Focused on Franchise Law - August 2014

by Lewitt Hackman

Appointment to State Bar Commission
Barry Kurtz has been appointed to the California State Bar's Franchise and Distribution Law Advisory Commission for a three year term. The Commission participates in the application and testing process for the certification of applicants. 

Barry Kurtz and David Gurnick published in The Los Angeles Business Journal
What should franchisors look for in potential franchisees? And how should investors decide on a successful franchise system? Read: What to Look for in a Franchisee or Franchisor for their insights.
David Gurnick quoted re franchise litigation forum selections
"If you are a franchisor with a franchisee in California and you don't want to litigate in California, you have to sue first in the venue stated in the franchise agreement..."
FRANCHISOR 101:  NLRB McDonald's Ruling May Put Crimp on Franchising

On July 29, 2014, the general counsel of the National Labor Relations Board (NLRB) stated that McDonald's could be held jointly liable with its franchisees in labor complaints filed by the employees of its franchisees. If upheld, the decision could upend the franchise industry as we know it.

One key aspect of franchising is that a franchisor (such as McDonald's), grants a franchisee the right to engage in a business using the franchisor's trademarks and system and in return the franchisee is required to pay the franchisor a fee for this right. Franchisees are independent contractors, and other than using the franchisor's trademarks and following the franchisor's system requirements properly, are free to hire and fire employees, set employment requirements, set rates and method of payment, supervise and discipline employees and otherwise operate their businesses as they deem fit.  

While the franchise model involves significant aspects of control by the franchisor - to ensure that each franchise location looks and feels the same - it also provides flexibility to the franchise operator. Since the start of franchising (in approximately 1850 with Singer sewing machines), courts have respected the premise that franchise operators were not employees of the franchisor and, correspondingly, that employees of the franchise operators were not employees of the franchisor.

The NLRB's counsel claims that McDonald's may be jointly liable if its franchisees interfere with or retaliate against their own workers who try to form unions, strike, or demand better pay or working conditions.
If upheld, this view would disrupt longtime practices in the fast-food and other industries and ease the way for unionizing nationwide. McDonald's vowed to fight the decision. However, if the NLRB counsel's push is upheld, franchising in the United States may not be as enticing and beneficial to both franchisors and franchisees as it has been for over 160 years.

Click NLRB Authorizes Complaints Against McDonald's to read the NLRB announcement.  

FRANCHISEE 101:  Franchisee Alleges Discrimination Lawsuit by Franchisor
A Party City franchisee in Minnesota (Newpaper, LLC) owning 26 franchised stores, successfully beat a motion to dismiss filed by its franchisor, Party City. The franchisee claimed that certain stores without franchise agreements received more favorable treatment than Newpaper's franchises, in violation of the Minnesota Franchise Act (MFA).

Newpaper argued that Party City terminated certain Party City franchisees and then entered into supply agreements with them with more beneficial terms than under their former franchise agreements. Consequently, these operators received the benefits of running Party City stores, without having to pay the advertising and royalty fees that other franchisees had to pay.

The court held that regardless of its label, an agreement may establish a franchise relationship under the MFA if the relationship satisfies the statutory elements. The court found that Newpaper plausibly alleged that the supply agreements allowed the non-franchised stores to continue a franchise relationship with Party City by another name. Taking those allegations as true, the court held Newpaper stated a viable claim for discrimination under the MFA.

Party City argued that even if the other stores were franchises, they belonged to a different system altogether: the "Party America" system. While the court found this argument may have merit, the court felt it was premature to dismiss Newpaper's claim.

The court held that the evidence may later demonstrate that these other stores do not have franchise relationships with Party City, or that they operate under a separate "Party America" franchise system. In either of those cases, Newpaper's MFA discrimination claim would fail. At this stage, however, the court found that since Newpaper plausibly alleged that, the franchisor deliberately advertised these other Stores using the "Party City" trademarks and offered precisely the same products, store designs, and other benefits as its franchised locations, these allegations supported a claim for discrimination.

Newpaper also argued that Party City engaged in unlawful competition by: 

1. Selling products online; 

2. Allowing the "supply" stores to continue operating in the their former territories; 

3. Requiring Newpaper to install e-commerce kiosks in its stores, which facilitated online sales; and 

4. Offering "web-only" items. 

The court held that none of these alleged violations stated a claim upon which relief could be granted and dismissed the franchisee's claim, finding the alleged violations fell under exclusions within the franchise agreement or were allowable under the franchise agreement's Internet addendum.

For franchisors, the case sends a message of caution in setting up a competing program in competition with franchisees when the same trademarks are involved. For franchisees, the case reaffirms the message that investors in a franchise program deserve to be treated respectfully and without discrimination. 


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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