ONGOING OPERATIONS CONSIDERATIONS
By Robert L. Zisk and Jeffrey L. Karlin
Certain core aspects of a franchised business present ongoing challenges to franchisors. Virtually all parts of the business are entirely within the day-to-day control of the franchisee, yet a number of them have significant potential to affect both the well-being of the system and the goodwill enjoyed by the franchisor’s trademarks. The first is the franchisee’s failure to meet its obligation to pay royalties and advertising fees (and sometimes percentage rent) based on reported gross sales. These funds drive the system and nonpayment or underreporting of sales cannot be ignored. Second, franchisors often face claims, both real and imagined, that they are vicariously liable for the acts of their franchisees. Franchisors can protect themselves from such claims by carefully structuring and maintaining their relationship with their franchisees, as well as by enacting required insurance coverage and indemnity provisions. Third, illegal activity on the premises or in connection with the franchised business is particularly pervasive in this era of rising taxes and unauthorized workers. Such conduct can have a serious impact on the goodwill of the system, and needs to be addressed. Fourth, the sale of unapproved products, perhaps as part of an effort to save on supply costs or to facilitate the underreporting of sales, can cause real customer confusion and harm to the trademark. Finally, changing economic and competitive circumstances require a franchise system to be flexible. The franchisor must make sure that it reserves the right to meet these challenges.
A. UNDERREPORTING AND NONPAYMENT OF ROYALTIES AND ADVERTISING FEES
One of the essential components of any franchise system is the establishment, operation, and enforcement of fee systems under which the franchisees pay a percentage of their gross sales to the franchisor. Royalties are the financial engine of the franchise industry because they are the principal means by which most franchisors obtain their operating income. Simply put, without these fees, franchising would not exist. Although some franchise systems generate income through other means, including the sale of supplies and products for resale, the modern trend in franchising has been the collection of royalty fees as a franchisor’s main source of revenue. Advertising fees, usually paid by franchisees at the same time as royalty fees and also based on a percentage of gross sales, are used to provide funding for a franchise system’s marketing efforts. The usual practice is for these fees to be contributed to national, regional, and/or local advertising funds or collectives. Advertising fees are a potentially powerful means of building the brand by increasing the ability of the franchisor to advertise and market the system, all of which helps to grow the business. Since the fees contributed to advertising funds are of a more direct benefit to franchisees, franchisees are generally supportive of efforts to enforce fee systems. Thus, it is of common interest to franchisors and franchisees to have fee systems that can be enforced effectively.
A typical franchise agreement royalty provision, as set forth below, requires royalties to be paid weekly based on the gross sales of the unit:
Royalty Fee: During the term of this Agreement, Franchisee shall pay to Franchisor a continuing royalty fee in an amount of X percent (X%) of the Gross Sales of the Unit per each one (1) week period. “Gross Sales” shall mean revenue from the sale of all products and services and all other income or consideration of every kind and nature received by the Unit, less any sales tax or other taxes collected by the Franchisee from its customers and thereafter paid to the appropriate taxing authority.
Franchise agreements also typically include a separate requirement for franchisees to report sales on a timely and accurate basis. Until recently, most fee systems operated on the honor system, with franchisors relying on franchisees to report sales accurately and make their payments. Franchise agreements may include a requirement to submit sales information on specific reporting forms. Some systems require their franchisees to transfer all of their sales proceeds to the franchisor, which then does the accounting, takes its royalty and advertising fees, and returns the remaining portion to the franchisee. A modern trend among franchise systems is to have the sales reported to the franchisor automatically through point-of-sale systems and to have royalties paid directly (through electronic means) to the franchisor from a designated bank account. These automated systems are often touted as increasing the efficiency of the system and allowing franchisees to spend less time dealing with the paperwork involved with reporting and payment requirements. Certainly, these systems can eliminate problems caused by the physical transfer of checks and sales reports through the mail or other forms of delivery. However, there is little doubt that one of the main purposes behind the increase in automated royalty systems is to increase the accurate reporting of sales and payment of royalties.
