Franchise Contract Discussion

Carlos Del Rey decided to open a fast-food Mexican restaurant and signed a franchise contract with a national chain called La Grande Enchilada. Under the franchise agreement, Del Rey purchased the building, and La Grande Enchilada supplied the equipment. The contract required the franchisee to strictly follow the franchisor’s operating manual and stated that failure to do so would be grounds for terminating the franchise contract. The manual set forth detailed operating procedures and safety standards, and provided that a La Grande Enchilada representative would inspect the restaurant monthly to ensure compliance.

Nine months after Del Rey began operating his restaurant, a spark from the grill ignited an oily towel in the kitchen. No one was injured, but by the time firefighters put out the fire, the kitchen had sustained extensive damage. The cook told the fire department that the towel was “about two feet from the grill” when it caught fire, which was in compliance with the franchisor’s manual that required towels to be at least one foot from the grills. Nevertheless, the next day La Grande Enchilada notified Del Rey that his franchise would terminate in thirty days for failure to follow the prescribed safety procedures. Using the information presented in the chapter, answer the following questions.

1. What type of franchise was Del Rey’s La Grande Enchilada restaurant?
2. If Del Rey operates the restaurant as a sole proprietorship, who bears the loss for the damaged kitchen? Explain.
3. Assume that Del Rey files a lawsuit against La Grande Enchilada, claiming that his franchise was wrongfully terminated. What is the main factor a court would consider in determining whether the franchise was wrongfully terminated?
4. Would a court be likely to rule that La Grande Enchilada had good cause to terminate Del Rey’s franchise in this situation? Why or why not?

1- ***Debate This:All franchisors should be required by law to provide a comprehensive estimate of the profitability of a prospective franchise based on the experiences of their existing franchisees

***The 4 questions are not required to be responded. The most important part is to read the above statement in boldface, take a position whether you agree or not and have 3 arguments supporting your position. Please take a look on the attachment because the debate has to be based on chapter (CH 30)***

2- The attached picture is a debate from a classmate. Pease read his debate and write a reply in a few statements to him.

Mark Summerfield/Alamy Stock Photo
30
Learning Objectives
The four Learning Objectives below are
designed to help improve your understanding. After reading this chapter, you should
be able to answer the following questions:
1. What advantages and disadvantages are associated with
the sole proprietorship?
2. What is required by the
Franchise Rule, and why?
3. What might happen if a
franchisor exercises too
much control over the
operations of a franchise?
4. When will a court decide that
a franchisor has wrongfully
terminated a franchise?
Entrepreneur One who initiates and
assumes the financial risk of a new
business enterprise and undertakes
to provide or control its management.
Sole Proprietorships
and Franchises
“Why not go out on
a limb? Isn’t that
where the fruit is?”
Many Americans would agree with Frank Scully’s comment
in the chapter-opening quotation that to succeed in business one must “go out on a limb.” Certainly, an entrepreneur’s primary motive for “going out on a limb” to start a
business enterprise is to make profits.
Frank Scully
An entrepreneur is one who initiates and assumes the
1892–1964
(American author)
financial risks of a new enterprise and undertakes to provide or control its management. Keep in mind that many of
the biggest corporations today, such as Apple, Alphabet (Google), and Amazon, were
originally very small companies. Jeff Bezos, founder of Amazon, and Steve Jobs, founder of
Apple, started their companies in their garages.
One of the first decisions an entrepreneur must make is which form of business organization will be most appropriate for the new endeavor. In selecting an organizational form,
the entrepreneur will consider a number of factors, including (1) ease of creation, (2) the
liability of the owners, (3) tax considerations, and (4) the ability to raise capital. Keep
these factors in mind as you read this unit and learn about the various forms of business
organization. In considering these business forms, remember, too, that the primary motive
of an entrepreneur is to make profits.
Traditionally, entrepreneurs have used three major forms to structure their business
enterprises—the sole proprietorship, the partnership, and the corporation. In this chapter,
we examine sole proprietorships. We also discuss franchises. Although the franchise is
not, strictly speaking, a separate business organizational form, it is widely used today by
entrepreneurs.
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727
The simplest form of business is a sole proprietorship. In this form, the owner is the business.
Thus, anyone who does business without creating a separate business organization has a sole
proprietorship.
More than two-thirds of all U.S. businesses are sole proprietorships. Sole proprietors can
own and manage any type of business from an informal home office or Web-based undertaking to a large restaurant or construction firm. Most sole proprietorships are small enterprises,
however. About 99 percent of the sole proprietorships in the United States have revenues of
less than $1 million per year.
Sole Proprietorship The simplest
30–1
Sole Proprietorships
30–1a Advantages of the Sole Proprietorship
A major advantage of the sole proprietorship is that the proprietor owns the entire business
and has a right to receive all of the profits (because he or she assumes all of the risk). In
addition, starting a sole proprietorship is often easier and less costly than starting any other
kind of business, as few legal formalities are involved. Generally, no documents need to be
filed with the government to start a sole proprietorship.1
form of business organization, in
which the owner is the business.
The owner reports business income
on his or her personal income tax
return and is legally responsible for
all debts and obligations incurred by
the business.
Learning Objective 1
What advantages and disadvantages are associated
with the sole proprietorship?
Taxes A sole proprietor pays only personal income taxes (including Social Security and
Medicare taxes) on the business’s profits. The profits are reported as personal income on
the proprietor’s personal income tax return. In other words, the business itself need not file
an income tax return. Sole proprietors are allowed to establish retirement accounts that are
tax-exempt until the funds are withdrawn.
Like any form of business enterprise, a sole proprietorship can be liable for other taxes, such
as those collected and applied to the disbursement of unemployment compensation. The unpaid
unemployment compensation taxes of a sole proprietorship were at issue in the following case.
1. Sole proprietorships may need to comply with certain zoning requirements, obtain a business license or other appropriate license from the
state, and the like.
Case 30.1
A. Gadley Enterprises, Inc. v. Department of Labor and Industry Office
of Unemployment Compensation Tax Services
Commonwealth Court of Pennsylvania, 2016 WL 55591 (2016).
Background and Facts Julianne Gresh operated Romper
Room Day Care, as a sole proprietorship in Pennsylvania. Gresh
owed the state’s Department of Labor and Industry Office of
Unemployment Compensation Tax Services $43,000 in unpaid
unemployment compensation contributions, interest, and penalties. Because she was about to lose her license to operate, Gresh
sold her business to A. Gadley Enterprises, Inc. A. Gadley agreed to
pay Gresh $38,000 for her business assets—$10,000 for the use
of the name “Romper Room,” $10,790 for a covenant not to compete, and $17,210 for items on an “Inventory List.”
The state’s unemployment compensation law contains a “bulk
sales provision.” It requires a buyer of 51 percent or more of an
employer’s assets to obtain a state-issued certificate from the
seller showing that all amounts owed to the state have been
paid. A failure to obtain the certificate renders the buyer liable
for any unpaid amount. A. Gadley did not obtain this certificate
from Gresh. As a result, the Department of Labor and Industry
notified A. Gadley that it was liable for Gresh’s unpaid debt.
A. Gadley asked a Pennsylvania court to review the assessment
of liability.
(Continues )
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In the Words of the Court
SIMPSON, Judge.
