Addressing the Most Common Franchisee Claims
May 2008 Franchising World
Common-sense steps that franchise systems often fail to apply.
By Mary Beth Brody, CFE
One thing that all franchisors can agree upon is that litigation with franchisees is a no-win situation. Even if the franchisor prevails on all claims, it takes an incredible toll on the franchisor and the franchise system. This article focuses on two areas in which a franchisor can make a big difference by taking steps to avoid the most common varieties of franchise litigation.
The most common claims brought by franchisees against franchisors include breach of contract, fraud and misrepresentation, breach of the implied covenant of good faith and fair dealing, and violation of franchise laws. While the claims are similar, the circumstances giving rise to them are often quite different. Two of the key areas in which a franchisor can take proactive steps to avoid such claims are in the franchise sales process and in franchisee communications. While the steps suggested are part of an effective litigation-prevention strategy, they are also best business practices for building a strong brand and a strong franchise system.
The Sales Process
The franchise sales process has always been fertile ground for franchisee claims. It also is one of the areas over which franchisors can and should exert a great deal of control. The steps franchisors should take to avoid claims arising from the sales process fall into three distinct categories. The first is the most obvious: franchise sales compliance. Every franchisor must have a formal franchise sales compliance program and must communicate to its staff that compliance is a top priority within the franchisor organization. At a minimum, the sales compliance program must ensure that: the franchise disclosure document and exhibits are accurate, complete and not misleading; the franchisor is registered or exempt in all states in which it conducts any sales activity; all of the franchisor’s personnel who will have dealings with prospects are completely familiar with the contents of the disclosure document and other franchise documents (so that they do not make any statements which are inconsistent with the documents) and are fully trained in the “dos” and “don’ts” of franchise sales; and there are processes to monitor the sales process including appropriate checklists, franchisee acknowledgment forms and similar items.
Other important components of a sales compliance program include designating and empowering a sales compliance officer and conducting sales compliance training at regular intervals. Beyond these concrete steps, it is critical that the highest level of management instill throughout the franchisor team a true appreciation and respect for sales compliance and disclosure. If there is an attitude that the franchise laws and disclosure obligations are merely a “nuisance” that sometimes get in the way of closing sales, the likelihood of sales violations will increase and so will the risk of franchisee litigation.
The second component of an effective sales process is more of a business component than a legal component, but it is probably the most critical area for avoiding franchisee litigation. It is the actual process that is involved in determining which franchisee candidates will be awarded franchises. The single biggest mistake that franchisors, especially start-up franchisors, make is to sell franchises to the wrong people. If there is not an effective screening process, the franchisees who enter the system are less likely to be qualified and more likely to struggle and fail. These, of course, are also the very franchisees who are most likely to sue. One key aspect of the screening procedure is the development of a profile of the ideal franchisee candidate. If the franchisor does not have a profile, it will be much easier to sign on a franchisee who does not have the skill set, personality traits, or financial resources necessary to succeed.
Another key aspect of the screening procedure is to structure the sales process in a fashion that allows the franchisor to evaluate whether the prospect is able and willing to follow procedures. To do this, the franchisor must have a step-by-step process through which all candidates proceed. If, for example, Step 3 in the process requires prospects to submit their financial and bank information by a certain date and the candidate does not follow through, this may signal that the franchisee is not likely to follow directions from others or does not respect deadlines or timetables set by others. If this same candidate fails to follow through on additional steps in the sales process, the franchisor should be getting a clear message that this will probably not be a compliant franchisee. The sales process is the time to weed out problem franchisees—not after they are part of the franchise system. A successful franchisor knows when to walk away from a marginal candidate, and how to identify which candidates are marginal. It cannot be emphasized enough that selecting the best possible candidates not only helps prevent litigation, but it is the most important thing a franchisor does to build on the strength and reputation of its system.