In addition to sales reporting, franchise agreements often require franchisees to provide periodic profit and loss statements and to retain a variety of financial, sales, and production records. These materials include, among other things: accounting records, inventory reports, production reports, profit and loss statements, product throwaway records, payroll records, income tax returns, bank statements, daily cash reports, and cash register receipts.1 Along with the requirement that franchisees retain such materials, franchise agreements commonly give franchisors the right to inspect, copy, and audit financial records. The right of a franchisor to inspect a franchisee’s financial records without the ability to copy and remove them from the franchise location is virtually meaningless. Financial documents often require a significant amount of scrutiny and sufficient time for the franchisor to review. Typically, the franchise agreement will also require the franchisee to pay the cost of the audit if the review identifies either intentional underreporting by a franchisee or negligent underreporting that is above a certain percentage of the franchisee’s gross sales. The franchise agreement should specify that these costs include professional fees for accountants, auditors, or lawyers who participate in the process. Franchisees should also be encouraged or required to operate their businesses through a corporation or other entity that is separate and apart from any of their other businesses. If franchisees commingle their financial and tax records with those of other businesses, it makes an audit much more difficult for a franchisor to conduct. A separate corporation also will help the franchisee for purposes of its own liability.
The purpose behind examining the financial documents is to allow franchisors to detect discrepancies between the amount of sales reported to the franchisor and the actual sales made by the franchisee. Such differences are sometimes identified as easily as comparing the sales reported on the franchisee’s business tax returns or in its financial records with the sales reported to the franchisor. However, the signs are usually more subtle than that. Underreporting of sales can also be detected if the franchisee is purchasing too many raw materials compared to the number of product units reported to have been sold by the franchisee or if the percentage of the cost of goods sold far exceeds the normal range for the franchisors’ other locations. Any other items on the profit and loss statement that are seriously out of line in light of sales and profits can also trigger an audit. For example, labor costs that are inordinately high given the level of reported sales can be cause for looking further into whether all sales are being reported.
Most franchise agreements also include an “obey all laws” clause, under which the franchisee is obligated to comply with all applicable laws in connection with the operation of the franchise—of which more will be said below. A franchisee that underreports sales to a franchisor also often fails to report all of its sales to federal and state tax authorities. As such, these activities violate the tax laws, constitute breaches of the “obey all laws” clause, and are grounds for termination of the franchise agreement.2 Interestingly, the courts have not required franchisors to prove that the franchisee has been convicted of any crime or has admitted to breaking the law. Instead, the franchisor need only prove—under a preponderance of the evidence standard—that the franchisee violated the law and thus breached the franchise agreement.3
Detecting underreporting can take many forms. A common approach is to audit the financial records of a select number of franchisees. The audits are either conducted at random or based on various criteria. In the quick-service food industry, for example, franchisors often identify franchisees for audits when their purchases of raw materials should have supported much greater levels of sales than were reported. This sort of “yield and usage” benchmark analysis has been recognized by the courts as evidence of underreporting.4 Other means of detecting underreporting include the use of customer counts (which may show much greater foot traffic than actual sales transactions recorded on the registers), and sales verification procedures though which representatives of the franchisor watch the registers while sales are rung over a period of time.
Regardless of the method used to ensure sales reporting compliance, it is important for the franchisor to publicize its efforts to require prompt, full payment of royalties and advertising fees and to identify underreporting franchisees. Since the franchisor cannot directly monitor all sales and must rely on franchisees to report their transactions at remote locations voluntarily, letting franchisees know that it will monitor underreporting is as important as auditing. Often the result of these efforts is a halo effect of increased sales either in the market where the underreporting franchisee is located or in the system as a whole.
Franchisors often treat a franchisee’s deliberate failure to report sales as an incurable breach and grounds for immediate termination.5 However, negligent underreporting (due to employee theft or register malfunctions) is also considered to be a breach of most franchise agreements, although a cure period is generally allowed. The general principle here is that the franchisee is responsible for making sure that all of the sales transacted at the location are recorded even if it is the employees of the franchisee who actually work the cash register.
