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

When a franchise agreement expires, franchisors and franchisees, many times, enter a decision making period to determine, discuss and negotiate whether or not the the franchise agreement will be renewed.  Although not preferred, this post-termination negotiating period is sometimes necessitated by on-going negotiations and delayed decisions.  During this critical negotiating period - one where the franchisee is, most likely, operating the franchised business without a franchise agreement - franchisors, many times, unnecessarily jeopardize the protection of their trademarks and trade dress by failing to require the Franchisee sign what should be a mandatory acknowledgment.

• The Scenario - Franchise agreement expires and franchisor and franchisee negotiate the potential renewal.  During the "post-termination negotiations" the franchisee continues to operate the franchised business and continues to utilize the franchisor's trademarks and trade dress.  Although the Franchisor does not expressly acknowledge the franchisees continued operation, the franchisor does not continue with the enforcement of the franchise agreement's post-termination restrictive covenants. 

• The Problem that Arises - By permitting the franchisee to continue operations - without the benefit of an on-going franchise agreement - the franchisor is legally acquiescing to the franchisees technical infringement of the franchise systems trademarks and trade dress.  In doing so, the franchisor weakens its marks and makes later enforcement of the franchisee's post termination restrictive covenants more difficult.  While this "problem" is, typically, not fatal, it is nevertheless costly. Especially where negotiations break down and the franchisee continues to violate the restrictive covenants.

• The Solution - During this gap negotiating period, insist that the franchisee sign an agreement whereby the franchisee acknowledges that the franchisor is withholding enforcement of the post-termination restrictive covenants for a limited period of time, i.e., two weeks

The foregoing "problem" is not that great but it is an issue that "muddies the water" in franchisor and franchisee litigation and results in unnecessary legal fees and time.  That is, rather than advancing the franchisors right to restrict the former franchisees future business operations, the franchisor is exposed to the frivolous defense that, somehow, the franchisor acquiesced and waived its right to enforce the post-termination covenants.

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When it comes to "franchise litigation" and disputes between franchisors and franchisees almost, inevitably, the issue of injunctive relief  is raised.  Franchisors typically seek injunctions involving (a) the turn-over of the franchise location, (b) the de-identification of the franchise location, (c) specific performance requiring the franchisee to protect the franchisors marks, and/or (d) the enforcement of non-competition covenants where the franchisee establishes a competing business.  Franchisees typically seek injunctive relief focused on the franchisee's preservation of its franchise location, enforcement of protected territories and specific performance as to the franchisor's on-going obligation to support the franchisees business and to maintain access to proprietary products and services.

So, when faced with a franchise dispute in the State of New Jersey, franchisors, franchisees and their legal counsel need to be aware of the basic but thoroughly applied standard of  review that New Jersey courts apply to applications / motions for injunctive relief.  The most commonly cited and relied upon legal decision is the decision of the New Jersey Supreme Court in  Crowe v. DeGioia. Although the Crowe decision did not involve a business or franchise dispute  (worse - it involved a marital dispute) it, nevertheless, sets the standard for New Jersey injunctions.  Under the Crowe decision, franchisors and/or franchisees seeking injunctive relief must evaluate and be aware of the following legal proofs:

• Demonstration of "Irreparable Harm".  When seeking an injunction the moving party - whether franchisor or franchisee - must demonstrate that absent the award of a preliminary injunction that such party will suffer "irreparable harm".  Irreparable harm is typically equated with a harm for which a future "monetary award" cannot serve as proper or adequate compensation.  For franchisors, "irreparable harm" is typically alleged to occur where the franchisor's trademarks are in jeopardy or where the franchisors proprietary trade secrets are alleged to have been disclosed or violated by the franchisee.  For franchisee's irreparable harm, typically, comes in the form of franchisor violations (i.e., non-renewal and violation of protected territories) where the goodwill of the franchisees business is placed in jeopardy.

• "Likelihood of Success on the Merits".  The moving party must demonstrate that as to the causes of action set forth in the underlying complaint that the moving party possesses a "likelihood of success on the merits".  For franchisors it is common to rely on claims and causes of action alleging a franchisees violation of the detailed "franchisee obligations" set forth in the applicable franchise agreement.  Since franchise agreements, typically, favor a franchisor, franchisees seeking an injunction are, many times, forced to rely upon New Jersey's franchise relation statute - the New Jersey Franchise Practices Act.  That is a franchisee would argue that the franchisors threatened actions violate the mandates of the New Jersey Franchise Practices act and that injunctive relief is merited.

