Protecting Your Brand and Networks During COVID-19 - Practical Steps for Brand Owners Relying on Independent Contractors

This communication is for brand owners (franchisors, suppliers, licensors) that rely on authorized brand users (franchisees, distributors, dealers, licensees) to operate businesses identified by your brand name that distribute the specific goods or services that you designate or supply. Below is a collection of best practices to assist you and your authorized independent operations and their employees during the COVID-19 pandemic.

Please monitor our COVID-19 Task Force page for updates as we include additional clarification on the COVID-19 situation as it continues to develop.

1. Be Your Brand’s Spokesperson - Your brand will be remembered for the messages you send to your employees, independent contractors, suppliers and customers during the worst of times. Put the human response first. Make your brand message transparent and authentic to your brand’s core values. As COVID-19 spreads to new epicenters in the U.S., be ready with a regionalized brand message. Because local media may want to interview your local brand users, arm them with talking points.


2. Downside Projections - If you haven’t done so yet, create downside financial models (30, 60, 90 day) to identify your immediate cash on hand and cash flow needs. Contact the banks with which you have established relationships to identify available lending. Help your licensees do their own financial models and tap their banking relationships. Share financial modeling tools or encourage them to speak with their CPAs. Knowledge is the best antidote to panic.


3. Closures - Given the interdependence between licensee sales and royalty fees, your licensees’ economic pain and uncertainty is your enterprise’s own economic pain and uncertainty.
• Closures will hit your network differently depending on whether your business is essential vs. nonessential and the locations of brand users. In some regions of the U.S., public health orders have closed nonessential businesses. Public agencies differ in how they define “essential.” There is no one-size-fits-all when it comes to addressing closures.
• Doing the “right thing” by your independent operators does not mean risking your company’s viability as the brand owner. As the brand owner, you need to keep your own lights on so that you are available to your entire network. To accomplish this, however, you will need reorganize priorities: consider trimming your own staff and salaries and dispensing with non-essential services.
• Consider different approaches to provide financial support for your licensees. For example, two of the largest franchisors without immediate liquidity concerns, Taco Bell and KFC, have announced a 60-day grace period on royalty fees: April and May royalties are now due in June, interest-free. This, of course, is the exception.
• With the priority of keeping the greatest number of licensees financially viable, many brands are deferring, but not waiving, percentage royalty fees. The deferral period varies.
• Brand owners with minimum royalty fees are waiving them for a specific time interval, then reevaluating whether to extend the time period.
• Look beyond royalty fees, however. If you sell products to your licensees for their use or resale, consider reducing prices or using their markup for the short term to help their licensees stay open. Transparent messaging means telling your brand users that price reductions are temporary.
• Closures may also affect your supply chain as manufacturing plants may be forced to shut down. Being nimble means identifying alternative suppliers, if possible, where a substitution does not sacrifice your brand’s core value.
• Some branded outlets may want to close even if they are not in a geography where local government mandates this. Be understanding of these requests and work with your licensees; you want them to remain good brand ambassadors during this crisis.
• To avoid closures, help your franchisees negotiate rent reductions, deferrals, and free rent periods. Landlords may expect something in return, such as an agreement to extend the lease. If this happens, let your licensee know you will extend the current license agreement for an equal period of time.
• If you or a franchisee are considering layoffs, be sure to consult with an employment attorney. You’ll need to consider federal and state laws regarding time periods for notice to employees; some states have temporarily relaxed their rules.


4. Taking on New Brand Users - Some essential businesses (e.g., grocery stores; restaurants with well-established take-out and delivery service) are experiencing heightened demand and may be tempted to onboard new branded outlets and sign on new licensees. However, this is rare as most brand owners have put expansion plans on hold and are not awarding new licenses.


5. Renewals in the Pipeline - If your existing licensee is eager to re-up their commitment, there is no need to put them on hold. On the other hand, if you have licensees up for renewal that are unsure if they can remain financially viable, offer to extend their current franchise agreement for another 90 days. They will be grateful.


6. Transfers in the Pipeline - If your licensees are in the midst of selling their businesses, their deals may crater soon (if not already). Transitioning ownership of an existing licensee-owned business to someone new to your franchise system may be impossible to accomplish with restrictions on travel, social distancing, and risks of community contagion.
   
   Training may be physically impossible other than virtual or remote training, which may be ineffective for teaching important operating skills. During the current national emergency, it would not be unreasonable to withhold consent to a transfer unless the selling licensee remains financially and operationally responsible for the business for a period of time after the pandemic ends.


7. FDDs and Renewal Filings (for franchisors)
   • A little good news for franchisors looking at looming deadlines for completing franchise disclosure document (FDD) updates and renewal filings: several states have already extended filing deadlines by 90 days. The International Franchise Association is working with the FTC and state franchise agencies to extend the remaining deadlines.
   • Best practice, however, is not to allow your existing registrations to lapse; doing so may result in the state franchise agency treating your next filing as an initial franchise registration application and subjecting your FDD to much stricter vetting and higher filing fees. Complete FDD fiscal year end updates and renewal filings within the extended deadlines just as a placeholder even if you do not plan on resuming new franchisee recruiting for some time.
   • Fiscal year end updates need to speak as of the last day of your last fiscal year, which for most companies is December, 31,2019, before COVID-19 arrived in the U.S. Consequently, when we emerge from the pandemic, your FDD will need to reflect any material changes in your financial condition, outlet count and other potential disclosures attributable to this crisis.


8. Financial Performance Representations – Item 19 (for franchisors) - If you plan to use your updated FDD during these uncertain times, consider removing Item 19 financial performance representation (FPR) as they may no longer meet the reasonable basis legal standard even if they accurately reflect pre-pandemic operating data. When we turn the corner on this pandemic and sunshine lights the end of the tunnel, the FPR that you add back to your FDD may not look the same as the current one.


9. Joint Employment Legal Risks - Directing your licensees and their employees to comply with CDC and World Health Organization (WHO) protocols will not expose you to joint employment legal risks. If you issue directives specific to your business model that are not addressed by the CDC or WHO, frame these directives as brand standards.
   Don’t be afraid to answer your licensees’ questions on what they should be doing vis-à-vis their employees by framing your advice according to what you’re doing within your own organization or by sharing what you regard as the best practices among other licensees.


10. Third Party Resources
    
    • Besides the CDC and WHO websites, there are many excellent resources specific to the industry in which your brand operates providing up-to-date information, to which you can link your website. For brand owners, the International Franchise Association has an excellent website with material relevant to brands that utilize independent contractors (even if you are not a franchisor!). Talking about COVID-19 on your company’s landing page communicates a proactive response to your stakeholders, which can differentiate your brand from your competitors and deliver comfort to your customers.
    • This Harvard Business Review article about how Chinese companies are responding to COVID-19 offers insight into what the other side of the pandemic may look like in the U.S.

The issues faced by brand owners during this time are confusing. For more in-depth discussion of the issues above, please contact DWT partner Shelley Spandorf, who advises brand owners in all industries including franchisors, manufacturers, and suppliers that operate networks of independent contractors (dealers, distributors, franchisees, licensees, independent operators, and brand users given other names) and chairs the firm’s national franchise practice group.

The facts, laws, and regulations regarding COVID-19 are developing rapidly. Since the date of publication, there may be new or additional information not referenced in this advisory. Please consult with your legal counsel for guidance.

DWT will continue to provide up-to-date insights and virtual events regarding COVID-19 concerns. Our most recent insights, as well as information about recorded and upcoming virtual events, are available at www.dwt.com/COVID-19.