Nonpayment of fees by franchisees that experience financial difficulties is another problem for fee systems. In these circumstances, the franchisee may have accurately reported sales to the franchisor, but failed to pay all of the royalty and advertising fees due on those sales because of the franchisee’s financial distress. In such circumstances, it is not uncommon for franchisees to ask franchisors for assistance through royalty or rent reduction or other financial considerations. Franchisors should be careful about waiving or reducing fees, rents, or other charges because they may run afoul of equal protection statutes. These acts prohibit franchisors from discriminating between franchisees in the charges offered or made for royalties, goods, services, equipment, rentals, advertising services, or in any other business dealings. Hawaii, Illinois, Indiana, Washington, Michigan, Minnesota, Connecticut, and California have statutes that require equal treatment of franchisees. Other states have equal protection provisions for certain types of clauses. Even in the absence of such statutes, there is little doubt that other franchisees in the system would ask for equal treatment and a reduction of the amount of fees collected by the system if a franchisor were to waive or reduce fees for one franchisee. At a minimum, it is not a good idea to have franchisees paying different royalty rates while they all receive equal benefits of the same system. Therefore, it is best to try other ways to help franchisees who are unable to meet their financial obligations. The focus should be on building the business through increased support or extra marketing efforts. After all, if a franchisee is not generating enough revenue to pay royalties, that is likely the result of more serious operational issues that need to be addressed, in the absence of obvious external causes such as market or economic changes.
Inevitably, some franchisees will fall behind in their payments. The first response in most cases from the franchisor’s point of view is to try to work with the franchisee and help bring the operation back to a performance level at which the stream of royalties and advertising fees will flow again. Problems occur, however, when nonpayment is tolerated for too long and the franchisee builds up a large receivables balance. If a compromise is reached or the franchisee agrees to pay the full amount over an extended period, the agreement should be memorialized in a promissory note. Under most franchise agreements, the franchisor is entitled to interest, which may be as high as 18 percent per year or the maximum rate permitted by law. Again, the best a franchisor usually can hope for in such circumstances is that the franchisee eventually will regain profitability, but will be saddled with a large note that is a burden on future performance. Therefore, it is best to deal with nonpayment issues when they first arise and are still small enough to resolve without much effort. The collections and operations departments should coordinate closely, so that the problem is spotted early and the root cause is addressed. A notice to cure should be issued, giving the franchisee the time permitted by the franchise agreement or any applicable statute to cure the default. The notice to cure should be delivered regardless of whether the intention is to work with the franchisee or to terminate. Many franchise agreements and some state statutes provide that repeated franchise agreement defaults—usually three or four in a twelve-month period—are grounds for termination regardless of whether any of those defaults have been cured. This allows the franchisor to deal with franchisees who may delay their payments as long as possible but stay one step ahead of termination.
If the franchisee fails to cure its financial default within the specified time period, then the franchisor may either seek to collect the unpaid amount or terminate the franchise agreement through a court action or arbitration. The underlying proposition in such an action is straightforward: the franchise agreement is a trademark license, and a licensee may not use the marks without paying for them as required by the contract. In keeping with the centrality of this issue to franchising, courts routinely enforce nonpayment terminations. “Failure to tender payment is generally deemed a material breach of a contract.”6 “The franchisor has the power to terminate the relationship where the terms of the franchise agreement are violated.”7
Underreporting and nonpayment actions thus arise out of the same impetus: protecting the flow of funds to the franchisor. These funds, collected though the fee systems outlined above, support the entire franchise system, including advertising in support of the brand, and are essential to its survival.
