Legal Issues That Can Harm Your Relationship with Franchisees

Contrary to the belief of many franchisors, legal issues are not usually the result of inconsiderate, selfish franchisees, although there are isolated instances of these. Most legal issues arise due to three actions or omissions on the part of the franchisor:

1. Failure to provide complete disclosure of material facts to potential franchisees.
2. Failure to recruit the right type of franchisees.
3. Failure to provide ongoing support, communication and training.

Disclosure Fails

Most jurisdictions have full disclosure legislation which demands that Franchisors provide Franchisees with full, true and clear disclosure of all material facts related to:

• The Franchisor,
• The Franchisor's owners, directors and officers, if they are critical to the success of the franchise and/or the Franchisee's location,
• The Franchisor's financial health,
• The Franchisor's ability to manage the business as indicated by:
  • length of time operating the franchise business
  • length of time within the industry
  • whether the Franchisor or any of its key people have been insolvent or involved in a legal action against them relative to the awarding of franchises,
• The Franchise Agreement and the key clauses which govern the Franchisor/Franchisee relationship.

Failure to comply with the provisions of this legislation can result in severe penalties including:

• The return of the initial franchise fee
• Any losses incurred by the Franchisee up to the point of dispute
• All costs associated with construction of the franchise location
• All inventory costs
• All legal costs.

A 2000 ruling in Alberta Court of Queen's Bench (Marshall v. Little Mac Enterprises Incorporated and the Security Company of Excellence Incorporated Action #0903-00468) illustrates the importance of disclosure. This case is significant for three reasons:

1. It clearly analyzes the elements of what may or may not constitute a franchise and therefore be subject to the Franchises Act.
2. The broad interpretation given to the Act by the Court.
3. The awarding of damages to the Franchisee in the amounts envisioned by the drafters of the Alberta Franchises Act. In this case, the Franchisee launched an action before large amounts were expensed by the Franchisee. What is significant is that the Court awarded the Franchisee costs incurred which were the initial franchise fee and the interest associated with financing the franchise fee.

Even if disclosure is not required in your jurisdiction, it is important to provide full disclosure to all franchise candidates regardless of their geographical location. Full disclosure sets a positive tone to the relationship between the parties.

Recruitment Fails

Recruitment tragedies are the major reason for deterioration of the Franchisor/Franchisee relationship. Rushing the recruitment process, or recruiting individuals who do not fit the profile, will result in a mismatched Franchisee who will not follow the operating system and will result in an inordinate amount of work for the Franchisor as the Franchisor develops the necessary documentation for termination. You will usually know within the first six months if you have made a bad recruitment decision. When this happens, it is important to first focus on assisting the Franchisee in developing the business from their location. Document all your efforts! That includes all visits to the franchise location, all telephone calls, emails and communications with the Franchisee, all support provided by outside services (e.g. advertising agencies), and all requests for assistance or other services made by the Franchisee and your response to these requests.

Document Everything!

Documentation will enable you to provide evidence of your efforts to assist the Franchisee in establishing and growing their business. It is good business practice to document all communications, support and assistance with all of your Franchisees from the very beginning of the relationship. Apart from your efforts to assist the Franchisee in developing the business from their location, you will also be documenting and giving written notice to the Franchisee of any and all breaches of the Franchise Agreement committed by the Franchisee. Your notice should set out the following:

1. Each breach and the section of the Franchise Agreement that the breach relates to.
2. The length of time that the Franchisee has to rectify the breach.
3. The consequences of not rectifying the breach within the given time.

Your documentation should include the Franchisee's response and efforts made to cure the breach, and what actions you took if the Franchisee failed to remedy the situation. If you want to ensure compliance, the prescribed penalty must be assessed if the Franchisee does not cure the breach. DO NOT indicate a consequence which you do not intend to follow through on. If you are unsure of the actions that you can take, consult your franchise lawyer.

Be prepared to take the ultimate action – divorce – if the Franchisee continues to breach the provisions of the Franchise Agreement. Providing for the final termination of the Franchise Agreement can be traumatic for both the Franchisor and Franchisee. This is the case even if the Franchisee has become a problem and a liability. If you have followed all the proper steps as noted above, termination will not be a huge expense. There will be costs associated with the removal of a non-system franchisee, but you can reduce these costs by proper documentation and proper support throughout the relationship.

Support, Communication and Training Fails

Failure to provide proper support and training can present a serious problem for the Franchisor, since the Franchisee's breach will be as a result of the Franchisor's poor operating practices. Obviously the thing to do is to ensure that you manage the franchise system so that all members of the system benefit. If, however, you find yourself in the opposite situation and the Franchisee is in breach as a retaliatory action, then focus on doing the following:

1. Immediately meet with the Franchisee and work out a plan for them to rectify the breach so you can resume providing the necessary services. Make this a workable plan for both parties and STICK TO IT. Make sure that it isn't one-sided.
2. Document both the breach and the actions that both parties will take to resolve the breach and strengthen the relationship. Both parties should sign off on the document to indicate their intent to carry through.
3. Develop and implement an internal plan of action to assist the Franchisee in building and growing the business.
4. Be constant and consistent in the support provided until all breaches have been resolved. Give the process at least six months, during which time you should document all of your efforts to assist the Franchisee.
5. If after six months the relationship and breaches have not improved, it's probably time to end the relationship.

Make sure your franchise system is prepared for, and has a procedure in place for, divorce from a franchisee. By demonstrating a sincere attempt to resolve the differences and assist the franchisee in business building, you will be able to minimize the financial consequences of divorce. And remember - the best way to prevent legal issues is by managing your system to avoid the "Fails" outlined above.