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Post-COVID Opportunities and Legal = Considerations=20 to Franchise Resale
It would be difficult to find any person or business that has not = been=20 affected by COVID-19. Over the last few months, most states have issued = =E2=80=9Cstay at=20 home,=E2=80=9D =E2=80=9Cshelter-in-place,=E2=80=9D and other similar = orders. Businesses all over the=20 country have ceased operating. Many others that have remained opened = have=20 experienced a substantial decrease in their business volume. Americans = have=20 filed for unemployment in record numbers. Franchise systems are no = exception and=20 have faced closures, layoffs, and myriad other issues. While this = ongoing crisis=20 is causing hardship all around, franchise systems will eventually = recover. This=20 will undoubtedly present opportunities for existing and prospective = franchisees=20 interested in buying or selling franchise units amidst recovery from = this=20 difficult period.
These mandated closures (or decreased business) and an uncertain = economic=20 climate will uniquely, and perhaps disproportionately, affect franchise=20 businesses. Although a number of franchisors have made concessions to = their=20 franchisees (i.e. waiving or deferring royalty payments or = making=20 concessions relating to defaults), not all franchisors are able or = willing to=20 make such accommodations. This means that many franchisees are not only = losing=20 revenue, and subject to the normal expenses of a business (rent, = utilities,=20 labor costs, and the cost of supplies and/or inventory), but they may = also still=20 be liable for royalty fees and/or required purchases.
These forced closures may make it impossible or undesirable for some=20 franchise units to return to business as usual. Some businesses will = suffer=20 financial hardship such that reopening will be impossible. Other = franchise=20 owners may have used this mandatory time off to consider what might be = next for=20 them. Regardless of the reason, it may be time for many franchisees to = consider=20 selling their businesses.
The good news is that there will probably be continued, and maybe = even=20 increased, interest in purchasing a franchise. Over 30 million Americans = have=20 filed for unemployment since the beginning of this pandemic.[1]<= /A>=20 With relief afforded under the CARES Act, this not only includes = traditional=20 employees, but also self-employed contractors and business owners. = For=20 those in this position looking for a new beginning, it may be a good = time to=20 consider investing in a franchise. While there are of course risks with = opening=20 a business, franchises offer certain advantages including: 1) a business = model=20 (everything from pricing to branding) that has already been established = and=20 proven; 2) scale for purchasing supplies and inventory; 3) communal = knowledge=20 and experience across the system; and 4) shared operating costs such as=20 marketing. These elements benefit franchises as they reopen following = quarantine=20 and make these businesses attractive to prospective purchasers. Further, = according to Franchise Direct, even though the 2008-2010 recession took = a toll=20 on the U.S. economy, franchises fared better than most other retail = chains and=20 small businesses.=20 [2]
Franchising is a unique and complex business model and the resale of = a=20 franchise unit by the franchisee includes a number of considerations. = This=20 article will address pertinent legal concerns relating to this type of = sale and=20 discuss some of the steps that can be taken now in preparation of a = sale.
Franchise Agreement and Other Contractual = Obligations
When addressing any question or issue relating to a franchise, the = first stop=20 should always be the relevant franchise agreement. A franchise agreement = outlines all of the terms of the franchise relationship. Most franchise=20 agreements contain provisions relating to the transfer of the franchise. = The=20 franchise agreement may contain provisions relating to any or all of the = following:
- Franchisor must approve of the sale.
- Purchaser will have to be approved by the franchisor and a=20 franchisee.
- Franchisee must pay a transfer fee.
- Franchisee must comply with the franchise agreement and other = related=20 agreements.
- Purchaser must execute franchisee=E2=80=99s current franchise = agreement (or a new=20 franchise agreement), and any subsequent addendums, or ancillary=20 agreements.
- Franchisee must execute a general release of the franchisor from=20 obligations under the franchise agreement and related agreements.
- The purchase agreement between franchisee and purchaser relating = to the=20 sale of the franchise must be approved by the franchisor.
