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Home :: News & Articles :: Articles by Zesb :: Ten Dangerous Contract

Ten Dangerous Contract Clauses That May Exist In Your Franchise Agreement

by Robert Zarco, Esq.

AAHOA Hospitality, A Magazine Dedicated to Asian American Hoteliers, September 1999

Your franchise agreement is a complex document; no doubt it is at least fifty (50) pages in length, contains a great deal of "legalese," and is truly the most boring material you have ever read. You are inclined to skim through it, or even avoid reading it at all, "trusting" the big American company. You want to sign the document as quickly as possible so that you can start making money. After all, there is nothing in the agreement that will ever really matter, right? Wrong!

The franchise agreement is the single most important document you will ever sign -- at least with regard to your investment in your franchise business. There are several reasons why you should read the franchise agreement carefully, and prior to signing anything, why you should consult an experienced franchise attorney about the meaning of each of its terms. Do not allow the franchisor to rush you into signing before you are properly prepared to do so. You are making a substantial investment and entering into a long-term business relationship. Your first line of defense must be to avoid agreeing to anything that will potentially threaten your investment. Even if you have already signed a franchise agreement, it is not too late. You must still be vigilant about knowing and fulfilling your own duties, and understanding what you can reasonably expect from your franchisor.

1. The Merger & Integration Clause

It is almost impossible to overstate the far-reaching effects of this type of contract clause. It usually reads as follows:

This Agreement and the documents provided for herein contain the entire agreement of the parties hereto with respect to the subject matter hereof and supersede all prior negotiations, agreements and understandings with respect thereto. This Agreement may only be amended by a written document duly executed by all parties hereto.

In simplest terms, the merger and integration clause means that any of your franchisor's verbal promises, agreements, or representation which are not contained in the final franchise agreement, i.e. in writing, will almost never be enforceable. Under any circumstances. How does this typically affect a franchisee?

One example is a 1998 case in which a hotel franchisee claimed that, during negotiations, the franchisor had promised that it would not allow another franchise to operate within the franchisee's market area, but later, granted its parent company a franchise near the franchisee's hotel and allowed its reservation system to favor the other hotel. Because of the merger and integration clause in the contract, the court found that the franchisee should not have relied on the franchisor's oral representations concerning an exclusive territory. The agreement also stated that it was a "nonexclusive license," and that the franchisee agreed not to contest the franchisor's right to grant the system to others. Based in part upon the merger and integration clause, the franchisee's reliance on oral representations regarding an exclusive territory was considered unreasonable by the court and the promises the franchisee had relied upon were unenforceable.

2. The Non-Committal/Disclaimer Clause

This type of clause gives the franchisor complete power as to whether it will carry out its "promises." Advertising is a common example. Franchisors make extensive promises about advertising programs -- but the contract says that the franchisor "will provide [the service] as it deems necessary," or that it has "sole discretion" to do so. If the contract allows the franchisor to decide how much and what type of advertising the system needs, it does not matter that the franchisees believe that the advertising program is poor. Remember, if a conflict arises, the written word always wins out. If the franchisor is within the parameters of what is written, the franchisee has no right to complain.

If on the other hand, the franchisor has promised, in the contract, to maintain a certain level of quality in the franchise system, and has not maintained consistent quality standards with other franchisees, you may have the right to complain. If the franchisor does not uphold the system's reputation and public image, it will impact upon the brand overall, and, eventually on your own profitability. The key to enforcing this type of provision is whether the quality decline has reached objectively-measurable levels.

3. Remodeling and Renovations

The franchisor may also retain complete discretion to require you to make certain repairs and renovations to your hotel property. Failure to make these changes within the time the franchisor has chosen often has serious consequences, such as termination of your franchise license. While some franchisors may be willing to give you more time if you ask for it, you must remember that the decision is the franchisor's, and not yours, to make.(1) If the franchisor agrees to give you more time, make sure to get that promise in writing, preferably before the original deadline has expired.

You may also have questions about the extent of remodeling which the franchisor is demanding. Is the franchisor asking you to make Hyatt-level renovations at a Holiday Inn or Quality Inn unit? You should address such questions and other, similar inquiries, to your franchise attorney.

4. The Choice of Law Clause

Your franchise agreement states that, in the event of a dispute, the laws of State "X" will govern. Sounds simple enough, you say. Actually, this is a very critical aspect of the contract, which most franchisees -- and many attorneys -- do not fully understand until it is too late.

The choice of one state's law can have far-reaching effects on future litigation. An example: a California franchisee sued its Florida franchisor. The parties had chosen Florida law to govern their franchise agreement. As a result of this contract term, the franchisee was not allowed to sue under a California franchise protection statute because Florida law applied. At the same time, the court did not allow the franchisee to sue under the corresponding Florida statute because that particular law did not apply to franchisees operating out-of-state. As a result, this franchisee was left in a legal "no man's land" -- unprotected by any state's unfair business practices statute. This result is especially troubling because these unfair business practices laws have been designed specifically to address franchisor abuses and to provide compensation above and beyond what is already available for ordinary commercial disputes. This is certainly an area in which it is a real benefit to have retained experienced franchise counsel who will recognize the far-reaching implications of these provisions.

5. Statute of Limitations

A statute of limitations is simply a rule which requires a party to bring a lawsuit within a specified time after it suffers some type of injury. The "injury" starts the limitations "clock" running. Ordinarily, state laws govern how long this period will be. Nevertheless, states may also allow contracting parties to agree to shorten what would otherwise be the applicable time period. These rules are notoriously harsh and inflexible, and your failure to act within that time frame will result in your losing the right to have your day in court.

