Key Trends in Franchise Law in 2011

Non-renewal and Transfer Issues. Review the qualifications for new franchisees. As the economy changes, franchisees will seize the opportunity to exit, and some franchisors will see the opportunity to obtain stronger operators. Make sure your criteria for new franchisees is defensible. For sellers, ensure yourself that you are reaching a qualified buyer pool. Franchisors will be looking to raise performance and deny renewal. They know the demand for franchises only needs financing to catch up with the supply.

David L. Cahn, Whiteford, Taylor, Preston

One recent trend that I expect to continue has been successful claims against food franchisors for extracting compensation from approved suppliers of products. In a case involving Wendy's, the franchise agreement was ambiguous concerning the franchisor's ability to designate a mandatory single supplier, as opposed to allowing the franchisee to obtain approval of alternative suppliers. As a result, a court held that Wendy's did not have the right to compel purchase from a sole supplier of buns that would pay Wendy's a percentage of its revenues from those sales.

Meanwhile, a class action brought by Quizno's franchisees was settled after the presiding court denied motions for dismissal prior to trial. While the ability of Quizno's to obtain rebates was stated in the FDD and franchise agreement, Quizno's also promised to establish purchasing relationships “for the benefit of the franchise system.” It is likely that the franchisees had evidence that the prices that they were being required to pay were higher than they would have paid as non-franchised sandwich shops.

So, franchisors' attorneys must make sure that the franchisor's rights to designate sole suppliers, limit the number of approved suppliers, and obtain compensation from suppliers are clearly disclosed. If franchisors promote that the size of the franchise system will enable franchisees to obtain volume discounts on supplies, they need to be able to prove that such a benefit actually exists.

Dave Hood, President, The iFranchise Group

With more than half of the U.S. state governments operating at a deficit and many facing the possibility of bankruptcy during 2011, it is not surprising that state governments are doing everything they can to increase revenues. For many years, experts have foreshadowed the likelihood that states would assess taxes on royalties paid to out-of-state franchisors who had no “assets” in the state other than their independently owned franchisees. California, Colorado, New York, Ohio, Oklahoma, and Washington, among others, have adopted standards preparing them for taxation based on a taxpayer's economic nexus in their state. Over the past few years, several states have sent nexus questionnaires to franchisors operating in their state ' laying the groundwork for future taxation.

In December 2010, the Iowa Supreme Court issued a decision upholding the state's right to tax franchisors based in other states based on their having only an “economic nexus” in Iowa. (See review of this decision on p. 1 of this issue.) This decision will likely encourage other states to become even more aggressive in taxing the revenues of out-of-state franchisors in 2011 and beyond. Franchisors should comply with any changes in the state tax requirements, while consulting with tax and legal counsel on how to best plan for these more aggressive tax measures.

Bruce Schaeffer, Principal, Franchise Valuations, Ltd.

Tax Nexus. I expect the states to intensify efforts to collect taxes ' income taxes and, probably, sales taxes as well ' from franchisors. Franchisors that cling to the argument that physical presence is a requirement for tax nexus will not prevail and will suffer threefold liabilities.

Liability. As suggested in the Federal Judicial Center Manual for Complex Litigation, 4th edition, litigation counsel will finally realize that “the attention given to liability issues ' may lead to neglect of injury and damages issues” and that “[e]arly scrutiny of the claimed damages can facilitate settlement, either because of the magnitude of the potential exposure or because provable damages are too small to justify the cost of pursuing the litigation”; and litigation counsel will see the wisdom of retaining damages experts at the beginning of a case rather than at the end.

Internet Security. I think that a prominent franchisor will be the victim of an Internet security attack, and millions of consumers will be subject to identity theft. The franchisor will face a huge financial burden to recover from the breach, and its reputation will suffer. As a result, members of the franchise community will finally wake up and realize they could be next.

Justin Klein, Partner, Marks & Klein

Franchising continues to grow and thrive as a driving force of the American economy, and 2011 should be no different. I believe in 2011 (and beyond) the industry will see a more experienced and more sophisticated franchisee entering the marketplace and fewer unqualified, inexperienced franchisors emerging. I believe the tightening of the credit markets has made it tougher for individuals to invest in many franchises, but that this has led to financially stronger franchisees, as well as franchisees with more business experience. Because unemployment rates remain high, otherwise qualified employees are turning to business opportunities such as franchises as an alternative to remaining unemployed. I am also optimistic that more experienced and sophisticated franchisees will lead to better relations between franchisee and franchisor. Franchisees will be better equipped to understand the nature of the relationship, and it will therefore be difficult for franchisors to engage in overly one-sided conduct.

