Franchisee Compliance Due Diligence

Twenty five years ago, before automatic POS systems tracked and forwarded business information of all sorts from franchisee to franchisor; back when it was still a new thing that you could remotely poll someone’s cash register; and field auditors wandered the earth dropping in on franchisees to look at their books to assure that there was no under reporting of sales and under payment of royalties; and some franchisees kept two sets of books and you couldn’t tell which was which without looking at bank statements, personal tax returns and canceled checks; and so on and so forth, the world was a happier place – and if not happier, at least different.

In the interim, franchise agreements became much stricter in providing for franchisor options. Business information management technology exponentialized in its ability to “report”. What was always thought of as an inherent abrasive interface between a franchisor and its franchisees became a hostile divide. Franchisees who previously believed they had been provided everything worth paying for in the first twelve months and spent the rest of their term looking for a way out, now frequently don’t last for much more than twelve months as franchise offerings have become more and more just make believe, hype driven guaranteed failure. The fraud issues in franchising became the front page, and the relationship opportunism issues, with few exceptions, took a back seat. The antitrust law view of sole source requirements, formerly known as illegal tying, became lawful with the Chicago school analysis of the Jefferson Parish case. Since then, all you have to do is disclose up front that that is how it is going to be, and you’re home free, legally at least.

The franchisee view of the real worth of franchise relationships is now so negative that vicious public name calling is a daily occurrence on sites such as Blue MauMau. If you visit that franchise blog site, you will encounter threads about Quiznos and Dunkin Donuts that would make Alan Ginsberg and Lenny Bruce blush.

The Quiznos issues are not the subject of this article. The Dunkin Donuts issues present us with a different dynamic – one in which franchisees go on the Internet, use anonymous names, and openly discuss their beliefs that cheating is now the only effective way to deal with franchisor abuses. That is hard to do in today’s high tech world. It is nonetheless the same fraudulent conduct that it was in the good old days when accountants wore green eyeshades and pocket protectors.

The Dunkin Donuts situation represents a good opportunity as a case study in what not to do. As a caveat, the postings on Blue Mau Mau have not been vetted for truthfulness. From what has been said, you can’t tell if exaggeration or worse is afoot. Some of the lawyers who regularly post on Blue Mau Mau have asked for corroboration of the accusations, but none has been forthcoming.

There are also some inconsistencies in the franchisee stories. Illustratively, while complaining that their franchisor is conducting goon squad raids in attempts to rid the system of selected franchisees – supposedly only the “Mom & Pop” operators – one of the posting franchisees says that his trouble is unfair because is came in the midst of his trying to buy more franchises, including some locations that were owned by a Mom& Pop that was being terminated. The question raised is, why would anyone in that environment want to get in even more deeply? From this alone, questions about the reliability of the franchisee side of the story have been raised.

Notwithstanding that issue, it appears to be a factual statement that the in house lawyer for DD was allowed by the company to go give a speech at an ABA Franchise Forum meeting in which he bragged about how he busts franchisees. If that is true, as it now seems truthful, serious questions are raised about the acuity of the folks in charge at franchisor headquarters. That man should, in my opinion, be summarily discharged for unbelievably bad professional judgment regarding the company’s business.

It has always been the case in franchising that franchisor field reps/field auditors were a thuggish lot, capable of every manner of oppressive and even depraved conduct, seeking frequently to intimidate franchisees into doing what they would never do in normal circumstances to avoid stated threats to deprive them of their business by termination. That the “loss prevention” people of DD would be the same as the thugs of most franchisors over a history of many years comes as no surprise. Still, however. We must await the trial of pending cases to see whether the accusations are true.

None of this high and sordid drama detracts from the need to police the quality of reportage of business information requisite to the best mode for collecting what is due the franchisor under the franchise contract. My point is that a professional grade franchisor today will have in place competent technology to enable determination of some “probable cause” evidence before sending in a goon squad to scour every scrap of paper pertaining to a franchisee’s business. Aggressive confrontations will not occur in the franchisee’s business premises in the presence of customers. Those will be held in private, if for no other reason, because they might be based upon inadequate evidence or improper evaluation of the evidence.

The practice of conducting a review of a franchisee’s compliance prior to consenting to the purchase of additional franchises; prior to consenting to renewal of the franchise; and prior to consenting to a sale of the business is a proper procedure. Non compliant franchisees are not entitled to the privileges of agreements they have broken. The caveat here is that contract violations should have to be really material, not trivial, in order to justify consent being withheld. According to the accusation of the DD franchisees on Blue Mau Mau, that has not been the case. From what they say, it might be that DD has some agenda to reconfigure their franchisee system to eliminate small operators for reasons of assumed better management opportunities – small franchisees are a pain in the neck not justified by the amount of revenue generated by them. I personally doubt that theory, especially since DD was perfectly willing in the first instance to accept small franchisee money for many years, as a consequence of which the company and the small franchisees thrived. But now there is a new owner of DD, and new owners have near term exit strategies that they often try to enhance by ridiculous means.

One question that remains unsubstantiated in the DD case study is whether the “audited” and terminated Mom & Pop franchisees were in fact in material breach of their franchise agreements. In some instances, it appears that is true and the termination was justified.

