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Franchise Legal Issues

Franchise Legal Issues (featuring Elle Gerhards of Fox Rothschild)

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Amanda: All right. Good afternoon, good morning, wherever you’re listening from today. We’re here with a brand new series. I’m joined by Elle Gerhards, an attorney at Fox Rothschild. Elle, thanks so much for being here. Tell us a little bit about yourself.

Elle: Oh, great. Well, thank you for having me. As she said, my name is Elle Gerhards. I’m a partner with Fox Rothschild, a national law firm with about 27 offices coast to coast. I co-chair their franchising and licensing distribution group, and have been with Fox for about 13 years, almost 13 years. And I am a corporate transactional and regulatory franchise attorney. So I work with both franchise systems, startup, emerging and established, as well as franchisees and multi-unit owners, and area developers in the regulatory and corporate matters that they deal with.

Amanda: Awesome. Well, thanks for being here, really looking forward to kind of picking your brain around some of those frequently asked questions that we get from franchisees, you know, what kind of conversations to have with your franchisor, all those things. So, let us start today with, again, kind of some frequently asked questions, really that due diligence that you should do before buying a franchise. So I’ll kick things off, which is kind of a very general question, but what are some of the things I need to do and consider, from a legal perspective, before buying a franchise?

Elle: Okay. So, if you’re talking about due diligence and what you should do before buying a franchise, you know, a lot of people and a lot of my clients from the franchisee perspective are going to, you know, get on the internet and do a lot of searching, and that’s great. You should. There’s a ton of information that’s out there about franchising, generally, what it means to be a franchisee, and about the franchise systems and industries that you may be interested in buying a franchise from. There are additional resources. And in addition to just, you know, sitting there at a computer at 11:00 at night and trying to make heads or tails of the vast amount of information that’s out there, I encourage clients to get out there and get really involved face-to-face. So, you know, there are franchise expos in various geographic regions. There’s a huge one every year in New York City. There’s ones in Florida, California, Dallas, every year. There’s usually more regional ones. And what these are, are opportunities, and big expo is where you can go for, you know, $5 and just walk the floor and look at the franchises that are out there, talk to franchise systems and their representatives, and get a feel for what opportunities there are. The great thing about these various expos that you have is that a lot of times they’ll be conducting most of the time free seminars and just educational series, during the expos. They’ll be from lawyers, and accountants, and finance folks.

And you can sit there and you can learn about, you know, what does it mean to be a franchise and all the things that, you know, we talk about on your podcast. You can find those things out. And then, the great thing is, you know, after the fact, you can ask questions to them directly. And so that’s a great way for you to find out more information about franchising and what’s out there sort of face-to-face. Another thing is, brokers. You know, there are brokers that work, you know, just for one or a couple of franchise systems, but they’re also franchise brokers that are really tailored to where you are in life. So let’s say, for instance, you know, you were laid off or retired early from a C-suite executive role, you know, there are brokers that will work with you to find a franchise that will work for you. And they’ll do a lot of the due diligence for you and find some of those systems that really are good, and that other franchisees and their clients have had success with. So those are two ways of doing due diligence, in addition to just maybe the internet searching that you would normally do.

Amanda: I feel like most people are like, “I’m just gonna Google how to buy a franchise,” right? You know, we talk a lot about the research behind the scenes, but it’s really easy to be overwhelmed, I feel like when you’re just kind of researching without kind of a purpose or a direction. And it sounds like those expos are a really great way to get in front of people to ask the right questions, to get some more kind of guidance on that journey. And you know, as much as we live in a world where nobody wants to get out and talk to people anymore, it sounds good or a really good way to go.

Elle: I think so. Yeah.

Amanda: And I love the concept of brokers, you know, working uniquely with you and where you’re at in your life, and your different financial profiles, and all the things that kind of go into that and not just kind of being one fish in a big sea of people looking for franchises. But somebody who’s really gonna take a look at your unique situation and your profile, and work with that.

Elle: Yeah. I mean, in full disclosure, these brokers are going to receive, you know, a commission or a fee from the franchise systems. But most of the time, you know, not most the time, all the time that I’ve seen my clients, they’re really in your court. You know, they’re really working to make sure that you find a successful fit.

Amanda: So they have your best interests at heart, right?

Elle: Exactly.

Amanda: Awesome. So we talked a little bit about kind of the research side of it, but what are some things that I need to kind of get in order? So how should I prepare my affairs before I purchase a franchise?

