This section summarizes the provisions of the franchise agreement regarding renewals, transfers, termination, and dispute resolution. For purposes of the FDD, we will call out the clauses that address these various issues.
The main question we will have for you in this section is related to how you want to resolve disputes with your franchisees. Our standard process for dispute resolutions is to start with non-binding mediation by bringing your non-compliant franchisees, or franchisees that believe you are not fulfilling your obligations, to the President/CEO of the franchisor for an in-person meeting to try and work out the problem. If it is not resolved, then you can take the next step to court (or arbitration) if necessary. Again, we prefer a gradual escalation of formality in the hopes that all disputes are resolved through negotiation.
We will insert our current best practices into your franchise agreement and ask that you read over them, understand them, and if you disagree or wish to change anything, let us know.
Agreement Term & Renewal
Many franchisors, especially when they start out, are concerned about locking in someone for 10 years or longer because they are just putting a toe in the water, testing out whether or not their brand and system can grow as a franchise. Especially service brands, without a lease or big SBA loan driving the term higher, you see many brands with five-year terms. Some think a five-year term is advantageous to the franchisee and will be perceived by them as better than a longer-term commitment; however, the exact opposite is true. A franchisee is making a commitment to build a business and a bedrock factor of any business is certainty. If the franchise agreement can terminate or dramatically change in five years, then how can franchises be certain they have a sufficient runway to be successful?
Banks and landlords recognize that a longer term is better for the franchisee. They also feel that a shorter term is worse for the franchisee. However, a shorter term doesn’t just hurt the franchisee. Remember that you are building your system with the end mind. When it comes time to harvest your brand and find a private equity buyer, longer terms are enormously important. PE firms are looking for future predictable cash flow and will directly calculate expected future royalties by relying on the remaining terms in your franchise agreements. The franchisees may have certain automatic rights to renew, but you as the franchisor can’t force it. Bottom line – think long-term by having a long term!
Litigation or Arbitration
There’s no one correct answer regarding selecting arbitration or litigation, and you will need to discuss this with your franchise attorney so you can make the final decision. The advantage of arbitration is that it is your best hedge against a class-action lawsuit in that you can prevent your franchisees from ganging up on you. The disadvantage to arbitration is that it is costly as you have to pay not only your own legal expenses but for the arbitrator as well. But that burden on you also creates a burden and disincentive for the franchisee wanting to fight.
On the flip side, we believe you’re better off in court because judges, in our experience, are more likely to take a narrower construction of a written agreement. Remember that judges, in contentious cases, have to issue written opinions that are subject to appeal. Arbitration has a much higher probability to split the baby and look at the “fairness” and “equity” of the situation in addition to the contract. That tilt usually benefits the franchisee as they are usually the ones not complying with their obligations and suffering the greater financial loss in the dispute. The arbitrator’s decision will most likely also stay confidential and not be subject to appeal. The confidentiality, of course, can be beneficial as you are not creating a public record of a private fight. The non-appealability of an arbitrator’s award should factor into your decision of whether to litigate or arbitrate.
There is no right answer, and it changes over time. However, our opinion is litigation as a way to resolve very contentious disputes is better for the franchisor.
We believe that great franchisors are not overbearing or overly aggressive with their enforcement and do everything they can to avoid formal disputes. That’s the pathway to building generational wealth. You will hear some franchise attorneys say litigation is part of being a franchise, or it’s inevitable. It is not inevitable. There are plenty of franchisors that grow to hundreds of units with zero litigation. A lot of litigation happens because of ambiguity, misunderstandings, and when people don’t come to a meeting of the mind at the outset of the relationship. If you are in a fight, you want to ensure you are on the right side of the facts and doing it because of a threat to your brand, not because you are upset.
You should only really find yourself in court if someone is knocking off your brand name, trying to compete against you unfairly, or grossly misrepresenting your brand. If that’s the case, you should drag them into federal court and take them out for a beating in the woodshed to show your entire system what is and what is not acceptable behavior. But don’t do it on a close call. Just like a nation should only go to war as a last resort when all other diplomacy fails, you shouldn’t start firing missiles at the first sign of non-compliance.
When it is a close call, we encourage you to have some empathy for the fact that the franchise failed and probably went broke trying to do what you did. Take the high road, write them a check, have them sign a confidentiality agreement, and be done with it. Either way, it’s going to cost you money, whether you fight it in court or allow the franchisee to disappear gracefully.
If your attitude is that you prefer to defend your brand through litigation for each and every infraction, then we’re probably not the law firm for you. We are here to help you build the multi-million-dollar enterprise, and our belief is that over-aggressive litigation is not the way to do it.