What You Should Know About Franchise Law and Distributor Agreements

Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Franchise Law Attorney

For many people, an established franchise seems less risky than starting up a new business.

INTRODUCTION TO NEW JERSEY FRANCHISE LAW

franchize-law-distributorThere are two general areas of concern and accompanying regulations of the franchise relationship. First, federal regulations and New Jersey law address the requirements that must be met by the franchisor in their franchise sale disclosures which are important for a franchisee to understand prior to the franchise being offered for sale, as well as important information about the franchisor itself.

Second, many states, including New Jersey regulate the franchise relationship following the sale of the franchise being operated from New Jersey, including franchise terminations and non-renewals. This law is known as the New Jersey Franchise Practices Act.

Federal Regulation of Franchising in New Jersey

Federal regulation of the franchising area began in 1979 when the Federal Trade Commission (FTC) approved amendments to the Federal Trade Act under the Amended Franchise Rule (AFR).

The Amended Franchise Rule requires that franchisors give you (as an interested purchaser of a franchise in NJ) a document called a Franchise Disclosure Document (“FDD”) at least 14 calendar days before you are asked to sign a binding franchise agreement or are required to make any payment to the franchisor or its affiliate in connection with the proposed franchise sale. The 14 day pre-disclosure period begins the day after delivery of the FDD. The signing of a binding agreement or receipt of payment by the franchisor or an affiliate can only take place on the 15th day after delivery of the FDD. This ensures that as a prospective franchisee, you have at least a full 14 days in which to review the disclosures (the so-called “cooling off period”).

Generally, a failure by the franchisor to follow the 14 day rule is considered to be an unfair or deceptive act or business practice which is a violation of the Federal Trade Act (FTA).

What Agreements Trigger Full Franchisor Disclosure?

Your franchisor may request that you sign a confidentiality agreement before being granted access to the franchisor’s operations manual and other proprietary information. This is not an unreasonable request and is perfectly legal. Signing a confidentiality agreement is generally a necessary initial step in the sales process, but is not the type of agreement that triggers disclosure obligations under Federal or state law.

Federal and New Jersey law does not mean that a franchisor must give a disclosure document to any person who may desire a copy. Rather, it applies where you and the franchisor have already conducted a series of specific discussions or negotiations and/or otherwise have taken steps to begin the sales process. The purpose of this law enables you as a prospective franchisee to ask to see a copy of the FDD before agreeing to travel to the franchisor company headquarters or spending additional money during the pre-sale process.

What Types of Relationships are Covered Under Federal Law?

Federal Franchise Law covers the offer and the sale of a franchise. A commercial business arrangement is a “franchise” if it satisfies three definitional elements. The franchisor must: (1) promise to provide a trademark or other commercial symbol; (2) promise to exercise significant control or provide significant assistance in the operation of the business; and (3) require a minimum payment of at least $500 during the first six months of operations.

The name or “title” given to the business arrangement by the franchisor is irrelevant in determining whether the business relationship is covered by federal and/or New Jersey Franchise Law. If your relationship meets the three criteria discussed above, it is a franchise relationship for purposes of Federal law. For example, a so called “distributorship agreement” or “license agreement” will be covered by the Amended Franchise Rule (AFR) if the three definitional elements are satisfied.

The Trademark Element

A franchise entails the right to operate a business that is “identified or associated with the franchisor’s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor’s trademark.” The term “trademark” is intended to be read broadly to cover not only trademarks, but any service mark, trade name, or other advertising or commercial symbol.

The “Significant Control or Assistance” Element

The Amended Franchise Rule covers business arrangements where the franchisor “will exert or has the authority to exert a significant degree of control over the franchise’s method of operation, or provide significant assistance in the franchise’s method of operation.”

When is Control or Assistance Significant?

The more a franchisee reasonably relies upon the franchisor’s control or assistance the more likely the relationship will be considered “significant.” A franchisees’ reliance is more likely to be found when they are relatively inexperienced in the business being offered for sale or when they undertake a large financial risk. Similarly, franchisees are likely to reasonably rely on the franchisor’s control or assistance if the control or assistance is unique to that specific franchisor, as opposed to a typical practice employed by all businesses in the same industry. Significant types of control include:

  • site approval for unestablished businesses;
  • site design or appearance requirements;
  • hours of operation;
  • production techniques;
  • accounting practices;
  • personnel policies;
  • promotional campaigns requiring franchisee participation or
  • financial contribution;
  • restrictions on customers; and
  • locale or area of operation.

Significant types of assistance include:

  • formal sales, repair, or business training programs;
  • establishing accounting systems;
  • furnishing management, marketing, or personal advice;
  • selecting site locations;
  • furnishing systemwide networks and website; and
  • furnishing a detailed operating manual.

What Types of Payments Constitute “Required Payments”?

“Payment” which triggers Federal protection is intended to be applied broadly, capturing all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to (1) associate with the franchisor, or (2) market its goods or services, and (3) begin operation of the business. Often, mandatory payments go beyond a simple franchisee fee, obligating other payments that the franchisee must pay to the franchisor or an affiliate of the franchisor by contract. Required payments may include:

  • an initial franchise fee;
  • rent;
  • advertising assistance;
  • equipment and supplies (including such purchases from third parties
  • if the franchisor or its affiliate receives payment as a result of the
  • purchase);
  • training;
  • security deposits;
  • escrow deposits;
  • non-refundable bookkeeping charges;
  • promotional literature;
  • equipment rental; and
  • continuing royalties on sales.

TESTIMONIAL

I own several small businesses. I’m good at what I do but legal matters and dealing with lawyers and legal issues is stressful. I called Fredrick P. Niemann and have developed a great relationship with his lawyers and staff. They have reviewed my leases, negotiated the buyout of my former business partner, handled land use problems in a neighboring county and generally have really been there for me. I really like them personally and professionally. If you are a small business owner, give them a call.

– Mike Halsey, Middletown, New Jersey

Fredrick P. Niemann Esq.

Fredrick P. Niemann Esq.

Do you have questions about the purchase of a franchise in New Jersey or have questions about an ongoing franchise in this state? Contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.