DOES YOUR AGENCY OR DISTRIBUTORSHIP AGREEMENT INADVERTENTLY CREATE A FRANCHISE RELATIONSHIP

OR,

 CONVERSELY, DOES YOUR FRANCHISE AGREEMENT CREATE AN AGENCY OR DISTRIBUTORSHIP RELATIONSHIP

 

Certainly, no supplier-distributor or principal-agent expects to end up defending franchise law violation allegations. Yet, these situations arise with considerable frequency both in the United States and other regions of the world. Manufacturers, suppliers, and trademark owners often overlook a possible franchise connection when they enter into relationships with independent third parties to sell their products or services.

Given the prevalence of franchising and the interstate, national, and even international scope of so many franchise networks today, attorneys need to know about potentially applicable federal, state, and foreign franchise laws. Franchise sales in the United States are subject to dual regulation at the federal and state level, depending on where the parties reside or do business. The federal franchise sales law, originally adopted in 1978 and overhauled in 2007 regulates franchise sales in all 50 states, including wholly intrastate transactions, per the 2007 version of 16 C.F.R. § 436 (Amended FTC Rule).

Why then, is a discussion of commercial agency and distributorship laws relevant? The first thought when dealing with international franchising may be, why should I be concerned? After all, agency and distribution models are likely not what the franchisor has established in its home market; it has chosen a franchise model over those other models. In fact, it is quite likely that the boilerplate provisions in the domestic franchise agreement specifically states that the agreement does not create a principal-agent relationship.

However, it has been our experience that when expanding internationally, franchisors may not wish to strictly adhere to the American-style franchise model. For example, the franchise legislation in the desired new market may be considered overly burdensome, or there may be business reasons for why the franchisor does not believe its domestic franchise model will work in the new market and it is therefore looking for alternative models. In those cases, the franchisor should carefully consider commercial agency and distributorship laws in the markets it is looking to enter. But the franchisor who wants to continue using its franchise model internationally should not ignore these laws either. The definitions of a franchise, agency, and a distributorship arrangement differ from country-to-country (or state-to-state, or province-to province). And even when the franchisor does not wish to establish an agency relationship or grant a distributorship, even when this type of relationship is denied by the express wording of the franchise agreement, an agency or distributorship may still be the unwitting result. Simply speaking, the laws of each country vary and a relationship that is not deemed to be an agency or distributorship in the franchisor’s home country may qualify as such in the new market.

It is not all that surprising that there may be overlap between franchise laws and agency and distributorship laws, as the underlying relationships share many characteristics: all three regulate a relationship where one party holds the knowledge and valuable intangible or tangible assets, and the other party, through its work and effort, is looking to exploit such knowledge and assets. The reasons for engaging an agent or distributor are also often the same as for engaging a franchisee. The local party can overcome language and cultural (including business culture) barriers and may already have an established network of business contacts that will help the franchised business expand faster than if the franchisor were to try to establish itself in the new market. The local party will have knowledge of local trade practices and know how to navigate the local bureaucracy necessary to obtain necessary permits and licenses. It may even be necessary to have a local party fulfil the function if local law restricts certain types of business activities to citizens of the country. The local party can also provide service locally in a way that the foreign party will not be able to do from a distance: help with installation, provide warranty repairs, and offer aftermarket sales of products and service in a way convenient to the local customer. The local party can also provide invaluable assistance in adapting the foreign party’s offering to local tastes and preferences, be that adapting the product itself, or marketing and product information. Finally, and typically one of the reasons a company chooses to franchise, the cost for getting started in the new market is often significantly less when the local establishment is set up by a local party and not the franchisor itself.

Because of a perceived imbalance of power in the franchisor-franchisee, supplier-distributor and principal-agent relationships, consumer protection laws have been drafted to protect the “weaker” party. Frequently in international dealings the allocation of power in these business relationships is often quite different. It is not unusual that the franchisee, distributor, or agent is a large organization and, at the very least, has significant local market knowledge that may be as important as the franchisor’s, supplier’s, or principal’s know-how. But be that as it may, the laws are there to protect the perceived weaker party, and franchisors expanding internationally need to take commercial agency and distributorship laws into consideration, so as not to find themselves unable to terminate the relationship as they wish according to the terms of their express agreements, or only able to terminate at considerable cost.

Differences Between Agencies and Distributorships

Before delving into more detail about common features of agency and distribution laws, it is important to point out that agencies and distributorships are not the same. While the definitions of agents and distributors vary between countries just as the definition of a franchise does, generally speaking, in an agency relationship the agent never takes title to the goods being sold. The agent solicits buyers for the supplier’s products or services, but the purchase agreement is then entered between the supplier and the customer directly. The agent is compensated on a commission basis, typically at a percentage of the sales price that the supplier receives. A distributor, on the other hand, usually takes title to the goods sold. The distributor typically buys the products from the supplier and then resells them to its own customers. The distributor’s compensation is the margin between the price at which it purchased the products from the supplier and the price at which it sold the product to its customers. The distinction between agents and distributors matters for many reasons and not in the least because they are often subject to different governmental regulatory regimes, statutes, or jurisdictional departments in different countries. For example, in many European countries there is no specific regulation of distributorships, but agency agreements are heavily regulated. However, in Germany (and most other European countries), distributorships are not specifically regulated, but agency relationships are. As a result, while a supplier may freely terminate its distributor in Germany, it must give its German agent as much as six months’ notice and may have to pay a termination payment to the agent.

A franchisor should also not assume that simply because the structure of its agreement made it an agency agreement or distributorship in one country, that will be the case in all other countries. As already alluded to, this is a country-specific determination.

For example, in the United Arab Emirates, a commercial agency is defined as the “representation of the principal by an agent for the purpose of distribution, selling, display or rendering of a commodity or service in the state, against a commission or profit.”

Under German law, an agent is a self-employed intermediary who has continuing authority to negotiate transactions on behalf of a principal or conclude transactions in the name of the principal.

The Swedish law regulating commercial agents defines a commercial agent as somebody who, for profit, has agreed with another, the principal, to act on behalf of the principal independently and continually for the purpose of selling or purchasing goods through the act of passing orders to the principal or entering into agreements in the name of the principal.

