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Franchise disputes – The reasons they occur and how to avoid or resolve them.

Updated: May 16, 2023


Resolving franchise disputes

Conflict and franchise disputes can be a problem in relationships between franchisees and franchisors.


This is hardly surprising because business partnerships are often fraught with difficulties and a franchise is, in many respects, a partnership. The most common areas of dispute are:-


  • Misrepresentation by the franchisor during the recruitment process.

  • Lack of training.

  • The franchisee comfort zone.

  • Social media and fake news.

  • Under-declaration of fees.

  • Poor management of the franchise by the franchisor.

  • A takeover of the franchisor by a multi-brand franchisor or venture capital.

  • Failure by the franchisee to comply with post-termination restrictions.

  • Errors in the defining of territories.


Misrepresentation by the franchisor


This falls into two different areas; untrue statements made by franchisors during the recruitment process and, very importantly, what they fail to disclose. Exaggerated profit forecasts are often protected by caveats such as ‘up to’ and ‘potential’ earnings. Small print is often used. Disclaimers such as: ‘projections are merely indicative’ and ‘profit forecasts cannot be guaranteed’, are all too easy to disregard by a prospective franchisee who is faced with a seductive and well-designed franchise prospectus.


Franchisors often don’t mention how many franchisees have failed, gone out of business, or been terminated. They have been known to hide the fact that the proposed territory has previously been occupied by a franchisee who has left or gone out of business.


Franchise agreements nearly always contain an ‘entire agreement’ clause. Typical wording states that the only representations on which the parties can rely are those that are annexed to the agreement and initialled by the signatories. This means that, in theory at least, a franchisor cannot be held responsible for making a misrepresentation unless the franchisee is sufficiently astute to have it included in the franchise agreement. Prospective franchisees are strongly advised to take independent advice from a solicitor who specialises in the franchise industry.


Lack of training.


This needs little explanation, but it also falls into two areas; the initial training, to enable the franchisee to commence trading, and the ongoing training during the term of the franchise. Poor training leads to inconsistency in the quality of the service for the end user. This can lead to dissatisfaction and unrest in the franchisee network which increases the risk of disputes.


The franchisee comfort zone.


This can occur when the initial expectation of both the franchisee and the franchisor is that they will work together to grow a much larger business. The problem manifests itself when the franchisee reaches a point at which their personal work-life balance has been achieved. The franchisee then loses the hunger for growth and settles into a happy state of equilibrium. This is obviously unsatisfactory for the franchisor. The situation can be overcome by the franchisor refusing to renew at the expiration of the franchise period but that itself can lead to a dispute. The only way to reduce the likelihood of encountering this problem is for the franchisor to have very rigerous recruitment criteria and only select applicants who fully commit at the outset to continually growing their business. Once operational the franchisor should continually motivate, train and reward continued expansion by the franchisee. Experience tells us that this is easier said than done. Realistic but growth orientated minimum performance levels will reduce the possibility of a challenge being made to a decision not to renew at the end of the term of the franchise agreement.


Social media and fake news.


This is an extremely complex subject which is encountered everywhere in daily life. At one end of the franchising spectrum, it manifests itself in secret WhatsApp groups of increasingly disgruntled franchisees. At the other it can lead to full blown class actions. With no right to reply or without even the ability to understand the problem and resolve it, the franchisor is seriously disadvantaged. Both sides of the relationship then suffer and disputes often ensue.

Under-declaration of fees.


This is self-explanatory, If allowed to go unchecked it can seriously damage the network of franchisees. Robust systems and a tight accounting culture are the best ways to minimise the problem. Even then, this is a common cause of dispute.


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Poor management of the franchise by the franchisor.


Disputes are inevitable when bad management leads to poor morale, lack of communication and mistrust. It is important that franchisees feel that they are valued stakeholders and are confident that they are all treated equally.


A takeover of the franchisor, especially by a multi-brand franchisor or venture capital.


This has happened so may times that one would think that the takeover party would be able to anticipate and avoid the problem. But they often don’t.

The reality of the sale of a franchised business is that the franchisees are not consulted and will only be informed after the sale has taken place. If this is not handled with great care they can feel betrayed by the previous owner who, up until now, has always appeared to be open and transparent. The previous owner has probably received a huge payout while the franchisees are left to carry on with the daily grind of running their branches.


The new owners are unlikely to have the same management style and in order to see as fast a return on their investment as possible, they will probably be more results orientated. Minimum performance levels that were previously not strictly applied are now widely used. Breach notices are issued. Top management may now be far-removed, adding to a deterioration in morale. Disputes erupt.


Failure by the franchisee to comply with post-termination restrictions.


Over the years this has been one of the most common causes of franchise disputes. Much case-law exists on the subject; most of which confirms that if the restriction is fair and reasonable it will be upheld by the courts. This is obviously at odds with the commonly held, but mistaken, belief that nobody can prevent someone from earning a living.

The purpose of a post termination restriction is to allow the franchisor to find a replacement franchisee and allow them to establish their business free from competition from the outgoing franchisee. If the ex-franchisee decides to ignore the restriction and continue to trade, possibly with a new limited company or a shadow owner, litigation is almost inevitable. As stated above, franchisors nearly always win.


Errors with defining territories.


Post codes are the most widely used method for defining franchise territories, but they can be complicated. Royal Mail who issue the codes, occasionally adjust them as new housing is developed. This is all too easy to overlook. To make matter worse, the codes seldom follow natural boundaries such as rivers, roads and railways. Great care must be taken by the franchisor to ensure that codes are not duplicated in different franchise agreements. Errors can remain undetected for long periods which adds to the seriousness by increasing the financial implications.


Other than misrepresentation, each of the reasons identified above is a variation on the common problem of a breakdown of the relationship between the franchisor and the franchisee. If both continually make an effort to work harmoniously most franchise problems can be avoided.

 

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