Archive for: August, 2015

By Guest Blogger Matthew Kreutzer

Last night I reviewed a franchise agreement and found a surprising, and illegal, provision buried deep in the contract. If ever there was a compelling case for being careful when you are choosing legal counsel, I just found the provision that makes it.

But first, some background. My law practice involves representing both franchisors and prospective franchisees. For franchisors, I primarily draft franchise disclosure documents (“FDDs”) and franchise agreements; I assist my clients in obtaining franchise state registrations; and I assist them with day-to-day issues that arise in running their businesses. For prospective franchisees, I will review their proposed franchise agreements and FDDs and help them understand what they will be committing to do if they decide to buy the franchise. If the franchise company is willing to negotiate, I help prospective franchisees through that process.

I find that reviewing other companies’ FDDs and franchise agreements also helps me in my practice for franchisors; it’s always instructive to see what other industry leaders are doing. I have noticed that, in a small minority of systems, some franchisors go well beyond what is legally permitted to be included in the franchise agreement and include provisions that unquestionably violate the FTC Franchise Rule (the “Franchise Rule”) as well as various state franchise laws.

The Provision

If you’re on either side of the franchise relationship, you should know if your contract has a provision like this one. Pull out your franchise agreement now. Go ahead, I’ll wait.

You have it now? Good. Here’s the provision we’re looking for:

Release of Prior Claims. By executing this Franchise Agreement, Franchisee, and each successor of Franchisee under this Franchise Agreement forever releases and discharges Franchisor and its Affiliates, Its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors. representatives, employees and agents, from any and all claims of any kind, in law or In equity, which may exist as of the date of this Franchise Agreement relating to, in connection with, or arising under this Franchise Agreement or any other agreement between the parties, or relating In any other way to the conduct of Franchisor, its Affiliates, its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors, representatives, employees and agents prior to the date of this Franchise Agreement, including any and all claims, whether presently known or unknown, suspected or unsuspected, arising under the franchise, business opportunity, securities, antitrust or other laws of the United States, any stale or locality.

In plain English: “you, the franchisee acknowledge that we, the franchisor, may have lied to you and might be lying to you right now. Our entire FDD might be one of the greatest works of fiction since Moby Dick. You agree, however, that you waive all your legal rights to take action against us based on those lies, even if you have invested hundreds of thousands of dollars of your hard-earned money in this phony business.” Wow.

Do you have that one in your franchise agreement? You might have to do a bit of hunting for it. You would think something like that would be on the first page, bolded, in caps, with a box around it and perhaps accompanied by a self-lighting sparkler that draws your attention directly to the provision when you open the contract. But no, in the case of the contract in which I found this provision, it was buried on page 36 of a 39-page franchise agreement, with no particular emphasis placed upon it.

I will never include a provision like this in a franchise agreement I draft, nor will I ever recommend that a prospective franchise buyer sign a contract when it includes this provision. Why? It’s not only unfair, but it’s also illegal under the Franchise Rule and under various state franchise laws.

The Problem with Having the Provision

Now, I highly doubt that in most situations, the franchisor even knows this provision is in its franchise agreement. Most start-up franchise companies trust their franchise counsel to draft the agreement and don’t necessarily carefully consider each provision in the contract. This sort of provision is typically created by counsel, who is seeking to protect his or her client. An admirable goal, to be sure.

The problem is that this provision is impossible to justify to a prospective franchisee that notices it and understands its implications. If you’re a franchisor, imagine trying to explain that to a potential buyer: “we’re not lying to you.  But you have to agree as a condition of buying this franchise that we might be and that you won’t ever do anything about it if we are.”

A franchisor may be able to slip this one by a franchisee unnoticed, but a franchisee that notices and understands this provision is always going to have a problem with it. A franchisee that has experienced franchise legal counsel review the agreement for them will certainly flag the term and warn the franchisee against agreeing to it. That could cost you a sale.

To make matters worse for the franchisor, the types of franchisees that actually read the agreement before signing it and have legal counsel review it for them are exactly the type of franchisees the franchisor wants: franchisees that take their commitments seriously and are willing to put their time, effort, and money into understanding commitments before they make them.

