Skewing Balanced Considerations in Franchising

I think I can see the beginning of a trend in franchise law for the purpose of enabling courts to deal with the worst influences in the industry. Unfortunately, if the trend continues, the way in which the law will change will adversely affect ethical franchisors that don’t deserve this.

For at least a dozen years the industry has watched while unscrupulous opportunists fleece franchise investors by aggressive misrepresentation of performance capabilities of their business models. This goes way beyond simply saying that franchises with little or no operating histories are “proven concepts”. It includes fabrication of spurious pro forma financial information, dodges like giving the information to SBA loan brokers instead of to the franchise investor and pretending it was not a representation to the franchise investor, and false claims that working with the franchisor represents savings in start up costs when after the fact it always becomes known that the opposite was the truth. The practices also include steering prospect to shill franchisees that are paid to provide endorsements and dodges far beyond what is stated here to illustrate the point.

The franchise industry does not police itself. The worst scoundrels are happily accepted into the IFA and display its Code of Ethics in all their adverts. They are also from time to time elected to officership in the IFA and rewarded with imprimatur that furthers the success of their scams. But the franchise industry is not the only one that does not police itself, so that isn’t seen as a big deal.

Prophylactics are inserted into franchise agreements and closing documents on franchise sales. The combination of merger clauses, acknowledgment clauses, non reliance clauses and the filling out of pre closing questionnaires in which franchisees acknowledge further that they were not told anything about the performance prospects of the franchise except what is contained in the FDD are believed to provide iron clad immunity from fraud and misrepresentation claims. Franchise investment law enforcement agencies have no budget to police compliance, and prosecutors have bigger fish to fry than to chase crooked franchisors.

To be fair, franchise investors have themselves partly to blame for not availing themselves of competent pre investment due diligence that vets the deal itself in addition to the legalities of the documentation. Never having vetted a small business investment in their lives, they stupidly believe they can outwit the professionals who sell toxic franchise opportunities. They sign the pre closing questionnaires saying they were not given information that they know they were given, out of fear that if they don’t sign off on the lie they might not be allowed to buy the franchise. This represents a level of stupidity that defies belief, but it is an everyday occurrence.

Most of these situations never enter the court system because crooked franchisors usually insert arbitration clauses into their contracts. Arbitration awards are almost never appealable, even if the arbitrator made an award contrary to applicable law. As of today, there is a case on the way to the Supreme Court in which the issue is whether there even are grounds for vacating arbitral awards for manifest disregard of applicable law. Some of them are finding their way into the courts, however, and these are the vehicles I see as harbingers of a potential sea change with regard to an important issue to all franchisors.

Up to now, courts have regarded franchise agreements as just another genre of commercial agreement with ordinary commercial agreement duties. Many have attempted to obtain rulings that there are implied covenants of good faith and fair dealing, and many have asked Congress for statutory confirmation of those extra fiduciary level obligations. All have failed, and for what has been perceived to be good reason.

Now, however, I see some judges wishing they had the latitude to impose fiduciary level responsibility on franchisors due to the egregious nature of the conduct the court is dealing with. The combination of franchise investment fraud and franchisor abuse during the franchise relationship is causing expressions of judicial outrage, and that is the kind of energy that leads to changes in the case law. If abuse and fraud remain unchecked, the industry can look to judges trying to find ways to correct the situation.

This is not what anyone wants, because implying obligations specifically targeted at franchising will place ethical franchisors at significant disadvantages in disputes where they clearly ought to be able to rely upon well drafted agreements for protection.

In the face of pre investment and relationship abuse, courts may be expected to look for “equitable” rationales that erode integration/merger clauses and the other barriers to dubious claims.

Courts will also look for ways to find implied duties for franchisors to consider the impact upon franchisee financial viability before adopting marketing programs, pursuing acquisitions, changing population density of their franchises, and a host of other regularly considered actions that as of today are not thought of as potentially actionable. The absence of impact studies has already been considered as evidence in encroachment cases. That makes it easier for doctrines of prior impact analysis to be adopted across a broad spectrum of conduct. The establishment of competently managed independent franchisee associations will take up the slack where government regulation has left a vacuum, and the presumed perquisites of system ownership will become significantly diluted.