****
Purchaser [A. Gadley argues that the state] erred in construing
the term “assets” in the bulk sales provision to include only business assets when determining whether a sale met the 51 percent
threshold. Purchaser asserts the provision does not differentiate
between business and personal assets of an employer and there
is no legal distinction when the employer is a sole proprietor.
****
* * * The definition of “employer” [in the Unemployment
Compensation Law] includes a sole proprietor like [Gresh]. The
word “assets” is not defined in the Law. [In Section 788.3(a)]
the term “assets” precedes a list of examples, followed by the
phrase “including but not limited to.”
****
* * * The examples * * * indicate that the term “assets” refers
to business assets. This conclusion is buttressed [reinforced] by
the context of the statute as a whole, which pertains to employers operating businesses and paying employees as part of their
business operations.
The factual circumstances surrounding the sale also indicate
the term “assets” means “business assets.” Here, the context is the
sale of a business, in the childcare industry, to another business
engaged in the same industry that intends to operate a childcare
facility at the location of the former business. The Agreement
reflects the intention of the parties that Purchaser would operate
the childcare facility as a satellite location. [Emphasis added.]
****
Moreover, Purchaser’s interpretation does not consider the
purpose of the bulk sales provision. That purpose is to ensure an
employer does not divest itself of assets without satisfying outstanding liabilities, either itself or by the purchaser. [Emphasis added.]
Decision and Remedy The Pennsylvania state court
affirmed the Department of Labor and Industry’s decision that
A. Gadley was liable for the unpaid taxes. Gresh’s sale of her
business assets triggered the certificate requirement. A. Gadley’s
failure to obtain the certificate rendered it liable for Gresh’s unpaid
unemployment compensation contributions.
Critical Thinking
• Legal Environment What action can A. Gadley take now
to avoid suffering the loss of the funds required to cover Gresh’s
unpaid taxes?
• Ethical Did A. Gadley act unethically by not obtaining from
Gresh the certificate required by the state’s unemployment compensation law? Discuss.
Flexibility A sole proprietorship also offers more flexibility than does a partnership or a
corporation. The sole proprietor is free to make any decision she or he wishes concerning
the business—including whom to hire, when to take a vacation, and what kind of business
to pursue. The sole proprietor can sell or transfer all or part of the business to another party
at any time without seeking approval from anyone else. In contrast, approval is typically
required from partners in a partnership and from shareholders in a corporation.
Ethical Issue
Can the religious beliefs of a small business owner justify
the business refusing to provide services to members of the
LGBT community? In recent years, American society has come a long way in accepting that
persons in the LGBT (lesbian, gay, bisexual, and transgender) community should be treated fairly.
Nevertheless, many business owners’ religious beliefs prevent them from wanting to have these
individuals as customers. In a number of cases, business owners refuse to provide services to gay or
lesbian couples based on their religious beliefs. This is particularly apparent in the wedding industry,
when same-sex couples are planning to marry.
For example, the owners of a wedding-photography business in New Mexico refused to photograph a ceremony held by clients who were gay. They based this refusal on their religious beliefs.
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New Mexico’s highest court ruled against the owners. Additionally, a New York court imposed a
$10,000 fine on the owners of a small business that refused to rent a wedding venue to a gay couple
for their ceremony.2
Currently, federal law does not provide protection against discrimination based on sexual orientation in the same way that it protects against discrimination based on race, color, and some other
“protected” characteristics. Many states, though, do have laws prohibiting discrimination based on
sexual orientation, as do many cities.
The intersection of business owners’ religious beliefs and the rights of gays and lesbians is certain
to be an area in which there will be continuing litigation, and additional laws may need to be created.
30–1b Disadvantages of the Sole Proprietorship
Personal Assets at Risk Because of the sole proprietor’s unlimited liability, creditors can
go after his or her personal assets to satisfy any business debts. Although sole proprietors
may obtain insurance to protect the business, liability can easily exceed policy limits. This
unlimited liability is a major factor to be considered in choosing a business form.
Example 30.2 Sheila Fowler operates a golf shop near a world-class golf course as a sole
proprietorship. One of Fowler’s employees fails to secure a display of golf clubs, and they fall
on Dean Maheesh, a professional golfer, and seriously injure him. If Maheesh sues Fowler’s
shop and wins, Fowler’s personal liability could easily exceed the limits of her insurance
policy. Fowler could lose not only her business, but also her house, her car, and any other
personal assets that can be attached to pay the judgment. ■
Anonymous
Protasov AN/Shutterstock.com
The major disadvantage of the sole proprietorship is that the proprietor alone bears
the burden of any losses or liabilities incurred by the business enterprise. In other words, the
sole proprietor has unlimited liability, or legal responsibility, for all obligations incurred in
doing business.
Case Example 30.1 Michael Sark operated a logging business as a sole proprietorship. To
acquire equipment for the business, Sark and his wife, Paula, borrowed funds from Quality
Car & Truck Leasing, Inc. Eventually, the logging business failed, and Sark was unable to pay
his creditors, including Quality. The Sarks filed a bankruptcy petition and sold their house
(valued at $203,500) to their son, Michael, Jr., for one dollar but continued to live in it.
Three months later, Quality obtained a judgment in an Ohio state court against the Sarks
for $150,480. Quality also filed a claim to set aside the transfer of the house to Michael, Jr.,
as a fraudulent conveyance. The trial court ruled in Quality’s favor, and the Sarks appealed.
A state intermediate appellate court affirmed. The Sarks were personally liable for the debts
of the sole proprietorship.3 ■
“Always tell yourself:
The difference between
running a business and
ruining a business is I.”
Can a person who owns a logging
business as a sole proprietorship
avoid liability for the business’s
debts?
Lack of Continuity and Limited Ability to Raise Capital The sole proprietorship also
has the disadvantage of lacking continuity after the death of the proprietor. When the owner
dies, so does the business—it is automatically dissolved.
Another disadvantage is that in raising capital, the proprietor is limited to his or her
personal funds and any loans that he or she can obtain for the business. Lenders may be
unwilling to make loans to sole proprietorships, particularly start-ups, because the sole
proprietor risks unlimited personal liability and may not be able to pay. (See this chapter’s
Adapting the Law to the Online Environment feature for a discussion of one court’s refusal to
discharge a loan made to a sole proprietor who had declared bankruptcy.)
2. See Elane Photography, LLC. v. Willock, 2013 -NMSC- 040, 309 P.3d 53 (2013); and Gifford v. McCarthy, 137 A.D.3d 30, 23 N.Y.S.3d 422
(Dept. 3 2016).
3. Quality Car & Truck Leasing, Inc. v. Sark, 2013 -Ohio- 44 (Ohio Ct.App. 2013).
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UNIT FIVE: Business Organizations
A Sole Proprietorship, Facebook Poker,
and Bankruptcy
O
ne major downside of a sole proprietorship is that it is more difficult for a sole
proprietor to obtain funding for start-up
and expansion. Moreover, if funding is
obtained through loans, the sole proprietor
is exposed to personal liability.
