Twin Cities Business Litigation Blog : Minneapolis Business Litigation Lawyer & Attorney : Gavin P. Craig Law Firm : St. Paul, Twin Cities, Minnesota MN

Several years ago I represented a company with a claim against another construction corporation. The owner of the defendant told me that neither he nor his company could be held liable for anything. His contracts, he told me, clearly stated that the company was not responsible for anything, and since he operated as a corporation, he could not be held liable.

He was wrong about the contract, but he could have been correct about the corporate shield. However there are exceptions, and the assumption that a corporation always shields the principals is just not the case. There are several exceptions to this rule.

MarcWard posted an interesting Blog about this issue in his Iowa Limited Liability Company Blog. The case he describes could apply equally to the principals of a corporation and an LLC. The case, Allen v. Dackman, 2010 Md. LEXIS 82 (Md. Ct Appls. March 22, 2010) is illustrative of several statutes that impose liability on the principals. In the Allen case, Hard Assets, the company, purchase foreclosed property. It purchased some property sight unseen, and soon afterwords, discovered that there was a tenant living in the building. Hard Assets had the tenant removed. So far so good.

The tenant then sued Hard Assets and Dackman for alleged lead poisoning of her children. Dackman was a member of the LLC and the manager. At this point Hard Assets had only owned the building for several months. In fact, it was only seven months from the purchase to the eviction. So, the tenant sued Hard Assets and Dackman for damages. Unfortunately for Dackman, Statutes and ordinances can change the liability situation. Dackman was deemed to be the person that could effect the property, so he became personally liable for the damages under the Baltimore Housing Code. (See Ward's Blog for more detail.)

The point is, don't assume an LLC - or corporation provides the protection you want.

In Minnesota, a the principal of a franchisor can be held personally liable for damages relating to the breach of a franchise agreement. While this doesn't sound like a major problem, consider this: Under Minnesota Law, and the law in many states, it is very easy to inadvertently create a franchise agreement. Some license agreements are in fact franchise agreement, even though the parties do not intend that result.

In general, a franchise is very easy to create. The basic elements are:

A contract or agreement, either express or implied, whether oral or written, for a definite or indefinite period, between two or more persons:

a. by which a franchisee is granted the right to engage in the business of offering or distributing goods or services using the franchiser's trade name, trademark, service mark, logotype, advertising, or other commercial symbol or related characteristics (you use my name and send me a fee and we will both make money);

b. in which the franchiser and franchisee have a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement, or otherwise (We both make money and I will expand my business);

c. for which the franchisee pays, directly or indirectly, a franchise fee.
 

This is so easy it is not hard to see that parties could easily enter into a franchise agreement without ever knowing it.  The point of this post is to show that there are some circumstances where the corporate or LLC shield does not provide protection to the principals. So beware!

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One of the many things that the unwary businessperson can do on occasion is unintentionally create a franchise. The obvious reason is the failure to consult an attorney. Every state has its own franchise laws, and some are better than others depending upon whether you are representing the franchiser or the franchisee.

In general, a franchise is very easy to create, and thereby subject the creator to state franchise laws and regulations. The basic elements are:

1. A contract or agreement, either express or implied, whether oral or written, for a definite or indefinite period, between two or more persons:

a. by which a franchisee is granted the right to engage in the business of offering or distributing goods or services using the franchiser's trade name, trademark, service mark, logotype, advertising, or other commercial symbol or related characteristics (you use my name and send me a fee and we will both make money);

b. in which the franchiser and franchisee have a community of interest in the marketing of goods or services at wholesale, retail, by lease, agreement, or otherwise (We both make money and I will expand my business);

c. for which the franchisee pays, directly or indirectly, a franchise fee.

Pretty easy. The owner makes a verbal agreement to allow someone to use his trade name for a fee would pretty much satisfy the requirements. Much of the franchise litigation is over the issue of whether the payments amounted to a fee. If they didn't - there is no franchise. But then, the problem is that the unintended franchiser must litigate whether the business arrangement was a franchise or not. So the unintended franchiser agrees to allow someone to use its trade name to conduct business, all for a small fee per transaction. Franchises are securities, and as such they must be registered.

In my experience, many business owners wanting to expand their businesses come up with plans that look a lot like a franchise. They have no idea that the proposed business arrangement might created a franchise or a security. If there is a franchise, most states carefully regulate the franchise and require filings and approvals. Franchise law is a world unto its self. The failure to comply with the relevant states franchise laws create serious potential liability for the unintentional franchiser.

Another great thing about a franchise is that, in many states, the franchisee is entitled to costs and attorney fees if the franchiser is in violation of the franchise agreement and the franchisee incurred real damages. This is especially interesting when the alleged franchise agreement is verbal.

Franchise laws are intended to protect the public. The smart business owner will talk to his or her counsel BEFORE entering into any agreement that allows others to use their trade name(s) or trade mark(s).

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