Elle: Sure. So, there are a lot of things, some of them are legal, some of them are not. One of the things is to get your finances in order. And I think you talked a lot about this with Steve on the last podcast series. But, you know, the franchisor is going to be doing its background checks, whether they’re credit checks, criminal background checks, you know, really looking into you, the same way that, you know, that you’re gonna be doing your due diligence on them. So make sure that, you know, you’ve looked into how you’re gonna finance your franchise purchase, and making sure that there…if there are any skeletons or anything that’s a little bit less than ideal in your background, that, you know, you’re ready to deal with that. The other thing is to find competent legal counsel. I may be a little biased in that, but depending on whether or not you’re working with an emerging or established franchise system having competent, knowledgeable legal counsel is really gonna help you understand the giant 200, 300 page legal documents that you’re gonna get. They’re gonna be able to help you make heads or tails of that. And they’re gonna be able to, you know, really sort of guide you through that process and make sure that you’re going in with open eyes as to what your responsibilities are gonna be as a franchisee. And also, you know, kind of give you a little bit of, “I’ve been there, I understand. You know, these types of contractual restrictions are standard and this is normal,” and that sort of thing.

So, with that said, I would definitely recommend finding a legal counsel that is well-versed in franchise law. So I know your Uncle Jim, he may be a criminal lawyer and he may know what’s going on or you may have a cousin that works at a white-shoe law firm doing M&A in New York all day. You know, franchising is its own specific area of law. These agreements are, you know, very well-known among franchise attorneys, but not so much about non-franchise attorneys. So, believe me, there’s plenty of us out there. So, you know, you can find competent franchise legal counsel, you know, no matter where you are in a variety of different price ranges. The other thing is to think about, you know, the territory that you’re going to wanna operate in. You know, if you are leaving the business world in your current capacity and maybe retiring in a few years, pin down where you think you wanna be operating your franchise because, that’s gonna be one of the narrowing, you know, specifics, when you’re talking to franchise systems. If there’s not a territory available, where you wanna operate, then you could sort of, you know, knock them out of contention right there. You know, I work with a lot of clients, you know, that may be East Coast-based, but are looking for territory in Florida or out west where they plan to retire. So you really have to think about those, about the territory that you’re gonna wanna operate in. And in connection with that, you also wanna think about time commitment.

So, some franchise systems are going to allow you to be a passive operator. You’re not gonna have to manage the day-to-day. And if you’re thinking, “Hey, I wanna buy a couple of franchises, I wanna operate them, you know, oversee them, but I don’t wanna be into the day-to-day management,” then you need to look for a franchise system that’s gonna allow you to do that because there’s a lot of franchise systems out there that want their owners to be involved in the day-to-day management. And if that doesn’t fit for you, then, you know, you wanna know that now. Another thing to prepare for is succession planning. You know, think really hard before you start looking as to, you know, what your long term goals are? Do you wanna build a business that you wanna pass down to your children or is this something that you wanna operate for as many renewal terms that the franchisor will let you? Do you wanna grow a couple of units so that you can sell them, you know, to another potential transferee franchise in a couple of years? Think about those things. The other thing is to get your family on board. So, you know, make sure that, you know, if you’re married or if you have children that you intend to help you out operate, that you’re talking and you’re open with your family, so that… These may not seem like legal things, and I have, you know, other legal, obviously, you know, information that we can provide, but, you know, you wanna get all of these ducks in a row and you wanna prepare these affairs so that when you are looking at franchise opportunities, that you’re able to go in knowing what you want out of it.

Amanda: Absolutely. And there’s a couple of things you just mentioned that I kind of wanna revisit. So when we talk about succession planning, you know, what is your 5-year, 10-year, 15-year plan and where do you wanna be through all those things? Whether like you said, it’s selling to a different franchisee, if it’s, you know, getting your family involved because we have talked a lot about kind of that family support and what it means to have a spouse on board or not on board, and what’s that gonna look like? You know, we’re kind of going into the realm of, I’ll call them professional partners in this situation, right, your financial person, your attorney, all of the people that are involved in that. But the question I had for you is… So you brought the example of you’re on the East Coast now, you’re looking to retire out in the West Coast, California, maybe, and looking to purchase a franchise out there. Is that something that you see a lot in franchises where I could buy a territory in California, as an example, right? Get it up and running so that when I’m ready to retire, it’s kind of already a running machine or is that kind of go back to that passive versus absentee owner idea, just depending on the franchise?