Personal Liability Exposure
for an Online Start-up
A case in point went before the United States
bankruptcy court in Massachusetts in 2015.a
Michael Dewhurst, living in Raynham,
Massachusetts, sometimes did computer
work for Gerald Knappik. Dewhurst decided
to start a new business venture—the commercial development of an online pokerplaying application. Dewhurst envisioned an
application that would enable multiple individuals to play poker together over the Internet through Facebook. Dewhurst informed
Knappik of his business plan and predicted
that his Facebook poker application “was
going to be something very big.”
a. In re Dewhurst, 528 Bankr. 211 (D.Mass. 2015). See also,
In re Zutrau, 563 Bankr. 431 (1st Cir. 2017).
Franchise Any arrangement in
which the owner of a trademark,
trade name, or copyright licenses
another to use that trademark, trade
name, or copyright in the selling of
goods or services.
Franchisee One receiving a license
to use another’s (the franchisor’s)
trademark, trade name, or copyright
in the sale of goods and services.
Franchisor One licensing another
(the franchisee) to use the owner’s
trademark, trade name, or copyright
in the selling of goods or services.
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30–2
Adapting the Law to the
Online Environment
Knappik initially loaned $50,000 to
Dewhurst for the project. The loan agreement stated, “The sole purpose of this loan
agreement is to provide funds on a personal level for the start-up of said business
project, in conjunction with borrower’s personal funds, not limited to start-up costs,
operating expenses, advertising costs.”
That was the first of a series of personal
loans that ultimately totaled $220,000.
Dewhurst had repaid only $9,000 on
the total outstanding debt when he filed
for bankruptcy. Ultimately, the bankruptcy
court ascertained that at least $120,000 of
the loans that were supposed to be used
exclusively for the Facebook poker project
had been used for other activities. Furthermore, Dewhurst kept “no contemporaneous records of his disbursements and uses
of this cash, no cash journal, ledger, or
disbursement slips of any kind.”
The Lender Objects to a Discharge
of the Debt in Bankruptcy
During bankruptcy proceedings, Knappik
requested that the bankruptcy court
deny discharge of Dewhurst’s debts to
him. Upon review, the court stated that
“Dewhurst’s failure to keep and preserve
adequate records makes it impossible to
reconstruct an accurate and complete
account of financial affairs and business
transactions.” The bankruptcy judge ultimately denied discharge of $120,000 of
the debt owed to Knappik. Thus, a sole
proprietor’s failed attempt to create an
online poker-playing application led to
personal liability even after he had filed
for bankruptcy.
Critical Thinking
Sole proprietorships, as well as other businesses, routinely seek funding for online
projects. How can the individuals involved
avoid personal liability?
Franchises
Instead of setting up a completely independent business, many entrepreneurs opt to purchase
a franchise. A franchise is an arrangement in which the owner of intellectual property—such
as a trademark, a trade name, or a copyright—licenses others to use it in the selling of goods
or services. A franchisee (a purchaser of a franchise) is generally legally independent of the
franchisor (the seller of the franchise). At the same time, the franchisee is economically
dependent on the franchisor’s integrated business system. In other words, a franchisee can
operate as an independent businessperson and choose any business form but still obtain the
advantages of a regional or national organization.
Today, franchising companies and their franchisees account for a significant portion of
all retail sales in this country. Well-known franchises include McDonald’s, 7-Eleven, and
Holiday Inn. Franchising has also become a popular way for businesses to expand their
operations internationally, as discussed in this chapter’s Beyond Our Borders feature.
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Franchising in Foreign Nations
I
n the last twenty-five years, many U.S.
companies (particularly fast-food chains
and coffeehouses) have successfully
expanded through franchising in nations
around the globe. Targeted locations include Asia and Central and South America,
as well as Canada and Mexico in North
America. Franchises offer businesses a way
to expand internationally without violating
the legal restrictions that many nations
impose on foreign ownership of businesses.
Cultural and Legal Differences
Are Important
Businesspersons must exercise caution
when entering international franchise
relationships, however. Differences in
language, culture, laws, and business
practices can seriously complicate the
franchising relationship. If a U.S. franchisor’s quality control standards do not mesh
with local business practices, for instance,
Beyond Our Borders
how can the franchisor maintain the quality
of its product and protect its good reputation? If the law in, say, China does not
provide for a high level of intellectual property protection, how can a U.S. franchisor
protect its trademark rights or prevent its
secret recipe or formula from being copied?
The Need to Assess the Market
Because of the complexities of international
franchising, a company seeking to franchise overseas needs to conduct thorough
research to determine whether its business
will be well received in the target country. It
is important to know the political and cultural
climate, as well as current economic trends.
Marketing surveys to assess the potential
success of the franchise location are crucial.
Because compliance with U.S. disclosure laws may not satisfy the legal requirements of other nations, most successful
franchisors retain attorneys knowledgeable
in the laws of the prospective location. The
attorneys can draft dispute-settlement
provisions (such as an arbitration clause)
for international franchising contracts and
advise the franchisor about the tax implications of operating a foreign franchise (such
as import taxes and customs duties).
Critical Thinking
Should a U.S.-based franchisor be allowed
to impose contract terms and quality control
standards on franchisees in foreign nations
that are different from those imposed on
domestic franchisees? Why or why not?
30–2a Types of Franchises
Many different kinds of businesses now sell franchises, and numerous types of franchises are
available. Generally, though, most franchises fall into one of three classifications: distributorships, chain-style business operations, or manufacturing or processing-plant arrangements.
(the franchisee) to sell its product. Often, a distributorship covers an exclusive territory.
Automobile dealerships and beer distributorships are examples of this type of franchise.
Example 30.3 Black Snow Beer Company distributes its beer brands through a network of
authorized wholesale distributors, each with an assigned territory. Marik signs a distributorship contract for the area from Gainesville to Ocala, Florida. If the contract states that Marik
is the exclusive distributor in that area, then no other franchisee may distribute Black Snow
beer in that region. ■
Chain-Style Business Operations In a chain-style business operation, a franchise operates under a franchisor’s trade name and is identified as a member of a select group of
dealers that engage in the franchisor’s business. The franchisee is generally required to
follow standardized or prescribed methods of operation. In addition, the franchisee may be
required to obtain materials and supplies exclusively from the franchisor.
McDonald’s and most other fast-food chains are examples of chain-style franchises. This
type of franchise is also common in service-related businesses, including real estate brokerage firms such as Century 21 and tax-preparing services such as H&R Block, Inc.
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alaincouillaud/E+/Getty Images
Distributorships In a distributorship, a manufacturer (the franchisor) licenses a dealer
If these brands of beer are sold
through authorized wholesale
distributors only, can a potential
distributor obtain an exclusive
territory?
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Know This
Manufacturing or Processing-Plant Arrangements In a manufacturing or processing-
Because a franchise
involves the licensing of
a trademark, a trade name,
or a copyright, the law
governing intellectual
property may apply in
some situations.
Learning Objective 2
What is required by the
Franchise Rule, and why?
plant arrangement, the franchisor transmits to the franchisee the essential ingredients or
formula to make a particular product. The franchisee then markets the product either at
wholesale or at retail in accordance with the franchisor’s standards. Examples of this type
of franchise are Pepsi-Cola and other soft-drink bottling companies.
30–2b Laws Governing Franchising
Because a franchise relationship is primarily a contractual relationship, it is governed by
contract law. If the franchise exists primarily for the sale of products manufactured by the
franchisor, the law governing sales contracts as expressed in Article 2 of the Uniform Commercial Code applies.
