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Inescapable litigation

When franchisee litigation makes sense


When the issues go to the very heart and soul of a company, maybe legal action can't be avoided. But the ramifications can be lessened for both sides.

Seemingly every article about franchisee litigation opens with the author advising franchisors on how to avoid it. I wrote that column some months back in Franchise Times and it is worth re-reading as a prescriptive way to foster good franchise relations.

But on occasion litigation is unavoidable. Sometimes it’s necessary, and depending on the issues, even beneficial. Sometimes the issues are so vital to the franchise system that working through a compromise should be avoided, because it makes for a bad business decision.

Michael Seid is the founder and managing director of Michael H. Seid & Associates (www.msaworldwide.com) an international franchise consulting firm with clients that include both established and new franchisors.

Michael can be reached at mseid@msaworldwide.com

Franchisors can create a serious risk to their brand, according to Barry Heller, a partner with DLA Piper in Reston, Virginia, and a top litigator, “when you compromise on issues that threaten the integrity of your brand or the system, such as trademark usage, sale of unapproved products or services or violation of system standards.Compromising on these could have broader implications than merely the one case in which the compromise occurs.” However, there is nothing wrong with making changes to system standards if the franchisor decides that changes would benefit the brand and the system, he adds. That becomes a business decision, not a legal one.

Litigation can sometimes be a management tool to settle disputes. Clearly though, other options need to be explored first. But unwise settlements can have unexpected consequences on how the brand is managed in the future and the results can be devastating to both the franchisor and the franchisees.

For the past several years, arbitration clauses were a popular addition to franchise agreements. The reasons often given were speed and lower costs (two things that no longer apply today). Franchisors tolerated an arbitrator’s decision, that for the most part could not be appealed, because the degree of risk was believed to be lower since the arbitration was one to one, and not with a class or group.

Today, there’s a movement away from including arbitration as a forum for dealing with disputes and one of the reasons is the possibility of group actions being allowed in arbitration. Group actions are back in vogue because of positive rulings in court cases, rule changes at AAA (American Arbitration Association) and JAMS and because franchisee litigators are directly or indirectly recruiting clients to join together to share the costs and to strengthen the appearance of their cases. With the recent attempts to create group actions in arbitrations, including the recent decision involving The Entrepreneur Source, many franchisors will likely rethink whether there are any real benefits left in arbitration.

When MSA is called in to work on a client’s litigation strategy team, our role is generally to facilitate business discussions on ways to preserve the value of the franchise system and to keep the business relationship between the franchisor and the litigating franchisee on a separate track. Often this requires working to find creative solutions that may not be apparent to the litigation team. As business advisors, we work with business or settlement counsel in tandem with the litigation team. It is imperative to look for solutions even when the underlying issues driving the litigation can’t be compromised.

Most people look at the concept of compromise in litigation in terms of splitting the baby and most litigators can readily identify the sacred cows of the relationship—the marks, trade secrets and system standards, to name a few. Once these issues are involved, many litigators will essentially resolve to try the case and in most cases commence making the procedural arguments that ring up so much in attorneys’ fees.

According to Lane Fisher, a partner, FisherZucker in Philadelphia, “In our experience, the franchisor generally has two goals: (1) to protect the revenue stream; and (2) avoid setting bad precedents in the system. Once the unit is deidentified, or closed, the only possible means of settlement is purely economic.

For everyone’s sake, franchisors and franchisees should look for a peaceful means to end the relationship, and to act early when the unit’s value and goodwill are still intact. If the parties can agree to a resale, using their collective efforts, they can create a dignified exit from the system.

How franchisors react to the threat of litigation and how they manage during the litigation affects their franchise systems going forward. In making a decision about litigation franchisors need to ask:

• What are the underlying issues that are being discussed? And, do any lend themselves to compromise?

• What other options are available in ending the dispute other than dealing with the core issues directly?

• What would be the impact of a settlement on other franchisees that may have similar claims?

• What is the financial or other exposure from admitting liability to these or other similar situated plaintiffs?

• What is the likely cost of the litigation? This includes not only the legal fees, but damages you may be entitled to, depending on your contract. Know, however, that the real cost in litigation is the impact on the rest of the franchise system. Litigation costs need to be measured in management’s time and loss of focus on other, more important business and growth issues.

Gather your litigation team to work through the strategy and understand the business and legal issues and risks. Determine whether any issues can be compromised or settled. Are there ways to assist the franchisee’s exit from the business or another resolution that does not impact issues that can’t be modified? Determine the costs in time, money and manpower and who will be responsible for the process internally. Let the lawyers do what they do best, but not without guidance and input from the litigation team that will expect updates regularly.

When the process is over, the litigants may still be your franchisees and you need to have a way back to a positive relationship.

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