Category: Intellectual Property

Enforcing Quality Standards in Hotel Franchise Agreements

August 6th, 2014
David Cahn

David Cahn

Take-away. A franchisor’s diligence in conducting and documenting quality assurance inspections is as important as ever, particularly if the franchisor seeks to exercise its ultimate weapon – termination of the franchise agreement. Prudent inspection and documentation practices are particularly crucial in the many U.S. states and territories that have statutes requiring a showing of “good cause” in order for a franchisor to terminate a franchise agreement. In such states, a franchisor must furnish evidence demonstrating that the franchisee failed to substantially comply with the material and reasonable franchise requirements; otherwise, a court may well restore the franchise rights and order money damages to the franchisee.

The Case.  Pooniwala v. Wyndham Worldwide Corp., a May 2014 decision by the U.S. District Court for the District of Minnesota, is an exemplary demonstration of how a franchisor establishes that one of its franchisees repeatedly violated quality assurance standards so that there was “good cause” to terminate the franchise agreement under state law. The franchisor’s in this case diligently conducted and documented regular quality assurance (“QA”) inspections.

The Facts. Minn. Stat. Section 80C.14, part of the Minnesota Franchise Act, allows a franchisor to terminate an agreement if the franchisor can show “good cause” for termination. Good cause means failure by the franchisee to substantially comply with the material and reasonable franchise requirements imposed by the franchisor, including “any act by or conduct of the franchisee which materially impairs the goodwill associated with the franchisor’s trademark, trade name, service mark, logotype or other commercial symbol.”

Pooniwala involved franchise agreements for two hotels, one a “Super 8,” and the other a “Travelodge.” The franchisee alleged that the franchisors, both of which are affiliated companies within the Wyndham Hotel Group, took retaliatory action against the franchisee because of a lawsuit between the franchisee and Ramada Worldwide Inc., its fellow Wyndham Group affiliate. The franchisors, for their side, argued that their attempts to terminate the franchise agreements were not retaliatory actions, but rather that the franchisee had repeatedly violated QA standards found in the respective franchise agreements, giving each franchisor good cause for termination.

The first attempted termination involved a Super 8 hotel facility in Roseville Minnesota. The franchise agreement for the Roseville Super 8 included quality assurance requirements, as well as provisions allowing Super 8 to inspect the facility to ensure that it was operating in compliance with Super 8’s system standards and QA requirements.  The franchisee had failed six consecutive QA inspections at the Roseville Super 8.  Each inspection was followed by a letter indicating that the franchisee had received a failing score on the QA inspections. The letters also gave the franchisee notice that it had sixty days to cure the QA deficiencies, the failure of which could result in termination of the franchise agreement. Finally in September 2013 Super 8 notified the franchisee that the franchise would terminate on December 29, 2013, unless the hotel passed a final QA inspection. The franchisee failed that final inspection, and shortly thereafter Super 8 informed the franchisee that termination would take effect on the originally scheduled termination date.

The second termination was for a Travelodge hotel facility in Burnsville, Minnesota. The Burnsville Travelodge agreement contained similar QA requirements, and the franchisee failed eight consecutive QA inspections, receiving letters documenting the failures following each inspection. Finally the franchisee received notice of termination for the Travelodge franchise. The notice described QA deficiencies, and stated that termination would take effect in ninety days, but that another inspection would be scheduled to determine whether the QA violations had been cured. The franchisee failed that inspection, and as a result Travelodge informed the franchisee that termination would take effect on the originally scheduled date.

Preliminary Injunction. It is not a wonder that motions for preliminary injunction are commonplace in hotel franchise termination cases. With the great potential for loss of good will among customers, employees and suppliers, franchisees will not want to give up their rights to franchise logos or their presence on a franchisor’s reservation system. In Pooniwala, the franchisee sought an order for preliminary injunction to stop the franchisors from terminating the franchise agreements before the court heard the case on its merits.

In deciding whether to grant a preliminary injunction, courts have to balance the harm to the two sides. They also consider the requesting party’s likelihood of success on the merits in the underlying claim–here, violation of the good cause requirement of the Minnesota Franchise Act.