Additionally, the federal government and most states have enacted laws governing certain
aspects of franchising. Generally, these laws are designed to protect prospective franchisees
from dishonest franchisors and to prohibit franchisors from terminating franchises without
good cause.
Federal Regulation of Franchising The federal government regulates franchising
through laws that apply to specific industries and through the Franchise Rule, created by
the Federal Trade Commission (FTC).
Industry-Specific Standards. Congress has enacted laws that protect franchisees in certain industries, such as automobile dealerships and service stations. These laws protect the
franchisee from unreasonable demands and bad-faith terminations of the franchise by
the franchisor.
An automobile manufacturer-franchisor cannot make unreasonable demands of
dealer-franchisees or set unrealistically high sales quotas, for instance. If an automobile
manufacturer-franchisor terminates a franchise because of a dealer-franchisee’s failure to
comply with unreasonable demands, the manufacturer may be liable for damages.4
Similarly, federal law prescribes the conditions under which a franchisor of service
stations can terminate a franchise.5 In addition, federal antitrust laws sometimes apply
to prohibit certain types of anticompetitive agreements involving service-station
franchises.
The Franchise Rule. The FTC’s Franchise Rule requires franchisors to disclose certain
material facts that a prospective franchisee needs in order to make an informed decision
concerning the purchase of a franchise.6 Those who violate the Franchise Rule are subject
to substantial civil penalties, and the FTC can sue on behalf of injured parties to recover
damages.
The rule requires the franchisor to make numerous written disclosures to prospective franchisees (see Exhibit 30–1). All representations made to a prospective franchisee
must have a reasonable basis. For instance, if a franchisor provides projected earnings
figures, the franchisor must indicate whether the figures are based on actual data or hypothetical examples. If a franchisor makes sales or earnings projections based on actual data
for a specific franchise location, the franchisor must disclose the number and percentage of
its existing franchises that have achieved this result. The Franchise Rule does not require
franchisors to provide potential earnings figures, however.
State Regulation of Franchising State legislation varies but generally is aimed at protecting franchisees from unfair practices and bad-faith terminations by franchisors.
4. Automobile Dealers’ Franchise Act of 1965, also known as the Automobile Dealers’ Day in Court Act, 15 U.S.C. Sections 1221 et seq.
5. Petroleum Marketing Practices Act (PMPA) of 1979, 15 U.S.C. Sections 2801 et seq.
6. 16 C.F.R. Part 436.
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733
Exhibit 30–1 The FTC’s Franchise Rule Requirements
REQUIREMENTS
EXPLANATION
Written (or electronic)
disclosures
The franchisor must make numerous disclosures, such as the range
of goods and services included, as well as the value and estimated
profitability of the franchise. Disclosures can be delivered on paper or
electronically. Prospective franchisees must be able to download
or save any electronic disclosure documents.
Reasonable basis for any
representations
To prevent deception, all representations made to a prospective franchisee must have a reasonable basis at the time they are made.
Projected earnings
figures
If a franchisor provides projected earnings figures, the franchisor
must indicate whether the figures are based on actual data or hypothetical examples. The Franchise Rule does not require franchisors to
provide potential earnings figures, however.
Actual data
If a franchisor makes sales or earnings projections based on actual
data for a specific franchise location, the franchisor must disclose
the number and percentage of its existing franchises that have
achieved this result.
Explanation of terms
Franchisors are required to explain termination, cancellation, and
renewal provisions of the franchise contract to potential franchisees
before the agreement is signed.
Smereka/Shutterstock.com
State Disclosures. A number of states have laws similar to the federal rules requiring
franchisors to provide presale disclosures to prospective franchisees.7 Many state laws also
require that a disclosure document (known as the Franchise Disclosure Document, or FDD)
be registered or filed with a state official. State laws may also require that a franchisor submit
advertising aimed at prospective franchisees to the state for approval.
To protect franchisees, a state law may require the disclosure of information such as the
actual costs of operation, recurring expenses, and profits earned, along with data substantiating these figures. State deceptive trade practices acts may also apply and may prohibit
certain actions on the part of franchisors.
Requirements for Termination. To prevent arbitrary or bad-faith terminations, state law may prohibit termination without “good cause” or require
that certain procedures be followed in terminating a franchising relationship.
Case Example 30.4 FMS, Inc., entered into a franchise agreement to become an
authorized dealership for the sale of Samsung brand construction equipment.
Samsung then sold its construction-equipment business to Volvo Construction
Equipment North America, Inc., which was to continue selling Samsung brand
equipment. Later, Volvo rebranded the construction equipment under its own
name and canceled FMS’s franchise.
FMS sued, claiming that Volvo had terminated the franchise without good
cause in violation of state law. Because Volvo was no longer manufacturing the
Can a construction-equipment franchisor
Samsung brand equipment, however, the court found that Volvo could legally
terminate the franchise of an authorized dealer
terminate FMS’s franchise. If Volvo had continued making the Samsung brand
after a change in equipment brands?
equipment, it could not have terminated the franchise.8 ■
7. These states include California, Florida, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode
Island, South Dakota, Texas, Utah, Virginia, Washington, and Wisconsin.
8. FMS, Inc. v. Volvo Construction Equipment North America, Inc., 557 F.3d 758 (7th Cir. 2009). See also Southern Track & Pump, Inc. v. Terex Corp.,
618 Fed.Appx. 99 (3rd Cir. 2015).
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30–3
“Business opportunities
are like buses, there’s
always another one
coming.”
Richard Branson
1950–present
(British entrepreneur)
The Franchise Contract
The franchise relationship is defined by a contract between the franchisor and the
franchisee. The franchise contract specifies the terms and conditions of the franchise and
spells out the rights and duties of both parties. If either party fails to perform the contractual
duties, that party may be subject to a lawsuit for breach of contract. Generally, statutes and
case law governing franchising emphasize the importance of good faith and fair dealing in
franchise relationships.
Because each type of franchise relationship has its own characteristics, franchise contracts
tend to differ. Nonetheless, certain major issues typically are addressed in a franchise contract.
30–3a Payment for the Franchise
The franchisee ordinarily pays an initial fee or lump-sum price for the franchise license (the
privilege of being granted a franchise). This fee is separate from the various products that
the franchisee purchases from or through the franchisor. The franchise agreement may also
require the franchisee to pay a percentage of advertising costs and certain administrative expenses.
In some industries, the franchisor relies heavily on the initial sale of the franchise for
realizing a profit. In other industries, the continued dealing between the parties brings profit
to both. Generally, the franchisor receives a stated percentage of the annual (or monthly)
sales or volume of business done by the franchisee.
30–3b Business Premises
The franchise agreement may specify whether the premises for the business must be leased or
purchased outright. Sometimes, a building must be constructed or remodeled to meet the terms
of the agreement. The agreement usually specifies whether the franchisor supplies equipment
and furnishings for the premises or whether this is the responsibility of the franchisee.
30–3c Location of the Franchise
William Hamilton/The New Yorker Collection/www.cartoonbank.com
Typically, the franchisor determines the territory to be served. Some franchise contracts
give the franchisee exclusive rights, or “territorial rights,” to a certain geographic area.
Other franchise contracts, though they define the territory
allotted to a particular franchise, either specifically state that
the franchise is nonexclusive or are silent on the issue of
territorial rights.
