Five Things to Check Before You Sign a Franchise Agreement

CORP - Nov 1.pngWhether your new franchise business involves ice cream or cleaning services, business ownership in an established business network can be very appealing. As a franchisee you’ll probably be provided training in a proven business system, and be given access to established brands. Starting out as a franchisee is an exciting time, and it’s common to focus on the mechanics of getting the business started, and projected revenues, rather than on problems which might arise later. But what if it doesn’t work out?

Franchisors selling franchises in Texas are subject to written disclosure requirements. Disclosures required under Texas and federal law include a wealth of valuable information, such as training promised by the franchisor, litigation in which the franchisor has been involved, and the franchisor’s financial statements. Be sure to check for these potential issues in your agreement:

  1. Read the franchise agreement carefully before signing, and make sure you
    understand agreement language. The franchisor should be ready and eager to explain the terms of the agreement. Any suggestion that language is just “the usual boilerplate” could be cause for concern. Pay attention to details on renewal, extending the term of your franchise, or if the franchisor has the right to change your agreement.
  2. Confirm that your franchise will have territorial protection. You don’t want to invest time, effort and money in your new business, only to find that the franchisor has the right to sell an identical franchise to someone else next door..
  3. Give some thought to what happens if you should suffer a physical or mental disability. May your spouse, business partner, or other trusted person continue to operate the franchise, or is continuation of the franchise threatened? Check to see what qualifies as a “disability” in the agreement.
  4. Examine the franchise agreement to see what right you have to terminate the agreement if you should be dissatisfied. How is termination handled? Equally important, check to see what right the franchisor has to terminate you. Can the franchisor terminate you only for specific reasons (e.g. dishonesty, fraud), or can the franchisor terminate you for more general reasons, such as “failure to meet franchisor’s expectations?”
  5. If you and the franchisor have a disagreement and are unable to resolve your differences, how is the matter resolved? Is mediation mandatory? Can you have your complaint heard and resolved by a jury of your peers, or must your complaint be heard in a private arbitration proceeding or in a certain geographic area.

Buying a franchise is an exciting but complex time. The matters above are just a few of the many things to consider before you sign an agreement.

When in Rome, Don’t Contract in English

CORP - Aug 22When advising clients on international transactions, we often provide counsel that runs counter to our clients’ expectations and initial inclinations. For example, Texas clients usually assume they want Texas law and courts to govern the contract, when often the foreign law is more favorable to their contract position, and a foreign court will be better able to enforce it. Clients can be particularly surprised when we advise that their contract should be translated into a foreign language.

On one recent client matter, our client was a US tech company negotiating a joint technology development agreement with a manufacturer in Brazil. When we recommended translating the client’s contract into Portuguese, the client responded, “There’s no way we’re signing our contract in a language we can’t read! Let them translate it.” We pointed out that we can easily ensure that the translation is done accurately so that the contract says what we intend, but it’s also important, though less obvious, that the contract be understood by the Brazilian party, and by the courts that may ultimately be asked to enforce it. It is not just “the other side’s problem.”

Principles of contract law provide that if two contracting parties fundamentally misunderstand each other on a key term, there’s no meeting of minds sufficient to form an enforceable agreement. Moreover, disputes over interpretation are typically resolved against the drafter, who bears the burden of ensuring that the written terms are understandable to both parties. Therefore, asking the Brazilian manufacturer to execute the client’s contract in English would simply provide the manufacturer a possible defense against enforcement that it wouldn’t otherwise have. If the manufacturer argued, “The way we translated that provision, it means that we own all the joint IP,” the client would bear the burden of demonstrating that the manufacturer’s interpretation was unreasonable.

Having the contract subject to international arbitration in English wouldn’t help, as it wouldn’t change the underlying principles of contract law. Moreover, even if the client obtained a favorable arbitral award, that award would still need to be enforced against assets of the manufacturer in Brazil—i.e., with the assistance of a Brazilian court. If the Brazilian court found there was no “meeting of the minds,” then arguably the contract was never validly formed and the arbitration clause is void ab initio; different jurisdictions have different approaches to this issue, but the Brazilian court would likely look favorably upon any argument protecting the local manufacturer.

Worse, if the client needed an injunction against the manufacturer to prevent IP theft, that relief could only be issued from a Brazilian court. If the contract was executed in English, then a translation would need to be provided to the court, and the parties would submit competing translations, each supporting their own arguments. At that stage, facing delays, expense, and uncertainty caused by arguing over translations, the client would sorely regret its decision to not to have an agreed translation into Portuguese from the outset.