These three definitions are quite different. To some extent they simply approach the agency relationship from different perspectives: the definition in the UAE is focused on the activities that the agent will undertake, while the German and Swedish definitions are more focused on the end result. But there are more material differences: the German and the UAE definitions appear to cover both products and services, while the Swedish definition only applies to products. In other words, a relationship that falls under one of the statutes may not fall within the scope of the other. These are but three examples and it is important to always understand the scope of agency and distributorship laws in countries a franchisor is entering.

Public Policy Laws and Default Contract Terms

Similar to franchise laws, in many countries both agency and distribution laws are deemed to be public policy laws, and as such, cannot be contracted or assigned to third parties. However, even if that is the case there may still be room to structure the agreements to minimize any perceived negative impact of those laws.

An additional point to be made is that the absence in a country of a specific statute regulating agencies and distributorships does not necessarily equate with a lack of regulation of those types of agreements. Even if there are no statutory rules specific to agency and distributorships, a franchisor should not assume that the country does not have rules regarding agency agreements or distributorship agreements. In many countries there is a commercial code with general rules regarding different types of agreements and there may be case law specific to agency and distributorship agreements. For example, in Germany there is no specific statute applicable to distributorships. However, through case law many statutory provisions applicable to agency agreements have been expanded to also apply to distributorships. And, even though there is no statutory requirement regarding termination notices for distributorship agreements under German law, there is case law supporting the idea that some of the statutory requirements for agency agreements should apply to distributorship agreements as well in some cases.

Specific Issues Arising Under Agency and Distributorship laws

Understanding the applicable agency and distributorship laws upfront is extremely important for at least two reasons. First, agency and distributorship laws often impose default provisions that will apply to the parties’ agreement if the agreement is silent on that point. Second, though the agency and distributorship laws are public policy laws, the default provisions (excluding termination-related provisions) can often be amended by contract. In other words, understanding these laws will help the franchisor draft an agreement that will reduce the number of surprises later on in the relationship, and that may help regulate the relationship in a way as close as possible to the supplier’s intent.

Some may presume that the statutorily imposed rights and obligations are always in the agent’s or distributor’s favor. While this is often the case, it is not always the result. Agency and distribution laws also impose obligations on the agent or distributor, such as the party’s best efforts to not compete with the supplier; keep the supplier informed about developments in the territory that may impact the business; maintain books and records; maintain a sufficient inventory of spare parts; and provide service to customers in the market. For example, under the Swedish agency law, the agent is required to use its best efforts, follow reasonable instructions from the supplier, inform the supplier of important developments in the market, take good care of inventory in its possession, and keep its funds separate from those of the supplier.  German law similarly requires the agent to provide the supplier with necessary information and must perform its obligations with due care. These types of provisions are not limited to EU countries and can also be found in other parts of the world, for example in Argentina.

Restrictions on Right to Terminate

One of the most common restrictions imposed by agency and distributorship statutes is on the supplier’s right to terminate the agreement.

On this point, contract drafting choices may have a significant impact on the legal obligations of the franchisor. Franchise agreements are typically for a definite term and require at least some steps to be taken by the franchisee, agent, or distributor in order to be renewed, so typically they would be considered agreements for a definite term under agency and distributorship statutes. From a supplier’s perspective, it is typically better to have an agreement for a definitive term. It avoids local law provisions regarding notice periods and termination indemnity. However, the just cause requirements described below in at least some countries apply not only to termination, but also to non-renewal, thus capturing within their scope definite term agreements.

Agreements for an indefinite term can be significantly harder to terminate in some countries than a franchisor may be used to, as they can often only be terminated for “just cause.” But this is not an issue solely for indefinite-term agreements. For all agreements, termination during the term is often restricted to just cause termination, which may render express contractual termination provisions unenforceable. Just cause is not necessarily the same thing as the often-exceedingly long enumeration of defaults that the supplier may have included in its agreement. Often statutes will contain relatively short lists of what constitutes just cause (though it is also not unusual for statutes to simply refer to material breaches by the other party as constituting just cause).

Just cause may generally include breach of contractual obligations to the supplier, but will typically require a truly material breach of the contractual obligations. The agency law in the Dominican Republic provides a good example in that it requires a failure to comply with “the essential obligations of the (agreement), any action or omission that could adversely affect in a substantial way the interest of the (supplier) in the promotion or negotiation of the import, distribution, sale, lease, or any other form of trade of his merchandise, products or services.”

In other jurisdictions general contract law provisions will affect a party’s right to terminate. For example, in Argentina the general termination provisions of the Civil and Commercial Code apply to agency agreements. The Civil and Commercial Code allows a party to terminate when the supplier is deprived of essential or substantial benefits of the agency agreement.

Termination Notice Requirements

Even if the applicable laws do not require just cause for termination, it is not uncommon that a lengthy notice of termination be provided. In EU countries in particular, termination notice for agency agreements can be significant, starting with one month for agreements that have lasted a year, and up to six months for agreements that have lasted six years or longer. However, an agreement for a definite period of time will expire upon the end of its term, without any notice. Long termination notice periods are not unique to the EU though. For example, in Argentina, for indefinite term agency agreements, the terminating party must give the other party one month’s notice per year of the contract term.

Termination Payments

Together with statutes that limit a franchisor’s ability to terminate an agreement other than for just cause, the statutory provisions that tend to give franchisors and other suppliers and principals the most grief are provisions requiring some type of termination payment. Often these payments are due whether the termination is for just cause or otherwise, though they tend to be significantly higher if a franchisor or other supplier terminates without just cause.

For example, in Germany and Sweden (reflective of other EU countries), an agent is entitled to termination payments, up to an amount of the total commissions for one year, if the agent has brought new clients to the supplier, or otherwise increased sales to existing customers.

In Colombia, agents are also entitled to payments upon termination, in the amount of one-twelfth of their commissions per year of the contract duration. This is assuming the supplier had just cause to terminate. If the agreement was terminated without just cause, then the supplier must pay indemnification reflecting the efforts the agent put in to promote the supplier’s goodwill.

But in other countries, these payments may be significantly higher. For example, in the Dominican Republic, an agent is entitled to payment to compensate them for the business that the agent is deprived of because of the termination (or non-renewal) of the agreement without just cause, the value of the services rendered to the supplier, the agent’s investment in equipment, furniture and fixtures used specifically for the agency business, and any inventory that the agent may have had that it can no longer use after the termination or non-renewal. More importantly, the agent is also entitled to the supplier’s gross profits from the sale of the products or services for the past five years, or possibly even more.

