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QSR Magazine draws lessons from the franchise tumult over the last decade of a few memorable franchisee lawsuits against franchisors.The cases it features are a small chip from the iceberg of hundreds of franchise torts that occur each year.
#1. Quiznos, Misrepresenting Material Facts: This franchisor saw a series of major lawsuits that involved thousands of franchisees. Angry owner-operators charged the franchisor with fraud and racketeering, claiming that Quiznos habitually misrepresented material facts to them. That's fancy legal speak for, “Our franchisor lies to us so it can gouge us.” The beef? Thousands of would-be franchisees allege they paid for a franchise license but essentially lost those fees when they became locked in a seemingly eternal loop of being disapproved for a store location. Franchisees also charged that the franchisor lied to them when they sold them a franchise, gouged them on hidden food costs, and churned its franchises so that they could make money on the re-sale of the franchise while the original owner lost hundreds of thousands. After years of being chased in U.S. Courts, as the company began to lose its lawsuits it decided to settle before a court verdict could be made. One settlement was valued among the highest in franchise history at $206 million. Er, that's lawyer-talk that equates to about $50 million in real cash being given out.
Lessons learned? “Prospective franchisees should examine the economics of the individual franchised unit, but should also familiarize themselves with the business model of the franchisor,” says franchise consultant Richard Adams to QSR Magazine.
Don's Translation: Now that's a tough order for you, your accountant and your lawyer. Buyers who are new to a system will need to understand not only the retail business of a store, but also the business of franchising. However it takes years of industry expertise to be familiar enough to catch the subtleties of fishy franchising practices and models. And even then many still slip by the experts.
#2. Dairy Queen, Necessity of Modernization? As the Great Recession descended on us in 2008, franchisor Dairy Queen got the big idea to have franchisees, the 6,000 mom & pop soft serve ice cream shops embedded in communities throughout America, become fast-food burger joints, called Grill and Chill. QSR Magazine reports, “The lingering tensions turned into litigation when owner associations with members in 10 states brought suit against Dairy Queen, claiming that they were being forced to accept the unproven new concept—at a cost of $275,000–$ 450,000—or lose their franchises.”
Lessons learned? “Absent that testing and successful ROI experience, franchisors should make the business decision to not try and impose such capital expenditures on their franchisees, even if their lawyers advise them they have the legal right to do so,” says franchisee attorney Michael Dady.
Don's Translation: If my franchisor's CEO one night gets the bright idea in a dream that there is fantastic business synergy between car buying and eating sandwiches, the next day he could require my sandwich shop “modernize” to become a multi-million dollar car dealership at my own expense. Apparently, there's not much to stop him except strained franchisee relationships. Aw shucks. Most franchise contracts understandably allow franchisors to require franchisees to put up money to “modernize” with the times. And "modernize" does not mean that change has to be incremental, like adding gourmet coffee drinks to a quick service restaurant that just had the usual traditional joe before. Modernizing could leverage your money for a quantum leap — from mail boxes to quick print stores, from soda shop to space station.
#3. Raving Brands, Where Are the Basics? In 2008 franchise buyers of franchisor Raving Brands cried fraud when they were sold the concepts of The Flying Biscuit Cafe and Doc Green's Gourmet Salads as established brands. They said the reality was that the conglomerate did not have a proven business model. It didn't have a comprehensive business plan. It couldn't provide adequate support to franchisees. It struggled to make its single prototype profitable. And it didn't even have a viable operating standard.
Lessons learned? Attorney Michael Dady declares, “Prospective purchasers of all franchise systems are entitled to expect that the franchisor will indeed at least ‘meet the basics’... If the purchasers of the franchise opportunity believe they have not received that, legal challenges and other stressors within the system are indeed likely.”
Don's Translation: If a company franchises a half-baked concept, it can expect lawsuits from franchisees. And attorneys can expect business. Buyers should pull the purchasing brakes if they see a franchisee lawsuit of fraud in the franchise disclosure document. Warning: Franchisor lawsuits by franchisees are supposed to be listed in the franchise disclosure document, but sometimes go mysteriously missing: after all, there is no government body that reads these disclosure documents, yet alone reads them for accuracy.
Read about more cases in the original story at QSR Magazine.