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Top 5 Legal Mistakes Developer Make When Franchising a Business

Legal Mistakes Franchise Developers Make

Key Takeaways

  • New franchisors should remember that all franchise development firms are not equal – and some can even leave your brand exposed to legal risks.

  • The wrong franchise developer can leave you without proper legal representation or trademark protection, and expose your brand to potential lawsuits.

  • To avoid possible costly legal trouble, consult a franchise attorney before franchising your business.

For new and emerging franchisors, avoiding legal mistakes and protecting your brand from potential lawsuits during the franchising process is critical – especially when you’re exclusively working with certain franchise consultants/developers and not with a franchise lawyer.

Although there are plenty of reputable franchise developers to work with, it’s important to remember that not all franchise development companies offer the same level of quality and expertise in their services. “One-stop shops” that claim to offer in-house legal services to startup franchisors can expose your brand to serious legal risks including future lawsuits, trademark issues, expensive penalties and more. Because of those risks, working with a credible franchise developer – and an experienced legal team – is critical for protecting your new franchise system.

5 Legal Mistakes Franchise Developers Make When Franchising a Business Include:

  1. Failing to provide legitimate legal representation
  2. Mishandling the trademark registration process
  3. Creating territory structures that might expose you to lawsuits
  4. Establishing boilerplate royalty structures
  5. Creating an Item 19 that doesn't align with your sales materials

In this guide, we’ll explore five common legal mistakes franchise developers make when franchising a business … and how you can avoid them as a new franchisor.

1. Failing to provide legitimate legal representation

When it comes to working with “all-in-one” franchise development companies, it’s not uncommon for developers to claim they offer in-house legal services and representation for clients during the franchising process. As a new franchisor, however, it’s important to keep in mind those claims aren’t always as great as they sound.

In some cases, franchise development companies might use a staff attorney to review legal documents and agreements before providing them to their clients. In those situations, however, the attorney-client relationship is typically between the franchise developer and their in-house lawyer – not between the franchisor (you) and your properly retained counsel. As a franchisor, this could leave you without legitimate legal representation or attorney-client privilege.

In other situations, unqualified developers might provide new franchisors with boilerplate documents that don’t meet the real-world legal needs of their business – something that could expose your brand to future lawsuits and other expensive legal consequences.

Common legal issues that might arise from improper legal representation provided by unqualified franchise developers can include:

  • A non-attorney preparing legal disclosures, agreements and other documents that don’t adequately shield your business from liability

  • No legal oversight for your franchise system’s state addendums

  • The absence of proper legal representation and attorney-client privilege

  • A lack of accountability to the franchisor for legal errors

Although a franchise developer might claim that the in-house legal services their company provides to new franchisors are pro forma, or that cookie-cutter legal documents can be used to franchise any business, those claims are inaccurate – and could leave your franchise system exposed to litigation in the future.

Instead, it’s best to work directly with an experienced franchise attorney when franchising your business. By taking the time to understand your brand and its industry, your properly retained counsel can draft custom legal documents that fit the specific needs of your brand while ensuring your franchise system complies with all federal and local state franchise laws.

2. Mishandling the trademark registration process

As a new franchisor, your trademarks are one of your franchise system’s most valuable assets. Because your brand’s logos, phrases, symbols and other intellectual property are licensed to franchisees, legally protecting and maintaining your trademarks is critical for your company’s long-term growth and success.

Often, unqualified or inexperienced franchise developers will simply file a new franchisor’s trademark application with the U.S. Patent and Trademark Office during the franchising process without evaluating the trademarks first – a mistake that could cost you time, money and even your brand identity.

Without properly evaluating your trademarks before applying for trademark protection, the USPTO could find that other confusingly similar marks are already registered at the federal level and reject your application. Because the trademark registration process is lengthy, this could happen ten months after launching your franchise. As a result, you may be forced to modify, rename or rebrand your business to ensure that its trademarks can be legally protected – in some cases, even after you’ve already sold franchises to franchisees. Failure to maintain protected trademarks could result in a similar outcome.

Because of those legal risks, working with an attorney who is experienced in the trademark registration process – including evaluating trademarks before applying for legal protection – can save you time and money by predicting with a high level of certainty whether or not your marks are legally protectable before filing your application.

3. Creating territory structures that might expose you to lawsuits

Another common mistake that unqualified franchise developers make is overlooking the legal significance of franchise territory structures – an oversight that could lead to costly litigation with franchisees in the future.

Often, developers define territories based on a model where the franchisor grants each franchisee an approved location and a designated territory within a specific radius around that location. It’s expected that franchisees will not operate outside their protected territory. While those terms might seem straightforward, there is often more to consider when it comes to planning your franchise system’s territory structure.

Among other potential legal issues, franchisors should think about the implications of online sales and deliveries within and beyond franchisees’ territories; distribution restrictions on private labeling another brand; multi-territory structures for service-based businesses; and whether to reserve certain rights, such as the ability to acquire competing businesses operating within a specific territory.

4. Establishing boilerplate royalty structures

Although royalty structures don’t have to be complicated, their baseline should be specific to a brand’s industry (for example, royalties for franchised restaurants are typically around 5% to 6% of a location’s gross sales).

One of the biggest mistakes franchise developers make during the franchising process is establishing the same royalty structure for every brand, rather than taking the time to understand the industry standards of each brand they develop.

Some important things for franchisors to take into consideration when determining their royalty structures include:

  • If your business is seasonal, is there a seasonal adjustment in royalties?

  • Are minimum royalty requirements built into your royalty structure?

  • Will you offer an option for underperforming franchisees to return territories or avoid legal conflicts in other ways?

  • How are the mechanics of your royalty structure incorporated into your franchise agreement?

By failing to take into account the unique ways franchises can vary between industries – and by overlooking the proper enforcement of royalty terms – developers could be setting new franchisors up for lawsuits in the future.

5. Creating an Item 19 that doesn't align with your growth strategy

The Franchise Disclosure Document (FDD) is a legally mandated disclosure document that all franchisors must have before offering or selling franchises in the U.S. per the federal Franchise Rule. Because of that, making sure its contents are legally compliant and aligned with your growth strategy and sales materials is critical.

This is especially true when it comes to your FDD’s Item 19 financial performance disclosures. Too often, unqualified franchise developers will create websites for their clients during the franchising process that make generic – and sometimes exaggerated – claims about the franchise brand’s finances or the benefits of buying a franchise. Unfortunately, such inaccurate claims can leave your brand open to legal liability.

As a franchisor, truthfully representing your brand’s financial performance during the franchise sales process is critical. Because of that, the information provided to franchisee candidates in your marketing materials should always be consistent with your FDD’s Item 19 financial performance representations.

Some key points that should be accurately reflected in your Item 19 disclosures include, but are not limited to, the following:

  • Key performance indicators

  • Select performance points

  • Gross sales data

  • Gross profit data

By working with a seasoned franchise attorney when franchising your business, you can ensure that your FDD is competitively positioned and that your Item 19 disclosures are accurate and legally compliant. The right attorney can also help you navigate the franchising process and discover creative ways to tell a compelling story about your brand while avoiding costly legal mistakes.

Thinking about franchising your business? Contact us to learn how we can help you avoid legal mistakes as a new franchisor.

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