However, not all countries afford this level of protection to agents. For example, in Argentina termination payments are limited to situations where the supplier terminated its definite term agreement without just cause, or where an indefinite term agreement was terminated without proper notice.

Restrictions on Competition

Another topic often covered by agency and distributorship laws is the agent’s or distributor’s right to compete.

In Germany, a post-term non-compete is permitted in agency agreements for up to two years after termination. However, the scope of the non-compete must be narrowly tailored to the territory of the agent or the customers the agent was assigned, and the supplier must pay reasonable compensation for the non-compete. Similarly, post-term non-compete provisions are permitted in Argentina for up to one year after termination, but must also be reasonable in scope.

Compensation

Many agency and distributorship laws set at least general parameters for how agents and distributors may be compensated. For example, both German and Swedish law dictate what agreements an agent is entitled to receive commission on and when. The payments are tied to the agent’s performance and value that is perceived to have been created through the agent’s efforts. In the UAE, a supplier is restricted to how many agents it may have (no more than one per state) and consequently the agent is entitled to commission payments not only on sales it helps close itself, but on all sales into the agent’s territory.

Registration

Another feature of agency and distributorship laws that is relatively unusual for franchise laws, is that the agreement must be registered. Many countries do not require registration of agents or agency or distributorship agreements, but in those that do, suppliers need to make sure they understand the implications of the registration. Leaving aside such practicalities as whether the entire agreement needs to be registered (or just an excerpt), and if the agreement or excerpt needs to be translated into the local language before it can be registered, registration often raises many other issues. For example, in some countries, the registration obligation may be on the agent, and the franchisor has little need of, or derives little value from the registration. In those situations, the franchisor may not wish to encourage registration. In other countries, the registration requirement may be on the franchisor or supplier, or it may be impossible for the agent to perform its duties without proof of registration. In some instances, the registration triggers the applicability of the statute, and in others, the supplier may not be able to register a new agency agreement until the previous one has been properly terminated.

Nationality Restrictions

While agency and distributorship laws are always consumer protection laws, they can sometimes also serve as laws reserving domestic enterprise to the citizens of the country. This is particularly common in the Middle East (though not exclusively in that part of the world). In some instances, only certain industries are protected, but sometimes the restrictions can be broader. It is crucial for a franchisor to be aware of these restrictions before entering countries with these types of restrictions. For example, in Saudi Arabia and the United Arab Emirates, an entity acting as an agent must be 100 per cent owned by nationals, and in Bahrain, Kuwait and Oman, at least 51 per cent must be owned by nationals.

The Fine Line Between Employee and Agent

The question of how franchisees, distributors and agents should be classified for labor and employment law purposes has received significant attention over the past several years in the United States and elsewhere. This is a serious concern in many countries and the consequences may be significant. Reclassification of an agent as an employee can have an impact on the obligations of the franchisor, both with respect to taxes and benefits, but also with respect to the supplier’s ability to terminate the relationship with the agent or employee. In addition, reclassification can have additional tax consequences in that the agent’s business could be considered a permanent establishment of the franchisor. As with other issues raised in this article, it is often possible to structure the contract and relationship to avoid an employer-employee relationship. Generally, the agent or distributor taking economic risk and having contractual independence are likely to be important factors. It is also generally advisable that franchisors do not appoint individuals as their franchisees, agents, or distributors in other countries. But rather, select established companies with a strong management team and marketing expertise.

 

 THE KOSNAR GROUP

2306 Wales Drive                                                                                                       

Tel 619-994-2258 • Fax 760-632-0772

Cardiff by the Sea, CA 92007 carl@kosnar.com   http://www.kosnar.com

An Innovative Approach To Structuring a Social Enterprise

the kosnar group

News Release

FOR IMMEDIATE RELEASE

 Nonprofit-Owned Business Entities:

An Innovative Approach To Structuring a Social Enterprise

 by 

 Carl Kosnar and Andi Kosnar, Founding Partners

 THE KOSNAR GROUP

San Diego, California (July 23, 2015) - The subject of Nonprofit-owned business entities has fascinated me over the past few years. Our firm has been involved in helping companies franchise their businesses for over 35 years. However, it has been the recent decision to join the Solana Beach ECO Rotary Club that encouraged my business partner, Andi Kosnar, and me to seriously begin to think about the subject of alternative revenue sources for our local Rotary Club. 

PURPOSE

The success of the American franchise business model is well documented through volumes of books and articles, including those I have written, over the last thirty years.  It is not my intent to add to the prolific amount of text that already exists, but rather to explore the opportunities that we perceive in attempting to merge the American franchise business model with a nonprofit “Social Enterprise.” My definition of a Social Enterprise is, “The utilization of a profitable business venture to generate unrestricted income on behalf of a nonprofit charitable organization.” 

Much has been written in recent years extolling the virtues of franchising as it exists in the United States and other countries.  However, there has been a dearth of information and analysis of the economic impact and potential of franchising, or similar economic expansion systems, in developing Social Enterprise ventures.

And Finally

Whatever posture your foundation or charitable governing board may decide to adopt on franchising as a vehicle for structuring a Social Enterprise, one thing appears fairly certain: franchising as a business expansion technique for generating additional revenue for charitable organizations cannot be indefinitely ignored.

For a complete copy of this dissertation please email a request to Carl Kosnar at: 

carl@kosnar.com/.

CARL J. KOSNAR

MANAGING PARTNER

THE KOSNAR GROUP

2306 WALES DRIVE

CARDIFF BY THE SEA, CA 92007

PHONE: (760) 632-8402

MOBILE: (619) 994-2258

FAX: (760) 632-0772

SKYPE: carlandandi

carl@kosnar.com 

www.kosnar.com 

A Trusted Franchise Advisor with 35 Years of Experience 

 

Franchise Litigation Continues to Grow

 the kosnar group

Franchise Litigation Continues to Grow

By

Carl J. Kosnar

August 2018

The franchise relationship between franchisor and franchisee is becoming fraught with problems leading to increased litigation in recent years. Two legal theories that have come to the forefront in the franchise litigation arena are “joint employer” and “vicarious liability.”

Following the global financial crisis many lawyers in multiple jurisdictions have reported seeing increased levels of litigation. In some instances this is often being instigated by franchisors to eliminate under-performing franchisees. Previously, lack of enforcement against under achievers was due to concerns about the economy, whereas now economic conditions have improved in many industries and litigation can be afforded.

