FREE CONSULTATION • CALL US 24 / 7 212-994-7777

Franchises and Franchising

A franchise is a legal and commercial relationship between the owner of a trademark, service mark, trade name, or advertising symbol (the franchisor) and someone who seeks to use that identification in a business (the franchisee). For example, McDonald's restaurants all share the same branding and menu items but are individually owned by franchisees. State laws govern how franchisors may operate and which disclosures they are required to make to prospective franchisees.

Types of Franchises

Generally, there are two main types of franchises:

  • Entire business format franchise – The franchisee receives the use of the trademarks, reputation (good will), trade secrets, copyrights, and marketing and service information of the franchisor. Examples include McDonalds and 7-Eleven.
  • Product distribution franchise – The franchisor distributes a particular product to franchisees, such as vending machines.

What Is a Business Franchise?

A business franchise is where one party allows another to utilize their company's marketing techniques, materials, and logos to start another branch of the company. This is common for businesses such as fast-food chains and retail department stores. The main company is called the franchisor, while the party starting the new chain branch is called the franchisee. The franchisee typically purchases rights to use the material and business processes from the franchisor.

Should You Purchase a Franchise?

Before you decide on what franchise to purchase, you should investigate the background and nature of the franchise company. Some questions to ask include:

  • What do other franchise owners say about the franchise?
  • Does the franchise have name recognition or a good reputation (good will)?
  • What does the franchise offer its franchisees as far as service for problems and questions?
  • Have there been any lawsuits against the franchiser by a franchisee? What was the outcome?
  • What is the required training?
  • What are the prospective returns on having that franchise in your location?

The Franchise Agreement

The franchise agreement is the contract that establishes the relationship, including rights and obligations, of the franchisor and franchisee. Generally, the franchise agreement provides the following:

  • The franchise fee
  • Restrictions placed on the business management structure of the franchisee
  • The cost of inventory
  • The income the franchiser requires and when it will be calculated
  • Length of the agreement
  • A termination clause  upon what event will the franchisor terminate the franchise agreement. For example, some franchisors require that if your franchise does not make a specified income, the franchise will be terminated.

It is best to have an attorney review the franchise agreement before you sign it.

Regulation of Franchises

Many franchise companies are subject to the strict guidelines of the Federal Trade Commission (FTC). The FTC requires, among other things:

  • Uniform Franchise Offering Circular – A franchise company is required to distribute a uniform franchise offering circular that includes all legal and financial information about the franchise company to any individual interested in purchasing a franchise.
  • Other Disclosures – The franchise company must also provide the franchise company's brochure and all potential franchise agreements to the prospective franchisee at either the time of the first meeting, before a fee is paid or before the agreement is signed.

What Is a Franchise Tax?

Franchise taxes are taxes that a business, usually a corporation, must pay in order to conduct business in the state. Franchise tax is separate from income or profit tax, which businesses also have to pay.

How Much Does My Business Have to Pay in Franchise Taxes?

Tax laws vary from state to state, and the franchise tax amount a business owes depends on the type of business. Non-profit organizations are usually exempt from franchise taxes, if they are also exempt from federal income taxes. Factors that affect the amount of franchise tax owed include:

  • Gross Assets of Business
  • Number of Authorized Shares of Corporation
  • Value of Property Owned by the Business

What Are Some Common Business Franchise Disputes?

Business franchise opportunities are often considered a straight-forward way of starting a business. It can be less complicated because the business owner usually just needs to follow the guidelines provided by the franchisor. However, franchise disputes can still arise. These may include:

  • Trademark or copyright violations, such as using the franchise logo for personal use
  • Unauthorized disclosure of trade secrets
  • Failure to follow company policies, such as instituting new changes to business operations
  • False advertising or unfair business marketing practices
  • Breach of business contracts, such as outsourcing the work without consent or hiring undocumented workers

Thus, most franchise disputes involve some cases where the franchisee has strayed away from the guidelines and intentions of the franchising company. For this reason, it is important that both parties be clear regarding the limitation and scope of what the business owner can and cannot do.

However, some cases may involve other types of violations, such as where the franchisee is suing the franchisor because they refuse to provide them with payments or benefits.

What Are the Legal Remedies involved in a Business Franchise Dispute?

Franchise disputes often involve some sort of breach of contract. These may be remedied by a damages award, which is a monetary amount that is paid to the non-breaching party. For instance, a franchisee may be required to pay compensation for losses caused by disclosing trade secrets, or the franchising company may be required to pay losses associated with withheld wages or benefits.

Other remedies may include an injunction that prohibits certain behavior, or an injunction that requires one of the parties to transfer property rights.

How Does Franchise Fraud Generally Work?

Most of the time franchise fraud will start with an ad sent through the mail or a booth at a business opportunity convention. The advertisement or a salesperson will tell of a great opportunity for business ownership and investment, and generally make a lot of promises about how successful your business will be and how well you will be supported if you just pay some fees for a franchising license. Once you show interest in owning a piece of the franchise, the person might arrange a meeting. The con artist may tell you about the great business advice and great products you will be entitled to get once you pay for your franchise license, as well as how much money you will make doing business under the license.

After you pay for the licensing rights for the franchise, the person will generally disappear and you will never hear from him again. As for any support or products you were promised, most likely none of those items will ever be delivered, or if some of them are, most likely they will be sub-par.

What Can I Do to Avoid Becoming a Victim of Franchise Fraud?

There are a few signs you should look for when evaluating whether or not to enter into a franchise or distributorship agreement:

  • Avoid any franchises that promise you will make a certain amount of money. No business can control all market forces.
  • Avoid any offers that guarantee you a refund if you are not completely satisfied as long as you operate your business according to the instructions.  This is a stipulation that allows them to deny your refund for almost any reason.
  • Make sure the person is not selling the franchise or distribution license, but is also selling the product or service of the business itself.
  • Make sure you are able to contact other investors who have participated in the franchise or distributorship.

What Should I Do if I Think I Have Been a Victim in a Franchise or Distributorship Fraud?

There are a number of things you can do if you are a victim of franchise or distributorship fraud:

  • File a consumer complaint with your local Better Business Bureau or your State Attorney General's Office
  • File a complaint with the Federal Trade Commission
  • If you were contacted about the franchise through a mailed advertisement, file a complaint with your local post office. See the article on mail fraud for more information.
  • Contact an attorney with franchise agreement experience to see if you have a strong case for a lawsuit

Should I Consult an Attorney about my Franchise Issue?

A business lawyer can help you determine whether you wish to become a franchisee, start your own business or buy an existing business. When entering into the franchise relationship, an attorney can help you negotiate a franchise contract that best suits your business goals and priorities.  A lawyer may also help you find legal relief if a party to the franchise agreement does not perform as promised, or is imposing unreasonable requirements.

Call our office today at 212-994-7777 or complete the convenient online contact form to set up a consultation.