Franchising · 8 December 2015

How to manage franchise disputes

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Managing relationships in franchising is important for achieving sustained business growth

Our expert Andrew Pena looks at the best ways to manage relationships in franchising – when the interests of a franchisor and franchisee are no longer mutually compatible and disputes arise.

Franchising has established itself as one of the better ways to achieve sustained business growth. But, the model can quickly cease to have value.

Franchising provides a well trodden path both for companies developing a business via a franchising model and individuals setting up and growing their own franchised business.

The 2013 NatWest/BFA Franchise Survey recently reported that the industry was now worth some £13.7bn with the vast majority of franchisees (92 per cent) reporting their business as profitable.

Whilst this suggests that franchising can provide a great way to build a business, it can come at some risk to both parties. On one side we have the independent franchisee who, having paid for an affiliation to a brand, is seeking to grow their own business and reap the rewards. On the other side, the more entrepreneurial franchisor who, upon receiving the franchisee’s investment, seeks to develop and drive the wider brand in a certain direction through management and leadership. The franchising industry might say that these are mutually compatible positions. However, sometimes these interests can create uncertainty and potential strife. This article looks at ways in which a franchisor can manage any disputes that may arise from its franchisee relationships.

The legal landscape

Franchising is not regulated in the UK. This means that any company can set up as a franchisor without any real barriers to entry. The beauty of franchising is that the franchisor and franchisee are independent entities, which means that the operational risks run by a franchisee are rarely capable of being passed on to the franchisor.

So, if a franchisee fails, or runs its business badly, the buck usually stops with them. The franchisor’s primary concern is therefore to ensure that the failure or poor performance of a franchisee is managed so as to limit any damage to the brand and/or risk a claim from a disgruntled franchisee.

Misrepresentation

In the UK, there is no obligation on a franchisor to provide pre-contract disclosure to a prospective franchisee. However, if information or documentation is provided, the franchisor needs to ensure that it is accurate and not misleading.

Around 50 per cent of franchising disputes arise from franchisees alleging that they having been misled. Such claims are actionable if the franchisee can show that, in entering into the franchise agreement, they relied on an important statement of fact that was made by the franchisor but which was untrue and/or an opinion provided by the franchisor which was not reasonably held. The bulk of such claims tend to focus on the financial projections provided by the franchisor in terms of the likely costs of setting up the franchise and the likely returns from operating the business.

So, a franchisor needs to decide on the level of pre-contractual information to provide and to ensure that such information that is does provide is accurate and not misleading.

The franchise agreement

Most franchise agreements are in a standard form and very heavily weighted in favour of the franchisor. Generally speaking the vast majority of obligations will fall on the franchisee who will usually have very few contractual rights against the franchisor. Most of the clauses in a franchise agreement – other than in respect of non-compete obligations and limits on liability – are not subject to reasonableness. So, although these contracts can, on an objective level, be quite unfair and unreasonable, they will generally be enforced by the courts.

So a franchisor needs to ensure they have a well drafted franchise agreement that properly and accurately documents both parties rights and obligations and also considers and addresses all the key areas that a franchisor may need for its future protection. A good, and well drafted franchise agreement is the foundation upon which a franchisor can manage its franchisees to ensure that they either operate sound and well-managed businesses, or can be easily and efficiently exited from the network whilst preserving the underlying business for the franchisor (or another franchisee).

Franchise management

A franchisor will need to put in place well documented and considered franchise management processes. These can include:

(1) A franchisor driven network or regional communication platform via a regular franchise conference

(2) A franchisee driven forum where network issues or niggles can be aired (and resolved) with the franchisor by a small representative group of franchisees

(3) An auditing or mystery shopper programme where operational or financial or training issues can be identified

(4) Training, support, mentoring and/or coaching programmes through which franchisees can be developed and improved to meet any operational or financial or training needs

(5) A compliance and/or legal team that can consider more significant issues which may result in default notices being sent (where the franchisee will be required to remedy breaches of the franchise agreement) or the franchise agreement being terminated

Every franchisor will need to put in place a well considered franchise management strategy. This should focus on the whole franchisee lifecycle from cradle (including the franchisee sale, recruitment, training and launch processes) to grave (exit or sale of a franchise). The strategy will be underpinned by a well drafted franchise agreement (which should protect the business and create the appropriate if and when required) and the day to day processes to identify issues and support or discipline franchisees with a hierarchy of sanctions for poor performers which may ultimately lead to exiting or terminating the worst (or most disingenuous) franchisees.

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ABOUT THE EXPERT

Andrew Pena is a commercial litigator who has worked at well-known City practices. Having acted for major international companies and many recognisable high street brands, he now heads up Cubism Law’s franchise law practice.

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