Franchisee Get Out Of Jail Free Card

Author Richard Solomon is a conflicts and crisis management lawyer with 50 years of experience in business development, antitrust and franchise law, management counseling and dispute resolution including trials and crisis management.

How many franchisees out there in franchise land hold a ticket to walk away from their franchises with no post term covenant not to compete liability? How that can happen, you ask.

Over my almost 55 years of practice in distribution law, which includes antitrust and franchising among other areas, I have had a front row seat to the back and forth of franchisees finding ways to defeat franchise agreements and franchisors then immediately redrafting their agreements to "fix" the mistake. It is a form of grand game. It is so important a game because so many franchises are simply not worth investment or, over the years, have lost their investment worthiness.

The lever to drive renewals is no longer investment quality driven, but is then driven solely by threat of enforcement of a post term covenant not to compete. That is how everyone thinks the land lies now.

I have found that in some situations, franchisors have become lazy, or their lawyers need to be taken out behind the woodshed. Some have come to think that they can do anything they like because their franchise agreements say they can do anything they like. Some of these systems' franchisees have been coming to me. There is a deep and wide sink hole in some systems that give unhappy franchisees a get out of jail free card. Here's an example of how that works.

The now vulnerable to mass revolt franchisor, whose management has no idea what their franchise agreement says because they have been taught that there is no limit to their options, screwed his own pooch by so positioning himself that he must insist upon rights that are not provided for in the agreement and, in many instances, is not even permitted by law in any state. A defense against franchisee options now works against him in ways that place his entire system into walkaway mode.

The some clients now have just such an advantage. The franchisor's big time huge law firm retained to deal with us is heaving a sigh of relief that they were not the franchisor's lawyer when the franchisor did this to himself. How does one deal with a situation like this?

The fact pattern in this particular situation involves a franchisor who was asleep at the switch and too stingy to handle renewals "by the numbers". Thinking the franchisees could not/would not leave because he could then put them out of business with his post term covenant not to compete, he failed to observe/enforce his renewal protocols and is now in an oral, terminable at will, including the covenant not to compete, "dealership" relationship in which his legal rights are few. He could refuse to deal with anyone at any time and make everyone who leaves stop using his trade identity. However, the trade identity and product/system access are no longer a market advantage worth investing in (if they ever were). The franchisees seeking to leave his system no longer have use for his system or products because the major premise underlying the agreement has left the scene due to normal market condition changes over the years.

How one goes about proving that is the litigator's art. This is not the situation where some smooth talking negotiating lawyer is worth having. This calls for the tactical expertise of the seasoned litigator. While it looks like a walk in the park, its execution requires tactical sensitivities that the "let's talk about this" lawyers lack.

To begin with, how is the battlefield shaped in this fight? Where did the franchisor screw himself and how does one exploit the opportunity to leave free and clear?

As I said, his big mistake was not following his own contract rules for renewals. He simply continued to collect royalty checks and sell products/services telling himself that everyone "morphed" into a continuation of the franchise relationship. In some instances, this delusional franchisor actually has decided that they have "morphed" into a renewal for a longer period of time that the now expired franchise agreement ever provided for in the first instance.

Now every franchisor will tell his attorneys to prepare "morphing" clauses that purport to bind people to lengthy commercial relationships with no eligible documentation to support it. That statement is intended to be a joke, but some franchisors believe that is all they have to do in order to prepare for any eventuality.

His present attorneys scramble around bluffing, in an attempt to avoid having to tell this emperor that he has no clothes on. If they tell him that, he will go seek other lawyers who have a deeper appreciation of the billable hours made available by their client's delusional state of mind. Instead, they write letters full of contentions that have not the slightest chance of ever being sustained.

Eventually the franchisees' lawyer will make a "feel good money" deal in exchange for universal mutual releases, but getting to that point calls for arriving at how much "feel good money" is right. That number is a simple metrics exercise comparing the cost of litigation against the costs of continuing to do business with this franchisor. When the metrics give the right answer the price of the ticket to independence becomes obvious. Where the franchisor has done something that causes him to be exposed like this, the last thing he wants is to find himself in court with a public record being made of how screwed up he is. If there are other franchisees who have not yet caught on to their good fortune, he knows that any dispute will immediately make them all aware. The consequences of that could easily be an end to his franchising company. Item 3 of his FDD will fail to enhance the sale of his franchises as well.

The get out of jail free card price must be arrived at quickly. Too many lawyers spend far too much time letting the franchisor's lawyers bully them into continuing a "dialogue" going nowhere, often demanding personal meetings and other theatrics calculated to give the franchisor an opportunity to try to bluster and intimidate. Franchisee counsel must, with some degree of deference, drive the franchisor rapidly to the proper conclusion. The longer one takes to pull the trigger, the more the franchisor is encouraged to think his bullying ploy is actually working. As that absurd chatting continues, the price of poker rises. That's why you need litigators to handle this. The litigator provides a reputational threat of taking decisive action against the franchisor on almost no notice. Just what these pressure points are and how to push on them is not to be discussed in a tutorial like this. That's the litigator's "secret sauce". When the litigator announces that discussions are going nowhere constructive and walks out of the room headed to court or worse, something happens that will not happen when the franchisees are represented by some lawyer who thinks he can just chat his way to a positive result. One does not go see a dentist to handle brain surgery.

Despite the stupidity of handling business in this manner, many franchisors have this in their woodpile. Most do not. They have good contract management sense. On the other hand, renewals are not the only situation in which franchisors hand out get out of jail free cards.

The combination of the long term of any franchise agreement and the inescapable changes in every market for all goods and services cannot help but create avoidance opportunities for franchisees.

Franchisors have been told at their conventions that their agreements are not time vulnerable. Well, folks, that just isn't so in a lot of instances. The impact of this set of circumstances ought to be that franchisors pay a bit more attention to the enhancement of the relationship for the franchisee, instead of just searching for ways to pile on extra charges every so often. No resentful circumstances ever occur without some good underlying factors working in pernicious directions. Eventually this drives franchisees to seek counsel regarding the exit cost. The worse the relationship quality, the more attractive the comparative metrics of exit become. Leveraging exploitative tactics over time into a subversion of investment quality is not a difficult assignment where the franchisor has been aggressive.

It gets down to the question whether the business relationship is there to serve the contract, or the contract is there to serve the quality of the business relationship. When resort to contract terms becomes a frequent event in any franchise system, things are not moving in a positive direction. So far this has been addressed primarily to franchisees to show them a path to liberation from abuse. It would be worthwhile for franchisors to think about taking a look at their system management and the inroads that time can make upon the assumed enforceability of the tougher provisions of their franchise agreements. Many of your contract provisions are amenable to use against your interests given an appropriate set of circumstances.

Ask someone about it who isn't afraid of losing you as a client. The cost of sorting out your issues before some opposing experienced franchise litigator shows up with some of your franchisees on board is some of the best money you will ever spend.