Legal Eagles-turned-scribes take up their pens to detail hot topics in 2019
Illustration by Jonathan Hankin
Normally I do the writing for this column tracking legal topics in franchising. But this time I asked our Franchise Times Legal Eagles to describe the top issue they’re watching in 2019, and many obliged with cogent analysis and writing flair. Here are a few excerpts:
Buckle up, urges Lee Plave of Plave Koch, to get ready for changes from the Financial Accounting Standards Board or FASB. “Every franchisor that files its FDD with a state examiner (so, virtually every franchisor in the U.S.) must address how changes to revenue recognition standards will impact the franchisor’s financial statements. The FASB issued clear guidance on the subject in November 2018, and auditors and state regulators will need time to sort out what these new standards will mean in terms of changes to net worth, the quick ratio (current assets to current liabilities), financial ratios that matter to lenders, etc.”
John Fitzgerald of Gray Plant Mooty agrees, and says the impact will hit emerging franchises the hardest. He writes: “Instead of recognizing an initial franchise fee in the year the franchisor receives it, the fee must now be amortized over the term of the franchise agreement (often 10 years or more) or be allocated to defined services that the franchisor will be providing to the franchisee, and then only partially recognized (that is, the portion allocated to a service) in the year the service is actually provided. The rest of the initial fee will have to be amortized over the term of the agreement.” He advises franchisors to “run, not walk, to their accountants” to work out the best strategy.
From one of our friends to the north, Chad Finkelstein of Dale & Lessmann, comes this pot tutorial: “Canada’s most populous province just announced to the world that it wasn’t quite sure what it was doing, and franchising is caught in the crosshairs,” he writes. Cannabis became federally legalized in Canada in October 2018, and each province was tasked with coming up with its own regulatory framework for cannabis retail stores. In an effort to prohibit the retail market being dominated by the largest players, the provincial government elected to limit licensed cannabis producers from owning more than 9.9 percent of any store.”
But, Finkelstein continues, due to shortages of cannabis supply across the country, the province of Ontario just announced there will be a cap of 25 stores for the first year, and those 25 will be chosen by lottery, and no one person can hold more than one license! Where will franchising fit in? Can multiple units that are independently owned and operated but share the same brand be eligible? What about all the leases already signed, and franchisees ready to go?
Erik Wulff of DLA Piper notes that anti-poaching clauses came under attack in 2018, “with the prospect of turning into a full-fledged assault in 2019 and beyond.” Franchisors typically provide in their standard franchise agreements that franchisees will not solicit each other’s employees. “With what appears to be motivated at least in part by political considerations, a number of state attorneys general have started to challenge these practices in order to champion the cause of higher wages for unskilled workers …
“No surprise then, with these numerous government investigations and their easily obtained settlements (who wants to take on the government?) the fires have been lit for plaintiffs’ class action lawyers to extract a handsome pay day,” Wulff continues. But of course with every publicly announced settlement, the litigation fires are further fueled. It will take at least one strong-minded franchisor to defeat this assault on its merits to start dousing the fires.
Peter Lagarias of Lagarias & Napell is watching out for the unconscionable, as he writes: “A key issue to watch in the coming year may be courts voiding unfair and illegal provisions in franchise agreements. For many years courts have stricken provisions that contravene franchise and other statutes. Lately courts have increasingly voided contract provisions that are unconscionable. Recently a Los Angeles Superior Court voided an unfair reservation of rights clause regarding territorial protections of an El Pollo Loco franchisee. The court invoked the unconscionability doctrine, and the franchisee subsequently obtained a damages award in a jury trial. The case, Bryman v. El Pollo Loco, is under appeal, so stay tuned for an appellate ruling on continued use of ‘unconscionability’ to void unfair provisions of franchise agreements.”
Kirk Reilly of Gray Plant Mooty has his eyes on a more macro issue, what he calls “the ticking time bomb that is hanging over all of us—the potential economic downturn and increased financial volatility.” If the economy does take a material turn for the worse, he continues, familiar issues will undoubtedly rise to the surface—including, who’s at fault for the franchisee’s declining performance? The key for franchisors will be to anticipate what they can do now, to both assist their franchisees through some tough times, and protect their interests from the almost certain increase in franchisee litigation that follows the beginning of a downturn.
The biggest surprise of all? None of the lawyers who responded mentioned joint employer as a top issue to watch, a complete reversal from 2014, when The International Franchise Association’s then-head called the ruling an existential threat to franchising, that would destroy “the fundamental tenets of the franchise model” and “eviscerate the most successful business model in existence.” As yours truly detailed in The Franchise Handbook, our new resource guide to all things franchising, although the issue may be tamed, it is certainly still alive and well. I thank the knowledgeable franchise attorneys who act as sources, and in this case as writers, for this column throughout each year.
Beth Ewen is editor-in-chief of Franchise Times, and writes the Continental Franchise Review® column in each issue. Send interesting legal and public policy cases to firstname.lastname@example.org.