What is an anti-poaching clause in franchise agreements? U.S. Attorney General Jeff Sessions, now involved in the issue, may have best described it when he stated, "Provisions in a franchise agreement limiting a franchisee's ability to solicit or hire workers from another franchise." Basically, it is a limitation on an employer's right to hire somebody else's employees.
In a Gray Plant Mooty webinar this month, titled, "New Risks of Anti-Poaching Regulations in Franchise Agreements, franchisor attorneys Carl E. Zwisler and Quentin R. Wittrock presented an overview of the latest developments relating to anti-poaching. They presented what has been involved in cases that have been filed against franchisors, and some of the theories that have been used in the defenses, and what the liabilities are in those claims. The presenters also discussed what franchisors should do and what they should not do in response to everything that is going on with anti-poaching regulations.
Attorney Wittrock, an anti-trust litigator in the firm's Minneapolis office, explained why there is so much talk about this topic today. He said this is a situation where a lot of people have gotten into the act related to the anti-poaching, which started with the Obama Administration in October 2016. The Office announced that it would be enforcing anti-trust laws through the Department of Justice and the Federal Trade Commission, having to do with the hiring or non-hiring of people pursuant to these kinds of no-poaching or no-hiring clauses in franchise contracts. Wittrock said, as is often the case, when the government speaks plaintiff lawyers listen, and that started class action lawsuits [filed by employees], two being the Deslandes v. McDonald's and Boutista v. CKE, in Illinois and California respectively, alleging franchisors are suppressing wages of workers with anti-poaching clauses.
An article in the New York Times, Why Aren't Paychecks Growing: A Burger King Clause Offers a Cluewas a further look into the effect of no-hire clauses or anti-poaching agreements, and then followed by an economics report on anti-poaching agreements, and two more class actions were filed. By Gray Plant Mooty's account, there are now four ongoing class action lawsuits against franchisors.
In 2018 the risks expanded when the Department of Justice Anti-Trust Chief, now under the Trump Administration, said they are preparing criminal cases to address anti-poaching agreements. That was followed by U.S. Attorney General Jeff Session last month issuing civil investigative demands that franchisors cough up their information regarding how much they use anti-poaching agreements.
Wittrock said as politicians began to get into the act, the Booker-Warren Bill, S2480, introduced by Sen. Corey Booker and Elizabeth Warren, came out just last week "to prohibit agreements between competitors that directly restrict the current or future employment of any employee." Sponsors Booker and Warren wrote a letter to the Department of Justice Anti-Trust division asking about how the enforcement was progressing, which the DOJ had promised.
No-hire clauses and variations
Attorney Carl Zwisler, a transactional lawyer in the firm's Washington D.C. office, explained what the variations are of these types of clauses. They apply to all employees, all store-level managers, during employment and time restrictions for 90 days, six months, twelve months after employment. The scope covers all franchised and company-owned outlets, anywhere, and within ten miles of another outlet. He said they had also found that in some cases it applied to affiliates of the franchisor.
Proscribed conduct applies to recruiting, soliciting, and hiring as an employee, recruiting or hiring as an employee, partner, owner or director. Additional requirements found were that each employee must sign a noncompete and recommend employment applications describing prior employment in franchise network. And, in some clauses franchisees are third party beneficiaries with the right to bring suit.
Remedies for violations were found to be termination, damages and in several class lawsuits the Gray Plant attorneys found one with liquidated damages claiming $50,000 plus attorneys' fees. According to an economics survey conducted for Krueger and Ashenfelter by Princeton economists, who retained Frandata to conduct the survey, they found that 58 percent of franchisors with 500 or more units had an APA (anti-poaching agreements) each franchisor with restrictions is identified by, a Princeton survey in "Theory and Evidence on Employer Collusion in the Franchise Sector," Sept. 28, 2017.
Legal theories used to challenge anti-switching agreements
Antitrust specialist Quentin Wittrock explained the legal theories that franchisee counsel is using to challenge anti-trust clauses in franchise agreements. The first is the Sherman Act, particularly Section 1 that prohibits competitors from agreeing amongst themselves, or colluding, to restrain trade. He gives three arrangements.
First, a horizontal agreement between three single-unit franchisees, all located in a certain geographic area. The franchisees had some type of meeting, making an agreeing that franchisees would not hire employees from another franchisee." That would be a violation of the Sherman Act, in the view of plaintiff attorneys. Just like it would be if they were agreeing to fix prices. They would be deemed to be restraining competition in the employment area.
The second is when the franchisor gets involved. The franchisor tells the independent store owners in their franchise agreement that the franchisee "agrees with the franchisor that they will independently agree not hire from the other franchisees in their system." That is more of a vertical arrangement, which seems less collusive among the franchisees themselves.
