Editorial

What Can Go Wrong (Or Why You May Be Calling Me)

I have been an attorney for franchisees for almost three decades now. I think I have seen it all, or most of it. I have seen very successful and rewarding Franchises – I have eaten there, shopped there, slept there. I have also seen the devastation experienced by those who have invested their money, time and energy in a Franchise where the conduct of the franchisor, initially and over time, sets the stage for eventual failure. In my experience, the stage is set most often with the following conduct.

1. The Franchise Opportunity was misrepresented or not fully and fairly disclosed. Unfortunately, sometimes the written and oral communications going from the franchisor to the prospective franchisee before the franchise documents are signed include misrepresentations. The prospective franchisee moves forward into the business based upon the information received, and the business flounders or fails. Franchisees frequently approach me at that time and want to know if they can get their investment back. The answer to that question is typically found in getting a thorough understanding of the written and oral communications, and analyzing that fact situation under all applicable common law and franchise disclosure statutes. Because promises made in sales materials are not always reflected in legal documents, generic and client-specific advertising and marketing materials are particularly helpful to review, as are any pro formas (be they the napkin variety or otherwise) furnished to the franchisee in advance of the time the franchise documents were signed. Pre-signing representations are not the only ones that are actionable; there are arguably cases when post-signing misrepresentations and/or material omissions are actionable ( e.g., if the full facts had been furnished during training, wouldn’t the franchisee have gotten out and cut its losses, rather than go forward?).

2. The assistance promised by the franchisor did not materialize. The franchisee expects to get at least as much value from the franchisor as it pays in up front and ongoing royalties. When that does not occur, franchisees search for a remedy. Unfortunately, the written promises concerning services may be far different than those orally promised during the sales presentations. A common type of complaint is that the franchisor’s promised cost savings from group buying have not occurred, with franchisees sometimes complaining that, in fact, franchisees can buy cheaper themselves than through the franchisor’s group buying efforts (which, in turn, frequently leads to findings that the franchisor is getting vendor kickbacks or rebates -- which, particularly if not disclosed, may create additional causes of action above and beyond contract claims). Advertising fund concerns are another common complaint (with the franchisor making unreasonable payments to itself to handle advertising/marketing being a common complaint; separate fund/right to audit issues also commonly arise). To prevail, franchisees and their attorneys must typically get beyond the restrictive language of the written agreement, and successfully argue that the common law of contract, as augmented by the covenant of good faith and fair dealing, create obligations from the franchisor to the franchisee not found in the writing.

3. The contemplated “critical mass” development of the franchise system within the ADI has not occurred. Unsuccessful franchisees frequently are also lonesome franchisees -- i.e., there is not a “critical mass” of franchised and/or company-owned stores within the ADI , which, in turn, causes marketing/advertising efforts to be unsuccessful and/or too expensive on a per store basis. A combination of misrepresentation, disclosure and/or contract claims must then be reviewed.

4. The franchisor is locating other franchise or company-owned stores too close to the franchise unit, or is otherwise encroaching. New forms of encroachment are more commonly occurring -- e.g., Internet sales by the franchisor and alternative forms of marketing such as direct mail or ads placed in grocery stores. Again, a combination of misrepresentation, disclosure and/or contract claims must then be reviewed.

5. The franchisee has pricing problems. This can occur if the franchisor’s promised “best pricing” does not materialize; if the franchisee is paying too much for goods from approved vendors to subsidize vendor payments to the franchisor; the franchisor is giving preferred pricing to competing franchisees; or the franchisor squeezes the franchisee’s profit margins by establishing maximum resale prices. Undisclosed or inadequately disclosed payments from vendors to franchisors based on franchisee purchases, if discovered, present an array of potential options. Franchisors are getting more aggressive in establishing maximum and minimum prices at which franchisees may resell. Antitrust laws continue to evolve in favor of franchisors and against franchisees.

6. The franchisor sells to a “bad buyer.” “Bad buyers” include buyers who are too highly leveraged, who have no expertise, or who have conflicts of interest ( e.g., they own competing franchise systems). While it has been historically accepted that franchisors have the right to prohibit the sale by the franchisee to an unsuitable buyer, it has also historically been assumed that the opposite is not the case. New uses of old theories, and new uses of new theories, give the franchisees some rights to challenge the franchisor’s sale to a bad buyer.

7. The franchisee’s efforts to transfer its business for fair value are impeded with rights of first refusal or with overly stringent enforcement of restrictions on rights to transfer. Franchisors are getting more aggressive in trying to steer sales to particular buyers or to themselves, with the necessary effect being a reduction in the value the franchisee can get for the business.

8. The franchisee is being faced with wrongful termination. While termination may be appropriate where underperforming franchisees, who, after having been given reasonable notice of the perceived deficiencies and an opportunity to correct them, fail to do so, there is an underutilized array of remedies available to franchisees who are performing (or who have not been given reasonable notice of claimed deficiencies) to prevent wrongful termination or to recover fair compensation in the event of termination or other substantial changes to their business. Athough franchisors’ aggressive drafting, attempting to limit forums and damages available, make this task more difficult, franchisees can be successful if they have the right tools available to them – including a good knowledge base of the rights and obligations of each party in the business relationship.

9. The franchisor refuses to renew or proposes to renew only if the franchisee agrees to a dramatically different agreement. Franchisees need reasonable criteria for renewals, ideally in both the written agreement and in an applicable statute.

10. The franchisee wants to “go private” or switch to another franchise system … or close without penalty. Mature franchisees, in particular, after realizing that they are paying more in franchise fees than they are getting value, are interested in getting out of their written agreement before it expires. The entire array of legal remedies must be reviewed, with “go private” options being available (and are easier, if the franchisor does not control the real estate, and if there is no post-term non-compete agreement).

If you find yourself in a position with any one or more of the problems described above, be sure to consult with experienced franchisee counsel. It is also quite important for franchisees to have a clear understanding, before entering into the franchise, of what the relationship with any particular franchisor will entail. After all, the franchisor spends a lot of time and energy ensuring that its franchisees’ obligations are clearly spelled out in the written agreement – why shouldn’t you do the same? Experienced franchisee counsel can help you achieve your business objectives even before the franchised business relationship starts.