Jay W. Schlosser, Partner, Briggs and Morgan

One item of interest in 2011 is the antitrust claim at issue in Burda v. Wendy's International, Inc., et al. (S.D. Ohio). In Burda, the franchisee asserted that after he had entered into his franchise agreement, Wendy's changed its policy and forced him to purchase supplies from Wendy's affiliates. The federal court in Ohio has allowed the franchisee to proceed with his illegal tying claim, under a Kodak locked-in theory, finding that the language in the franchise agreement was not specific enough to put the franchisee on notice of the potential imposition of exclusive purchasing restrictions. Franchisors should carefully review the language in their agreements to ensure that it permits the franchisor to designate an exclusive supplier for products.

A second area that appears ripe for 2011 is the issue of vicarious liability of franchisors. Two recent decisions, Soto v. Superior Telecom, Inc. 2010 WL 2232145 (S.D. Ca., June 2, 2010) and Bauer v. Douglas Aquatics, Inc., Bus. Franchise Guide (CCH 14,459) (Sept. 7, 2010), suggest that courts, focusing on implied/apparent agency theories, will be carefully reviewing the franchise relationship before summarily dismissing claims against franchisors. Franchisors will need to closely examine their “control” over the day-to-day activities of franchisees.

David Koch, Plave Koch PLC

Franchise Sales on the Rise. The pent-up demand to sell franchise brands, which cracked open in 2010, will be fully released in 2011. Many brands are held by private equity firms that are well past their normal exit horizon. They've kept their holdings longer because of market conditions in the last two- to three-years. Franchise counsel should polish-up their due diligence checklists and prepare for battle over representations and warranties. The same goes for existing franchises: More owners will look to sell because, with employment prospects improving, they will have less fear of making a move, and buyers will have a better shot at financing. Franchisors ought to consider developing a set of transfer guidelines that walk existing franchisees through the franchisor's transfer process.

Supply Chains. The backlash against franchisor supply chain restrictions might grow as franchise owners gain confidence in business conditions. Franchisors and their counsel should confirm that supply chain practices align with existing contract terms.

New Concepts. I think we'll see more “surrogate parenting” in franchising. By this, I mean situations where external investors (the “surrogates”) negotiate for the right to franchise a concept whose owners don't wish to franchise it themselves.

Sarah J. Yatchak, Special Counsel, Faegre & Benson

Good or bad, change will be the key theme for franchising in 2011. With every sign of life that surfaces in the economy this year, franchisors will confront the reality that they must adapt to shifting consumer demand or be left out of the game. The ability to adapt or change is only possible if franchisors first listen to consumers and then work through myriad business and legal issues associated with implementing various system refinements and improvements, all with any eye toward helping the system (and their franchisees) stay relevant.

International franchising also will continue to be a hot trend in 2011, especially in countries such as India and China, both of which are experiencing periods of record economic growth. In addition, Australia, Brazil, and South Africa recently have attracted more attention from U.S.-based franchisors given their relative economic stability and consumer demand for foreign products and services. Smart franchisors that wish to expand internationally not only will work diligently to determine the regulatory framework within which they will be expected to operate and secure the necessary trademarks in the country of choice, but also they will engage their advisers in early, frequent, and robust discussions about how best to strategically enter a particular market from both a business and legal perspective.

Finally, as more franchisees take stock of their own interests in 2011, franchisors may be faced with an increasing number of transfer requests brought about by franchisee estate planning. These types of transfers (i.e., transfers to trusts) bring with them a host of unique legal issues ' from personal guarantees to releases to basic control ' that need to be addressed before an estate plan is put into place. Franchisors should develop protocol specific to handling transfers to trusts for estate planning purposes. Franchisees will appreciate the franchisor's forward-thinking approach to this issue.