Now, I have my doubts that this type of provision will be enforceable in any event because, as I said, including a provision like this one is an explicit violation of the Franchise Rule, which “prohibits franchise sellers from disclaiming or requiring a prospective franchisee to waive reliance on any representation made in the disclosure document or in its exhibits or amendments.” This provision does exactly that – and, as a result, the franchisor that included it in its agreement is in violation of the Franchise Rule (and various state laws) just for having the term in the contract.

Violating the Franchise Rule and state franchise laws leaves the franchisor exposed to lawsuits by franchisees that may have a state law “unfair trade practices” cause of action against the franchisor because of it. When those legal claims exist, a franchisor could face claims for damages or rescission. Moreover, state franchise administrators could refuse to register the franchise offering with a provision like this one (if they notice it) or worse, later take administrative action against the franchisor based on its violation of franchise law.

The better practice for franchisors that want to protect themselves, but do so within the bounds of the law, is to use exculpatory provisions and “compliance questionnaires” as part of the agreement signing process. A well-drafted exculpatory provision will provide a measure of protection to franchisors for unauthorized statements made by a renegade sales person, but will not seek to disclaim statements made by the franchisor in its FDD (and therefore is permissible under the Franchise Rule and many state laws).

The Lesson for Franchisors and Franchisees

If you are a franchisor, inclusion of a provision like this in your franchise agreement should make you question your legal counsel. Ask yourself: are you willing to risk losing a potential sale to a qualified, savvy, and ideal franchisee because you have a provision in your franchise agreement that probably isn’t enforceable anyway? Are franchisees that sign your contract without even reading or understanding it really the type of franchisees you want? And is “sneaking something past” your unwitting franchisees who don’t review every term of your contract really the way you want to do business? As I explain above, there are better (and legally-enforceable) ways to protect yourself in your franchise agreement, anyway.

If you are a prospective franchise buyer, this situation highlights the importance of: (1) reading your franchise agreement, cover-to-cover; and (2) hiring legal counsel experienced in franchise law to review your contract before you sign it. Contrary to the opinion of some, franchise agreements aren’t all boilerplate, and not all franchise contracts are created equally. Don’t assume that your franchise agreement doesn’t contain something objectionable just because other franchisees signed it.

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In Nevada, the elements for a claim of fraudulent transfer are:

  1. A transfer was made with actual intent to hinder, delay, or defraud any creditor of the debtor;
  2. Without receiving a reasonably equivalent value in exchange for the transfer or obligation;
  3. The debtor was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction;
  4. Debtor intended to incur, or believed, or reasonably should have believed, that he would incur debt beyond his ability to pay as they became due; and
  5. There is heightened scrutiny if the transfer or obligation was to an insider as defined by statute.

NRS 112.180; NRS 112.210; NRS 112.190; In re: FSG-R, LLC, 2012 WL 753353; In re 155 East Tropicana, LLC, 2012 WL 668579; Herup v. First Boston Financial, LLC, 123 Nev. 27, 162 P.3d 870, 873 (2007); Montana Nat’l. Bank v. Michels, 631 P.2d 1260 (Nev. 1981); Crescent v. White, 92 Nev. 661, 556 P.2d 1265 (1976); Matusik v. Large, 85 Nev. 202, 462 P.2d 457 (1969); 32 Am. Jur. 2d Fraudulent Conveyances § 10, at 701.

 

See elements for other claims at the Nevada Law Library

In Nevada, the elements for a claim of constructive fraud are:

  1. The existence of a confidential relationship or some legal or equitable duty or fiduciary duty;
  2. Breach of that duty in a way that the law declares fraudulent because of its tendency to deceive others or to violate a duty or confidence; and
  3. Causation and damages.

Perry v. Jordan, 111 Nev. 943, 947, 900 P.2d 335, 337 – 338 (1995); Long v. Towne, 98 Nev. 11, 13, 639 P.2d 528, 530 (1982); Exec. Mgmt. v. Ticor Title Ins. Co., 114 Nev. 823, 963 P. 2d 465 (Nev. 1998);  In re Guardianship of Chandos, 18 Ariz.App. 583, 504 P.2d 524 (Ariz. App. 1972); Kudokas v. Balkus, 26 Cal. App.3d 744, 103 Cal.Rptr. 318, 321 (1972).

 

See elements for other claims at the Nevada Law Library

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While you may be tempted to cash any check received these days, with a memo noted “paid in full”, the cashing of that check may modify your earlier agreement and extinguish your contract.

