• Franchise & Dealership Law
  • Need for Disclosure?
  • Federal Requirements
    • Federal Trade Commission Rule
      • The FTC Document
        • Information about the Franchisor
        • Information about the Franchisee
        • Details of the Franchise Agreement
        • Supporting Facts for any Earnings Claims Made by the Franchisor
      • The UFOC
    • Federal Penalties for Failure to Disclose
  • California Requirements
  • Other States' Requirements
  • The Termination Decision
    • Step One: Determine the Reasons for the Termination
    • Step Two: Review the Written Agreement
      • Termination Provisions
      • Forum Selection, Arbitration, Choice of Law, and Integration Clauses
        • Choice of Law Provisions
        • Forum Selection Clauses
        • Arbitration Clauses
        • Integration Clauses
    • Potential Antitrust Concerns
    • Dealer Protection Statutes
      • State Franchise Acts
      • Deceptive Trade Practices Acts
      • Industry Specific Legislation
      • Good Cause for Termination?
      • Who is Liable?
    • Common Law Considerations
      • What is the Contract?
      • Unwritten Terms
      • Terms Implied by Operation of Law
    • Damage Analysis
  • Recommendations for Distributors and Dealers
  • Recommendations for Manufacturers
  • Resources

Franchises have become a popular option for many prospective business owners. Especially for a person starting out in the business world, a franchise offers a relatively simple way to run a business without having to develop new marketing strategies, logos, products, services, or a corporate identity. The person or company that grants the right to a franchise (the franchisor) and the person or company that is granted a franchise (the franchisee) invest a great deal of time, money, and energy into the relationship. Franchises are not trouble-free, however, and even a sophisticated businessperson can seriously overestimate the earning potential of a new franchise or the amount of operational support he or she can expect from the franchisor.

Two areas generate most disputes in franchise law--the initial offer and the termination decision. Franchisors and franchisees who want to stay on the right side of the law and have mutually satisfactory business relations need to be aware of state and federal franchise laws. These laws require disclosure by the franchisor of the most significant terms of the franchise relationship and impose penalties for not following the disclosure requirements. Franchisors and franchisees also need to be aware of the complex legal framework surrounding termination of franchises.

Failure to understand the risks involved in opening a franchise can be a costly mistake. A key to understanding franchise regulations is recognizing that the law does not try to eliminate risk for investors. In keeping with capitalist economic ideals, the law does not seek to prevent businesspersons from making poor business decisions; rather, it seeks to ensure that businesspersons are able to make informed decisions regarding franchise opportunities. If, after learning all the facts about a franchise opportunity, an investor still wants to undertake the risks inherent in opening a franchise, he or she is free to do so.

The Federal Trade Commission (FTC) enforces federal laws and rules regulating franchises. These rules apply only to franchises that are "in or affecting interstate commerce." For federal franchise laws to apply, it does not matter what the written agreement is called as long as the relationship meets the FTC's definition of a franchise. For example, if a business is entering into what it calls a limited partnership, it also may be entering into a franchise agreement for purposes of the FTC's franchise regulations. The FTC rules define a franchise as a "continuing commercial relationship" between two or more parties.

There are three basic types of "continuing commercial relationships" covered by the FTC rules. They are:

• Package franchises, or "business format" franchises, which are prepackaged business programs developed and identified by the franchisor. McDonald's is an example of a package franchise.

• Product franchises, in which the franchisor sells goods that bear his or her trade name to a franchisee, who sells them to the public under the same name. The franchisor maintains some degree of control over the selling of the goods by the franchisee under this arrangement.

• Business opportunity ventures, defined as arrangements in which the franchisee is required to buy and sell the goods or services of the franchisor or another business. The franchisor arranges the location of the business, seeks out business for the junior partner, and may even provide employees. An example of this type of arrangement is a vending machine route. The franchisor finds a place to put the machines and sells the candy to the franchisee, but the franchisee collects the money and restocks the machines.

