Rocky Road Ahead For Franchise Relationships

July 27, 2021by Brian Walsh

The Covid-19 pandemic devastated franchisee businesses across the country. The stay-in-place measures implemented by State and local governments especially hurt the hospitality and restaurant businesses located in the Southeast portion of the United States. The International Franchise Association estimated that 32,700 franchised operations employing 1.4 million workers closed within six months of the outbreak. An Alignable survey in March 2021 found that 45% of small businesses remain “highly concerned” that they can stay in business through the end of the pandemic

The Rocky Road Ahead

Despite optimistic predictions that businesses will return to normal in 2021, the battered survivors have a lot to worry about.

The events of the past eighteen months intensify the interdependence between franchise operators and their franchisees as both struggle to honor agreements made in better times. According to the Wall Street Journal, the days of chummy relations are over as store owners and [franchise] corporate bosses “are bickering publicly as never before.”

Franchisor/Franchisee Issues

A franchise agreement aligns the interest of the two parties together so that the franchisor benefits when its franchisees do well.

The parties of a franchise agreement have a special relationship. In return for an upfront license fee and an ongoing royalty, the franchise gets an established brand, a proven system of financial success, mentorship, and access to specialized suppliers and marketing programs.

During the last eighteen months, many franchisors, recognizing the difficulties of their franchisees, stepped in to help their partners weather the storm.

Their efforts included increased communications, education programs regarding financing such as SBA’s PPA and EDL programs, developing new revenues streams for franchisees such as takeout and delivery for restaurants, and deferring a portion or all royalties owed. By reaching out to show franchisees they cared, some franchisors saved and possibly, strengthened their relationships.

Unfortunately, some franchisors took a short-term view, cutting franchisee services to save expense, aggressively protecting their royalties, or insisting that an agreed-upon expansion proceed despite the market circumstances. In some cases, franchisors have sold new franchises within the markets of existing franchisees despite previous understandings or oral agreements. These actions exacerbate negative feelings, effectively throwing gasoline on embers.

Common issues arising between franchisors and franchisees include:

  • Disappointing operating results –Franchisee complies with franchisor’s operating and marketing systems, but customer base and revenues lag expectations. State franchise laws impose strict requirements for Franchise Disclosure Documents (FDDs) and other marketing materials provided to franchisees during the sales process.
  • Poor location –Franchisee’s site does not generate projected traffic counts.
  • Supplier restrictions– Franchisee wants to buy supplies from an unapproved vendor with similar quality at lower prices. State and federal antitrust laws limit the competitive conditions that franchisors can place on their franchisees.
  • Deficient training– The franchisor’s training does not meet the franchisee’s understanding or expectations.
  • Exorbitant royalty fees – Franchisor fails to deliver expected services.
  • Franchisee-directed marketing program – Franchisee wants to direct local marketing and advertising, dropping out of franchisor program.
  • Franchisor discrimination Franchisor favors some franchisees over others. Selective enforcement of franchisees’ obligations may be unlawful discrimination.
  • Territorial disagreements –Franchisor sells additional franchisees in a current franchisee’s market. Territory encroachment, whether by company-owned outlets or allowing other franchisees to “fish in your pond,” may be restricted by the agreement.
  • Sale restrictions –Franchisee sells operation to competitive franchise or unapproved buyer.
  • Franchisee termination.A Franchisor wrongly terminates a franchisee despite their contract.

The above list is not intended to be complete nor indicate the validity of any of the claimed deficiencies. Lawsuits, including class lawsuits, regularly arise, such as:

  • Burger King. The chain’s franchisee association filed a lawsuit in 2010alleging that the company cannot require restaurant operators to sell the Whopper for $1 and lose money at that price.
  • Dominos. The franchisor required franchises to buy dough onlyfrom the company. The same issue – controlling suppliers – was litigated between a franchisee and International Dairy Queen.
  • UPS-Mailboxes. There were several different suits Mailboxes and franchisees when the franchisor attempted to change the franchisees’ existing business model.

Handling Disputes

Engaging in a lawsuit can be considerably frustrating, expensive, and lacks a guaranteed outcome.

During stressful times, tensions between a franchisor and franchisee frequently bubble to the surface, sometimes over trivial matters that explode into bitter battles before the bench. Going to court is the last, least desired option to settle a dispute. No outcome is certain. Before taking this final step, both parties’ interest is to resolve their issues before a trial is necessary.

