Personal Liability in Franchising

In the traditional corporate environment, the corporate umbrella shelters individuals from personal liability while conducting business.  Franchising, however, is not your traditional corporate setting.  With the abuses that once occurred in franchising, the federal government and many states determined that the unsophisticated purchaser required additional protection.  As a result, franchise law evolved from an amalgamation of common law principles, federal and state statues and judicial decisions.  Blended together, these legal precepts override the traditional corporate umbrella protection and make individual liability a very real concern for everyone involved in the Franchise process. 

At the Federal level, individuals within the Franchise Company face personal liability from Section 5 of the Amended FTC Act, which makes unlawful any unfair method of competition or deceptive act or practice in or affecting commerce. 

While the FTC Act sets minimum standards, most states have enacted their own legislation affecting Franchising and at the same time, exposed individuals in franchising to personal liability.  These state statutes also provide for both governmental enforcement and private action. 

If an unsatisfied franchisee files suit, their claims usually appear in multi-count complaints which not only include statutory claims, but also common law remedies against both the franchisor and individuals employed by the franchisor in the area in which the franchisee’s claims arose.  Examples of areas where individuals could be exposed to personal liability occur in the sales process, real estate, inspection, build-out, training and support.  Suits also normally include the officers and/or directors overseeing the area where the claims arose.  Because the claims are intentional in nature, many states allow punitive or exemplary damages which can far exceed the actual out-of-pocket loss claimed.  How can Franchisors and their employees protect themselves?  Skilled drafting of every franchise document can help shield officers, directors and employees from personal liability.  At risk individuals can further obtain protection by entering into indemnity agreements with their Franchise company.  Franchise companies should also consider initiating programs to obtain written acknowledgements from Franchisees at every step of the franchise process.   Additionally, all franchise companies should consider “D&O” insurance to protect officers and directors. 

Perhaps the best safeguard to prevent individual liability is the implementation of a personal liability analysis as part of each franchise company’s annual legal checkup.  For clients we work with in completing annual renewals, we incorporate this liability analysis into our clients annual renewal review.

The rapid growth of franchising has contemporaneously produced greater Franchise litigation and with it, personal exposure of individuals involved with the franchise process.  Make sure you have initiated your annual legal check-up to protect those individuals who might be at risk.

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