Additional Insured Endorsements:  Beware!

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Many franchise agreements require that the franchisee name the franchisor as an “additional insured” on the franchisee’s liability insurance policies.  Similar requirements are included in many distribution agreements.  The purpose of this coverage is to protect the “additional insured” from claims relating to the operations of the party purchasing the policy, as well as the purchasing party itself.

It is easy to forget, however, that insurance policies are contracts that must be carefully reviewed to confirm that the insurer is obligated to provide coverage and defend a lawsuit as the parties intended.  A recent case heard by the Illinois Appellate Court illustrates the difficulties in assuring that proper additional insured protection has been obtained.

An individual suffered injuries while lighting a cigarette behind a gas station. He sued  the gas station owner and Shell Oil, which had granted a franchise to the gas station owner to use Shell Oil’s marks.  The franchise agreement required the gas station owner to name Shell Oil as an additional insured on its liability policies.

The applicable policy endorsements, however, contained limiting language.  The first endorsement applied to Shell Oil “only with respect to their liability as grantor of a franchise to you.” The second provided that Shell Oil was an additional insured, but “only with respect to liability arising out of your operations and premises owned by or rented by you.” In the end, the Illinois court found that notwithstanding their ambiguity, the endorsements created a duty for the insurer to defend Shell Oil. 

In working with clients, we increasingly see insurers claiming they cannot provide satisfactory additional insured endorsements, for a multitude of reasons. With a little persistence, however, these objections may be overcome.  A couple reminders:

  • Merely being listed as an additional insured on a certificate of insurance does not guarantee insurance coverage.  To be afforded coverage as an additional insured, a party must be named in an endorsement to the policy, and not just on a certificate of insurance.
  • The endorsement and policy should be reviewed to confirm that (a) the party is properly named in the endorsement and (b) coverage definitions and limitations do not serve to defeat the intention of the parties, which is to protect the additional insured against claims related to the operations of the franchisee or distributor.

Filed Under: Addtional Insured, Franchise Agreement, Distribution Agreement, Insurance Endorsements

Cousins Subs decision:  No fiduciary duty to 50% shareholder

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Do the co-founders of a franchise company owe a fiduciary duty to each other by virtue of their roles as equal owners of the business?  Last week, the Wisconsin Court of Appeals ruled that the answer is no, affirming the dismissal of certain claims in a decision recommended for publication by the court.

The estate of one co-founder of Cousins Subs, James Sheppard, sued his co-founder, William Specht, and the Cousins corporate entities.  Sheppard's estate alleged a breach of fiduciary duty arising out of failed negotiations to sell the business.   Prior to Sheppard’s death, Sheppard and Specht had been negotiating the sale of their shares to Crosslane, a British firm.  Sheppard, Specht and the potential buyer had entered into a Memorandum of Understanding (“MOU”), under which Crosslane stated its intention to purchase Cousins for $10 million in cash plus a $2 million promissory note.   The MOU was not binding on the parties.

After Sheppard’s death, negotiations between Specht and Crosslane broke off.   Sheppard’s estate then filed suit, alleging that (i) Specht had reneged on an agreement between Specht and Sheppard to sell the company if the buyer met a certain price, (ii) that Crosslane had met the price, but (iii) Specht refused to sell after the condition was met. 

Wisconsin law does impose a fiduciary duty from a majority shareholder to a minority shareholder. However, no previous reported Wisconsin decision had addressed whether a 50 percent shareholder owes a fiduciary duty to another 50 percent shareholder. Counsel to Sheppard’s estate argued that the court should extend the Wisconsin shareholder fiduciary duty rule to nonmajority shareholders.  The Court of Appeals declined to do so, noting that it is mainly an error-correcting court and “cannot declare new law.” Thus, in his role as shareholder, Specht did not owe a fiduciary duty to Sheppard or his estate.

