News Briefs

NASAA Draft Commentary Offers Little New

The North American Securities Administrators' Association (NASAA) released a draft Commentary about the new Franchise Rule, reflecting many of the major issues that have been raised during franchise registrations under the new system. “There's nothing dramatic in the Commentary,” said Adam Siegelham, Stark & Stark (Princeton, NJ), “But it's useful to see what issues are recurring for franchise registration.”

During the nearly months of implementation of the new rules, franchise attorneys have encountered delays in obtaining state registrations. Siegelham said that this is to be expected, given examiners' and attorneys' unfamiliarity with the new disclosure requirements. “In certain cases, it's been significantly slower, but it does seem to be getting better,” he said. “What we saw in the earliest stages were state examiners' comment letters were more extensive ' and now attorneys are fixing the problems noted in those letters.”

The NASAA Commentary include identifies areas that had apparently raised questions for attorneys, and the new guidance is expected to help them avoid those mistakes that could delay registration. For example, several questions in the Commentary address Item 1 in the Franchise Disclosure Document (“FDD”) ' noting that a non-U.S. franchisor does not need to establish an office in the U.S., but it still must disclose its “principal business address,” wherever it is located. Also, the Commentary states that franchises must disclose in Item 1 all foreign affiliates that “offer franchises in any line of business or provide products or services to the franchisees of the franchisor.”

Item 8's disclosure of rebates includes “disclosure of the franchisee's obligation to purchase or lease goods or services either from the franchisor, its affiliates, its designees or suppliers approved by the franchisor, or under the franchisor's specifications.” This is a broad definition of rebate disclosures, notes the Commentary. To read the draft Commentary, go to http://www.nasaa.org/content/Files/FranchiseCommentary.pdf.

Atlanta Bread Litigation Goes to Georgia Supreme Court

The Georgia Supreme Court has agreed to review the appellate court decision in the case of Atlanta Bread Company v. Sean Lupton Smith, et al, litigation that the franchise industry considers significant for in-term covenants not to compete. (For a review of Atlanta Bread Company, see FBLA, September 2008.)

According to David French, IFA vice president of government relations, the trial court rule, upheld by the Georgia Court of Appeals, applied a very strict standard to in-term covenants and ruled that the Atlanta Bread Company non-compete was unenforceable. “IFA believes that the lower courts erred in evaluating the in-term restrictions under standards more appropriately applied to post-term limits,” French said. “This case is important to preserving the franchise model because the lower court's ruling, if allowed to remain as is, could render unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia.”

In a statement, the Georgia Supreme Court noted that it is particularly concerned with the following: “Did the court of appeals err in holding that under Jackson & Coker v. Hart, 261 GA 371 (1991), the reasonableness standard applicable to post-termination restrictive covenants also applies to in-term restrictive covenants? And, did the court of appeals err in applying to in-term restrictive covenants in franchise agreements the rule against allowing the blue-pencil doctrine of severability?”

Franchise Valuations, Ltd. Debuts IT Risk Management System

Franchise Technology Risk Management (“FTRM”) has launched a suite of information security services for franchise systems. The services include “penetration tests” to assess if corporate Websites, wireless networks, or the IT infrastructure can be hacked, said Bruce Schaeffer, co-founder of FTRM and a franchise attorney who is best-known for franchise valuations and appraisals. “Most importantly, conduct regular penetration checks for all of your Internet-facing applications and the corporate network perimeter to ensure the proper mitigating controls are in place,” said Schaeffer. For information, go to www.ftrm.biz.

Cold Stone Settles Lawsuit Over Limits on Arbitration

A case that challenged franchisors' ability to enforce arbitration agreements in franchise contracts will not be heard by the California Supreme Court, as franchisor Cold Stone Creamery settled its dispute with a former franchisee. The settlement of Lesa Meyers v. Cold Stone Creamery was not made public; its terms are confidential, and even the existence of the settlement was not noted until it was reported online by BlueMauMau.com about two months after the settlement was reached.

“The Meyers case really speaks to the need for trial lawyers in franchise cases to educate their tribunals, both courts and arbitration panels alike, thoroughly and early in the case,” said John Jacko, Fellheimer & Eichen LLP (Philadelphia).

