FranchiseLAW. Consultants And. Complementary Roles In Franchise Success. Lawyers Play. Coupons & Gift Certificates. Ownership Matters.

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1 FranchiseLAW Bringing together franchisors and legal services Q Consultants And Lawyers Play Complementary Roles In Franchise Success Kay Marie Ainsley and Michael H. Seid Managing Directors MSA Worldwide Coupons & Gift Certificates Online Security Ownership Matters Consultants & Lawyers Cheng Cohen LLC Bryan Cave LLP Roetzel & Andress MSA Worldwide

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3 FranchiseLaw : Coupons & Gift Certificates BY MAUREEN E. MULVIHILL Do Gift Certificate Laws Apply to Coupons? Recently, Groupon and LivingSocial, two leaders in daily deal website offerings, have been hit with multiple lawsuits. These complaints allege that the sale of online prepaid discounted coupons with short-term expiration dates is illegal under the federal Credit Card Accountability Responsibility and Disclosure Act of 2009 and the Electronic Funds Transfer Act of 1978, as well as under similar state laws. The plaintiffs claim that the coupons are gift certificates under federal and state laws, and are therefore subject to federal and state law limitations on expiration periods. Groupon and LivingSocial operate websites that allow consumers to purchase discount coupons for products and services. Purchasers pay a specified amount of money, and in return receive a redeemable coupon. For example, a consumer may pay $20 for $40 worth of food, or $50 for a $75 manicure. Coupons often expire within weeks or months of issuance. Gift certificates Federal and state laws have expiration date limitations for gift certificates. Under federal law, a gift certificate must be valid for at least 5 years from the date of issuance. State laws vary. For example, California prohibits expiration dates, whereas Illinois limits expiration dates to 5 years from issuance. Gift certificates are generally defined as a card, code, or other device that: (i) is not reloadable; (ii) is issued on a prepaid basis; (iii) is issued in a specified amount; and (iv) can be used only at a single or affiliated group of merchants. Under federal law, a card, code, or other device is not issued in a specified amount if it is redeemable for a specific good, service, or experience Courts have yet to decide whether coupons are gift certificates under federal or state laws, or whether they qualify for the promotional certificate exclusion. (e.g., spa treatment). However, a card, code, or other device is a gift certificate if issued in a specified/pre-denominated amount that can be applied to a specific good or service (e.g., redeemable for a spa treatment up to $50 ) or a specific value is stated (e.g., a $50 value ). Federal law and many state laws also provide that gift certificates issued in connection with a promotional program (such as a sales promotion where a consumer receives a coupon or discount redeemable toward a product or service) may expire at any time so long as certain disclosure requirements are satisfied. Generally, a consumer is permitted to provide value or money in exchange for such promotional certificates. However, state laws differ and prohibit the exchange of money or other things of value for the promotional certificate. Coupons Coupons generally satisfy many of the definitional requirements of a gift certificate. Typically, they are redeemable at a single or affiliated merchant, are not reloadable, and are purchased on a prepaid basis. However, coupons may not meet the requirement that they be issued in a specified amount. Specifically, if a coupon is redeemable for a specific experience with no value referenced, then arguably the specified amount requirement is not met, and the coupon is not a gift certificate subject to expiration date limitations. While couponing for a specific experience may appear as a reasonable strategy to avoid the application of federal and state gift certificate laws, in reality this may be difficult to implement since some state laws governing the issuance of coupons may require that the coupon have a stated cash value. In that case, the coupon will trigger the specified amount requirement and be subject to federal and state law expiration date limitations. It may be possible to issue coupons with a stated cash value and a short-term expiration date if structured to take advantage of the promotional certificate exclusion. Generally, if the coupon is structured in this way, the purchase value (i.e., the amount paid for the coupon) will not expire, while the promotional value (i.e., the amount in excess of the purchase value) will. In order to fall within this exclusion, the coupon must be specifically structured and contain certain disclosures. Courts have yet to decide whether coupons are gift certificates under federal or state laws, or whether they qualify for the promotional certificate exclusion. However, given the pending lawsuits in various jurisdictions, it is likely that one or more courts will address these issues in the near future. Until then, franchise systems offering coupons (including through daily deal offerers like Groupon and LivingSocial) should understand the potential application of federal and state laws and structure their coupon programs to minimize the risk of violating these laws. n Maureen E. Mulvihill is an attorney at the Chicago law firm of Cheng Cohen LLC. She practices primarily in the area of domestic and international franchising, licensing, and distribution transactions. Contact her at or maureen. mulvihill@chengcohen.com. Q FranchiseLaw 1

