Your franchise is up and running and generating a buzz. You are getting inquiries from across the US, some of which are clearly qualified buyers itching to get into this new franchise opportunity.
It’s difficult to turn away a prospective buyer, but sometimes that’s exactly what you need to do, at least temporarily.
Say, you get an inquiry from a prospective franchisee in New York. You are aware that New York is one of the states that requires franchise registration–in fact, you have already begun the process of registration with the state. Is now a good time to enter preliminary conversations with the prospective buyer? What if you fully disclose to the buyer the fact that you are still waiting on approval from the State of New York and cannot consummate any deal until such time as you are approved, are you in the clear now?
The answer, as you may have suspected, is no.
The previous summary is based on Reed v. Oakley, 661 N.Y.S. 2d 757 (1996). In Reed, a franchisor began negotiating with a prospective buyer after the franchisor had registered with the state of New York, but before receiving approval. The franchisor informed the buyer it was not able to close the deal until it was approved by New York, and the initial agreement of the parties even specified that the buyer was to receive disclosure documents and have the required time to review them before any deal would close.
When the relationship between buyer and franchisor later soured, the buyer cried foul, claiming that the franchisor violated New York’s Franchise Sales Act by soliciting and negotiating the sale of a franchise prior to receiving approval to sell franchises in the state of New York. The court agreed with the buyer, finding that New York’s Franchise Sales clearly prohibits solicitation or negotiation of a franchise sale prior to registration approval. The fact that franchisor appears to have acted in good faith and did in fact give the buyer all the relevant disclosures plus time to review them prior to closing the deal appeared to have no influence on the court’s decision.
The real rub in this case for the franchisor is the loss it sustained. Typically, the remedy for violation of the New York Franchise Sales Act is the amount of damages the buyer can prove were sustained by the franchisor’s violation of the law. If, however, the franchisor has “willfully” violated New York’s Franchise Sales Act, then the franchisee may rescind the contract, get all his money back, plus 6% interest, plus attorneys fees, and court costs.
Sometimes the word “willfull” is associated with conduct you would think of as knowingly wrong, but in Reed v. Oakley, the court determined that the word “willful” means simply “voluntary and intentional, as opposed to inadvertent.” The franchisor had, in fact, voluntarily and intentionally negotiated with Reed, and in so doing it “willfully” violated New York law, subjecting it to all of the penalties.
In the world of franchise and business opportunity sales, it is almost unavoidable that a few buyers will feel that the business they have bought does not quite meet their expectations. If this happens to you, you want to be sure that you have fully complied with all state disclosure laws.
Compliance can be challenging, given the fact that there are both federal and state requirements, state franchise laws vary from state to state, and franchise requirements can be rather complex. Sometimes franchisors are tempted to do it all themselves, but like an attempted home haircut that winds up back in the barber’s chair, a do-it-yourself approach all too often results in franchisee complaints, state action, wasted money, and worst of all, wasted time. A franchise attorney can help you avoid the disclosure pitfalls, protect your intellectual property, and bolster your contracts and agreements, freeing you up to focus on the job you should be doing, growing your business.
Before you begin soliciting franchisees or advertising in a state, make sure you are informed of the law. Develop a registration roll-out game plan, follow it, and avoid the pitfalls. A franchise attorney at Briskin, Cross and Sanford can help you do this.