Another reason given by some is that long-term relationships between the more mature franchisors and franchisees are changing or dissolving as franchisor management and franchisee generations change, resulting in litigation.

Some lawyers have noted an increase in arbitration, and, in some instances mediation, since some courts are much more in favor of alternative dispute resolution. Where possible, courts are forcing individuals to try these methods first.

In Canada there seems to be a consensus that litigation levels have increased, particularly in relation to class actions, which is a fairly new development in this jurisdiction. Although there have not been an abundant number of class actions held yet, there is definitely an increase on the horizon. As one practitioner explained, “The franchising industry certainly lends itself to class actions given that franchisees can come together with common grievances against the franchisor.”

Disclosure is another issue that has resulted in increased activity in the courts, with reports of active franchisee lawyers “hunting for” potential cases. Five of Canada’s provinces have now adopted the Franchise Act, which includes rules of franchise disclosure documents, with Manitoba the most recent in October 2012. According to one franchisor lawyer, “Franchisee lawyers know they can get an easy win if there was no disclosure. If they find these cases, which they are actively seeking, the question is not if but how much they will get.”

Similarly in the UK there are reports of increasing litigation brought by franchisees and, in tandem, a growing franchisee bar that exclusively represents them. This is part of a larger trend noted by lawyers in such diverse jurisdictions as California, Germany and South Africa, franchisees are becoming stronger. This seems to be a result of, first, increased awareness by franchisees that they have rights and can get legal help, and second, that there is much better representation and organization of franchisees than ever before, with the internet playing an important role.

About the author:

The Kosnar Group litigation support team has provided attorneys and their clients with franchise expert witness and litigation support services for years, with some of our professionals having over 35 years of franchise experience. Our opinions are valued by attorneys, clients, and triers of fact because we are professionals who work exclusively in the franchise industry. We communicate and present our positions in a fashion that attorneys, clients, judges, and juries can understand.

CARL J. KOSNAR

MANAGING PARTNER

THE KOSNAR GROUP

PHONE: (619) 994-2258

FAX: (760) 632-0772

carl@kosnar.com 

www.kosnar.com 

September 1, 2018

 News Release 

Carl J. Kosnar Becomes Consultant for the IFA Social Sector Franchising Task Force

SAN DIEGO, CA--(September 1, 2018) — The International Franchise Association’s (IFA), Social Sector Franchising Task Force Group, has announced that The Kosnar Group’s Managing Partner, Carl J. Kosnar, has been selected as one of its social franchise mentors, to counsel companies seeking assistance with developing a social franchise.

“The subject of social enterprise business entities has fascinated me over the past few years. Our firm has been involved in helping companies franchise their businesses, and license products and services through technology transfer for over 35 years,” said Mr. Kosnar.

“The success of the American franchise business model is well documented through volumes of books and articles, including those I have written, over the last thirty-five years.  It is not my intent to add to the prolific amount of text that already exists, but rather to explore the opportunities that we perceive in attempting to merge the American franchise business model with a Social Enterprise Franchise,” added Kosnar.

Much has been written in recent years extolling the virtues of franchising as it exists in the United States and other countries.  However, there has been a dearth of information and analysis of the economic impact and potential of franchising, or similar economic expansion systems, in developing Social Enterprise ventures.

One of the pioneers in the U.S. to promote social franchising is the IFA Social Sector Franchising Task Force. The Task Force is made up of IFA members, experienced and innovative franchise professionals who have joined together to help social sector franchisors and other NGOs. The Social franchise model creates opportunities for local entrepreneurs to deliver products and services in underserved communities worldwide.

Commercial franchising and social franchising are variations on the same basic strategy for expanding a business. They differ in just two ways:

·         The type and purpose of the products and services offered by the business being franchised

·         The profile of the target customer

Social franchised businesses, like those operated by traditional NGOs (nongovernmental organizations) are primarily developed to offer products and services that people need — not simply want — such as healthcare, safe drinking water, sanitation, clean energy, and education. These are social enterprises whose creation is targeted to achieve goals such as those set in the 2030 Sustainable Development Goals established by the United Nations.

For more information about social enterprise franchising, please contact Carl Kosnar.

Contact:

CARL J. KOSNAR

MANAGING PARTNER

THE KOSNAR GROUP

2306 WALES DRIVE

CARDIFF BY THE SEA, CA 92007

PHONE: (619) 994-2258

FAX: (760) 632-0772

carl@kosnar.com 

www.kosnar.com 

A Trusted Franchise Advisor with 35 Years of Experience

EXPORTING YOUR FRANCHISE TO THE UNITED STATES

EXPORTING YOUR FRANCHISE TO THE UNITED STATES

By Carl J. Kosnar

The greatest growth in franchising over the past decade has been outside the United States. After examining the 2010 Asia-Pacific Franchise Guide and reviewing national franchise association Websites, it is obvious that franchising is increasing in popularity throughout the world. Despite their ever-increasing number, it is surprising that very few foreign franchise systems have extended their franchising programs to the United States.

This article is intended to provide practical advice for non-United States companies that are considering franchising in the United States. Although each company’s particular situation will be different, the following are some general considerations with regard to establishing a franchise system in the United States.

One of the major reasons foreign franchise companies have avoided the United States market has been the cost of conforming to old FTC Rule 436. The Amended Rule has made it substantially easier to do business in the United States.

Amended Franchise Rule Exemptions

Three new exemptions to the Rule enable many foreign-based franchise companies to avoid the franchise disclosure process altogether. The Amended Rule exempts franchise offers made to “sophisticated investors,” companies that have been in business for at least five years and have a net worth of at least $5 million. Only one member of an investor group needs to meet the requirement for the exemption to be applicable. Therefore, franchises may be granted to companies with established regional or national businesses without the need for a disclosure document, audited financial statements, or other documents usually required by the Amended Rule.

Also exempt are franchises requiring investments exceeding $1 million, excluding the cost of investments in unimproved land and any financing provided by the franchise organization. In calculating the investment, franchise companies may include the expenses and fees associated with establishing franchised outlets under multi-unit franchise agreements, such as area development agreements and master franchise agreements. Multi-unit franchising programs are the norm in international franchising and are therefore likely to satisfy the $1 million investment threshold in many retail and hospitality franchise offerings. Prospective franchisees who agree to convert existing business operations to a franchise also may include the value of their business assets in the calculation of the amount they are investing in a franchise.

