IFA Legal Symposium Tackles Wide Range of Issues

When in doubt, Hershman, said that the FTC has said that franchisors must look 'to the language of the Franchise Rule ' it prevails.' He added that 'while many of the changes to the UFOC are stylistic,' they should be followed 'to the letter' even if they do not seem material.

Use of integration clauses ' in which the franchisee acknowledges that it is
buying the franchise without relying on any statements made in the FDD ' is
prohibited in the revised Franchise Rule. However, franchisors continue to
use questionnaires at or before closing a franchise sale that seek to at least put on record the franchisee's statement that he is relying only on the FDD in making the investment decision. Yet it is uncertain whether even those questionnaires violate the integration clause.

'I think a questionnaire or a closing document is a very handy tool to include,' said panelist Rochelle Spandorf, partner, Sonnenschein, Nath & Rosenthal (Los Angeles), while acknowledging that the issue is unresolved in the regulatory guidance.

'The answer depends on what the questionnaire says,' wrote the panelists in a commentary that accompanied their remarks. 'The practice of using a closing questionnaire, in itself, does not in our view offend the Revised Rule's integration clause prohibition, and franchisors are advised to use such a document.' The critical distinction, the panelists said, is that franchisors cannot use the closing questionnaire to disclaim any statement in the FDD; it can only be used in reference to statements made outside the FDD.

Based on questions that have arisen in the franchise community, franchisors are eager to use the large-investment exemption so that they do not have to furnish an FDD. The new Franchise Rule allows aggregation of investments in several franchise units by a single investor to reach the $1-million threshold that qualifies for the large-investor exemption, said panelist John Tifford, partner, Plave Koch PLC (Reston, VA). Also, a conversion of an existing business to a franchisor's brand can qualify if the investment in that original business exceeded $1 million. However, Tifford questioned the benefit of trying to use the large-investor exemption, even when applicable. 'We still have some states without a large-investor exemption,' he said. 'You might as well give the FDD to all franchisee prospects anyway as long as you have [produced] one.'

Another major change in the FDD occurs in Item 20, which affects disclosure of franchised and company-owned outlets. Panelist Charles Modell, shareholder, Larkin, Hoffman, Daly & Lindgren (Minneapolis), credited the new charts in Item 20 as being 'more readable and understandable to franchisees' and helping to avoid the problems of 'double-counting' franchises in the old format. Modell added that a franchisor must give a business phone number of any franchisee who left the system, but if a business phone is not available, a home phone or an e-mail contact is permissible.

While Item 20 has become clearer, the rules still can result in misleading counts of franchise units in some of the tables, added Tifford. 'I drop in a footnote that says that the numbers in the tables won't match due to rules on compliance,' he said.

All the discussion about the Revised Rule at the symposium took place under the shadow of a new Franchise Compliance Guide for the FDD that was released less than a week prior to the conference. This guidance document represents the FTC's most up-to-date interpretation of the Revised Rule, and the panelists agreed that their interpretations about how to comply with the new Franchise Rule might change as that document is studied.

Meanwhile, informal guidance about the rule also emerged from the regulator community and was discussed at the IFA Legal Symposium. Dale Cantone, chair of the North American Securities Administrators Association's Franchise and Business Opportunity Project Group, recently published online a list of 10 mistakes he sees commonly in FDDs. (The list is summarized in a box on page 3.)

The 'Greening' of Franchising

As if the changes to franchise disclosure rules weren't enough to tackle, attendees at the conference also heard about how they have to stay on top of even more massive legislative, regulatory, and business changes based on the threat of global warming. 'The timing of this topic could not be more precise,' said Joseph Goffman, legislative counsel for Sen. Joe Lieberman (R-CT), noting that on the same day as his presentation, John McCain would announce his plan for an emissions cap-and-trade system. Democratic presidential contenders Hillary Clinton and Barack Obama are noted supporters of cap-and-trade, too, Goffman observed. Thus, he predicted that a broad cap-and-trade, perhaps encompassing the six greenhouse gases listed in S. 2191, will be put into law in the next few years, and that franchises should pay attention today. 'I suspect that very few of the businesses represented here today will encounter a legal mandate to reduce greenhouse gas emissions,' Goffman said. 'But our hope is that businesses like yours will find a way to participate directly or indirectly in greenhouse gas emissions reductions markets.'