I expect to see this over a period of about the next ten years if the situation is not corrected from within the industry. I think of it as whacking the golden goose, something people do all the time, much to the benefit of lawyers and the detriment of clients. Sarcastically I suppose I should be grateful that excesses go unchallenged within the industry. Lawyers need to make a living too, right? Seriously, the cost to investors is now so substantial and fatal that the invitation to correction is compelling.

Franchisors with integrity need to take the lead here. The unscrupulous are not only setting you up for a potential failure of legal protection, they are also taking franchise sales from you. People who could have invested in your franchises are being taken – literally – by scoundrels.

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Comments

Skewing Considerations

There are additional aspects that I would suggest are worthy of thought here.  Looking past the rogue franchisors for 2 seconds [make that 1], the failure to maintain the protection of quality franchisors attacks not only the value of all franchisor investments but in doing so it therefore attacks the value for all franchisee investments. 

This is such a complex, catch 22, rock and a hard place, pain in the ass topic to come to terms with. On one hand I appreciate the burning at the judicial stake of those that destroy franchisees’ lives but on the other hand there is a great danger to everyone in franchising when the imbalance swings the other way.  Don’t get me wrong; I am all for some corrective burning at this point in time while the industry ignores the operation of rogues and as Richard points out; the industry is also ignoring the dangers of ignoring the rogues. 

I am convinced that the outrage Richard speaks of will swell unless the industry gets off its fat [GM type] ass.  Public outrage will flow to the judicial level and so it should based on the behaviours that are currently tolerated.  I am convinced that franchisor lobbyists cannot overcome the influence that the internet will have on the industry and that outrage that will grow if abuses are left unchecked.  It will be damaging for all participants including the associated businesses that feed from the industry such as brokers etc.  Litigators will be the only winner.  Public benefit from franchising will suffer.

Getting quality franchisors to protect their butts by ‘outing’ the rogues and demanding that the industry police the germs seems to align with similar efforts to get franchisees off their lazy butts to protect their investments.   

One suggestion is for franchisors to promote and protect the reputation and the future of a healthy industry [and you will laugh] is to actively and openly join with their IndFAs and promote the collaborative relationship that makes their IndFAs such assets to all parties to franchising. 

Recognise the problems that will face the industry and utilize the independent relationship. The suggestion I refer to here is simply this: that the industry promote that the only franchises buyers should consider are those where an IndFA exists. A concerted and strategic industry promotion of the relationship between franchisors and IndFAs sends a warning message to existing systems where there are no IndFAs adding value to those franchises.  IndFAs have the ability to police damaging behaviour and flex some muscle and recognise that the brand value only holds while the franchisor has protection.

Quality franchisors need to get off their fearful, lazy, stupid butts to consider that their representative associations are doing nothing that will be effective in the long term to protect franchising from the outrage. It should all start with franchisors questioning the performance and naivety of their representative bodies.   In the mean time; let the judges be rightfully outraged and set some examples.  Let franchisors wake up to headlines that impact and they say .... ‘Holy Siht!’ … burn the bastards.

Some good points

I agree about requiring an IndFranAssn as a precondition to investment, but you have to go beyond that and vet the IndAssn too. What has it done? What have been its programs/agendas? How effective has it been? Is it professional or just obstructionist? There is more.

Good franchisors aren't lazy or stupid. They have a lot on their plate, certainly in these times. Worrying about ultimate issues of good and bad are very low priority issues for almost everyone until it is too late - sadly. It's the same with everything, not just franchising. We only respond to disasters. Here in the USA, for example, we only fix bridges that have already collapsed and killed some folks, while thousands of bridges and dams are way past their useful life and go unattended to. Texas ranks highest in teenage pregnancies and we still don't allow birth control to be taught in schools on the grounds that it will encourage "fornication" (favorite word of the ultra religious). So don't expect the industry to do anything.

I raised that point only to illustrae that the problem is pervasive and deserves attention. If it gets attention at all, it will only (in reality) come from Independent Franchisee Associations. Mike Webster has a great future promoting the formation of those associations, and I am happy to have rich friends with good future prospects. Maybe one day he and I can team up in a good cop - bad cop scenario in which people flock to him because they don't want me gnawing at their entrails. He can use me as his disease prevention poster child. 

Contracts are not likely to get softer on the issue of franchisor prerogatives. With a good franchisor tough contracts do no harm. But people need to hire lawyers who can explain to them that every franchise agreement really says "You are entitled to whatever I may feel like providing; subject to whatever I may feel like reserving and limiting for my own benefit; and if you don't like it that way it's just tough rocks." Mike doesn't agree with that, but the law limitations of franchise relationships are only available for those who can provide very generous litigation budgets - which makes them functionally unavailable to almost everybody.