Finally, franchises sold to officers, owners or managers of a franchise system which have been employed by the franchise company for at least two years before purchasing the franchise will be exempt. This will allow a joint venture formed to enter the United States market to be sold as a franchise if one of the franchise company’s management staff owns a 50 percent interest in the venture without the need for FTC disclosures. An entity “which is at least 50 percent owned by a person who, within 60 days of the purchase of the franchise, has been, for at least two years, an officer, director, general partner, individual with management responsibility for the offer and sale of the franchise system’s franchises or the administrator of the franchised network” qualifies for the disclosure exemption. The same exemption applies to a person who has owned at least a 25 percent interest in the franchise system for a two-year period, ending no later than 60 days before the franchise sale. Thus, if a member of a franchise firm’s management or ownership team could acquire a 50 percent “ownership interest” in a United States franchisee, and operate it as a prototype unit in the United States, the exemption would be available. The Amended Rule does not prohibit the other owners from having voting control over the franchisee entity, nor from investing a majority of the capital needed to acquire the franchise and launch the franchised business.

Financial Audit Requirement Changes

The Amended Rule relaxes the audit requirement somewhat, and allows foreign companies to use statements prepared under their country’s Generally Accepted Accounting Principles, so long as the statements also satisfy criteria published by the United States Securities and Exchange Commission for the use of foreign financial statements in United States securities offerings. Foreign franchise companies can usually find accounting firms willing and able to modify existing statements to meet the SEC criteria in a cost-effective way.

State Regulations Remain in Place

The Amended Rule applies to all franchises offered for locations in the United States and its territories. However, franchise sales laws in 15 states also regulate offers and sales of franchises by their residents to their residents, and sometimes to non-residents if franchised locations will be established in those states.

Market Research

Before entering the United States market, the first step is to determine the United States consumer market for the products or services. Is there demand for the products or services? What is the competition? What is the pricing? What are the costs of production and distribution considerations?

In addition, a company should conduct research on the market for franchises to sell the same products or services. Are there already systems which offer similar franchises? What are the initial fees and royalties? What type of training or support do they provide?

How to Get Started

A non-United States company should open at least one “company-owned” location (owned by the franchising entity) in the United States, before it begins to franchise in the United States. It needs to have this experience, so that it will know what is involved in opening a store in the United States, in terms of start-up costs, fees, build-out, government permits, supplies, and other aspects of the operations. This will also give it experience in determining the demand for the products and services in the United States, as well as the right form of marketing and pricing.

The experience of opening and operating a store in the United States will also give the foreign company the opportunity to “Americanize” the services and products, trying different business methods, branding, and pricing for the United States market. Only after it has this first-hand experience in the United States, will the company be ready to start offering franchises in the United States.

Corporate Structure

Normally, we advise foreign companies to form a United States affiliate company, which will issue the franchises in the United States.

This accomplishes a number of things: 1) limits potential liability of the “Mother” company if franchising in the United States does not go well; 2) avoids the possibility that a United States taxing authority may declare the”Mother” company must report all of its income to the United States taxing authority; and, 3) makes it less expensive to prepare audited financial statements for the franchising entity.

Trademark Registration

Trademark rights are generally determined in the United States by priority of use, and not priority of registration. Nevertheless, a company that is considering franchising in the United States should register its trademark as soon as possible. Registration serves a number of useful purposes, including putting the world on notice that the owner considers it a protected trademark, and also providing additional remedies if someone uses the trademark.

United States trademark law allows an applicant to file an application for trademark registration even before the applicant has started using the trademark in the United States (an “intent-to-use” application), provided that the applicant files a certification within three years after the application is approved confirming that it has in fact started using the trademark in the United States.

Training, Communication and Support

To succeed in any country, a franchisor must provide good training, support and communication.

Because it is normally unrealistic for franchisees to travel to a foreign county for training, the company must have staff in the United States to provide the training and support, either through the United States affiliate or master franchisees.

And most important for the long-term, the franchisor must have a good communication system, such as a Skype video telephone system, to allow the franchisor to communicate frequently with the franchisees, including providing rapid updates of the operations manual and approved supplier lists, as well as sharing solutions to common problems faced by franchisees throughout the system.

As most potential foreign franchise companies know, franchising in the United States presents a tremendous opportunity. The best way to get started will be different for each company, because each company’s situation is unique. Doing it properly can provide tremendous rewards.

*********

THE EVOLUTION OF FRANCHISING

Where it all began. The evolution of franchising.

By: Carl J. Kosnar, Managing Partner, The Kosnar Group

There are references in American history to early business relationships which, while possibly not meeting the current FTC definition, were without a doubt, franchise/licensing relationships. These relationships existed in the selling of wares from town-to-town by peddlers, licenses granted for general stores at military outposts, and certain livestock sales and other goods in which exclusive territorial rights were granted to the "franchisees" by the holder of the rights. Unfortunately, while the relationships are mentioned in the literature, the names of these early franchise founders and the structure of the business arrangement are not.

Throughout its long history, there have been four constants that have fueled the growth of franchising, the desire to expand, the lack of expansion capital, the need to overcome distance, and managing people from a distant location.

The use of franchising can be traced to the expansion of the church and as an early method of central government control, probably as far back as the Middle Ages. Some have written that it may indeed date back as far as the Roman Empire or earlier and given the necessity of large territorial controls, coupled with the lack of modern transportation and communication at the time, there is reasonable basis for this assumption.

Franchising was also used in England and Europe, where Royalty granted land rights to powerful individuals. In exchange for these land grants, the noblemen were required to protect the territory for the monarchs by establishing an army and were free to set tolls and establish and collect taxes, a portion of which was paid to the monarch. As it was an agrarian society, the control over the land represented enormous power and was the foundation for the feudal system. It occurred to me recently, that the movie Robin Hood, starring Errol Flynn, was simply the tale of a franchise relationship that went bad, with King Richard as the franchisor, Prince John as the master franchisee and the Lockslie family as the vociferous, disenchanted franchisee.

This system of governmental control existed in England until it was outlawed at the Council of Trent in 1562. With the economic opportunities presented by the discovery of the New World, colonialism of the period, and the emerging international trading opportunities, franchising was again used by government to expand and exercise control.

