You don’t need a law degree to buy a franchise, but you will need a lawyer.
Understanding and dealing with franchising legal considerations can be a daunting but essential task for potential franchisees that are considering business ownership. Franchisors provide their franchisees with training and established business models, however, the burden of understanding legal ramifications falls on the franchisee.
There are a multitude of potential legal issues with any type of business model, from the “mom and pop” shops to the franchising model. With franchising, many of these problems involve contract issues stemming from the franchise agreement. Understanding the franchise agreement is essential, as most issues that arise are addressed in this contract.
“The franchisor/franchisee relationship is governed mostly by contract, that is the franchise agreement,” cooperate attorney Ben Kinney explained. One of the most common issues concerning this document is that of truthful claims.
“If a franchisor is making false claims to a prospective franchisee about the status of the company, the franchisor might be in violation of state and federal laws and may have committed fraud against the franchisee by making the false statements,” Kinney said. “If the franchisee is making false statements about the earnings of the individual store to the franchisor, the franchisor likely has a claim against the franchisee for breach of contract.”
One particularly sensitive breach of contract involves the royalty system. Because the relationship is governed by the contract, the agreement will spell out exactly how the franchisor is to collect their royalties. This is a major one for conflict between franchisors and franchisees.
“Many franchise agreements allow the franchisor to take a percentage of revenue (not profit). This can create conflicting interests between a franchisor and franchisee. In this instance, the franchisee gets paid on profits and franchisor gets paid on revenue. The franchisee wants to increase profits as much as possible but not necessarily increase revenue. Franchisees can do this by potentially cutting costs, maybe cutting corners,” Kinney said. “There are tons of legal complications that can arise, but most seasoned franchise attorneys will know how to prepare for them and avoid them by crafting a thorough franchise agreement.”
There are also laws outside of the franchise agreement that must be understood before opening a franchise. Many individual states have defined franchising laws that go beyond that of the federal government. States like California and Florida have state registration fees. In addition, states like Maryland, Wisconsin, and Virginia require registration of the Franchise Disclosure Document.
“As a franchisee you will be subject to all federal and your individual state's laws,” Kinney explained. “If you have employees, be aware of employment laws; if you sell food, be aware of FDA and state food regulations; if you sell goods, think about product liability laws.”
The most important thing to keep in mind when considering legal issues and contracts associated with opening a franchise is to always consult the appropriate counsel.
“Laws are always complicated to navigate and it is worthwhile, in this instance, to speak to someone with experience who can guide you through what to expect and to help protect you going forward,” Kinney said. “If you are a franchisee and you think that something shady is going on with the franchisor, you should speak with an attorney,” he added.
Asking questions and being familiar with not only the franchise agreement, but the Franchise Disclosure Document as well will position you for a smoother business venture. Educating yourself on these documents could allow you to get ahead of any breaches in contracts. Attorneys can help you sift through legal jargon and help protect you from any consequences.