Peter Lagarias of Luther Lanard
Franchisees and franchisors alike don’t go into a partnership with separation in mind, but it’s a reality of the model.
Long before these situations develop, attorneys at franchise law firms suggest including mediation clauses in initial agreements. Peter Lagarias of Luther Lanard said those types of clauses are becoming more common, much to the benefit of all parties.
“Many of them provide for it because litigation and arbitration can be quite expensive,” Lagarias said. “If it gets a result and the matter is resolved, it’s good for everybody.”
“I would say mediation often works wonders,” said John Gotaskie Jr. of Fox Rothschild. “I think it’s because by the time you get to that state, people have a pretty good idea of where the issues are, and a skilled mediator can get things done.”
David Kaufmann, an attorney with Kaufmann Gildin & Robbins, said for the franchisors he usually represents, mediation clauses can prove especially important, as when a dispute comes up, counterclaims are created fast.
“They are a constant,” Kaufmann said. “When a franchisee is sued by a franchisor, say an agreement expires and the owner keeps operating, they automatically file a countersuit against the franchisor. They’ll come up with something for a counterclaim. It’s usually to make the franchisors spend money and that’s what I see a lot of.”
Gotaskie Jr., though, said in many cases franchisors never want it to get to that point, whether the dispute is over expirations or terminations. It’s something franchisors work arduously to avoid, when possible, he said.
“Take default for example,” Gotaskie Jr. said. “It begins before there’s even a default letter. Brands have their regional people going to the franchisee on a regular basis and compiling reports if there are negatives. The franchisor representatives then meet with the owners and talk about where the issues are, and I’d say 98 or 99 percent of the time it stops there.”
“If it doesn’t get resolved there, steps are still available, such as a regional trainer coming in,” he continued. “It can also depend on the type of violation. If it’s a case of food safety violations, they move in quickly and get it fixed in a short timeline. If it’s a financial issue, the franchisor will still try to work with them.”
If a financial situation can’t be resolved, Gotaskie Jr. said franchisors still have the option of working out an agreement with the owner. In these scenarios, the franchisee voluntarily terminates the agreement, and can then market the store, getting equity they have in the location through a sale.
John Gotaskie Jr. of Fox Rothschild
Sometimes litigation is inevitable, and like Kaufmann, Gotaskie Jr. noted how franchisees will respond with counterclaims alleging unfair trade practice under state or federal law.
When these situations do occur, Kaufmann said there’s been an increasing trend to go toward arbitration and mediation. At his firm, Kaufmann said they work hard to avoid the former, as it has changed over the years.
“Back in the day, arbitrations were faster, cheaper and less formal,” Kaufmann said. “There was no discovery and no pre-arbitration motions. Now, arbitration is almost identical to litigation. There’s full discovery of documents, depositions and motions brought before the hearing, ramping up expenses.”
“Rules of evidence also don’t apply in arbitration,” said Kaufmann. “In court, there are safeguards as to what evidence can and can’t be considered. Speculative and emotional testimony is excluded, but not in arbitration, which also can’t be appealed.”
Because of the issues with arbitration and the costs of litigation, if mediation isn’t possible, Kaufmann said settling is sometimes the best option.
“If it’s a meritless suit, where it will cost so much to litigate, our advice is to settle for less than the potential legal fees,” Kaufmann said. “Pay them instead of us. Get this done with a general release, because you’ll save money that you would put into litigation and a possible appeal.”
While there are legitimate termination and expiration cases with franchisors, though, Lagarias said there are also times when franchisees are subject to unfair practices.
“These things are written by and for franchisors,” Lagarias said of franchise disclosure documents and agreements. “The franchisees spent, let’s say, $300,000 to build their store, and they have all this equipment and contracts. It’s a big investment. They shouldn’t be subject to termination for a ticky tacky foul, and they should have time and the ability to protect their investments.”
In those situations, Lagarias said the franchisees don’t file a counterclaim, but just defend against the original complaint. In other cases, franchisees may want to exit a deal earlier than the agreed term if an operation isn’t profitable, even after improvement efforts.
“With a client like that, there are two things,” Lagaria said. “One, they may not have enough money to keep going as they’ve been losing money. Two, they may have a loan which in some cases they put up their house as collateral. And they say ‘I’d like to file for bankruptcy, but I’m going to lose my house if I do that.’”
Like including a mediation provision, Gotaskie Jr. said it’s important to get ahead of bankruptcy situations.
“I encourage both sides to start talking as quickly as possible,” Gotaskie Jr. said. “If your operations team on the franchisor side starts to notice issues, or you’re the franchisee facing challenges, get on the phone and start talking. There’s usually an issue going on that, if you nip it in the bud, you can get it resolved and move on successfully.”
