"Fundamentals 201: Transfers and Assignments in Franchising," ABA Forum on Franchising 2014

Fundamentals 201:

Transfers and Assignments in

Franchising

David BeyerQuarles & Brady LLP

Tampa, Florida

&

Phyllis Alden TrubyPhyllis Alden Truby, APC

Los Angeles, California

INTRODUCTION • Fundamentals:

– Basic principles

– Broad brush

• Basics for

– franchisor counsel drafting Franchise Agreement

– franchisee counsel reviewing transfer and

assignment provisions

Summary

• Legal Framework

• Drafting Practices and Franchise Agreement

Provisions

• Some Common Requirements

• Third Party Considerations

• Evaluating and Documenting Transfers

LEGAL FRAMEWORK

• To Disclose or Not to Disclose

–Disclosure and Registration

• FTC Rule

–Presale Disclosure

• State Laws

–Presale Disclosure / Registration

FTC Rule Legal Framework

“Franchise Seller”

–does not include existing franchisees selling own outlet

–unless otherwise engaged in franchise sales

FTC Rule Legal Framework

“Sale of a Franchise”

– “any arrangement whereby a person obtains a franchise from a franchise seller …”

– Does not include transfer by an existing franchisee if the franchisor has no significant involvement with the prospect

FTC Rule Legal Framework

What is significant involvement?

– Approval / disapproval alone is not

– But these are:

• Imposing new agreement or new material terms

• Referring potential buyers• Furnishing financial performance

information

State Law Legal Framework

• Similar to FTC Rule

– Exempt sales by franchisees for own account

• Not “by or through” franchisor

– Approval / disapproval not enough

State Law Legal Framework

• Some expressly acknowledge exemption applies

–Reasonable transfer fee

• Some impose restrictions on number:

– Isolated Sale: HI, MI, NY, OR

– MN: 1 Sale / 12 months

FDD Transfer Disclosures Legal Framework

Item 6: Other Fees

• Type and Amount

• Due Date and Explanatory

• Payable to Whom

• Refundable

• Uniformity

FDD Legal Framework

FDD Legal Framework

Item 9: Franchisee’s Obligations

Table cross-references to

• Franchise Agreement

• FDD Items

FDD Legal Framework

FDD Legal Framework

Item 17 Transfer Disclosures

• Assignment by franchisor

• Definition

• Franchisor approval

• Transfer conditions

• Franchisor right of first refusal

FDD Legal Framework

FDD Legal Framework

FDD Legal Framework

FDD Legal Framework

Item 19: Financial Performance Representations

• Actual operating results of outlet for sale excluded from FPR definition

• Making an FPR is “significant involvement”

FDD Legal Framework

FDD Legal Framework

Item 20: Outlets and Franchisee Information

• 3 fiscal years of franchise and company outlet activity

• Franchisees who sold outlet are disclosed as former franchisees

–Name, city, state, phone number

FDD Legal Framework

Table No. 2 – Separate table

• Defined as “acquisition of a controlling interest in a franchised outlet, during its term, by a person other than the franchisor or an affiliate

• Covers private sales of outlet assets and controlling ownership

FDD Legal Framework

FDD Legal Framework

Additional disclosure for franchisor sales of previously franchised outlets:

• Previous owner contact information / 5 years

• Time period for each prior owner

• Reason for change

• Time period controlled by franchisor

•

FDD Legal Framework

•

FDD Legal Framework

State Relationship Laws Legal Framework

10 States Regulate Transfers

• All 10 limit franchisor’s right to restrict transfers

• Supersede contract terms

• Regulate withholding consent by franchisor

State Relationship Laws Legal Framework

• 4 require franchisees to notify before

Arkansas Nebraska

Iowa New Jersey

• 3 specify 60 days prior and must provide transferee information

Iowa Nebraska New Jersey

State Relationship Laws Legal Framework

• 4 States require franchisor to act reasonably or in good faith in denying transfer

Hawaii Minnesota

Iowa Washington

State Relationship Laws Legal Framework

• 3 States require good cause or a legitimate business reason:

–Hawaii, Iowa, Michigan

• 2 give examples (Hawaii and Michigan):

–Failure to meet qualifications

–Competitor or doesn’t sign agreements

–Failure to cure defaults

State Relationship Laws Legal Framework

• 4 limit franchisor’s disapproval right to conditions relating to transferee qualifications:

Arkansas Nebraska

Iowa New Jersey

• Character, finances, experience

State Relationship Laws Legal Framework

5 States require written notice of denial and deem approval if not timely

Arkansas (60) Nebraska (60)

Hawaii (30) New Jersey (60)

Iowa (60)

State Relationship Laws Legal Framework

• 4 States regulate transfers in context of succession after death:

California Indiana

Iowa Washington

Legal FrameworkState Relationship Laws

Iowa (most comprehensive)

• Deemed approval if not rejected in writing in 60 days specifying reasons

• Rejection limited to failure to meet “reasonable current qualifications … for new franchisees”

Legal FrameworkIowa (cont’d) State Relationship Laws

• Qualifications must be legitimate business reasons – not arbitrary or capricious

• No discrimination: race, color, national origin, religion, sex or disability

Legal FrameworkIowa (cont’d) State Relationship Laws

Permitted Conditions:

• Completion of reasonable training

• Payment of reasonable transfer fee (reimburse reasonable and actual expenses)

