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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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About RichardSolomon

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I am a lawyer whose practice focuses on franchise matters,antitrust issues and crisis counselling - bet the company situations. My practice information may be found at FranchiseRemedies.com. I have now been doing this for over 49 years, My focus in dealing with conflict resolution is to get into it as early as possible, when the client first suspects it may be coming, and head it off. The avoidance of conflict is just about always the least costly and the least injurious way to deal with it.

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Buying a Franchise