Katherine Wallman, Associate, Gray Plant Mooty

In most states, courts evaluate the reasonableness of the scope, time, and geographic reach of a post termination non-compete covenant in a franchise agreement to decide whether it is enforceable. Courts are only beginning to deal with post-term covenants that prevent franchisees from selling products and services over the Internet. Because an Internet sales ban could be regarded as a global ban, whether or how such restrictions will be enforced is an unresolved question. Last September a Maryland state court, in In Wild Bird Centers of America, Inc. v. Duer, CCH Business Franchise Guide ' 14,490 (Sept. 2, 2010), interpreted a post-term non-compete covenant to preclude Internet sales into territories specified in a franchise agreement, but not in others. Although the franchise agreement did not expressly address Internet sales, the franchisor sought to shut down a terminated franchisee's Web site from which he was selling the same products that were sold through the franchise. The court concluded that the covenant should be enforced within 20 miles of Duer's franchise territory and within 20 miles of the territory of any other WBCA franchisee (as the franchise agreement provided). The terminated franchisee was free to sell to customers outside the territory, even though the former franchisee operated his Web site from within the former franchised territory. In light of this decision, franchisors should continue to evaluate the types of language they need to protect their e-commerce Web sites from both in-term and post-term competition by franchisees, and they should carefully consider the reasonableness of any contractual remedies that they may draft in their franchise agreements.

Carl Zwisler, Principal, Gray Plant Mooty

The enforceability of pre-dispute arbitration agreements will continue to be much debated in 2011. The U.S. Supreme Court recently ruled that certain challenges to arbitration agreements must be decided by arbitrators, and not judges. Rent-a-Center Inc. v. Jackson, No. 09-497, __ U.S. __, slip op. (June 21, 2010) involved an employee, Jackson, who filed a racial-discrimination claim against Rent-A-Center in federal court. Rent-A-Center moved to have the complaint dismissed because Jackson had agreed in his employment contract to submit such disputes to arbitration. The contract also provided that any question of whether the arbitration was enforceable would be decided by an arbitrator, not a judge. Jackson claimed that the arbitration agreement as a whole was unconscionable. The Supreme Court concluded that because Jackson consented to have disputes settled by arbitration, it made “no difference” that the dispute at issue was about the enforceability of the arbitration agreement itself. Franchisors should determine if they want questions of arbitrability to be decided by an arbitrator and draft their franchise agreements accordingly. Franchisees' lawyers wishing to challenge arbitration clauses that do not expressly reserve the right to determine arbitrability to the arbitrator should be prepared to distinguish the Rent-A-Center case.

Leonard Vines and Beata Krakus, Greensfelder, Hemker & Gale

Financial difficulties facing state governments are forcing many states to find new sources of revenue. Activities of franchisors and franchisees are among the targets. In December 2010, the Iowa Supreme Court, in KFC Corporation v. Iowa Department of Revenue, found that the state could impose a corporate income tax on revenue earned by an out-of-state franchisor that did not have physical presence in Iowa, solely because the franchisor's intangible property was used by franchisees located in the state. Observers will closely watch this case to see if KFC appeals to the U.S. Supreme Court. (See review of this decision on p. 1 of this issue.)

Other examples include reporting requirements by franchisors. In New York, they are required to submit annual transaction information about their franchisees to the Department of Taxation and Finance. The California Franchise Tax Board has advised some franchisors that they must withhold 7% of royalty payments if they have not registered as a resident corporation. South Dakota has been asking out-of-state franchisors to pay sales and use tax on initial franchise fees and royalty income. This year, several states have introduced tax legislation that would affect franchisors.

Yet another potential revenue source is gift cards. New Jersey is attempting to raise millions of dollars by seizing unredeemed gift cards. Constitutional objections have been raised, and the state intends to appeal a decision that enjoined enforcement of the law. (See American Express Travel Related Services Company, Inc. v. Sidamon-Eristoff, Civil No. 10-4890, 2010 WL 4722209 (D.N.J. Nov. 13, 2010).)

And let us not forget Pius Awuah et al. v. Coverall North America Inc., Civil No. 07-10287-WGY, 2010 WL 1257980 (D. Mass. Mar. 23, 2010), where a Massachusetts federal district court classified franchisees as employees of the franchisor. Although this case is fact-specific and based on Massachusetts law, it would not be surprising if some other states followed suit. If so, some franchisors could be required not only to pay more taxes, but also to provide other benefits available to employees but not to independent contractors. The case is on appeal on the certified question of damages available under the Massachusetts Wage Act.

