For many, franchising is the fool-proof way of fulfilling the American Dream. For others, immediate business success is not guaranteed.
Robert Zarco, a Miami franchise litigation attorney, sees the idea of investing in a successful franchise operation as a potentially lucrative investment. He also views it as a potential pitfall for those who are not leery and fail to tread with caution.
Zarco successfully obtained a potential landmark ruling in favor of Massachusetts franchisee Steven Scheck in a case against Burger King Corporation. In that Federal case, Judge William Hoeveler upheld his previous ruling that a jury should decide whether the food giant breached the increasingly popular Implied Covenant of Good Faith and Fair Dealing, a doctrine which governs every contract. Scheck claimed that Burger King "cannibalized" his business by 24-30 percent when it sold a competing franchise less than 2.0 miles from his store to its competitor, the Marriott Corporation, owner of Roy Rogers, a similar fast food concept. The national precedent-setting franchise case has become even more important to franchisees in every major system in that Judge Hoeveler also allowed Mr. Scheck to assert a claim for fraud. In that claim, Scheck alleged that Burger King knowingly failed to disclose very important facts to him, which were going to adversely affect the value of his real estate and viability of his franchise. The claim stated the Burger King, at the same time, induced Scheck to purchase his Burger King restaurant's underlying real estate for $691,000 and to remodel his store for an additional $200,000. Burger King settled the case with Scheck prior to trial.
Mr. Zarco also represents and counsels other franchisees from various states in important disputes against Burker King, McDonald's, Dunkin' Donuts, Tony Roma's. Bonanza Steakhouses, Arby's, Wendy's, T.C.B.Y., Kentucky Fried Chicken, Kenny Rogers Roasters and others. The McDonald's Corporation is and has been pursued by Zarco, who represents long-term McDonald's franchisees in many states, including California, Arizona, Massachusetts, Florida and Texas. Their claims against the fast food corporation range from encroachment and cannibalization issues similar to those present in the Scheck case, unreasonable refusal to approve a buyer for the franchise, fraud, misrepresentation, civil rights violations, discrimination and breach of contract claims. One of the California franchisees, for example, claims that over fifty potential purchasers expressed an interest in buying their franchise, but when McDonald's was presented with several of the agreements for approval, they arbitrarily declined to allow the sale to go through. Another McDonald's franchisee experienced severe impact from other McDonald's restaurants developed around his restaurant, just as in the Scheck case. In that case, McDonald's own ombudsman recommended that the franchisee should be granted one of those new stores in order to compensate for the substantial impact.
Franchising is the boom-industry of the 1990's. Franchises account for one-third of retail sales in the U.S. according to Francorp, a Chicago consulting firm. Franchises are expected to account for 50 percent of all retail sales generated in this country by the year 2000. With approximately 850,000 franchised outlets nationwide, it is no wonder that a new franchisee opens for business approximately every 10 minutes.
From food to healthcare to child care to a cadre of retaining services, budding business people across the nation are buying into the more than 3,000 U.S. franchise operations. But there's a downside: For everyone looking to buy in, a company is luring the uninformed so as to profit from the sale of a pipe dream. And it doesn't come cheap. Some franchises cost upwards of $500,000 in capital investment, franchise fees, start-up fees, and require payment of up to 20 percent of gross sales for rent, marketing, royalties and advertising. Therefore, be careful that you do not get in over your head financially.
While most franchisors hold the upper hand and few will negotiate away strong points in their agreements, without asking, the franchisee will never know what can be gained. Zarco offers the following tips for the hopeful franchisee.
- Invest in what you know. People who pursue their heart's desire often fare better than those who tackle an industry because it looks good on paper. Remember: Franchising is at least a 15-year commitment. "Its like everything else," Zarco said. "If you like what you do, you'll give it 110 percent." Look at all Federal Trade Commission disclosure documents prior to signing any agreements to see if what the company is representing is actually correct. Review the franchisor's financial statements and Securities and Exchange Commission quarterly and yearly filings to ascertain its financial strength and thus its ability to provide the services and support it promises.
