Focused on Franchise Law - December 2012

by Lewitt Hackman


The Federal Trade Commission ("FTC") regulates the offer and sale of franchises at the Federal level by way of the FTC Rule, as amended in 2007 (the "FTC Rule"). Franchisors and their attorneys often submit questions to the FTC staff seeking clarification of provisions in the FTC Rule.  Occasionally, the FTC staff publishes a frequently asked question and provides an answer, which answer essentially becomes law on that issue (a "FAQ").


The FTC Rule requires franchisors to provide extensive disclosures in Item 12 of their FDDs regarding the territory rights they will grant to, or withhold from, their franchisees and specifically requires disclosure of any rights that are granted for an exclusive geographic territory. If a franchisor reserves the right to place other franchised or company owned outlets within the same territory granted to a franchisee, the franchisor must provide a specific disclaimer in Item 12 stating that franchisees "will not receive an exclusive territory".


Before October 16, 2012, the FTC staff defined an exclusive territory as "a territory in which the franchisor contractually promises not to establish company owned or other franchised outlets selling the same or similar goods or services under the same or similar trademarks or service marks." Franchisors interpreted this to exclude outlets located at "non-traditional venues," such as airports, arenas, hospitals, hotels, malls, military installations, national parks, schools, stadiums and theme parks. Franchisors routinely stated in their FDDs that their franchisees would receive exclusive territories, despite the fact that they had placed, or reserved the right to place, company owned or franchised outlets at "non-traditional venues" within their franchisees' territories.


On October 16, 2012, the FTC published FAQ 37 stating: "[I]t is the staff's view that a franchisor that reserves the right to sell through 'non-traditional venues' must make the disclosure that it does not provide an exclusive territory." Franchisors must now review their FDDs to determine whether they reserve the right to place outlets in "non-traditional venues." If so, they must include the required disclaimer to ensure they do not run afoul of FAQ 37.




Under California's Franchise Investment Law ("CFIL"), a business relationship constitutes a franchise if: 1) the franchisor grants the franchisee the right to engage in a business offering, selling or distributing goods or services substantially associated with its trademark, service mark, trade name or logotype; 2) the franchisor provides significant assistance or exercises control by prescribing a system or marketing plan; and 3) the franchisee agrees to pay, directly or indirectly, a fee or charge of at least $500 for the right to enter into the business under a franchise agreement (the "Fee Element"). Payments for goods or services will satisfy the Fee Element; payments for ordinary business expenses will not. That said, California courts typically interpret the Fee Element broadly.


In Zentner v. Farmers Group, Inc., et al., Zentner claimed he was wrongfully terminated under a District Manager's Appointment Agreement he entered into with Farmers (the "DMAA"), which he claimed was a franchise agreement under the CFIL. The California Court of Appeal disagreed, holding that Zentner failed to satisfy the Fee Element.


Under the DMAA, Zentner recruited and trained prospective insurance agents for Farmers. If Farmers signed a "career" or full-time agent that Zentner trained and recommended, Zentner was required to sign a second contract with Farmers partially guaranteeing subsidy loans Farmers provided to the agent. If the agent failed to repay the loan or quit working for Farmers within a specified period of time, Farmers could automatically deduct fees relating to the guarantee from monthly payments it made to Zentner under the DMAA. The court found that while Zentner may have guaranteed loans under those separate agreements, he had never incurred any liability. Regardless, such a "fee" would not satisfy the Fee Element because it was not required before Zentner could engage in business and was entirely contingent on the agent's status as a "career agent," the term of the agent's service and whether the agent failed to repay the loan. The court viewed this as a "potential recruitment cost, rather than a franchise fee." The court also rejected Zentner's claim that expenses he incurred to attend Farmers conferences, establish call centers to generate leads, buy leads from Farmers and promote Farmers products were franchise fees. Although these were expenses required under the DMAA, the court found that they were merely ordinary business expenses. Click here to see the case.


We generally advise our franchisor clients that just about any payment or commitment can amount to a franchise fee IF the franchisee agrees to pay it as a condition to obtaining the right to commence operation of the franchised business. The Zentner case reminds us that contingent fees and ordinary business expenses will not satisfy the Fee Element, a fact that disgruntled licensees should carefully consider before engaging in costly litigation claiming the existence of a franchise.




Barry Kurtz has been selected as a 2013 Super Lawyer in his specialty of Franchise Law. This honor is bestowed by the Journal of Law and Politics, in conjunction with Los Angeles Magazine. Barry was likewise selected as a Super Lawyer in 2010, 2011 and 2012.
The Super Lawyer designation is the result of peer evaluation. Nominations are received from thousands of lawyers throughout the state. According to the Journal of Law and Politics, this honor is reserved for the top 5% of the lawyers in each practice area.


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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