Avoiding litigation (oct 2014) by iFranchise Group

The iFranchise Group

About the Speakers • •

Mark Siebert, CEO, the iFranchise Group More hands-on experience than any other firm – – – –

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26 consultants with over 450 years of franchise experience Our consultants have worked with 98 out of the top 200 franchise companies worldwide Former CEOs, CFOs, and EVPs of major franchise companies Experience with start-up franchise programs, not just established franchisors

Breadth across four functional areas –

Strategic Planning

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Quality Control

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Marketing

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Implementation (Sales Assistance through Franchise Dynamics)

Franchise Dynamics –

200,000+ leads processed

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500+ sales per year

TopFire Media –

Nation’s first fully integrated media firm

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SEO, PPC, Social, Blogging, PR, and Mobile

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Both brand/consumer focused and franchise lead generation

The iFranchise Group

About the Speakers • Gaylen Knack, Principal, Gray Plant Mooty – – – – – – –

25+ years in franchise law Former in-house council at public franchisor Best Lawyers in America 2010 – present Legal Eagle, 2007 – present Who’s Who of Franchise Lawyers 2003 - present Chambers USA – Leading Lawyer 2008 - present Frequently published author and speaker

The iFranchise Group

Experience with Litigation Avoidance • Dave Hood, 650 stores, no litigation, none since • Leonard Swartz – – – – – –

No litigation at Dunkin while he was there No litigation at Adia No litigation at Dunhill One lawsuit at PIP to collect fees, PIP won ITT had no franchise-related, but had unrelated litigation Snelling had litigation when he started with them

• iFranchise Group Summary: Having led 20+ companies, only three had any franchisee litigation and in every instance that litigation was there when we started. • Franchise Dynamics – 25 sales & marketing professionals with 7,000 franchise sales – 500+ sales each of the last two years – Never been subject to a franchisee lawsuit, arbitration, or regulatory action

The iFranchise Group

Litigation in Franchising

The iFranchise Group

The Negative Impacts of Franchisee Litigation Litigation with franchisees often results in negative consequences such as the following: 

Drain on the franchisor’s financial resources

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Drain on staff time of the franchisor

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Emotionally challenging for the franchisor’s staff

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Damaging to overall franchisor-franchisee relationships

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Required disclosures of litigation within the FDD

The iFranchise Group

Why Do Franchisees Sue? • Failure – Franchisees who are doing well in their businesses seldom sue their franchisor. Franchisees who are failing will blame the franchisor, not themselves. • Lack of honesty and transparency – “Fraud” is the basis for the majority of all lawsuits. • Lack of effort/support – Franchisees that are failing want to see a genuine concern and concerted effort to help. People seldom sue those that they feel are on their side. • Promises that are not kept – Nothing will offend a franchisee’s sense of fairness faster than the perception that they cannot trust their franchisor. • Poor communications – Franchisees want open and honest communications. They also want a franchisor that will listen to what they have to say. Copyright, The iFranchise Group, 2014. All rights reserved.

The iFranchise Group

Evolution of Franchise Contracts • Franchise law in the 1970s was new • Like all law, it is defined by “case law” • Decisions rendered in the last two decades have better defined the law and reduced litigation – Series of lawsuits involving marketing funds – Series of lawsuits involving territory disputes – Series of lawsuits involving “good faith” – Series of lawsuits involving “duty of competence” – Series of lawsuits involving dual distribution

• As cases are resolved by the courts, the lawyers drafting the contracts get smarter • Far fewer litigation cases on these issues today • Role of Private Equity Firms in Reducing Litigation Copyright, The iFranchise Group, 2014. All rights reserved.

The iFranchise Group

What’s left to sue over? • Contract violations – But a franchise contract is so one-sided this is almost impossible to find grounds within the contract – “Periodic visits”

• Franchise law violations – Preventable by retaining qualified franchise counsel – Compliance systems and checklists

• Fraud in the sales process – This is the basis for most franchisee lawsuits – It is largely preventable

The iFranchise Group

The Litigation Myth • Survey by independent industry source indicated that only 27% of franchisors had any litigation – Most of this litigation was with larger companies

– Companies like McDonald’s are targeted for frivolous lawsuits and lawsuits unrelated to franchising – McDonald’s, with 30,000+ contracts had only six pending lawsuits. Big Target. Litigation rate of 0.02% – Examples: • • • •

A group claiming that the way they make chicken is unhealthy Group suing them for making their children obese Group suing them for beef tallow in cooking oil A Group suing them and others for collection of tax on bottled water • One suit by a JV partner • One pending franchisee lawsuit from a franchisee who owes $3 million in unpaid royalties

The iFranchise Group

The Litigation Trade Off: Franchising Versus Company‐Owned Growth Liability Type Franchise Contract Liability Employment Liability

Well‐Executed Franchising

Company‐Owned Growth

X Usually not*

Property Lease Liability

Equipment Lease Liability

Workers Comp Liability

Slip and Fall Liability

Vicarious Liability Can require third party to insure you against liability Can insure against internally

Usually not*

You always have liability for your agents

Yes – franchisee

Yes

* Not Responsible for acts of an independent contractor (franchisee) relative to third parties. Exceptions are when a) you create an agency and/or b) if you are negligent.