4 Bryan Cave s Franchise Group A Global Leader in Franchise Law Kenneth R. Costello Partner, Los Angeles Top 14 Most Highly Regarded Franchise Lawyers Globally by International Who s Who of Franchise Lawyer s (Law Business Research, Ltd., London, ) Chambers Franchise ; Global Best Lawyers In America - Franchise ( ) Los Angeles Magazine Southern California Super Lawyers List ( ) Legal Eagle list of top US franchise lawyers in Franchise Times Certified by the California State Bar as a Franchise & Distribution Specialist Jonathan C. Solish Partner, Los Angeles Highly trusted counsel. One of the best franchise litigators in the nation. - Best Lawyers in America Leader and go-to-guy for franchisors. - Who s Who Legal California A tremendously able attorney. - Chambers USA, Franchising Best Lawyers In America - Los Angeles Franchise Lawyer of the Year (2011) Certified by the California State Bar as a Franchise & Distribution Specialist Arindam Kar Partner, St. Louis Keith D. Klein Partner, Los Angeles Mark B. Leadlove Partner, St. Louis Super Lawyers Rising Star, Missouri/ Kansas, 2010 Missouri Lawyers Weekly, Up & Coming Lawyers, 2010 Practice focus on antitrust litigation and counseling Regularly represent franchising distributorships Co-Author of California Franchise Law & Practice Member, California State Bar Franchise Law Committee Argued before California Supreme Court on key franchise-related issue Represents Start-up to Fortune 500 franchisors in hotel and food service industries Certified by the California State Bar as a Franchise & Distribution Specialist Benchmark: Litigation - Future Star (2010), Leading Litigator (2011) Super Lawyers, Business Litigation, Missouri/Kansas, years experience in franchise and distributor litigation issues, commercial litigation, restrictive covenants and trade secret litigation Practiced before numerous federal courts, state courts, administrative bodies and arbitration panels Lieutenant Colonel (Ret.), Judge Advocate, USAR Rebecca A. D. Nelson Partner, St. Louis Glenn Plattner Partner, Los Angeles Anthony J. Marks Counsel, Los Angeles More than 15 years experience advising franchisors about antitrust law issues, as well as a full range of franchise regulatory matters Frequently published author and invited speaker on franchise and distribution related topics Best Lawyers In America - St. Louis Antitrust Lawyer of the Year (2012) SuperLawyer, Antitrust Litigation, Missouri/Kansas Experienced in a wide variety of industries including food service, automotive, hospitality, clothing/footwear, medical instruments and chemicals Los Angeles Magazine Southern California Super Lawyers List ( ) Who s Who Legal One of Top 20 Franchise Lawyers in California ( ) The Franchise Lawyer Associate Editor ( ) State Bar of California Chair, Franchise & Distribution Law Advisory Commission (2008-Present) State Bar of California, Business Law Section Co-chair, Franchise Law Committee ( ) Certified by the California State Bar as a Franchise & Distribution Specialist State Bar of California, Franchise Law Committee - Co-Chair Franchise Law Committee ( ) Co-Author of California Franchise Law & Practice Law & Politics Southern California Rising Stars List ( ) Represents start-up and mature franchisors in domestic and international franchising and merger and aquisition transactions Certified by the California State Bar as a Franchise & Distribution Specialist Philip Haleen Of Counsel, Hamburg 25 years professional experience in Germany Practice focus on distribution and franchise law Regularly establish distribution and franchise systems in Europe R. Andrew Chereck Associate Los Angeles Co-Author of ABA Franchise Desk Book and other publications Shelly C. Gopaul Associate Los Angeles Law & Politics Southern California Rising Star List (2011) Kristy A. Murphy Associate Los Angeles Atlanta Charlotte Chicago Dallas Hamburg Hong Kong Irvine Jefferson City Kansas City London Los Angeles New York Paris Phoenix San Francisco Shanghai Singapore St. Louis Washington, D.C. Bryan Cave LLP 120 Broadway, Suite 300 Santa Monica, CA

5 FranchiseLaw : Online Security BY DAVID ZETOONY & LOUISE NUTT Managing Data Breaches Data breaches are common: more than 300 major breaches involving more than 100 million consumer records are reported each year. Almost every breach is unanticipated and extremely costly (studies indicate that companies often pay between $50 and $79 per lost record). Like most companies, franchisors have significant quantities of sensitive data that often includes information on customers, employees, and their franchisees. Franchisors face an additional obstacle: their franchisees often collect large quantities of sensitive data about their customers and their employees. When franchisees experience data security problems, those problems often have a ripple effect that creates severe reputational (and often legal) costs to the entire franchise system. Promoting good data security practices internally and among franchisees is essential. The following steps may help reduce the chance of a data security breach occurring in the first place, and the costs of dealing with a breach if (or when) one does occur. 