Elle: Yeah. So it’s very franchise system dependent. Typically, and I have worked and I’m recently, coincidentally working with a franchisee who’s purchasing three units, and they plan to retire in two years, the two of them, the husband and wife out to the West Coast. But the wife is going to be there on the ground. Even though they’re not living on the West Coast yet, she plans to go out there because you really are still going to need someone there, at least for the interim, while you’re doing the build out. And you know, while you’re hiring, while you’re, you know, finding lease location, all the things that you need to do in order to, you know, get up and running, and open, and successful. You can’t do that remotely. So, there’s certainly opportunities and in this case, the franchise system, you know, is going in understanding that, you know, in a couple of years, they will be passive. But for now, if your long term goals is to, you know, open in a different location than where you’re currently living, you’re still gonna have to make a commitment to be out there.

Amanda: Either be hands-on, especially in that early launch period.

Elle: Yes. And you want to. I mean, this is gonna be your business.

Amanda: Yeah. It’s exciting, right? You wanna be part of it, especially, the early stages. And I’m gonna go back kind of the beginning of the question is, you know, what should I ask? How should I prepare my affairs? And you talked about finding competent legal counsel. And I know that there are a ton of them out there. I’m sure there are just as many that would fall maybe into the other category. So what are some things, when you are looking for a legal counsel, what are some things to be aware of, maybe what are some questions that you should be asking to make sure…because this person is gonna be on this journey with you and you wanna make sure that, again, they’ve got your best interest at heart. So what are some ways we can find those folks?

Elle: Sure. So, there’s a couple of parts to the question. First, if you’re looking for a competent franchise legal counsel, make sure when you’re talking to them, ask them, obviously, how many years have you been in franchise practice and are you a franchise litigator or are you a franchise transactional corporate attorney? Because corporate attorneys, you know, are typically what you would look out for when you’re forming a company and buying a franchise. And if, you know, entering into these contracts, make sure that they’ve reviewed, you know, or drafted hundreds, if not thousands of franchise disclosure documents and franchise agreements. You know, a lot of the things that I would think about if I was purchasing a franchise, that I would make sure that I was asking my franchise counsel right off the bat is, and the answers that they give are gonna be able to tell you whether or not they know what, you know, they’re talking about, you know, is the franchise offering that I’m looking at, are they industry standard business in legal terms? So, I can’t tell you as an attorney, whether or not to purchase a franchise, whether it’s a good business decision. That’s something that you’re gonna decide, you know, with your business advisors, with your accountant, you know, with your lenders, that sort of thing. What I can tell you, in my experience is, are these terms business and legal, standard terms that I see?

So royalty rates, ad fund requirements, technology fees. I’m gonna be able to tell you, you know, initial franchise fees, fairly quickly, whether or not they’re within the range of what I typically see for a similar competitive system. So that’s something that I would definitely talk with your franchise attorney, “Hey, you’ve reviewed hundreds, or drafted hundreds, if not thousands of these, it seemed… And that’s the question that I get all the time. Does this seem normal? Does this seem standard? Same with the legal terms. You know, things like we’ll talk down the line, but you know, when we get into the FDD but, you know, is it standard for a franchise system to be able to terminate me under these circumstances? Is it standard for a franchise system to be able to, you know, impose a different additional, you know, fees on me down the line? So those sorts of things, you’re gonna wanna talk to your franchise counsel about and ask them about red flags. You know, “Do you know anything about the system?” If you’re a franchise attorney, you should be able to… You know, you’re involved in the franchise world, is there any red flags? Do you know anything? Have you heard anything about this franchise system? Have you represented any other franchisees in this system? You know, what do they think about? You know, have they had good experiences? The other thing, you know, that I talk to and I think when you’re talking to a legal counsel, it’s…and other, you know, advisors, something that’s important to discuss is, tell me the difference between buying an established brand, pros and cons, versus a startup or emerging brand. So one of the things, at least, in my experience, that I’ve dealt with a lot is, “Okay. You know, I’m gonna buy an established plus 500 unit franchise, a franchise system that has 500 plus operating units, what are the benefits there?”