Many franchise cases involve disputes over territorial
rights, and the implied covenant of good faith and fair dealing
often comes into play in this area of franchising. If the franchise
contract does not grant exclusive territorial rights to a
franchisee and the franchisor allows a competing franchise
to be established nearby, the franchisee may suffer a significant loss in profits. In this situation, a court may hold
that the franchisor’s actions breached an implied covenant
of good faith and fair dealing.
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30–3d Quality Control by the Franchisor
The day-to-day operation of the franchise business normally is left up to the franchisee. Nonetheless, the franchise
agreement may specify that the franchisor will provide some
degree of supervision and control so that it can protect the
franchise’s name and reputation.
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CHAPTER 30: Sole Proprietorships and Franchises
Means of Control When the franchise prepares a product, such as food, or provides a service, such as motel accommodations, the contract often states that the franchisor will establish certain standards for the facility. Typically, the contract will state that the franchisor is
permitted to make periodic inspections to ensure that the standards are being maintained.
As a means of controlling quality, franchise agreements also typically limit the franchisee’s ability to sell the franchise to another party. Example 30.5 Mark Keller, an authorized
Jaguar franchise, contracts to sell its dealership to Henrique Autos West. A Jaguar franchise
generally cannot be sold without Jaguar Cars’ permission. Prospective franchisees must
meet Jaguar’s customer satisfaction standards. If Henrique Autos fails to meet those standards, Jaguar can refuse to allow the sale and can terminate the franchise. ■
Degree of Control As a general rule, the validity of a provision permitting the franchisor to
establish and enforce certain quality standards is unquestioned. The franchisor has a legitimate
interest in maintaining the quality of the product or service to protect its name and reputation.
If a franchisor exercises too much control over the operations of its franchisees, however,
the franchisor risks potential liability. A franchisor may also occasionally be held liable—
under the doctrine of respondeat superior—for the tortious acts of the franchisees’ employees.
Example 30.6 The National Labor Relations Board (NLRB) received nearly two hundred
employee complaints that certain McDonald’s restaurants had engaged in unfair labor practices. Employees alleged that the restaurants had fired or penalized workers for participating in protests over wages and working conditions. Investigators found that at least some
of the complaints had merit. The NLRB ruled that McDonald’s USA, LLC, could be held
jointly liable along with several of its franchisees for labor and wage violations. The NLRB
reasoned that McDonald’s exerts sufficient control over its franchisees to be found liable
for the franchisees’ employment law violations. ■
30–3e Pricing Arrangements
Franchises provide the franchisor with an outlet for the firm’s goods and services. Depending
on the nature of the business, the franchisor may require the franchisee to purchase certain
supplies from the franchisor at an established price.9 A franchisor cannot, however, set the
prices at which the franchisee will resell the goods, because such price setting may be a
violation of state or federal antitrust laws, or both. A franchisor can suggest retail prices but
cannot mandate them.
30–4
Learning Objective 3
What might happen if a
franchisor exercises too
much control over the
operations of a franchise?
Know This
Under the doctrine of
respondeat superior, an
employer may be liable
for the torts of employees
if they occur within the
scope of employment,
without regard to the
personal fault of the
employer.
Franchise Termination
The duration of the franchise is a matter to be determined between the parties. Sometimes, a
franchise will start out for a short period, such as a year, so that the franchisor can determine
whether it wants to stay in business with the franchisee. Other times, the duration of the
franchise contract correlates with the term of the lease for the business premises, and both
are renewable at the end of that period.
30–4a Grounds for Termination
Usually, the franchise agreement specifies that termination must be “for cause” and then
defines the grounds for termination. Cause might include, for instance, the death or disability
of the franchisee, insolvency of the franchisee, breach of the franchise agreement, or failure
to meet specified sales quotas.
In the following case, a franchisee contended that its franchisor did not have good cause
to terminate the franchise.
9. Although a franchisor can require franchisees to purchase supplies from it, requiring a franchisee to purchase exclusively from the franchisor
may violate federal antitrust laws.
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UNIT FIVE: Business Organizations
Case 30.2
S&P Brake Supply, Inc. v. Daimler Trucks North America, LLC
Montana Supreme Court, 2018 MT 25, 390 Mont. 243, 411 P.3d 1264 (2018).
Background and Facts S&P Brake Supply, Inc., was the sole
authorized dealer of Western Star Trucks in Yellowstone County,
Montana. S&P operated its franchise under an agreement with
Daimler Trucks North America, LLC. The agreement required that
S&P sell a certain number of trucks in its area of responsibility
(Yellowstone County). Over a three-year period, S&P sold only two
trucks. Daimler advised its franchisee to use more effective marketing strategies and to hire more sales staff, among other things.
The next year, primarily because of S&P’s failure to meet its
sales goals, Daimler notified S&P that the franchise was being terminated. S&P objected, but the Montana Department of Justice,
Motor Vehicle Division, ruled in Daimler’s favor, and a state court
upheld the department’s decision. S&P appealed to the Montana
Supreme Court.
In the Words of the Court
Justice Jim RICE delivered the Opinion of the Court.
****
S&P argues * * * the [lower] court erred in its assessment of
the [Montana Department of Justice, Motor Vehicle Division’s]
determination.
****
S&P argues that an analysis of its sales performance [should
have been] restricted to evidence related to Yellowstone County.
Daimler established that S&P had failed to meet new truck sales
objectives * * *, which are set for all Western Star dealers using
an algorithm that considers market factors and the population of
a dealer’s area of responsibility. * * * Daimler offered its analysis
of S&P’s “dealer market share,” which compared how many trucks
S&P sold in its AOR [area of responsibility] to how many Western
Star trucks were annually registered in Yellowstone County, to
measure how well S&P was reaching and serving local customers.
Of the seven Western Star trucks registered in Yellowstone County
[during the last four years of S&P’s franchise,] only two had been
sold by S&P, an indicator to Daimler that S&P was not well serving
its market, as the majority of customers were purchasing their
Western Star trucks elsewhere. This evidence was premised upon
S&P’s performance in Yellowstone County.
Daimler also argued S&P’s “dealer market share” was low
compared to Western Star’s “regional market share,” a factor
which is compiled from national truck registration data to compare
S&P’s sales performance in its AOR with Western Star’s regional
performance. While this assessment included evidence from outside the Yellowstone County franchise location, the [lower] court
properly noted that limiting the evidence to only Yellowstone
County would not allow a comparison to other dealers where
there is only one dealer in a county, reasoning that “when only
one franchisee exists in a market, expanded data must be considered. Otherwise, a lone franchisee could never be terminated.”
[Emphasis added.]
* * * The Department found, “The bottom line is that S&P’s
sales were deficient no matter which way one analyzed the data,”
and this determination was supported by substantial evidence.
Decision and Remedy The Montana Supreme Court
affirmed the judgment of the lower court. The court concluded,
“The evidence focused on S&P’s performance in Yellowstone
County and was properly considered.” Thus, Daimler had the
grounds to terminate S&P’s franchise.
Critical Thinking
• Economic The department concluded that S&P’s failure to
use more effective marketing strategies and to hire more sales
staff breached the franchise agreement. S&P argued that these
were not material breaches because the agreement’s fundamental
purpose was to sell trucks. Is S&P correct? Discuss.
• Legal Environment Considering that S&P was the only
Western Star truck dealer in Yellowstone County, did discontinuing the franchise injure the public interest? Explain.