Federal Trade Commission Rule

The FTC requires franchisors and sellers of certain other business opportunities to disclose certain material facts before a sale can be closed. These disclosure requirements officially are titled "Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures" and are frequently referred to as the "FTC Rule." The coverage of the FTC Rule is quite broad, but some narrow exceptions to coverage are available. For example, certain presentations at business opportunity trade shows are specifically exempt from the FTC Rule and some franchises have been exempted from coverage by informal advisory opinions issued by FTC staff. A lawyer familiar with this area of practice should be able to advise whether a particular venture would qualify for an exemption.

There are two official forms that a franchisor may use to meet the disclosure requirements of the FTC Rule--the FTC Disclosure Document (FTC document) and the newer Uniform Franchise Offering Circular (UFOC). Although either form is acceptable for compliance with the FTC Rule, the FTC document does not meet the requirements of most state disclosure laws. The UFOC is acceptable (with minor alterations) in all states with franchise disclosure laws. The two documents have some similar sections, but the franchisor may not pick and choose sections from each document; either the entire FTC document or the entire UFOC must be completed.

The FTC Document

The FTC document requests information in four broad categories--information about the franchisor, information about the franchisee, details of the franchise agreement, and supporting facts for any earnings claims made by the franchisor.

Information about the Franchisor

The FTC document must contain the following information about the franchisor:

• The business history of the franchisor

• The employment history of the officers and executives of the company

• The litigation history of the officers and executives of the company

• The history of the company and certain key individuals with regard to filing for bankruptcy

• Financial statements

Information about the Franchisee

The FTC document must contain the following information about the franchised business:

• Detailed description of the franchised business

• Initial investment to be made by the franchisee

• Any requirements that the franchisee make certain purchases or use specific suppliers

• Details of any finances provided by the franchisor

• Services that the franchisor is obligated to perform on behalf of the franchisee

• Right to use trademarks, patents, and copyrights

• Restrictions, if any, on sales

• Details about both current and terminated franchisees

• Site selection

• Employee and management training

Details of the Franchise Agreement

The disclosure statement must contain the following information about the franchise agreement:

• Required fees

• Exclusive right to serve an area

• Extent of the franchisee's personal participation in the business

• Renewal, repurchase, and termination rights and responsibilities

• Procedures for modifying the agreement

• Covenants not to compete

• Term of the agreement

• Arrangements upon the death of the franchisee

Supporting Facts for any Earnings Claims Made by the Franchisor

Information to support earnings claims is required only if the franchisor has made such claims, typically in promotional materials to prospective franchisees. Some franchisors have been tripped up by this requirement because they have not understood how broadly the term "earnings claims" is interpreted by the FTC. Earnings claims include oral, written, or visual representations that can be used to calculate, state, or even suggest sales, income, or profit levels. Also included are claims of past or potential future earnings, or data presented in such a way that income or costs could be calculated by arbitrarily selecting a sales figure. An attorney experienced in this area of compliance can help a potential franchisor understand whether any of his or her statements might be considered earnings claims.

The UFOC

The UFOC was developed by the Midwest Securities Commissioner's Association with the goals of making franchise disclosure statements shorter and easier to read and understand, and of requiring disclosure of additional helpful information while eliminating information of little use but still required by the FTC document. The UFOC has 21 major items:

• Item 1--Background Information. Basic information about the franchisor and franchise offering, definitions of terms used in the circular, and regulations specific to the industry in which the franchise will operate.

• Item 2--Business Experience. The business experience of the franchisor's directors, officers and executives.

• Item 3--Litigation History. The litigation history of the franchisor, predecessors, and affiliates selling franchises under the franchisor's principal trademark, including confidential settlement terms of concluded litigation.

• Item 4--Bankruptcy History. Whether the franchisor, any predecessor, or general partner has been involved in a bankruptcy or reorganization within the past 10 years.

• Item 5--Initial Fees.

