"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


“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


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

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

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


• 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


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

Hawaii Minnesota

Iowa Washington


• 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


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

Arkansas Nebraska

Iowa New Jersey

• Character, finances, experience


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

Arkansas (60) Nebraska (60)

Hawaii (30) New Jersey (60)

Iowa (60)


• 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


Permitted Conditions:

• Completion of reasonable training

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

• Payment of amounts owed


Prohibited Conditions:

• Entering into a new or different contract

• Transferee undertaking new obligations or relinquish rights

• Sign release


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


Who: Entity Franchisees

• Trusts

• Corporations

• Professional Corporations

• Limited Partnerships

• LLC’s


Who: Entity Franchisees


Some issues:

• Thresholds

• Among owners

What is Transferred

• Franchise Agreement only

• Premises lease

• Furniture, fixtures, equipment


What is Transferred

Entity Interests

• Corporations

– Voting Stock

– Nonvoting Stock


What is Transferred

Entity Interests


• LLC’s

– Entire Membership

– Economic Interest Only

What is Transferred

Entity Interests


• Partnerships

– General

– Limited

What is Transferred

Entity Interests


• Family Trusts

Flexibility and Consistency

• Wide range of circumstances

• Wide range of transferees


Flexibility and Consistency

Some Examples:

• Among existing owners

• Among or to family members

• To third parties

– Investors

– Operational personnel


Some Common Standards for Consent

1. Complete Discretion

2. Not Unreasonably Withhold

3. Comparably Qualified

Drafting Practices: Standards

Some Common Standards for Consent:


Complete Discretion

• Why

• Why not

– Franchisee perception



Not Unreasonably Withhold

• A good compromise

• What does it mean

– Commercially reasonable?

• Why not

– Franchisee perception



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



• Compromises

Requirements

Release



• 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


• 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


• Prepare and utilize transfer checklist

• Always obtain a franchise application

• Test transferee against qualifications for new franchisees

• If disapproved, specify all material reasons


Assignment and Assumption Agreement should specify any terms and conditions:

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


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

©2014 Quarles & Brady LLP. This document provides information of a general nature. None of the information contained

herein is intended as legal advice or opinion relative to specific matters, facts, situations or issues. Additional facts and

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

about your particular circumstances before acting on any of this information because it may not be applicable to you or your

situation.

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

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