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The Cleaning Authority Cleans Out Franchisee Retirement Fund

You can't kickback money to yourself, a court tells Cleaning Authority zees.

The Cleaning Authority became involved in litigation with South Carolina franchisees Joanna & Frederick Neubert of Greenville, and Scott & Denise Aldrich of Columbia.

Franchisor owners Steve Robinson & Tim Evankovitch had set up an affiliated entity (S&T Management Inc) which the franchisees were required to use. S&T were supposed to send out ad mailers to prospective customers within the franchisees' territory.

The Neuberts had used their retirement funds to buy the TCA franchise, and paid a $35K franchise fee to TCA and $2K "setup fee" to S&T. Then the Neuberts proceeded to pay more than $200,000 to TCA and another $500,000 to S&T over the course of their time as franchisees.

There was some dispute as to whether S&T actually mailed the flyers it had been paid for, but the main issue was whether the franchisor had adequately disclosed the remuneration which it got from S&T; another issue was the franchisor's failure to permit any alternate source of advertising.

The court held:

[A]ny reasonable reader of the [Offering Circular] would have understood that he or she had no option when it came to a source for advertising mailers. As for...the allegation that [the franchisor] received monies from [the affiliate] contrary to its representation in the [Offering Circular] that it, at that time, did not recieve rebates from any of its approved suppliers, the [franchisees] have not pleaded sufficient facts to establish the materiality of the financial relationship between [franchisor] and [affiliate] to their decision to purchase a...franchise.

The Aldriches made similar claims against their franchisor, and the court responded in similar fashion:

[The mailing company] was affiliated with [the franchisor] and the [Offering Circular] fully disclosed that relationship. The FTC statement [FTC Statement of Basis and Purpose Relating to Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures] makes a clear distinction between "affiliated persons" and "suppliers" and thereby exposes the fallacy of the [franchisees'] theory.

Of course, one might argue that the FTC statement (and common sense) reason that a prospective purchaser must have knowledge of kickbacks and other supracompetitive pricing in order to assess whether their raw materials costs were de facto disguised royalties (an argument often made by franchise attorney Michael Webster).

Another interesting aspect of the case in light of the recent debate over using the term "kickback" is that the court cites to 43 Fed.Reg. 59657 n.217, which specifically uses the term to refer to fees passed from a supplier to a franchisor.

________________________________________

The Cleaning Authority v. Joanna Neubert et al, D. Maryland, February 11, 2011

For franchisor: Venable Baetjer Howard (Towson MD), Hogan Lovells US LLP (Baltimore), Faegre & Benson LLP (Minneapolis)

For franchisees: Kern Hillman (Hamden CT), Dady & Gardner (Minneapolis)

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Cleaning Authority v Neubert OPN 11 Feb 2011.pdf44.45 KB
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Corbin is the online pen name of a contracts aficionado who needs to get a better hobby.

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