YOU DID WHAT? – POTENTIAL PITFALLS FOR THE FRANCHISOR MARK H. MILLER JACKSON WALKER L.L.P. 112 E. PECAN, SUITE 2400 SAN ANTONIO, TEXAS 78205 [email protected] FRANCHISE AND DISTRIBUTION LAW INSTITUTE State Bar of Texas MARK MILLER Jackson Walker L.L.P. 112 East Pecan, Suite 2400 San Antonio, Texas 78205 (210) 978-7751 (210) 978-7790 (Fax) [email protected] BIOGRAPHICAL INFORMATION EDUCATION B.A. in Chemistry, Austin College J.D., St. Mary’s University Law School PROFESSIONAL ACTIVITIES Partner and Shareholder, Jackson Walker L.L.P. Member: American Bar Association Forum Committee On Franchising, and Antitrust Section; State Bar of Texas Intellectual Property Section, Franchise and Distribution Law Committee; State Bar of Texas Antitrust Section; San Antonio Bar Association; American Chemical Society; San Antonio Intellectual Property Law Association; American Arbitration Association, Arbitrator for franchise and business disputes LAW RELATED PUBLICATIONS, ACADEMIC APPOINTMENTS AND HONORS Author/Speaker: Fair Use in the Electronic Age – Trademark Registration and Copyrights on the Internet, 1999, San Antonio Chapter Texas Society of Certified Public Accountants Antitrust and Relationship Issues for Agricultural Product Dealers, 1994, Texas Agricultural Industries Association, South Texas Regional Meeting Franchising Primer, 1993 Texas State Bar Intellectual Property Law Institute How To Represent Prospective Franchisees Effectively, 1992 The Franchise And Distribution Law Committee Of The Texas State Bar Intellectual Property Law Section Trademarks and Franchising, American Bar Association Forum Committee on Franchising Fundamentals Of Franchising Institute 1991 How to Protect Trade Secrets, 1990 San Antonio Intellectual Property Law Association Seminar Franchising Opportunities And Pitfalls, Our Lady Of The Lake University 1989 and 1990 Franchising And The Business Lawyer, Texas State Bar Advanced Business Law Institute 1989 How To Recognize And Avoid Franchising, Houston Intellectual Property Law Association, 1988 Woodlands Institute Protecting Intangible Assets, 1987 and 1988 Texas Society of C.P.A.s Entrepreneur’s Conference i Franchising: Pros And Cons, 1987 Entrepreneur’s Conference Expanding Through Franchising, 1987 Texas State Bar Institute On Franchising Franchising In Texas, 14 St. Mary’s Law Journal, 301-49 1983 ii TABLE OF CONTENTS I. INTRODUCTION ...............................................................................................................1 II. YOUR FRAGILE SMALL FRANCHISOR CLIENT ........................................................1 III. OH MY GOD! (DISASTER USUALLY ARRIVES WITH A THUD) ............................3 A. Organization Leads to a Plan ...................................................................................3 B. Your Role as an Attorney ........................................................................................3 IV. COLLATERAL ESTOPPEL ...............................................................................................4 A. Legal Collateral Estoppel .........................................................................................4 B. Emotional Collateral Estoppel .................................................................................5 V. THE ATTORNEY’S ROLE ................................................................................................6 A. Proactive Problem Solving ......................................................................................6 B. Educate the Client ....................................................................................................7 1. Emphasize Personal Liability ......................................................................7 2. Franchise Business Advice ..........................................................................9 C. You Are Not The Client ...........................................................................................9 D. Order of Awfulness ................................................................................................10 E. Toolbox of Legal Alternatives ...............................................................................11 VI. TEXAS DTPA AND BOA HIGH-LIGHTS......................................................................13 A. Deceptive Trade Practices Act ...............................................................................13 B. Business Opportunity Act ......................................................................................14 VII. NON-EXHAUSTIVE LIST OF POTENTIAL FRANCHISOR PIT-FALLS ...................15 A. Franchise Sales – Practical Problems ....................................................................15 1. Over-Expansion .........................................................................................15 2. Under Capitalization ..................................................................................17 3. Cannot Sell Franchises to the Right Franchisees .......................................18 B. Franchise Sales – Legal Problems .........................................................................20 1. Misrepresentations in Sales........................................................................20 2. Failure to Comply with Franchise Sale Laws ............................................23 3. Failure to Disclose Adverse Information ...................................................24 4. Impound Imposed ......................................................................................25 5. Franchisee’s Costs Exceed UFOC Estimate. .............................................26 6. Franchisee’s Income is Less Than Represented ........................................27 iii C. System Changes .....................................................................................................29 1. Bad Concept. ..............................................................................................29 2. Bad Execution of the Concept ...................................................................30 3. Franchise Agreement Not Applicable to New Conditions ........................31 D. Franchisor Non-Performance .................................................................................32 1. Failure to Provide Promised Support .........................................................32 2. Non-Performing Subfranchisor ..................................................................34 3. Unusable Trademark ..................................................................................35 E. Specific Franchisee Problems ................................................................................37 1. Bad Franchisee ...........................................................................................37 2. Restrictions Unacceptable to Franchisee ...................................................38 3. Bad Location. .............................................................................................41 4. Franchisee is Too Successful for Your Good ............................................42 5. Liability for Franchisee Acts .....................................................................43 F. Franchisee Concerted Action .................................................................................45 1. Rebellious Franchisees...............................................................................45 2. Franchise Associations...............................................................................45 G. Transfer and Renewal ............................................................................................46 1. Request for Transfer to a Bad Franchisee ..................................................46 2. Request for Approval to Move to a Bad Location .....................................47 3. Franchise Renewal Terms ..........................................................................48 4. Termination and Non-Renewal ..................................................................48 H. Insolvency and Bankruptcy ....................................................................................49 1. Insolvent Franchisees .................................................................................49 2. Insolvent Franchisor...................................................................................51 I. Dispute Resolution .................................................................................................52 1. Litigation with Franchisees ........................................................................52 2. Breakaway Franchisee. ..............................................................................53 3. Arbitration ..................................................................................................55 4. Protecting the Franchisor’s Principals .......................................................56 J. Taxes ......................................................................................................................57 1. State Sales Taxes........................................................................................57 2. State Franchise Taxes ................................................................................58 iv VIII. ATTORNEY LIABILITY .................................................................................................58 A. Generally ................................................................................................................58 B. The Potential Plaintiffs ..........................................................................................58