B. INTERLOCKING DEFENSES: VICARIOUS LIABILITY CLAIMS, INSURANCE COVERAGE REQUIREMENTS, AND INDEMNITY CLAUSES
Another central feature of franchising involves the ability of franchisors to shield themselves from exposure to tort liability arising out of the operation or physical condition of their franchised locations. This protection is accomplished through a triple ring of defenses: (1) the limited application of vicarious liability claims to franchisors; (2) requiring franchisees to obtain insurance coverage with franchisors named as additional insured parties; and (3) indemnity clauses in franchise agreements under which franchisees agree to hold franchisors harmless for claims arising out of the franchisee’s activities. The defenses do not provide blanket protection for franchisors. However, they do provide a far broader range of protection for franchisors for claims based on their franchisee’s operations than might otherwise be expected, especially given that franchisees are required to adhere to extensive operating standards established by franchisors. And they are essential. These defenses have allowed franchise systems to expand more than they ordinarily would have because they serve to reduce the risk (and expense) of having so many locations operating under the same trademarks.
1. VICARIOUS LIABILITY
The legal concept of vicarious liability is based on the fairly simple principle that an individual is as liable for the actions of his or her agents as are the agents themselves. The concept is simple because an “agent” is not an agent unless he or she is under the control of another party (usually referred to as a “principal” or by the more archaic term “master”). Thus, the agent/tortfeasor follows the principal’s orders and that principal shares in the responsibility for any harm caused by the agent’s acts or omissions. Being an agent is not a defense to a claim brought against it; the agency status of the tortfeasor merely allows the aggrieved party to file suit against the principal as well.
The level of control that a principal can exercise is the central element in determining whether it can be held vicariously liable for the acts or omissions of its agents. In particular, an agency relationship depends on “the extent of control which, by the agreement, the master may exercise over the details of the work.”8However, “control” in the franchise context is a more complicated issue than it is in many other kinds of business relationships. While franchisees ostensibly operate on an independent basis, they are also required to adhere to a franchisor’s detailed standards in every aspect of their operation. Further complicating matters is that franchisors must diligently enforce their standards and promote uniformity or risk undermining their trademark protections under the Lanham Act. Therefore, franchisors are caught in a conundrum of competing risks: if they exercise too much control over their franchisees’ activities, they risk being held vicariously liable for their franchisees’ shortcomings, but if they exercise too little control, they face an equally imposing risk of undermining the enforceability of their trademarks.
Not surprisingly, the terms of most franchise agreements accurately reflect this conundrum. On the issue of agency, franchise agreements typically provide a description of the legal relationship between the parties that states, for example, that a franchisee is not “an agent, legal representative, joint venturer, partner, employee or servant” of the franchisor. Instead, franchise agreements state that the franchisee is an “independent contractor” and, as such, is not authorized to make contracts or any other type of obligation on behalf of the franchisor. Furthermore, most franchise agreements contain an explicit disclaimer stating that the parties to the contract do not have a fiduciary relationship between them. This last provision is consistent with the widely accepted view by the courts that there is no fiduciary relationship between a franchisor and its franchisees.9 This conclusion is usually based on the fact that there is no fiduciary relationship between independent economic actors unless one of the parties, as the court in Broussard v. Meineke Discount Muffler Shops, Inc. described it, “figuratively holds all the cards [i.e.,] all the financial power or technical information ….”10
Despite these mutual declarations of independence, most franchise agreements make it clear that franchisees are required to adhere to system standards without any deviation whatsoever. The typical agreement provides, for example, that:
Franchisee agrees to operate the unit in strict accordance with all of Franchisor’s standards as they may be communicated to Franchisee from time to time. Standards shall be established for and distributed to franchisees generally and/or Franchisee specifically, in such form and content as Franchisor may from time to time in its sole discretion prescribe.
The following provision demonstrates just how inclusive these standards can be:
Franchisee shall use all materials, ingredients, supplies, paper goods, uniforms, fixtures, furnishings, signs, equipment, methods of exterior and interior design and construction and methods of product preparation, delivery and sale prescribed by or which conform to Franchisor’s standards; and to carry out the business covered by this Agreement in accordance with the operational standards established by Franchisor and set forth in Franchisor’s operating manuals and other documents as they presently exist or shall exist in the future or as may be otherwise disclosed to franchisees from time to time.