We usually advise, then, that such contracts be executed in both languages, with the text of the two versions appearing side-by-side in columns, and with each version having equal effect. The key objective is to ensure that there is an agreed foreign-language version that can be enforced in the relevant foreign courts, and in US courts, with no squabbling over misunderstandings or strained translations.

When a client remains unwilling to give effect to any contract not drafted solely in English, then we recommend adding language such as the following, in hopes that this will at least help to weaken a foreign counterparty’s ability to hide behind alleged misinterpretation of the agreed terms.

COUNTERPARTY represents that it has carefully reviewed this Agreement with the involvement and assistance of COUNTERPARTY’s officials, advisors, and legal counsel fluent in the English language, that it has consulted with legal counsel competent to render advice with respect to transactions subject to the law that the Parties have chosen to govern this Agreement, that it has no questions regarding the meaning of any of this Agreement’s terms, and that it has obtained high-quality translations of this Agreement for use by any of COUNTERPARTY’s officials who are not fluent in the English language, with the understanding that COUNTERPARTY alone shall bear the risk of any misunderstandings that may arise as a result of such translation.


FDA Steps Up Oversight of Physicians Receiving Medications From Outside U.S.

CORP - July 19.pngAs a practicing physician, it may seem like the great price you got from a third party distributor for Botox is too good to be true. You might be right. Let’s look at the legal side of what could go wrong. If the distributor is bringing medications from out of the country into the U.S., they must be licensed or registered with the FDA to sell in the U.S. The FDA requires specific coding on the drug labels that allow them to track the product throughout the supply chain. Based on this code and the product’s final destination for sale, the FDA may conclude that the physician is administering medications that are ‘misbranded.’ If the medications are not stored properly en route to the physician’s office, there is a risk of selling products that are ‘adulterated’, another FDA violation.

What has changed?

The FDA has stepped up its oversight which will result in increased enforcement. The FDA’s import software screening program (PREDICT) and U.S. Custom’s software program (ACE) now require more information from the foreign source(s). The FDA’s product codes and U.S. Harmonized Tariff Schedule (HTS) now link these requirements. The software coding information must be correct or a physician may face costly delays and possibly a refusal of entry for the medications into the U.S. In addition, information on the entry’s commercial or pro forma invoice must be consistent with the information entered into PREDICT and ACE software: however, the FDA does offer some relief from the strict requirements if you participate in a voluntary Affirmation of Compliance (AOC).

Still, delays are not the physicians’ biggest problem. What also occurs is a spotlight on the importation, or attempted importation, of medications that may or may not conform to regulations. In these cases, the FDA may deem the purchasing physician to be ‘in receipt of misbranded and/or adulterated drugs in interstate commerce and delivering those drugs to others – the end user, or patient. The laws are clear in that they require all healthcare providers who dispense or administer prescription drugs to purchase drug products from authorized trading partners licensed by, or registered with, the State or Federal government.

How do they do it?

The new import entry filing requirements became effective in 2016 and are posing problems for users who fail to provide the correct information, creating costly delays and, in some cases, the frustrating task of contacting the FDA to resolve the issue. PREDICT and U.S. Custom’s ACE program link your legal requirements by using the correct Harmonized Tariff Schedule (HTS) code. This sets up how the FDA will apply its requirements. Any error means the FDA may flag a physician as a problem that requires greater scrutiny for data verification.

Why is it important?

Physicians do not want to have an Agent from the Office of Criminal Investigations showing up at their office to search and seize misbranded and/or adulterated prescription drugs. The FDA stance is that non-FDA approved prescription drugs are virtually always misbranded and/or adulterated. Their mission is to ensure the safety of the public and to stop the use of medications that are improperly labeled or may not have been manufactured, transported and/or stored under proper conditions. Violations, including past violations, are subject to enforcement actions, including criminal prosecution. A typical Acknowledgement Letter to be signed by the physician from the FDA’s Special Agent will reflect that he or she has been informed that the ‘minimum penalties for a criminal violation of the Food, Drug & Cosmetic Act authorizes a sentence of up to one year in prison and/or a fine that could exceed $100,000 for each separate offense committed.’ In addition, violations can extend to the responsible corporate official for misdemeanor violations without proof of intent, or even negligence, even if the corporate official did not have actual knowledge of the specific offense.

So what’s a physician to do?

One immediate step a physician can take to protect themselves is to first make sure that all existing medications received in the office are in compliance with the FDA regulations. Following that, the medical office should have in place an “Approved Vendors” policy that evaluates the suppliers for all prescription drugs before initiating a purchase and understands the approval steps involved in the evaluations of their vendors. Know, too, that once a physician takes receipt of the medications, he or she is responsible for conforming to the requirements of the Drug Supply Chain Act in how they are stored. Finally, a physician should know how to read the coding on the medication labels and be able to cross check to verify that the medications being receiving are actually coming from authorized trading partners or ‘Approved Vendors.’