Notice Requirements Most franchise contracts provide that notice of termination must
be given. If no set time for termination is specified, then a reasonable time, with notice, is
implied. A franchisee must be given reasonable time to wind up the business—that is, to do
the accounting and return the copyright or trademark or any other property of the franchisor.
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CHAPTER 30: Sole Proprietorships and Franchises
737
Opportunity to Cure a Breach A franchise agreement may give the franchisee the right
Tupungato/Shutterstock.com
to attempt to cure an ordinary, curable breach within a certain period of time after notice
so as to postpone, or even avoid, the termination of the contract. Even when a contract
contains a notice-and-cure provision, however, a franchisee’s breach of the duty of honesty
and fidelity may be enough to allow the franchisor to terminate the franchise.
Case Example 30.7 Milind and Minaxi Upadhyaya entered into a franchise contract with
7-Eleven, Inc., to operate a store in Pennsylvania. The contract included a notice-and-cure
provision. Under 7-Eleven’s usual contract, franchisees lease the store and
equipment, and receive a license to use 7-Eleven’s trademarks and other intellectual property. 7-Eleven receives a percentage of the store’s gross profit (net
sales less the cost of goods sold).
A 7-Eleven manager noticed a high rate of certain questionable transactions
at the Upadhyayas’ store and began investigating. The investigation continued
for nearly two years and revealed that the store had been misreporting its sales
to 7-Eleven so as to conceal sales proceeds. Evidence indicated that nearly
one-third of the store’s sales transactions had not been properly recorded.
7-Eleven sent a “non-curable” notice of material breach and termination
of the franchise to the Upadhyayas. The franchisees argued that they had not
been given an opportunity to cure the breach. The court found there was
Why did a court prevent 7-Eleven franchisees from
sufficient evidence of fraud to warrant immediate termination without an
curing a breach in their franchise agreement?
10
opportunity to cure. ■
30–4b Wrongful Termination
Because a franchisor’s termination of a franchise often has adverse consequences for the
franchisee, much franchise litigation involves claims of wrongful termination. Generally, the
termination provisions of contracts are more favorable to the franchisor. This means that
the franchisee, who normally invests a substantial amount of time and funds to make the
franchise operation successful, may receive little or nothing for the business on termination.
The franchisor owns the trademark and hence the business.
It is in this area that statutory and case law become important. The federal and state laws
discussed earlier attempt, among other things, to protect franchisees from arbitrary or unfair
termination of their franchises by the franchisors.
Learning Objective 4
When will a court decide
that a franchisor has
wrongfully terminated a
franchise?
30–4c The Importance of Good Faith and Fair Dealing
Generally, both statutory law and case law emphasize the importance of good faith and
fair dealing in terminating a franchise relationship. In determining whether a franchisor
has acted in good faith when terminating a franchise agreement, the courts generally try to
balance the rights of both parties.
If a court perceives that a franchisor has arbitrarily or unfairly terminated a franchise, the
franchisee will be provided with a remedy for wrongful termination. When a franchisor’s
decision to terminate a franchise was made in the normal course of the franchisor’s business
operations, however, that weighs in favor of the franchisor. In that situation, a court generally will not consider termination wrongful as long as reasonable notice of termination was
given to the franchisee.
The importance of good faith and fair dealing in a franchise relationship is underscored
by the consequences of the franchisor’s acts in the following case.
10. 7-Eleven, Inc. v. Upadhyaya, 926 F.Supp.2d 614 (E.D.Penn. 2013).
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UNIT FIVE: Business Organizations
Spotlight on Holiday Inns: Case 30.3
Holiday Inn Franchising, Inc. v. Hotel Associates, Inc.
Court of Appeals of Arkansas, 2011 Ark.App. 147, 382 S.W.3d 6 (2011).
Background and Facts Buddy House was in the construc-
tion business. For decades, he collaborated on projects with
Holiday Inn Franchising, Inc. Their relationship was characterized by good faith—many projects were undertaken without
written contracts. At Holiday Inn’s request, House inspected a
hotel in Wichita Falls, Texas, to estimate the cost of getting it
into shape. Holiday Inn wanted House to renovate the hotel and
operate it as a Holiday Inn. House estimated that recovering
the cost of renovation would take him more than ten
years, so he asked for a franchise term longer than Holiday
Inn’s usual ten years. Holiday Inn refused, but said that if he
ran the hotel “appropriately,” the term would be extended at
the end of ten years. House bought the hotel, renovated it,
and operated it as Hotel Associates, Inc. (HAI), generating
substantial profits. He refused offers to sell it for as much as
$15 million.
Before the ten years had passed, Greg Aden, a Holiday Inn
executive, developed a plan to license a different local hotel as a
Holiday Inn instead of renewing House’s franchise license. Aden
stood to earn a commission from licensing the other hotel. No one
informed House of Aden’s plan. When the time came, HAI applied
for an extension of its franchise, and Holiday Inn asked for major
renovations. HAI spent $3 million to comply with this request.
Holiday Inn did not renew the term for HAI, however, and granted
a franchise to the other hotel instead. HAI sold its hotel for
$5 million and filed a suit against Holiday Inn, asserting fraud. The
court awarded HAI compensatory and punitive damages. Holiday
Inn appealed.
In the Words of the Court
Raymond R. ABRAMSON, Judge.
****
Generally, a mere failure to volunteer information does not
constitute fraud. But silence can amount to actionable fraud in
some circumstances where the parties have a relation of trust or
confidence, where there is inequality of condition and knowledge,
or where there are other attendant circumstances. [Emphasis
added.]
30301_ch30_hr_725-742.indd 738
In this case, substantial evidence supports the existence of a
duty on Holiday Inn’s part to disclose the Aden [plan] to HAI. Buddy
House had a long-term relationship with Holiday Inn characterized
by honesty, trust, and the free flow of pertinent information. He
testified that [Holiday Inn’s] assurances at the onset of licensure
[the granting of the license] led him to believe that he would be
relicensed after ten years if the hotel was operated appropriately.
Yet, despite Holiday Inn’s having provided such an assurance to
House, it failed to apprise House of an internal business plan * * *
that advocated licensure of another facility instead of the renewal
of his license. A duty of disclosure may exist where information
is peculiarly within the knowledge of one party and is of such a
nature that the other party is justified in assuming its nonexistence. Given House’s history with Holiday Inn and the assurance
he received, we are convinced he was justified in assuming that
no obstacles had arisen that jeopardized his relicensure. [Emphasis added.]
Holiday Inn asserts that it would have provided Buddy House
with the Aden [plan] if he had asked for it. But, Holiday Inn cannot
satisfactorily explain why House should have been charged with
the responsibility of inquiring about a plan that he did not know
existed. Moreover, several Holiday Inn personnel testified that
Buddy House in fact should have been provided with the Aden
plan. Aden himself stated that * * * House should have been
given the plan. * * * In light of these circumstances, we see no
ground for reversal on this aspect of HAI’s cause of action for
fraud.
Decision and Remedy The state intermediate appellate
court affirmed the lower court’s judgment and its award of compensatory damages. The appellate court increased the amount
of punitive damages, however, citing Holiday Inn’s “degree of
reprehensibility.”
Critical Thinking
• Legal Environment Why should House and HAI have been
advised of Holiday Inn’s plan to grant a franchise to a different
hotel in their territory?