1. Have an up-to-date security policy. Many companies (including franchisors) do not evaluate security risks regularly. Every business should consider evaluating its data security policy at least annually. Reviews should include how the business is collecting information, the types of information being collected, what steps have been taken to keep that information safe, and internal policies regarding use of technology. An annual review is a good time to consider new (and old) technological threats. For instance, a good security policy should take into account where breaches occur. Consider the following rough breakdown of the types of breaches, and ensure your security policy addresses each: 40 percent laptop thefts (half stolen outside the company, half stolen inside); 20 percent human or software error; 15 percent non-laptop theft; 15 percent hackers; and 10 percent employee intentional acts. 2. Train franchisees on data security. The FTC recently suggested that a company can be held liable for giving sensitive information to another company that does not employ good data security practices. This raises the question of whether a franchisor is liable for a franchisee that does not use good security practices. Although this legal issue is currently the subject of debate, as a practical matter the bad security practices of a franchisee can be devastating to the business reputation of the entire franchise. As a best practice, provide routine training to franchisees on topics such as 1) recommended procedures for data disposal of data, 2) data security, and 3) mandatory and recommended procedures for responding to data security incidents in short, any situation that might involve an unauthorized person getting hold of sensitive data. 3. Require franchisees to notify you of security incidents. Often, franchisees do not have the expertise or knowledge to properly investigate and respond to a data security incident. To protect the brand and to ensure that data security incidents are handled quickly and appropriately, franchisors should consider requiring franchisees to report data security incidents to them immediately, to fully comply with any legal obligation to investigate the incidents, and, if legally required, to report the incident to governmental authorities and consumers. 4. Create a consumer notification policy. Almost every state has passed a statute requiring companies to notify consumers in certain instances in which data becomes breached. Most notification statutes, however, provide that if a company creates a policy for notifying consumers consistent with the law s timing requirements, then a company complying with its own policy will be deemed in compliance with the statute. Fashioning a recommended notification policy for all franchisees, in addition to a policy for internal reporting and procedures, can help avoid some of the largest costs associated with consumer notifications. For instance, a data breach notification policy may provide that a company can alert consumers of data security breaches using instead of regular mail. 5. Keep a written chronology of the breach. The hours and days following a breach are usually hectic. Few franchisors or franchisees keep a formal log of what the franchisee or franchisor knows, and when the information was discovered. Have your attorneys (or whomever is investigating the incident) keep a detailed written chronology that can form the basis of what may ultimately become an incident response report, which can save countless hours reconstructing the events. Conclusion Perhaps the most important rule to keep in mind in the context of data security is to learn from past incidents, and to continually re-evaluate how you and your franchisees protect information and respond to security events. Setting time aside each year to reassess your overall security practices, and time after each security event to consider where the company responded well, and where the company s response could be improved, can save a large amount of time and money down the road. n David Zetoony is an attorney at Bryan Cave LLP in Washington, D.C. He has assisted dozens of companies to respond to data security incidents and government investigations resulting from data security breaches, and is the co-author of Data Security Made Simpler, a publication of the Council for Better Business Bureaus. Contacted him at david.zetoony@bryancave. com. Louise Nutt is an attorney at Bryan Cave in Los Angeles. She can be contacted at louise.nutt@bryancave.com. Q FranchiseLaw 3

6 Go for it. We ve got your back. At Roetzel, our attorneys are like our clients - entrepreneurial, innovative and results oriented. Just ask Dick Mulligan and Tony Calamunci. Our franchise law attorneys focus on maximizing opportunities and minimizing risks so you can focus on your business. Team members, including Tae Shin, Mike Carey, Judi Levine, Steve Funk, Dick Mulligan and Tony Calamunci, have your back. To learn more, call Tony at or Dick at Visit us at ralaw.com/franchise_law, and follow our franchise law blog at ralawfranchiselaw.blogspot.com. NEW YORK CHICAGO CLEVELAND TOLEDO AKRON COLUMBUS CINCINNATI WASHINGTON, D.C. TALLAHASSEE ORLANDO FORT MYERS NAPLES FORT LAUDERDALE

