Focused on Franchise Law - November 2012

by Lewitt Hackman


On October 28, 2012, Barry Kurtz was selected by the Pacific Coast Business Times as one of the top attorneys in Santa Barbara, San Luis Obispo and Ventura Counties. The attorneys and accountants that were chosen were highlighted as "very important firms that are the backstops for our business community ... based upon the quality and quantity of their efforts advising clients" in these three Counties. Click here to see the article.



Each franchisor must renew the registration of its franchise disclosure document (FDD) annually. The rule in most registration states, as well as under the FTC's Franchise Rule, which governs the sale of franchises in the non-registration states, is that a franchisor must update its FDD within 120 days of its fiscal year end, or discontinue selling franchises. California and Hawaii, both of which are registration states, require renewal applications to be filed within 110 days and 90 days of a franchisor's fiscal year end, respectively. If a franchisor fails to file its renewal application on time, its registration will expire and its application will no longer be treated as a renewal; it will be treated as a new application--which will cause a delay in its approval, a "gap period" in the franchisor's franchise registration and an increase in filing fees and legal costs. Moreover, a late renewal application and unintended registration expiration will significantly raise the potential for franchise sales violations during the "gap period," a problem all franchisors must avoid.


Most California franchisors schedule their fiscal year end to coincide with the end of the calendar year (December 31st). Therefore, the California Department of Corporations (DOC) will receive thousands of renewal applications on or about April 20th of next year. Due to the sheer volume of applications and the DOC's personnel cutbacks, franchisors that miss that date should expect to experience a significant "gap" in their California registrations. On the other hand, franchisors that file their renewal applications at least 15 business days before their expiration dates will benefit from automatic renewal, provided their applications are complete and they have paid the proper fees.


We will send out renewal packets to our franchisor clients before December 31 and ask that they provide the necessary information to us by February 1st, even if their 2012 audited financial statements are not completed by that date. That said, delayed renewal filings often occur because the franchisor has not received its audited financial statements from its auditor. To avoid such a delay, get in touch with your auditor to determine what information he or she will need, and schedule your 2012 audit now. Also, review last year's FDD. Note any changes that you would like to make, and collect the numbers for your Item 20 charts now. Getting started early makes the difference!



Typically, franchise agreements require franchisees to comply with all civil and criminal laws and provide that franchisees will be in default under their franchise agreements if any of their franchise owners commits a felony or other offense that is injurious to the "System" or the franchisor's marks.


In Dunkin' Donuts Franchising, LLC v. Oza Bros., Inc., Dunkin received a tip from the Franchisee's former employees that the Franchisee was underreporting sales. Dunkin performed an audit and determined that the Franchisee was depositing checks from its wholesale customers into its corporate account rather than ringing them into its cash registers and that the Franchisee's deposits exceeded the sales it reported to Dunkin' and on the Franchisee's tax returns for three years. Dunkin' terminated the Franchisee without providing an opportunity to cure. Evidence presented at trial showed that the Franchisee had misreported the deposits as shareholder loans on its taxes, and worse yet, the Franchisee's accountant testified that the Franchisee deducted sales tax payments twice to underestimate sales tax payments due. The Franchisee argued the termination was wrongful because no tax authority had audited it or indicated that any deficiency existed, but the court agreed with Dunkin' and held that "whether Defendants are actually prosecuted is irrelevant to whether there is a tax deficiency," and "the Franchise Agreement did not require Dunkin' to wait until [the Franchisee was] prosecuted before terminating the Franchise Agreement." The Franchisee's failure to obey applicable tax provisions by underreporting income to the IRS was sufficient to constitute a breach of the Franchise Agreement.


Franchisees beware: Franchisors and courts alike will consider tax evasion to be injurious to the Franchisor's "System" and marks, regardless of whether the franchise agreement specifically identifies it as such or not. More importantly, franchisors can, and will, terminate a franchise agreement for tax related violations, regardless of whether the franchisee has been prosecuted by any tax authority. If your franchisor believes that you have intentionally underreported income or sales tax to the government, most franchise agreements will allow the franchisor to terminate the agreement without an opportunity to cure. Click here to see the case.



"Inside Perspective on Franchise Law" authored by Barry Kurtz and Bryan Clements was published in the November 2012 issue of Valley Lawyer, the magazine of the San Fernando Valley Bar Association []. To see the article, click here.


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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