- Franchisor requires franchisee or purchaser to update the = franchise to the=20 most current facility image, which may include design, construction, = signage,=20 and equipment specifications required by the franchisor.
- Franchisee must pay all costs of the franchisor in granting=20 approval.
The franchise agreement may also contain provisions relating to a=20 franchisee=E2=80=99s conduct following its termination (which would = occur along with a=20 sale). Such provisions may include any or all of the following:
- Non-compete, exclusivity, or territorial requirements =E2=80=93 = prohibition=20 against franchisee engaging in business that competes with the = franchise=20 system, owning competitor franchises, or locating a new franchise in = another=20 franchisee=E2=80=99s exclusive territory.
- Non-solicitation =E2=80=93 prohibition against the franchisee = recruiting=20 customers, suppliers or employees of the business being sold.
- Confidentiality obligations with respect to the = franchisor=E2=80=99s trade=20 secrets, financial information, business model, etc.
- Requirement that the franchisee ceases using the = franchisor=E2=80=99s trade name,=20 service marks, or trademarks.
- Requirement that the franchisee de-identify or disassociate = property with=20 the franchise system (in the event the selling franchisee retains such = property)
If a franchisee owns multiple units or has additional arrangements = with the=20 franchisor, such as an area development agreement or territory = agreement, there=20 may be additional documentation to consider relating to a sale of one or = multiple franchise units. Each such document should be carefully = reviewed by an=20 attorney experienced in franchise law to determine what contractual = obligations=20 exist between the franchisor and franchisee that will affect the = sale.
In addition to the franchisor, there may be other parties affected by = the=20 sale. If there is any financing associated with the business, it may be=20 necessary to obtain the lender=E2=80=99s approval for = the sale.=20 Likewise, depending on whether real property is owned or leased, = approval from a=20 lender, transfer of the property, or assignment of a lease may need to = occur. If=20 the business involves special licenses or permits, those may need to be=20 transferred and may require approval of a government agency or other = third=20 party. When updating a facility image, there may be local governmental = approvals=20 required in connection with design and construction. Lastly, the sale = may=20 trigger contractual rights of other parties such as suppliers or = customers that=20 may have a right to notice or consent to the sale.
Statutory Law
Generally, franchises are governed by both state and federal law. The =
federal=20
law, the Federal Trade Commission=E2=80=99s Franchise Rule, focuses on =
the disclosure=20
requirements for a franchisor selling franchises and does not contain =
anything=20
specific to subsequent transfers. A number of states contain statutes =
specific=20
to franchises. A smaller subset of those states have what is known as =
franchise=20
relationship laws. Certain relationship laws contain provisions relating =
to the=20
transfer of franchises. If the business is located in one of the ten =
states
These laws differ in content but generally impose one or both of the=20 following: 1) restrictions on the franchisor's right to approve or = disapprove=20 the sale of the franchise and/or 2) notice requirements that provide = certain=20 time periods during which the franchisee must provide notice of the = proposed=20 sale to the franchisor. These state statutes will overrule the = contractual terms=20 contained in the franchise agreement.
Preparing for Sale
The purchaser of a franchise business from a franchisee (as opposed = to=20 purchasing a new unit directly from a franchisor) will need to assume = the rights=20 and obligations of the existing franchisee under the franchise agreement = (or=20 enter into a new franchise agreement). Further, the purchaser will = assume all or=20 some of the assets (including contract rights and obligations) of the = seller.=20 The purchaser will learn all about the brand and related franchise = system from=20 the franchisor; however, the seller will be responsible for providing = detailed=20 information about its specific unit(s). This process, common in the sale = of all=20 businesses (not just franchises), is typically referred to as due = diligence.