The third arrangement is more complicated. Wittrock explains that the "franchisor and franchisee will not hire from each other" or the "franchisee may not hire from the franchisor or other franchisees." And, the franchisor will not hire away from the franchisee, all in the terms of the franchise agreement. He said, "This now becomes more in the plaintiff lawyer's eyes a demonstration of collusion" not to hire amongst competitors, and they are competitors in that they are all competing to hire/employ the same people.
The fourth arrangement is even more complicated when there is a fourth store owned by the franchisor. So, when the franchise agreement states the franchisees won't hire from other stores in the system, the franchisor is also agreeing it will not hire from other franchisees or the franchisor, so then they are deemed to be competitors. Wittrock said this is a situation that historically has been referred to as "dole distribution" where a franchisor or supplier operates at the same level as the franchisees or dealers. He said there is a separate analysis for that and we don't know how that will play out in this situation.
In the litigation, plaintiffs describe these various arrangements as a "big scheme to reduce wage competition." Wittrock said that is a cultural hot bottom, that there are the "haves and the haves not." His review of the current class litigation has found that the ones representing the workers, using very demeaning language toward the employers, the franchisor and the franchisee stores. When you read the lawsuit complaints, Wittock says they are full of "spurious" allegations about the CEO of the company making hundreds of times more than the workers who are being repressed and restrained from competition.
The plaintiffs in the litigation also seem to take great relish in making the argument that this "no joint-employer" language that has found its way into franchise agreements is further evidence that supports the plaintiffs allegations. They assert that franchisors state that franchisees are independent contractors who make their own hiring decisions and employment practices, and that the franchisor is not involved, when in reality that is a falsehood that demonstrates the bad faith of the franchisor.
Gray Plant Mooty states that in the class action lawsuits, defendants' arguments have been that no court has ruled a no-hire agreement to be illegal. And that franchising by nature is vertical relationship, and that no-hire agreements should be governed by Rule of Reason, rather than per se rule of illegality under Sherman Act.
Since no rulings have been made in these cases, franchisor should be aware of the risks:
Liability for treble damages (A class of plaintiff, all the workers in a franchisor's system, and going back five years)
Attorney's fees (both sides, plaintiffs' and franchisors', and in settlements of these cases, attorneys normally get all of the money in these cases)
Distraction from business
What the Washington Attorney General is demanding
Attorney Carl Zwisler said after they scheduled the Gray Plant Mooty webinar for last week, they learned the Attorney General had requested from a number of franchisors the following information:
Statement whether any franchise agreement during the last five years contains a no-poaching agreement
Reasons for having or changing a no-poaching agreement during last five years
Identify each restaurant owned by franchisor and franchisees in Washington
Why should franchisors be concerned about how they respond?
Zwisler gave the following warnings to franchisors responding to the Attorney General's demands:
Untruthful or misleading response could lead to sanctions
Justifications/reasons will bind franchisor in any litigation
(See: Yaffe and Nowark, "The Unwelcome Phone Call—Responding to Regulatory Audits and Investigations"
Quentin Wittrock also advised franchisors that they may want to drop or modify anti-switching language in agreements. He asks, is it useful, enforced, necessary? And is it arguably horizontal, or is it overly restrictive?
In a recent post on this site, I argued that (absent a specific agreement) there is no general requirement that the Awards issued in arbitration must remain secret and that:
Lawyers that try cases for a living know both intrinsically and anecdotally the risk of hearing frivolous arguments and perjury is much higher when the offending lawyers and witnesses believe their words will most likely remain secret. The deliberately mistaken belief that arguments can be made in secret, often heard from franchisors seeking one-sided advantage from secrecy, inevitably spawns the presentation of arguments that would be sanctionable if made in open court and which sometimes cross the line into moral outrage.
A perfect example of this was presented in a recently concluded Arbitration in which the Arbitrator rejected a $25 million damages claim being asserted by the Franchisor against a terminated Area Developer as being “disproportionate, unreasonable, unconscionable and grossly oppressive.” The same Arbitrator held that the Franchisor could not recover Liquidated Damages from the same Area Developer, which was also a franchisee of a failed unit, because the LD clause was an unenforceable penalty under the facts of the case.
I respectfully submit that in a court of law, in a trial open to the press and public and where the decision would be published and become a precedent for future cases, a franchisor would be very reluctant to make claims that are “disproportionate, unreasonable, unconscionable and grossly oppressive.” So why did Tilted Kilt Franchise Operating LLC (the proprietor of the TILTED KILT “breastuarant” pubs) feel free to make these “disproportionate, unreasonable, unconscionable and grossly oppressive” arguments in Arbitration? The apparent reason is this franchisor would prefer to argue in perceived secrecy, lest the world of prospective franchisees be clued in to how this franchisor and its attorneys (veteran members of the American Bar Association Forum on Franchising) prefer to operate.
