Typically, franchise agreements require franchisees to comply with all civil and criminal laws and provide that franchisees will be in default under their franchise agreements if any of their franchise owners commits a felony or other offense that is injurious to the “System” or the franchisor’s marks.
In Dunkin’ Donuts Franchising, LLC v. Oza Bros., Inc., Dunkin received a tip from the Franchisee’s former employees that the Franchisee was underreporting sales. Dunkin performed an audit and determined that the Franchisee was depositing checks from its wholesale customers into its corporate account rather than ringing them into its cash registers and that the Franchisee’s deposits exceeded the sales it reported to Dunkin’ and on the Franchisee’s tax returns for three years. Dunkin’ terminated the Franchisee without providing an opportunity to cure. Evidence presented at trial showed that the Franchisee had misreported the deposits as shareholder loans on its taxes, and worse yet, the Franchisee’s accountant testified that the Franchisee deducted sales tax payments twice to underestimate sales tax payments due. The Franchisee argued the termination was wrongful because no tax authority had audited it or indicated that any deficiency existed, but the court agreed with Dunkin’ and held that “whether Defendants are actually prosecuted is irrelevant to whether there is a tax deficiency,” and “the Franchise Agreement did not require Dunkin’ to wait until [the Franchisee was] prosecuted before terminating the Franchise Agreement.” The Franchisee’s failure to obey applicable tax provisions by underreporting income to the IRS was sufficient to constitute a breach of the Franchise Agreement.
Franchisees beware: Franchisors and courts alike will consider tax evasion to be injurious to the Franchisor’s “System” and marks, regardless of whether the franchise agreement specifically identifies it as such or not. More importantly, franchisors can, and will, terminate a franchise agreement for franchise
tax related violations, regardless of whether the franchisee has been prosecuted by any tax authority. If your franchisor believes that you have intentionally underreported income or sales tax to the government, most franchise agreements will allow the franchisor to terminate the agreement without an opportunity to cure. Click here to see the case.