If an FDA Criminal Investigations Special Agent shows up at your office, be prepared to show proof of conformity and that purchasing policies are in place.

Recent Legislation May Ease LLC “Divorces”

CORP - July 5It is always a best practice for persons forming a limited liability company (an LLC) to agree in advance about terms of separation, how to end the relationship in case they become unable or unwilling to remain co-owners of the LLC. These provisions, which could be thought of as an LLC-owners’ “prenup,” are usually set out in the Company Agreement of the LLC. However, sometimes the Company Agreement does not contain adequate terms for owners separating themselves from each other or from the LLC. If the Agreement is inadequate, owners have always had another remedy, which is a lawsuit asking a court to order a termination of the LLC.

Section 11.314 of the Texas Business Organizations Code (the law that deals with LLC’s and other business entities — sometimes called the TBOC) provides that a court can order the winding up and termination of a Texas LLC. Under the current law, this can only happen if the court finds that it is not “reasonably practicable” to carry on the LLC’s business under its governing documents. It is not clear when discord or lack of cooperation among owners makes it no longer “reasonably practicable” to carry on the LLC’s business. This uncertainty may have discouraged unhappy LLC owners from seeking a court ordered termination.

This situation changed somewhat this year when the Texas legislature amended the TBOC (effective September 1, 2017) to expand the reasons a court can order a termination of an LLC. Under the new law, the court can also order the termination of an LLC if it finds that the economic purpose of the LLC is likely to be unreasonably frustrated or when an owner has engaged in conduct that makes it not reasonably practicable to carry on the business with that owner. When problems arise with an LLC that lead an owner to want a “business divorce” from another owner, there are usually allegations of bad actions by the other owner. By adding bad owner conduct to the list of ways a court can terminate an LLC, the legislature has hopefully made it a little easier for an owner to exit from an LLC relationship that the owner wants to end.

Crowdfunding: What’s best for your business?

CORP - June 20In recent years, many entrepreneurs have turned to crowdfunding in their efforts to raise capital. Platforms like Kickstarter and Indiegogo largely popularized this method of financing, but the industry is only in its infancy, with options in this space growing day by day. With the implementation of federal crowdfunding rules in May 2016, startups and small businesses in the U.S. now have a legal framework for equity-based crowdfunding, allowing for private offerings of securities to a much wider pool of investors. There are, however, significant restrictions in place making this option less attractive for some business owners.

So how do you decide if crowdfunding is right for your business? Here are the basics:

Reward-Based Crowdfunding

The word “crowdfunding” is often synonymous with the crowdfunding site Kickstarter, a reward-based platform. With this type of crowdfunding, individuals pledge money to your business idea in exchange for some type of benefit. A significant upside to reward-based crowdfunding is that you are not giving up ownership of your business in exchange for capital: reward-based crowdfunding is more analogous to selling a product than taking on investors.

Some start-ups have found enormous success using this method of crowdfunding, with projects like the Pebble smartwatch raising $2.6 million on Kickstarter in only three days. However, this method tends to work best for creative projects or consumer goods that grab attention and are easy to understand. Software or tech companies looking to raise significant amounts of capital are often better served using other types of fundraising.

Equity-Based Crowdfunding

Equity-based crowdfunding platforms are akin to online venture capitalists, connecting companies seeking investment to a wide range of small investors. Even reward-based platforms are branching into this space, like Indiegogo, which recently partnered with equity platform Microventures to form a new securities crowdfunding portal.

True equity crowdfunding was only made possible through the Jumpstart Our Business Startup (“JOBS”) Act, passed in April 2012, and its implementing regulations, adopted by the Securities and Exchange Commission (“SEC”) in October 2015. These rules now allow companies to raise up to $1 million in a crowdfunded offering during any 12-month period, although individual investments are capped at certain amounts depending upon the investor’s income and net worth.

Companies who choose this route should consider the significant requirements placed upon them, including sharing an annual report, with financial statements, on the company’s website and filing this report with the SEC. For early stage businesses, preparing such a report may be too burdensome, and the risks of sharing sensitive information with the public too great.

Under the JOBS Act rules, all equity crowdfunding must be conducted through registered intermediaries, meaning the platform itself must be registered with the SEC. This registered intermediary is also required to have a financial interest in the company raising funds. As a result, often 10-15 percent or more of each fundraising round will be given over as an upfront fee to the platform. For smaller businesses, this cost is simply impractical.

