Franchise Law 101: FAQs

1. What laws govern the franchise relationship?

Franchising is governed by a complex set of federal and state franchise laws. On the federal level, the FTC requires – with limited exceptions – franchisors to provide a Franchise Disclosure Document (FDD) to those seeking to purchase and open a franchise anywhere in the United States. FDDs are often hundreds of pages long since the document must include 23 categories of disclosures to a prospective franchisee, including the form franchise agreement. On top of this, many states have enacted their own franchise-specific statutes. These statutes often add additional disclosure requirements, such as requiring immediate audited financial documents, and/or require FDDs to be submitted to state agencies for review and comment.

In New Jersey, the New Jersey Franchise Practices Act, N.J.S.A. 56:10-1 et seq. (the “NJFPA”) governs the relationship between certain business relationships. The NJFPA does not add any additional disclosure or registration requirements, but does provide significant protections to covered franchisees, including against terminations without good cause and the imposition of “unreasonable standards” on franchisees.

2. Is my business relationship a franchise? What is an “accidental” franchise?

The definition of a “franchise” varies widely, with significant implications. On the federal level, the FTC defines a “franchise,” and therefore a relationship that often requires the preparation of an FDD, etc., as any relationship where (1) “[t]he franchisee will obtain the right to operate a business that is identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark;” (2) “the franchisor will exert or has authority to exert a significant degree of control over the franchisee’s method of operation, or provide significant assistance in the franchisee’s method of operation;” and (3) “as a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.”

State definitions vary. In New Jersey, the NJFPA defines a covered “franchise” relationship, generally, as follows: (a) a written arrangement; (b) a license; (c) a community of interest; (d) $35,000 in gross sales over 12 months; (e) 20% of gross sales “derived” from franchise (or “intended” to derive from franchise); and (f) a New Jersey “place of business.” The meaning of each of these elements has been the subject of litigation for decades.

For those relationships that the parties do not call “franchises” – but nonetheless fit an applicable statutory/regulatory definition – such business relationships are often referred to as “accidental franchises.”

3. Are franchise agreements negotiable?

It is a pervasive myth that franchise agreements are never negotiable. Indeed, many – though not all – franchisors will negotiate some, though not many, terms of franchise agreements. Any negotiated terms will often be included in an amendment or addendum to the franchise agreement. Common provisions to negotiate include, without limitation, renewal terms, territory size, transfer fees, and liability limitations.

4. Should I franchise my business? What’s involved?

Franchising a business is a significant undertaking. First, both federal and state laws often require significant disclosure and accounting work at the outset. A prudent new franchisor will also confirm proper ownership of the businesses’ intellectual property and branding, as well as prepare an Operations Manual for franchisees to follow to ensure brand uniformity.

More fundamentally, a business must also determine if the franchise model is a viable option for expansion. Can the business be effectively replicated? Has more than one location already been tried? Does the business have enough capital for the start-up (and recurring) costs to set up the franchise? Is the offering unique? All these questions should be addressed before engaging in the process of setting up a franchise system.

5. Can I own multiple franchise locations?

Yes, individuals and businesses often own multiple locations of the same brand, as well as multiple locations of different, though not competing, brands. If you are interested in multi-unit ownership, the franchise agreements, including Area Development and/or Multi-Unit Agreements, must be carefully reviewed to ensure multi-unit ownership is both practical and permissible.

6. Can I get out of a franchise agreement?

Depending on your jurisdiction, both your agreement(s) with the franchisor, as well as state laws (as applicable), may govern whether you can terminate a franchise agreement before its expiration. Specifically, franchise agreements often expressly set forth a period of time that the franchise agreement will remain in effect, as well as a list of defaults that can result in the franchisor’s early termination of the agreement. There may also be a section included that delineates when a franchisee can terminate the agreement. Moreover, unhappy franchisees often seek to sell their franchise locations as a way to potentially avoid liability for abandoning the franchise early.

State laws, depending on the circumstances, can enable franchisees to terminate a franchise agreement, even absent an express provision in the franchise agreement permitting a franchisee to do so.

7. Can my franchisor terminate my franchise agreement and shutdown my franchise?

Franchisees may have recourse against a threatened termination. In addition to the termination terms set forth in the franchise agreement, state laws may prevent such a termination if not done in accordance with the governing laws.

For example, the NJFPA prohibits a covered franchisor from terminating a franchisee – even if the franchise agreement would otherwise permit it – unless the franchisor can show: (1) 60 days prior notice provided and (2) franchisee did not substantially perform its obligations. If a covered franchisee believes that a franchisor intends to shut down its franchise in violation of the NJFPA, the franchisee may have immediate recourse with the New Jersey courts, including by seeking preliminary injunctive relief to stop the termination.

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