In Pooniwala, the court denied the franchisee’s motion for preliminary injunction and ordered it to go ahead with its post-termination obligations, such as removing the franchised brands’ signage. The court found that, given the many QA inspection failures at the two hotels, and the fact that the franchisees had continuing franchise relationships with Wyndham Hotel Group affiliates at other hotel properties, the franchisee did not demonstrate an adequate likelihood of success of proving that the termination was without good cause. Further, the court held that, while the franchisee would suffer obvious harm through loss of the franchise rights, the franchisors were also suffering continuing, irreparable harm as long as the franchisee’s hotels continued to operate under their trademarks while not maintaining brand quality standards.

Conclusion. Hotel franchise agreements typically provide for substantial liquidated damages if the franchisor terminates for cause, meaning that the Pooniwala franchisees are likely to owe hundreds of thousands of dollars. In other franchise cases, the terminated franchisee may be forced to cease operating a similar business due to a covenant not to compete.

The stakes are high, and franchisors can expect a fight. So if they decide to take the drastic step of terminating for cause, they had better have their “ducks in a row.” In Pooniwala, the Wyndham Hotel Group franchisors showed how this is done.

 Nicholas Cintron, a law clerk at the firm and a 2016 J.D. candidate at Wake Forest University Law School, contributed to the preparation of this article.

How Can You Know If Your Business Is Ready To Franchise? part 2 of 2

August 30th, 2010

David Cahn

(This is the conclusion of the August 23, 2010 post on this Blog.)

Franchising vs. Other Methods of Expansion  

The main advantage that franchising has over expanding a business on your own is that you get to invest other people’s time, skills, and money to growing the business instead of borrowing against your business and personal assets or granting stock to outside investors. Having franchisees allow a business to play off of a diverse pool of talent that may attract different types of people to the business.  

Many businesses have found that, by granting franchises, they can recruit talented individuals who will be driven to tremendous lengths to make their business a success.   While incentives to the managers of company-owned remote locations can drive good short-term results, franchisees who risk their net worth on the enterprise have the ultimate incentive to develop the businesses for long-term profitability.

As the franchisor, your business will be less likely to be held liable for any claims of personal injury or employment discrimination that that may happen on the premises of a franchised unit, as opposed to one opened with borrowed or equity capital.   Making sure that this liability shield is effective takes careful planning, but when properly executed it is a substantial benefit of franchising.

It’s not all good news however.  After outside lenders or investors are repaid, company units may yield more profit to the brand founder than franchises.   It can be more difficult and costly to terminate a misbehaving franchisee than a location manager.  Finally, company owned units located near franchises could suffer revenue losses through competition with the franchises.

So You’ve Decided to Franchise…

With all of that in mind, and you’ve decided that your business is ready to franchise, there are a few things you should do before looking for your first franchisee.

  1. Develop the operating manual and training plan. Owners often create these items with the help of a consultant and with overall legal guidance.
  2. Put money aside. A thoughtful and responsible business owner should have at least $100,000 available for franchising purposes, including legal, development of training programs and operations manuals, and advertising for franchisees (both creative and placement).  Also, a shrewd businessman might put away that money, spend half on the aforementioned items, and keep the rest on hand to show sufficient capitalization to obtain state franchise registration on favorable terms. 
  3. Be prepared to do some hand-holding. Business owners that are looking to franchise need to be realistic when they look at the additional operating costs of getting a franchise up and running. They must spend money and time recruiting and supporting the new franchisees. Time away from the core-business means money for managerial costs for the original businesses that form the “prototype” for the franchises.

Conclusion

Potential franchisors need to accept that franchising successfully will require some short term sacrifices in terms of time and money. Done correctly and thoroughly can mean the growth of your business to larger regional or national markets. Improperly, underfunded, and rushed could mean the loss of the business entirely. Early investment in franchise resources and assistance will give the business a better chance at success and growth within your industry.