Seeing green issues as an opportunity is exactly the attitude that franchisors and their counsel will need to take, said David Mandelbaum, partner-in-charge, Environmental Practice Group, Ballard Spahr Andrews & Ingersoll, LLP (Philadelphia). 'When an environmental expert stands up, we ordinarily talk about risks, but this is an area where I believe there is tremendous opportunity,' he said. 'Those who are best and fastest [in re-engineering to be greener] will do very well by doing good.'

Counsel to franchisors can play a significant role, Mandelbaum said, by 'disentangling the issues and identifying the constituencies, distilling down to the key issues, and helping to formulate a plan.' Issues can arise in many areas, he said:

• Costs. 'Reduce your exposure to volatile costs, such as energy.'
• Marketing. 'Customers care about these things. That's one reason why my firm has a sustainability program ' [our resource usage] might not have much of an impact, but if we talk the talk, we must walk the walk.'
• Investors. 'They associate better environmental practices with better management.'
• Community and regulators. 'Compare wind farms to nuclear power plants. Both don't emit greenhouse gases, but one has regulatory support.'
• Employees and franchisees. 'Your ideals are very important to them.'

AAMCO/Cottman Transmissions is reaping the rewards of moving aggressively toward a greener system, said Todd Leff, president of the franchisor. The company launched a voluntary Eco-Green Certification program for franchisees five months ago, and already has 85 franchises that have met the standards. 'We know that green must have a business opportunity attached to it, in order to get franchisee buy-in,' he said. 'But we need it, too, because it's risk control. Case law is rife with cases of franchisors being liable for not managing the back side of their businesses ' franchisees not following the laws.'

The Eco-Green Certification program has about 35 separate categories in which a franchisee can go green. By adopting a sufficient number of the new practices, the franchisee earns a certification that can be part of its promotional campaigns. For example, a franchisee can offer a green tuneup service that includes a 'permanent' air filter or high-efficiency air filter, long-use synthetic oils, and more. This service appeals to consumers, and it costs a $450-$550, a premium over regular service. The franchisee also can recycle solvents used to wash a car's transmission, rather than sending the solvents offsite for disposal; the savings are $3,400 per year, said Leff.

'Twenty years ago, my attitude about environmental policy was let's not have a policy ' it was too risky,' he said. 'You can't do that today. You can't advise clients not to have a policy.'

Dunkin' Donuts' experience was detailed by Steve Caldeira, chief global communications and public affairs officer, Dunkin' Brands, Inc. 'We are teaching our franchisees about how to be more efficient through better lighting, updated thermostats, etc.,' he said. 'The upfront costs are about $10,000, but the savings are $8,500 per year.'

Dunkin' recently received Leader- ship in Energy Efficiency and Design ('LEED') certification for a new store format, thus qualifying for speedy permitting. 'Our first LEED-certified store will open in September 2008 in St. Petersburg, FL. It's corporate-owned for now, but it will go to a franchise eventually,' he said.

Recent Legal Developments

Arbitration continues to be one of the most active areas of franchise law, so it was no surprise that the symposium's Legal Update, prepared by Robert Calihan, partner, Nixon Peabody LLP (Rochester, NY) and Kirk Reilly, principal and co-chair, Franchise & Distribution Group, Gray Plant Mooty (Minneapolis), included a detail discussion of recent litigation related to franchise arbitration agreements. 'The reported decisions from the past year continue to address challenges to [arbitration] clauses on the ground that they are procedurally and substantively unconscionable. The decisions also address the proper scope of such clauses, the parties bound by them, and the parties' ability to challenge a decision ultimately rendered by an arbitrator,' commented Calihan and Reilly.