In Meyers, the judge referenced Nagrampa v. Mailcoups, Inc., a 2006 decision by the U.S. Court of Appeals for the Ninth Circuit. That decision applied California law to void a franchise agreement on the basis of its “take it or leave it” offer to a franchisee, and franchise attorneys commented at the time that it could have a significant impact. “Because franchisors arguably often have superior bargaining power, draft franchise agreements, and present them to franchisees on a take-it-or-leave-it basis, there may be no practical way to avoid a finding of procedural unconscionability if the standard set forth by the court in Nagrampa is applied,” said Eric Wulff, partner, DLA Piper (Washington, DC).

IFA's brief criticized Nagrampa and referenced the dissent from that decision that noted the benefits of a uniform franchise contract that affords to small, presumably less sophisticated franchisees, the same terms that were developed to be attractive to large, presumably more-sophisticated franchisees. In fact, IFA noted that California's franchise laws discourage deviation from the standard franchise contract, in order to “assure that smaller, supposedly 'weaker' franchisees will enjoy the same protections in a franchise agreement as their larger, more 'powerful' counterpart.”

Apparently, franchise attorneys will have to wait longer for a test of Nagrampa. Meanwhile, Jacko added that “arguments over the alleged unconscionablility of arbitration provisions, by their nature, require a case-by-case analysis. The Meyers case changed nothing in that regard.”

Super 8 Motel Franchisees Lawsuit Receives Class Action Status

On Sept. 25, the U.S. District Court, District of South Dakota, Southern District, granted class action status to a lawsuit filed in October 2007 by more than 200 franchisees of Super 8 Motels (see FBLA, January 2008, for background on Bird Hotel Corporation v. Super 8 Motels, Inc.). The lawsuit was filed by Bird Hotel Corp. of Manitoba, Canada, which is disputing the additional 5% charge on gross room sales levied by Super 8's owner, Cendant Corp. Cendant bought Super 8 in 1992, and in 2003 it began to levy the additional charge to reflect the franchisees' inclusion in the franchisor's TripRewards program.

The franchisees do not dispute that franchise agreements signed after Cendant bought Super 8 do grant the franchisor the right to charge the fee. They say, however, that franchise agreements that predate the sale do not allow it.

Certification of the class action references 226 franchise owners who are potential members of the class. Notice has been distributed to them about joining the class action, according to Jay Patel, chair of the Owners 8 Association, an independent association of Super 8 franchisees.

NASAA Draft Commentary Offers Little New

The North American Securities Administrators' Association (NASAA) released a draft Commentary about the new Franchise Rule, reflecting many of the major issues that have been raised during franchise registrations under the new system. “There's nothing dramatic in the Commentary,” said Adam Siegelham, Stark & Stark (Princeton, NJ), “But it's useful to see what issues are recurring for franchise registration.”

During the nearly months of implementation of the new rules, franchise attorneys have encountered delays in obtaining state registrations. Siegelham said that this is to be expected, given examiners' and attorneys' unfamiliarity with the new disclosure requirements. “In certain cases, it's been significantly slower, but it does seem to be getting better,” he said. “What we saw in the earliest stages were state examiners' comment letters were more extensive ' and now attorneys are fixing the problems noted in those letters.”

The NASAA Commentary include identifies areas that had apparently raised questions for attorneys, and the new guidance is expected to help them avoid those mistakes that could delay registration. For example, several questions in the Commentary address Item 1 in the Franchise Disclosure Document (“FDD”) ' noting that a non-U.S. franchisor does not need to establish an office in the U.S., but it still must disclose its “principal business address,” wherever it is located. Also, the Commentary states that franchises must disclose in Item 1 all foreign affiliates that “offer franchises in any line of business or provide products or services to the franchisees of the franchisor.”

Item 8's disclosure of rebates includes “disclosure of the franchisee's obligation to purchase or lease goods or services either from the franchisor, its affiliates, its designees or suppliers approved by the franchisor, or under the franchisor's specifications.” This is a broad definition of rebate disclosures, notes the Commentary. To read the draft Commentary, go to http://www.nasaa.org/content/Files/FranchiseCommentary.pdf.

Atlanta Bread Litigation Goes to Georgia Supreme Court

The Georgia Supreme Court has agreed to review the appellate court decision in the case of Atlanta Bread Company v. Sean Lupton Smith, et al, litigation that the franchise industry considers significant for in-term covenants not to compete. (For a review of Atlanta Bread Company, see FBLA, September 2008.)

