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

The maintenance of a "current and updated" FDD represents one of the primary regulatory requirements imposed on a franchisor.  Failure to maintain a current FDD and/or renewed state registration will result in either lost franchise sales (since franchises cannot be sold) or litigation exposure (in the event that sales are made during a period of non-compliance).  Although the timing of the FDD updating process is well understood (and not often disputed) it is nevertheless important for franchisors and their management team to recognize the significance of maintaing a "current FDD" and the timing of when an FDD must be updated.  

Starting with the premises that the information and disclosures contained in a franchisor's FDD must be current, under the federal franchise rule, Franchisors are required to update their FDD under the following three circumstances:

• Annually (Mandatory).  Franchisors must update their FDD no less frequently than annually.  Annual revisions and updates to an FDD must occur within one hundred and twenty (120) days from the close of the franchisor's fiscal year;

• Quarterly (If Material Change Occurs). If events or circumstances materially change information or disclosures contained in the FDD then the FDD must be revised.  The revisions will be attached to the current FDD and must be reported "within a reasonable time" from the close of the franchisors most recent fiscal quarter;

• Immediately (When dealing with Item 19). When providing a prospective franchisee with a disclosure document a franchisor must also immediately notify the prospective franchisee of any and all material changes that the franchisor knows or should have known about respecting any Item 19 financial performance representations contained in the FDD.

Knowing when to update your FDD is not a complex process, however it does require organization and the implementation of safeguards to ensure that your financial performance representations (if any) are continuously monitored and that your management team discusses and evaluates the status of your FDD disclosures on a regular basis. 

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(Part two of a two part series)

Franchise agreements drafted for common law countries tend to be longer and more comprehensive than franchise agreements used in civil law countries. Franchisors based in the United States often use their common law agreements in civil law countries without localization, reasoning that a more comprehensive agreement is all that is needed to protect them in a civil law system. However, when considering this approach, franchisors and their counsel need to be aware that a more comprehensive franchise agreement alone may not be enough to protect them in a civil law system. Recently, when discussing this issue with Kenneth A. Goss, Esq., in house counsel to a franchisor experienced in franchising in countries under common law, civil law and Islamic law systems, Mr. Goss explained some general principles common to many civil law systems from the perspective of a common law practitioner. The following is the second of Mr. Goss' two part guest post on this important topic:

Common Law Franchise Agreements in Civil Law Systems

As discussed in Part I of this series, courts in civil law systems are not bound by precedent, may look only to statutes as the source of law applicable to a franchise relationship and may go beyond the plain meaning of the terms of a franchise agreement to ascertain the parties' intent. As a practical matter, this means that franchisors should expect courts in a civil law system to apply certain mandatory rules regardless of whether the parties have negotiated and agreed to different terms in their common law franchise agreement. Additionally, courts may apply by analogy rules the legislature intended to govern contracts other than franchise agreements if the legislature is silent on an issue or the court otherwise deems it appropriate. In each case, courts in civil law systems typically will not recognize that a common law franchise agreement contains the complete agreement between the parties and may look beyond the four corners of a franchise agreement to ascertain the parties' intent.
Mandatory Rules

Civil codes typically delineate general rules of contract construction that are applicable to all contracts including franchise agreements. Examples of terms that are often mandatory in civil law systems relate to the definition of a contract, whether or not parties have the capacity to enter into a contract, the object of the contract, the formalities for creating the contract, the evidence a court will use to determine the parties' intent and the legal effect of the contract. Such are analogous to the boilerplate terms found in contracts in the United States. However, unlike boilerplate, parties cannot agree to opt out of mandatory terms provided by civil codes. In other words, courts in civil law countries will simply substitute mandatory terms for conflicting provisions of a franchise agreement, even when to do so is contrary to the express intent of the parties. Therefore, franchisors should be prepared to accept the mandatory terms of a civil code of the target country as part of their franchise agreement.

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Inherent to every franchise system is the license of intellectual property rights that, for good reason, has been (and should remain) focused on the trademarks and trade dress associated with the franchise system. While trademarks, logos, and trade dress are critically important intellectual property ("IP") assets, an additional (and possibly overlooked) IP asset may exist in the form of "design patents" issued by the United States Patent and Trademark Office. Design patents relate to the "novelty" and "ornamental appearance" of a product and may add a supplemental layer of IP protection for franchisors. When evaluating your IP portfolio and whether or not you are maximizing the legal protection of your IP assets, consider the following:

• Design patents relate to the protection of the "ornamental design" of a product and may include the "surface" design and appearance of products and equipment.

• "Utility patents" protects the way a product is used and works, while "design patents" protects the way a product looks;

• The elements of a "design patent" must be limited to the "ornamental appearance" of a product (i.e., how the product looks) and not thef unctional aspects of the product (i.e., how the product works); and

• Examples of design patents include, the layout of buttons on the "Google" search page, the original Coca-Cola bottle, the exterior surface design of custard vending machines and the ornamental appearance of numerous other products and equipment - many of which may appear quite ordinary.

