Is a Franchise Fee Refundable in Minnesota?

What decides whether a franchise fee is refundable?

The franchise agreement decides it first: its refund clause says whether, when, and how much of the initial fee comes back. Minnesota law can return the fee to a franchisee who suffers harm by reason of a violation of “any provision of this chapter or any rule or order thereunder” under § 80C.17, subd. 1, and a state order under § 80C.05, subd. 3, can “require the escrow, impoundment, or deferral of franchise fees” “until no later than the time of opening of the franchise business.”

The initial fee is a franchise fee under Minnesota law. Minn. Stat. § 80C.01, subd. 9 defines a franchise fee as any fee or charge that a franchisee “is required to pay or agrees to pay for the right to enter into a business or to continue a business under a franchise agreement,” including “an initial capital investment fee.” The federal FTC Franchise Rule requires the franchisor’s disclosure document to state the refund terms. That duty applies to a franchise sale in the United States “unless the transaction is exempted under subpart E of this part.” 16 C.F.R. § 436.2. Item 5 of that document must “Disclose the initial fees and any conditions under which these fees are refundable.” 16 C.F.R. § 436.5(e).

That federal rule is a disclosure rule. It tells you what the refund terms are; the agreement and Minnesota law decide whether you get the money. My page on franchise fees and royalties covers the fees you pay after opening.

Where does the disclosure document state the refund terms?

Three items of the Franchise Disclosure Document address refunds: Item 5 for the initial fee, Item 6 for other fees, and Item 7 for each payment in your estimated initial investment. You should have the document well before you sign or pay anything.

What each item must say:

1. Item 5, initial fees. “Initial fees” means “all fees and payments, or commitments to pay, for services or goods received from the franchisor or any affiliate before the franchisee’s business opens, whether payable in lump sum or installments.” 16 C.F.R. § 436.5(e). Item 5 must state any conditions under which those fees are refundable.
2. Item 6, other fees. The table’s remarks should state “Whether the fees are non-refundable or describe the circumstances when the fees are refundable.” 16 C.F.R. § 436.5(f).
3. Item 7, estimated initial investment. A footnote should state “Whether each payment is non-refundable, or describe the circumstances when each payment is refundable.” 16 C.F.R. § 436.5(g).

Timing matters because a fee is easiest to protect before it is paid. For a sale the FTC Rule does not exempt, it requires the franchisor to furnish the disclosure document “at least 14 calendar-days before the prospective franchisee signs a binding agreement with, or makes any payment to, the franchisor or an affiliate.” 16 C.F.R. § 436.2(a). For a franchise subject to Minnesota registration, Minn. Stat. § 80C.06, subd. 5 separately requires delivery of the offering statement and “all proposed agreements relating to the sale of the franchise” at least seven days before you sign any agreement or pay any consideration, whichever occurs first. The federal rule leaves room for Minnesota’s. The FTC “does not intend to preempt the franchise practices laws of any state or local government, except to the extent of any inconsistency with part 436,” and a state law “is not inconsistent with part 436 if it affords prospective franchisees equal or greater protection.” 16 C.F.R. § 436.10(b). My page on Item 5 of the disclosure document walks through that item line by line.

How does Minnesota protect a fee you pay before opening?

Minnesota lets the Commissioner of Commerce require a franchisor to escrow, impound, or defer your fees until no later than opening when the franchisor has not shown adequate financial arrangements to fulfill “obligations to provide real estate, improvements, equipment, inventory, training or other items included in the offering.” This protection comes from the franchisor’s registration with the state.

Under Minn. Stat. § 80C.05, subd. 3, “If the commissioner finds that the applicant has failed to demonstrate that adequate financial arrangements have been made to fulfill obligations to provide real estate, improvements, equipment, inventory, training or other items included in the offering, the commissioner may by rule or order require the escrow, impoundment, or deferral of franchise fees and other funds paid by the franchisee or subfranchisor until no later than the time of opening of the franchise business.” The statute says “may,” so an escrow, impoundment, or deferral applies when the commissioner imposes one by rule or order.

When an impoundment is imposed, the commissioner’s rule sets the mechanics:

• Where the money goes. “100 percent of franchise fees and all other funds paid by the franchisees or subfranchisors located in Minnesota for any purpose shall, within two business days of the receipt of such funds, be placed with the depository until the commissioner takes further action pursuant to Minnesota Statutes 1973 Supplement, section 80C.05.” Minn. R. 2860.1800. The funds sit “in a separate trust account with a bank located in Minnesota.”
• Your receipt. “the franchisor shall deliver to each franchisee or subfranchisor a purchase receipt, in a form approved by the commissioner.”
• When the franchisor gets paid. The commissioner authorizes release “upon a showing that the franchisor has fulfilled its obligations under the franchise agreement or that for other reasons the impoundment is no longer required for the protection of the franchisee.”
• A bond instead. “In lieu of the imposition of an impoundment,” a franchisor “may post a surety bond in such amount as shall be required by the commissioner,” and “The state of Minnesota shall be named as an obligee.” Minn. R. 2860.1900.