The Dutch East India Company was founded in 1602 by the Dutch Republic to conduct all trade between the Cape of Good Hope and the Straits of Magellan. The Company was capitalized by stock valued at 6.5 million guilders. The company, acting as a sovereign power, conquered territory from the Portuguese and established its headquarters in Jakarta in 1619. From that base, it created a monopoly of trade with Japan in 1641 and fought off British attempts to break into the spice trades. Turning west, the company engaged the services of Captain Henry Hudson in 1609, who was formerly in the employ of the English Muscovy Company, a franchisee of England, to find the Northeast Passage, giving the Dutch claims over the Hudson Valley in upstate New York as far as Albany. In 1799 the Dutch East India Company filed for bankruptcy and its possessions and rights were assumed by the Dutch Republic.

In 1607 the London Company was granted a charter for Virginia by England and hired Captain Christopher Newport to locate and settle the area. The story of Jamestown, the first permanent British settlement in North America, and Captain John Smith, who succeeded Captain Newport in managing Jamestown, is well known. Following the massacre of 347 settlers by the Powhatan Indian Confederacy on March 22, 1622, the British Crown, charging mismanagement of the area by the London Company, withdrew its charter in 1624 and the Colony of Virginia came under direct British control.

Much of the colonization and exploration by the British and European powers was conducted under similar "franchise-type" relationships.

Franchising, as a business concept, was transplanted into the United States from England and Europe where it was used "commercially" in the tavern and brewery industries. Tavern owners, in exchange for financial assistance from the breweries, agreed to sole purchase agreements with the breweries. The breweries did not exercise any controls over the operation of the local tavern except for the sole purchase arrangement.

It is important to understand in examining the birth of franchising in the United States that prior to franchising there was limited experience in chain operations. Chain operations would ultimately form the foundation for the franchise method of distribution.

Not surprisingly, transportation and the growing mobility of Americans were the impetus for the establishment of retail and restaurant chains and franchising in the manufacturing segments of the economy.

The earliest known restaurant chain in the United States was founded in the 1850's by Frederick Henry Harvey, an Englishman who opened his first restaurant in 1852. This initial restaurant failed during the Civil War. In 1876, Frederick Harvey opened the first of the Harvey House restaurants in a terminal of the Atchison, Topeka & Santa Fe Railroad. The railroad wanted to open depot restaurants for its passengers and provided Frederick Henry with locations and free transportation of restaurant supplies. By 1887, there was a Harvey House restaurant every hundred miles along the 12,000-mile-long Atchison, Topeka, & Santa Fe line. Frederick Harvey believed strongly in quality control and established regular field visits to his restaurants similar to those used today by franchisors.

Following World War I, the advance of the automobile gave birth to another restaurant innovation, the drive in. In 1919, Roy Allen purchased the formula for his root beer recipe from a pharmacist and, together with Frank Wright, started A&W Root Beer. Needing capital to expand, Allen bought out his partner in 1924 and began franchising the A&W concept. A&W offered car-side service with "tray boys". Later A&W added female "car hops" on roller skates to service its customers.

One of A&W's early franchisees was Sherman and J. Willard Marriot who opened franchises in Fort Wayne, Indiana, and Washington, D.C. in the 1920's. The Marriots' first A&W in Washington was owned by J.W. Marriot and his partner Hugh Colton and grossed $16,000 in its first year. As with many of today's franchise systems, it was the Marriots as franchisees of A&W who brought innovation to A&W when they requested permission to add food to the restaurant to increase the unit sales.

Using the automobile, curb service, and an innovative hamburger cooked on onions, Billy Ingram and Walter Anderson opened their first White Castle restaurant in 1921 in Wichita, Kansas. White Castle is credited with many innovations in the fast food industry, particularly in their use of advertising and discount marketing, the first take-out packaging to keep the food warm and the folded paper napkin. While it is still a company-owned operation in the United States, White Caste has commenced international expansion via franchising. Copying the White Castle format, in 1932 R.B. Davenport opened the first Krystal restaurant and began franchising in 1990.
During that same period, Howard Dearing Johnson acquired a pharmacy in Quincy, Massachusetts, and began to sell three flavors of ice cream together with a limited menu of cooked items. In 1935 Howard Johnson awarded its first franchise to Reginal Sprague. Over the years the concept increased to an expanded menu and to 28 flavors of ice cream. Developing a distinctive roadside presence from orange roofed locations, and featuring one of the first pylon signs with its name and logo, the company secured the first turnpike contract on the Pennsylvania Turnpike.

While it was the innovation of the restaurant pioneers that established their menus, methods of operations and standards, it was the automobile and the movement of a growing nation that created the opportunity for these early restaurant chains to grow.

Many of the legendary franchised restaurant chains that began franchised operations over the next three decades included Carvel, established in 1934; Kentucky Fried Chicken, established in 1930; Dairy Queen, established in 1940; Dunkin Donuts, established in 1950; Burger King, established in 1954; McDonald's, established in 1955; and The International House of Pancakes, established in 1958. The stories of these early pioneering concepts have been the basis for many books over the years and the lessons learned are evident in the many food service chains that followed.

Tracing back to the late 1800's, the automobile and the growing mobility of Americans again become the basis for other early developments in franchising.

The earliest non-food franchises were relationships in which manufacturers established licensed selling and service locations for their manufactured goods through franchising. This can be seen in the establishment of Singer Sewing Centers and McCormack Harvesting Machine Company Dealerships in the 1850's and 1860's and the birth of the automotive franchises at the turn of the century by General Motors and Ford. The first franchise for General Motors was issued in 1898 to William E. Metzger of Detroit.

The American Industrial Revolution began the mass production of consumer goods. It was mass production which created the opportunity for these companies to produce manufactured goods at lower costs which fueled consumer demand and the need to sell and distribute the products efficiently and cost effectively. Many methods of sale and distribution were tried before franchising including direct factory sales, sales through non-branded locations such as pharmacies, direct mail and traveling salesmen. While all proved to be insufficient to satisfy the needs of the company, local salesmen were the most effective.

By selecting franchisees, and providing them with exclusive territories, hard goods manufacturers were able to effectively and efficiently bring their products to market.
As the automobile manufacturers solved their distribution problems through franchising and began the changeover from steam engines to internal combustion engines, there became a need to establish locations for these vehicles to obtain fuel. Lacking the capital required to purchase the real estate and establish an adequate distribution system to meet the needs of the growing number of automobiles, over the next 30 years the oil industry began to establish dealerships through franchising.