Okay. Well, you know, it’s a proven successful model. There’s franchisees have proven success. You know, they probably have in place all of the support, and training, and operational guidance. You know, they’ll likely have people that are gonna help you with leasing, help you finding a location, you know, help you with training, employee type matters, versus a startup system, which, you know, may not have all that in place yet. But the benefits are, you know, maybe you’re going to be able to negotiate some more favorable terms. You know, an established brand is pretty much a take it or leave it scenario. You know, they have other people waiting in the pipeline. They’re established, they don’t, you know, necessarily need to make any concessions to franchisees, and often don’t. And that’s with good reason. What they’ve done has proven successful. So they don’t need to deviate from it. You know, but in an established or emerging…or in an emerging or startup system, you know, you may have more options for territory. Sometimes, you know, there’s just no territory available. And if you’re getting in on the ground floor in a location that a franchise system hasn’t moved into yet, you may have first pick of the territories and you may be able to negotiate, but you’re also taking a leap and there’s a risk there. So, you know, as I said, look for your…number one, finding a legal counsel. You know, you can ask for recommendations from your lenders, your brokers, you know, friends and family, searching on the internet, you know, finding franchise attorneys that are very active in the American Bar Association or who have written or spoken on franchise matters. And then, again, once you find that person, you know, asking some of these initial questions to kind of dig a little deeper and make sure they know what’s going on.

Amanda: Yeah. Absolutely. It’s good to have the right person in your corner. It sounds like the Bar Association is a good resource as well, I’m talking about in your area and things of that nature.

Elle: Absolutely.

Amanda: So as we kind of move through the process here, right, we’ve kind of got our ducks in a row, so to speak, and we’ve made a decision on opening a franchise, and identified brands and territories available, and all those kinds of things. But from a legal standpoint, what should I be prepared for when opening that franchise? Are there things that you see commonly that people are kind of out of left field caught by or just things to be aware of?

Elle: Sure. So, you know, that’s a really good question. And I would say, time and time again, I do have the same questions that come up. And also, just the sort of misconceptions that come up. So, first and foremost, is to understand, from a legal standpoint, when you’re purchasing a franchise, you’re in it. You know, you’re in it. Once you sign that franchise agreement, you know, you can’t walk away just because, you know, you don’t like how things are going or you’re losing money. And hopefully, that’s never gonna be the case. And hopefully, your franchise is, you know, extremely successful. But a lot of franchisees that I talk to who aren’t very familiar with franchising, don’t know that, “Hey, I’m making a 10-year, maybe 20-year commitment under this franchise agreement, the same way the franchisor is making a commitment to me, I’m making a commitment to them,” and you can’t just walk away. I mean, you know, you have to be all in and there’s no ability in the franchise agreement contract for you to say, “You know what? I’m gonna terminate this agreement. I don’t like how things are going. I don’t like the new ownership. You know, I think this isn’t what I thought it was going to be.” That’s one big legal issue that, you know, point that all franchisees should understand. The second thing is the concept of a personal guarantee. When you are signing up as a franchisee, you’re going to have to sign a personal guarantee to a franchise system, to the franchisor, the same way that you’re going to have to the lender or the bank if you get out an SBA loan.

And a lot of franchisees, you know, may not understand that. They may think, “Well, I’m gonna form a limited liability company. I’m gonna form a corporation. That should isolate my liabilities. You know, how am I still liable?” Well, you know, when you start up as a…form a new entity and you’re operating a business, there’s really not a whole lot of assets in that business. And so it makes sense, the same way a bank would, to say, “Well, wait a minute. You know, we need you, you know, to put your money where your mouth is. We need to ensure that you’re going, you know, to put your best foot forward and to operate the franchise and aren’t just gonna walk away. So, you’ll have to sign a personal guarantee, which means that your personal assets, you know, are on the line if you were to stop paying royalties, or if there was a lawsuit in which you are required to hold the franchisor or acquirer harmless, or stop paying ad fees, or had other amounts owed to them. So that’s another sort of legal issue that comes up from time to time, where franchisees ask me questions about, “Well, what does that mean to be personally liable to the franchisor? Final thing is, you know, that from a legal standpoint, is to understand that you’re going to have to comply with their ways of doing business. You’re deciding to purchase a franchise because you’re entrepreneurial and you’re looking for a new way to operate and grow business, maybe you’re going into a new part of your life, but you’re buying into a franchise because you want someone there, that’s going to help you along the way. And so, you know, I have a lot of franchisees who’ll say, “Well, you know, they tell me who I have to buy my supplies from, and they tell me how I have to operate and how my building looks, or how my location looks, and how the signage is, and how to do everything. And if I don’t do it that way, then, you know, I could be in default and I can get in trouble.” And that’s right.

Amanda: That’s why you buy a franchise.

