As a partner at Dady & Gardner, known for representing franchisees in disputes with their brands, attorney Jeff Haff has seen piles of litigation. When told our new research project turned up a wide gap in the number of lawsuits at franchises—from 855 cases listed in Item 3 all the way down to zero—he was quick to sum up what the numbers mean to him.
"If you have a lot, and I would consider a lot to be 10 or above," he said, "that indicates that you as a franchisor are A, having a lot of franchisees that are failing and B, that you take a very aggressive posture in either arbitration or litigation against your franchisees." (See related article on page 41.)
Of Subway in particular, with those 855 lawsuits as mentioned, he said the aggressive stance dates back to when the late Fred DeLuca ran the brand. "Subway has always taken a more, certainly when Fred DeLuca was alive, a more aggressive position in suing or arbitrating" against franchisees.
McDonald’s is different, as our research showed, with 32 total cases or less than one per thousand. "McDonald’s tends to say, if you have a failing unit, we don’t want to engage in a lawsuit with you. We want to either transfer it to another franchisee who wants it or we want to work something out with you," Haff said.
Execs and attorneys make a big difference. "We have franchisor counsel who are very reasonable, very easy to deal with," he said. "You have other franchisor counsel who take a very aggressive position who say, I’m sorry, there can only be one winner here, and it’s not gonna be you." Asked if the same goes for franchisee counsel, he demurred.
‘When in doubt, disclose’
Shelley Spandorf, the Davis Wright Tremaine attorney who represents mostly franchisors, said the rules for determining what constitutes a "material" lawsuit, and thus requiring inclusion in Item 3, is "loosey-goosey." "It’s material in the eye of the beholder, and it’s in hindsight," meaning "every plaintiff could call something material" and bring an action under federal or state statute or common law.
Her advice to clients: "When in doubt, disclose," she said.
Told about the litigation project, she said, "I would be fascinated by the discrepancies but I would want to drill down," meaning read the cases and determine the reasons for them.
Brian Schnell of Faegre Baker Daniels also advises full disclosure to his franchisor clients. "I suppose somebody might say, if I’m a big organization and have thousands of franchisees, one fraud/franchise lawsuit may or may not be material. That’s not a space that I would play in," because certain franchise laws define materiality as anything a prospective franchisee might consider important in its decision-making process.
"So my view is I don’t want to get dragged into some lawsuit with some franchisee lawyer arguing about materiality. It’s just not worth the risk."
To potential buyers, he says, "We’ve heard it for decades. Prospective franchisees don’t do enough of their own due diligence, to take what’s in the FDD and ask the necessary and appropriate questions."
Expensive, contentious, caustic
Andrew Bleiman of Marks & Klein, which represents mostly franchisees, noted the rise of mandatory arbitration clauses in franchise agreements in the last several years, which compels parties to first go through the arbitration process before filing lawsuits.
A handful of attorneys said this could be one reason why some brands have few or zero lawsuits—they get rulings without lawsuits and thus have nothing to disclose in Item 3.
Although that route is often touted as less costly and more efficient than litigation, "I don’t think that’s the case whatsoever," Bleiman said.
"Litigation, you pay $500 or so and you can file a lawsuit. Arbitration, the filing fee is $2,500 or more, plus you’re paying an arbitrator by the hour to make a decision," and arbitrators can command "$500, $600, $700 an hour," he said. "The cost to go through arbitration is very significant. The bill can be six figures. That obviously cuts against the ability of franchisees to pursue it," he said and further stacks the deck against franchisees.
He notes one obvious reason that can explain lots of franchise litigation: "The unit economics are not very strong. For a lot of these folks they bought a job." Beyond examining all of the lawsuits in Item 3 and finding out who’s suing whom and what for, he also advises looking at Item 20 about transfers and sales of franchises.
"So it’s very difficult to sell some of these where the unit economics aren’t working. Sometimes litigation can be used as a way to extricate themselves from the situation," he said. "Most of the time you’re not going to see that type of stuff in systems where the franchisees are making money."
For at least one former franchise litigator turned general counsel, Jim Goniea of Self Esteem Brands, parent of Anytime Fitness, lawsuits are to be avoided.
"Litigation is an extremely poor way to resolve disputes. It’s expensive, contentious, it interferes with the relationship between franchisor and franchisee in a caustic way," said Goniea.
Protracted litigation usually occurs, he said, when one of the parties is behaving irrationally. "My philosophy is to never be the irrational actor, to always be the adult in the room, and to always be the one that’s trying to find a reasonable resolution because ultimately I think the courts punish irrational behavior."
Beth Ewen is senior editor of Franchise Times, and writes the Continental Franchise Review® column in each issue. Send interesting legal and public policy cases to email@example.com.