Recent Case Demonstrates the Importance of Protecting Intangible Property Rights

June 15th, 2010

A recent decision by the Maryland Court of Special Appeals illustrates the fundamental importance of seeking affirmative legal protection for your intellectual property rights. While Brass Metal Products, Inc. v. E-J Enterprises, Inc., 984 A.2d 361, 189 Md. App. 310 (Md. App. 2009) involves an inventor’s loss of rights as a result of his failure to obtain a patent for his invention, the principles applied by the Court are equally applicable to other forms of intangible property.

In Brass Metal Products, Brass Metal, a distributor of aluminum construction railing products, entered into a wholesale supply agreement with E-J Enterprises (“E-J”), under which E-J would purchase unique aluminum railings from extrusion mills for resale to Brass Metal on an as-needed basis. The railings were designed by Brass Metal’s owner, James Burger, but Burger never obtained patents on his designs. Several years later Brass Metal authorized E-J to sell its excess inventory of railings extruded from Burger’s designs.

Eventually, E-J began selling railings it had purchased for Brass Metal to Parthenon, a new company owned by Brass Metal’s top salesman. When E-J refused Brass Metal’s request to stop these sales, Brass Metal filed suit against Parthenon and E-J. However, since neither Brass Metal nor its owner had obtained patents for the designs, Brass Metal was limited to basing its claim concerning use of designs on the tort theory of conversion rather than a statutory patent infringement. Brass Metal settled with Parthenon before trial, but lost its case against E-J and then appealed.

Conversion is essentially theft (“any distinct act of ownership or dominion exerted by one person over the personal property of another in denial of its right or inconsistent with it”). Darcars Motors of Silver Spring, Inc. v. Borzym, 379 Md. 249, 261 (2004). Fundamental to any claim for conversion is that the claimant must have a property interest in the thing that it claims was converted. This requirement imposes unique hurdles to protect intangible property rights. To succeed on a claim for conversion of intangible property, the Maryland courts have held that the owner’s rights must be “merged or incorporated into a transferable document.” Allied Inv. Corp. v. Jasen, 354 Md. 547 (1999). Burger and Brass Metal failed to meet this requirement in this case, at least as to E-J.

Brass Metal also asserted that custom and usage in the industry demonstrated that E-J understood that Brass Metal’s rights in the railings’ design were protected. The court denied this claim, citing Brass Metal’s failure to meet the “clear and convincing evidence” standard for establishing the custom and usage of the aluminum extrusion industry.

Absent the prerequisites for a claim for conversion of intangible property, since Brass Metal failed to obtain a patent for Burger’s design, it did not have the right to prohibit E-J from selling to Parthenon (or anyone else) aluminum railings extruded from Burger’s designs or extremely similar ones provided by to E-J by Parthenon. As a result, the trial court ruled in favor of E-J Enterprises on all claims.

The Maryland courts have held that, subject to the limitation discussed above, claims for conversion may succeed for forms of intangible property other than patents, such as partnership interests and copyrights, although conversion claims for copyrightable materials may be subject to preemption by the federal Copyright Act. See U.S. ex rel. Berge v. Bd. of Trustees of the Univ. of Alamaba, 104 F.3d 1453 (4th Cir. 1997).   Before entering into any transaction involving any type of creative work, including technical designs or specifications, business people should be sure to take all steps necessary to fully protect their intangible rights and write contracts properly safeguarding these rights.

Intellectual Property Focus: Copyright Ownership of Architectural Plans and Buildings

February 2nd, 2010

By: Jeffrey S. Fabian

Many businesspeople have misconceptions about copyright ownership in the situation where an independent professional is hired to prepare or design unique and protectable matter for use in the hiring party’s business. A common example is the hiring of a design firm to create a company website. Unless you and the design firm expressly agree in writing, the developer will likely own the copyrights for your website. While you retain rights (to the extent that you have them) to any photographs, text or other content that you supply, the developer will own the rights in the overall design of the site. In the best of circumstances, you will share joint ownership with the developer. A written work-for-hire or assignment agreement must be executed in order for you to obtain copyright ownership in materials commissioned from independent parties.

Another area where copyright ownership issues come into play is in the preparation of architectural drawings and the physical construction of retail locations. The same principles described above apply—unless you and your architect otherwise agree in writing, the architect will own the copyrights to all architectural plans they develop, and probably even in the physical structure of your building itself.

