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

Customer promotions / "sweepstakes" are a popular marketing tool for promoting franchise systems sales and growth. However when considering the implementation of these marketing programs, franchisors and lawyers need to be aware of "hidden pitfalls" and regulations associated with both federal and state regulation.   Recently when discussing this issue with Kenneth A. Goss, Esq. - an in-house franchise to a national franchisor - Mr. Goss raised some interesting points that I believed would be helpful to our readers.  The following is Mr. Goss'  guest post on this important topic:

(Guest Post: Kenneth A. Goss, Esq.) The issue of franchise system promotions involving "consumer oriented" sweepstakes is an issue that franchisors and franchise lawyers must carefully evaluate and are a powerful and effective marketing tool franchisors often used to increase franchise system sales of its product. However, a franchisor that does not comply with applicable law risks possible litigation, administrative action and criminal penalties if,  for example, the franchisors seemingly innocuous sweepstakes turns out to be an illegal lottery governed by state gambling laws.  The following is a brief overview of some of the important factors that franchisors should consider before conducting a sweepstakes.

A sweepstakes is defined by federal law as a game of chance for which no consideration is required to enter. Typically, franchisors use sweepstakes to incentives consumers to buy a particular product by offering customers a chance to win a prize. There is no single uniform law applicable to sweepstakes. Instead, franchisors interested in conducting a nationwide sweepstakes face having to comply with both federal law and the law in each state where the sweepstakes will be conducted.

A starting point in evaluating a sweepstakes is the federal Deceptive Mail Prevention and Enforcement Act (the "DMPEA"). The DMPEA applies to sweepstakes entries sent through the mail, which, in most cases, is necessary to satisfy the "no consideration" element of a sweepstakes. The DMPEA states that any sweepstake entry is deemed "non-mailable" if it does not "clearly and conspicuously" disclose certain information including, among other things, the terms and conditions, the sponsor and sponsor's address, the odds of winning, and all relevant particulars about the prize(s) being offered. The DMPEA gives district courts the authority to enjoin a franchisor that fails to comply.

After evaluating the DMPEA, franchisors and franchise legal counsel must evaluate applicable law in each state in which the franchisor intends to conduct the sweepstakes. While state law will vary, at a minimum, franchisors will be required  to issue official rules and disclose the terms and conditions of the sweepstakes. Florida, New York and Rhode Island each require sponsors of sweepstakes to register with the state if the total retail value of all the prizes is greater than a certain dollar threshold. Florida and New York also require the posting of a bond and submission of winner lists. California and Texas regulate sweepstakes to the point where compliance in those states may be cost prohibitive to most franchisors. In each case, records must be kept in accordance with applicable law.

State laws applicable to sweepstakes vary widely from state to state. The good news for franchisors is that many of the requirements overlap, meaning that a franchisor with a properly structured sweepstakes can be compliant in more than one jurisdiction and realize the marketing benefits that sweepstakes can have for a franchise system. 

Information about Kenneth A. Goss, Esq. and Disclaimer.

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In the current economic climate there are many news reports discussing franchise failure and the harsh economic realities faced by some well intentioned and hard working franchisees.  These articles typically feature a struggling franchisee and then proceed with a discussion as to the economic difficulties that the franchisee is experiencing.  When reading many of these articles - especially the portion where the franchisees express what he or she believes is causing the failure in the franchised business - I am concerned that many franchisees (including prospective franchisees reading the article) may be missing some critical points.

In Eilene Zimmerman's CNNMoney.com article, "Trench Warfare in the Franchise Field", Rita's franchisee Tish Reisman discusses some of the difficult circumstances that she is currently experiencing.  While it certainly appears that Ms. Reisman is a hard working and well intentioned individual, I am concerned that the points she raises (as to the possible causes for her business losses) may be off the mark.  In the article Ms. Reisman, raises the following points that she attributes to her losses:

(a) Encroachment:  "A competing Rita's opened five miles away";

(b) Time Consuming Promotions:  "A corporate marketing campaign required her to stand in front of Wal-Mart and Kmart stores handing out coupons, sucking up time and resources she couldn't spare";

(c) Product Introductions:  "Rita's requires her to sell every new flavor it introduces for 24 days - even if it tanks"

While the issues raised by Ms. Reisman are certainly issues of concern, are they the actual cause of the "franchise failure" that she seems to be experiencing?  Here are some of my thoughts:

• Encroachment - Encroachment is an extremely serious issue for franchisees and indeed a major contributor to franchisee failure and diminished profits / losses.  However, in Ms. Reisman's case we are advised that the competing Rita's franchisee is located 5 miles away.  When dealing with the "local nature" of ices and similar quick serve products is this really an encroachment issue?  Five miles sounds quite reasonable and could actually serve as a benefit to Ms. Reisman in terms of economies of scale that may be created through possible joint marketing efforts and brand penetration.  While encroachment is a serious issue for all franchisees, I am not certain that this is a significant factor for Ms. Reisman.

• Time Consuming Promotion - I am not sure if I buy this issue at all as a contributing factor.  Having a franchisor interested in market promotion is a good thing and, quite frankly, Ms. Reisman could have paid some teenagers to hand out coupons - as opposed to doing it herself.  

• Product Innovation - many times franchisees complain, and rightfully so, that the franchisor is not actively engaged in product innovation and development.  So, here to, I would not criticize Rita's for its constant product introduction.  However, to the extent that franchisee's are experiencing higher levels of waste (due to poor sales of new products) there should certainly be a royalty adjustment for the franchisee.  This is certainly an issue for Ms. Reisman, but, again is this a substantial contributor to her unprofitability?

While Ms. Reisman may be experiencing other issues not addressed in the article, I can not  help but believe that she needs to be addressing and evaluating some serious additional factors.  For both Ms. Reisman and any individual considering a franchise investment, here are some other factors that I would be considering:

• Debt Service - The issue of debt service is not mentioned in the article but could be playing a substantial factor in the economics experienced by Ms. Reisman.  Did Ms. Reisman borrow money to establish her Rita's franchise and, if so, how much?  Too many times prospective franchisees do not consider the substantial impact that debt service will have on their bottom line.  Is Ms. Reisman over levereged? 

• Expectations - When purchasing her Rita's franchise what were Ms. Reisman's expectations about profitability.  My only point here is that when evaluating something as a success or failure , a lot depends on your expectations.  Did Ms. Reisman have the right expectation when she purchased her franchise?  Did she base her expectations on solid "due diligence" involving discussions with existing franchisees, a thorough evaluation of the FDD and her legal obligations?

There are many other factors that are of extreme relevance to understanding the unfortunate circumstances that Ms. Reisman is facing.  It is not enough to simply blame the franchisor and, quite frankly, Ms. Reisman needs to thoroughly assess her current circumstances and implement some immediate corrective measures.  Unfortunately, if Ms. Reisman's  due diligence or expectations were off, going forward, the Rita's franchise may not be the correct business for herself and her family.  

UPDATE:

In a comment Paul Segreto of Franchise Essentials links to his excellent and "honest" post "Fear and Consequence of Failure: A True Story".  If you are a franchisee definitely read what Paul has to say as I believe that the advice he offices speaks from experience.  If you are a struggling franchisee consider what Paul has to say - especially the part of considering an exit strategy.

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