What remains, therefore, is a cleansing of the process, unless the truth is that there really is a DD agenda to so reconfigure the franchisee population for other purposes.

Where does that leave us? It leaves us at the conclusion that DD is now a FranWhack – a franchise investment opportunity that should now be avoided. No one should risk large investments in joining troubled systems, no matter what their past performance might have been. Anyone buying a DD franchise today is simply not conducting adequate pre investment due diligence. In my opinion as a franchise counselor, this is a troubled company and a troubled system. This is not where intelligent people put their investment money.

Moreover, since it is true these days that franchisor ownership frequently changes, that change in itself raises questions about the reliability of past performance as an indicator of present tense investment worthiness. Much more astute and focused due diligence must be done before investing in the franchises of systems in which the ownership has recently changed or is about to change.

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Comments

Confusing Essay

RS: One question that remains.. .is whether the “audited” and terminated Mom & Pop franchisees were in fact in material breach of their franchise agreements. In some instances, it appears that is true and the termination was justified. - Richard

DW: Give us an example.

RS: "franchisees go on the Internet, use anonymous names, and openly discuss their beliefs that cheating is now the only effective way to deal with franchisor"

DW: Can you show us where this occured? (Hint: This is a good place for a link.)

RS: "why would anyone in that environment want to get in even more deeply? From this alone, questions about the reliability of the franchisee side of the story have been raised."

DW: I have issues with this franchise owner's story as well. However, this is not one of them. My understanding is that the franchise owner didn't realize the trouble he was in. I'm with you in that I would not personally expand franchise units if my franchisor accused one of my employees in such a rough and tumble manner to get the goods on me.

I like my employees being treated with dignity. But not everyone in this world thinks like me.

RS: It leaves us at the conclusion that DD is now a FranWhack

DW: All of a sudden there's a big jump in your argument. You seemed to be arguing that Dunkin' Brands has some good points and that the franchisees who have posted or are cited aren't quite so pure. So I didn't quite follow how you reached your stated conclusion that Dunkin' Donuts is now a FranWhack, a name given by you for a franchisor that receives your recommendation of NOT BUY / SELL.

Sorry to be such a school marm but I'm confused.

Confusing Essay

RS: One question that remains.. .is whether the “audited” and terminated Mom & Pop franchisees were in fact in material breach of their franchise agreements. In some instances, it appears that is true and the termination was justified. - Richard

DW: Give us an example.

RS: "franchisees go on the Internet, use anonymous names, and openly discuss their beliefs that cheating is now the only effective way to deal with franchisor"

DW: Can you show us where this occured? (Hint: This is a good place for a link.)

RS: "why would anyone in that environment want to get in even more deeply? From this alone, questions about the reliability of the franchisee side of the story have been raised."

DW: I have issues with this franchise owner's story as well. However, this is not one of them. My understanding is that the franchise owner didn't realize the trouble he was in. I'm with you in that I would not personally expand franchise units if my franchisor accused one of my employees in such a rough and tumble manner to get the goods on me.

I like my employees being treated with dignity. But not everyone in this world thinks like me.

RS: It leaves us at the conclusion that DD is now a FranWhack

DW: All of a sudden there's a big jump in your argument. You seemed to be arguing that Dunkin' Brands has some good points and that the franchisees who have posted or are cited aren't quite so pure. So I didn't quite follow how you reached your stated conclusion that Dunkin' Donuts is now a FranWhack, a name given by you for a franchisor that receives your recommendation of NOT BUY / SELL.

Sorry to be such a school marm but I'm confused.

Good points, Darnelle

The answer to the first question about franchisee actually  bgeing caught in violation of the agreemrnt is the Cindy Gluck situation in which she purported to transfer an ownership interest in her franchise without first obtaining franchisor consent.

The line(s) about cheating being an acceptable reply to DD oppression occurred in the thread of DD discussions on BMM a few weeks ago

FranWhack is not an argument. That is what I would advise anyone who asked mne about investing in a DD franchise at this time. It isn't a leap because right now we have no idea where all this is going. That isn't leaping, it's recognition of exceptional risk. I evaluate risk based in part upon changes in the way a franchise system decides to run its governance protocols. As that seems to me to be a big issue now in DD, where is wasn't before ownership changed, and since ownership is no longer a franchisor but a speculator looking to flip the system, the increased riskiness makes it a FranWhack--

Richard Solomon, FranchiseRemedies.com,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

Fact and speculation

"ownership is no longer a franchisor but a speculator looking to flip the system"

What makes you say that? Can you provide evidence?

Bain Capital is a packager of properties for speculation and

flipping over to public suckers in an IPO. These companies may own franchisors for a while, but they aren't in it to be franchisors.--

Richard Solomon, FranchiseRemedies.com,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

Gluck Violation Yet Unknown

RS: "The answer... is the Cindy Gluck situation in which she purported to transfer an ownership interest in her franchise without first obtaining franchisor consent."

I remember Ms. Sparks reporting Dunkin's accusation that Ms. Gluck had transferred ownership. But didn't Ms. Gluck deny that?

