Focused on Franchise Law - November 2013

by Lewitt Hackman
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FRANCHISOR 101: FRANCHISE AGREEMENT LEAVES PRETZEL FRANCHISEE TWISTED

Post-termination non-compete covenants are not always enforceable by franchisors against terminated franchisees-it depends on the state and the franchisor's own compliance with the terms of its franchise agreements. Based on the outcome of Soft Pretzel Franchise Systems, Inc. v. Taralli, Inc., though, its seems that franchisors with franchise agreements governed by Pennsylvania law and that adhere to the terms of their own contracts have a pretty good shot. 

Soft Pretzel Franchise Systems, Inc. (SPF), a Pennsylvania based franchisor, sold a Philly Pretzel Factory franchise in Marlton, New Jersey to Taralli. The franchise agreement said that SPF could terminate the franchise agreement if Taralli failed to pay fees due to SPF within 15 days after notice, gave SPF the option to purchase the pretzel making equipment Taralli used in the operation of the business after notice following the termination of the franchise agreement, and included a post-termination non-compete provision. After Taralli defaulted in the payment of fees due to SPF and did not cure, SPF terminated the franchise agreement and notified Taralli that it intended to enforce the post-termination non-compete and exercise its option to buy-back Taralli's equipment. Tarralli refused to sell SPF the equipment and continued to operate a pretzel business at the same location under a new name.

 

A federal district court in Philadelphia held that SPF was entitled to a preliminary injunction enforcing the non-compete and equipment buy-back provisions of the franchise agreement against Taralli. The court ruled that under Pennsylvania law, SPF could likely enforce the non-compete because it was: (1) ancillary to the sale of a legitimate business interest-an SPF franchise, (2) supported by adequate consideration, and (3) reasonably limited in time (two years) and geographical scope (10 miles). Further, the court held that SPF could enforce the equipment buy-back provision because SPF had timely exercised its option to purchase Taralli's pretzel making equipment. To read the full case, click here.

 

FRANCHISEE 101: MINIMUM WAGE HIKES: HOW WILL YOU COPE?

California recently passed a law raising its minimum wage to $10 per hour by 2016 (from $8 to $9 by July 2014, and from $9 to $10 by January 2016), the highest hourly minimum in the nation. New Jersey's minimum wage was increased to $8.25 per hour beginning in January 2014 and Massachusetts' Senate just passed a bill that would, if signed by its Governor, raise its minimum wage from $8 to $11 per hour, a 37.5% increase. Not to be outdone, several other states, including Alaska, Hawaii, Idaho, Illinois, Maryland, Minnesota, South Dakota and Washington D.C. are considering similar changes. To sum it up, franchisors and franchisees alike should expect the minimum wage in most states to rise above the federal minimum wage of $7.25 an hour.

 

Proponents of legislation to increase the minimum wage often point to a large franchise company, such as McDonalds, and say: "a company that size can afford it." The truth is, however, that an increase in the minimum wage really impacts franchisees because franchisees hire and employ the workers who work in their franchised businesses. Considering that, and the fact that minimum wage rates will continue to rise throughout the country, franchisees must be proactive and determine how they can continue to turn a profit in the face of this challenge.

 

Most small business owners will have to do one or more of the following to survive: cut costs, increase efficiency, develop or sell new/additional products or services or find alternate streams of revenue, or raise prices. Cost cutting in a franchise scenario may be achieved in many ways: reducing employee hours, postponing plans for hiring and expansion, reducing the total number of employees and renegotiating the terms of leases and financing obligations, just to name a few. Increased efficiency may be realized by employing energy saving technologies, increasing employee productivity through better training and management and reducing waste. Franchisees, though, may find it tough to add new products or develop alternative streams of revenue without their franchisor's permission, as most franchise agreements restrict the products a franchisee may sell to those approved by the franchisor. And, when all else fails, franchisees may be forced to pass along their additional costs to customers by raising prices, which is sometimes pretty tough to do.

 

Needless to say, the time is at hand for franchisees to address the issue of rising minimum wage costs with their franchisors and other franchisees in their systems. Both groups are facing the same issues and may have already come up with some creative solutions. 

 

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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