Business Law Notes
Summer 2005 Edition
The Franchise Rule promulgated by the Federal Trade Commission (FTC) in 1979 requires detailed disclosures by a franchisor to prospective franchisees. It is probably the single most important law or regulation affecting franchising in the United States. The rule has not been amended since 1986, but the FTC staff has issued a lengthy report suggesting changes to the rule. Significant proposed changes are listed below:
- Written disclosures would have to be made at least 14 calendar days before paying money to the franchisor or signing a binding agreement.
- Electronic disclosures would be specifically permitted.
- Disclosure of a franchise broker would no longer be required.
- Disclosures made in the Uniform Franchise Offering Circular (UFOC) could not be superceded by the franchise agreement. This is a significant proposed change.
- Disclosure of prior litigation would be expanded.
- Use of plain English in disclosures would be required.
- Revised disclosures of the franchisor’s plans to operate a competing system for similar goods or services would be required. This is a significant proposed change. No timetable has been set for acting on the staff’s recommendations.
Businesses frequently lease equipment without the slightest thought about the legal risks involved in the transaction. In the vast majority of cases, the lease does not become a problem. However, occasionally a business dispute arises and the lessee suddenly finds that the documents he signed and the law are stacked against him.
The statute governing equipment leases in North Carolina, and in many other states, is Article 2A of the Uniform Commercial Code. At least one commentator believes that the drafting of Article 2A was dominated by the leasing industry and that this has produced a statute drastically lopsided in favor of lessors. Here are some of the problems in a typical commercial lease of equipment:
- If you default under the lease, the lessor may repossess your leased equipment without any notice to you whatsoever!
- The lessor may repossess your equipment and simply hold it, but still require you to pay the full rent.
- As an alternative to repossession, the lessor can disable your equipment. You would continue to be liable for rent but would not be able to use the equipment.
- If you are buying used equipment, a UCC search will disclose the existence a lien on this equipment. However, a UCC search may not reveal the existence of a valid lease. You may believe that you have purchased a piece of equipment only to find out that the seller had no authority to sell it and you do not actually own it. (Most commercial leasing companies file a UCC financing statement with the appropriate Secretary of State, even though they are not required to. Therefore, in most cases you can learn about the existence the lease with an appropriate UCC search.)
- Frequently, a lease will be governed by the law of another state; if that state has not adopted the most recent revisions to Article 2A, you may be subjected to some very onerous provisions. If the lease provides that it is governed by North Carolina law, this is cold comfort since the North Carolina version of Article 2A is almost as bad. Visit our firm and our attorneys at our website:
- In real estate leases and virtually every other contract situation, there is a duty for the injured party to “mitigate damages.” This means the injured party must make reasonable efforts to limit his losses. The duty of a lessor of equipment to mitigate damages, on the other hand, is very limited. In fact, many commentators argue that there is no meaningful duty to mitigate damages at all.
- If the lessor decides to sell the repossessed equipment, he may do so and must give you “an appropriate credit” against the amount owed. However, unlike other UCC provisions, there does not appear to be any requirement that the goods be sold in a commercially reasonable way.
- When the lessor is a financial institution, the lessor gives no warranties. The supplier’s warranties to the financial institution pass through to you. However, the lessor has no incentive to negotiate strong warranties. Therefore, you should carefully negotiate with the supplier yourself.
- Article 2A gives the lessor the opportunity by agreement to further limit rights of the lessee. For this reason, the “boilerplate” of the lease should be read carefully.
- A common area of abuse is a “liquidated damages” clause. Such provisions can give the lessor a windfall in the event of a default.
- Typically, at the end of the lease term, you are required to ship the equipment back to the lessor. While you may have leased the equipment locally, you may find that you are required to ship the equipment to some far away location.
- Commercial leases typically cannot be canceled early. Because you are leasing, you do not own the equipment and cannot sell it. Assignment of the lease to someone else is subject to the lessor’s consent. In practical terms, a lessee can sometimes find himself with a piece of equipment that he no longer needs, he cannot sell, and that he cannot return to the lessor.
Commentators on Article 2A frequently refer to the standard commercial lease as a “hell or high water” lease. That is to say, you are probably stuck with your lease, come hell or high water. Unless there are strong advantages to a particular lease, a decision to purchase the equipment might be a better move.
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