Jennifer Dolman and Andraya Frith, Partners, Osler, Hoskin & Harcourt

Trends in Ontario, Canada. In the past five years, there have been many successful class action certification motions against franchisors alleging breaches of the Ontario franchise legislation. This trend is likely to continue in 2011 and beyond, particularly in light of recent statements by the Ontario Court of Appeal in Quizno's that “a dispute between a franchisor and several hundred franchisees is exactly the kind of case for a class proceeding” (Quizno's Canada Restaurant Corporation v. 2038724 Ontario Ltd., 2010 ONCA 466 at para. 62). While a common agreement shared by numerous franchisees may work to a franchisor's detriment in resisting class action certification, franchisors faced with defending a certification motion should consider seeking summary judgment which, if successful, will stop a class action in its tracks at an early stage.

We also anticipate continued reliance by Ontario franchisee counsel on not just the statutory duty of fair dealing under section 3 of the Arthur Wishart Act, but also the franchisee's right of association under section 4. In Midas, the Ontario Court of Appeal affirmed that this right includes the right to participate in a class action and that releases obtained from individual franchisees on renewal or transfer to prevent class actions are not enforceable (405341 Ontario Limited v. Midas Canada Inc., 2010 ONCA 478). In Sobeys Capital, a franchisor's restriction of a franchisee's access to funds to pay legal fees was found on the hearing of an injunction to constitute a serious issue to be tried as to whether the franchisor had interfered with the franchisees' ability to pursue collective action (1318214 Ontario Ltd. v. Sobeys Capital Inc., 2010 ONSC 4141). Since there is a right of damages for any breach of section 4, franchisors must tread cautiously in their day-to-day dealings with franchisees.

FBLA asked leading franchise attorneys and other experts about key trends in franchise law in 2011. Here are their outlooks and their advice about how to prepare for new developments in franchise law and business.

Craig Tractenberg, Partner, Nixon Peabody

Social Media and False Advertising Risks. Review your social media policy, educate your constituencies, and coordinate the policy with the franchise agreement, the operations manual, and best practices. Suppose a negative review appears and a franchisee requests that a customer respond with positive reports and affirmations on LinkedIn, Myspace, and Facebook affinity sites and on blogs. But the customer is also an employee of the franchisee, which is not disclosed on the sites but is later exposed. A competitor then brings a false advertising claim. Better make sure that you know about the risks of such claims and educate your colleagues about using best practices on social media.

Non-renewal and Transfer Issues. Review the qualifications for new franchisees. As the economy changes, franchisees will seize the opportunity to exit, and some franchisors will see the opportunity to obtain stronger operators. Make sure your criteria for new franchisees is defensible. For sellers, ensure yourself that you are reaching a qualified buyer pool. Franchisors will be looking to raise performance and deny renewal. They know the demand for franchises only needs financing to catch up with the supply.

David L. Cahn, Whiteford, Taylor, Preston

One recent trend that I expect to continue has been successful claims against food franchisors for extracting compensation from approved suppliers of products. In a case involving Wendy's, the franchise agreement was ambiguous concerning the franchisor's ability to designate a mandatory single supplier, as opposed to allowing the franchisee to obtain approval of alternative suppliers. As a result, a court held that Wendy's did not have the right to compel purchase from a sole supplier of buns that would pay Wendy's a percentage of its revenues from those sales.

Meanwhile, a class action brought by Quizno's franchisees was settled after the presiding court denied motions for dismissal prior to trial. While the ability of Quizno's to obtain rebates was stated in the FDD and franchise agreement, Quizno's also promised to establish purchasing relationships “for the benefit of the franchise system.” It is likely that the franchisees had evidence that the prices that they were being required to pay were higher than they would have paid as non-franchised sandwich shops.

So, franchisors' attorneys must make sure that the franchisor's rights to designate sole suppliers, limit the number of approved suppliers, and obtain compensation from suppliers are clearly disclosed. If franchisors promote that the size of the franchise system will enable franchisees to obtain volume discounts on supplies, they need to be able to prove that such a benefit actually exists.