- Study the marketplace. Don't blindly trust the company's performance statistics. Many times the numbers provided are extremely misleading. Especially with younger and smaller franchisors, analyze financial statements and market performance. Interview existing franchisees on their success with the company, the business, the marketplace, the company's track record in living up to its promises as to the services and support it has agreed to provide. Make site visits, monitor traffic. What are the pitfalls? When digesting the input, be skeptical: Franchisees may see you as potential competition and skew their answers to scare you from becoming their competitor.
- Be prepared for the unexpected. After your franchise lawyer has prepared the franchise documents, consult a franchise litigation attorney to review it further. Franchise litigators are trained to anticipate lawsuits on every issue and will recognize a problem before it is too late to negotiate the issue. Also, make certain that the offering circular and franchise agreement don't conflict. Have your attorneys review both.
- Look ahead. Does the contract allow you to automatically renew after the initial contract period for a new successor term? The new Iowa Franchise Act requires automatic renewal for qualified franchisees in that state, some states are beginning to follow Iowa's lead. Assuming your outlet performs up to corporate financial and operating standards, you -- not the franchisor should be the one to make the decision whether you wish to continue in the business.
- Promises, promises. If the franchisor make a promise, get it in writing. Consider verbal promises and agreements -- especially without witnesses -- as worthless. Experience has shown that corporate executives have faulty and selective memories, especially as it applies to following through on their own promises. Furthermore, with the rapid movement among executives to different positions and companies, the likelihood that the individual who made you the promise will be there to follow through on the promise is slim to none. Follow-up every conversation in which some promise was made to you with a confirmation letter to your franchisor's representative. If they fail to respond and do not dispute your confirmations, they may be considered to have acquiesced by their failure to respond.
- Don't get eaten alive. To prevent cannibalization by other outlets within the company, get your franchisor to commit -- as much as possible -- to your market. If the company plans to build another store in your area, negotiate either the right of first refusal to buy that store, or for the company to compensate you on the decreased revenues and market share you will lose as a result of the encroachment. Make certain you request in writing the company's encroachment policies as well as its future development plans for new stores in your market area and neighboring trade areas. The franchisor's failure to disclose a known material fact which could in any way affect the value or viability of your franchise could constitute a fraud and misrepresentation.
- Get more bang for you ad dollar. You will be paying national marketing fees. Try to negotiate that any national or regional advertising campaign is also to be done in your market area. Follow up to make certain that the advertising dollars are being used for their designated purpose and not for any other reason. It is not uncommon for franchisors to use advertising funds to fun corporate operations or other ventures having nothing to do with marketing or advertising. Additionally, when a competing chain launches a special offer -- for example, "Breakfast for a Buck" -- commit your company to match it or put it to a vote of the franchise community.
- Thanks for the memoris. If you decide to sell your franchise, who chooses the buyer? Any reasonably qualified buyer with the financial wherewithal and operations acumen should be acceptable, and approval of the potential buyer should not be at the sole discretion of the franchisor or unreasonably withheld. Furthermore, beware of restrictive covenants precluding you from operating the same type of business for a number of years within a prescribed area. You might be negotiating away your ability to earn your livelihood.
- Keep it close to home. Determine the location as to where a lawsuit or other legal matter has to be initiated. Sometimes venue and jurisdictional provisions require that any dispute which arises out of the agreement has to be resolved in the courts of another state, even if it is across the country. Such provisions can prove to be quite costly in the future and create an unequal bargaining position in favor of the franchisor.
- Avoid the slippery pen. Do not sign any documents, regardless of time pressures, without first consulting your franchise lawyer. Often times, hidden releases of liability may prejudice any future claims you may have against the franchisor.
- Negotiate. Often the franchisor won't allow side agreements to be written into the contract. Always remember, "Franchisors will never negotiate away their right to protect themselves. Except now, that franchise law is in such turmoil some franchisees have a better chance," Zarco siad. "You may not be able to negotiate these items, but it's the awareness. Focus on these issues and show that you've done your homework."
Franchisors and franchisees across the country are following Zarco's cases. Several of these pending cases could well determine the course of U.S. franchise law and how franchisors treat and deal with their franchisees in the future. You must be aware of these rights and obligations before entering into a franchise relationship.