• Maintenance of the "Status Quo".  The purpose of a preliminary injunction and/or temporary restraints is to maintain the "status quo" pending the ultimate resolution of each parties legal rights in the litigation.  Accordingly, injunctive relief proper only where the moving party seeks to preserve and maintain its rights in a condition that is the same as when the litigation began.  From a franchisee perspective the proper scope of an injunction should be to preserve the status of the franchisor / franchisee relationship and the on-going operations of the franchisees business.  As to this standard, franchisors are, typically, afforded more latitude due to the express terms of the franchise agreement.  For Franchisor's preserving the "status quo" is typically viewed from the point in time after termination of the franchisees rights.

In all instances it is critical for franchisors and franchisees to recognize that "injunctive relief" is an equitable remedy and is subject to the jurisdiction of New Jersey's Chancery Courts. Applications for injunctive relief (and opposition thereto) must be supported and backed-up by detailed factual certifications and affidavits. Applications for injunctive relief serve a critical tactical and substantive role in New Jersey franchise litigation.

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In the State of New Jersey any determination as to the existence or non-existence of a franchise relationship requires a a factual evaluation of the legal rights and obligations between the parties.

What Constitutes a Franchise in New Jersey?

The parameters and factors to be evaluated are defined and proscribed by the New Jersey Franchise Practices Act, N.J.S.A. 56:10-3(a), which defines a "franchise" and "franchise relationship" as one  requiring:

a written agreement for a definite or indefinite period, in which a person grants to another person a license to use a trade name, trademark, service mark, or related characteristics, an in which there is a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement or otherwise.

Based on New Jersey's definition of a franchise, franchise relationships in the State of New Jersey are characterized by (a) a written agreement, (b) a trademark license, and (c) a community of interest in the marketing of goods or services.  Factors (a) and (b) are relatively self-explanatory.  As to factor (c), a "community of interest", typically exists, where the presumptive "franchisor" / party granting the trademark license, maintains control to direct and/or influence the potential franchisees marketing and business activities.  

Why Should you Care?

If your business relationship qualifies as a franchise your legal obligations and rights will exist subject to the mandates of, among other things, the New Jersey Franchise Practices Act.  That is, your relationship as "franchisor and franchisee" will not only be governed by the terms of your written agreement but also by the statutory requirements set forth in the New Jersey Franchise Practices Act.  Examples of some statutory mandates that will be imposed on your business relationship include restrictions limiting a "franchisors" ability to terminate a franchise without "good cause" and restrictions prohibiting a franchisor from imposing  unreasonable performance requirements on its franchisees.

If you are a manufacturer or distributor with "licensed" retail outlets you must be on guard that your distribution /  licensing agreement - depending on its terms - may impose and subject your business to franchise regulation and restrictions.  if you are an independent "distributor / licensee" who sells or distributes product or services - if you qualify as a franchisee  - you may have more legal protections than you realize. 

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Franchisors of retail stores should become familiar with federal consumer protection laws and the consumer protection laws of each state in which the franchisor has retail operations. Recently, when discussing this issue with Kenneth A. Goss, Esq., Senior Counsel for a leading franchisor of retail businesses, Mr. Goss mentioned a development in California’s law. The following is Mr. Goss' guest post on this important topic:

California’s highest court recently expanded the Song-Beverly Credit Card Act of 1971 (the “Act”) to prohibit brick and mortar outlets in California from asking customers for zip codes in connection with credit card transactions. Franchisors with units in California should be aware of this expanded application of the Act and consider whether any changes are needed to system standards to keep franchisees in California operating within the bounds of the law.

By way of background, the Act (codified at Cal.Civ.Code § 1747 et seq.) prohibits retailers from asking customers who pay by credit card for personal identification information. The Act defines the term “personal identification information” to mean information concerning the cardholder that is not set forth on the credit card, including the cardholder's address and telephone number. According to the Act, a retailer could violate the law, for example, simply by asking a customer for his or her address at the point of sale. A retailer could also violate the Act by having space for a customer to provide personal identification information on a credit card transaction form. In any case, a violation of the Act could cost a retailer up to $1,000 in penalties per transaction plus other liabilities.

