Avoiding litigation

Franchise Litigation: Fact, Fiction, and Prevention

About the Speakers • •

Dave Hood, President, 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

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About the Speakers • Harold Kestenbaum, Partner, Gordon & Rees – – – – –

Named one of the top 100 franchise attorneys in America 30+ years in franchise law Former board member of publicly traded franchisor Noted author: “So You Want to Franchise Your Business” Many hundreds of franchisors developed

• A lot to cover, so please hold questions • Will email copies of this presentation, so you do not need to write notes • A little about you?

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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 Copyright, The iFranchise Group, 2013. All rights reserved

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Litigation in Franchising

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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.

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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 Copyright, The iFranchise Group, 2013. All rights reserved

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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

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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

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

Well-Executed Franchising

Company-Owned Growth

X

Employment Liability

X

Property Lease Liability

X

Equipment Lease Liability

X

Workers Comp Liability

X

Slip and Fall Liability

X

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

No

Yes

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.

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Litigation Avoidance

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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

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Five Critical Points of Franchisee Qualification

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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) Copyright, The iFranchise Group, 2013. All rights reserved

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Franchisee Versus the Entrepreneur

Franchisee       

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

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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.”

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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.

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

Validation

Sales Communication Marketing Plan

Franchisee Success is Critical

Ongoing and Field Support

Message & Materials Opening Assistance

Quality Control

Advertising Expenditures Documentation & Training Selectivity

Sales Process

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All rights reserved.

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

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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.

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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.

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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.

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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!

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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

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Operations Documentation

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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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

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Questions