Under the authority of these kinds of provisions, most franchisors establish detailed and extensive standards and operating procedures for their franchisees to follow. Franchisors stringently enforce their standards or, at the very least, strongly encourage their franchisees to adhere to these standards. Thus, franchise agreements typically give franchisors the authority to issue notices to cure for violating those standards and the right to terminate the agreements where a breach of a standard has not been cured. For example, in McDonald’s Corp. v. Robertson,11 the court upheld a preliminary injunction terminating a franchise agreement because of the franchisee’s failure to comply with the franchisor’s quality, safety, cleanliness, and food safety standards. Despite the fact that franchisors have the authority to set detailed standards for their franchisees concerning virtually every aspect of the franchised business and to enforce these standards rigorously, the courts have generally found that franchisors are not vicariously liable for the acts or omissions of their franchisees. In fact, in deciding whether a franchisor may be held vicariously liable for the acts of its franchisees, the courts focus on whether the franchisor exercises control over the franchisees’ day-to-day operations and more specifically, over the activity at issue in the case.12 Thus, the majority of courts have taken the position that a franchisor’s retention of the authority to issue detailed operating standards to franchisees and to enforce those standards is not enough to impose a duty on it for the acts or omissions of the franchisee in operating under those standards. Merely setting standards of operation and enforcing them is insufficient to show the requisite control over day-to-day operations to subject franchisors to vicarious liability.13
This does not mean that franchisors have received a free pass from the courts on the issue of vicarious liability. In the recently decided case of Awuah v. Coverall North America, Inc.,14 a federal district court found that the franchisees of a cleaning service franchise system could not be classified by the franchisor as independent contractors. Under the state independent contractor statute at issue in that case, employers could not classify their employees as independent contractors if, among other things, they were engaged in the same business as their employees. To distinguish itself from the activities of its cleaning service franchisees, the franchisor claimed that it was merely “a product distribution system.” The court rejected this position, commenting that the franchisor’s description sounded “vaguely like a description for a modified Ponzi scheme—a company that does not earn money from the sale of goods and services, but from taking in more money from unwitting franchisees to make payments to previous franchisees.” In reaching this conclusion, the court in Coverall emphasized the fact that the franchisor trained its franchisees, provided them with uniforms and identification badges to wear while engaged in cleaning services, and contracted with and billed all of the franchisees’ customers directly. In addition, the customers’ payments were made directly to the franchisor, which would then pay the franchisees out of the money collected, retaining franchise and advertising fees for itself. It was on the basis of these facts that the court determined “Coverall sells cleaning services, the same services provided by these plaintiffs” and thus the franchisees were not independent contractors.
Although Coverall is an outlier case with its broad (and inaccurate) definition of franchising, it does demonstrate the dangers to franchisors of exercising too much direct control of their franchisee’s activities. The facts of the case, at least as described by the court, showed that the parties had gone beyond the traditional role of franchisee and franchisor. And if standards are too detailed and mandatory and are unrelated to the protection of the trademarks, then the courts will likely find that the franchisor is liable for the acts of the franchisee. Manuals and Franchise Disclosure Documents (FDDs) should be written with these principles in mind to make sure that they do not provide evidence that a court could use to impose vicarious liability on franchisors.
As mentioned above, the limited reach of vicarious liability principles in the franchise context is only one of the defenses available to franchisors. Most franchise agreements also contain broadly worded indemnity clauses that provide that franchisees will hold franchisors harmless for any claims arising out of the operation of the franchise. The broad scope of franchise agreement indemnity provisions can be seen in the following clause, which is typical:
Franchisee shall save, defend, exonerate, indemnify and hold harmless Franchisor and its subsidiaries, and their respective officers, directors, employees, agents, successors, and assigns, from and against any and all claims based upon, arising out of, or in any way related to the operation or condition of any part of the Store or the Premises, the conduct of business thereupon, the ownership or possession of real or personal property and any negligent act, misfeasance, or nonfeasance by Franchisee or any of its agents, contractors, servants, employees, or licensees, including, without limitation, all obligations of Franchisee incurred pursuant to any provisions of this Agreement. Franchisee shall also pay any and all fees, including reasonable attorneys’ fees, costs, and other expenses incurred by or on behalf of FRANCHISOR in the investigation of or defense against any and all such claims.
