Friday, February 05, 2010

California’s Tax Authority Joins New York’s in Going After Franchisors

This posting was written by Bruce S. Schaeffer of Franchise Valuations, Ltd., co-author of CCH Franchise Regulation and Damages.

As most franchise practitioners know by now, New York recently enacted a statute amending Sec. 1136 of the Tax Law to mandate that all franchisors file information returns giving the names and addresses of all their franchisees in the state. The legislation also provides that information on all payments from franchisees to franchisors and records of all sales from franchisors to their franchisees will be required.

An even more onerous situation has evolved in California, where the California Franchise Tax Board has begun contacting non-resident franchisors about their nexus status for tax purposes.

State regulators are taking the position that non-resident franchisors must either register as resident corporations with the Secretary of State or have their California franchisees withhold seven percent of royalty payments.

Section 18662-2 of California's tax code is being cited as justification for this interpretation. Specifically:

Withholding at source is also required in the case of rentals or royalties for the use of, or for the privilege of using in this State, patents, copyrights, secret processes and formulas, good will, trademarks, brands, franchises, and other like property of such intangible property having a business or taxable situs as defined in Regs. 17951-1 through 17951-5, 17952 and 17953 in this State, and payments of prizes, premiums, rewards, winnings, etc., to nonresidents

“Constructive” Wrongful Termination, Attorneys Fees, and Expert Fees

On occasion, the issue under wrongful termination statutes is whether or not there has been a “constructive” wrongful termination. A recent New Jersey case is instructive.

In Maintainco, Inc. v. Mitsubishi Caterpillar Forklift (CCH Business Franchise Guide ¶14,195) a forklift manufacturer's forcing out an authorized dealer was held to have amounted to “constructive” termination in violation of the New Jersey Franchise Practices Act (NJFPA). The manufacturer argued that the NJFPA prohibited only actual terminations; thus, because the dealer was never terminated, there was no violation.

However, the record established that the manufacturer’s officers were well aware that the NJFPA prohibited them from terminating the dealer unless they could establish "good cause," and the court rejected the manufacturer's assertion that the dealer had breached a best efforts provision in the parties' agreement.

The court held that a dealer's loss of an exclusive territory, in and of itself, could qualify as a constructive termination. Therefore, the trial court’s ruling and its award of compensatory damages for lost profits to the dealer in the amount of $679,414 were affirmed. Additionally, the trial court's substantial award of attorney fees to the dealer in the amount of $3,533,642 was also upheld, but an award of $477,611 in expert witness fees was reversed.

Termination: The Insurance Agent Cases

It started with a Connecticut case against Nationwide Insurance, alleging that a terminated agent was entitled to the protection afforded a franchisee under Connecticut law. It was imperfectly resolved. There were similar cases in Missouri and Washington.

This was recently followed by Michigan, in a case of first impression, holding that an insurance agent could maintain a cause of action under the Michigan Franchise Investment Law if it could show it paid a franchise fee (which the court thought to be unlikely but could not so rule on the pleadings).Bucciarelli v. Nationwide Mutual Insurance Co.(E.D. Mich. 2009) CCH Business Franchise Guide ¶14,200.

In another insurance agent case, a California appellate court overturned a trial court holding that the relationship between an insurance company and one of its agents was that of franchisor/franchisee, entitling the agent to the protections of the California Franchise Investment Law and the California Franchise Relations Act. The court found there was no actual, present controversy, which was a requirement to bring the claim as a declaratory judgment action.

Thus, the trial court erred in reaching the merits of the agent’s claims and was ordered to vacate its summary judgment to the insurance company on the merits (Business Franchise Guide 2008-2009 New Developments Transfer Binder ¶13,897). The court was directed to issue a new order granting summary judgment on the sole ground that declaratory relief was not appropriate. Vice v. State Farm Mutual Automobile Insurance Co. (Cal. Ct. App. 2009)CCH Business Franchise Guide ¶14,219.

Additional information on the issues discussed above is available in CCH Franchise Regulation and Damages by Byron E. Fox and Bruce S. Schaeffer.

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