Written by attorney Aaron Matthew Kelly

Franchise agreements, breach of contract, and the role of franchisee

Typically when we hear the word franchise we think of the large commercial chains of stores that spring up overnight, offering everything from fast food to spray tanning. A franchise is actually much much more. Franchising is a marketing technique where the maker of a product or service grants to others the exclusive right to market their product or service. The maker (franchisor) gives this exclusive right to the person (the franchisee) for a specified area and length of time to market the product with the franchisors trademark and marketing plan. This relationship differs from a mere exclusive license to sell the product or service in that it contemplates a continuing close, cooperative relationship between the franchisor and the franchisee. Sometimes, the relationship is anything but smooth.

Interactions between the franchisor and franchisee may give rise to many possible causes of action under both federal and state statutes. There is a basic premise that, because of the franchisor's superior and economically more powerful position, it must deal with the utmost good faith, integrity, and fidelity. A failure to do so can lead to a cause of action by the franchisee for breach of contract, breach of the implied covenant of good faith and fair dealing, and fraud.

Breach of Contract

Breach of contract on the part of the franchisor may consist of refusal or failure to perform any promise which forms all or part of the agreement, refusal to recognize the existence of the contract, or conduct inconsistent with its continued existence. Examples would be the failure to provide training and supervision or the failure to furnish goods, equipment, or facilities as required by the contract. In these scenarios some have likened the relationship between the parties as being akin to a fiduciary relationship. In doing so, it creates a standard of care by which the franchisors conduct in performing under the contract meet the stringent obligations of full disclosure and fair treatment. Again, this is because of the franchisee's lack of bargaining power in the situation.

Deceptive Practices

Not only does the franchisee have a significant lack of bargaining power, but it also must worry about deceptive practices by the franchisor. We have seen cases where misleading statements were made to the franchisee in respect to the potential profitability of the franchise, refusal to divulge actual profit and loss figures, or high-pressure tactics to force closing of the sale. These misrepresentations can sometimes be found in brochures or prospectuses, or in collateral documents that are ancillary to the sale.

Franchise documents as evidence

The above being said, it is important for a franchisee to keep all pertinent documents when entering into an agreement. It is also imperative to see the financial records. If possible, have your accountant review the records to make sure that they are not showing you just the months of profitability. If the franchisor refuses to disclose this information, it may be in your best interest to look for another opportunity.

The franchise relationship is also a breeding ground for antitrust violations. The entire franchise model is built on continuity, and therefore there are typically allegations of price fixing, price control, and market domination.

Embroiled in a lawsuit

Burger King found out first-hand the consequences of price setting when it became embroiled in litigation with the National Franchisee Association over its "$1 whopper" advertisements. The argument by the franchisees is that Burger King, as the franchisor, only has the right to recommend prices. In fact, the franchisee's voted down the $1 whopper twice before Burger King insisted on introducing it nationally in its advertisements. The class action lawsuit claims that the franchisee's can no longer have it "their way right away" since Burger King essentially forces all of its stores to sell the $1 burgers at a loss.

Like the Burger King case, the bulk of the court cases find the franchisee in the role of the plaintiff. As you can see, franchise cases can be very complex and involve a study of the numerous documents and records. What is more telling is that rarely does a franchisee seek the advice of legal counsel when negotiating the purchase of a franchise. The crux of most franchisee complaints are that the franchisee would not have purchased the franchise had all of the facts been made known to them. Unfortunately, many franchisees' conduct can be held to be a waiver of his right to sue, since it is often several months or years until the franchisee is able to discover any misleading statements by the franchisor.

Should the franchisee enter the realm of litigation, it is important that they select a competent and experienced attorney to guide them through. There is no guarantee as to how long a case will take, or what the outcome will be. The speed at which the franchisee case moves depends on the nature of the relief sought, as well as the status of the defendant franchisor. Often times if the claim is for recovery of a deposit or a franchise fee paid, it may be necessary to move quickly against the company before it dissolves via bankruptcy or liquidation of assets.

The above being said, franchise litigation can be very time consuming and costly. Certain conduct between the parties may amount to a breach of the franchise agreement, for which there are available a variety of remedies. It is important to seek experienced counsel when negotiating a franchise agreement, and having legal counsel that is responsive to your needs that is available for your franchise questions.

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