• Item 6--Ongoing Fees. In tabular form, all additional, ongoing fees to be paid by the franchisee, including but not limited to royalties, service charges, lease payments, and advertising fees.

• Item 7--Initial Investment. In tabular form, the initial costs and expenses.

• Item 8--Required Purchases:
  • Restrictions on sources of products and services, including required purchases by the franchisee
  • Disclosure of any franchisor or affiliate revenues from any required purchases or leases
  • The existence of any purchasing or distribution cooperatives
  • Disclosure of any consideration the franchisor receives from any required sales or leases of supplies by the franchisee
  • Disclosure of any requirement that the franchisor negotiate purchase agreements with suppliers on behalf of franchisees

• Item 9--Franchisee Obligations.

• Item 10--Financing. All direct or indirect offers of financing, and the franchisee's potential liabilities upon default.

• Item 11--Franchisor Obligations. Details of the franchisor's obligations to the franchisee, including site location, training, record-keeping, and advertising.

• Item 12--Territorial Limitations.

• Item 13--Trademarks. The principal trademarks, service marks, trade names, logotypes, or any other commercial symbols to be licensed to the franchisee.

• Item 14--Patents & Copyrights. All patents and copyrights to be licensed to the franchisee and the terms, conditions, and duration thereof.

• Item 15--Operation of Business. The obligation, if any, of the franchisee to participate personally in the direct operation of the business and whether the franchisor recommends such participation.

• Item 16--Restrictions on Goods and Services Sold by the Franchisee.

• Item 17--Termination and Other Events. In tabular form, the conditions for termination, renewal, repurchase, modification, or assignment of rights under the franchise agreement.

• Item 18--Public Figures. The names of public figures whose images are used in the promotion of franchise sales, compensation given to the public figures, their actual interest in the franchise, and the extent of their actual involvement in the business.

• Item 19--Earnings Claims. Any reasonable earnings claims made in the franchisor's offer. If no earnings claims are made, the UFOC must contain a negative disclosure, the wording of which is specified in the UFOC Guidelines.

• Item 20--Statistics. Statistics about the franchisor's total number of franchises, broken down by location, type of franchise agreement, and owner, and the names of terminated franchisees, dates of termination, and reasons for termination.

• Item 21--Financial Statements. Detailed financial statements of the franchisor conforming to Generally Accepted Accounting Principles and audited by an independent public accountant.

Federal Penalties for Failure to Disclose

The FTC has authority to impose fines of up to $10,000 per day, to order rescission, reformation, payment of refunds and damages, and to issue cease and desist orders against franchisors who fail to follow disclosure requirements. Persons liable for failing to properly disclose may include directors, officers, brokers, subfranchisors, attorneys, accountants, and other individuals. Currently, there is no private cause of action provided under federal law, although Congress is considering legislation that would provide a private cause of action for injunctive relief and damages.

Under the California Franchise Investment Law and the California Franchise Relations Act, a franchise is an agreement between two or more persons that gives the franchisee a right to do business using all or most of the franchisor's marketing plan, trade name, trademark, service mark, logotype, advertising, or other commercial symbol, for which the franchisee pays a franchise fee. The California Franchise Investment Law requires any offer or sale of a franchise to be registered with the Commissioner of Corporations on a Uniform Franchise Registration Application. Certain offers and sales, however, are exempt from this requirement if the franchisor meets minimum requirements for net worth, experience, and disclosure and has filed a notice of exemption with the Commissioner. If registration is required and the application is approved, the registration is valid for one year. The registration may be renewed for additional periods of one year each. The fee for filing an application for registration of a franchise offer is $675; the fee for renewal is $450. The fee for filing an initial notice of exemption is $450; the fee for each subsequent notice is $150.