At the turn of the century, because of the high cost of transporting the finished product and the reusable glass bottles, American soft drink bottling was a localized industry. By shipping syrup concentrate to its franchisees, and requiring the local franchisees to bottle under strict formulas and processes, bottlers were able to control the quality of their product in distant markets, and expand rapidly without the need for the capital which company ownership would have required. Franchisees obtained the rights to exclusive markets and a valuable trade name and the bottlers were able to overcome the transportation issues that had to that time restricted their growth. In 1901 Coca Cola issued its first franchise to the Georgia Coca Cola Bottling Company.

Most of the early franchises were all based on a product line sold to its franchisees. During the 1850's and 1860's both Singer Sewing Machine and McCormack Harvesting Machine Company began franchising the sales and service of their equipment. In 1902 Louis Liggett formed a manufacturing cooperative with 40 independent drug stores, each investing $4,000 to start the manufacturing cooperative under the Rexall name. Following the end of World War I, the Rexall cooperative began to franchise independently owned retail outlets under the Rexall trade name, supplying franchisees with branded Rexall products.

One of the great innovations in franchising came in 1909 with the establishment of the Western Auto franchise. Up to that time, product franchisers sought franchisees with industry experience and, except for the supply of branded product, did not provide any significant business related services. While still relying on the mark-up on product sales to its franchisees rather than royalties on sales, Western Auto provided its franchisees with many of the same services which modern franchisors provide today. These included site selection and development, retail training, merchandising, marketing assistance and other continuing services. Western Auto also sought franchisees without industry experience as many franchisors do today.

While franchising continued to grow up until the beginning of World War II, the truly explosive growth in franchising began at the end of the war.

Franchising emerged as a force to be reckoned with in the post war 1950's, taking advantage of pent up consumer demand, available franchisees, ideas from the returning veterans and capital provided by separation pay and the GI bill. The growth of franchising in America was further advanced when prospective franchisees were assured of safety using federally protected trademarks and service marks, essential to the successful local operation of a nationally established franchise system.

Before Congress enacted the Trademark Act of 1946, better known as the Lanham Act, trademark protection was at best inconsistent and uncertain.

Once potential entrepreneurs became confident of trademark and logotype integrity and protection, more and more individuals flowed into the selling stream of franchising in the 1950s and 1960s.

The franchising boom in the 50's and 60's achieved almost mystical stature. Franchisors of convenience goods and services grew. Companies like McDonald's, Kentucky Fried Chicken, Laundry and Dry Cleaners, Hotels, Rental Cars, automotive aftermarket and temporary help companies proliferated in the marketplace. By 1965 McDonald's had grown to approximately 1000 units in only ten years and made their first public offering opening at $22.50. It closed the same day at $30 and closed the first month at $50. Nate Sherman's Midas Muffler during the same period had grown to 400 locations, Kemmons Wilson's Holiday Inn grew to 1000 locations and Jules Lederer's Budget Rent A Car opened their 500th franchise.

The growth in franchising did not come without problems. By the latter half of the 1960's the bloom was off the rose. Many franchisor companies focused more on the sale of franchises than on operating their franchise systems. Some franchisors made misrepresentation in attracting franchisees; some based their sales effort on the use of celebrity names and endorsements and failed. Some even sold franchises for concepts that didn't exist.

Due to the problems of the 50's and 60's several states led by California began to enact laws governing the disclosure of information provided to potential franchisees. These states required the franchisor to deliver to a potential franchisee a disclosure document providing information explaining the opportunity. It was not until the summer of 1979 that the federal government promulgated Federal Trade Commission Rule 436 which established minimum uniform disclosure requirements throughout the United States.

Today, the format and content of the disclosure documents are undergoing change to further strengthen disclosure and there are new laws being proposed at the federal and state level to further regulate franchising. Some would say that the pendulum has swung too far and unduly burdens legitimate franchise companies from utilizing the franchise system to establish new channels of distribution.

Today, more than 3,000 franchisors and over a half-million franchisees testify to the increasing growth of an industry that has burgeoned forth from roots dating back at least 2,000 years.
The evolution of modern franchising, created by the innovative companies and the pioneers that have led them, is an exciting tale in itself. The future, energized by still unimagined new concepts, new business techniques and international expansion, promises to add still more dynamic chapters to the continuing and growing adventure of franchising.

GLOBAL ECONOMIC DEVELOPMENT THROUGH THE UTILIZATION OF THE FRANCHISE SYSTEM - Parts II & III

DEFINITION OF FRANSHIP SYSTEM

The Franship system is a comprehensive commercial joint venture in which one party (the grantor) grants to another party (the grantee) the right to operate a business selling products and/or services produced or developed by the Franship entity under the grantor's business format and identified by the grantor's logo and trademark. The Franship entity is owned jointly by the grantor and the grantee and receives a license to operate by the grantor in the grantee’s country. The grantor is usually a large franchise company and provides the training, support, and the entire business format. The grantee is a business group, company or governmental agency domiciled in the country where the Franship is located and operated and, in most cases, provides the majority of the funding to establish the Franship business activities.

The Franship system can also be thought of as a pooling of resources and capabilities. The grantor contributes the know-how and experience and the grantee contributes the initial capital investment, or supplemental capital investment, motivated effort, and operating experience within the country and its variety of markets. The Franship, like the franchise model, includes a format for the conduct of a business, a management system for operating the business, and a shared trade identity.

The Franship system is a business expansion method and joint venture relationship, not a franchisor-franchisee relationship, nor is it a buyer-seller relationship; it is a partnership with equity shared by both parties, and, in my opinion, is an acceptable business expansion model for countries that do not accept the Western “McDonaldization” of their economies.


THE FRANSHIP SYSTEM AS A MEANS OF IMPORTING ENTREPRENEURIAL ACTIVITY INTO DEVELOPING COUNTRIES

To date, franchising has been developed to a greater extent in the United States than anywhere else in the world, despite the fact that the concept had its early origins in Europe. The last 20 years, however, have witnessed an unprecedented spread of franchising across international frontiers prompted almost exclusively by American franchise companies wishing to cope with problems of market saturation and monopoly legislation at home. Exports by European franchise companies, by way of comparison, range from modest to trivial depending upon the country in question. Countries such as France, the United Kingdom, and Australia are becoming involved in international franchising activity but appear to be currently concentrating on ex-colonies and are geared towards serving expatriates.

Franchisor internationalization began initially by establishing a presence across industrialized nations with developed economies and language/cultural proximity and affinity to the United States. As markets began to become saturated in America, and as the export potential of franchising became more evident, the growth rate accelerated and global expansion has broadened.

