Franchisee Litigation

Occasionally someone asks me if they should become a franchisor. Depending on the situation I will answer with a smart remark such as “do you like litigation”. My remark comes from the facts of today’s belief that whatever may have gone wrong it has to be someone else’s fault. In franchising there are lots of reasons why it must be someone else’s fault or at very least you didn’t tell me about something before I bought the franchise.
I attended a legal seminar last week that discussed what areas most franchisee litigation was coming from. The almost obvious answer is from the Franchise Disclosure Document (FDD) that every franchisor must give to every potential franchisee at least 14 days before signing any documents or collecting any money. Sometimes seemingly innocent things can give an opening for complaint.
One example is rebates, when a franchisor is in the first 5 years, give or take, of business they might say something about the fact that they may take rebates from approved suppliers. As time goes on and the franchise grows purchases from some suppliers grow and a rebate can be negotiated based on volume or other factors. However the FDD has not changed, today rebates have to be explicit. Such as “We receive a 5% rebate from XYZ Company for all purchases you make from them”. That’s probably not the language the attorney would use but that’s how specific you must be. Not done properly opens the door for litigation from a franchisee who makes the claim that he/she was not informed and is damaged because they should get the rebate not the franchisor.
There is a section of the FDD called Financial Performance Representation or Item 19. Franchisors can put certain information about the performance of the franchise to assist potential franchisees in evaluating the business. Most franchisor in the past avoided this section for fear that they would say something that could be held against them. Modified regulations and common sense now tell most good franchisors that there is more litigation from not providing good information than there is from providing honest, factual information. The reasons are pretty simple, everyone wants to know if they will, or at least can, make money if they invest in the business. If there is not good information in the FDD they will get that information where ever they can, and it could be a salesman making up numbers to complete the sale.
The other leading cause of litigation is failure of the business. It often does not matter how hard the franchisor tried to make the franchisee successful, if the business failed “it can’t be my fault”. There certainly are bad or just ineffective franchisors so some litigation in this area is probably justified but the vast majority of these claims in my experience are franchisees who didn’t follow the system, or did something to ruin the business. Divorce, other business opportunities that detract and a thousand other things can come up to interrupt good business practices.
Franchising must be a win/win situation and the franchisor is responsible to use good sense, proper disclosure and recognize the importance of treating franchisees like partners not subordinates if they want to avoid litigation and have a friendly, peaceful franchise system.
If you have questions on avoiding litigation contact me at jack@franway.com.