Franchise Litigation – The Last Resort

Here is a paper Fortman Law submitted as part of Jon being a keynote presenter at the 2019 Leadership Summit of the American Association of Franchisees and Dealers:

Franchising can be a breeding ground for litigation due to the unique relationship between the parties. Franchisees pay substantial sums of money to enter a system and make ongoing royalty payments. In exchange, franchisees expect to obtain the expertise of the franchisor, ongoing support, and assistance during the turbulent times which will ultimately occur. When the franchisee is not as successful as expected or when the franchisee perceives that the franchisor is not providing proper support, the seeds of litigation are planted.

Franchise litigation is a broad term which includes many processes beyond simply filing a lawsuit in a court. Many franchisors, in anticipation of the possibility of litigation, put dispute resolution procedures into the franchise agreement in order to deter franchisees from seeking to enforce their rights. These include pre-suit mediation and arbitration. In theory, arbitration is designed to allow parties to resolve disputes quickly. However, the reality is that the significant costs incurred in arbitration means that many franchisees are unable to enforce their rights. In addition, most franchise agreements require the franchisee to bring any litigation in a court where the franchisor is located. The expense of finding an attorney in that location to represent the franchisee along with the costs of travel to that location can be too great for a franchisee who has suffered significant financial losses. In effect, these types of clauses can render a franchisor immune from any lability for fraud or breach of the franchise agreement.

While much of the litigation surrounding the franchise relationship arises after termination of the franchise agreement, a significant percentage of franchise cases involve disputes which arise prior to any termination. These types of disputes can involve product pricing issues, issues related to costs of remodeling a location, encroachment on protected territories, or use of the advertising funds just to name a few. In those cases, the parties are not seeking to end their relationship. Rather, franchise litigation is used to clarify the requirements under the franchise agreement. If the goal in these types of cases is to maintain the franchise relationship, the franchisor and franchisee must be mindful of their tactics and strategies. Litigation is an adversarial process where each side wants to “win” their case. However, it can also lead to irreparable damage to the relationship.

Many times, franchisees who are struggling and facing significant financial losses look at litigation as their first option. Franchisees invest more than money into their franchise. They also invest significant mental and emotional energy. When all of that is threatened, the natural response is to go on the offensive and take a “scorched earth” approach. The major disadvantage of litigation is that it is not a quick and efficient method of resolving disputes. During that time, the franchisee must be able to put emotion aside and look at options based on sound business decisions. An attorney experienced in representing franchisees must be consulted.

There are options available short of filing a lawsuit or claim in arbitration. Many franchise agreements require an informal meeting to attempt to resolve the dispute before litigation can begin. If that does not resolve the issue, a more formal pre-suit mediation may be required. These pre-suit negotiations can be beneficial in that the parties may be lead to early resolution before significant legal fees are incurred. For the franchisor, early resolution may permit them to enter into a confidential settlement without having to disclose the terms in the Franchise Disclosure Document. The disadvantage of mediation at this early stage is that without the benefit of receiving documents or other information from the franchisor, it may be difficult to adequately address the issues. The franchisor may also view early mediation as a means to threaten and intimidate the franchisee. An experienced mediator can prevent pre-suit mediation from deteriorating into something which just causes the parties to dig in their heels. Once again, an attorney experienced in these types of disputes is crucial.

As should be clear by now, franchise litigation should not be the first option. Many franchise disputes arise due to a breakdown in communication between the franchisor and franchisee. In turn, the parties may no longer trust each other preventing both parties from rationally assessing the business issues at stake in the litigation. The parties become entrenched in their positions. It is at this point that a franchisee association may be critical. If there is a system-wide issue, a string franchisee association may be key to re-establishing communication. Not surprisingly, many franchisors try to discourage the franchisees from forming associations. Franchisors may view an association as interfering with its ability to implement changes to improve the system. One of the goals of the association early in the process is to convince the franchisor that an association can assist in preventing and managing conflict with the franchisees. The officers of the association, elected by the franchisees, can serve as informal mediators in potentially contentious situations, such as when the franchisees are struggling financially or when large numbers of franchisees are upset with the performance of the system of the franchisor’s business decisions. If the franchisor knows that implementing a particular business decision may be controversial, explaining it to the association representatives in advance and listening to their feedback can go a long way to keeping the peace. If the franchisor is still resistant and the problems persist, the association now has significant strength due to the numbers of its members to proceed to litigation is necessary.

While franchise litigation can be a valuable tool to assist franchisees in enforcing their rights, it must be carefully considered. Otherwise, franchisees may find themselves in a long and costly battle with no certainty as to the end result. Fortman Law has significant experience in representing franchisees nationwide. Should you wish to discuss any issues you may have please do not hesitate to contact us.