In an increasing number of countries, escalating urbanization, rising disposable incomes, and expanding consumer markets provide conditions favorable to the growth of franchising.

U.S. ATTITUDES TOWARDS FRANCHISE GLOBALIZATION

High profile American involvement in international franchising is looked upon favorably at the highest levels in the U.S. government because of the strong benefits to the U.S. economy. From a balance-of-payments perspective, international franchising is considered (in the U.S.) as a safe and rapid means of obtaining foreign currency with a relatively small financial investment abroad. It is notable that it neither replaces American exports nor exports American jobs. These reasons make this business arrangement one of the most preferred and government-supported forms of international involvement. The same argument can be made for the Franship system.

The advantages of a global Franship, or franchise, program to an American company may be summarized as:

Fewer financial resources are required as the Franship entity (foreign partner) incurs the majority of the costs involved.

Raw materials can often be produced internally in countries under the Franship structure where direct imports may be limited under the franchising system.

There is less susceptibility to political, economic and cultural risks if the ownership is local under the Franship program. Property is less likely to be expropriated since the grantees are local nationals. China is a good example, as it begins to expand its nationalistic tendencies toward foreign corporations.

Grantees under the Franship program are more familiar with local laws, language, culture, and business norms and practices of the country. And, having ownership in the parent company creates more motivation rather than just owning an American franchise.

The Franship program also helps to avoid some of the following risks of employing franchising as a vehicle to international expansion from the franchisor's viewpoint:

Possible difficulties in repatriating royalties

Difficulties in protecting copyright and intellectual property rights

Difficulty in policing quality standards, unfamiliar laws, regulations, language, and business norms

Difficulties in servicing franchisees

Difficulties in terminating contracts because of local laws

Creation of local competition as the franchise concept is copied or products are bootlegged

TECHNOLOGY TRANSFER

The transfer of franchise know-how across national boundaries can be viewed as a process providing local franchisees with access to value-added businesses as well as the marketing techniques and managerial support implicit to firms developed in industrialized economies. However, not all countries and cultures readily accept Western franchising concepts.

Franship-type joint ventures have traditionally been a more popular method for international development because the franchisor receives financial assistance with the costs of globalization. Sharing the equity with a local partner also assists the franchisor with the sensitivity needed to cope with cultural, political and administrative norms, and behavior patterns in the franchisee’s country.

In some Asian and Middle East countries there are relatively few, if any, foreign (or indeed home-based) franchise companies registered. There were, and are still, stringent foreign investment laws and a preference for Franship-type joint ventures rather than outright foreign ownership. In other countries even joint ventures were restricted to sectors specifically targeted by the national government.

GLOBAL UTILIZATION

As the major American franchise companies grow more competitive in the United States, the large chains have looked to overseas markets for their future growth. A dozen years ago, McDonald’s had approximately 3,200 restaurants outside the United States; today it has over 20,000 restaurants in over 125 foreign countries. It currently opens approximately 6 new restaurants every day, and at least 5 of them are overseas. The economic values and industrial practices of American franchises are being exported to every corner of the globe. American franchising systems have not only become symbols of Western commercial advancement, but have proven successful in helping to grow foreign economies as well. American franchise companies are often the first multinationals to arrive when the country has opened its markets, serving as the pioneers in the reconstruction of the local economy. Seventeen years ago McDonald’s opened its first restaurant in the Republic of Turkey, no other foreign franchisor or chain did business there. Turkey, now has hundreds of franchise outlets, including 7-Eleven, Nutra Slim, ServiceMaster, Re/Max Real Estate, Mail Boxes Etc, (now owned by UPS), Ziebart Tidy car, plus many others.

The anthropologist Yunxiang Yan has said that in the eyes of Beijing consumers, U.S. franchises represent, “Americana and the promise of modernization.” Thousands of people waited patiently for hours to eat at the city’s first McDonald’s in 1992. Two years later when a McDonald’s opened in Kuwait, the line of cars waiting at the drive-through window extended for seven miles. About the same time, a Kentucky Fried Chicken (KFC) restaurant in Saudi Arabia’s holy city of Mecca set new sales records for the chain, earning US$200,000 in a single week during Ramadan. In Brazil, McDonald’s has become the nation’s largest employer. Many international franchise businesses have become the center of commerce, and disperse economic benefits throughout the foreign city or country. Classes at the McDonald’s training facility in Oak Brook, Illinois, are taught in more than two dozen languages.

As the American franchise chains move overseas, in order to diminish the fears of American domination, the chains purchase as much food and supplies as possible in the country where they operate. Instead of importing food and supplies, they import their systems and procedures so that local businesses can learn and prosper by providing the needed products and services. Seven years before McDonald’s opened its first restaurant in India, the company began to establish a supply network there, teaching Indian farmers how to grow iceburg lettuce with seeds specially developed for the nation’s climate. A McDonald’s restaurant is just the entry point of a much larger system comprising an extensive food-chain, leading back to all the local suppliers and eventually back to the farms.

CONCLUSION

The Franship system, as a modification of the Western franchise business model can have a useful “role-model” effect in encouraging local entrepreneurs in countries with developing economies to set up their own franchises and even consider expanding these “home-grown” franchise models outside the country. An implicit feature of a Franship, and/or franchise system, is the concept of technological transfer to the learning organization or country, where technology refers to skills and know-how rather than just machinery and hardware. This broader process relates to methods of organization and operation, quality control, and various other manufacturing procedures.

Notwithstanding my belief in the Franship system rather than conventional franchise structures in some developing economies, there will be circumstances that exist within other countries that nevertheless warrant the use of master franchise relationships.

For governments of developing countries that wish to tap the potential of franchising and concentrate on promoting local businesses while resisting the downside factors of imported Western franchise know-how, the Franship model has proved effective.

However, it may well be that, in exchange for exposure to managerial, marketing and consumer know-how which imported franchise systems bring with them, there may a price to pay. The cultural homogeneity which exposure to Western tastes may bring, the loss of economic diversity, the possible displacement of existing local businesses, the repatriation of fees and profits, plus the notion of control from a distance, all need to be taken into account by policy-makers in developing economies before deciding to either embrace or reject this source of technology transfer and know-how.

Whatever posture governments of developing economies decide to adopt on franchising or the Franship system, one thing appears fairly certain: franchising as a business expansion concept cannot be indefinitely ignored.