Dave Hood, President, The iFranchise Group

With more than half of the U.S. state governments operating at a deficit and many facing the possibility of bankruptcy during 2011, it is not surprising that state governments are doing everything they can to increase revenues. For many years, experts have foreshadowed the likelihood that states would assess taxes on royalties paid to out-of-state franchisors who had no “assets” in the state other than their independently owned franchisees. California, Colorado, New York, Ohio, Oklahoma, and Washington, among others, have adopted standards preparing them for taxation based on a taxpayer's economic nexus in their state. Over the past few years, several states have sent nexus questionnaires to franchisors operating in their state ' laying the groundwork for future taxation.

In December 2010, the Iowa Supreme Court issued a decision upholding the state's right to tax franchisors based in other states based on their having only an “economic nexus” in Iowa. (See review of this decision on p. 1 of this issue.) This decision will likely encourage other states to become even more aggressive in taxing the revenues of out-of-state franchisors in 2011 and beyond. Franchisors should comply with any changes in the state tax requirements, while consulting with tax and legal counsel on how to best plan for these more aggressive tax measures.

Bruce Schaeffer, Principal, Franchise Valuations, Ltd.

Tax Nexus. I expect the states to intensify efforts to collect taxes ' income taxes and, probably, sales taxes as well ' from franchisors. Franchisors that cling to the argument that physical presence is a requirement for tax nexus will not prevail and will suffer threefold liabilities.

Liability. As suggested in the Federal Judicial Center Manual for Complex Litigation, 4th edition, litigation counsel will finally realize that “the attention given to liability issues ' may lead to neglect of injury and damages issues” and that “[e]arly scrutiny of the claimed damages can facilitate settlement, either because of the magnitude of the potential exposure or because provable damages are too small to justify the cost of pursuing the litigation”; and litigation counsel will see the wisdom of retaining damages experts at the beginning of a case rather than at the end.

Internet Security. I think that a prominent franchisor will be the victim of an Internet security attack, and millions of consumers will be subject to identity theft. The franchisor will face a huge financial burden to recover from the breach, and its reputation will suffer. As a result, members of the franchise community will finally wake up and realize they could be next.

Justin Klein, Partner, Marks & Klein

Franchising continues to grow and thrive as a driving force of the American economy, and 2011 should be no different. I believe in 2011 (and beyond) the industry will see a more experienced and more sophisticated franchisee entering the marketplace and fewer unqualified, inexperienced franchisors emerging. I believe the tightening of the credit markets has made it tougher for individuals to invest in many franchises, but that this has led to financially stronger franchisees, as well as franchisees with more business experience. Because unemployment rates remain high, otherwise qualified employees are turning to business opportunities such as franchises as an alternative to remaining unemployed. I am also optimistic that more experienced and sophisticated franchisees will lead to better relations between franchisee and franchisor. Franchisees will be better equipped to understand the nature of the relationship, and it will therefore be difficult for franchisors to engage in overly one-sided conduct.

Jay W. Schlosser, Partner, Briggs and Morgan

One item of interest in 2011 is the antitrust claim at issue in Burda v. Wendy's International, Inc., et al. (S.D. Ohio). In Burda, the franchisee asserted that after he had entered into his franchise agreement, Wendy's changed its policy and forced him to purchase supplies from Wendy's affiliates. The federal court in Ohio has allowed the franchisee to proceed with his illegal tying claim, under a Kodak locked-in theory, finding that the language in the franchise agreement was not specific enough to put the franchisee on notice of the potential imposition of exclusive purchasing restrictions. Franchisors should carefully review the language in their agreements to ensure that it permits the franchisor to designate an exclusive supplier for products.

A second area that appears ripe for 2011 is the issue of vicarious liability of franchisors. Two recent decisions, Soto v. Superior Telecom, Inc. 2010 WL 2232145 (S.D. Ca., June 2, 2010) and Bauer v. Douglas Aquatics, Inc., Bus. Franchise Guide (CCH 14,459) (Sept. 7, 2010), suggest that courts, focusing on implied/apparent agency theories, will be carefully reviewing the franchise relationship before summarily dismissing claims against franchisors. Franchisors will need to closely examine their “control” over the day-to-day activities of franchisees.