Many other states have franchise or general business opportunity statutes that require disclosure by the offeror. There is little uniformity among states' regulations. Some state laws only apply to limited types of franchises, some apply only to transactions within their borders, and others apply to franchisors located within their borders even if the offer is made to someone in another state. Several states make a franchisor's failure to provide an offering circular or disclosure document an automatic violation of state law. It is wise to check the requirements in each jurisdiction in which one is planning to offer a franchise or general business opportunity. An attorney experienced in representing franchisors should be familiar with the complexities of multi-state offerings.

Manufacturers, distributors, dealers, and their attorneys often wrongly assume that the respective rights and responsibilities of the parties in a franchise agreement are completely defined in the written agreement and by federal antitrust laws. In fact, manufacturers and dealers or distributors have rights and responsibilities that may be different from--or even contrary to--the specific language of the written document or federal antitrust laws.

A proper evaluation of a dealer termination requires the following six-step analysis: (1) determine the reasons for the termination, (2) review the written agreement, (3) evaluate potential antitrust concerns, (4) analyze potentially applicable dealer protection statutes, (5) consider the potential for common law contract and tort claims, and (6) do a damages analysis. Manufacturers typically do a good job on steps 1 through 3, then skip steps 4 and 5 entirely, thereby underestimating their damages exposure. Such oversights can be very costly.

Step One: Determine the Reasons for the Termination

The first step in analyzing the termination decision is to determine all actual and arguable reasons for the termination, because the ultimate decision as to whether the termination is lawful will depend on what the factfinder concludes is the real reason for the termination. From the manufacturer's perspective, it is crucial that the manufacturer's attorney be involved in the termination planning process, so that the array of arguable reasons for termination can be examined in light of the other factors listed below, and a course of action can be planned that will minimize the likelihood of litigation. Documents that arguably support or refute any potential reason for the termination also should be reviewed as a part of this step.

Step Two: Review the Written Agreement

The second step in analyzing the termination decision is to review the written agreement between the manufacturer and dealer. The primary focus in reviewing the written agreement should be on the provisions concerning termination.

Termination Provisions

Termination clauses in written dealer agreements tend to fall into two broad categories: termination at will clauses and termination for good cause clauses. Following are examples of the language in these categories.

Common Termination at Will Language: "The Dealer's appointment may be terminated at any time by written notice by either the Company or the Dealer to the other party given at least one hundred twenty (120) days prior to the effective date specified in such notice."

Common Termination for Good Cause Language: "Company may terminate this Agreement by giving Dealer not less than sixty (60) days prior written notice of termination in the event of any of the following:

• Dealer does not maintain a level of sales of products and parts to the satisfaction of Company as required by this Agreement.

• Dealer does not perform satisfactorily its obligations listed in this Agreement.

• Failure of Dealer to perform any of the promises given or obligations undertaken in this Agreement.

• Any dispute, disagreement or controversy between or among principals, partners, managers, officers or shareholders of Dealer, which in the opinion of Company may adversely affect the business of Dealer or Company."

"Company may terminate this Agreement immediately by delivering to Dealer or its representative written notice of such termination in the event of any of the following:

• Any transfer or assignment, or attempted transfer or assignment of this Agreement or any right or obligation hereunder or any sale or transfer of any interest in the ownership or active management of Dealer without prior written approval of Company

• The insolvency of Dealer

• The filing of a petition for bankruptcy or for reorganization, whether voluntary or involuntary

• If Dealer makes an assignment for the benefit of creditors

• If a receiver is appointed for a Dealer or its property if Dealer defaults in the payment of any obligation owing to Company or its affiliates, successors or assigns; or, upon demand fails to account to Company, or its affiliates, successors or assigns for the proceeds from the sale of goods for which Dealer is indebted to Company or its affiliates, successors or assigns.

• Dealer makes any material written or oral statement or representation which is false or otherwise misleading."

Forum Selection, Arbitration, Choice of Law, and Integration Clauses

Within the last five years, manufacturers and franchisors increasingly have used, and courts increasingly have enforced, contractual provisions intended to modify or circumvent statutory requirements.