The Resolution Process

Step 1. Know Your Rights

Most franchise disputes begin with a telephone call, usually followed by a face-to-face conversation between the franchisor representative and franchisee. The franchisee should understand his legal position before the complaint. The agreement between the two parties (the “contract”) defines the relationship between the franchisor and franchisee. A valid and binding contract must have

  • Agreement– an offer from one party (franchisor) with terms that are accepted by the second party (the franchisee).
  • Capacity– all parties have the ability to understand the terms of the obligations with acceptance given voluntarily of free will.
  • Consideration– parties must exchange something of value, i.e., cash fee for a franchise right.
  • Intention– parties must have clear intent to enter into the contract.

Franchise agreements are regulated by the Federal Government and some State governments (Florida, for example, has not enacted franchise-specific laws and is not a franchise registration state. The Sale of Business Opportunities Act regulates franchise offerings in that state.) Most franchise agreements have detailed, specific terms that describe each party’s obligations, including location, protected territory (if any), hours of service, products or services offered, and supply requirements. Federal law requires the disclosure of 23 specific items of information to a franchisee.

Before taking any steps to confront a franchisor, the franchisee must know their rights spelled out in the agreement. In many cases, the obligations have been confirmed or amended by previous court decisions and may be unknown to the franchisee. Many franchises have independent groups of company franchisees, i.e., franchise advisory councils, created to protect the rights of franchisees. They are generally good sources of information.

Contract breaches are typically a matter of fact, a binary condition of “yes” or “no” to the question. Unfortunately, the issues underlying most disputes are not easily resolved by contract terms. For example, a franchisee needing relief from royalty payments due to Covid closure is unlikely to find justification in the contract. In such cases, the advice of an attorney may be warranted.

Step 2. Negotiation

Contrary to general opinion, everything is negotiable to some degree. For example, many businesses renegotiated bank loans or mortgage agreements even though the other parties had no obligation to change the original terms. In many cases, the interests of both parties are best served by amending the initial agreement to accommodate the changed conditions. A terminated franchise affects both parties negatively – the franchisee loses their investment; the franchisor has a public relations problem that will likely affect future franchise sales and lose a flow of royalties.

Negotiation is a learned skill that few people can acquire and practice. Due to the franchise business’s legal requirements, franchisors typically have access to experienced negotiators on staff. Franchisees are usually not so advantaged – the equivalent of “taking a knife to a gun fight.”

Another disadvantage of franchisees representing themselves in negotiation with a franchisor is the possibility that discussions become acrimonious, straining future relations after the current disagreement is settled. In such cases, the franchisee might be better served by an independent, knowledgeable, experienced negotiator.

Step 3. Mediation

Mediation may be a necessary step defined in a franchise agreement before litigation. An impartial third party, the mediator, facilitates negotiations between the disputing parties with the aim for the parties to reach a win-win agreement that benefits both parties.

The mediator might rule on the issues in dispute, but the ruling is generally not binding on the respective parties. The mediator’s role is to be a neutral go-between between the parties to clarify issues in dispute and help the parties arrive at a resolution agreeable to both.

Mediation procedures can be as short or last several days depending on the attitudes of the participants and the nature and complexity of the issue(s) in dispute. The advantage of mediation is its lower costs compared to a lawsuit and trial.

Step 4. Litigation

The dispute resolution processes identified in this article and outlined in the Franchisee Code do not affect a party’s right to take further legal action concerning a franchising dispute.

However, if you are considering commencing legal proceedings against a franchisor, seek legal advice to assess your position and the likelihood of prevailing in court. Non-lawyers typically do not understand the factors in play during a trial, including the opposing  party’s commitment to their position.

In some situations, the parties may feel they cannot withdraw or settle due to external concerns. For example, a franchisor may not be willing to change any aspect of the royalty agreement believing that other franchisees will request similar new terms.

Final Thoughts

The franchise system has provided an opportunity for thousands of people to own a thriving business and avoid the growing pains that often accompany new companies. According to Forbes magazine, only one in three small businesses last ten years; just one-half make it to the fifth year. By contrast, three-quarters of the franchisees of the top forty franchises are in business in their tenth year. The advantages of a proven system, mentorship, and a national brand are incalculable.

Nonetheless, issues between franchisors and franchisees invariably erupt, especially in times of financial stress. In most cases, the parties can resolve their problems in the ordinary course of business. Hopefully, the economy will continue to recover during the latter half of 2021, and society will return to normal. Franchisors and franchisees should consider the past and the future before taking any step that severs their relationship.

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