News

THINKING OF INVESTING IN A FRANCHISE?

Read This First!

By Jordan Esensten, Esq.

Investing money into a franchised business can be very lucrative. However, it can also be very costly, not only to you, but to your family members as well. Before deciding whether to invest in a franchise-model business, either as a franchisee or franchisor, it is important to consider issues that typically arise in two major categories: business and legal. For example, one considering becoming a franchisee should ask the following business-related questions:

• What is the product or service and how does it work?
• Have previous franchisees been successful?
• How unique is the business and how easy is it to duplicate?
• Who is the competition?
• Are they selling the same products or services and, if so, how successful have they been?
• What are the financial resources of the franchisor?
• What does the franchisor offer that I cannot obtain elsewhere?
• Has the franchisor already made a name for itself? If not, will it be able to do so in the future?

Only after a potential franchisee reviews these issues and decides that the business will likely be profitable should he or she consider the legal issues that typically concern franchisees. Of course, the franchisee should always read the franchise agreement before signing, as it will typically outline many things the franchisee will need to know on an ongoing basis. For example, the franchisee should consider whether the franchise agreement calls for him or her to be held personally liable for performance thereunder. If this is the case, the franchisee may want to consider creating a legal entity through which he or she does business (such as a corporation or limited liability company), which will help shield the franchisee and his family from liability, should there be bumps in the road ahead. To the extent possible, the franchisee may also want to consider whether the franchisor would be willing to allow him or her to assign liability under the franchise agreement to that corporate entity.

Unfortunately, such assignment options are not typically granted by franchisors, who ordinarily require personal guaranties prior to engaging in business with prospective franchisees. A franchisee that is personally liable places his personal assets, and possibly those of his family in jeopardy, should certain criteria not be met. In such an instance, the franchisee will not be able to hide behind his or her corporate “shield” or “veil.” Moreover, even if a franchisee uses an incorporated business to sign the agreement, doing so does not necessarily preclude them from being held personally liable under that contract. If the franchisee abuses the corporate form and/or uses the corporation as a mere “shell corporation,” the franchisor (or anyone else with whom the corporation does business) may be able to “pierce the corporate veil” and sue the franchisee for damages in his or her personal capacity.

The franchisee that consults his or her attorney prior to signing any legal paperwork is placing himself or herself in the best position to succeed, as doing so ensures his or her legal interests are protected to the maximum extent possible. Indeed, the old adage “the person who represents himself has a fool for a client” applies just as forcefully to franchisees as litigants. One of the most important reasons to hire a lawyer is to allow someone with legal expertise to review the franchise agreement, as in many instances, what the franchise agreement omits is more important than what it affirmatively represents. For example, the franchisor’s oral representations to the franchisee may not be included in the contract language, and additional clauses may make such representations inadmissible in court, should the parties find themselves engaged in litigation concerning the requirements of that contract, and whether or not it has been breached. (Please see page five of this newsletter for more information about oral contracts)

Attorneys are also useful in assisting the franchisee in determining whether certain events give rise to the franchisee’s right to terminate the agreement once it has been signed. The lack of an express termination clause in a franchise agreement may mean that the franchisee’s full performance is required regardless of the success or failure of the business. However, the presence of a termination clause may also subject the franchisee to monetary penalties that serve to deter franchisees from exercising such termination rights. In other situations, a termination clause may not only apply to the franchisee, but the franchisor as well. A termination clause may also dictate what happens to the assets of the business should the franchisee or the franchisor terminate the agreement. All of these facts can have a significant impact on the future of the franchisee’s business.

Jordan Esensten (jesensten@wccelaw.com) is a junior associate in WCC&E’s class action and business litigation departments. He represents individuals and businesses involved in real estate, intellectual property, contract, employment, corporate and complex business disputes, in both the trial and appellate contexts.