Choice of Law Provisions

A choice of law provision in a contract is an agreement that any dispute arising out of the agreement will be determined applying the laws of a particular state. An enforceable choice of law provision dramatically affects the rights of those on both sides of the distribution relationship, because there is a wide variety of state laws regulating the termination or substantial alteration of distribution relationships, and a great disparity in the nature and amount of regulation.

Historically, state statutes regulating the conduct of parties to a franchise or dealership agreement have been viewed as the embodiment of the state's public policy and, as such, the statutes prevailed over conflicting language in agreements between the parties. Recent cases, however, have dramatically eroded this view and have led to the development of a four-part test to determine whether conflicting contractual provisions--such as choice of law provisions designating the law of a different state to govern--should eliminate statutory protection that otherwise would be available:

• Did the parties agree to the choice of law in advance?

• Is there an equal number of parties in each state?

• Are the parties of relatively equal bargaining strength?

• Is the application of the law chosen repugnant to the public policy of the franchisor's state?

Not all jurisdictions have followed this trend, however and some states' courts are resisting the trend toward enforcement of choice of law provisions that effectively take away franchisees' and dealers' statutory protections.

Forum Selection Clauses

As a practical matter, a terminated dealer may be much less willing or financially able to pursue litigation in a forum distant from the dealer's home state. Also, the manufacturer's or dealer's home forum may have more sympathetic judges and juries. Forum selection clauses, therefore, also may have a profound effect on the ultimate consequences of termination. Like choice of law provisions, the courts seem increasingly willing to enforce forum selection clauses.

Arbitration Clauses

Arbitration clauses are proliferating in franchise and dealer agreements, and for the most part continue to be received warmly by federal courts, even though some state laws designed to protect dealers and franchisees specify that arbitration cannot be required of disputing parties.

Integration Clauses

Manufacturers often assume that if a contract contains an "integration clause"--a clause indicating that the written document is the "entire agreement" between the parties--they need not consider other communications or practices that might otherwise affect the agreement. While integration clauses are often effective against some types of claims, it is dangerous and often erroneous to assume that an integration clause will erase the effect of promises and conduct not contained in the written document. Courts often take into account, under a variety of legal theories, what the parties' "real agreement" is. Courts frequently consider the parties' oral communications, their course of dealing, the custom and practice, and other conduct and statements outside of the written agreement--even when the document contains an integration clause.

Step Three: Evaluate Potential Antitrust Concerns

Even when federal antitrust laws pose no problem, state antitrust laws may differ from their federal counterparts. The best antitrust insurance is to have a good reason for terminating a relationship, or a bad reason may be inferred.

Step Four: Analyze Potentially Applicable Dealer Protection Statutes

States have a number of ways to protect dealers from unfair termination decisions.

State Franchise Acts

Many states have statutes that specifically govern franchise relationships, often prohibiting termination of the relationship by the franchisor except for good cause. For example, California regulates franchise sales under the Franchise Investment Act and controls other aspects of the franchise relationship, such as termination, under the Franchise Relations Act. The definition of franchise and the extent of regulation varies from state to state. Most, but not all, of the states require the payment of consideration from the franchisee to the franchisor in order to qualify as a franchise relationship.

"Little FTC" and Deceptive Trade Practices Acts

In addition to statutes regulating certain types of distribution relationships, another potentially applicable source of statutory rights and duties is found in statutes regulating business conduct in general. These statues commonly include deceptive trade practices acts and "Little FTC" acts.

Most, if not all, states have consumer protection statutes, many of which are modeled after the Uniform Deceptive Trade Practices Act. These statutes generally prohibit "deceptive" trade practices and therefore may encompass conduct that might not meet the definition of fraudulent. However, they frequently provide only for injunctive relief, not damages. California has an Unfair Practices Act and various consumer protection laws. Additional information on these laws is provided in the Antitrust Chapter and in the Consumer Protection Chapter.