When financing your business, remember you have multiple options. Consulting with the right attorney may help you figure out which decision is best for your company.

Profits Interests Transform Employees into Partners, and Why You Should Care

CORP - June 6.pngBusinesses frequently wish to incentivize and reward key employees with equity ownership. Those businesses operating as pass-through entities will often find a profits interest a convenient and tax favorable way to accomplish this goal. The profits interest can generally be structured to be received by the employee without triggering a current tax liability while still incentivizing the employee with participation in the up-side of an exit.

However, many are unaware that the granting of a profits interest to an employee transforms the employee into a partner for tax purposes. Profits interest holders are partners and the longstanding position of the IRS, as laid out in Revenue Ruling 69-184, is that a partner in a partnership may not also be an employee of that partnership.

What are the consequences of this transformation? Employees are subject to income and FICA tax withholding (and Form W-2 reporting) while partners, on the other hand, receive Form K-1 and pay income and self-employment taxes on a quarterly estimated basis. Further, this transformation may increase new partners’ employment tax burden because employment taxes for employees are borne equally by both the employee and employer, while employment taxes paid under the self-employment system are born 100% by the self-employed (i.e., by the new partner).

Also, only employees are eligible to participate in cafeteria plans, including flexible spending accounts, whereas partners are not.

What are the consequences of treating a partner like an employee anyway? Aside from potential over or under paying of employment taxes or potentially disqualifying a cafeteria plan by virtue of enrolling a non-qualified participant, future grants of profits interests to a partner who is incorrectly being treated as an employee may lose the benefit of the profit interest safe harbor and be taxable to the partner upon receipt.

The increase in self-employment tax burden caused by the issuance of a profits interest can be mitigated through a salary gross-up or may be overshadowed completely by the up-side of being able to participate in an exit. Complications of profits interest related to cafeteria plans and the future grant of more profits interests can be avoided through understanding the employee’s transformation into a partner and treating such individual accordingly.

Planning opportunities may exist for those businesses that wish to grant equity ownership to their key personnel while retaining the employment status of such personal. Such businesses should carefully vet these opportunities with their tax advisors.

Are B-Corps Coming to Town?

CORP - May 22Texas may be on its way to joining thirty-one states that have already passed Public Benefit Corporations (B-Corps) legislation, which include Delaware, California, Florida and New York. House Bill 3488, which allows for the creation of B-Corps in Texas, has generally garnered bi-partisan support and was passed by the Texas House of Representatives earlier this month. Currently with the Texas Senate, if passed, HB 3488 is expected to become effective later this year.

What is a B-Corp?

A B-Corp is a voluntary election that allows companies to incorporate with the intention of pursuing a public benefit in addition to creating profits for its shareholders. The move to codify the requirements for corporations with a public benefit focus may be attributable to a general trend among millennials to financially support companies that make the environmental and social good a central corporate tenant. Some noteworthy B-Corps that have been formed in other jurisdictions include Etsy, Patagonia, Ben & Jerry’s, Kickstarter and This American Life.

According to the current draft of HB 3488, which will likely undergo further amendments prior to its passage, a B-Corp in Texas will be denoted by “PBC” in its corporate name. The managers of a B-Corp would be tasked with balancing not only its shareholders’ pecuniary interests, but also the interests of those materially affected by the B-Corp’s conduct and the public benefit(s) specified in the B-Corp’s certificate of formation. A director of a B-Corp would be considered to have satisfied her or his fiduciary duties to shareholders and the corporation if in balancing these interests, the director’s decisions are informed, disinterested and those that a person of ordinary, sound judgment would approve.

HB 3488 currently requires a B-Corp to deliver a statement to its shareholders at least every two years with a description of the corporation’s promotion of its specified public benefit(s) and promotion of the best interests of those materially affected by the corporation’s conduct.

A Texas B-Corp would otherwise remain subject to the same requirements as a Texas for-profit corporation.

If the legislation passes, how do I create a B-Corp?

Consult legal counsel before forming your B-Corp to ensure the certificate of formation includes adequate language designating the public benefit of the B-Corp, proper shareholder reporting practices, and directors are aware of their fiduciary duties.

How do I convert my current corporation to a B-Corp?

If the legislation passes as currently contemplated, the owners of two-thirds of the outstanding shares of the corporation entitled to vote on the matter are required to approve changes to the certificate of formation that would convert a for-profit entity into a B-Corp. Alternatively, a B-Corp could be formed by a merger or consolidation between a for-profit entity and a newly created B-Corps, with such B-Corp surviving. Any shareholder affected by a conversion or merger described above would have the rights of dissent and appraisal.