What to do about Franchisee Litigation

By Michael Seid, Managing Director, MSA Worldwide

Seemingly every article about franchisee litigation opens with the author spending time on how you should find ways to avoid it. I wrote that column some months back in Franchise Times, and it is worth re-reading as a prescriptive way to foster good franchise relations.

Sometimes litigation is unavoidable in a franchise system. Sometimes it is even necessary and, depending on the issues, even beneficial. Sometimes the issues are so important to the franchise system that even working through a compromise – while it might make for a good litigation strategy – would make for a bad business decision and really should never be considered as an option.

Preserving the Integrity of Your Brand

Barry Heller, a partner with DLA Piper in Reston, Virginia, is one of the top litigators in franchising. When discussing which issues are difficult for a franchisor to compromise on, Barry’s position is that you “create a serious risk to your brand when you compromise on issues that threaten the integrity of your brand or the system, such as trademark usage, sale of unapproved products or services, or violation of system standards. Compromising on these could have broader implications than merely the one case in which the compromise occurs.” However, he reminds us that there is nothing inappropriate about making changes to system standards if the franchisor decides, after further consideration, that such changes would benefit the brand and the system. Making that decision, he notes, is a business decision – not a legal one.

Contrary to many articles you read about working through franchisee disputes, litigation can sometimes be a tool which management needs to use in settling disputes. Clearly though, where other options are available, they need to be explored. But many settlements have unexpected consequences on the future of how the franchisor manages the business, and those can have devastating results on both the franchisor and the franchisee.

Arbitration, for many years, was something that many lawyers recommended should be included in the franchise agreements. The reasons often given were the speed and the lower costs (two things that really don’t exist today). Franchisors were willing to tolerate a decision by the arbitrator that for the most part could not be appealed, because the degree of risk was felt to be lower since the arbitration was between the franchisor and a franchisee and not among a class or group of franchisees, among other legal benefits.

Reduced Use of Arbitration

Today, there seems to be a movement away from including arbitration as a forum for dealing with disputes, and one of the reasons often mentioned is the possibility of group actions being allowed in arbitration. Group actions have come about again because of some court cases, rule changes at AAA and Jams, and also because many franchisee litigators are directly or indirectly recruiting clients to join together to share the costs and also to strengthen the appearance of their cases. With the recent attempts to create group actions in arbitrations, including the recent decision involving Entrepreneur Source, many franchisors are likely going to rethink if there are any real benefits at all left in arbitration. Many of MSA’s clients that included arbitration in their franchise agreements are currently rethinking that today.

If you ask most franchisor lawyers, group actions do not change the issues, but may actually change the way the case is managed. According to Arthur Pressman, a partner and trial lawyer with Nixon Peabody in Boston, “group actions offer franchisors more procedural options to defend a case.” In doing so the plaintiff’s momentum is often slowed while the court or a panel of arbitrators wrestles with the procedural challenges. “This may play into the franchisor’s strengths,” says Pressman, “because often, but not always, it is the franchisor who is better suited financially to withstand a lengthy litigation.”

Cost of Franchisee Litigation

Cost is always an issue in litigation, and most clients ask their trial lawyers early in the process “How much will this cost? How long will this take?” And, “What will be the impact on the franchise system?” Even in the best of situations, it is difficult for any lawyer to provide a definitive answer to these questions, and therefore options should be used to work through other business channels, even while the litigation is proceeding.

When MSA Worldwide works with a client as part of its litigation strategy team, our role is generally to facilitate business discussions that look at ways to preserve the value of the franchise system, and keep the business relationship between the franchisor and the litigating franchisee on a separate track. Often, this requires working to find creative solutions that may not be apparent to the litigation team. As business advisors, we work with business or settlement counsel in tandem with the litigation team. It is always important to look for solutions even when the underlying issues driving the litigation can’t be compromised.

Most people look at the concept of compromise in litigation in terms of splitting the baby, and most litigators can readily identify the sacred cows of the relationship – the marks, trade secrets, and system standards, to name a few. Once these issues are implicated, many litigators will essentially resolve to try the case and in most cases commence making the procedural arguments that consume so much in attorneys’ fees.

According to Lane Fisher, a partner, Fisher Zucker in Philadelphia, “In our experience, the franchisor generally has two goals: (1) to protect the revenue stream; and (2) avoid setting bad precedents in the system. Any business solution should attempt to maintain the unit. Once the unit is identified, or closed, the only possible means of settlement is purely economic. “

Franchisors and franchisees should look for a peaceful means to end the relationship, whenever possible. By acting early when the unit’s value and goodwill are still intact, if the parties can agree to a resale, using their collective efforts, they can resolve their dispute and create a dignified exit from the system.

Settlement discussions which require compromises are not always an option. However, how franchisors react to the threat of litigation, and how they manage through the issues during the litigation, is essential not only to a positive legal outcome but more importantly, how they manage their franchise systems going forward. In making a decision about litigation you need to include:

• What are the underlying issues that are being discussed?
• Are they issues that lend themselves to compromise?
• What other options are available in ending the dispute other than dealing with the core issues directly?
• What would be the impact of a settlement on other franchisees that may have similar claims?
• What is the financial or other exposure from admitting liability to these plaintiffs or other similarly situated plaintiffs?
• What is the likely cost of the litigation? This includes not simply the legal fees. If you are confident in your case, those may be damages you can collect, depending on your contract. Talk to your lawyer about those costs. The real cost in litigation is the impact on the rest of the franchise system including the other franchisees. Litigation costs need to be measured in the time and loss of focus of management on other more important business and growth issues.

The Business Leaders Make the Decisions

In managing your litigation, the most important thing to remember is that it is the role of the business leaders to make the decisions about the conduct of the litigation after conferring with legal counsel. Winning a case at the cost of the franchise system is not an acceptable outcome. However, settling a case that compromises the integrity of the system or your ability to manage it or grow it is also not an acceptable outcome.

When the process is all over, the litigants may likely still be your franchisees, and you need to have a way back to a positive relationship. You also need to manage the process so that it has as little negative impact on your other franchisees and potential franchisees.

Bring together your litigation team to work through the strategy and understand the business and legal issues and risks. Determine whether there are any issues that can be compromised or settled. Are there ways to assist the franchisee to exit the business or come to another resolution that does not impact those issues that can’t be modified? Determine the costs, in time, money and manpower, and who will be responsible for the conduct of the process internally. Let the lawyers do what they do best, but not without guidance and input from the litigation team that will expect updates regularly on the case from the trial lawyers.

Litigation is stressful, costly and often nasty. It is something that needs to be managed for the benefit of the franchise system.