Many states have statutes patterned after Section 5 of the Federal Trade Commission Act, which prohibit unfair methods of competition and unfair or deceptive acts or trade practices. Unlike most deceptive trade practices acts, these "Little FTC" acts prohibit "unfair" conduct as well as deceptive conduct, and often allow private actions for damages, attorney's fees, and sometimes multiple damages. These claims have been successfully advanced in some dealer termination cases.

The search for potentially applicable state dealer protection statutes must go beyond the state where the distributor or dealer has its principal place of business, and must include (1) the other states in which the distributor or dealer is doing business, (2) the state where the manufacturer has its principal business location, and (3) any other state mentioned in any choice of law clause in the written dealer agreement.

Many dealer and franchise statutes have been enacted relatively recently, and their applicability to existing contracts is often in dispute. These disputes frequently arise either under statutes that do not address retroactive application, or under statutes that apply to agreements with no expiration date that were in effect at the time the statute was enacted. Even if a statute purports to apply to a contract existing prior to its enactment, the court may decline to apply the statute because of concerns over the constitutionality of its retroactive application. An attorney experienced in franchise litigation should be able to advise a concerned party about whether state law applies.

Industry Specific Legislation

Several industries have industry-specific statutes that govern their particular manufacturer-dealer relationships. Among the industries with industry-specific dealer protections are petroleum, automobiles, farm implements, beer, and construction and industrial equipment. Typically, these statutes have arisen out of prior terminations and litigation in those particular industries. The definitions in industry-specific statutes are often broad, and the titles of those statutes can be misleading. It is imperative, therefore, that all potentially applicable industry-specific statutes be consulted in order to determine whether they apply.

Is There Good Cause for Termination?

Assuming that either an industry-specific or a general franchise termination protection statute applies, the next question is whether there is a violation. Because statutes generally require "good cause" for termination, cancellation, nonrenewal, or (in some cases) the substantial change in competitive circumstances, the first question is what is "good cause"? The applicable statute itself often spells out at least some of the acts, omissions, or circumstances that constitute good cause. If the statutory "laundry list" is not applicable to a particular situation, the following commonly constitute good cause:

• Failure to meet performance criteria. To constitute good cause, the performance criteria must be reasonable, essential, and applied in a non-discriminatory way.

• System-wide changes. A non-discriminatory, reasonable change in all of a manufacturer's dealerships may constitute good cause under certain circumstances.

• Violations of contract or law.

• Market withdrawal. There are conflicting decisions as to whether a manufacturer's withdrawal from a market constitutes good cause. However, a change in distribution allegedly required by economic necessity is not good cause for termination of existing dealers absent withdrawal from the market.

Who is Liable?

A question arising with increasing frequency in these days of mergers and acquisitions is the liability of a successor manufacturer for his or her predecessor's obligations to dealers. In recent years, the agricultural and construction equipment industries have seen numerous acquisitions of one manufacturer's business by another through asset purchase transactions. In these transactions, the purchasing manufacturer typically disclaims assumption of the selling manufacturer's agreements with its dealers. A dealer terminated by the selling manufacturer under such a scenario is faced with what appears to be no-win situation: the terminated dealer can pursue a judgment against an entity that no longer exists or no longer is solvent, or the terminated dealer can seek redress from the purchasing manufacturer, who undoubtedly will disclaim any obligation to the dealer. Generally, attempts to establish common law successor liability on manufacturers in asset purchase situations do not succeed. However, some courts and legislatures have attempted to impose successor liability under these circumstances.

Step Five: Common Law Considerations

The fifth step concerns common law considerations. This is the step that very few manufacturers and dealers or their counsel complete, but frequently it is the most important. Even when a written agreement states that it is the entire agreement between the parties and that it may be terminated without cause on short notice, when no protective state legislation applies, and when the termination takes place under circumstances that are unlikely, termination without good cause still may be unlawful.

What is the Contract?