On February 10, 2011, the California Supreme Court ruled that a zip code alone can constitute personal identification information within the meaning of the Act in the case of Pineda v. Williams-Sonoma Stores, Inc. (2011 WL 44692), which overturned an earlier Court of Appeal decision. The issue in Pineda arose when a cashier at a Williams-Sonoma store asked the customer/plaintiff, Jessica Pineda, for her zip code at the time Ms. Pineda was making a purchase with her credit card. Williams-Sonoma recorded Ms. Pineda’s credit card number, her name and zip code in a database and subsequently used that information to determine Ms. Pineda’s address. Williams-Sonoma obtained Ms. Pineda’s address for the purpose of marketing products to Ms. Pineda and possibly also selling her information to other businesses. The California Supreme Court held that the act of asking for and recording Ms. Pineda’s zip code violated the Act because “the word ‘address’ in the [Act] should be construed as encompassing not only a complete address, but also its components.” The Court’s reasoning included that the legislature intended for the Act “to provide robust consumer protections by prohibiting retailers from soliciting and recording information about the cardholder that is unnecessary to the credit card transaction.” In light of the Pineda decision, franchise systems should be wary of their California units collecting information in connection with a credit card transaction.

The good news for retailers is that there continues to be important exceptions to the application of the Act. For example, the Act provides for exceptions in certain circumstances to (a) the collection of information for purposes incidental to the credit card transaction, such as when the retailer asks for an address to fulfill a delivery obligation; (b) the collection of personal identification information in connection with a credit card transaction if the retailer is contractually obligated to the card issuer to provide personal identification information in order to complete the credit card transaction; and (c) a retailer requiring a customer to provide reasonable forms of positive identification, provided that no information on the identification is written or recorded. Moreover, the Act has been held by a federal court not to apply to a consumer's credit card transaction in connection with purchases online because of the unique fraud concerns associated with online transactions. (See Saulic v. Symantec Corp., 596 F.Supp.2d 1323 (2009)). These exceptions simply mean that a franchisor should pay close attention to the practices of its California units because not all instances of a retailer asking for information is a violation of the Act.

Franchisors and their counsel should consider the expanded application of the Act as part of the franchisor’s analysis of consumer protection requirements in connection with developing uniform system standards to keep franchisees operating within the bounds of the law.
 

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As franchise counsel, like many of my colleagues and clients, maintaining an updated and current database of state specific franchise laws, registration requirements and regulatory entities is a critical task that we continuously work on and improve.  After recently launching our internal client accessed database - and receiving some extremely positive feed back -  we thought that starting a "public" database of "state specific franchise links and information" would be a helpful resource for our readers and the franchise community.   At the very least, it could serve as a time-saver.

So, we are pleased to announce that we have added the "State Franchise Resources Map" to our site. The map is somewhat interactive: By "Clicking" on a particular state you will be linked/taken (willingly, of course) to our resource page for the selected state.  Presently, our state specific resources include: (i) registration status, (ii) relevant franchise laws, (iii) applicable regulatory agencies, and (iv) useful links. Click here to access the State Franchise Resources Map.

The resources available for each particular state varies and, presently, our launch is at its "beta" stage. We intend to further refine and supplement our state specific information and we would appreciate any comments, criticisms or input that you may have.

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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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 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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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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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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Although the State of New Jersey is not a Franchise Registration State, over the years, the New Jersey State legislature has implemented laws pertaining to and affecting the legal rights between franchisors and franchisees.  The New Jersey Franchise Practices Act (NJSA 56:10-1)("NJFPA") adopts an extremely "paternalistic" approach to the franchisee / franchisor relationship and implements a number of legislated rights designed to benefit franchisees.

Both franchisors and franchisees with operations in the state of New Jersey should be aware of the NJFPA and its legislated rights, including NJFPA's  extremely vague "prohibition" against "unreasonable standards of performance".

Franchisor Standards of Performance must be "Reasonable".  Under the NJFPA franchisors are prohibited from imposing "unreasonable standards of performance on franchisees". This extremely vague "prohibition" is open to a broad range of interpretation and is designed, among other things, to prevent the termination of franchisee rights under the pre-text of "non-compliance".  

Relevance to Franchisees: This provision of the NJFPA, essentially, imposes a "reasonableness" standard when evaluating a franchisors attempted termination of a franchise relationship.  Under the NJFPA lawyers for the "terminated franchisee" are afforded the legal right to challenge, question and have the court evaluate the "reasonableness" of the franchisor's standards.

Relevance to Franchisors: Even if your system standards are well thought out, balanced and fair (as is typically the case with "successful" franchisors) when dealing with New Jersey franchisees, franchisors and their legal counsel must recognize that your system standards may be subject to interpretation and evaluation in a judicial proceeding.  To avoid unnecessary litigation costs and expenses, before terminating a franchise relationship take extra caution to document and communicate your performance standards and issues of non-compliance. 

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