The court then acknowledged that Specht was also a director of the company, and thus owed a fiduciary duty to both the corporation and its shareholders in that role.  Although the estate alleged that Specht breached a contract to sell if the shareholders received an offer of $12 million, the MOU was not binding on the parties.  The court noted that Specht and Sheppard never agreed on how much of the $12 million would be cash and how much would be seller-financed, the interest rate on any seller-financed amount, or how corporate debt and receivables would be handled in a sale. The court found that the estate failed to state any factual allegations supporting a claim of a breach of fiduciary duty by Specht as a director.

The battle among the shareholders of Cousins Subs (which ranks among the five largest Wisconsin-based franchisors, with approximately 150 units operating in six states) is not over.  Of course, the estate may seek review by the Wisconsin Supreme Court.  And should the Supreme Court decline to hear the case, or if it hears the case and upholds the court of appeals' decision, the trial court still must address an issue that was not appealed -- the trial court's finding that a shareholder deadlock exists between the estate and Specht. 

Out-of-state franchisor’s royalties and the Wisconsin income tax

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Assume you have never set foot in a particular state.  Let’s say that state is Iowa.  But you do business with a party in Iowa – a party that has contracted for the right to franchise your business concept in Des Moines, Iowa.  The Iowa party sends you weekly royalties based on its sales from its Des Moines location.

Can the state of Iowa tax you on the royalties you receive?  What’s more, can the state of Wisconsin tax franchisors who receive royalties from franchisees located in places like Madison or Milwaukee?

Yes, and yes – at least under existing law as interpreted by the Iowa Supreme Court and the Wisconsin Department of Revenue.

In KFC Corp. vs. Iowa Department of Revenue,  the Iowa Supreme Court held that the state of Iowa could assess income taxes against franchisors (such as Kentucky Fried Chicken) that did not have a physical presence in Iowa, but which received royalties from franchisees who used the franchisor’s intangible property (e.g., trademarks) in Iowa. The Iowa Supreme Court held that physical presence was not required for the state of Iowa to impose income tax on revenues arising from the use of a franchisor’s intangibles in Iowa.  By licensing franchisees in Iowa, the Court held, KFC had received the benefit of “an orderly society within the state” and thus Iowa met the constitutional requirements of nexus needed to assess income tax against KFC.

KFC appealed the decision to the U.S. Supreme Court, claiming that KFC’s business operations lacked sufficient nexus with Iowa to give the state jurisdiction to impose the tax.  But last fall, the U.S. Supreme Court declined to review the case. As a result, the Iowa Supreme Court’s ruling stands. 

The Wisconsin Department of Revenue (WDOR) appears to be asserting a position akin to Iowa’s on taxation of franchisors: that sufficient nexus exists for the department to assess income taxes against franchisors who receive royalties from Wisconsin-based franchisees, even if the franchisor does not have a significant physical presence in the state.  Recently, counsel to a national franchisor posted an inquiry on the ABA Forum on Franchising’s listserv, asking if any listserv members had challenged the WDOR’s theory of nexus for taxing franchisors. According to the post, WDOR has asserted that the mere signing of the franchise agreement in Wisconsin provided sufficient nexus for Wisconsin income tax to be assessed against the out-of-state franchisor.

We asked WDOR whether the department takes the position that Wisconsin can impose an income tax on out-of-state franchisors as to royalties received from Wisconsin franchisees.  WDOR declined to comment on current enforcement strategies, but provided the following analysis:

In Wisconsin, royalties and other gross receipts received for the use or license of intangible property (including patents, copyrights, trademarks, trade names, service names, franchises, licenses, etc). are sourced to Wisconsin if the purchaser or licensee: (1) uses the intangible property in operating their business in Wisconsin, (2) is billed for the purchase or license in Wisconsin, or (3) has their commercial domicile in Wisconsin.