David Koch, Plave Koch PLC

Franchise Sales on the Rise. The pent-up demand to sell franchise brands, which cracked open in 2010, will be fully released in 2011. Many brands are held by private equity firms that are well past their normal exit horizon. They've kept their holdings longer because of market conditions in the last two- to three-years. Franchise counsel should polish-up their due diligence checklists and prepare for battle over representations and warranties. The same goes for existing franchises: More owners will look to sell because, with employment prospects improving, they will have less fear of making a move, and buyers will have a better shot at financing. Franchisors ought to consider developing a set of transfer guidelines that walk existing franchisees through the franchisor's transfer process.

Supply Chains. The backlash against franchisor supply chain restrictions might grow as franchise owners gain confidence in business conditions. Franchisors and their counsel should confirm that supply chain practices align with existing contract terms.

New Concepts. I think we'll see more “surrogate parenting” in franchising. By this, I mean situations where external investors (the “surrogates”) negotiate for the right to franchise a concept whose owners don't wish to franchise it themselves.

Sarah J. Yatchak, Special Counsel, Faegre & Benson

Good or bad, change will be the key theme for franchising in 2011. With every sign of life that surfaces in the economy this year, franchisors will confront the reality that they must adapt to shifting consumer demand or be left out of the game. The ability to adapt or change is only possible if franchisors first listen to consumers and then work through myriad business and legal issues associated with implementing various system refinements and improvements, all with any eye toward helping the system (and their franchisees) stay relevant.

International franchising also will continue to be a hot trend in 2011, especially in countries such as India and China, both of which are experiencing periods of record economic growth. In addition, Australia, Brazil, and South Africa recently have attracted more attention from U.S.-based franchisors given their relative economic stability and consumer demand for foreign products and services. Smart franchisors that wish to expand internationally not only will work diligently to determine the regulatory framework within which they will be expected to operate and secure the necessary trademarks in the country of choice, but also they will engage their advisers in early, frequent, and robust discussions about how best to strategically enter a particular market from both a business and legal perspective.

Finally, as more franchisees take stock of their own interests in 2011, franchisors may be faced with an increasing number of transfer requests brought about by franchisee estate planning. These types of transfers (i.e., transfers to trusts) bring with them a host of unique legal issues ' from personal guarantees to releases to basic control ' that need to be addressed before an estate plan is put into place. Franchisors should develop protocol specific to handling transfers to trusts for estate planning purposes. Franchisees will appreciate the franchisor's forward-thinking approach to this issue.

Katherine Wallman, Associate, Gray Plant Mooty

In most states, courts evaluate the reasonableness of the scope, time, and geographic reach of a post termination non-compete covenant in a franchise agreement to decide whether it is enforceable. Courts are only beginning to deal with post-term covenants that prevent franchisees from selling products and services over the Internet. Because an Internet sales ban could be regarded as a global ban, whether or how such restrictions will be enforced is an unresolved question. Last September a Maryland state court, in In Wild Bird Centers of America, Inc. v. Duer, CCH Business Franchise Guide ' 14,490 (Sept. 2, 2010), interpreted a post-term non-compete covenant to preclude Internet sales into territories specified in a franchise agreement, but not in others. Although the franchise agreement did not expressly address Internet sales, the franchisor sought to shut down a terminated franchisee's Web site from which he was selling the same products that were sold through the franchise. The court concluded that the covenant should be enforced within 20 miles of Duer's franchise territory and within 20 miles of the territory of any other WBCA franchisee (as the franchise agreement provided). The terminated franchisee was free to sell to customers outside the territory, even though the former franchisee operated his Web site from within the former franchised territory. In light of this decision, franchisors should continue to evaluate the types of language they need to protect their e-commerce Web sites from both in-term and post-term competition by franchisees, and they should carefully consider the reasonableness of any contractual remedies that they may draft in their franchise agreements.