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CHAPTER 30: Sole Proprietorships and Franchises
739
Practice and Review
Carlos Del Rey decided to open a fast-food Mexican restaurant and signed a franchise contract with
a national chain called La Grande Enchilada. Under the franchise agreement, Del Rey purchased the
building, and La Grande Enchilada supplied the equipment. The contract required the franchisee to
strictly follow the franchisor’s operating manual and stated that failure to do so would be grounds
for terminating the franchise contract. The manual set forth detailed operating procedures and safety
standards, and provided that a La Grande Enchilada representative would inspect the restaurant
monthly to ensure compliance.
Nine months after Del Rey began operating his restaurant, a spark from the grill ignited an oily
towel in the kitchen. No one was injured, but by the time firefighters put out the fire, the kitchen
had sustained extensive damage. The cook told the fire department that the towel was “about
two feet from the grill” when it caught fire, which was in compliance with the franchisor’s manual
that required towels to be at least one foot from the grills. Nevertheless, the next day La Grande
Enchilada notified Del Rey that his franchise would terminate in thirty days for failure to follow the
prescribed safety procedures. Using the information presented in the chapter, answer the following
questions.
1. What type of franchise was Del Rey’s La Grande Enchilada restaurant?
2. If Del Rey operates the restaurant as a sole proprietorship, who bears the loss for the damaged
kitchen? Explain.
3. Assume that Del Rey files a lawsuit against La Grande Enchilada, claiming that his franchise was
wrongfully terminated. What is the main factor a court would consider in determining whether the
franchise was wrongfully terminated?
4. Would a court be likely to rule that La Grande Enchilada had good cause to terminate Del Rey’s
franchise in this situation? Why or why not?
Debate This
All franchisors should be required by law to provide a comprehensive estimate of the profitability
of a prospective franchise based on the experiences of their existing franchisees.
Key Terms
entrepreneur 726
franchise 730
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franchisee 730
franchisor 730
sole proprietorship 727
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740
UNIT FIVE: Business Organizations
Chapter Summary: Sole Proprietorships and Franchises
Sole Proprietorships
The simplest form of business organization, the sole proprietorship is used by anyone who does business
without creating a separate organization. The owner is the business. The owner pays personal income taxes
on all profits and is personally liable for all business debts.
Franchises
1. Types of franchises—
a. Distributorships (for example, automobile dealerships).
b. Chain-style business operations (for example, fast-food chains).
c. Manufacturing or processing-plant arrangements (for example, soft-drink bottling companies).
2. Laws governing franchising—Franchises are governed by contract law. They are also governed by federal
and state statutory laws, as well as agency regulations.
The Franchise Contact The franchise relationship is defined by a contract between the franchisor and the franchisee. The contract
normally spells out the following terms:
1. Payment for the franchise—Ordinarily, the contract requires the franchisee (purchaser) to pay an initial
fee or lump-sum price for the franchise license.
2. Business premises—The contract may specify whether the business premises will be leased or
purchased by the franchisee and which party will provide the equipment and furnishings.
3. Location of the franchise—The franchisor typically specifies the territory to be served by the franchisee.
4. Quality control—The franchisor may require the franchisee to abide by certain standards of quality
relating to the product or service offered.
5. Pricing arrangements—The franchisor may require the franchisee to purchase certain supplies from the
franchisor at an established price but cannot set retail resale prices.
Franchise Termination Usually, the contract specifies the duration and conditions of termination of the franchise arrangement.
Both federal and state statutes attempt to protect franchisees from franchisors who unfairly or arbitrarily
terminate franchises.
Issue Spotters
1. Frank plans to open a sporting goods store and to hire Gogi and Hap. Frank will invest only his own funds. He expects that he will not
make a profit for at least eighteen months and will make only a small profit in the three years after that. He hopes to expand eventually.
Would a sole proprietorship be an appropriate form for Frank’s business? Why or why not? (See Sole Proprietorships.)
2. Thirsty Bottling Company and U.S. Beverages, Inc. (USB), enter into a franchise agreement that states that the franchise may be terminated at any time “for cause.” Thirsty fails to meet USB’s specified sales quota. Does this constitute “cause” for termination? Why
or why not? (See Franchise Termination.)
—Check your answers to the Issue Spotters against the answers provided in Appendix D at the end of this text.
Business Scenarios and Case Problems
30–1. Franchising. Maria, Pablo, and Vicky are recent college
graduates who would like to go into business for themselves.
They are considering purchasing a franchise. If they enter into a
franchising arrangement, they would have the support of a large
company that could answer any questions they might have.
Also, a firm that has been in business for many years would be
30301_ch30_hr_725-742.indd 740
experienced in dealing with some of the problems that novice
businesspersons might encounter. These and other attributes
of franchises can lessen some of the risks of the marketplace.
What other aspects of franchising—positive and negative—
should Maria, Pablo, and Vicky consider before committing
themselves to a particular franchise? (See Franchises.)
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CHAPTER 30: Sole Proprietorships and Franchises
30–2. Control of a Franchise. National Foods, Inc., sells
franchises to its fast-food restaurants, known as Chicky-D’s.
Under the franchise agreement, franchisees agree to hire and
train employees strictly according to Chicky-D’s standards. In
addition, Chicky-D’s regional supervisors must approve all new
hires and policies, which they generally do. Chicky-D’s reserves
the right to terminate a franchise for violating the franchisor’s
rules. After several incidents of racist comments and conduct by
Tim, a recently hired assistant manager at a Chicky-D’s, Sharon, a
counterperson at the restaurant, resigns. Sharon files a suit
against National. National files a motion for summary judgment, arguing that it is not liable for harassment by franchise
employees. Will the court grant National’s motion? Why or why
not? (See The Franchise Contract.)
30–3. Spotlight on McDonald’s—Franchise Termination.
C.B. Management, Inc., had a franchise agreement
with McDonald’s Corp. to operate McDonald’s restaurants in Cleveland, Ohio. The agreement required C.B.
to make monthly payments of certain percentages of the gross
sales to McDonald’s. If any payment was more than thirty days
late, McDonald’s had the right to terminate the franchise. The
agreement also stated that even if McDonald’s accepted a late
payment, that would not “constitute a waiver of any subsequent
breach.” McDonald’s sometimes accepted C.B.’s late payments,
but when C.B. defaulted on the payments in July, McDonald’s
gave notice of thirty days to comply or surrender possession
of the restaurants. C.B. missed the deadline. McDonald’s
demanded that C.B. vacate the restaurants, but C.B. refused.
McDonald’s alleged that C.B. had violated the franchise agreement. C.B. claimed that McDonald’s had breached the implied
covenant of good faith and fair dealing. Which party should prevail, and why? [McDonald’s Corp. v. C.B. Management Co., 13
F.Supp.2d 705 (N.D.Ill. 1998)] (See Franchise Termination.)
30–4. Business Case Problem with Sample Answer—
Quality Control. JTH Tax, Inc., doing business
as Liberty Tax Service, provides tax preparation and
related loan services throughout the United States in
more than two thousand company-owned and franchised stores.
Liberty’s agreement with its franchisees reserved the right to control their ads. In company operations manuals, Liberty provided
step-by-step instructions, directions, and limitations to its franchisees regarding their ads. Liberty retained the right to unilaterally
modify the steps at any time. The California Attorney General filed
a suit in a California state court against Liberty, alleging misleading or deceptive ads by its franchisees regarding refund anticipation loans and e-refund checks. Can Liberty be held liable?