Since 1990, architects have enjoyed two forms of copyright protection for their works. While architects have always retained exclusive rights to their drawings (absent a work-for-hire agreement or transfer of ownership), the Architectural Works Copyright Protection Act of 1990 (AWCPA) extended their rights to the completed physical structures themselves. This change in the law was intended to clarify the protections afforded to architects under federal copyright law. Prior to the enactment of the AWCPA, while architects could prevent others from copying their actual drawings, they were powerless to prevent others from copying their designs as embodied in the completed buildings. The AWCPA now affords architects the right to prevent others from copying the physical products of their designs.

This issue is particularly noteworthy for retail-based franchisors: Unless you and your architect agree otherwise, you will not have the right to license the design and specifications for your prototypical outlet or restaurant to your franchisees. The rights in these aspects of your concept will remain exclusively with your architect. As noted above, only work-for-hire agreements or copyright assignments can remedy this concern.

A work-for-hire agreement must be signed before the architect begins work on your project. This is because copyrights attach immediately and automatically upon the creation of a protectable work. If you commission a work without first executing a work-for-hire agreement, you will have to get the architect to agree to assign at least undivided joint ownership of the copyrights to you in order for you to have protectable and licensable rights. The architect may well request that additional consideration be paid, as he or she is under no obligation to transfer any rights to you. But, unless you obtain these copyrights, you will find yourself re-commissioning the same plans for each outlet or restaurant that you intend to open.

Minimum Contacts in the Digital Age: Using Online Resources Can Subject You to Foreign Jurisdiction

October 9th, 2009

The United States District Court for the District of Maryland recently held that use of a company’s website can be sufficient to subject the user to jurisdiction in the state where the company resides. In CoStar Realty Information, Inc. v. Mark Field d/b/a Alliance Valuation Group, Case No. 08-00663, the Court held that the defendants, who resided in California, Florida and Texas, were subject to jurisdiction in Maryland based on their use of CoStar’s website (CoStar’s principal place of business is in Bethesda, Maryland). This means that, to avoid having a court judgment entered against them, they had to defend against the claim in Maryland.

A court may exercise jurisdiction over a defendant only if requiring the defendant to appear before the court will not infringe the defendant’s due process rights under the Fourteenth Amendment of the U.S. Constitution. The U.S. Supreme Court has held that the requirements of due process are satisfied where: (1) exercise of jurisdiction will not “offend traditional notions of fair play and substantial justice”; and (2) the defendant, as a result of its actions, “should reasonably anticipate being hailed [before the court].” State “long-arm” laws can further define specific actions or conduct that will satisfy these constitutional requirements.

In CoStar Realty, the defendants were alleged to have improperly shared a user ID and passcode for accessing CoStar’s subscription-based website, which had been authorized for use only by a limited number of individuals. The defendants regularly accessed CoStar’s website, and also used Co-Star’s live telephone support, representing themselves as valid customers. Otherwise, the Court did not cite any relationship between the defendants and the State of Maryland for purposes of the due process analysis. However, based on these actions alone, the defendants were found to have availed themselves of the privileges of doing business in Maryland and therefore were held subject to the Court’s jurisdiction.

The Court also noted that, even though the defendants were not valid CoStar customers, by using CoStar’s website they implicitly agreed to the website’s Terms of Use, which included, among other things, the user’s consent to jurisdiction in Maryland.

While jurisdiction in this case was based specifically on the defendants’ alleged wrongful actions, so-called “general jurisdiction” can be based on systematic and continuous contacts with the forum state, whether or not they relate directly to a plaintiff’s claims. With the rapid growth of Internet-based commerce, your online activities may subject you to potentially being sued in more states than you expect.

Copyright 2009

Beyond the Contract: Protecting Rights in Intellectual Property

September 25th, 2009

A franchisor’s intellectual property rights can be some of its most valuable assets. Indeed, and for service-based franchise systems in particular, the franchisor’s intellectual property can be the vast majority, if not sum total, of the value of the franchise. Therefore, it is critical for franchisors to protect the value of their intellectual property, not only through careful drafting in their franchise agreements, but through ongoing proactive protective measures as well.