The third component of the sales process relates to the screening process, but merits separate consideration, in part, because it may run counter to basic sales principles. In many businesses, the most important job for the sales person is to get the sale. That is fine when the salesperson is selling cars, refrigerators, insurance or other commodities. When the sale entails a long-term relationship between the parties such as is the case in franchising, there are more critical considerations than just closing the sale. It is absolutely imperative that throughout the sales process the franchisor and staff manage the expectations of the prospective franchisee. The franchisee who signs on with unrealistic expectations of potential profit, capital requirements, the amount of time needed to devote to the business, or any other aspect of the franchise will be an unhappy business owner and is likely to blame the franchisor for his disappointment and perceived problems.
Establishing and maintaining strong lines of communication with franchisees is a critical component to a successful franchise system. Effective communication can also serve as a powerful deterrent to franchisee lawsuits. It is part of human nature that franchisees, like everyone else, have a basic need to be heard and to be validated. Even if the franchisor does not agree with a franchisee on a particular issue, if the franchisee genuinely feels that the franchisor understood and appreciated his concerns, this will often alleviate unnecessary hostility and resentment. The precise forums and vehicles for effective franchisee communication may vary somewhat with the size and the particular characteristics of the franchise system.
For start-up franchisors, effective communication may take the form of regular e-mails, telephone calls and onsite visits. As the system grows, establishing a franchisee advisory council or similar body which provides input on various areas may be appropriate. However, for an advisory council to be effective, it must have meaningful input on the issues and must be recognized by the general franchise population as representing franchisee interests. Some franchisors set up a franchisee advisory council consisting of hand-picked franchisor favorites whom the franchisor expects to rubber-stamp its decisions. This type of council probably does more harm than good. Regardless of the form franchisee input takes, it will not be effective unless franchisees feel empowered to participate in the present and future direction of the franchise system.
Many franchisee advisory councils provide input on advertising and marketing programs, convention planning and other franchisee meetings. In addition, they often provide input on new products or services to be offered by the franchise system. If the advisory council is regarded as a representative body with real input, it can be an incredible asset to the franchisor when a franchisor is looking to implement a major change in the system (another area that can be ripe for lawsuits). A change that is supported by the franchisee advisory council is typically a much easier “sell” to the rest of the franchise system.
Another key aspect of effective franchisee communication is having internal procedures in place to resolve disputes when they arise. The franchisor should have a process for dealing with franchisee complaints before they take on a life of their own. As with the importance of training the franchisor’s staff on franchise sales compliance issues, the franchisor should train its team on the proper procedures for dealing with franchisee issues and complaints. This includes the staff at franchisor’s headquarters, as well as the field support. If the franchisee’s concerns are ignored or if the franchisee is just told to “read the franchise agreement,” the particular issue is more likely to get blown out of proportion and contribute to the franchisee’s perception of unfair treatment by the franchisor.
One area of franchisee communication that is often overlooked by franchisors is the importance of what might be referred to as “smart writing.” This entails thoughtful communications with franchisees. Too often franchisor personnel will send off a letter or, even more likely, an e-mail without giving much forethought to the impact of the communication. For example, the company may write the letter or e-mail for posturing purposes rather than to try and find common ground. Harsh words from a franchisor representative in the heat of the moment are likely to create hard feelings by the franchisee and not ultimately serve the franchisor’s best interests. This is especially true in the case of e-mail for which people tend not to use the same degree of care in writing as they would a business letter.
There are three key “smart writing” rules that a franchisor will want to impart to its employees. The first is to stick to the facts. In other words, the franchisor’s staff should not write any unsolicited, or even solicited, opinions on issues. The second rule is to recognize that e-mails are often drafted casually and emotionally and that instead of sending them immediately, the author should set them aside for later review and transmission. The third rule is to “say what you mean and mean what you say.” In other words, it is not a good idea to try to appease a franchisee by promising to do something about which the franchisor does not intend to do, or cannot, follow through.
While the steps outlined in this article are mostly common sense, it is amazing how many franchisors do not apply them and how many lawsuits could have been avoided if they had.
Mary Beth Brody, CFE, is a franchise attorney with the Minneapolis office of Faegre & Benson LLP. She can be reached at 612-766-8067 or firstname.lastname@example.org.