The franchise contract consists of the parties' various expressions of interest. California courts have broadly defined a contract as a legal relationship creating enforceable obligations between two or more parties. The usual requirements for a valid contract are offer, acceptance, consideration, competent parties, and a legal purpose. A contract may be express or implied. Express contracts are those in which the terms of the contract are disclosed in the words or writings of the parties. Implied contracts are those in which the agreement is inferred from the acts, conduct, or course of dealings of the parties. A contract can be oral, written, or partly oral and partly written.

Unwritten Terms

The enforceable agreement may be different from, or even contrary to, the written contract for several reasons. Often, there are oral communications between field or territory representatives of the manufacturer and the dealer concerning the duration of the dealership or the circumstances under which it may be terminated. These communications, if enforced, may prevent termination even when the written agreement does not.

Such evidence is admissible to explain or clarify ambiguous writings in all jurisdictions. If the language used in a contract is "reasonably susceptible of more than one meaning," it is ambiguous. In such cases, evidence of the custom and practice in the industry with respect to dealer terminations, and the course of dealing between the particular manufacturer and dealer, commonly is admissible to assist the jury in determining the extent of the agreement. Courts have permitted introduction of evidence of course of performance, dealing, and usage of trade, as long as that evidence does not completely negate the terms of the written contract.

Terms Implied by Operation of Law

Additional, contrary terms may be implied by operation of law. An obligation of good faith is implied by the common law of most states. Although the covenant of good faith and fair dealing cannot be extended to contradict specific contract terms, it may provide rights not found in the written contract.

If a manufacturer has, by its conduct, led the dealer to believe it would not rely on a particular clause against that dealer, the dealer may invoke the doctrine of "estoppel." The manufacturer is said to be "estopped" or prevented from relying on the clause in question.

"Recoupment" implies a minimum term in an at-will agreement, and is defined as the length of time in which the dealer can reasonably be expected to recoup its investment. It is a breach of contract if the agreement is terminated before the recoupment term. A few courts have interpreted the recoupment doctrine to apply only to exclusive dealers.

Fraudulent inducement generally means one person has misrepresented a material fact, knowing it is false, intending that the other party rely on the misrepresentation, and on which the other party does, in fact, rely. The person making the promise must have had--or appeared to have had--the authority to make the representation. Franchisors are having increasing success in asserting that the integration clauses contained in the written agreements bar, as a matter of law, fraudulent inducement claims.

Another issue that is frequently overlooked is whether the conduct of the manufacturer satisfies the elements of tortious interference with contracts and prospective contractual relationships. By introducing a tort theory of liability into dealer termination litigation, the possibility of punitive damages follows. This may have a substantial effect on the manufacturer's potential exposure and the terminated dealer's potential recovery. Tortious interference theories may successfully be employed in dealer termination litigation, and may give rise to liability under circumstances in which no obligation can be found in the relevant agreements or statutes. Tortuous interference with a contract is intentionally and improperly interfering with the performance of a contract between another and a third person by causing the third person not to perform the contract.

Many jurisdictions also recognize a cause of action for tortious interference with prospective business relationships. Elements of this tort generally include: (1) the existence of a valid business relationship or expectancy, (2) knowledge of the relationship or expectancy on the part of the interferer, (3) an intentional interference causing a breach or termination of the relationship or expectancy, and (4) resulting damage to the party whose relationship or expectancy has been disrupted. There are three types of interference that may occur in the franchise context: (1) interference with the dealer/distributor contractual relationships with its customers and prospective customers, (2) interference with the contractual relationship between individual owners or operators and the corporate entity itself, and (3) manufacturer refusal to provide customary and reasonable assistance to the dealer during the time between notice of termination and the effective date.

Step Six: Do a Damage Analysis

Manufacturers may minimize potential liability problems because they assume damages will be limited to a standard formula, such as a multiplier of the pro rata net profits of the dealership. There are at least two reasons why this common assumption is not valid.