For most franchise systems, the key intellectual property rights involved include: the franchisor’s trademarks and/or service marks; the franchisor’s trade dress and trade secrets; and the franchisor’s confidential and copyrighted information. These items will be provided or disclosed directly to franchisees, whether through training programs, operations manuals, a franchisee intranet, advertising templates, or other electronic means. The franchise agreement then will limit the franchisee to use of the franchisor’s intellectual property in strict conformity with the franchisor’s standards and specifications, and will limit disclosure of confidential and proprietary information on a need-to-know basis.

However, these contractual protections will not be able to fully serve the franchisor’s interests unless the franchisor also is making efforts to ensure that it has and maintains a protectable interest in its intellectual property. What follows is a brief outline of some steps franchisors should take to protect their intellectual property rights.

Trademarks and Service Marks

                Trademarks and service marks are words, designs, symbols and logos that are used to identify the source or origin of products and services. A trademark or service mark is the franchisor’s “brand name” that identifies the goods or services provided by franchisees with the franchisor.  As indicators of source and origin, trademarks and service marks should be used descriptively – as adjectives – rather than as nouns or verbs. For example, if a franchisor’s trademark was “SuperBuildersTM”, it would advertise “SuperBuildersTM construction services,” but not, “our franchisees are SuperBuildersTM,” or, “our franchisees are experts in SuperBuilding.”

                Trademarks and service marks should always be used consistently, and franchisees should not be permitted to use altered versions of the franchisor’s marks. The franchisor should issue written specifications for spelling, capitalization, font, layout and color. If the mark includes a design, all franchisees should be required to use the same, unmodified design. Registered marks should always include the “®” symbol, and unregistered marks should include the “TM” or “SM” symbol, as appropriate.

                In addition, trademark owners can lose rights in their marks through challenging or unauthorized use of the marks or confusingly similar marks by unrelated third parties. The doctrines of dilution, genericism and abandonment all relate to the loss of trademark rights due to the owners’ failure to police others’ use of its marks. Additionally, trademark rights can be challenged or affected by the use or registration of confusingly similar trademarks.

                To avoid these issues, franchisors should monitor franchisees’ use of their trademarks and service marks, and also monitor third-party uses of and attempts to register similar trademarks. This can be done through a regular review of the U.S. Patent and Trademark Office’s Official Gazette, which publishes marks proposed for registration; through Internet and domain name searches for potential conflicts; and through a review of relevant industry and trade publications. If potentially harmful uses are discovered, the franchisor should be prepared to take action to protect its rights.

Copyrights

                Copyrights arise automatically in the author of creative works. Authoriship may reside with an independent agency or freelance artist or writer unless the work is specifically developed as a “work made for hire” or is specifically assigned to the franchisor. While registration of a work is not required for copyright protection, registration with the Copyright Office of the Library of Congress does provide certain benefits. Principally, registration is a pre-requisite to filing a complaint alleging infringement. Registration also constitutes prima facie evidence of validity, and entitles the owner who prevails in litigation to statutory damages.

                Regardless of whether a copyrighted work is registered, the franchisor should include notice of its claim of ownership on the work itself. This may be done with the simple notation “©2009 ABC, Inc.”

                Copyright protection is only available for works that are disclosed to the public, and registration of a copyrighted work necessarily makes the work available for public review. Thus, registration of the copyright in a franchisor’s operations manual or other confidential information should be done with care to ensure that the confidential materials are not publicly disclosed. Nonetheless, registration of a franchisor’s operations manual with the confidential information redacted can serve the franchisor well in the event a franchisee leaves the system and attempts to copy the franchisor’s system and materials.

                By taking proactive measures to preserve their rights in their intellectual property, franchisors can protect the value of their system and the investments of their franchisees. A great brand name and catchy ad campaign can become worthless, and even damaging, for franchisors who do not protect their intellectual property from unauthorized and infringing uses.

By: Jeffrey S. Fabian