When managing the legal protections to be afforded to your intellectual property, it is critical to recognize that design patents could very well play an important role in your IP strategy. By branding and acquiring design patents in the ornamental designs associated with the equipment, displays and products offered by your franchise system, you will be adding a valuable layer of IP protection. One valuable strategy to consider is to evaluate the overall trade dress associated with your franchise system and determine whether or not design patents maybe applied to certain products, equipment and designs associated with your system. Dont overlook this IP asset.

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Many times, "start-up" franchisors (and, too often, some established franchisors) overlook the necessity of maintaining a thorough operations manual that is both "current and relevant" to the particular franchise system. That is, many times operations manuals are viewed as an "afterthought" or a"generic" obligation to be sourced out to third party vendors.

Much more than a "generic resource", your operations manual must be drafted, updated and maintained as an integrated extension of your franchise agreement and FDD disclosures. Recognizing the critical importance of a properly prepared and integrated operations manual, startup and established franchisors should consider the following:

• Franchise agreements are typically drafted and structured to integrate and obligate franchisees to abide by both current "and future" operational requirements set forth in the operations manual. If the franchise agreement is drafted properly, the operations manual should create "contractual flexability", allowing the franchisor to modify elements of the franchise system through amendments and supplements to the operations manual.

• Your operations manual must serve as a thorough blueprint to provide franchisees with detailed "how to" information respecting each and every administrative and operational element of the franchise system.  

Examples of "administrative obligations" include (a) the franchisees royalty and financial reporting obligations, (b) franchisees financial record retention obligations, and (c) system requirements for point of sale systems. 

Examples of "operational obligations" include (a) franchisees obligations respecting the management of the franchise business, (b) requirements for management and control of inventory and supplies, (c) building and construction plans and specifications, (d) training programs and obligations, and (e) operational elements respecting the day-today management and operation of the franchised business.

• The preparation of your operations manual cannot be a task that you simply "outsource". While it is prudent to obtain the advice and input of a qualified consultant (including your franchise attorney), the operations manual must directly reflect and embody "your" direct understanding and knowledge about the franchised business. "You" must be the primary contributor and driving force behind the preparation and development of your operations manual.

• Your operations manual must be consistent with your franchise agreement and FDD. Review with your franchise lawyer the content of your operations manual to ensure that there is consistency with your franchise agreement. Ensure that your training programs are extensively identified in the operations manual and properly disclosed.

• Your operations manual should be constantly updated, refined and clarified to reflect the constant and continuous evolution and growth of your franchise system. 

Your operations manual is critically important to the long-term success of your franchise - treat it as such.
 

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 Franchise agreements drafted for common law countries tend to be longer and more comprehensive than franchise agreements used in civil law countries. Franchisors based in the United States often use their common law agreements in civil law countries without localization, reasoning that a more comprehensive agreement is all that is needed to protect them in a civil law system. However, when considering this approach, franchisors and their counsel need to be aware that a more comprehensive franchise agreement alone may not be enough to protect them in a civil law system. Recently, when discussing this issue with Kenneth A. Goss, Esq., in house counsel to a franchisor experienced in franchising in countries under common law, civil law and Islamic law systems, Mr. Goss explained shared some general principles common to many civil law systems from the perspective of a common law practitioner. The following is the first of Mr. Goss' two part guest post on this important topic:

Common Law verses Civil Law.

There are two dominant legal systems in the world today - the common law and the civil law. In addition to the specific franchise disclosure, relationship and other laws applicable to franchising in any specific country, franchisors in the United States should carefully consider the different approach each system takes to contract law before using a common law franchise agreement in a civil law country. This series looks at some characteristics typical of most civil law systems. Part I of this series compares common law and civil law systems generally and Part II takes a closer look at what affect a civil law system will have on a common law franchise agreement.

Common law and civil law systems are similar in principle but differ considerably in the methodical approach each takes with respect to statutes and interpretation. Both common law and civil law systems are rooted in liberal philosophy, which has the purpose of protecting and advancing individual rights. In this regard, common law and civil systems are more akin than, for example, Islamic law, which is based on religious teachings and is regarded as the word of God. However, a major difference between common law and civil law systems is the priority given to sources of law. Specifically, the common law gives priority to jurisprudence over legislation and the civil law gives priority to legislation over jurisprudence. As a result, there are considerable differences between common law and civil law systems in style, terminology, interpretation, conception and emphasis on certain elements over others, all of which are relevant for a franchisor that is thinking about operating between the two systems.

Common Law Systems

Most U.S. based franchisors are familiar with operating in a common law system. The common law is the Anglo-American legal tradition based on unwritten usage and custom that derives its authority from the legal opinions of judges. The common law was adopted by each of the United States, except Louisiana, and has spread to India, Australia, most of Canada and other countries formerly part of the British commonwealth.

In common law systems, the judiciary has the power to make law and each court is bound to apply precedent to cases with similar fact patterns as they arise. This means that the judiciary in a common law system has the power to create new rules for cases with novel fact patterns where the legislature has not enacted a statute addressing the specific issue. The power of a court to make law in a common law system is typically constrained by precedent and is a function reserved to the highest courts of appeal. 

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