Identical bills pending in the New Jersey Legislature propose major changes to the Franchisor – Franchisee relationship in the hospitality industry. Among the provisions of S3762 and A2682 are the following:
a. Non-competition agreements for locations outside the county of the franchise location are limited to six months duration. This proposed change would not preclude a franchisor from enforcing its contractual rights against the particular location at issue. Before this proposed change, the general rule is that non-compete agreements must be reasonable as to scope, duration, and geography.
b. A franchisor may not require a franchisee to relocate a hospitality franchise or to make any capital investment over $25,000 more than once every five years. Although this limitation can be overcome if the franchisor can demonstrate that the franchisee will recover the amount of that investment before the end of the franchise agreement, it places a new burden and restrictions on the franchisor. Limiting required re-locations to once per five-years may not significantly impact the franchise relationship because of the joint interest of the parties to have a profitable location. But the $25,000 limit on capital investment may have a significant impact. First, the term “capital investment” is not defined – is re-building a hotel pool maintenance and repair, or a capital investment? Second, in the hospitality industry, a motel may require a $2m initial investment, while a franchised resort may require a $100m initial investment. In both cases, a limit of $25,000 on additional required capital investment may be insufficient.
c. Rebates to the franchisor from a vendor making sales to a franchisee must be disclosed and turned over to the franchisee. Disclosure is already required under the FTC Franchise Rule 16 C.F.R. Part 436, but turning over the rebates to a franchisee is entirely new. On the one hand, rebates are a revenue source for a franchisor. But on the other hand, the franchisor has expenses to cover in approving suppliers and maintaining quality control.
d. A franchisor may not require a franchisee, as a condition for the approval of a renewal or transfer of a hospitality franchise, to assent to a general release from liability for the franchisor unless the franchisor provides to the franchisee a reciprocal general release. This change may not have a significant effect on the franchise relationship where there is a contractual requirement that, as a condition for the approval of a renewal or transfer of a hospitality franchise, the franchisee must cure all defaults or breaches of the franchise agreement.
e. A franchisor may not require a franchisee to purchase goods, services, supplies or inventories exclusively from the hospitality franchisor or designated sources where goods, services, supplies or inventories of comparable quality are available from sources other than those designated by the franchisor.
f. A franchisor may not establish, directly or indirectly, another location in a substantially identical business within the franchisee’s exclusive or protected territory, if the franchise agreement provides for either. The change would have little effect, except to make a breach of the franchise contract a violation of the Franchise Practices Act.
g. A franchisor may not make any material change in the terms of the franchise agreement through any unilateral change, made by the franchisor, to any operations manual or through any bulletin or other communication. This section might make a major change to the franchise relationship. Franchise agreements require a franchisee to follow the operation manual and any updates to the manual. Franchisors update the manuals to improve business operations. How should it be determined whether or not a change is material? As a workaround, franchisors can and do offer consideration to franchisees to permit any changes without dispute – for example, an account credit against royalties.
h. A franchisor may not impose any fee or charge upon a franchisee that has not previously been disclosed in a franchise disclosure document without the franchisee’s written agreement to pay the fee or charge. The change would have little effect, except to make a breach of the franchise contract a violation of the Franchise Practices Act.
i. A franchisor may not impose any fee or charge upon a hospitality franchisee because of published guest reviews or criticisms of a franchisee.
j. A franchisor may not sell points or credits in a loyalty program to a guest for the purpose of permitting the guest to redeem points for a specific stay at a specific franchisee’s facility without compensating the franchisee for the stay at no less than the franchisee’s lowest publicly advertised rate for that stay or the value of the points sold, whichever is less.
k. A franchisor may not suspend, restrict, stop-sell, or prevent access to franchise services, including but not limited to property management systems, online listings, phone call sales, use of approved marks, or any other specified services included in the franchise agreement or provided in the usual course by a franchisor to a franchisee. This is a major change. Suspensions are a contractual method to ensure a franchisee’s compliance with the terms of the franchise agreement.
l. A franchisor may not impose any costs, fees, charges, or penalties for a franchisee’s alleged failure to perform, including but not limited to: re-inspection fees, inspection failure fees, loyalty sign up fees, rate parity violation fees, customer care fees, conference attendance fees, retraining fees, and loyalty program fees. This is another major change that may have unintended consequences. Generally, apart from initial training costs (usually rolled into the initial franchise fee), additional training and conference attendance fees are the responsibility of the franchisee. Franchisors do inspections, as part of their duty to police their trademarks to ensure quality control, and commonly impose fines and penalties for failures. The same goes for financial audits. However, such fees, charges, and penalties are required to be disclosed in the Franchise Disclosure Document and made part of the franchise agreement. This change is another intrusion into the franchise contractual relationship.
Confusingly, the proposed law states that a franchisee’s failure to comply with Section 7 of the Franchise Practices Act or the proposed law shall not constitute good cause for termination of the franchise. But Section 7 and the proposed law regulate a franchisor’s conduct, not the conduct of a franchisee.
It should be noted that the proposed law would not affect existing franchise agreements, unless modified, amended, or renewed after the law takes effect.
Alan L. Poliner is an experienced litigator who provides counsel to franchisors and business owners in New Jersey.
