Tuesday, 4th October 2016
Why do franchise disputes arise? Any long term commercial relationship has the potential for friction but the complicated nature of franchise relationships make them particularly susceptible to dispute.
Drivers leading to disputes include changes in:
- The relationship between the parties.
- Their commitment and expectations
- Their respective bargaining power
- Economic conditions and the trading market itself.
That potential is then compounded by the number of franchises within the network hence it is perhaps not surprising how frequently franchise disputes arise.
Disputes usually occur when either Franchisees believe that they are no longer receiving benefit from trading as a franchise or where the franchise business starts to fail.
Loss of Franchise Benefit
Commonly, unhappy franchisees, who feel they are not benefiting from the costs of being a franchisee, will look at ways of trading outside the franchise agreement - this will often mean selling products or services outside the franchise system in order to escape the application of turnover based franchise fees. This can mean buying products and consumables from outside designated supply chains or in more extreme cases parallel trading involving the sale of alternative goods or products to customers 'off the books'. We have seen examples of Franchisees creating separate companies through which to process alternate trade or more simple examples of unrecorded cash transactions . This is almost certainly likely to constitute a breach of the terms of the franchise agreement which would give rise to a right to terminate. Often the Franchisor will have a contractual right to undertake audits to confirm the veracity of the Franchisee's revenue; a powerful tool often overlooked.
Moreover, such conduct by the franchisee is a breach which goes to the heart of the relationship between the parties and their duties of good faith towards one another. Further, in order to protect the goodwill in the franchise (both for its own benefit and for that of the other Franchisees) the Franchisor feels compelled to take action - or at least be perceived to be doing so. This will usually take the form of a 'Breach Notice' putting the Franchisor on notice of the alleged breach of agreement and requiring remedy of the breach - very often as a precursor to the termination of the Franchise itself and possibly legal action to recover concealed franchise fees and other losses.
The Failed Franchise
When a franchise fails, the Franchisee might seek to lay blame on the Franchisor or on the Franchise system. Criticisms are varied but commonly might include lack of Franchisor support, supply problems, lack of lead generation (where applicable) and claims based around mis-selling and mis-description of the original franchise opportunity - often by reference to projections supplied to the Franchisee prior to entering into the franchise agreement.
The Franchise Agreement
Franchise agreements are generally written to be 'pro Franchisor' and the obligations falling on the Franchisor will be far less onerous than those falling on the Franchisee. Similarly information provided before the grant of the franchise will be heavily qualified and often clauses will be included within the Franchise Agreement acknowledging that the Franchisee has not relied upon such information as a basis of deciding to enter into the franchise agreement. For these reasons Franchisee claims can sometimes be difficult to bring - however recent developments in relation to common law duties of good faith have strengthened the Franchisee's position.
Prevention is better than cure and, in the case of contractual disputes, usually far more cost effective. Whilst some disputes will be unavoidable, the majority, in our experience, could be avoided by better communication and expectation management, increasing the perception of value which the franchise model brings to the franchisee throughout the term of the franchise agreement and early, open and honest engagement when problems do arise.
Dealing with Disputes
When disputes cannot be avoided, the parties respective positions can vary greatly. The best way to resolve disputes will often be to seek a commercial solution avoiding the costs and inconvenience of litigation. However, there are very good reasons why a Franchisor may want to adopt a tough position - they have a very real need to protect the goodwill in the franchise system and from a Franchisor's perspective there is often a 'bigger picture' to consider. We will often take instructions from Franchisors who want to make an example of an errant Franchisee, sometimes at a costs which is disproportionate to the issues in hand - this is important in sending out a strong message to other Franchisees that they must observe the franchise obligations, or 'pay the price' if they do not.
From a Franchisee's perspective, once the relationship has soured, there will usually need to be a parting of the ways. The question for the Franchisee will often be whether he can establish a breach of the Franchise Agreement by the Franchisor, which entitles the Franchisee to terminate allowing them to carry on trading (under a different brand) but free of the post-termination restrictions contained in the Franchise Agreement. There will often be a significant power imbalance between the Franchisor and Franchisee, which can have a significant bearing on the Franchisee's ability to 'take on' a dispute. Settlements will often include the Franchisee selling its interest in the Franchise, or buying itself out of its obligations.
We are often instructed in relation to group franchise actions where we will act for (or against) a body of Franchisees with a common dispute with the Franchisor. This will often 'rebalance' the negotiation position and Franchisees will often seek to impact the Franchisor's cash flow (and in turn its ability to fund legal fees), by withholding franchise fees whilst the dispute is ongoing to force the Franchisor to negotiate or submit.
Commonly we will encourage the parties to enter into mediation. Under this process the parties each attend a meeting at which an independent mediator acts as a travelling diplomat, going between the parties, seeking to identify the key drivers to the dispute and encouraging the parties to explore alternative propositions in order to reach a compromise. The process is quicker and cheaper than litigation and can lead to negotiated outcomes which could not be achieved in court.