New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

Recently on satellite radio I listened to a radio advertisement, allegedly, by a national franchisor promoting the resale of what I believe to be previously closed franchise locations. The franchisor is allegedly Quiznos and this morning I checked out their website relating to their promotion and sale of opportunities relating to the "re-opening" of closed Quiznos locations. Basically, the website is promoting and offering prospective franchisees the opportunity to acquire rights to own or operate closed Quiznos locations.  Presented as a "low start-up cost" opportunity, the website operator makes the following "promotional" statments about this Quiznos "re-open" opportunity:

Own a Big Brand without a Big Investment.

Jump into a proven business system for as little as $12,500 down.

Own your own business in as little as 90 days.

Quinos has a limited inventory of stores available through this program.

 While I readily admit that I have not reviewed  Quiznos disclosure documents respecting this alleged  "reopen opportunity", here is my take on this advertisement and potential opportunity:

• Understand Why the "Closed Location" Originally Failed.   Franchise failure resulting in closed stores  may be attributed to many factors and may not necessarily be attributed to the the Franchisor, i.e., failure could be attributed to a deficient and non-performing franchisee. However, when a franchisor possesses an "inventory of closed stores" and is looking to resell these opportunities you must question whether or not the closed stores (and especially the particular store that you are considering) may be attributed to failings or deficiencies on the part of the franchisor, the franchise system or the business location, i.e., Is the continuing royalty too high? Is the food cost too high? Is the rent reasonable? Is the advertising program insufficient? Does the location generate enough traffic?  You must understand what contributed the original "store closing" and insure that the facts and legal obligations that you are undertaking are different.  That is, learn from the mistakes of others.

• Your Investment Goes Far Beyond your Initial Out of Pocket Expense.  When buying a franchise your investment goes far beyond  "out of pocket" expenses.  Although this opportunity is presented as one with limited start up costs, you must also consider the loan obligations that you will be agreeing to and assuming.  While your "out of pocket" may be nominal you could be acquiring substantial debt obligations.  Also, always remember that your time has value and in and of itself represents a substantial investment - especially if your store is not generating a profit.

• Don't Just "Jump In". I think that you probably know this already, but we all need to be reminded of this critical point.  So, "don't, do not just jump in".  Due diligence is key.

Disclaimer: Michael Webster of BizOp makes a great comment about this  alleged Quiznos website and the possibility that it may not be directly affiliated with Quiznos. Michael's comment is instructive for prospective franchisees and a reminder as to why prospective franchisees must engage in a detailed due diligence process.  Thanks Michael.

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Can you expand your business in the State of New Jersey through a "license agreement" without triggering New Jersey's franchise relationship laws?  (This is not a simple question and, unfortunately, the answer involves an evaluation of both "objective" and "subjective" factors.)

Short Answer:  

Yes, however you must discuss and evaluate the substance of  your license agreement, including your degree of control over your "licensees" operations and your economic influence over your "licensees" business.  

Long Answer :

The New Jersey Franchise Practices Act contains extensive prohibitions and restrictions governing (and in many cases modifying) the contractual relationship between franchisors and franchisees within the state.  Under New Jersey law the following criteria give rise to a franchise relationship and the potential imposition of franchise regulation:

1. The existence of a written agreement for a definite or indefinite period;
2. Providing for a license to use a trade name, trademark, service mark or related characteristic is granted; and
3. The existence of a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement, or otherwise.

With New Jersey's definition of a "franchise" heavily dependent on the existence of a "trademark license", your contemplated "license agreement" may have the unintended consequence of creating a regulated "franchise relationship".  To determine if your (1) written (2) trademark license agreement "crosses the line into franchise territory" you must evaluate the (3) community of interest criteria and determine whether or not your written license agreement "creates a community of interest [between you and your licensee] in the marketing of goods or services..."

This "community of interest" criteria is not defined by the New Jersey statute, involves a subjective determination and has been expansively evaluated by New Jersey courts in favor of finding a franchise relationship. To make this determination the courts look to the relationship between the parties and, among other things, the extent to which the licensee (franchisee) is economically dependent on the licensor (franchisor).  That is, where a licensee invests in a business that is largely dependent on a licensor's trademarks, products and/or services and where the licensor possesses significant influence over the licensees business, a "community of interest" (and thereby a franchise relationship) may exist.  Some of the factors that the courts have found to be relevant, include:

• The extent and nature of the licensees /franchisees business investment;
• The bargaining power between the parties;
• The licensees/franchisees economic dependence on the licensor's/franchisor's goods or services;
• The licensor's/franchisor's control over the goods and services offered by the licensee/franchisee; and 
• The licensees/franchisees ability to procure and/or offer goods supplied by a third-party.

