Ch. 36 Sole Proprietorships and Franchises

Question 1

Define entrepreneur.

Answer 1

• One who initiates and assumes the financial risk of a new business enterprise
• AND undertakes to provide or control its management

Question 2

In selecting an organizational form, an entrepreneur will most likely consider what four factors?

Answer 2

(1) ease of creation
(2) liability of the owners
(3) tax considerations
(4) ability to raise capital

Question 3

What is the primary motive of an entrepreneur?

Answer 3

To make profits

Question 4

What are three major business forms that entrepreneurs have traditionally used?

Answer 4

• Sole proprietorship
• Partnership
• Corporation

Question 5

Strictly speaking, is a franchise a business organizational form?

Answer 5

NO

Question 6

What is the simplest form of business?

Answer 6

• Sole proprietorship

Question 7

What is a major advantage of the sole proprietorship?

Answer 7

• Proprietor owns entire business and receives all the profits (b/c he assumes all the risk)

Question 8

Generally, do any documents need to be filed with the government to start a sole proprietorship?

Answer 8

NO

Question 9

What taxes does a sole proprietor pay?

Answer 9

• Only personal income taxes (including SS and Medicare taxes) on the business profits, which are reported as personal income on the proprietor’s personal income tax return

Question 10

What is the major disadvantage of the sole proprietorship?

Answer 10

• Proprietor alone bears the burden of any losses or liabilities incurred by the business enterprise (unlimited liability)

Question 11

What was the key issue in the Quality Car & Truck Leasing v. Sark case?

Answer 11

• Issue: Personal liability of the owner of a sole proprietorship
• Decision: “The Sarks are clearly judgment debtors to Quality Leasing and the judgment has not been satisfied.” Quality Leasing is entitled to judgement as a matter of law.

Question 12

In a sole proprietorship, can creditors pursue the owner’s personal assets to satisfy any business debts?

Answer 12

YES

Question 13

When the owner of a sole proprietorship dies, what happens to the business?

Answer 13

• Business auto dissolves

Question 14

What is a franchise?

Answer 14

• An arrangement in which the owner of intellectual property (e.g. trademark, trade name, copyright) licenses others to use it in the selling of goods or services

Question 15

Define franchisee.

Answer 15

• Purchaser of a franchise
• Generally legally independent of franchisor
• Economically dependent on franchisor’s integrated business system

Question 16

Define franchisor.

Answer 16

• Seller of the franchise

Question 17

Give an example of a well-known franchise.

Answer 17

• McDonald’s
• 7-Eleven
• Holiday Inn

Question 18

Franchises generally fall into what three classifications?

Answer 18

(1) Distributorships
(2) Chain-style business operations
(3) Manufacturing arrangements

Question 19

In a distributorship, _________ licenses a ________ to sell its product.

Answer 19

• Manufacturer (Franchisor)

- Dealer (Franchisee)

Question 20

Give an example of a common type of distributorship.

Answer 20

• Automobile dealerships

- Beer distributorships

Question 21

Explain the operations of a chain-style business operation.

Answer 21

• Franchise operates under a franchisor’s trade name and is identified as a member of a select group of dealers that engage in the franchisor’s business
• Franchisee is generally required to follow standardized methods of operation and maintain certain standards of performance

Question 22

Give an example of a chain-style operation.

Answer 22

• McDonald’s
• Century 21, a real estate brokerage firm
• H&R Block, tax preparing service firm

Question 23

What happens in a manufacturing arrangement (or processing plant arrangement)?

Answer 23

• Franchisor transmits to the franchisee the essential ingredients or formula to make a particular product
• Franchisee then markets the product either at wholesale or at retail in accordance with franchisor standards

Question 24

Give an example of a manufacturing arrangement.

Answer 24

• Pepsi-Cola

- Other soft drink bottling companies

Question 25

A franchise relationship is primarily a what type of relationship?

Answer 25

Contractual relationship

Question 26

What law governs franchising?

Answer 26

Contract law

Question 27

If a franchise exists primarily for the sale of products manufactured by the franchisor, what law applies?

Answer 27

• Law governing sales contracts (as expressed in Article 2 of the UCC)

Question 28

How does the federal government regulate franchising?

Answer 28

• Through laws that apply to specific industries

- Through the Franchise Rule (created by the FTC)

Question 29

What does FTC stand for?

Answer 29

Federal Trade Commission

Question 30

Congress has enacted laws that protect franchises in certain industries (e.g. auto dealerships and service stations). These laws protect the franchisee from what?

Answer 30

• Unreasonable demands

- AND bad faith terminations of the franchise by the franchisor

Question 31

In general, the FTC’s Franchise Rule requires franchisors to disclose what?

Answer 31

• Certain material facts that a prospective franchisee needs in order to make an informed decision concerning the purchase of a franchise

Question 32

Specifically, what does the Franchise Rule require?

Answer 32

(1) Written, or e-recorded, disclosures
(2) Reasonable basis for any representations
(3) Projected earnings figures
(4) Actual data
(5) Explanation of terms (termination, cancellation, renewal provisions)

Question 33

Those who violate the FTC’s Franchise Rule are subject to what?

Answer 33

• Substantial civil penalties

- AND FTC can sue on behalf of injured parties to recover damages

Question 34

In regards to state regulation of franchising, many states require that what be registered or filed with a state official?

Answer 34

• Franchise Disclosure Document (or FDD)

Question 35

The franchise relationship is defined by what?

Answer 35

• Contract b/w franchisor and franchisee

Question 36

What does the franchise contract contain?

Answer 36

• Specifies terms and conditions of the franchise and spells out the rights and duties of the franchisor and franchisee

Question 37

If the law required franchisors to provide estimates of potential earnings, would there be more or less growth in the number of franchises?

Answer 37

• Less growth

Question 38

Franchise Contract:

How does a franchisee ordinarily pay for a franchise?

Answer 38

• Pay an initial fee or lump sum price for the franchise license (the privilege of being granted a franchise)
• Pay for products from or thru franchisor
• Pay % of franchisor’s advertising costs and certain administrative expenses
• Pay % of annual or monthly business sales

Question 39

What are some key issues addressed in the franchise contract?

Answer 39

• Payment for franchise
• Business premises
• Location of franchise
• Business organization
• Quality control (means and degree of control)
• Pricing arrangements

Question 40

Can a franchisor mandate retail prices?

Answer 40

NO

Question 41

Usually the franchise agreement specifies that termination must be “for cause” and then defines the grounds for termination. Cause might include what?

Answer 41

• Death or disability of the franchisee
• Insolvency of the franchisee
• Breach of the franchise agreement
• ## Failure to meet specified sales quotas

Question 42

Even when a contract contains a notice and cure provision,may a franchisee’s breach of the duty of honesty and fidelity be enough to allow the franchise to terminate the franchise?

Answer 42

YES

Question 43

True or false.

Generally, the termination provisions of contracts are more favorable to the franchisee than to the franchisor.

Answer 43

FALSE

Question 44

What was the key question in the Mac’s Shell Service v. Shell Oil Products case?

Answer 44

• Under the PMPA, must a franchisee abandon its franchise in order to recover for constructive termination ?