According to David French, IFA vice president of government relations, the trial court rule, upheld by the Georgia Court of Appeals, applied a very strict standard to in-term covenants and ruled that the Atlanta Bread Company non-compete was unenforceable. “IFA believes that the lower courts erred in evaluating the in-term restrictions under standards more appropriately applied to post-term limits,” French said. “This case is important to preserving the franchise model because the lower court's ruling, if allowed to remain as is, could render unenforceable the in-term restrictive covenants in the vast majority of franchise contracts for businesses operated in Georgia.”

In a statement, the Georgia Supreme Court noted that it is particularly concerned with the following: “Did the court of appeals err in holding that under Jackson & Coker v. Hart , 261 GA 371 (1991), the reasonableness standard applicable to post-termination restrictive covenants also applies to in-term restrictive covenants? And, did the court of appeals err in applying to in-term restrictive covenants in franchise agreements the rule against allowing the blue-pencil doctrine of severability?”

Franchise Valuations, Ltd. Debuts IT Risk Management System

Franchise Technology Risk Management (“FTRM”) has launched a suite of information security services for franchise systems. The services include “penetration tests” to assess if corporate Websites, wireless networks, or the IT infrastructure can be hacked, said Bruce Schaeffer, co-founder of FTRM and a franchise attorney who is best-known for franchise valuations and appraisals. “Most importantly, conduct regular penetration checks for all of your Internet-facing applications and the corporate network perimeter to ensure the proper mitigating controls are in place,” said Schaeffer. For information, go to www.ftrm.biz.

Cold Stone Settles Lawsuit Over Limits on Arbitration

A case that challenged franchisors' ability to enforce arbitration agreements in franchise contracts will not be heard by the California Supreme Court, as franchisor Cold Stone Creamery settled its dispute with a former franchisee. The settlement of Lesa Meyers v. Cold Stone Creamery was not made public; its terms are confidential, and even the existence of the settlement was not noted until it was reported online by BlueMauMau.com about two months after the settlement was reached.

“The Meyers case really speaks to the need for trial lawyers in franchise cases to educate their tribunals, both courts and arbitration panels alike, thoroughly and early in the case,” said John Jacko, Fellheimer & Eichen LLP (Philadelphia).

In Meyers, the judge referenced Nagrampa v. Mailcoups, Inc., a 2006 decision by the U.S. Court of Appeals for the Ninth Circuit. That decision applied California law to void a franchise agreement on the basis of its “take it or leave it” offer to a franchisee, and franchise attorneys commented at the time that it could have a significant impact. “Because franchisors arguably often have superior bargaining power, draft franchise agreements, and present them to franchisees on a take-it-or-leave-it basis, there may be no practical way to avoid a finding of procedural unconscionability if the standard set forth by the court in Nagrampa is applied,” said Eric Wulff, partner, DLA Piper (Washington, DC).

IFA's brief criticized Nagrampa and referenced the dissent from that decision that noted the benefits of a uniform franchise contract that affords to small, presumably less sophisticated franchisees, the same terms that were developed to be attractive to large, presumably more-sophisticated franchisees. In fact, IFA noted that California's franchise laws discourage deviation from the standard franchise contract, in order to “assure that smaller, supposedly 'weaker' franchisees will enjoy the same protections in a franchise agreement as their larger, more 'powerful' counterpart.”

Apparently, franchise attorneys will have to wait longer for a test of Nagrampa. Meanwhile, Jacko added that “arguments over the alleged unconscionablility of arbitration provisions, by their nature, require a case-by-case analysis. The Meyers case changed nothing in that regard.”

Super 8 Motel Franchisees Lawsuit Receives Class Action Status

On Sept. 25, the U.S. District Court, District of South Dakota, Southern District, granted class action status to a lawsuit filed in October 2007 by more than 200 franchisees of Super 8 Motels (see FBLA, January 2008, for background on Bird Hotel Corporation v. Super 8 Motels, Inc.). The lawsuit was filed by Bird Hotel Corp. of Manitoba, Canada, which is disputing the additional 5% charge on gross room sales levied by Super 8's owner, Cendant Corp. Cendant bought Super 8 in 1992, and in 2003 it began to levy the additional charge to reflect the franchisees' inclusion in the franchisor's TripRewards program.

The franchisees do not dispute that franchise agreements signed after Cendant bought Super 8 do grant the franchisor the right to charge the fee. They say, however, that franchise agreements that predate the sale do not allow it.

Certification of the class action references 226 franchise owners who are potential members of the class. Notice has been distributed to them about joining the class action, according to Jay Patel, chair of the Owners 8 Association, an independent association of Super 8 franchisees.