There appears to be no reported decision in which either the Wisconsin Tax Appeals Commission (WTAC) or an appellate court considered whether Wisconsin has sufficient nexus to tax royalties of franchisors with little or no physical presence in the state.   But although the WTAC or a Wisconsin court facing the issue may consider the Iowa Supreme Court’s KFC decision, neither would be required to follow KFC or accept its rationale. Given the amounts potentially at stake, odds are that a WDOR assessment that asserts that Wisconsin has nexus to impose income tax on an out-of-state franchisor will be challenged and wind its way through the Wisconsin appellate courts.

Stay tuned.

Wisconsin Permits Electronic Filing of Franchise Registration Forms

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Rarely are the terms “law” and “early adopter of technology”  found in the same sentence.  This certainly is true as to some aspects of franchise regulation.  Whereas most businesses regularly send and receive documents electronically, most state franchise registration forms still are filed the old-fashioned way – by mail or other physical delivery.

As of January, 2010, however, the Wisconsin Department of Financial Institutions  (“WDFI”) got ahead of the curve and began accepting electronic filings of franchise registration and amendment forms.  These forms are required to be filed with the department under Chapter 553 of the Wisconsin Statutes, the Wisconsin Franchise Investment Law.  According to the WDFI website, Wisconsin was the first state to accept such electronic filings.  

A representative of WDFI says that about one-half of Wisconsin franchisor registrants currently utilize the electronic filing system.  To use the system, a registrant clicks on a link on the DFI website, completes a form about the franchisor, attaches a .pdf copy of the filed documents and pays the applicable filing fee by credit card.  

WDFI has no immediate plans to mandate electronic filing of Wisconsin franchise registration and amendment forms.  Thus, franchisors may opt to file registrations or amendments electronically or may do so by physical delivery, such as by mail or other carrier.

Given the ease and lower cost of filing electronically, why wouldn’t a franchisor utilize the electronic filing system? One likely reason is that electronically filed documents (including franchise disclosure documents) may be downloaded from WDFI’s website.    Documents that are delivered by mail or other physical delivery, however, are not scanned and made available for download on the WDFI website. While third parties can visit WDFI’s offices and obtain a copy of a franchisor’s file, the inconvenience and expense of doing so make it less likely that someone will undertake the effort.  Franchisors who wish to limit disclosure of their franchise disclosure documents thus may prefer to utilize mail or physical delivery.

But as will be discussed in a future post on this blog, there are other means to obtain copies of franchise disclosure documents filed by national franchisors.   The North American Securities Administrators Association (NASAA) is also considering issues regarding the use of electronic filing.  Although Wisconsin’s electronic filing system may be unique for now, it’s inevitable that other states will follow Wisconsin’s lead. And who knows -- in the not-too-distant future, all franchise regulatory filings may be made electronically.
 

Getting Off The Ground

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Begin, be bold, and venture to be wise.

--Roman poet Horace*


This is my inaugural post on Wisconsin Franchise and Distribution Law,  a blog created to distribute useful information collected in the course of my work at Stafford Rosenbaum LLP to clients, friends and blog followers.

In our daily practice, my colleagues at Stafford Rosenbaum and I have the pleasure of working with a number of franchisors, franchisees, manufacturers, distributors and independent sales representatives.  In this blog, I will emphasize developments and practices in franchise and distribution law occurring in the state of Wisconsin, but will review and discuss national trends as well.

Why franchise and distribution law?  I am intrigued by the nature of the relationships that develop between franchisors and franchisees, manufacturers and distributors, and manufacturers and independent sales representatives.   At their best, these relationships are win-win deals.  They resemble a  form of joint venture, one in which both parties receive significant value from the arrangement.  But any joint venture is a complicated legal animal.  It is no different in the areas of franchise and distribution law.  We aim to help our clients navigate the challenges that inevitably arise.

[*What does the poet Horace have to do with franchising and distribution?  When I Googled the above quote, the first link I clicked displayed a Google ad promoting “100s of franchises for $10,000 or less.”  Apparently, some advertiser sees a connection.]

It is my hope that you will find the ensuing posts to be bold, informative and containing some measure of wisdom and levity.  Please e-mail to let me know what you think  -- thumbs up or thumbs down.
 

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