Elle: And that’s why you buy a franchise because, you know, every customer that goes into a location or a service, if it’s a service franchise, you know, whether it’s Pennsylvania, or Florida, or Texas, they wanna make sure that they’re getting the same quality and level of service. And this benefits you because if another franchisee down the street is not operating in accordance with system standards and up to the level that the system expects, then you want the franchisor to make sure that they’re rectifying the situation or exiting the system. So the one thing I would say is, if you’re someone who says, “Oh, you know, I don’t really wanna take orders. And I don’t want to assist…” You know, I’ve had franchisees who have come to me and said, “I just wish the franchisor would leave me alone.” And you’re like, “No, that’s not how it works and that’s not how it should work.” And most people who get into franchising, if not all, love the idea of having a support system there, and other like-minded business professionals and other franchisees that you can talk to about issues, and a franchisor that you can reach out to. Like I said, as a corporate attorney, I represent both franchisors and franchisees, and I can’t tell you the number of franchisor clients that, you know, call me up on a day-to-day basis and say, “You know, my franchisees are asking about this issue or facing these issues. And I know we can’t tell them what to do but, you know, how can we help them out and how can we provide advice, and what can we do here? I mean, the best thing about a franchise system is you have that…that you have those outlets, that you’re not on your own. But with that, it means that you’re gonna have some contractual restrictions on how you can operate.

Amanda: Absolutely. And we talk a lot about in kind of very early episodes that you’re in business kind of for yourself, but not by yourself, which is the benefits of franchise, but you’re absolutely right. There are, you know, varying degrees, I’m sure based on the franchise of how much control or there’s… Again, it all goes back to the industry that you wanna be in, the brand that you’re looking for. And I love that you talked about kind of, you know, why those things are in place about the brand standard and the experience. You know, as a service brand ourselves at Griswold Home Care, it’s very important that if somebody calls an office in Florida, they have the same great experiences for their mom or dad or loved one as when they call an office in New Jersey or California or anywhere else. So thanks for sharing that because it is so, so important when you buy a franchise to keep everything consistent across the board. So your customers are getting the experience that they expect.

Elle: Exactly.

Amanda: So it’s not just for the sake of, you know, having a rule book, there’s a reason behind it, and it’s for the franchisees’ benefit as well.

Elle: Exactly. Yep.

Amanda: Awesome. We’ve referenced the FDD a couple of times here. Before we dive into that, anything else you wanna kind of add and things to consider, either before buying a franchise or, you know, things to be considered during an opening process?

Elle: Yeah. I could probably spend 50 podcasts talking about franchise, you know, issues and things that I’ve seen over the years. You know, the one thing that I see time and time again, and I would when you’re looking at various franchise systems, the one thing I would say is, when we talked a little bit before about territory and if there’s open territory for established versus, you know, startup franchise systems, you know, what I see a lot is franchisees who will come to me and say, “I’m getting a good deal because this franchise system has been operating throughout the south for the last 10 years, and now they’re moving up north. And, you know, I’m getting a great deal. I’m gonna be the first people on the ground in Connecticut, or Pennsylvania, or New Jersey.” And what you wanna be careful in those situations is making sure that the franchise system has done its own due diligence and had people on the ground to make sure that the system will replicate and work in a different geographic region. So, I often deal with franchisees who say, “You know what? I signed this franchise agreement and, you know, I can’t find a location that’s going to be within the metrics. The construction costs are too high or we didn’t realize how many regulatory hurdles there are up here that there aren’t where they’re based.” Or they may not have the same sort of people to assist with leasing or understanding the location and the area and traffic patterns and even the consumer patterns on services or habits in that location. So, I would say to just, you know, be very careful and just talk to the franchisor about these things. Again, you know, you wanna go in with an open mind that they know, you know, what’s going on, but when you’re talking one-on-one with them, say, “You know, is there gonna be someone there, you know, that understands my geographic location. Have you thought about these things?” And see what their answers are.

Amanda: Yeah. Absolutely. Especially when you’re talking…you know, a brand that’s maybe really popular in one area of the country moving into somewhere else, that’s definitely something to be considered, for sure.

This information is intended for general purposes only. It does not constitute legal advice. Listeners should consult with knowledgeable legal counsel to determine how applicable laws apply to specific facts and situations. This information is based on the most current information at the time it was recorded. Since it is possible that the laws or other circumstances may have changed since recording, please discuss any action you may be considering as a result of listening to this podcast with knowledgeable legal counsel.