For example, in U-Save Auto Rental of America, Inc. v. Furlo et al., 2007 WL 2684006 (S.D. Miss. Sept. 7, 2007), franchisor U-Save was able to win the court's support to compel arbitration, even though the franchisees in the lawsuit, each of whom were based in Florida, sought to take their claims to Florida state court. 'The federal court held that choice-of-law issues are for the arbitrator to decide in the first instance and, therefore, the arbitrator acted within its discretion in concluding that Mississippi law applied and in dismissing the claims filed under Florida law,' said Calihan and Reilly.

Arbitration clauses also were upheld in litigation that arose between two Dunkin' Donuts franchisees. Katuga Enterprises, Inc. v. KNZ LLC, 2007 NY Misc. LEXIS 7821 (N.Y. Sup. Ct., Oct. 11, 2007). Katuga entered into a stock-purchase agreement with KNZ for four Dunkin' Donuts franchises that were owned by KNZ, but not yet opened; the stock-purchase agreement contained an arbitration clause. When the new stores struggled financially, KNZ sought to have Katuga held liable for 100% of the financial obligations of being a franchisee, even though Katuga at the time only owned 49% interest through the stock-purchase agreement (Katuga's partial share had been necessitated because it was not a Dunkin' Donuts-approved franchisee at the time the agreement was executed). An arbitrator determined that he could not find Katuga was the sole owner of the franchises without Dunkin' Donuts' consent, nor could he conclude that Katuga was entitled to recovery of the full purchase price it had paid. The court upheld the arbitrator's award on appeal.

In two other cases, courts declined to vacate arbitrators' awards, one benefiting a franchisor and one benefiting a franchisee. In Xenium S.A. De C.V. v. Regent Hotels Worldwide, Inc., Bus. Franchise Guide (CCH) 13,750 (N.D. Tex. Nov. 8, 2007), the franchisee 'argued that the arbitrator exceeded his powers by issuing a damages award that contradicted the merits of a prior final award issued by the arbitrator as to liability,' wrote Calihan and Reilly. 'In finding that the damages award did not revisit the merits of the liability award, the court highlighted the arbitrator's statements that the issue of liability had already been determined and would not be reconsidered.' The court also observed that the parties had clearly agreed to bifurcate the arbitration proceeding into two phases: liability and damages. In TES Franchising et al. v. Kastel et al., 2007 WL 1748141 (Conn. Super. Ct. May 25, 2007), the court denied a franchisor's request to vacate an arbitrator's finding that the parties' franchise agreement allowed for class arbitration.

'Top 10' Mistakes in New Franchise Disclosure Documents

The following list of mistakes that franchise examiners are commonly encountering in FDDs was developed and published online by Dale Cantone, chair of the North American Securities Administrators Association's Franchise and Business Opportunity Project Group, and Deputy Securities Commissioner of the State of Maryland.

1. FTC cover page and state cover page are not separated.
2. Use of legalese or legal antiques instead of plain English in the FDD.
3. Lack of simple, one-sentence statement on cover page that states the total investment necessary to begin operation of the franchise.
4. Deviation from mandatory language when it is required in the FDD, including in headings of charts.
5. Deviation from language required in the preamble for Item 19.
6. Deviation from required formats for charts in Item 20.
7. Lack of disclosure in Item 4 of foreign bankruptcies, and lack of negative disclaimer if none occurred.
8. Lack of disclosure (or sufficient disclosure) in Item 12 of the franchisor's
   reserved rights to engage in alternative channels of distribution.
9. Lack of two new mandatory disclosures in Item 20 related to confidentiality clauses and franchise terminations.
10. Lack of notification on the Receipt Pages that, while the 14-day requirement is now in effect, the 10-business-day/first personal meeting delivery rule may still apply in certain states, too.

Kevin Adler is Associate Editor of this newsletter.

Rarely has the International Franchise Association ('IFA') Legal Symposium, come at a busier time for the franchise industry, as a wide range of legal and business issues are generating change at a rapid rate. The conference, which was held on May 12-13 in Washington, DC, addressed everything from green business practices to new disclosure regulations, and the protection of marks on the Internet to states' efforts to expand their ability to tax franchise activity.

The continuing implementation of the Federal Trade Commission's ('FTC') new Franchise Disclosure Document ('FDD') under the revised Franchise Rule was uppermost in the minds of franchisors and counsel. With the July 1 mandatory deadline looming, attorneys shared their experiences updating FDDs and the challenges they have encountered in getting FDDs approved by federal and state franchise administrators.