Under such provisions franchisees are obligated to take on any liability for franchisors (and any of their associated entities and their employees) from claims arising out of the operation or condition of the property on which the franchise is located. Such provisions allow the franchisor to invoke the right to indemnification by the franchisee for any claim brought directly against it and to shift the costs of that defense over to the franchisee. Indemnity provisions, however, do not protect franchisors from their own negligence, unless there is specific language in the franchise agreement that provides for that protection.15
For good measure, the franchise agreement should provide a final level of protection for franchisors by including a provision requiring the franchisee to obtain insurance coverage for both itself and the franchisor for claims arising out of the operation of the franchise and its premises. A good example of such a provision follows:
Franchisee shall procure, before the commencement of business, and maintain in full force and effect during the entire term of this Agreement, at Franchisee’s sole expense, an insurance policy or policies protecting Franchisee and Franchisor, and their directors and employees, against any loss, liability, including without limitation employment practices liability, or expense whatsoever from, without limitation, fire, personal injury, theft, death, property damage or otherwise, arising or occurring upon or in connection with Franchisee’s operation of the franchise location or Franchisee’s occupancy of the premises.
Many franchise agreements also specify the type of insurance to obtain and the coverage limits, along with naming the franchisor as an additional insured. For a franchise with a physical location, the insurance provisions usually require the franchisee to obtain general liability insurance, including product, contractual, and vehicle liability coverage. Property damage coverage is also usually required, including full replacement cost value of the premises and all other property within the premises themselves. Many franchise agreements mandate that the franchisees provide proof to the franchisor that coverage has been obtained, including production of all of the relevant policies and proof that the premiums have been paid in full. The failure to obtain coverage, not surprisingly, is a breach of the franchise agreement that can lead to termination.16
Thus, franchisors are—for the most part—protected from direct liability for their franchisees’ acts and omissions even though franchisees are required to follow detailed standards of operations and business methods promulgated by the franchisor. Given that most franchisees are smaller in size and have fewer resources than most franchisors and that litigants and their counsel are highly motivated to go after the franchisor’s deep pockets, it is remarkable that franchisors have been protected to the extent that they have. There is no question that without such protections, franchising would be less economically viable and perhaps less prominent as a business model.
II. ADDRESSING UNLAWFUL CONDUCT
To understand the “obey all laws” clause, one must first appreciate that trust between franchisor and franchisee is an essential part of any successful franchise system. The franchisor trusts the franchisee to operate its business and to promote the brand in an honest and forthright manner. Likewise, the franchisee trusts the franchisor to manage the brand and to safeguard the integrity of the entire system. This mutual trust is broken when a franchisee engages in illegal conduct, which threatens the goodwill of the brand by exposing it to bad publicity. Few consumers will understand that it was the franchisee’s actions that brought about the adverse publicity arising out of illegal activity; they will only see the brand name associated with it. Thus, damage to the brand’s goodwill affects not just the franchisor, but also all the innocent franchisees within a franchise system who abide by the terms of their franchise agreements and do not engage in illegal acts.17 A franchisee’s failure to obey the laws that govern the operation of its franchise is a material breach of the franchise agreement that strikes at the very heart of the franchise relationship. To protect their systems, many franchisors will include an “obey all laws” clause in their standard franchise agreement so that they will have the ability to terminate franchisees who engage in illegal conduct.