For example, say you had an agreement to provide goods or services for $5,000.  You invoice the client.  The client sends you a check for $3,500 with a note marked “paid in full”.  If you cash the check, you may be held to effectively amend the agreement to accept the contract price of $3,500.

So, you ask, what are you to do when you get a check for less than the full amount?  Under the Uniform Commercial Code (UCC), you are not required to return the check; therefore, you could simply destroy the check.  As a business point, and this is not in the UCC, you can negotiate a payment plan or other settlement. (more…)

In Nevada, the elements for a claim of concert of action are:

  1. Two or more persons act together while committing a tort pursuant to a common design or plan; and
  2. Liability attaches for the tort of concert of action when two people commit a tort while “acting in concert with one another or pursuant to a common design.” (Proof of an agreement alone is insufficient, as the conduct of each tortfeasor must be individually tortuous);
  3. Causation and damages.

GES, Inc. v. Corbitt, 117 Nev. 265, 21 P.3d 11 (Nev. 2001); Halbertam v. Welch, 705 F.2d 472, 489 (D.C. Cir. 1983); Dow Chem. Co. v. Mahlum, 114 Nev. 1468, 1488, 970 P.2d 98, 112 (1998) overruled in part on other grounds by GES, Inc. v. Corbitt, 117 Nev. 265, 21 P.3d 11 (2011); Juhl v. Airington, 936 S.W.2d 640, 644 (Tex. 1996); Restatement (Second) of Torts § 876, bc (1979).

 

See elements for other claims at the Nevada Law Library

In Nevada, the elements for a claim of fraudulent concealment are:

  1. Defendant concealed or suppressed a material fact;
  2. Defendant was under a duty to disclose the concealed fact;
  3. Defendant intentionally concealed or suppressed the fact with the intention of defrauding plaintiff;
  4. Plaintiff did not know about the fact and would have acted differently had they known; and
  5. Plaintiff sustained Causation and damages as a result of the concealment or suppression of the fact.

NEVADA JURY INSTRUCTIONS 9.03; Nevada Power Co. v. Monsanto Co., 891 F.Supp. 1406, 1415 (D. Nev. 1995); Riviera v. Morris, Inc., 395 F.3d 142 (9th Cir. 2005) (citing Dow Chem. Co. v. Mahlum, 14 Nev. 1468 (1998) overruled in part on other grounds).

 

See elements for other claims at the Nevada Law Library

In Nevada, the elements for a claim of civil conspiracy are:

  1. A combination of two or more persons;
  2. Who intend to accomplish an unlawful objective together;
  3. The association acts by a concert of action by agreement, understanding, or “meeting of the minds” regarding the objective and the means of pursuing it, whether explicit or by tacit agreement;
  4. The association intends to accomplish an unlawful objective for the purpose of harming another;
  5. Commission of an unlawful act in furtherance of the agreement; and
  6. Causation and damages.

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Many homeowners or car owners are shocked, after an accident, to find that their insurance does not pay for all of their losses (or those of someone they injured), or in some cases, even most of their losses.

How Much is Enough?

Whether you have the right amount and type of coverage may well depend on the amount of assets you have to protect. If you make $30,000 a year and rent an apartment, $100,000/ $300,000 coverage may suffice. If, on the other hand, you earn a six figure annual salary, have a business, or significant assets, carrying that little amount of coverage would be foolish. (more…)

Officers and directors have a fiduciary duty to protect the interests of the corporation and act in the best interests of its shareholders.  Guth v. Loft. fuc., 5 A.2d 503, 510 (Del. 1939).  Where a director is charged with breach of his or her fiduciary obligations, the ‘business judgment’ rule is utilized.  Horowitz v. Southwest Forest Indus., 604 F. Supp. 1130, 1134 (D. Nev. 1985)  The business judgment rule applies to protect managers of limited liability companies just as it does to protect directors of corporations.  Froelich v. Erickson, 96 F. Supp. 2d 507, 520 (D. Md. 2000).

Simply stated, the business judgment rule “bars judicial inquiry into the actions of corporate directors taken in good faith and in the exercise of honest judgment in lawful furtherance of corporate purposes.”  Id.  However misguided the business decision may be, the rule protects directors from judicial review of the wisdom of that decision.  See Citron v. Fairchild Camera & Instrument Corp., 569 A.2d 53, 64 (Del. 1989) (protecting Board decision for an arguably lower offer for the company). (more…)