In a session titled 'Complying with the Updated and Upgraded FTC Franchise Rule: Lessons Learned So Far,' four leading attorneys proffered strategies for getting FDDs approved, and they highlighted areas that remain unresolved and confusing to franchisors. 'Issues will remain in flux for the foreseeable future,' said Stuart Hershman, partner with DLA Piper US LLP (Chicago). 'Issuance of compliance guides will not fully resolve these issues, and they have created new ones due to internal consistencies in the guides themselves.'

When in doubt, Hershman, said that the FTC has said that franchisors must look 'to the language of the Franchise Rule ' it prevails.' He added that 'while many of the changes to the UFOC are stylistic,' they should be followed 'to the letter' even if they do not seem material.

Use of integration clauses ' in which the franchisee acknowledges that it is
buying the franchise without relying on any statements made in the FDD ' is
prohibited in the revised Franchise Rule. However, franchisors continue to
use questionnaires at or before closing a franchise sale that seek to at least put on record the franchisee's statement that he is relying only on the FDD in making the investment decision. Yet it is uncertain whether even those questionnaires violate the integration clause.

'I think a questionnaire or a closing document is a very handy tool to include,' said panelist Rochelle Spandorf, partner, Sonnenschein, Nath & Rosenthal (Los Angeles), while acknowledging that the issue is unresolved in the regulatory guidance.

'The answer depends on what the questionnaire says,' wrote the panelists in a commentary that accompanied their remarks. 'The practice of using a closing questionnaire, in itself, does not in our view offend the Revised Rule's integration clause prohibition, and franchisors are advised to use such a document.' The critical distinction, the panelists said, is that franchisors cannot use the closing questionnaire to disclaim any statement in the FDD; it can only be used in reference to statements made outside the FDD.

Based on questions that have arisen in the franchise community, franchisors are eager to use the large-investment exemption so that they do not have to furnish an FDD. The new Franchise Rule allows aggregation of investments in several franchise units by a single investor to reach the $1-million threshold that qualifies for the large-investor exemption, said panelist John Tifford, partner, Plave Koch PLC (Reston, VA). Also, a conversion of an existing business to a franchisor's brand can qualify if the investment in that original business exceeded $1 million. However, Tifford questioned the benefit of trying to use the large-investor exemption, even when applicable. 'We still have some states without a large-investor exemption,' he said. 'You might as well give the FDD to all franchisee prospects anyway as long as you have [produced] one.'

Another major change in the FDD occurs in Item 20, which affects disclosure of franchised and company-owned outlets. Panelist Charles Modell, shareholder, Larkin, Hoffman, Daly & Lindgren (Minneapolis), credited the new charts in Item 20 as being 'more readable and understandable to franchisees' and helping to avoid the problems of 'double-counting' franchises in the old format. Modell added that a franchisor must give a business phone number of any franchisee who left the system, but if a business phone is not available, a home phone or an e-mail contact is permissible.

While Item 20 has become clearer, the rules still can result in misleading counts of franchise units in some of the tables, added Tifford. 'I drop in a footnote that says that the numbers in the tables won't match due to rules on compliance,' he said.

All the discussion about the Revised Rule at the symposium took place under the shadow of a new Franchise Compliance Guide for the FDD that was released less than a week prior to the conference. This guidance document represents the FTC's most up-to-date interpretation of the Revised Rule, and the panelists agreed that their interpretations about how to comply with the new Franchise Rule might change as that document is studied.

Meanwhile, informal guidance about the rule also emerged from the regulator community and was discussed at the IFA Legal Symposium. Dale Cantone, chair of the North American Securities Administrators Association's Franchise and Business Opportunity Project Group, recently published online a list of 10 mistakes he sees commonly in FDDs. (The list is summarized in a box on page 3.)

