Commercial Cleaning Franchise System Challenges SBA’s Determination of Eligibility for Paycheck Protection Program Loans Under CARES Act

23 April 2020 Legal News: Distribution & Franchise Publication
Authors: Michael J. Lockerby Peter Loh

Three members of the JANI-KING® franchise system filed suit last week in federal court in Washington, D.C. alleging that the United States Small Business Administration (the SBA) has discriminated against franchised businesses in general and commercial cleaning franchises in particular — including the JANI-KING® franchise system — by unlawfully restricting eligibility for loans under the Paycheck Protection Program (PPP) established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act.1  

Under the CARES Act, loans to cover payroll costs during the COVID-19 pandemic shutdown are supposed to be available to any “small business,” defined as one with fewer than 500 employees. One of the plaintiffs, Ohio Services–CLE, LLC — the JANI-KING® master franchise in the Cleveland area — is owned by a husband and wife and has only 18 full-time employees. Nevertheless, the complaint alleges, the SBA found that it was not an eligible “small business,” i.e., one with fewer than 500 employees.

The experience of the Ohio master franchise was not an isolated occurrence, according to the two other plaintiffs. The other plaintiffs are Jani-King International, Inc., the owner of the JANI-KING® trademarks, and Jani-King Franchising, Inc., a subsidiary of Jani-King International that is the franchisor of the JANI-KING® franchise system. Most members of the JANI-KING® franchise system have been denied eligibility for PPP loans altogether, the complaint alleges. The SBA, according to the complaint, has applied discriminatory eligibility criteria for “small businesses” that happen to be “franchises” by declaring them ineligible for PPP loans unless they meet certain eligibility requirements imposed by the SBA that are not set forth in any statute or regulation — including the CARES Act and its implementing regulations.

The complaint seeks injunctive relief to prevent the SBA from applying certain eligibility criteria that the plaintiffs allege discriminate against franchised businesses in general, compared to other types of small businesses. These include the SBA’s practice of denying access to PPP loans to any “franchise” — defined by the SBA in some cases to include “distributor,” “dealer,” “license,” “jobber,” or “member” agreements — unless the agreement has been approved for listing in the SBA Franchise Directory maintained at https://www.sba.gov/document/support--sba-franchise-directory. In connection with the directory listing, the SBA makes an independent determination whether the agreement in question establishes a “franchise” within the meaning of the Franchise Disclosure Rule promulgated by the Federal Trade Commission (FTC).

Unlike the FTC, the SBA has no enforcement authority for the Franchise Disclosure Rule. Unlike the members of the JANI-KING® franchise system — whose agreements are undeniably franchise agreements — many manufacturers and other suppliers do not agree with the SBA’s classification of their distributor, dealer, and other agreements as “franchises.” If the SBA nevertheless determines that the agreement is a “franchise,” the SBA will not approve a PPP loan (or a loan under the pre-existing Section 7(a) SBA loan program) unless the franchisor, manufacturer, or other supplier agrees to an addendum that modifies standard contract terms. One contract term that must be modified, according to the SBA, is any provision whereby the “franchisor” has discretion to withhold transfer or assignment of the contract — a right that trademark licensors claim is essential for brand integrity.

Besides challenging the SBA’s directory listing requirement, the complaint also challenges the SBA’s application of its so-called “affiliation” rules to find members of the JANI-KING® franchise system ineligible. According to the SBA, Plaintiff Ohio Services — literally a “Mom and Pop” business with 18 full-time employees — should not be classified as a “small business” (one with fewer than 500 employees). The SBA instead asserts that Ohio Services, the JANI-KING® master franchise in Cleveland, should be considered to be an “affiliate” of its franchisor and all other franchisees in the JANI-KING® franchise system. The relief that the plaintiffs seek therefore includes a judicial determination that Ohio Services and other members of the JANI-KING® franchise system with fewer than 500 employees are, in fact, small businesses that are eligible for PPP loans. Without such relief, the complaint alleges, the potential consequences for at least some members of the JANI-KING® franchise system may include closure of their businesses and layoffs of employees that the CARES Act in general and the PPP loan program in particular were intended to avoid.

Plaintiffs are represented in the litigation by Michael J. Lockerby and Peter L. Loh, partners in the law firm of Foley & Lardner LLP. Mr. Lockerby, resident in the firm’s Washington, D.C. office, is national co-chair of the firm’s Distribution & Franchise Practice Group. Mr. Loh, resident in the firm’s Dallas office, is national vice chair of the firm’s Distribution & Franchise Practice Group. They are assisted in the matter by Frank S. Murray, Jr., partner, and Jack G. Haake, associate, both resident in the Washington, D.C. office.

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1 Copies of Plaintiffs’ Verified Complaint, Motion for TRO and Preliminary Injunction, and related filings in Jani-King International, Inc. et al. v. U.S. Small Business Administration et al. (Case No. 1:20-cv-00989 in the U.S. District Court for the District of Columbia), are available at https://www.foley.com

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