No rights are self executing. If you don't defend your turf you don't have any turf. That indisputable truth is the single most misunderstood rule of franchising. Like I have always said, wolves eat sheep.

"You are entitled to whatever

"You are entitled to whatever I may feel like providing; subject to whatever I may feel like reserving and limiting for my own benefit; and if you don't like it that way it's just tough rocks."

THIS IS THE PROBLEM.  The issue is the one sided agreement,  the lack of balance in the contract itself.  That is what needs to be changed.  And good or bad they all have the same boiler plate. 

I am beginning to think the problem is Franchising as a whole.  The whole concept itself.  It is legal rape.

The contracts are NOT going to change, no matter what you

may think or want.

That is why vetting the deal is more important than "reading the contract and the FDD". People seeking fair contracts - whatever those might be - are kidding themselves. No contract, no matter what it may say, will ever be a fair contract if the deal is bad. Pre investment due diligence needs to focus on deal due diligence more than contract due diligence. The contracts say the same thing in every important area, from franchise to franchise. It is the deal that makes or breaks you.

WHEN ARE Y'ALL GONNA GET THIS THROUGH YOUR HEADS?

Explain "Vetting the Deal"

Explain "Vetting the Deal"

Vet the deal

Get FRANCHISING experts to review the contract, check the financial performance of the franchisor, what is in the franchisor’s background that gives you confidence, how does the franchisor generate revenue, does the concept offer longevity, will the cost justify the return within the term of the contract for the particular individual franchise, what is the term of the lease and does that period and cost align with a potential to be successful, has franchisor initiatives [changes to the Ops Manual] historically provided a positive for franchisees, is there anything in the local market that will help or hinder, what are the franchisee complaints, do you get what you pay for, is there an IndFA, is it an industry where available staffing is a problem, etc  etc etc. 

Be satisfied with every aspect you are about to gamble everything on including what you bring to the table; can you manage a positive workplace culture to create customer focus, will you need your hand held forever, do you understand what compliance to the system is or are you a cowboy etc.  Then consider whether there is a likelihood that the franchisor will sell.

Read BMM.  Research franchising and then your franchise of choice.  Keep an open mind but be sceptical and don’t trust anyone without absolute reason.

If you have to ask about vetting then either don’t sign or, don’t sign until you have someone who knows how complex due diligence should be to investigate the franchise and the business for you.  Understand the true level of risk; get satisfactory answers or be prepared to walk. Start by vetting your advisors.

Vetting the deal that can destroy or build on your life is to investigate seriously and thoroughly and not be taken in by your excitement and the ‘dream’. 

Vets dealing

Guest wrote:

Explain "Vetting the Deal"

Here are some Vets Dealing:

to vet the deal

You take that puppy to the vet and maike sure it has all its shots.

See now here's a problemo.  People say they want to "own their own business", but then want it treated like a consumer transaction if it goes sour.  "What do you mean its not a money back guarantee if not to my satisfaction?"

If you don't have enough info to properly evaluate the deal then DON'T SIGN IT.  But like most scams, people apply a self-imposed urgency to sign today to get in on the ground floor, so skip their homework.  Sure there are scammers and non-performers among the Zors.  But in so many cases the new Zee was also lazy and/or greedy (yes, that's on the Zee side too).  They were lazy not to do their homework and greedy to rush into today's hot concept on the ground floor. Tthere would not be 3-Card Monte dealers if there were no 3-Card Monte marks to play with.

Nothing inherently wrong with franchising.  We have been Zees since 1995.  That is how we make our living.

How can you Vet the Deal when

How can you Vet the Deal when the franchise agreement allows them to change the deal

You can't vet the deal. That doesn't mean the deal can't be

vetted. You hire expertise to vet deals.

How do you do that?

You get on a search engine. You search for "franchise lawyer"

You ask everyone on page one the following questions:

Do you do pre investment franchise due diligence as a major part of your practice?

Do you vet the deal as well as the legal issues?

Hire the lawyer who answers YES to both questions.

Think you can do that?

Yes daddy

Yes daddy

Not the contract, not franchising

The strength and the weakness in franchising  ... is the people in franchising. Think 'David Copperfield'.