Litigation Avoidance

The iFranchise Group

Marketing and Sales Best Practices

Limiting your liability:  Have your attorney review franchise marketing materials and ads  Have your attorney review any form letters or correspondence  Train sales staff on what is appropriate in communications  Be selective in the franchise sales process

The iFranchise Group

Five Critical Points of Franchisee Qualification 

Intelligence

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Capitalization 

Biggest reason for failure

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Can cause franchisees to cut corners

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Work Ethic

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Job Specific requirements

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Personality 

Experience in leading a team

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Tendency toward being an entrepreneur

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Honesty and ethics

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Philosophy and cultural fit

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Nature (Confrontational or adaptive)

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Compatibility (you are “married” for the next 20 years)

The iFranchise Group

Franchisee Versus the Entrepreneur

Franchisee       

Straight A Student Long tenure with job Corporate job Drives family car Few tickets Married Looking for security

Entrepreneur       

B or C Student Moved from job to job Owned businesses Sports car Lots of tickets Divorced “Never saw a rule he didn’t want to break.”

The iFranchise Group

Marketing and Sales Best Practices

Limiting your liability:  Be sure the basic rules in the sales process are followed: • • • • •

Always tell the truth Only say what is in the FDD Document that the truth was told Franchisee verification at signing Continually train, test, and monitor sales force

 Mystery shop your franchise sales force using an outside firm to ensure legal compliance – will also be a great report to have if you ever do have litigation.

The iFranchise Group

Don’t Sell Faster Than Your Ability to Provide Support Concept & Value Proposition Offer/Structure

Validation

Sales Communication Marketing Plan

Ongoing and Field Support

Franchisee Success is Critical Message & Materials

Opening Assistance

Quality Control

Advertising Expenditures Documentation & Training

Selectivity

Sales Process

Legal Best Practices

Limiting your liability:  Be sure your FDD is kept current  Develop a system to track state renewals and ensure compliance for each franchisee  Conduct appropriate background checks  Develop and monitor a system (at closing) for verifying and documenting that no inadvertent disclosures were made  Train your franchise sales force on an annual basis on legal compliance  Stay alert for trouble brewing – head off disputes early

The iFranchise Group

Accounting and Auditing Best Practices

Limiting your liability:  Make sure that the audit is begun on a timely basis and that auditors finish on a timely basis so you do not “go dark” on franchise sales  Install a system for tracking and documenting that each franchisee is maintaining proper insurance coverage  Install a system for tracking and documenting that all franchisee licensing is kept current  Install a system for documenting appropriate franchise background checks, financial diligence, representations.

The iFranchise Group

Operational Support

Limiting your liability:  Have a standard compliance checklist for field support that does not leave room for interpretation  Make sure your support people document everything and that you keep a detailed file on each franchisee including all correspondence, contracts, FA, FDD, etc.  Supplement field support visits with Secret Shopper Programs  Document all franchisee communications using Contact Management Software  Train your staff on a regular basis on appropriate franchisee communication and interaction, as well as best practices communications techniques – especially emails!  Develop a Field Support Manual for identifying problems and maintaining best practices. Copyright, The iFranchise Group, 2014. All rights reserved.

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Real Estate Support

Limiting your liability:  Document your requirements and process the franchisee must follow  Ensure the franchisee conducts and documents their own due diligence  “Approving” versus “accepting” the franchisee’s site  Ensure the franchisee retains a qualified real estate attorney  Review each lease to ensure your lease requirements have been met prior to execution.

The iFranchise Group

Avoiding Vicarious Liability •

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Liability for the actions taken by someone else (franchisee or franchisee’s employees) –

A customer sues the franchisor because a franchisee “made the coffee too hot” and it burned them

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An employee sues the franchisor because the franchisee sexually harassed them

The Law is on Your Side! –

Technically speaking, you are not liable for the actions of a third-party independent contractor

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Third party needs to create a nexus through either the franchisor’s negligence or by claiming that an “agency” was created

Be sure that the franchisee is clearly identified as and independent contractor –

Signage in a location

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Use of name on business cards, letterhead, etc.

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Develop a best in class Operations Manual

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Insurance –

Franchisee should carry and name you as a co-insured

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Have system for tracking franchisee insurance compliance

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You can carry your own insurance on top of this

The iFranchise Group

Operations Documentation

Limiting your liability:  It is critical to have a well drafted operations manual  Your manual is an extension of your Franchise Agreement  Key points the manual must address o System requirements to protect your standards o Best practices to help franchisees run profitable businesses o Suggested business practices in many areas (e.g., human resources) where you want franchisees to make their own decisions as business owners

 The manual should cross-reference important sections in your Franchise Agreement  Should be updated annually and reviewed by your franchise attorney

The iFranchise Group

Other Steps to Avoid Litigation • Hire experienced franchise legal counsel • Strong contracts that “under-promise” • Train franchisees thoroughly • Make franchisee success and good franchisee relations your priority • Create an attitude of franchise support – and do not tolerate an attitude of “us vs. them” • Communicate with franchisees frequently and through a variety of methods • Solicit franchisee input (advisory councils, etc.) • Have dispute resolution mechanisms in place

The iFranchise Group

Questions