Not only does the perception of secrecy spawn bad behavior, in this as in most areas of life, a deeper problem is that secrecy in arbitration serves by design to weaken the "common law" by creating a new brand of "private law" in which the same franchisor is free to repeat the same “disproportionate, unreasonable, unconscionable and grossly oppressive" arguments in its next arbitration. Injured from this intended secrecy are the next franchisees that might not have the same success defeating these claims as well as future franchisees who might buy into a brand without knowing it is dealing with a company that is all too willing to make arguments and claims that do indeed cross the line into moral outrage.
My colleague Jackie Condella and I are proud to have defeated these damage claims in this particular case and we would be delighted to share the elements of the arguments we made to benefit other franchisees facing similary ludicrous claims.
But there was another aspect of this decision we find equally troubling that we will address in a separate post.
Until then, lawyers committed to justice must work towards bringing arbitration awards into the light of day.
Court Rules Franchise Laws Reflect Fundamental State Policies That Cannot Be Disclaimed by Contract
Posted Tue, 2017-10-03 16:25 by Peter Lagarias
An Arizona court has ruled that franchise disclosure laws reflect fundamental state policies, which cannot be disclaimed by contract fine print in Zounds Hearing Franchising, LLC v. Bower.
Four franchisees of Zounds Hearing Franchising, LLC brought a group lawsuit in Ohio alleging that the franchisor violated the Ohio Business Opportunity Law by making earnings claims not in their disclosure document, making false statements, and by failing to provide a five-day cancellation right.
The franchisees had not fared well in their operations. Two were already out of business.
Zounds responded by moving to enforce multiple fine print provisions from its standard franchise agreement and then the fireworks began. Next, Zounds filed four lawsuits in Arizona seeking to enforce the one-sided provisions against each Ohio franchisee separately. The four separate Arizona lawsuits sought to enforce an individual action clause prohibiting group lawsuits, and to force individual mediations in Arizona as specified in another contract term written by Zounds. In the group lawsuit filed by the franchisees in Ohio, Zounds moved to dismiss under these many provisions, and alternatively invoked a venue provision requiring that suits be brought only on its home turf in Arizona. Zounds’ motion to transfer was granted by a federal judge in Ohio, and the case was sent to Arizona where the four individual actions were already pending.
Zounds next moved to enforce its individual action and Arizona mediation clauses and to apply Arizona law under the Arizona choice-of-law provision it had written into its franchise agreements. Arizona, unlike Ohio, had no franchise statute providing for a five-day cancellation notice, for mandatory earnings claims disclosures, and prohibiting false representations in franchise sales. Citing the Arizona choice-of-law clause, Zounds asked the court to dismiss the franchisees’ claims under Ohio law. Thus, the question was could the Ohio Business Opportunity Law claims survive the Arizona choice-of-law clause under a conflict of law analysis?
Senior United States District Judge Neil Wake said no; Zounds could not contract its way out of the laws which Ohio has enacted to protect its own residents in the sale of franchises. In a thorough opinion Judge Wake also explained why some previous cases denying enforcement of such choice-of-law clauses were correct, and why cases granting enforcement of choice-of-law provisions in such situations should not to be followed.
The decision is worth a careful reading. Here is a portion of what Judge Wake found as an “easy” decision:
Under choice-of-law principles, parties cannot circumvent by contract the investor protections a state provides to all within its boundaries, especially for its own residents . . . First, the franchise and the franchisees are both located in Ohio. In those circumstances, a foreign-domiciled franchisor may not “contract” out of the Ohio protections any more than an Ohio-domiciled franchisor could. There is no scenario in which another state would have a materially greater interest in having its less protective franchise laws applied than the more protective laws of the state in which the franchisee resides and the franchise operates.
The decision continued with a five-fold victory for the Zounds franchisees. Judge Wake refused to enforce the Arizona venue clause and ordered the case transferred back to Ohio. Judge Wake also voided the bar on joint suits by franchisees, allowing the franchisees to continue jointly rather than having to pursue four separate and prohibitively expensive individual lawsuits. Accordingly, Judge Wake ordered mediation of the four franchisees claims to occur jointly in Ohio rather than Arizona. And Judge Wake ordered Zounds to pay the franchisees’ attorney’s fees. The victory of the Zounds franchisees and their counsel was critical, given the cost of individual mediations in Arizona and possible dismissal of claims in Arizona. And at the end of the day, on an issue many franchisees have fought for years, the court came down clearly and definitively on their side. Franchisors should not be able to avoid state franchise and business opportunity disclosure laws enacted as important public policy to protect their citizens, by use of venue, choice-of-law, integration, no representation and no reliance provisions.
