Gallet Dreyer & Berkey, LLP | Franchise Law Update - New Regulations and Recent Court Decisions Affecting Franchising
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Franchise Law Update - New Regulations and Recent Court Decisions Affecting Franchising

12/07/2012 | Winter 2012 Newsletter
FTC broadens scope of federal business opportunity regulations
In December 2011, after years of consideration, the Federal Trade Commission announced changes effective March 1, 2012 to the federal regulations which govern the sale of business opportunities, by broadening the types of businesses which are governed by the regulations to include more at-home business ventures, while at the same time lessening the nature of the disclosure requirements for businesses that fall under the new rule.

The FTC’s regulations which govern the sale of business opportunities require that companies selling business opportunities must give the buyer a written disclosure document describing the offering before the buyer signs any agreement or pays any money.

Under the new federal rules, the definition of a business opportunity was broadened to include any arrangement under which the business opportunity seller offers the buyer the opportunity to enter into a new business, requires a payment of any amount (not limited to $500 or more) and promises the buyer it will i) provide locations for the use or operation of equipment, displays or vending machines, ii) provide accounts or customers for the buyer; or iii) buy back the goods or services the buyer makes or provides.

Accordingly, the new regulations reach two main categories of business ventures that were not previously covered under the prior regulations: 1) cheap at-home business opportunities which required a payment of less than $500, and 2) business opportunities in which the seller promised to buy back the goods or services or to provide wholesale customers for the buyer.

At the same time, the new regulations narrow the scope of the disclosure document that is required for the sale of business opportunities to only five categories of information, rather than requiring business opportunity sellers to provide the more extensive franchise disclosure document which requires the disclosure of 21 categories of information and financial statements.

The impact of the new federal regulations will be felt mainly in the states without business opportunity laws. Twenty six states have their own business opportunity laws which already require pre-sale disclosure. New York’s franchise laws contain a unique broad definition of a franchise which already covers most arrangements normally considered to be business opportunities.

Court decisions addressing claims that franchisees are employees
Franchisors have been concerned since late last year after a Massachusetts state appeals court ruled in Awuah v. Coverall that, under Massachusetts’ employee misclassification statute, the individual franchisees of the Coverall commercial cleaning franchise system should have been classified as employees, rather than franchisees, subject to all of the payroll, unemployment insurance and workers compensation rules. In that case, the franchisor provided all the accounts to its individual commercial cleaning franchisees and collected all the customer revenue, while the individual franchisees provided the cleaning services to the customers.

Although the court decision contained broad language, so far it appears that the ramifications of this court decision are limited to the unique provisions of the Massachusetts state law and the structure of that franchise system. No courts have adopted this reasoning in other states. In a ruling by a Georgia appeals court last year in another case, Jan-Pro Franchising v. Depianti, which addressed the same state statute, the court concluded that the Jan-Pro commercial cleaning franchisees should not be considered employees under the Massachusetts employee misclassification statute. And in a ruling late last year by a Kentucky appeals court, the court ruled in Doctor’s Associates v. Uninsured Employer’s structured trust that will benefit the taxpayer’s spouse while she is alive, but not subject the assets remaining in the trust to estate tax upon the surviving spouse’s death.

Residents of states such as New York, which impose their own estate tax, have an even greater reason to plan their estates properly. Take, for example, a couple with combined assets of $2 million, all of which are held jointly with a right of survivorship (for example, a home, their checking and savings accounts, etc.) Upon the first death, there would be no estate tax payable since all of the assets will pass to the survivor by virtue of the manner in which the assets are owned — often referred to as a “will substitute.” For this purpose, New York State follows federal law. Upon the survivor’s death, and assuming the value of the assets remained at $2 million, the estate would be subject to a $99,400 New York State Estate Tax. Had the couple in our example merely changed the manner in which they owned their assets from a joint tenancy with a right of survivorship to a tenancy-in-common (and assuming the assets did not pass to the surviving spouse at the first death), each would have had a taxable estate of $1 million. The combined New York State Estate Tax would have been zero, a savings of almost $100,000, for their family. Of course if the federal exemption is allowed to return to $1 million, or if the value of the asset increases, the savings would be even larger. If the couple wanted to make sure that the survivor had the benefit of all the assets during the survivor’s lifetime, each of them would have created a trust within their will which would hold the assets for the benefit of the survivor and then ultimately either pass the assets to, or continue to hold the assets for the benefit of, the couple’s children.