A narrower escrow rule applies to a franchisor that skips registration under the one-sale exemption. That exemption requires that “the franchisor deposits all franchisee fees within two days of receipt in an escrow account” until its pre-opening obligations “have been performed,” with a Minnesota bank as escrow agent. Minn. Stat. § 80C.03, para. (e)(3). The same paragraph provides: “Upon a showing of good cause the commissioner may waive the escrow of franchise fees.”

The deferral can appear in documents that disagree with each other. A franchise agreement can make the franchise fee due at signing while its Minnesota rider defers initial fees until the franchisor completes its pre-opening obligations. I suggest reading the Minnesota addendum’s fee terms against the agreement’s, because the two can set different dates for when the fee is due. Registration itself is covered in my page on Minnesota’s registration and disclosure rules.

What refund terms should you look for in the franchise agreement?

Read the refund clause for five things: when the fee is earned, what makes it forfeitable, what the franchisor must do before opening, what it deducts from any partial refund, and what you must sign to receive one.

The provisions to find and read together:

1. When the fee is earned. An agreement can state that the fee is fully earned at signing, or tie it to training, site approval, or opening.
2. Forfeiture triggers. Look for any deadline to sign a lease, finish training, or open. Some agreements let the franchisor end the territory rights and keep the fee if the business does not open within a set period after signing. I suggest asking to extend any deadline that depends on the franchisor, such as site approval, because under a clause like that one a missed deadline could cost you the fee.
3. The franchisor’s pre-opening obligations. Compare what the franchisor promises to deliver before opening with what the agreement says happens to the fee if it does not deliver.
4. Deductions from a partial refund. Some clauses refund the fee minus the franchisor’s expenses or a flat amount. The clause should define those expenses, so the deduction can be checked.
5. Conditions on the refund. A refund conditioned on a release, a confidentiality promise, or a noncompete is a trade; the release section below covers what a release gives up.

Three Minnesota rules bear on these clauses:

1. Termination penalties. Under the opening of Minn. R. 2860.4400, every franchise contract and franchisor practice “shall conform to the following provisions” listed in the rule. Its item J makes it unfair to require a franchisee “to consent to liquidated damages, termination penalties, or judgment notes” in the agreement.
2. Security deposits. Item K of the same rule makes it unfair to “require a security deposit except for the purpose of securing against damage to property, equipment, inventory, or leaseholds” from a franchisee.
3. Statements about getting the fee back. Minn. R. 2860.4500 treats as deceptive a statement about the “recovery of a portion or all of a franchisee’s fee or other investment from the franchisor without written disclosure whether such fee or investment is secured or guaranteed, and, if so, in what manner” in connection with a sale. If a sales representative tells you the fee is protected or refundable, that rule is a reason to ask for the protection in writing.

Termination before opening has its own limits under Minn. Stat. § 80C.14, subd. 3, covered in my page on termination and good-cause rules. If the franchisor asks for a personal guaranty, read it with the refund clause, because a guaranty can make your own assets answer for the payments the refund clause leaves in place.

When does Minnesota law return a fee the contract calls nonrefundable?

Minnesota law can return the fee when you suffered harm by reason of the franchisor’s violation of the Franchise Act or a rule under it, whatever the refund clause says. Minn. Stat. § 80C.17, subd. 1 makes a violator liable to the franchisee, “who may sue for damages caused thereby, for rescission, or other relief as the court may deem appropriate.”

The violations that most directly involve the fee:

1. Selling without registration. Minn. Stat. § 80C.02 bars offering or selling a franchise in Minnesota “unless there is an effective registration statement on file” or an exemption applies. The franchisor carries “the burden of proving an exemption or exception from a definition.” Minn. Stat. § 80C.12, subd. 4.
2. Late disclosure. For a franchise subject to registration, § 80C.06, subd. 5 requires the seller to present the current public offering statement and all proposed agreements at least seven days before you sign any agreement or pay any consideration, whichever occurs first.
3. Misstatements in the sale. Minn. Stat. § 80C.13, subd. 2 bars selling a franchise “by means of any written or oral communication which includes an untrue statement of a material fact” or a misleading omission. Minn. R. 2860.4500 also reaches a statement “that is contrary to any disclosure made in the public offering statement.”