The 'Greening' of Franchising

As if the changes to franchise disclosure rules weren't enough to tackle, attendees at the conference also heard about how they have to stay on top of even more massive legislative, regulatory, and business changes based on the threat of global warming. 'The timing of this topic could not be more precise,' said Joseph Goffman, legislative counsel for Sen. Joe Lieberman (R-CT), noting that on the same day as his presentation, John McCain would announce his plan for an emissions cap-and-trade system. Democratic presidential contenders Hillary Clinton and Barack Obama are noted supporters of cap-and-trade, too, Goffman observed. Thus, he predicted that a broad cap-and-trade, perhaps encompassing the six greenhouse gases listed in S. 2191, will be put into law in the next few years, and that franchises should pay attention today. 'I suspect that very few of the businesses represented here today will encounter a legal mandate to reduce greenhouse gas emissions,' Goffman said. 'But our hope is that businesses like yours will find a way to participate directly or indirectly in greenhouse gas emissions reductions markets.'

Seeing green issues as an opportunity is exactly the attitude that franchisors and their counsel will need to take, said David Mandelbaum, partner-in-charge, Environmental Practice Group, Ballard Spahr Andrews & Ingersoll, LLP (Philadelphia). 'When an environmental expert stands up, we ordinarily talk about risks, but this is an area where I believe there is tremendous opportunity,' he said. 'Those who are best and fastest [in re-engineering to be greener] will do very well by doing good.'

Counsel to franchisors can play a significant role, Mandelbaum said, by 'disentangling the issues and identifying the constituencies, distilling down to the key issues, and helping to formulate a plan.' Issues can arise in many areas, he said:

• Costs. 'Reduce your exposure to volatile costs, such as energy.'
• Marketing. 'Customers care about these things. That's one reason why my firm has a sustainability program ' [our resource usage] might not have much of an impact, but if we talk the talk, we must walk the walk.'
• Investors. 'They associate better environmental practices with better management.'
• Community and regulators. 'Compare wind farms to nuclear power plants. Both don't emit greenhouse gases, but one has regulatory support.'
• Employees and franchisees. 'Your ideals are very important to them.'

AAMCO/Cottman Transmissions is reaping the rewards of moving aggressively toward a greener system, said Todd Leff, president of the franchisor. The company launched a voluntary Eco-Green Certification program for franchisees five months ago, and already has 85 franchises that have met the standards. 'We know that green must have a business opportunity attached to it, in order to get franchisee buy-in,' he said. 'But we need it, too, because it's risk control. Case law is rife with cases of franchisors being liable for not managing the back side of their businesses ' franchisees not following the laws.'

The Eco-Green Certification program has about 35 separate categories in which a franchisee can go green. By adopting a sufficient number of the new practices, the franchisee earns a certification that can be part of its promotional campaigns. For example, a franchisee can offer a green tuneup service that includes a 'permanent' air filter or high-efficiency air filter, long-use synthetic oils, and more. This service appeals to consumers, and it costs a $450-$550, a premium over regular service. The franchisee also can recycle solvents used to wash a car's transmission, rather than sending the solvents offsite for disposal; the savings are $3,400 per year, said Leff.

'Twenty years ago, my attitude about environmental policy was let's not have a policy ' it was too risky,' he said. 'You can't do that today. You can't advise clients not to have a policy.'

Dunkin' Donuts' experience was detailed by Steve Caldeira, chief global communications and public affairs officer, Dunkin' Brands, Inc. 'We are teaching our franchisees about how to be more efficient through better lighting, updated thermostats, etc.,' he said. 'The upfront costs are about $10,000, but the savings are $8,500 per year.'

Dunkin' recently received Leader- ship in Energy Efficiency and Design ('LEED') certification for a new store format, thus qualifying for speedy permitting. 'Our first LEED-certified store will open in September 2008 in St. Petersburg, FL. It's corporate-owned for now, but it will go to a franchise eventually,' he said.

Recent Legal Developments

Arbitration continues to be one of the most active areas of franchise law, so it was no surprise that the symposium's Legal Update, prepared by Robert Calihan, partner, Nixon Peabody LLP (Rochester, NY) and Kirk Reilly, principal and co-chair, Franchise & Distribution Group, Gray Plant Mooty (Minneapolis), included a detail discussion of recent litigation related to franchise arbitration agreements. 'The reported decisions from the past year continue to address challenges to [arbitration] clauses on the ground that they are procedurally and substantively unconscionable. The decisions also address the proper scope of such clauses, the parties bound by them, and the parties' ability to challenge a decision ultimately rendered by an arbitrator,' commented Calihan and Reilly.