7 FranchiseLaw : Ownership Matters By Richard S. Mulligan Does It Matter How You Own Your Franchise? A State of Washington Appellate Court ruling (Marte v. Hernandez, May 16, 2011) demonstrates that deception can cause even blood relationships to disintegrate. In this case, two brothers formed a partnership and purchased two Mc- Donald s franchises. McDonald s does not sell franchises to partnerships. It sells franchises only to individuals or to entities wholly owned by an individual (both the equity interests and any interests in profits). To avoid McDonald s requirements, only one of the brothers applied to McDonald s as a franchisee, while the other was a financial investor and partner providing a portion of the money needed to purchase the franchise and fund the initial operating costs. The brothers concealed the existence of the partnership and further misrepresented the purpose of the investor brother s financial contributions to the partnership. The brother listed as the franchisee died about a year after the business began. The investor brother filed a claim against the deceased s estate, arguing that he had an interest in the partnership. The estate rejected his claim and the investor brother then filed suit. The Appellate Court concluded that the partnership was unlawful and any agreement between the brothers with respect to the partnership was unenforceable because it violated a Washington securities statute that makes it unlawful for any person to engage in any act that operates as a fraud upon another person, when the act is in connection with the sale or purchase of any security. The investor brother argued that his acquisition of the partnership interest was not a security and that the securities statute did not apply. The court reasoned that this argument was not persuasive because the investor brother supplied funding but depended on the other brother s managerial efforts. The court further held that even if the partnership did not amount to a security, the brothers violated the Washington If the franchise is not owned in the proper manner or if attempts are made to transfer it, the franchisor has the right to object and may terminate the franchise. Franchise Investment Protection Act, which prohibits using a scheme to defraud or engage in any act that operates as a fraud upon any person. The brothers committed fraud upon McDonald s when they intentionally concealed the existence of the partnership and listed only one of the brothers as the franchisee, and this fraud rendered the partnership unlawful. As a result, the court refused to enforce the partnership agreement between the brothers, and the investor brother lost his investment and his claim to ownership of the franchise. Further, while not discussed in the case, the deceit by the brothers almost certainly gave McDonald s the right to terminate the franchise agreement with the deceased brother. Franchisors are careful to set forth guidelines as to how a franchise may be owned. Great detail is described in the Franchise Disclosure Document (FDD) and in the franchise agreement. Pay attention to these important documents and seek advice on how to own your franchise because, as evidenced by Marte, the ownership structure of the franchisee is a very important initial step to consider. Properly structuring the ownership of the franchisee should not be done in a haphazard fashion or with the thought that it can easily be changed in the future. Once the owner of a franchise is established, the franchisor will most likely have policies that restrict or prohibit the transfer of an interest in the franchise to another party. Franchisees may wish to gift interests to family members or transfer to trusts established for estate planning purposes. Each of these transfers may be subject to the franchisor s review and approval. The bottom line is that the ownership structure of a franchisee is subject to the rules and procedures that the franchisor sets forth; and those provisions must be understood and dealt with at the time the franchise is purchased and throughout the ownership of the franchise. If the franchise is not owned in the proper manner or if attempts are made to transfer it, the franchisor has the right to object and may terminate the franchise if proper approval is not obtained. As this case demonstrates, not only the franchisor has an interest as to how the franchise is owned and titled, but so do the other purported owners of the franchise. Attempts to cut corners or conceal the truth in hopes of not getting caught are very risky, and you may find yourself on the outside looking in, having lost your investment of time, money, and effort. n Richard S. Mulligan is a partner in the Columbus, Ohio office of Roetzel & Andress and represents franchisors and franchisees in his business practice. Contact him at Katy Wiles, an associate of Roetzel & Andress, assisted with this article. Q FranchiseLaw 5