First, different liability theories justify different types of damages recoveries. Statutory violations typically permit the recovery of attorneys' fees. The recoupment theory permits the recovery of unrecouped investments in the dealership. For example, a dealership that has never made a profit, but has lost $500,000 over the years in an effort to build up a market for the manufacturer's product, may be able to recover that amount, plus interest. Tort theories create the possibility of punitive damages in an amount sufficient to punish the wrongdoer for its conduct and to deter others from engaging in similar conduct in the future.

Second, even in those cases in which the measure of damages is limited to the value of what has been lost, courts have allowed far greater damages awards than what would be yielded by a simple multiplier of the pro rata net profits of the dealership. For example, a dealer who carried five lines of equipment may have covered its overhead with the first four and made its profit on the fifth. The loss of the fifth line represents the difference between profit and loss to the dealer, a loss much greater than the proportion of profit represented by revenues from the terminating manufacturer's product. Some courts therefore have recognized that a dealer whose overhead was not substantially reduced by a termination may recover damages on the basis of anticipated gross profits attributable to the terminating manufacturer's products.

A strategic consideration for both sides in a dealer termination case is whether to seek injunctive relief or a declaratory judgment. Courts recognize that often a dealer threatened with termination will not want to live on the income from a damages award, but would prefer to continue to operate the business. Courts often grant injunctive relief to preserve the relationship pending trial if an injunction is sought before termination becomes effective. However, courts generally are unwilling to grant injunctive relief after the termination becomes effective. In other words, even though one party may prefer the franchise relationship to continue, courts are loathe to order the continuation of a franchise gone sour.

• Ask good questions about how the termination provision will work and obtain a side letter with respect to termination concerns.

• Pay close attention to forum selection, arbitration, choice of law, limitation of damages, and contractual "statute of limitation" clauses.

• If you see a termination coming, try to negotiate reasonable performance criteria as an alternative to termination.

• Consider seeking injunctive relief in advance of the effective date of the termination, negotiate an extension of the termination date, and try to negotiate a resolution of the dispute, such as continuation of the distributorship or dealership subject to meeting reasonable performance criteria.

• Consult a franchise attorney before entering into a franchise relationship and upon receiving notice of termination.

• Terminate for good reasons only, and communicate those reasons in advance of the termination, giving the distributor or dealer a reasonable opportunity to correct any correctable reasons for termination.

• Do the above six-step analysis before implementing a termination decision.

• Make sure the written franchise agreement contains a definite duration, the right of the manufacturer to appoint other dealers within the territory, the right of the manufacturer to terminate the relationship upon sale of assets or a decision to go to direct distribution, a choice of law provision, a forum selection clause, and a limitation of damages clause.

• Make sure any written contract contains an integration clause, with references to how ongoing relationships, including day-to-day business agreements, will be handled.

• Consult an experienced franchise attorney before establishing the franchise and when termination issues arise.

For general information about federal and state laws affecting franchises, see the Business Franchise Guide (Commerce Clearing House, Chicago, IL 1995). The Guide is updated periodically and contains the text of relevant state and federal regulations.

The Federal Trade Commission (FTC) also may have useful information. Contact the FTC at 6th Street and Pennsylvania Avenue N.W., Washington DC 20580, (202) 326-2000.

For additional information on the requirements of California franchise law, contact the California Secretary of State, Corporate Division, 1500 11th Street, Sacramento, CA 95814, (916) 657-5448.

Businesses interested in offering or purchasing a franchise also should contact the California Corporations Department, 3700 Wilshire Boulevard #600, Los Angeles, CA 90010-2901, (213) 736-3481, or the Corporations Department Franchise Information Division, 1390 Market Street #810, San Francisco, CA 94102, (415) 557-3787.

Another valuable resource on franchises generally is David Laufer & Patrick Carter, Evaluating a Franchise Opportunity (With Checklist), 40 The Practical Lawyer 59 (Apr. 1994).