During the due diligence process, the purchaser will request a = considerable=20 amount of information about the business it is purchasing. Requests for=20 information may include some or all of the following documentation:
- Corporate records (formation documents, bylaws, operating = agreements,=20 minute books, list of officers, directors, and/or managers, = organization=20 chart)
- Member or shareholder information
- Financial statements for the past 3-5 years (as well as internal = budgets,=20 projections and other financial reports)
- Financings/encumbrances (debt agreements, financing arrangements, =
details=20
of any governmental grants, subsidies, or other financial assistance) =
=20
-
Lists of assets
- Material contracts and commitments (vendor contracts, distributor=20 contracts, sales representative contracts, joint ventures or = partnership=20 agreements, franchise agreements, license agreements, advertising, and = consultant agreements, equipment or other personal property leases,=20 installment sales agreements, standard form contracts, etc.)
- Tax returns for the past 3-5 years (including any correspondence = from the=20 IRS, audits and reports by the IRS, list of any deficiencies, fines, = penalties=20 or assessments, etc.)
- Legal/liability issues (including all law suits, claims, = administrative=20 proceedings or other governmental investigations, etc.)
- Intellectual property (including registered and unregistered = patents,=20 trademarks, copyrights, tradenames, domain names, software licenses,=20 technology sharing, use and disclosure agreements, etc.)
- Insurance policies
- Environmental matters
- Human resources (including a list of all employees, including = positions=20 salaries and bonuses paid, employment agreements, non-solicitations or = non-competition agreements, employee benefits, retirement plans, = company=20 handbook, etc.)
The list above is not exhaustive. The information a prospective = purchaser=20 will need to evaluate depends on the type of business involved and the=20 individual circumstances underlying the transaction. Ideally, every = business=20 would maintain accurate and complete records. Realistically, this does = not=20 always happen. It is not uncommon for records to be disorganized, out of = date or=20 incomplete. The recent closures and/or decline in business due to = COVID-19 may=20 be a great time to do an internal audit of records and get things in = order. This=20 is especially a good idea if a sale is on the horizon.
Conclusion
The decision to buy or sell a franchise is a difficult one. As = outlined in=20 this article, there are a number of considerations to take into account = and the=20 initial decision is just the beginning of the process. The current state = of=20 affairs in the world with mass quarantines, business closures, and = economic=20 uncertainty is alarming to say the least. While no one is certain when = things=20 will return to business as usual, we do know it will happen eventually. = This=20 crisis may give rise to an increase in opportunity for the purchase and = sale of=20 franchise businesses. Securing experienced and knowledgeable advisors to = assist=20 with this process including attorneys, accountants and financial = advisors is=20 invaluable preparation for such opportunities.
Whether you are a prospective franchisee, an existing franchisee = looking to=20 expand within their current system, or a departing franchisee ready to = sell=20 their business; Dickinson Wright PLLC is in a position to assist. Our = firm is=20 full service with attorneys experienced in representing all types of = businesses=20 in mergers and acquisitions as well as advising clients with respect to = the=20 unique and varied issues that come along with the franchise business=20 model. The sale or purchase of a franchise can be a = trying=20 process, but we are here to assist at every turn and protect our = client=E2=80=99s=20 interests so that they can focus on looking toward closing the = transaction and=20 planning a new beginning.
<= SPAN>[1]=20 https://www.nytimes.com/2020/04/30/business/stock-market-today-coronaviru= s.html
<= SPAN>[2]=20 https://www.franchisedirect.com/information/a-look-at-how-franchises-impa= ct-the-economy
<= SPAN>[3]=20 Arkansas, California, Hawaii, Indiana, Iowa, Michigan, Minnesota, = Nebraska, New=20 Jersey and Washington. See Ark. Code Ann. =C2=A7=20 4-72-205(a); Cal. Bus. & Prof. Code =C2=A7 20027; = Haw. Rev.=20 Stat. Ann. =C2=A7 482E-6(2)(I); Ind. Code Ann. = =C2=A7 23-2-2.7-2(3);=20 Iowa Code =C2=A7 523H.5; Mich. Comp. Laws Ann. = =C2=A7=20 445.1527(g); Minn. R. 2860.4400; Neb. Rev. Stat. = =C2=A7=20 87-405; N.J. Stat. Ann. =C2=A7 56:10-6; Wash. Rev. = Code Ann.=20 =C2=A7 19.100.030.