Seattle Franchising Law Blog

Why would you spend the time and money to set up a legal entity--a corporation or LLC (Limited Liability Company)--if you did not plan to use it?  It seems that almost weekly we learn that people have a legal entity they paid for--but they never took the steps necessary to properly transfer their business or its assets into the entity. 

It is easy to set up a Washington corporation or LLC.  You can just go online and do it for "free" using the Secretary of State's online form and paying the State's fee.  Leaving for another day, the quality of legal advice the state gives, in many cases "free" just means you have to spend a lot more money later to fix problems.  This is particularly true when you have been operating a business for a period as a sole proprietor or partnership before deciding to set up an entity.  It can also become an issue when you are taking personal assets and contributing them to the entity in exchange for your ownership rights.

If you do not transfer the assets the new company is going to use to the entity, you have just gained a short stack of paper that will gather dust in the corner of your office or shop.  You may float along for weeks or years before discovering that you have a potentially expensive and troubling problem. 

If the business gets sued, the opposing party will soon discover that you co-mingled the entity with your personal affairs--by using your personal assets in and for the benefit of the business and meanwhile taking advantage of business tax and other benefits through the entity.  Suddenly that protection from personal liability for business liabilities you thought you had is not available. 

Another place we see problems from not properly transferring assets is when "partners" get into a dispute.  Suddenly you discover that the computer on which you kept all of the business records is not an asset of the entity--and never was.  Meanwhile, she takes the position that you did transfer your existing book of business and customer list to the business.  In effect you set up an entity (corporation or LLC) that sat on the shelf with no assets and conducted business using assets it may not have owned.  It can take an expensive and business-killing lawsuit to even try to unravel the mess. 

The solution: make it clear in advance, in writing.  A good rule is that if it is not in writing it did not happen.  An experienced small business attorney can guide you as to documents and actions needed to make it clear what assets are transferred to the business entity and which remain personal. 

Franchisor Dream Dinners caught by Washington.  Dream Dinners been caught violating franchise laws.  Janet Sparks of Blue MauMau reports that the Washington Department of Financial Institutions has obtained a "consent order" from Dream Dinners based on its solicitation of franchisees during a time when it was not registered to offer or sell franchises.  The consent order also addresses other issues. 

Dream Dinners recently mailed copies of the consent order to every current and former Dream Dinners franchisee.  The State of Washington required that mailing to inform each of those investors that their rights might have been violated. 

Although neither the order nor the accompanying cover letter addresses it, the order has a huge impact on every current and former franchisee.  It very clearly starts their statute of limitations running.  As a practical matter, that means that, at the outside, each franchisee must file a lawsuit no more than three years after the day they received the letter--or they will be forever barred from making a claim based on the violations described in the order.  This assumes that Washington law will apply.  If the franchisee is located in another state or has a contract that specifies the law of another state, the time period could be shorter.  Depending upon what the franchisee already knew about the facts described in the order, the period might be a lot shorter--or it may already be too late. 

Any person who purchased a Dream Dinners franchise at any time up until October 18, 2012 has an urgent need to consult with qualified and experienced franchisee counsel.  They should not let the holidays or any other events distract them from obtaining a review of their facts to determine what their options might be.  Any delay could be fatal to their ability to recover part of what they lost on their adventure in franchise ownership. 

Unfortunately, Dream Dinners again finds itself a poster child.  It previously was reported as being number 5 on the United States Small Business Administration's 2011 list of franchises with the highest percentage of loan defaults.  Anyone now considering investing in a Dream Dinners franchise (or any other franchise with such a track record) should think long and hard and consult with experienced franchisee counsel before signing a contract or writing a check. 

To read Janet Sparks' article in Blue MauMau, click here. 

Almost every franchisee, when buying a franchise, is asked to sign a document containing false statements--in order to be "awarded" a franchise.  No franchise or other business opportunity is worth signing something false to get it. 

Any relationship in life that begins with a lie is doomed to failure.  You know from the beginning that you cannot trust the other person.  The whole foundation is false.  Franchisors love to refer to their franchisees as "partners".  The essence of a partnership is a fiduciary duty of loyalty and honesty between partners.  If you agree to compromise that loyalty and honesty right at the beginning it will cost you dearly.

The lies you are asked to agree to are sometimes buried in the fine print on page 33 of the franchise agreement.  Most often, they are in a separate "questionnaire" you are told you must sign.  The first few questions seem (and often are) innocuous.  However, the questionnaire quickly moves on to ask you to agree that you have not received any financial information outside of the formal documents (Franchise Disclosure Document and franchise agreement).  In many cases, they are carefully written so that you are agreeing that you did not even rely on the Franchise Disclosure Document. 

Before you sign such agreements or answer any of those questions, it is critical that you understand the questions and answer them truthfully--even if it means the franchisor withdraws their "offer".  You can be sure that the questions are carefully written in "legalese" that is disguised as "plain English"--in other words, it has legal meanings that may not be apparent from the words used.  You should not go it alone.  Even if you are otherwise determined to make the biggest investment of your life without consulting a lawyer, you should consult an experienced franchisee lawyer before signing any such "questionnaire".  Remember, the more innocuous the document appears to be, the worse it often is for you. 

Many franchise sales consultants will tell you that you have to sign the false statements "in order to get the franchise".  If that is the case, you should fire the consultant and walk away from the franchise.  Don't compromise your honesty and ethics to get into a business under false pretenses.  If a statement you are asked to sign is not true, you should not sign it.  If that means the franchisor has a harder time selling franchises, perhaps it will change the franchisor's way of doing business.  Meanwhile, you can get on with your life--in a different business venture that you can enter into without having to compromise your integrity. 

In a continuing effort to highlight important new court decisions, this time regarding vicarious liability of a franchisor for the actions of its franchisee, you need to be aware of Patterson v. Domino's Pizza.  In the Patterson case, which had been dismissed by the trial court, the California Court of Appeal reversed, saying:  "a franchisor's actions speak louder than words." 

The case involved claims of sexual harassment of a young employee by her manager.  After the litigation started, the franchisee filed for bankruptcy.  That left the franchisor as the primary defendant.  The franchisor argued that, because the contract said the franchisee was an independent contractor, the franchisor had no liability. 

The Court of Appeal decided that it had to look beyond the contract to determine whether the franchisor had and exercised sufficient controls over the details of the franchisee's operations to create liability.  The court seemed impressed by testimony from the franchisee that Dominos forced him to fire the accused employee--suggesting the consequences of not complying with the demand would have been substantial. 

The case bears reading by every franchisor.  It is food for thought every time a franchisor feels the desire to exercise detailed control over major aspects of a franchisee's operation.  It is yet another signal that courts are going to look beyond the words of the franchise agreement and examine the facts on the ground--how the parties actually behave and operate within the context of the contract. 

Much of the vicarious liability case law, often finding no vicarious liability of franchisors, comes from earlier days of franchising.  As franchisors and their advisors try to write the "perfect contract" and as franchisors seek greater and greater control, the courts may expand that field of liability--where it seems appropriate because the franchisor had the power to prevent the act from happening. 

One decision does not indicate a sea change.  However, it would be a worthwhile exercise for every franchisor to consult with their franchise attorneys about this trend toward vicarious liability and what steps it can and should take to minimize the risk of being held responsible for something bad done by an employee of a franchisee.