“Obey all laws” clauses come in various forms. Although a few of these clauses appear broad enough on the surface to permit termination if a franchisee violates federal or state laws that are unrelated to the operation of the franchise, most clauses explicitly or implicitly require that the franchisee adhere to the laws that do relate to the business. Given the potentially devastating effect of criminal conduct that is related to a franchise’s operations on the reputation of a franchise system, it is usually not difficult to demonstrate how a violation of most types of laws can constitute a material impairment of a franchisor’s trust and goodwill. Some “obey all laws” clauses define the criminal activity to involve a felony or a “crime of moral turpitude,” while others stipulate that the franchisee actually must be convicted before a breach occurs. Despite the absence of an explicit “obey all laws” clause in some franchise agreements, franchisors have terminated franchisees for criminal conduct under those agreements based on a broadly written clause requiring the franchisee to avoid any conduct “injurious, harmful, or prejudicial” to the franchisor’s goodwill, proprietary marks, or system.
In franchise agreements, it is common for the “obey all laws” language to be associated with environmental, sanitation, and safety requirements. The typical “obey all laws” clause provides, for example, that:
You agree to comply with all civil and criminal laws, ordinances, rules, regulations, and orders of public authorities pertaining to the occupancy, operation and maintenance of the Franchise and Premises, including those relating to health, safety, sanitation, employment, environmental regulation, public access, and taxation.
Another example demonstrates just how inclusive “obey all laws” clauses can be:
Franchisee shall meet and maintain the highest health standards and ratings applicable to the operation of the Restaurant, shall comply with all federal, state, and local laws, rules, and regulations including but not limited to OSHA, USDA, and other food safety regulations, and labor laws, and shall timely obtain any and all permits, certificates, or licenses necessary for the full and proper conduct of the restaurant including, without limitation, licenses to do business, fictitious name registrations, sales tax permits, certificates of occupancy, and fire clearances. Franchisee shall notify Franchisor by telephone and facsimile within twenty-four (24) hours after receipt of any notice alleging a possible health or safety problem, and also shall furnish to Franchisor, within three (3) days after receipt thereof, a copy of any notice alleging non-compliance with the requirements of this Section.
Some “obey all laws” clauses are also quite specific about the right of the franchisor to terminate even before there has been a conviction for criminal conduct. For example:
Whether or not convicted or charged, if Franchisee or any principal engages in any conduct that violates any law, regulation, ordinance, or rule, including, without limitation, those relating to health, safety, sanitation, employment, environmental regulation, and/or taxation, as established by a preponderance of the evidence. Because no criminal conviction is required for termination, the express intent of the parties is that the civil standard for “burden of proof”—rather than the criminal “beyond a reasonable doubt” standard—will apply in any action to enforce termination based on the Franchisee’s alleged breach of this Paragraph.
As noted above, not all franchise agreements contain “obey all laws” clauses. However, almost all franchise agreements contain “injury to goodwill” clauses and those provisions work in similar fashion. The following are two examples of this kind of clause:
Franchisee shall not do or perform, directly or indirectly, any act injurious or prejudicial to the goodwill associated with the Company’s Marks and System.
If Franchisee or any principal engages in conduct that may adversely affect the goodwill or reputation of the Franchisor or otherwise engages in any conduct or act injurious or prejudicial to the goodwill associated with the Franchisor’s Service Marks and/or System … Franchisee is subject to immediate termination without opportunity to cure.
Finally, some franchise agreements contain overlapping “obey all laws” and “injury to goodwill” language in the same clause:
You must, at your sole expense, operate the Franchised Business in full compliance with all applicable laws, ordinances and regulations. You must pay all costs and expenses incurred by, and in the conduct of, the Franchised Business, including but not limited to, all rent, salaries, taxes, disbursements, license or permit fees, traveling expenses and any other business expenses. You must notify us in writing within three (3) days of the commencement of any action, suit or proceeding, or of the issuance of any order, writ, injunction, award or decree of any court, agency or other governmental instrumentality, which may adversely affect your ability to operate, or your financial condition or that of the Franchised Business. Any such notice must be accompanied by a copy of the complaint, order, writ, injunction, award, decree or other similar document. You must, in all dealings with your customers, suppliers, the public, and us adhere to the highest standards of honesty, integrity, fair dealing and ethical conduct. You agree to refrain from any business practice that may be injurious to the System or the goodwill associated with the Proprietary Marks.