Disputes between Franchisor and Franchisee

Over the years, franchising has gained a, somewhat unfair, reputation for disputes and litigation between franchisors and franchisees. Is this the reality of franchisees’ experience in the sector, and what are the causes of disputes?

Franchising is a long-term relationship that requires a high element of trust between the parties. Franchisees can spend life savings, or take out loans to fund franchise acquisitions and to set up in business on their own, with the support and systems that a franchisor can offer. They need to trust a franchisor to deliver. On-going fees are payable, usually as a percentage of turnover and franchisors have to trust franchisees to declare that turnover accurately. They also want to see franchisees following the same system and using the same branding.

How franchise disputes arise

Disputes can arise when franchisees do not achieve the sort of income they expected to when signing on the dotted line. This may be their own fault, or it may reflect market factors, or it may, in rare circumstances, be because the franchisor has misrepresented the earnings potential. Other disputes arise when franchisees feel that the franchisor is cutting back on the level of support it provides, perhaps to preserve its own profitability or when there has been a change of ownership and culture within the franchisor company, and franchisees lose that relationship with the founder.

Whatever disputes arise, they are often exacerbated by a failure of communication between franchisor and franchisees. If disputes are to be avoided, it is essential that both parties keep open the lines of honest communication, but if that communication and trust is broken down, what can the parties do?

Know your franchise agreement

Franchisors and franchisees need to pay close attention to the wording of the franchise agreement, which governs the relationship and the rights, duties and obligations on both parties. Franchisees often have higher expectations of the performance of obligations by a franchisor than the Franchise Agreement actually requires them to fulfil. The franchisor’s obligations are often generic. Franchisees should not be over-confident in assuming they could establish breach of contract on the part of a franchisor, concerning their ongoing obligations to provide advice, guidance and support. Obligations on the franchisee are far more detailed. Failure to adhere to these obligations, and the system, can lead to the franchisee being in breach and susceptible to the termination of the Franchise Agreement, if they fail to remedy their failures.

Dispute resolution procedures

The Franchise Agreement also, usually, sets out a procedure for resolving disputes including face-to-face meetings and mediation before either party can start Court proceedings (unless the franchisor seeks an injunction to stop some competitive activity). Before embarking on litigation, both parties need to weigh up the considerable legal costs they would incur, and the likelihood of being able to enforce a judgment against their opponent, if they were successful. They also need to be wary of opening a can of worms. The two leading cases on misrepresentation in the last nine years both resulted from the franchisor suing a former franchisee for compensation. Counter-claims for misrepresentation were then made which were successful.

Group action claims

Conditional fee (no win no fee) arrangements are still available, but are less attractive. The winner now has to pay the lawyer’s success fee as well as any insurance premium covering the opponent’s costs. These additional liabilities will be taken from the damages, but if that sum is insufficient, or if it is not paid due to the opponent’s insolvency, the costs are still payable. This means that low value claims cannot be run economically under the conditional fee regime. Franchisees know this, and are now looking at alternative ways of funding their disputes, often by seeking financial support from like-minded fellow franchisees. This has led to a growth in “group actions” which are a far more serious threat to a franchisor than a single claim. Franchisors can ask their own lawyers for a conditional fee agreement, and there are also products available to franchisors to fund legal costs through an insurance scheme renewed annually. The parties could also consider a damages-based agreement, where the lawyer’s fee is taken as a percentage of the recovered compensation, but these are rare and, like other risk-based funding arrangements, complex.

Seek early legal advice

Early legal advice should be obtained, not just when the relationship has broken down and litigation seems inevitable, but beforehand in order that parties can be focussed on trying to settle their dispute quickly and economically. If litigation teaches us anything, it is that whilst winning is usually good, losing is catastrophic.

(This article first appeared in Making Money Magazine.)