In one case, an Illinois franchisee/distributor believed that the manufacturing company had wrongfully terminated his contract to distribute equipment. The franchisee consulted a friend who was also an attorney, (and not well versed in the intricacies of franchise law) who advised the franchisee that he had no apparent remedy against the termination. A year passed. One day, the attorney-friend read an article discussing the Illinois Franchise Act and realized his mistake. It was too late. Ultimately, the franchisee learned that he had had a potential remedy under the Illinois Act, but also learned that his time had run out -- the clock had begun ticking when he had consulted his attorney-friend. It did not matter that the attorney was not a specialist in franchise law: the clock had begun running when he consulted an attorney. Even an appeal to the federal circuit court of appeals could not revive the claim, regardless of how meritorious it might have been.

This case is a good example of just how critical the time limits can be, generally. It is always very important that you be aware of whether your franchise agreement contains a statute of limitations-type of clause, and if you are considering a lawsuit, you must be sure to start the process within the time frame stated in the contract.

6. The Arbitration Clause

Almost all Franchisors prefer arbitration to litigation. On the surface, arbitration sounds friendlier, simpler, less threatening. Nothing could be further from the truth. Arbitration is easier -- but only if you are a franchisor. The rest of the bad news is that once you have signed a contract agreeing to arbitrate your disputes, it is almost impossible to avoid the arbitration and instead, go straight to court.

What are these disadvantages of arbitration?

  • First, in court you can obtain a jury trial assuming that you have not waived this right elsewhere in the agreement. Having a dispute resolved by a jury of your peers is a valuable right which should not be underestimated. Arbitrators are usually lawyers. They may be friendly with your franchisor or its attorneys since arbitration clauses typically require arbitration to take place in the city where the franchisor's headquarters are located.       
  • Second, arbitration is very expensive, even as compared to litigation. Unlike state and federal courts where judges are compensated by taxpayer dollars, you must pay the arbitrators by the hour (from approximately $ 250-350 per hour), and must pay additional filing and administrative fees for the arbitration process.       
  • Third, the discovery process -- during which each side gathers its evidence (depositions, documents, etc.) for trial -- is very limited. This aspect hurts a franchisee disproportionately because he or she has the "burden of proof," and usually needs additional facts and documents in the possession of the franchisor to build the case.       
  • Fourth, the normal rules of evidence and procedure do not apply in the same way as they would in federal or state court. Instead, the law affords the panel a great deal of flexibility and discretion in conducting the arbitration hearing, and a reviewing federal court will rarely, if ever, reverse the panel's decision -- even if it is legally and/or factually incorrect!

The bottom line is -- do not agree to arbitration if you can possibly avoid it.

7. The "No Jury Clause"

A close cousin of the arbitration clause, the "no jury clause," requires that the franchisee waive what would otherwise be its right to a trial by jury. Jurors are sometimes thought to be "sympathetic" to a franchisee who has been mistreated. At the very minimum, you, as a franchisee, want to be the one to decide whether you ultimately will present your case to a jury -- do not forfeit this option unknowingly when you sign the contract!

8. The Supplier Control Clause

A franchisor will likely require you to purchase certain proprietary items available only from its approved sources. The franchisor will also "allow" you to purchase other items for the facility from any other source you select, subject to the items meeting or exceeding the system's standards, but again, it is solely the franchisor's decision as to whether you will be able to do so. You should be aware that some franchisors have received "kickbacks," rebates, or other favors from the suppliers it designates for this purpose. Nevertheless, it is also difficult to prove and attack these types of arrangements if the agreement gives the franchisor enough discretion to designate its system's suppliers.

9. The Sales/Assignment/Transferability Clauses

No doubt your franchise agreement has one. This clause allows the franchisor to withhold its consent to a proposed transfer unless and until the transferee meets certain, unspecified requirements. The franchisor may also require you to submit information about the proposed transfer a month or two before the planned transaction, meaning that you must plan well in advance of when you wish to transfer ownership. Your failure to do so may result in the franchisor's refusal to "recognize" that you no longer operate the hotel. The franchisor will then hold you responsible for the new owner's transgressions.

Also as a condition of the proposed transfer, the franchisor may also demand that you sign a general release of claims, stating that you will not initiate legal action for anything that may have occurred during the franchise relationship.

At the same time it limits your discretion, however, the franchisor may give itself the freedom to assign, delegate or subcontract any of its own contractual rights and duties. If this provision is in your agreement, you may end up dealing with various other entities or companies to obtain the services and products which you thought your franchisor was going to provide. If any of these third parties do not perform to your liking because of operational inexperience or lack of financial resources, you will have to deal directly with that party, instead of your experienced franchisor.

10. The "Loss of Exclusive or Protected Territory"

If your franchise agreement provides you with a protected territory, guard it well. If the franchisor attempts to infringe on your area, consult a franchise attorney immediately. The right to enforce this type of clause is one of your most valuable assets. Unfortunately, without a contract provision granting an exclusive or protected area, it is virtually impossible to stop franchisor "encroachment," or the placement of a new, competing franchise unit near an existing site. Be attentive to your own obligations under the franchise agreement that correspond to your maintaining the exclusive area -- your franchisor would like nothing better than to justify placing a competing unit in your "backyard."

Robert Zarco is a regularly-featured columnist of AAHOA's monthly publication, and a guest speaker on franchise issues at the AAHOA's regional conventions. Mr. Zarco is scheduled to speak at the AAHOA's annual convention in January, 2000 in Las Vegas. The author welcomes comments and suggestions pertaining to this column or to his presentations. You may contact Robert Zarco, Esq. at the law firm of Zarco Einhorn Salkowski & Brito, P.A. at the address listed above; by telephone at (305) 374-5418; by facsimile at (305) 374-5428; or by e-mail at zarco@zarcolawo.com.

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1. See Robert Zarco's column in the August, 1999 issue for an in-depth discussion of the legal consequences of franchisor