One of the first items in any franchise agreement is the “term.” That is the duration of the franchise agreement. Here’s an example:
This Agreement shall take effect as of the date of this Agreement (the “Effective Date”), and, unless previously terminated, its term shall extend for a period of twenty years from the Effective Date.
Not very complicated, right? But think about it: the term determines how long a person is agreeing to be a franchisee. Many marriages do not even last ten years. Many franchisees apparently think that if things don’t work out, they’ll just get a divorce.
Now, a franchisee can simply “stop” being a franchisee during the term of the franchise agreement or can attempt to formally terminate the franchise relationship. Like a divorce, however, that can be a painfully expensive proposition. Believe it or not, some franchisors will take the position that a franchisee is obligated to pay royalty fees for the entire term even if it is not using the franchise system.
We recently encountered such a scenario. We represented “XYZ, Inc.” (a pseudonym), a former franchisee of Legacy Academy, Inc. (“Legacy”). Legacy sells “childhood education” (daycare) centers. In 2002, XYZ entered into a Legacy franchise agreement with a 20 year term. Under the terms of that franchise agreement, XYZ promised to pay Legacy six percent of its gross revenue as royalty and advertising fees to use Legacy’s trademarks and the franchise system. XYZ did so and was fortunate enough to do well.
In 2010, however, the Superior Court of Gwinnett County confirmed an arbitration award we obtained finding Legacy had given “misleading financial information in the [Federal Trade Commission’s (“FTC”)-required Uniform Franchise Offering Circular (“UFOC”)] and outside the UFOC to [five (5) other franchisees] and [in doing so] violated the disclosure requirements of [16 C.F.R. § 436.1].” As a result, five (5) former Legacy franchisees were awarded more than $1 million in damages and had both their promissory notes (totaling about $1 million in principal obligations) and their franchise agreements rescinded.
In connection with this arbitration and thereafter, the size of the Legacy franchise system shrunk drastically, as did the goodwill associated with the brand name for which XYZ was paying royalties. In other words, the momentum that Legacy had enjoyed previously and that franchisees relied upon in joining the system ground to a halt. As a result, XYZ had no choice but to de-identify and leave the franchise system and did so at the end of 2010.
When Legacy sued XYZ (apparently for having the temerity to acknowledge unavoidable business realities), Legacy took the position that XYZ was obligated to pay royalty fees and advertising fees from 2011 through 2022, which they contended amounted to $836,833.51 (exclusive of attorneys’ fees).
We defended XYZ on this claim in a two-day bench trial. The result was a judgment for only $23,841.80, which included Legacy’s attorneys’ fees after almost three years of litigation. How is this possible? Because we mobilized every possible defense available in the most forceful way possible, particularly with respect to the murky and often convoluted law of future lost profits.
Whether helping franchisors with litigation avoidance or franchisees with avoiding potentially catastrophic financial ruin, Ichter Davis LLC is ready and able to provide a full array of legal services on your behalf. If you are interested, please call Cary Ichter or William Daniel Davis at 404-869-7600.