New Jersey Franchise Practices Act: When Does It Apply Part 3: “Community of Interest”- Investment Issues

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Franchise Law Attorney

I am going to wrap up our series on the applicability of the NJFPA by discussing the economics of the franchisor-franchisee relationship when invoking this law.  The discussion has been focused on the power dynamic between franchisor and franchisee.  In particular, the courts teach us that there needs to be a power disparity between the parties.  Agreements where a material is being supplied to manufacture a final product will not be considered a franchise agreement if there are other suppliers that the manufacturers have contracts with.  However, companies whose majority of revenue comes from the sales of a certain product, and whose agreements require the company to conform to certain requirements by the product’s manufacturer, can be considered in a franchise relationship.  Today, we look at the economics of the power dynamic, specifically what type of investment the franchisee should be making in the franchisor in order to establish this community of interest.

The most illustrative of the cases comes from the Third Circuit in Cassidy Podell Lynch, Inc. v. SnyderGeneral Corp.  Cassidy was the exclusive sales representative of SnyderGeneral products.  The agreement with SnyderGeneral provided that Cassidy cannot sell competing products.  The majority of Cassidy’s income came from the sale of SnyderGeneral products, yet Cassidy sold non-competing products, managed his own workforce, and solicited customers.  This case introduced the idea that the franchisee needs to make a substantial investment in goods that will have minimal utility outside of the franchise before a court will recognize a franchise relationship.  Because Cassidy was merely a distributor of SnyderGeneral goods, he could go outside the agreement to sell other products, he did not need to make a substantial investment in SnyderGeneral beyond the products he bought from them, and he had a lot of freedom to manage his company as he wished, so there was no community of interest.  The “substantial investment” test has also been adopted by the New Jersey Supreme Court in Instructional Systems, Inc. v. Computer Curriculum Corp.

The investments made need to be specific to the franchise, and be required to be made per the terms of the parties’ agreement or nature of the business.  The reason for this is simple and relates to the central theme of power disparity between the two entities.  When franchises make this large investment that cannot be put to good use outside of the franchise, they lose bargaining power, and if terminated, a vast majority of the value of its assets would be gone.  So the franchisee has no choice but to succumb to the whim of the franchisor.  The NJ Supreme Court listed other types of investments that would qualify under the NJFPA.  Buying the franchisor’s software and products, along with special equipment made specifically for the products of the franchisor and the franchisor’s demonstration models are examples of large investments.  Some other investments include designing the franchise building a certain way and absorbing the cost of computer upgrades and hardware, along with absorbing the cost of performing market studies.

I conclude this blog by answering the earlier question I posed.  To refresh your memory, consider a local watch store allowed to be an authorized dealer of a brand name of watches, such as Rolex, but sells other types of watches.  Does the store have a franchise relationship with Rolex such that it is subject to the protections of the NJFPA?  Well this is the case of Orologio of Short Hills, Inc. v. The Swatch Group (U.S.) Ltd.  Orologio owned a store in the Garden State Mall in Paramus that sold watches.  Orologio executed an agreement with Swatch to sell its watches in the store.  Orologio would obtain a flat fee percentage of sales above an established threshold, and would split the costs of advertising Swatch watches with Swatch evenly.  Orologio was the authorized dealer of Swatch watches until Swatch terminated the agreement when it opened its own store.  The court held that this was not a franchise relationship because Orologio was not dependent on Swatch, as it sold many other brands of watches.  No substantial investment was made by Orologio to buy into Swatches.  Interestingly, after Swatch opened its own store, Orologio’s business revenue increased.  So clearly there was no dominant relationship between those two, nor was there a franchise relationship.

To discuss your NJ Franchise matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com.  Please ask us about our video conferencing consultations if you are unable to come to our office.

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