Franchise Litigation: Fact, Fiction & Prevention by iFranchise Group

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More hands-on experience than any other firm

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More “senior level” experience

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Breadth across four functional areas

◦ 27 consultants with over 700 years of franchise experience ◦ Our consultants have worked with 98 out of the top 200 franchise companies worldwide ◦ Offices: Chicago, Dallas, Los Angeles, Miami-Ft. Lauderdale-Boca Raton, Atlanta, Toronto, Dubai, Riyadh

◦ Former CEOs, CFOs, EVPs of over 50 major franchise companies  Adecco, Armstrong Tile, Auntie Anne’s, Dunkin’ Donuts, LINE-X, Pearle Vision, McDonald’s, PIP Printing, Schlotzsky’s, Snap-on Tools, Snelling & Snelling, and other (inter)national brands ◦ Experience with start-up and established franchise programs ◦ Vertical specialties by industry segment ◦ ◦ ◦ ◦

Strategic Planning Quality Control Marketing Organizational Development and Implementation

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Rated the best consultant by 750+ franchisors

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TopFire Media for lead generation

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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.

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Franchise law in the 1970s was new

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Like all law, it is defined by “case law”

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Decisions rendered in the last two decades have better defined the law and reduced litigation ◦ ◦ ◦ ◦

Series of Series of Series of Series of

lawsuits involving marketing funds lawsuits involving territory disputes lawsuits involving “good faith” lawsuits involving “duty of competence”

◦ Series of lawsuits involving dual distribution 

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As cases are resolved by the courts, the lawyers drafting the contracts get smarter Far fewer litigation cases on these issues today

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Contract violations ◦

But a franchise contract is so one-sided this is almost impossible to find grounds within the contract

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“Periodic visits”

Franchise law violations ◦

Preventable by retaining qualified franchise counsel

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Compliance systems and checklists

Fraud in the sales process ◦

This is the basis for most franchisee lawsuits

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It is largely preventable

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 Litigation Trade Off: Franchising Versus Company-Owned Growth Liability Type Franchise Contract Liability

Well-Executed Franchising

Company-Owned Growth

Employment Liability

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. © 2021 iFranchise Group. All rights reserved.

Litigation Avoidance

 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

Selecting qualified franchisees will help reduce a franchisor’s litigation:  Does the candidate have prior experience in the franchisor’s industry?  Does the candidate have prior business ownership experience?  Has the candidate hired and managed people before?  Is the candidate adequately capitalized?  How strong is the candidate’s credit history?  Will the candidate be opening a franchise in an established or a new market for the franchisor?  Has the candidate initiated litigation against others in the past?

Marketing and Sales Best Practices

Limiting your liability: 

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Be sure the basic rules in the sales process are followed: o

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.

Legal Best Practices 

Limiting your liability: o

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

Accounting and Auditing Best Practices 

Limiting your liability: o

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.

Operational Support 

Limiting your liability: o

Have a standard compliance checklist for field support that does not leave room for interpretation

Make sure your support staff document everything and 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

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Limiting your liability: ◦ Document your requirements and process that 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

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Best practices for managing the fund include: ◦ Account for advertising monies separately ◦ Audit the fund annually ◦ Seek input from franchisees on how the marketing fund should be spent ◦ Don’t spend fund monies on initiatives that you know most franchisees won’t support ◦ Be conservative when allocating overhead expenses against the fund ◦ Be transparent in terms of sharing accounting information relative to the fund with your franchise owners

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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 the customer was burned

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An employee sues the franchisor because the franchisee sexually harassed an employee

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 an independent contractor ◦

Signage in a location

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Use of name on business cards, letterhead, etc.

Develop a best-in-class Operations Manual Insurance ◦

Franchisee should carry and name franchisor 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

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Limiting your liability: ◦ A good Operations Manual can help you avoid vicarious liability ◦ A bad Operations Manual can be a franchisor’s worst nightmare ◦ Operations Manuals must provide you with adequate brand control but should not be too prescriptive – a fine line ◦ Must avoid creating an inadvertent “agency” relationship ◦ Must avoid potential areas of negligence or take great care when prescribing actions ◦ Should cross-reference regulations and not cite them ◦ Should be updated annually and reviewed by professionals and attorney.

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Hire experienced franchise legal counsel

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Strong contracts that “under-promise”

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Train franchisees thoroughly

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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

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Solicit franchisee input (advisory councils, etc.)

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Have dispute resolution mechanisms in place