For example, in U-Save Auto Rental of America, Inc. v. Furlo et al., 2007 WL 2684006 (S.D. Miss. Sept. 7, 2007), franchisor U-Save was able to win the court's support to compel arbitration, even though the franchisees in the lawsuit, each of whom were based in Florida, sought to take their claims to Florida state court. 'The federal court held that choice-of-law issues are for the arbitrator to decide in the first instance and, therefore, the arbitrator acted within its discretion in concluding that Mississippi law applied and in dismissing the claims filed under Florida law,' said Calihan and Reilly.

Arbitration clauses also were upheld in litigation that arose between two Dunkin' Donuts franchisees. Katuga Enterprises, Inc. v. KNZ LLC, 2007 NY Misc. LEXIS 7821 (N.Y. Sup. Ct., Oct. 11, 2007). Katuga entered into a stock-purchase agreement with KNZ for four Dunkin' Donuts franchises that were owned by KNZ, but not yet opened; the stock-purchase agreement contained an arbitration clause. When the new stores struggled financially, KNZ sought to have Katuga held liable for 100% of the financial obligations of being a franchisee, even though Katuga at the time only owned 49% interest through the stock-purchase agreement (Katuga's partial share had been necessitated because it was not a Dunkin' Donuts-approved franchisee at the time the agreement was executed). An arbitrator determined that he could not find Katuga was the sole owner of the franchises without Dunkin' Donuts' consent, nor could he conclude that Katuga was entitled to recovery of the full purchase price it had paid. The court upheld the arbitrator's award on appeal.

In two other cases, courts declined to vacate arbitrators' awards, one benefiting a franchisor and one benefiting a franchisee. In Xenium S.A. De C.V. v. Regent Hotels Worldwide, Inc., Bus. Franchise Guide (CCH) 13,750 (N.D. Tex. Nov. 8, 2007), the franchisee 'argued that the arbitrator exceeded his powers by issuing a damages award that contradicted the merits of a prior final award issued by the arbitrator as to liability,' wrote Calihan and Reilly. 'In finding that the damages award did not revisit the merits of the liability award, the court highlighted the arbitrator's statements that the issue of liability had already been determined and would not be reconsidered.' The court also observed that the parties had clearly agreed to bifurcate the arbitration proceeding into two phases: liability and damages. In TES Franchising et al. v. Kastel et al., 2007 WL 1748141 (Conn. Super. Ct. May 25, 2007), the court denied a franchisor's request to vacate an arbitrator's finding that the parties' franchise agreement allowed for class arbitration.

'Top 10' Mistakes in New Franchise Disclosure Documents

The following list of mistakes that franchise examiners are commonly encountering in FDDs was developed and published online by Dale Cantone, chair of the North American Securities Administrators Association's Franchise and Business Opportunity Project Group, and Deputy Securities Commissioner of the State of Maryland.

1. FTC cover page and state cover page are not separated.
2. Use of legalese or legal antiques instead of plain English in the FDD.
3. Lack of simple, one-sentence statement on cover page that states the total investment necessary to begin operation of the franchise.
4. Deviation from mandatory language when it is required in the FDD, including in headings of charts.
5. Deviation from language required in the preamble for Item 19.
6. Deviation from required formats for charts in Item 20.
7. Lack of disclosure in Item 4 of foreign bankruptcies, and lack of negative disclaimer if none occurred.
8. Lack of disclosure (or sufficient disclosure) in Item 12 of the franchisor's
   reserved rights to engage in alternative channels of distribution.
9. Lack of two new mandatory disclosures in Item 20 related to confidentiality clauses and franchise terminations.
10. Lack of notification on the Receipt Pages that, while the 14-day requirement is now in effect, the 10-business-day/first personal meeting delivery rule may still apply in certain states, too.

Kevin Adler is Associate Editor of this newsletter.