• Payment of amounts owed

Legal FrameworkIowa (cont’d) State Relationship Laws

Prohibited Conditions:

• Entering into a new or different contract

• Transferee undertaking new obligations or relinquish rights

• Sign release

Legal FrameworkIowa (cont’d) State Relationship Laws

Certain transfers automatically approved with no strings attached:

– Death or disability

– Transfers among existing owners, or spouse or child, ESOP, but must meet qualifications (50% or more owner) or controlled companies

DRAFTING PRACTICES AND

FRANCHISE AGREEMENT

PROVISIONS

Defining what constitutes a transfer or assignment

Elements of Definitions

• Who

• What

• How

Drafting Practices: Definitions

Who: Individual Franchisees

• Single Person

• Married Couples

• Domestic Partners

• De Facto Partnerships

Drafting Practices: Definitions

Who: Entity Franchisees

• Trusts

• Corporations

• Professional Corporations

• Limited Partnerships

• LLC’s

Drafting Practices: Definitions

Who: Entity Franchisees

Drafting Practices: Definitions

Some issues:

• Thresholds

• Among owners

What is Transferred

• Franchise Agreement only

• Premises lease

• Furniture, fixtures, equipment

Drafting Practices: Definitions

What is Transferred

Entity Interests

• Corporations

– Voting Stock

– Nonvoting Stock

Drafting Practices: Definitions

What is Transferred

Entity Interests

Drafting Practices: Definitions

• LLC’s

– Entire Membership

– Economic Interest Only

What is Transferred

Entity Interests

Drafting Practices: Definitions

• Partnerships

– General

– Limited

What is Transferred

Entity Interests

Drafting Practices: Definitions

• Family Trusts

Flexibility and Consistency

• Wide range of circumstances

• Wide range of transferees

Drafting Practices: Definitions

Flexibility and Consistency

Some Examples:

• Among existing owners

• Among or to family members

• To third parties

– Investors

– Operational personnel

Drafting Practices: Definitions

Some Common Standards for Consent

1. Complete Discretion

2. Not Unreasonably Withhold

3. Comparably Qualified

Drafting Practices: Standards

Some Common Standards for Consent:

Drafting Practices: Standards

Complete Discretion

• Why

• Why not

– Franchisee perception

Some Common Standards for Consent:

Drafting Practices: Standards

Not Unreasonably Withhold

• A good compromise

• What does it mean

– Commercially reasonable?

• Why not

– Franchisee perception

Some Common Standards for Consent:

Drafting Practices: Standards

Comparably Qualified

• Taking the measure of the current franchisee

• Then or now

SOME COMMON

REQUIREMENTS AND

CONSIDERATIONS

Pay Transfer Fee

• Is it a profit center?

• Purpose dictates amount

• Exceptional events

Requirements

Execute Current Form of

Franchise Agreement

• Franchisee’s perspective

• Franchisor’s perspective

• Are there exceptions?

Requirements

Continued Right to Occupy

Requirements

Review and Approval of Sale or Other

Transfer Documents

• Purpose

– Cash Flow

– All assets

– Assumption

• Risks

Requirements

Payment of All Sums Due at Time

of Transfer

• Audit

• Closing condition?

– Immediate payment

– Assumption by buyer

Requirements

Franchisee Not in Default

• When requested

• During sale process

• Upon closing

• Buyer curing default at close

Requirements

Renovating, Remodeling, and

Upgrading Franchise Location

• Franchisee’s view

• Franchisor’s view

• Compromise?

Requirements

New Owner’s Successful Training

• Timing

• Cost

• Effect of Failure

Requirements

Assignor’s Secondary Liability

• Franchisee’s view

• Franchisor’s view

• Compromises

Requirements

Release

• Franchisor’s view

• Franchisee’s view

• Mutuality

• Effect of state laws

Requirements

Not to Competitor

• Defining competitor

• Effect

Requirements

THIRD PARTY CONSIDERATIONS

Landlords

• Consent considerations

• Lease Addendum

• Timing issues

Third Party Considerations

Lenders

• Franchisee’s counsel: review loan

documents

• Request consent early and often

Third Party Considerations

EVALUATING AND PAPERING

THE TRANSFER PROCESS

Evaluating and Papering the Transfer Process

• Observe any applicable state relationship

laws

• Implied covenant of good faith and fair

dealing

Evaluating and Papering the Transfer Process

• Generally, franchisor transfer decisions exercised in good faith will be respected

• Franchisor’s legitimate business reasons for refusing transfers will be upheld

But, lack of good faith or reasonable business justification may overturn a franchisor refusal

Evaluating and Papering the Transfer Process

• Prepare and utilize transfer checklist

• Always obtain a franchise application

• Test transferee against qualifications for new franchisees

• If disapproved, specify all material reasons

Evaluating and Papering the Transfer Process

Assignment and Assumption Agreement should specify any terms and conditions:

• Release• Transfer fee• Ancillary agreements• Cure of defaults or payments due

Evaluating and Papering the Transfer Process

Assignment and Assumption Agreement should specify any terms and conditions (cont’d):

• Exclude post-term obligations to still bind seller

• Waive right of first refusal• Follow-up with any third-party

documents that may also affect franchisor in the transfer

End

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information or future developments may affect the subjects addressed in this document. You should consult with a lawyer

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