Many franchisees enter into contract agreements with franchisors under the impression that they need no experience because the franchisor will provide a brand and framework from which success can be derived, but in fact there are no such agreements between the two parties. Franchise law is largely a matter of contract law, and when franchisors write the contracts it often leaves very little room for argument on the side of the franchisee if the franchisor proves to be incompetent in the care they afford their investors. That is why many experts argue competence among franchisors should be the law, the same as it is for doctors, lawyers and many other professionals. For more on this continue reading the following article from Blue MauMau.
One would think that franchisors should owe a duty of competency to their franchisees. After all, franchises are sold on the very idea that their franchise system excels in its particular business. In Franchising for Dummies, none other than Dave Thomas, the late founder of Wendy’s, wrote that a franchise business includes not only "a nationally known brand name" but also "a proven and successful way of doing business." For this reason franchises are often touted to prospective franchisees as no experience needed. Many franchisees acquire their franchise businesses with not only no industry experience but also with having never previously operated a business.
Limits of Franchise Contracts
The International Franchise Association website sells advantages of franchising including:
"Owning a franchise allows you to go into business for yourself, but not by yourself. … A franchise increases your chances of business success because you are associating with proven products and methods."
FranNet, a company providing franchise selection assistance, promulgates franchising on its website this way:
"Franchise businesses provide a number of benefits over traditional business opportunities such as training, start-up assistance, marketing programs, tested operating systems, and continued support."
Here is one of many franchisor Internet advertisements, this one by Sharkey’s Cuts for Kids, stressing no experience needed:
"No experience necessary, we’ve got all you need! Take control of your future with a proven business and turn your dreams into reality with Sharkey’s Cuts for Kids. … Sharley’s Cuts for Kids brilliant formula for success is all about multiple sources of revenue that flow through our shops daily (haircuts, birthday parties, merchandise, and lots more."
Here is a franchise agreement recital about the franchise system:
"The distinguishing characteristics of the System include a unique, specially developed concept which provides the services and products set forth above; a specially designed method for offering and marketing such services and products by the Franchisee to the customer; operating, instructional and teaching procedures; methods and techniques for financial controls, record keeping, accounting and reporting, sales and sales promotion, marketing and advertising; and the proprietary know how developed by the Company and any part of which System, services and products may be further developed, improved, changed and modified by the Company from time to time." – Young Rembrants Franchise Agreement, Para. 1.2 (2011 FDD).
Here is a franchise agreement provision requiring the franchisee to follow the franchisor’s changing manuals, policies and procedures or face default and termination:
"The Franchisee hereby acknowledges receipt and loan of a copy of the Company’s Franchise Operations Manual, and shall faithfully, completely and continuously perform, fulfill, observe and follow all instructions, requirements, standards, specifications, systems and procedures contained therein; including, those dealing with the selection, purchase, storage, preparation, packaging, service and sale (including menu content and presentation) of all food and beverage products, and the maintenance and repair of Restaurant buildings, grounds, furnishings, fixtures, and equipment, as well as those relating to employee uniforms and dress, accounting, bookkeeping, record retention and other business systems, procedures and operations. By this reference, the Company’s Franchise Operations Manual, as presently constituted and as it may hereafter be amended and supplemented by the Company from time to time (the "Manual") is incorporated in and made part of this Agreement. The Franchisee acknowledges that the materials contained in the Manual are integral, necessary and material elements of the System.
The Company shall have the right at any time and from time to time, in the good faith exercise of its reasonable business judgment, consistent with the overall best interests of Restaurants generally, to revise, amend, delete from and add to the System and the material contained in the Manual. The Franchisee shall promptly comply with all such revisions, amendments, deletions and additions. – Taco Bell Franchise Agreement, Paras. 3.2 and 3.3 (2009 FDD).
Professor Gillian Hadfield in her seminal article, Problematic Relations: Franchising and the Law of Incomplete Contracts, 42 Stanford Law Review 927, 945 (1990) cited the McDonald’s franchise agreement:
In contrast, the contract left the franchisor’s duties relatively undefined, a difficult-to-quantify duty to "advise and consult." Thus the franchisee paid fees for a service that the service-provider retained full discretion to define in content and duration. In the McDonald’s contract, as in many franchise contracts, the contract frames franchisor obligations in terms such as "reasonable," "periodic," and "from time to time." The franchisor had no contractual duty to employ prudence or consideration in the making of decisions that directly affect the profitability of the franchisee.
One can search a long and fruitless time for court decisions recognizing a duty of competency from franchisors to franchisees. Yet a duty of competency through due care is deeply engrained in our legal system. Architects, doctors, engineers, and lawyers are uniformly required by courts to exercise due care in their actions with their clients. Thus, for example, doctors must exercise "that reasonable degree of skill, knowledge and care ordinarily possessed and exercised by members of the medical profession . . ." Mann v. Cracchiolo, 38 Cal.3d 18, 36, 210 Cal.Rptr. 762 (1985). When we drive our cars all of us are required under the law to exercise due care. Why not a duty of due care in franchising? In other words, the franchise system, its required procedures and regulations, and its mandated products and equipment, should be required by law to be provided competently with due care by the franchisor.