As I recall from the news stories, it is a he-said, she-said stand-off when it comes to franchisee violations. Do you have any specific quotes or links to resources that say otherwise?

I wonder what the legal records will say about the transfer of ownership? The courts should be able to answer that question very easily - either Gluck transfered ownership or didn't. No guess work needed on whether she violated the franchise agreement.

Gluck Violation Yet Unknown

RS: "The answer... is the Cindy Gluck situation in which she purported to transfer an ownership interest in her franchise without first obtaining franchisor consent."

I remember Ms. Sparks reporting Dunkin's accusation that Ms. Gluck had transferred ownership. But didn't Ms. Gluck deny that?

As I recall from the news stories, it is a he-said, she-said stand-off when it comes to franchisee violations. Do you have any specific quotes or links to resources that say otherwise?

I wonder what the legal records will say about the transfer of ownership? The courts should be able to answer that question very easily - either Gluck transfered ownership or didn't. No guess work needed on whether she violated the franchise agreement.

My recollection of the threrad of the subject is that her

position was that she did it to reward a loyal employee. But I have not catalogued the references. And you are correct that in the final analysis it will be a court that answers the questions in the absence of private resolution.

I'm not here to be the judge of the fact patterns, only look at the situation as it appears from the entirety of the postings and try to decide the apparent riskiness of making a franchise investment in the teeth of this kind of storm.

I see bad conduct on both sides from what has been posted, and I make my assessments from that.

Is it an exact science? No. Pre investment vetting isn't an exact science. It is the process of looking for risk issues. Instability is one of my major risk issues. For instance, if what the franchisees are saying is partially true, what would I say to an investor looking at the prospect of purchasing the DD franchise rights to the Houston market? In addition to the other risk factors, how would I feel about the riskiness of committing to a 20 - 40 store market  when the franchisees claim that termination campaigns are motivated by some system configuration agenda? Moreover, since the Houston market development would probably include sub franchising in addition to investor developed stores, how would the disclosure liability risks look to me during times of extreme turmoil?

Can I just assume that all the franchisees are lying through their teeth in furtherance of some agenda of their own? --

Richard Solomon, FranchiseRemedies.com,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

Judging on Facts

RS: "I'm not here to be the judge of the fact patterns"

DW: If you are not then can you point me to who is?

RS: "she did it to reward a loyal employee"

DW: My recollection from the articles here and comments of those close to the situation was that Gluck brought up the subject with a Dunkin' rep because she wanted to find a way to reward a manager and give them a sense of ownership. According to her, Dunkin' then terminated her.

I also recall Dunkin's spokesperson saying that they had records that Gluck actually transferred her company to the employee without corporate approval. However, no one has shown any evidence of ownership.

Judging on Facts

RS: "I'm not here to be the judge of the fact patterns"

DW: If you are not then can you point me to who is?

RS: "she did it to reward a loyal employee"

DW: My recollection from the articles here and comments of those close to the situation was that Gluck brought up the subject with a Dunkin' rep because she wanted to find a way to reward a manager and give them a sense of ownership. According to her, Dunkin' then terminated her.

I also recall Dunkin's spokesperson saying that they had records that Gluck actually transferred her company to the employee without corporate approval. However, no one has shown any evidence of ownership.

Complaint

I have the DD complaint downloaded on the Gluck case and it appears that they are contending two things.  First, is that a transfer of interest happened in the corp some time after the first store opened and before the second one opened.  Second, when the second franchise agreement was signed, Gluck and her partner stated that they were the only owners of the company, when in fact 15% interest had been transferred to two employees of the first store.  So, they are claiming that when the franchise agreement was signed they did so knowing that they hadn't disclosed these facts to DD.

 

The judge of the facts is the court/arbitrator or

if the franchisee pays up the reinstatement demand, that will be the fact determinator for all practical purposes. I doubt that I will know the ultimate facts by that time, or care for that matter.

Knowing the exact facts is not the same as knowing the risks.--

Richard Solomon, FranchiseRemedies.com,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

POS and Compliance

Charlie Munger praised the introduction of the cash register as one of the most important fraud prevention devices.

And so is the modern POS system.

Richard writes: "None of this high and sordid drama detracts from the need to police the quality of reportage of business information requisite to the best mode for collecting what is due the franchisor under the franchise contract."

The negotiating problem is that the franchisor has a legitimate reporting interest, but the franchisees have legitimate interest in the compilation of the data, appropriately cleansed of personal data, being sent to individual franchisees.

What stands in the way of a Coasian deal is that the FTC's stance on earnings claims.

The data would give rise to an earnings claim, and so the franchisor uselessly hoards it.  Instead of selling it to the franchisee association for a reasonable fee. 

Michael Webster PhD LLBFranchise News

There are ways to deal with that if the assn has resources to

collect and anonymise (through third party resource) the information provided to the franchisor.--

Richard Solomon, FranchiseRemedies.com,  has over 45 years experience with franchise litigation and crisis management. He is a graduate of The Citadel and The University of Michigan Law School

Agree

But they need to have pitch to their members as to the value of this information. 

Michael Webster PhD LLBFranchise News