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franchising

2016 Annual Legal Checkup

By Newsletter

We all acknowledge the importance of seeing our doctor annually for a physical checkup. Unfortunately, when it comes to the well-being of your franchise business, many companies never consider the importance of an annual legal checkup. If you are not reviewing documents or systems yearly, then new technology, new legislation or changing case law among other factors, may put your franchise business at risk.

Statistics show that most franchise systems which fail, do so within the first five years, principally for one or more of the following: undercapitalization; poor operations; lack of training and support; selling franchises for survival; lack of the skills required to be a successful Franchisor; or, looking only at the short term rather than building for the long-term. All of these failure precepts are likely to result in litigation against the franchise entity and against the principals and franchise sellers of the Franchisor, who are likely to be sued individually by the disgruntled franchisees. Without question, such litigation can be avoided by the company regularly consulting with its franchise attorney to provide advice and guidance in advance of any legal entanglements.

The need for a legal checkup is not just for the new Franchisor. For the mature Franchisor to be successful, there must be constant innovation and change. Change facilitates resistance from franchisees and requires close legal support from the planning stage through the implementation of the change.

A clear example of change occurred when McDonald’s added breakfast to its franchise system. Suddenly franchisees were faced with increased cost, not just for additional equipment, but new labor cost and having to manage a whole new process.

Without legal input prior to implementing the modification, McDonalds would have been in court for years from suits by their own franchisees.

In a field so seemingly narrow as franchising, it is always interesting to me that few law students and law professors have ever heard of and many, perhaps the majority of practicing lawyers, likewise have no awareness of and do not recognize the field of franchise law and the fact that there are so many subcategories of the law to consider. Franchising is filled with numerous subfields starting with the law of contracts and includes the core of franchising, trademarks, trade secrets and copyrights. Always present in franchising are antitrust issues, changing laws, litigation and the rapidly developing areas of joint liability and ostensible agency. From the initial prospect package through the termination of a dissident franchisee, a Franchisor’s records, information and processes should be reviewed no less than annually and, when necessary, updated, modified or changed to meet legal requirements. 

CONCLUSION

Does your company conduct an annual legal checkup? Will you be one of the casualties when the list of former franchise companies is posted? How successful do you want to be?

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Personal Liability in Franchising

By Newsletter

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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