A contract clause cannot waive these protections for a covered franchisee. Minn. Stat. § 80C.21 voids any provision, “including any choice of law provision,” that would make a covered person “waive compliance” with the Act or any rule or order under it. The covered persons are a person who was a Minnesota resident when acquiring the franchise, a Minnesota partnership or corporation, and a person acquiring a franchise to be operated in Minnesota. A franchisee outside all three groups may find another state’s law governs the clause. If your agreement has an exclusive arbitration clause, the forum for these claims may be arbitration rather than court. Minn. R. 2860.4400, item J, provides “that this part shall not bar an exclusive arbitration clause,” and under 9 U.S.C. § 2 a written arbitration provision in “a contract evidencing a transaction involving commerce” “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract or as otherwise provided in chapter 4.” The full set of claims is in my page on remedies for a Minnesota Franchise Act violation.

How does rescission return the franchise fee?

Rescission cancels the franchise agreements: the agreements are treated as void and the franchisor must return what you paid, less the value of anything you keep. The Minnesota Supreme Court has affirmed the return of franchise fees this way and reversed a ruling that left out prejudgment interest.

In Martin Investors, Inc. v. Vander Bie, 269 N.W.2d 868 (Minn. 1978), the franchisor sold an unregistered franchise into Minnesota. Before suing, that franchisee stopped operating and mailed a notice of rescission. The court affirmed “rescission of its contract with restitution of sums expended in setting up a business under the contract in order to place both parties at status quo ante the contract.” The award included “return of its $10,000 downpayment and $20,000 promissory note that was declared null and void.” The court reduced the award by $250 for a projector the franchisee kept. It also stated that the chairman and president of the franchisor, CCC, “were properly held liable along with CCC for the restitution of sums due Martin Investors under the express provisions of § 80C.17, subd. 2.”

Two later decisions add to the remedy. In Chase Manhattan Bank, N.A. v. Clusiau Sales & Rental, Inc., 308 N.W.2d 490 (Minn. 1981), the court construed the rescission remedy. It read the remedy as the right of “the franchisee who suffers harm by reason of the franchisor’s violation of the franchise statute” “to have his agreements with the franchisor treated as entirely void and to be restored to the position he occupied prior to his involvement with the franchisor.” In Nauman v. J’s Restaurants International, Inc., 316 N.W.2d 523 (Minn. 1982), the trial court had ordered the franchisors “to refund to plaintiffs what were found by the trial judge to be franchise fees, as well as the plaintiffs’ costs, disbursements, and attorneys fees,” and the Supreme Court reversed the part of the decision “which excluded prejudgment interest.”

Who pays, and what else you recover:

• Officers and directors. Under § 80C.17, subd. 2, liability extends to “every principal executive officer or director of a corporation so liable” and to control persons, jointly and severally and “to the same extent” as the company, “unless the person who would otherwise be liable hereunder had no knowledge of or reasonable grounds to know of the existence of the facts.”
• Damages and attorney’s fees. Subdivision 3 allows a suit “to recover the actual damages sustained by the plaintiff together with costs and disbursements plus reasonable attorney’s fees.” In Dunn v. National Beverage Corp., 745 N.W.2d 549 (Minn. 2008), the court held “that an award of attorney fees under section 80C.17, subdivision 3, requires that the plaintiff seek and recover some relief under the franchise act.”
• Timing. Subdivision 5 provides: “No action may be commenced pursuant to this section more than three years after the cause of action accrues.” I suggest checking the current statute text and when the claim accrued before relying on any date; my page on deadlines for franchise claims covers the other limits.

Why should you read a refund-for-release offer closely?

A franchisor may offer to return part of the fee if you sign a release. Minnesota bars a franchisor from requiring a release of its Franchise Act liability, but that bar “shall not bar the voluntary settlement of disputes,” so a release you choose to sign in a settlement can end your claims.

Minn. R. 2860.4400, item D, makes it unfair to “require a franchisee to assent to a release, assignment, novation, or waiver that would relieve any person from liability imposed by Minnesota Statutes 1973 Supplement, sections 80C.01 to 80C.22.” A release that is a condition of a refund the agreement already promises reads differently from one you negotiate to settle a dispute about whether a refund is owed.

Before you sign, I suggest comparing the offered amount with what rescission would return: in the words of Martin Investors, restitution of “amounts expended for which no significant redeemable value has been retained,” plus interest and possibly attorney’s fees. The comparison tells you what the release costs you. If the franchisor’s sale broke the Act, the release may be giving up more than the refund it buys.

What should you do before you pay the fee?

Before you pay, read Items 5, 6, and 7 of the disclosure document, the agreement’s refund clause, and any Minnesota addendum together, and ask in writing about any promise that the fee is protected. Check whether the registration carries an escrow, impoundment, deferral, or bond, and whether the fee comes due before the franchisor’s pre-opening work is done. If the fee is already paid and you suffered harm by reason of the franchisor’s violation of the Act, rescission under § 80C.17 can return it whatever the refund clause says.

If you would like me to analyze a franchise agreement’s refund terms before you pay, or tell you whether Minnesota law gives you a way to recover a fee already paid, email me at [email protected] with a brief description of the situation. More on these questions is in my franchise law practice section.