Carl Zwisler, Principal, Gray Plant Mooty

The enforceability of pre-dispute arbitration agreements will continue to be much debated in 2011. The U.S. Supreme Court recently ruled that certain challenges to arbitration agreements must be decided by arbitrators, and not judges. Rent-a-Center Inc. v. Jackson , No. 09-497, __ U.S. __, slip op. (June 21, 2010) involved an employee, Jackson, who filed a racial-discrimination claim against Rent-A-Center in federal court. Rent-A-Center moved to have the complaint dismissed because Jackson had agreed in his employment contract to submit such disputes to arbitration. The contract also provided that any question of whether the arbitration was enforceable would be decided by an arbitrator, not a judge. Jackson claimed that the arbitration agreement as a whole was unconscionable. The Supreme Court concluded that because Jackson consented to have disputes settled by arbitration, it made “no difference” that the dispute at issue was about the enforceability of the arbitration agreement itself. Franchisors should determine if they want questions of arbitrability to be decided by an arbitrator and draft their franchise agreements accordingly. Franchisees' lawyers wishing to challenge arbitration clauses that do not expressly reserve the right to determine arbitrability to the arbitrator should be prepared to distinguish the Rent-A-Center case.

Leonard Vines and Beata Krakus, Greensfelder, Hemker & Gale

Financial difficulties facing state governments are forcing many states to find new sources of revenue. Activities of franchisors and franchisees are among the targets. In December 2010, the Iowa Supreme Court, in KFC Corporation v. Iowa Department of Revenue, found that the state could impose a corporate income tax on revenue earned by an out-of-state franchisor that did not have physical presence in Iowa, solely because the franchisor's intangible property was used by franchisees located in the state. Observers will closely watch this case to see if KFC appeals to the U.S. Supreme Court. (See review of this decision on p. 1 of this issue.)

Other examples include reporting requirements by franchisors. In New York, they are required to submit annual transaction information about their franchisees to the Department of Taxation and Finance. The California Franchise Tax Board has advised some franchisors that they must withhold 7% of royalty payments if they have not registered as a resident corporation. South Dakota has been asking out-of-state franchisors to pay sales and use tax on initial franchise fees and royalty income. This year, several states have introduced tax legislation that would affect franchisors.

Yet another potential revenue source is gift cards. New Jersey is attempting to raise millions of dollars by seizing unredeemed gift cards. Constitutional objections have been raised, and the state intends to appeal a decision that enjoined enforcement of the law. (See American Express Travel Related Services Company, Inc. v. Sidamon-Eristoff, Civil No. 10-4890, 2010 WL 4722209 (D.N.J. Nov. 13, 2010).)

And let us not forget Pius Awuah et al. v. Coverall North America Inc., Civil No. 07-10287-WGY, 2010 WL 1257980 (D. Mass. Mar. 23, 2010), where a Massachusetts federal district court classified franchisees as employees of the franchisor. Although this case is fact-specific and based on Massachusetts law, it would not be surprising if some other states followed suit. If so, some franchisors could be required not only to pay more taxes, but also to provide other benefits available to employees but not to independent contractors. The case is on appeal on the certified question of damages available under the Massachusetts Wage Act.

Jennifer Dolman and Andraya Frith, Partners, Osler, Hoskin & Harcourt

Trends in Ontario, Canada. In the past five years, there have been many successful class action certification motions against franchisors alleging breaches of the Ontario franchise legislation. This trend is likely to continue in 2011 and beyond, particularly in light of recent statements by the Ontario Court of Appeal in Quizno's that “a dispute between a franchisor and several hundred franchisees is exactly the kind of case for a class proceeding” (Quizno's Canada Restaurant Corporation v. 2038724 Ontario Ltd., 2010 ONCA 466 at para. 62). While a common agreement shared by numerous franchisees may work to a franchisor's detriment in resisting class action certification, franchisors faced with defending a certification motion should consider seeking summary judgment which, if successful, will stop a class action in its tracks at an early stage.

We also anticipate continued reliance by Ontario franchisee counsel on not just the statutory duty of fair dealing under section 3 of the Arthur Wishart Act, but also the franchisee's right of association under section 4. In Midas , the Ontario Court of Appeal affirmed that this right includes the right to participate in a class action and that releases obtained from individual franchisees on renewal or transfer to prevent class actions are not enforceable ( 405341 Ontario Limited v. Midas Canada Inc. , 2010 ONCA 478). In Sobeys Capital , a franchisor's restriction of a franchisee's access to funds to pay legal fees was found on the hearing of an injunction to constitute a serious issue to be tried as to whether the franchisor had interfered with the franchisees' ability to pursue collective action ( 1318214 Ontario Ltd. v. Sobeys Capital Inc. , 2010 ONSC 4141). Since there is a right of damages for any breach of section 4, franchisors must tread cautiously in their day-to-day dealings with franchisees.