In addition to several new chapters addressing key concerns for franchise prospects and how the franchise business model has evolved over the years, I have also included the Franchise Glossary to provide readers with definitions for key terms they’ll see during the due diligence process. This is the first time the glossary, which is also found inThe Franchisee Workbook (a fill-in-the-blank step-by-step workbook that will help address everything a modern-day prospect will face during their franchise exploration process), is making an appearance in The Educated Franchisee.
As a teaser, I’d like to share with you 10 key franchise terms and definitions readers can find in the glossary that can help educate themselves about all aspects of franchising.
Franchise - The FTCFranchise Rule defines a “franchise” as an arrangement whereby a franchisor grants franchisees the right to operate a business that: 1) is identified with the franchisor’strademark; 2) is subject to the franchisor’ssignificant control and/or assistance; and 3) in exchange for which, the franchisee pays a “franchise fee” to the franchisor or its affiliate. Most state franchise lawsadopt a definition (except in New York, where any combination of elements 1 and 3, or elements 2 and 3, are enough to satisfy the state law definition of “franchise”).
Discovery Day - An event set up by the franchisor so that potential franchisees may learn more about becoming a franchisee. A discovery day typically takes place at the franchisors headquarters and is often the final step in the due diligenceprocess. It provides the opportunity to meet the management team, support team, and trainers face-to-face. Occasionally called “Meet The Team Day” or “Open House.”
Due Diligence - Usually undertaken by investors, but also customers, due diligencerefers to the process of making sure that someone is what they say they are and can do what they claim; i.e., investigation of a business (e.g., Does the product or system really work? Does the franchise really have customers?).
Financial Performance Representation - Any oral, visual, or written representation to a prospective franchisee or for general dissemination in the media which states or suggests a specific level or range of potential or actual sales, income, gross, or net profit. This information must be provided in Item 19 of the Franchise Disclosure Document. Previously called “Earnings Claim.”
Franchise Disclosure Document - The Franchise Disclosure Document (FDD) is the form for providing disclosure in the U.S. under the FTC Franchise Rule. Before the 2007 amendments to the FTC Franchise Rule, the principal format for providing disclosure in the U.S. was a document prepared under the “Uniform Franchise Offering Circular” (UFOC) format. The FDD provides extensive information about the franchisor and the franchise organization in a uniform format, which a prospective franchisee can use to compare different franchiseofferings. The FDD is meant to give a potential franchisee certain specified information to help make educated decisions about their potential investments. Also see “Disclosure Document” and “FTC Franchise Rule.” NOTE – The Educated Franchisee Resource Center, an extension of the print edition of the book, includes The FDD Exchange,an online Franchise Disclosure Document library with more than 2,500 FDDs from leading franchise brands in various industries.
Area Developer - The franchisor awards a single franchisee the right to operate more than one unit within a defined area, under a development agreement and based on an agreed-upon development schedule.
Master Franchisee - A system whereby a franchisor grants to a party (usually referred to as the Master Franchisee) the right to operate franchised businesses and to grant sub-franchises to third parties, within an agreed-upon geographic area. The Master Franchisee serves as if it were the “franchisor” within the sub-franchise territory, providing localized support services within the territory. The Master Franchisee typically retains a portion of the royalty as compensation for its services.
Operations Manual - The document detailing the operation of a particular franchised business. Operations manuals—also called franchise manuals—describe such items as: quality control requirements; recommended hours of operation and financial and management practices; the correct use of any trademarks or trade names; forms and written materials for use in business operations; payment of fees and royalties; approved suppliers; and so on. Increasingly, operations manuals also address other matters, such as systemwide policies concerning data, environmental and energy standards, health and safety matters, etc.
Royalty Fee - A regular and continuing payment made by the franchisee to the franchisor, often paid on a weekly or monthly basis. The royalty may be a percentage of sales, a fixed recurring fee, or a combination. Royalties commonly cover use of a trademark and trade name and also constitute a fee for services performed by the franchisor such as training and assistance, marketing, advertising, accounting, and so on. Also called “service fees” and/or “license fees.”
SBA-Guaranteed Loan - A program of financial assistance available to small business owners from the U.S. Small Business Administration (SBA). While the SBA seldom loans money directly to franchisees, an SBA guaranteed loan makes it easier for a qualified individual to borrow money from a commercial lending institution, such as a bank. Under the program, the loan is made directly by the bank to the franchisee. The SBA protects the bank against financial loss in the event of business failure.
The Franchise Glossary has almost 200 key terms that will help educate the reader on all of the ins and outs of the franchise process. The Educated Franchisee is now available for purchase through Amazon and in bookstores around the country.