Most courts in franchise cases currently examine franchisor duties only through the prism of contract law. Namely courts usually ask only what duties are expressly set forth in the franchise agreement. The problem for franchisees with such an emphasis on contract law, however, is that franchisors draft the contracts. And franchisors expressly promise their franchisees little, if anything, in the one-sided agreements the franchisors draft. A franchisee will be reduced to asserting an implied breach of the covenant of good faith, which in many states can be defeated by express contract terms and disclaimers. Thus the emphasis on express contract provisions resulted in one court ruling:
"In its last breach of contract claim, [the franchisee] JRT alleges that [the franchisor] TCBY did not give JRT a reasonable chance to succeed. There is no such express term in the contract documents, nor have we found any precedent for an inherent contract right to a reasonable opportunity to succeed. The district court correctly found as a matter of law that there was no such obligation, either express or inherent, in the contract." – JRT, Inc. v. TCBY Systems, Inc., 52 F.3d 734, 738 (9th Cir. 1995).
The very core of what is being sold in a franchise and provisions of franchise agreements support a franchisor duty of competency. Most franchise agreements expressly trumpet the franchisor’s experience and competency in preambles and recitals. Today’s franchise agreements also universally require franchisees to follow the franchisor’s business procedures and manuals. These provisions while not couched as express franchisor obligations surely imply franchisor competence. Is the franchisee supposed to assume that the franchise system and operations do not work? Is the franchisee required to follow manual provisions and specifications that are harmful, counterproductive or illegal? Is the franchisor responsible for nothing that it requires of its franchisees?
One vivid example of a need for franchisor competency by statute involves franchisor manuals and procedures. Through their manuals franchisors dictate what franchisees must do under threat of breach and termination. But what if the specifications are for incompetent services and products that the franchisee must sell? What if the required actions are illegal? Shouldn’t the franchisor be liable to the franchisee for such required actions under a duty of competency?
Currently a number of BP ARCO am/pm gas station franchisees have filed a lawsuit against their franchisor over Retalix, a new franchisor required point of sale system. The franchisees have alleged that BP required the franchisees to use the Retalix POS system which was not properly tested and failed to work correctly. One of the plaintiff franchisees described franchisee problems with Retalix in an earlier column in this Forum as follows:
Recently, our franchisor forced its franchisees to use a Retalix point of sale and back-office system to electronically run the entire business. Through beta testing and thereafter, BP had actual knowledge that the system was defective. The system shuts down, sometime for hours at a time, during which no transactions can be processed at the AM/PM stores and no gasoline can be sold. The system fails to track and on occasion mischarges for transactions, resulting in product being received but not incoming money in exchange. In addition, promised features such as an inventory tracking system and station reports and metrics are absent. Despite these failures, BP has charged franchisee owners the full price for the system they mandated at $30-40 thousand dollars per site. BP has also failed to remunerate franchisees for the losses suffered due to the defective system. BP knew the system was defective when they forced franchisees to install the system because they participated with test stations during a beta test process where the system displayed the same symptoms suffered after the full rollout of the system.
As a result the franchisees alleged in their lawsuit that due to Retalix they could not conduct business at times, lost payments, and suffered damages. If established why should franchisees suffer losses due to franchisor incompetence?
Court decisions have, from time to time, found franchisor programs illegal. The Liberty Tax franchisor was held by a California court to have improperly marketed its tax refund loan program in violation of false advertising and unfair business practices laws. We The People, a legal forms and services franchisor, improperly provided bankruptcy services for franchisees that were in contravention of bankruptcy court rules. Why should franchisees be at risk or suffer losses due to franchisor programs that are or may be illegal? Franchisors ought to be under a duty of competency to provide service standards that are right and legal.
Franchisor mandated conduct has few boundaries in most franchise agreements. Franchisors mandate specify store builds-outs, require particular equipment on start-up and during the relationship, provide cooking standards, insist on particular vendors, specify product purchases, impose hours of operation, and so on. Operations manuals sometimes exceed one hundred pages. They may be changed at any time and often are. Franchisors maintain that the right to change is essential for a multiyear franchise relationship as business environment and competition require ongoing changes.
Franchisees often have their life savings tied up in their business and look to their businesses for their livelihoods. Just because they signed a franchise agreement they should not be subject to incompetent behavior by their franchisors. Instead, franchises are sold under the premise of a viable business with no experience necessary. That is why a statutory duty of competency is needed. Without a statutory duty, franchisors will craft new and bolder contract disclaimers of competency. Indeed, if possible, franchisors will draft their version of the perfect franchise agreement for themselves, namely one that provides for no liability of franchisors under any circumstances and no remedies for franchisees. This is why a statutory duty of competency is needed.
This article was republished with permission from Blue MauMau.