November 8, 2017
Did you ever play board games as a kid with a friend who made up the rules? It can be extremely frustrating to finally start making traction only to have the rules change half way through.
When dealing with a franchise agreement, no one is going to change the rules half way through the agreement. Instead, what will happen is the franchisee suddenly discovers that another state’s law applies in their Franchise Disclosure Document (FDD). This brings about similar feelings to playing ball with constantly changing rules.
To help combat this sudden—and gut wrenching discovery—it’s important to understand how state laws apply to franchise agreements. Let’s address the elephant in the room: just because you reside in and operate in one state doesn’t mean your franchise agreement is bound to that state’s law. Even more, the franchise agreement might evoke a state’s law that neither you nor the franchise are located in.
When crafting the FDD, franchisors will work with a legal team to apply more franchise-friendly laws. The owner and legal team will weigh which state law will serve their interests when writing that bulky legal agreement.
Here are several areas where it is crucial to understand which state law is being applied and what that might mean for you down the line.
Since the 1970s, lawmakers and the court have been enacting measures that strive to regulate the franchising industry. Recent legislation and ruling trends have been working to increase protections for franchisees, and even employees in some cases.
Some states have been more aggressive than others in this endeavor.
California in particular has been on the forefront of this trend, especially with Assembly Bill No. 525. This law puts limitations on reasons a franchisor can terminate the agreement. Additionally, California requires franchisors to buy back equipment if they terminate the franchise agreement
Each state has varying degrees of case law and regulations around terminations and nonrenewal. It’s important to know where you stand in the event the relationship goes sour and termination is on the horizon. Laws in many states supercede the language in the franchise agreement. Understanding if the franchise agreement language or the laws of the state you reside in can be confusing to prospective franchisees.
Fundamentally, franchisors will try to evoke home field advantage for any dispute resolution. Again, the law that applies and the venue to resolve the dispute may differ. For example, a franchise headquartered in San Diego may choose to use the Nevada law for dispute resolution, but require that all dispute resolutions take place at the headquarters. Despite being headquartered in California, that state’s law gives more favor to franchisees than other more pro-business states.
This is important because disputes that elevate to the point of needing legal intervention will have additional travel costs associated. Dispute resolution is actually a very big topic, so be sure to review FDD dispute resolutions basics as well.
Just because the FDD chooses to apply a specific state law doesn’t mean that the court will always uphold that choice. There have been some court cases where the franchisor tried to apply different laws to different sections of the agreement. This always runs the risk that the court disagrees with that strategy and chooses which law to apply.
Understanding which law applies isn’t the only perplexing aspect facing you as you make your way through the 200-plus-page FDD. This complex and bulky document is written in complete legalese, oftentimes created by multiple lawyers.
You need a franchising lawyer in your corner to review it with you. Not only do I help ensure that you understand each section, I also identify discrepancies or irregularities that raise red flags. Ultimately, my goal is to protect your investment and ensure you have a secure legal foundation to grow on.
If you’re in the process of buying into a franchise, contact me today.