Ultimately, any determination as to whether or not your New Jersey license agreement "crosses the line" into franchise territory will require a detailed evaluation of your written agreement and the economic relationship and legal rights that you create.  If your "license agreement" gives rise to a "franchise relationship", your licensee (and now franchisee) will be granted substantial protections and rights granted by the New Jersey Franchise Practices Act.    The key is to be aware of this "unintended consequence" when structuring and planning your "license" agreements and business relationships

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Recently I received some interesting and insightful comments from an  individual commenting on issues involving franchisee rights.  Her main point of contention appears to be the disparity of bargaining power and legal rights between franchisors and franchisees.  While this is certainly an issue of concern, I believe that her comments may be giving a "free pass" to franchisees who don't take the time to conduct the appropriate pre-purchase franchise due diligence.  The following are some of the commentators insightful points:

On Franchise Agreement Liquidated Damages:

Isn't it true that most franchisees don't understand that the "optional" liquidated damages terms in the contract are premeditated to give the franchisor the advantage when the franchisee fails to thrive? The failure fee is hidden within the contract from the view of franchisees.

Do attorneys point this "failure fee" out to their clients?

My Take on this Serious Issue:  As I have previously discussed, "liquidated damage" provisions in franchise agreements - especially those that kick-in when a franchisee "closes his or her doors" have the potential to inflict serious financial harm on a franchisee who already may have lost a substantial investment.  However, these provisions may be negotiated by franchise attorneys and are exactly the types of "legal issues" that a franchisee should be discussing with a franchise attorney before signing a franchise agreement. Liquidated damage clauses can be negotiated.

On Franchisees Reading and Negotiating their Franchise Agreement:

While it may be true that franchise agreements may be legally negotiated with the franchisor by individual prospective franchisees, isn't it true that most of the mature franchisors don't or won't negotiate changes and will acknowledge that pre-sale, their contracts are not negotiable. Don't they acknowledge this to the courts, when asked?

My Take on this Serious Issue: Franchise agreements are negotiable and even "mature" franchisors are willing to make reasonable modifications.  However, even if we assume that a particular franchisor will not make changes why would a prospective franchisee invest his or her livelihood in a franchise and sign a franchise agreement without first reviewing, understanding and evaluating each and every right and obligation contained in the franchise agreement.  Look,  there are many times where I believe that franchisees need an advocate but franchisees cannot  get a "free pass" when they neglect to conduct even the most basic due diligence.  

In the end, you do not have to sign a franchise agreement and, sometimes, even with successful franchise systems, not signing the agreement might be the best course of action for you. No one is forcing you to sign the agreement.  Likewise you must know that no matter how many other franchisees may have signed the franchise agreement you - personally - must understand and evaluate what you are signing.  Your livelihood depends on it.

For franchisors, a policy that permits limited but targeted franchise agreement modifications may actually strengthen the enforceability of your franchise agreements when faced with litigation. 

My thanks to Ms. Cross for some really insightful comments.

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In certain "franchise sales settings" franchisees are sometimes led to believe that modifications cannot be legally made to their franchise agreement.  That is, to induce a franchisee to sign the franchise agreement - without the benefit of any negotiations or review by a franchise attorney - the franchisee is led to believe that the franchise agreement is a "standard agreement" (signed by everyone) and that legally the franchisor is not allowed to make any changes.  The implication: you might as well just sign the agreement and not waste time or money since "we can't change the franchise agreement even if we wanted to".  

Sadly this misstatement / "myth" leads to a false sense of security and sometimes some big mistakes by prospective franchisees.  To be clear:

• Franchise agreements are negotiable;
• It is not illegal for a franchisor to modify its franchise agreement; and
• It is extremely common for franchisees to negotiate certain aspects of the franchise agreement.

Understanding these facts keep in mind that the extent to which a franchisor may be willing to negotiate the terms of its agreement varies depending on the negotiating power of the parties - one major factor includes the financial resources of the franchisee.  Also, certain core provisions of a franchise agreement - such as the royalty rate, methods of operation and use of proprietary products - usually are not and should not be subject to change.  

Some of the critically important franchise agreement terms that you should be evaluating and potentially negotiating, include:

• Scope of your protected territory;
• Grace periods regarding the commencement of royalty obligations;
• Liquidated damages and liability for early termination;
• Renewal rights;
• Transfer rights; 
• Cure periods for alleged defaults; and
• Potential "rights of first refusal".

Depending on your circumstances and concerns there are many other issues that, as a prospective franchisee, you should be considering.  However, it is critical that, as a prospective franchisee, you recognize that you have the "right" to negotiate the terms of your franchise agreement.  This "right" must be taken seriously.

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