just to name a few.

If your franchisor files for bankruptcy, several negative things can happen. You might be cut off from suppliers; negative press could impact your revenues; your franchise contract could be assigned to a franchisor or other third party who knows little about your business; or, the franchise could be liquidated, in which case you will lose your investment. At the very least, bankruptcy spells uncertainty.

So, what should you know and what can you do? First, remember this: if you snooze, you lose! If you hear a rumor or suspect that your franchisor is defaulting on its obligations or headed for bankruptcy, consider it a red flag. If your franchisor is collecting advertising fees, but isn't advertising, ask questions. Also, review your franchise agreement to determine your rights under the agreement. Don't ignore these warning signs because once bankruptcy is filed, things happen quickly.

Next, consider what alternatives would exist for you if your franchisor defaults. Make a list of alternate suppliers and maintain extra supplies. Contact other franchisees to share information and resources. Better yet, consider forming a franchisee group to share costs, strategize and obtain joint legal representation, since a group should have increased negotiating power before any bankruptcy filing, and especially during the bankruptcy proceedings. For example, the group could act quickly to require the franchisor to honor its obligations or to potentially gain status in the bankruptcy proceedings as a formal franchisee committee. A substantial sized group could potentially acquire assets or locate a friendly buyer before or during bankruptcy-think economies of scale.

The moral of this story is to pay attention to your franchisor's financial status and to act quickly if you learn it is at risk. You can survive the unthinkable, but it may not be easy. You'll have more control over your destiny the sooner you act!


On Wednesday, June 20, 2012, Barry Kurtz will be the featured speaker at the meeting of the Intellectual Property/Technology Business Section and the In-House Counsel/Corporate Law Section of the Santa Barbara County Bar Association.  The presentation, entitled Franchise Law: The Basics Every Business Lawyer Should Know, will distinguish franchise relationships from licensing, dealerships and distribution arrangements and advise business attorneys on how to keep their clients from becoming "accidental franchisors".


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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