COURT RULES AGAINST MORE RED TAPE FOR FRANCHISE REGISTRATIONS

Date: August 17th, 2010

Anyone who wants to sell a franchise in Washington needs to make sure the franchise offering has been reviewed and approved by the State, and all necessary information is disclosed to buyers. Washington franchise law is now much clearer about how subfranchisors can rely on the compliance of the franchisor and certain disclosure obligations.

In Something Sweet, LLC v. Nick-N-Willy’s Franchise Company, LLC, 2010 Wash. App. LEXIS 1135 (June 1, 2010), the Washington Court of Appeals explained that: (1) subfranchisors do not need to register franchise offerings with the State of Washington if the franchisor has already done so; and (2) if contracts have the right language in them, people buying franchises do not need to be told of potential changes in business strategies.

Consider Nick-N-Willy’s, which sells two types of pizza franchises. One kind is for a business that offers only take-and-bake pizzas, while the other is for a business that offers take-and-bake pizzas and in-store dining of cooked pizzas. In 2005, Washington resident Michael Moore purchased from Nick-N-Willy’s the exclusive right to sell both kinds of franchises in King County. In other words, he became a subfranchisor.

A year later, Moore sold a take-and-bake only franchise to a company called Something Sweet, LLC. He did not register the franchise offering, because Nick-N-Willy’s had already done so and had gotten approval from the State. He also did not inform Something Sweet that Nick-N-Willy’s “was planning to discontinue” the take-and-bake only model, and require all future stores to offer in-store dining.

Something Sweet filed a lawsuit in 2008 against Nick-N-Willy’s and Moore claiming that Moore violated the Franchise Investment Protection Act (“FIPA”), RCW 19.100 et seq., by failing to register a franchise offering, and that Nick-N-Willy’s violated FIPA by failing to tell Something Sweet it was going to stop selling take-and-bake only franchises. The Court of Appeals considered both issues and decided the trial court was correct when it dismissed both of Something Sweet’s claims without the need for a trial.

The court first looked at Something Sweet’s claim that Moore violated FIPA by failing to register the franchise offering as a subfranchisor. The court’s opinion begins by reminding us that it is unlawful to sell an unregistered franchise in Washington. However, everyone in this case agreed that Nick-N-Willy’s properly filed a franchise offering under FIPA, well before Something Sweet purchased its franchise. The court then explained that “[b]ased on its plain language, RCW 19.100.020 does not prohibit a subfranchisor from selling or offering to sell a franchise if the offer of the franchise has already been properly registered.” That conclusion makes quite a bit of sense because under FIPA, Moore would have only needed to resubmit the franchise offering Nick-N-Willy’s already had approved by the Director of Financial Institutions (DFI). Put another way, there was no reason to increase bureaucratic red tape by having the same application submitted and approved a second time.

The court also considered the issue of whether Moore and Nick-N-Willy’s had an obligation to tell Something Sweet that Nick-N-Willy’s “was planning to discontinue” the take-and-bake only model. The court began by explaining that, similar to the Securities Act of Washington, information is material under FIPA “if a reasonable person would consider it important in determining what action to take with respect to the transaction in question.”

The evidence showed that after Something Sweet purchased its franchise Nick-N-Willy’s began requiring new franchises to offer in-store dining. However, it was also true that Nick-N-Willy’s continued to support take-and-bake only franchises in several states across the country and did not require stores like Something Sweet’s to start offering in-store dining. The court went on to observe that the offering circular Something Sweet received and the franchise agreement it signed both indicated that Nick-N-Willy’s might change its store operating methods in the future. Neither document mentioned how many of which kinds of store Nick-N-Willy’s intended to offer or require. Based on that language, the court held that “the nationwide mixture of outlet and restaurant models was not a key feature of the franchise agreement,” and Nick-N-Willy’s had no obligation to tell Something Sweet of its plans.

There are a few important lessons to take away from this case. First, we are reminded that franchise offerings must be reviewed and approved by DFI. Second, sellers of franchises should strongly consider having legal counsel review offering circulars, franchise agreements and other similar documents before submitting them to DFI for review to make sure they have language giving them the flexibility they need to adjust business models and make other tough decisions. In these trying economic times, that kind of flexibility can be the difference between a business surviving, or going out of business.

PS: DFI has a very convenient website where the public can easily search by company name to see if a franchise offering has been registered.