Discuss. [People v. JTH Tax, Inc., 212 Cal.App.4th 1219, 151 Cal.
Rptr.3d 728 (1 Dist. 2013)] (See The Franchise Contract.)
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741
—For a sample answer to Problem 30–4, go to Appendix E at the
end of this text.
30–5. Quality Control. The franchise agreement of Domino’s Pizza,
LLC, sets out operational standards, including safety requirements, for a franchisee to follow but provides that the franchisee
is an independent contractor. Each franchisee is free to use its
own means and methods. For example, Domino’s does not know
whether a franchisee’s delivery drivers are complying with vehicle safety requirements. MAC Pizza Management, Inc., operates
a Domino’s franchise. A vehicle driven by Joshua Balka, a MAC
delivery driver, hydroplaned due to a bald tire and wet pavement,
and struck the vehicle of Devavaram and Ruth Christopher, killing
Ruth and injuring Devavaram. Is Domino’s liable for negligence?
Explain. [Domino’s Pizza, LLC v. Reddy, 2015 WL 1247349 (Tex.
App.—Beaumont 2015)] (See The Franchise Contract.)
30–6. Franchise Termination. Executive Home Care Franchising,
LLC, sells in-home health-care franchises. Clint, Massare,
and Greer Marshall entered into a franchise agreement with
Executive Home Care. The agreement provided that the
franchisees’ failure to comply with the agreement’s terms
would likely cause irreparable harm to the franchisor, entitling it to an injunction. About two years later, the Marshalls
gave up their franchise. They returned thirteen boxes of documents, stationery, operating manuals, marketing materials,
and other items—everything in their possession that featured
Executive Home Care trademarks. They quit operating out of the
franchised location. They transferred the phone number back
to the franchisor and informed their clients that they were no
longer associated with Executive Home Care. They continued
to engage in the home health-care business, however, under
the name “Well-Being Home Care Corp.” Is Executive Home
Care entitled to an injunction against the Marshalls and their
new company? Discuss. [Executive Home Care Franchising, LLC
v. Marshall Health Corp., 642 Fed.Appx. 181 (3d Cir. 2016)] (See
Franchise Termination.)
30–7. Location of the Franchise. Chrysler, LLC, awarded a
Chrysler-Jeep franchise in Billings, Montana, to Lithia Motors,
Inc. Lithia exceeded the sales goals and other expectations
expressed in the franchise agreement. Later, Chrysler approved
an application by Rimrock Chrysler, Inc., to open an additional
Chrysler-Jeep franchise less than a mile from Lithia’s location.
Lithia’s agreement was silent on the issue of territorial rights,
but the dealer protested Chrysler’s approval of Rimrock’s application. Could Chrysler’s actions be considered a breach of the
franchisor’s deal with Lithia? Discuss. [Rimrock Chrysler, Inc. v.
State of Montana Department of Justice, Motor Vehicle
Division, 2018 MT 24, 390 Mont. 235, 411 P.3d 1278 (2018)]
(See The Franchise Contract.)
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UNIT FIVE: Business Organizations
30–8. A Question of Ethics—The IDDR Approach and
Sole Proprietorships. Tom George was the sole
owner of Turbine Component Super Market, LLC
(TCSM), when its existence was terminated by the
state of Texas. A TCSM creditor, Turbine Resources Unlimited,
filed and won a suit in a Texas state court against George for
breach of contract. The plaintiff sought to collect the amount
of the judgment through a sale of George’s property. Instead of
turning his assets over to the court, however, George tried to
hide them by reforming TCSM. Without telling the court, he
paid an unrelated debt with $100,000 of TCSM’s funds. George
claimed that the funds were a loan and that he was merely an
employee of TCSM. [Mitchell v. Turbine Resources Unlimited,
Inc., 523 S.W.3d 189 (Tex.App.—Houston [14th Dist.] 2017)] (See
Sole Proprietorships.)
1. Is it more likely that the court will recognize TCSM as an LLC
or a sole proprietorship? Why?
2. Using the Discussion step of the IDDR approach, consider
whether the owner of a business has an ethical obligation
to represent the character and purpose of the organization
truthfully.
Critical Thinking and Writing Assignments
30–9. Business Law Writing. Jordan Mendelson is interested
in purchasing a franchise in a meal-preparation business. Customers will come to the business to assemble
gourmet dinners and then take the prepared meals to
their homes for cooking. The franchisor requires each store
to use a specific layout and provides the recipes for various
dinners, but the franchisee is not required to purchase the
food products from the franchisor. What general factors should
Mendelson consider before entering into a contract to buy such
a franchise? Is location important? Are there any laws that
Mendelson should consider, given that this franchise involves
food preparation and sales? Should Mendelson operate this
business as a sole proprietorship? Why or why not? (See The
Franchise Contract.)
30–10. Time-Limited Group Assignment—Franchise
Termination. Walid Elkhatib, an Arab American,
bought a Dunkin’ Donuts franchise in Illinois. Ten
years later, Dunkin’ Donuts began offering breakfast
sandwiches with bacon, ham, or sausage through its franchises.
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Elkhatib refused to sell these items at his store on the ground
that his religion forbade the handling of pork. Elkhatib then
opened a second franchise, at which he also refused to sell
pork products. The next year, at both locations, Elkhatib began
selling meatless sandwiches. He also opened a third franchise.
When he proposed to relocate this franchise, Dunkin’ Donuts
refused to approve the new location and informed him that it
would not renew any of his franchise agreements because
he did not carry the full sandwich line. Elkhatib filed a lawsuit
against Dunkin’ Donuts. (See Franchise Termination.)
1. The first group will argue on behalf of Elkhatib that Dunkin’
Donuts wrongfully terminated his franchises.
2. The second group will take the side of Dunkin’ Donuts and
justify its decision to terminate the franchises.
3. The third group will assess whether Dunkin’ Donuts acted in
good faith in its relationship with Elkhatib. It will also consider
whether Dunkin’ Donuts should be required to accommodate
Elkhatib’s religious beliefs and allow him to not serve pork in
these three locations.
8/30/18 1:43 PM
I agree with the statement “All franchisors should be required by law to provide a comprehensive estimate of the profitability of a prospective franchise based
on the experiences of their existing franchisees”.
Franchisors are required under FTC Franchise Rule to disclose certain material information to prospective franchises as part of the pre-sale process. Some of the
material information may involve the history of the franchisor including bankruptcy or litigation, franchisor’s business experience, fees related to the operation of
the franchise, products the franchisor requires the franchisee to use, financing information, exit strategies, dispute resolution, and financial performance among
others. However, franchisors are not required by federal or state law to disclose financial information such as projections of revenue, gross income, net income,
or profits with prospective franchises. In my opinion, these projections can be used as a powerful sales tool, and they should always be included in the sales
process. Sharing financial performance information allows for prospective franchises to make a more educated and reasoned decision to purchase. The
single act of sharing profitability information can be interpreted as an act of transparency. This could increase the prospective franchises’ trust in the
business and attract new investors.
Works Cited
Miller, R. L. (2020). Business Law Today (Comprehensive edition, 12th edition ed.). Cengage.