Starting Up A Franchise: Legal Tips

An on-going and, almost, unavoidable reality that franchisors must continuously monitor, anticipate and evaluate relates to the prospect and threat of “franchisee litigation”.  Established franchisors, typically, are well aware of this risk and understand the necessity of implementing  and following a strict franchisee compliance program designed to mitigate “litigation exposure” and keep legal fees in check.  However, many times, start-up franchisors are unaware of the “litigation risks” associated with franchising and the consequences for failing to implement the appropriate litigation procedures.

During the start-up phase of a franchise system (i.e., one, two or five years into selling franchises) start-up franchisors are extremely susceptible to the legal and financial risks associated with franchisees attempting to “break away” from the franchise system.  That is, where your initial group of franchisees attempt to “save money”  by attempting to terminate their franchise agreements (and their obligation to pay royalties) and invalidate their non-compete covenants  under the pretext of an alleged default and fraud associated with the franchise relationship (i.e., where the franchisees claim that you have failed to meet your obligations as a franchisor and fraudulently induced them into becoming franchisees).  From a tactical standpoint, this franchisee “break away” type litigation is typically funded by wealthy franchisees who have experienced success with their franchises and are looking to establish a competing business and/or franchise system.  Some factors that start-up franchisors should consider, include:

  • Be Aware of Economic Imbalances with Franchisees – Although franchises should only be sold to competent and responsible individuals with sufficient assets and capital, be aware of “millionaire” franchisees who are looking to become your “partner”.  These individuals have typically experienced success in other industries, may be experienced with the “business advantages” that litigation sometimes affords and possess the capital to overwhelm a start-up franchisor with limited funds. 
  • Be Diligent about the Enforcement of your Franchise Agreements – From day one of the franchisor-franchisee relationship you must enforce each and every provision of your franchise agreement.  Franchisee non-compliance must be immediatly addressed and remedied.  
  • Uniformly Enforce your Franchise Agreements – Ensure that you uniformly enforce your franchise agreement.  If there is disparity in the treatment of your franchisees (i.e., where you excuse one franchisee from performing a obligation performed by and enforced against other franchisees) , you will be exposing your franchise system to unnecessary franchisee claims.
  • Act Promptly to Enforce Non-Competition Covenants Contained in Your Franchise Agreement.  When faced with “rogue” franchisees who attempt to operate a competing business (under the pretext that they terminated their franchise relationship) you must immediatly review with your franchise lawyer the necessity of  commencing litigation and filing an emergency motion for injunctive relief.  

The “best litigation” is the litigation that is avoided.  Ensure that you implement franchisee compliance programs focused on the diligent enforcement of well defined procedures and obligations both on your part as the franchisor and on the part of your franchisees.