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9 FranchiseLaw : Consultants and Lawyers BY MICHAEL SEID AND KAY MARIE AINSLEY The Different Roles of Consultants and Lawyers The most obvious area in franchising where the lines between consultants and lawyers frequently blur is within the professional services provided to emerging franchisors. Companies new to franchising have difficulty understanding the essential differences between services provided by experienced franchise legal counsel and those provided by qualified franchise consultants in developing the structure and strategy of a franchise system. Mature franchisors generally have a better understanding of the nature of franchising and what constitutes a business issue and a legal issue, and can therefore engage the proper advisors to assist them. Emerging franchisors often are more naive and are led to believe that because franchising requires defined legal documents and sales methodologies the law has a greater role in the structure of a new franchise system than do the underlying business issues. Without causing too much consternation among our legal colleagues and friends, in some areas of the law (and certainly in some areas of applying the law), business advisors may have a superior understanding than do lawyers. This is common in many specialized industries and is the linchpin of the debate concerning the unauthorized practice of law. (A discussion of this issue can be found in the 2007 ABA presentation, The Respective Roles of the Franchise Consultant and the Franchise Lawyer in Structuring the Franchise System, by Lenny Vines and Michael Seid.) However, business advisors are not lawyers and do not have the depth of training and understanding of the nuance of the law, especially in areas of the law that do not routinely affect their clients businesses. Consultants should never get caught in the trap of thinking they can provide legal advice, even when it may be legally allowed, and by extension practice law unnecessarily. It is past time that members of the bar and the ABA begin to focus on some of the bad practices in this area including, but not limited to, consultants preparing form agreements for review and approval by their client s general legal counsel. Consultants view their primary role as helping their clients assess their current business performance and developing strategies and tactics to change and grow the channel sufficient to maximize the returns for all stakeholders. Clients turn to us and other professional business advisors because we bring to the table experience and expertise from working with numerous other companies in a wide variety of industries. This outside expertise offers them a unique and external perspective on their own situation and frequently enables us to develop approaches more quickly and with greater clarity and lower cost than they could do internally. The primary role of the lawyer, from the perspective of the business advisor, is to ensure that the strategies and tactics developed by business management are legal and that documentation required to execute that strategy is properly prepared and, where necessary, filed and approved. Just as lawyers chafe at consultants who make legal representations and recommendations, consultants are equally alarmed by lawyers who propose business strategies often based on limited knowledge or research and prepared without using the same professional rigor generally applied by the consultants in reaching their conclusions and recommendations. Indeed, from the viewpoint of the professional consultants, the practice of business without due care by lawyers is as risky (maybe more so) for the client as is the practice of law by the nonlawyer. Simply because providing business advice generally does not require a license (as does the practice of law) does not mean that professional standards in consulting do not exist. Similar to the ABA, the AICPA has standards of practice and ethics that professional consultants who choose to be members must apply in their practice. While lawyers may offer business advice, they need to understand that simply giving their clients averages or structures that have been used by other clients before is not adequate. As with the lawyers, there are professional rigors in developing strategies and tactics employed by business consultants, and unless a lawyer follows a similar rigor, they should not be providing that level of advice to their clients. Clearly, in providing professional services to franchisors, consultants and lawyers cross over into each other s turf on a regular basis. This is both needed and beneficial. However for the benefit of the client, it is important that each discipline respect the need for the other s contribution. Best practices, even in simple systems, must involve both disciplines. The services lawyers and consultants bring to a franchisor are distinct and important, and both are needed. n Michael Seid and Kay Ainsley are managing directors of MSA Worldwide, the nation s leading franchise advisory firm, providing guidance to new and established franchisors. Contact them at or mseid@msaworldwide.com, or or kainsley@msaworldwide.com. Q FranchiseLaw 7

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12 Rely on the Experts at MSA for Litigation Support. Attorneys and their clients know to rely on the vast franchise experience and industry knowledge of MSA when preparing for litigation. If your case would benefit from the opinions of credible, seasoned and respected franchise professionals for expert witness testimony, litigation and alternative dispute resolution support services, call MSA. Contact Kay Marie Ainsley, Managing Director at Contact Michael Seid, Managing Director at msaworldwide.com