Many businesses have growth potential when franchising, but it is challenging. Legal disputes between franchisors often turn into litigation, which could affect the company and the franchisor's reputation.
Fraud and Misrepresentation in the Purchasing of a Franchise
Fraud and misrepresentation are among the top reasons litigation is brought in franchises. Potential franchisees who spend time and money to buy a franchise expect franchisors to provide accurate and honest information. An exaggeration of possible profits, an understatement of risks, or a misleading projection of financial information can break the trust if it is done by a franchisor.
A franchise litigation lawyer knows how important transparency is. The franchisor must provide actual information with data and reasonable projections. This diligence not only helps to avoid litigation but also contributes to a good relationship with franchisees.
Fee Disputes
Disputes over fees are common between franchisors and franchisees. Franchise agreements usually include various fees, including:
Initial franchise fees
Ongoing royalty fees
Marketing contributions
Conflicts can arise if a franchisee thinks they’ve been overcharged or a franchisor doesn’t deliver the services for which it promised to receive fees.
Fees should be transparent to franchisors, and detailed information should be provided about how funds are applied to the franchise system. It will minimize misunderstandings and prevent financial litigation.
Protected and Exclusive Territories
The only other common cause of litigation is the protection of territories. Franchisees’ exclusive territories provide them with a territory where they can operate without competition from other franchisees of the same brand. However, franchisors may dispute these protected areas or sell franchises to third parties infringing on the territory.
One example is if a franchisor opens a new location in the territory already owned by a franchisee, that franchisee might feel betrayed. This also sets the stage for the franchisee to claim lost profits and continue business. Territorial agreements are required for franchisors to follow, and they must respect the rights of existing franchisees while looking for expansion opportunities.
Territory in franchise agreements can be defined clearly, reducing the risk of litigation. Before franchising, franchisors should conduct a thorough market analysis and communicate with franchisees whenever territorial rights change.
Breach of Franchise Agreement and Default
Franchisors are concerned about breaches of the franchise agreement, which spells out each side's rights and obligations. Howevertigation is possible if one party fails to uphold its end of the deal. Breach examples include failure to pay royalties, poor adherence to operations standards, or brand violations.
For instance, if a franchisee habitually disregards the quality standards stipulated in the franchise agreement, the franchisor should react to safeguard the franchise's image. Disputes also arise when the franchisor wants to terminate the franchisee’s agreement for non-compliance.
To avoid this, franchisors should regularly monitor franchisee operations and communicate consistently regarding performance expectations. Issues can often be resolved early before they escalate to full-blown litigation.
Post-Termination Issues
Litigation continues after a franchise agreement expires. Post-term post-termination may cover intellectual property issues, the return of proprietary material, and the cementing of non-compete clauses.
Questions about trademarks and branding use arise when a franchisee's relationship with the franchisor prevents them from continuing to operate under the franchisor’s brand, which may result in legal action for trademark infringement.
Ensure that franchise agreements include explicit post-termination obligations. These obligations involve ordering franchisees to stop using trademarks and return all proprietary materials. Laying out these guidelines up front will help minimize the risk of a dispute after termination.
Trademark Infringement and Other Intellectual Property Issues
Any franchise system depends on intellectual property rights. Trademark infringement occurs when a franchisee ends their agreement and starts using the brand name or logo without the franchisee’s permission. It can also be confusing to consumers and damage the franchisor’s brand.
Franchisors must guard intellectual property beyond trademarks, including proprietary recipes, software, or training manuals. When these assets are misused or disclosed, litigation can result.
Franchisors should invest in comprehensive trademark registration and monitoring to protect their intellectual property. Furthermore, defining how intellectual property should be handled in the franchise agreement can prevent misuse.
Breach of Restrictive Covenants and Non-Compete Clauses
Franchise agreements contain restrictive covenants and non-compete clauses. These clauses prevent franchisees from setting up competing businesses in a particular area or time frame after the franchise ends. Disputes occur, however, when franchisees break these covenants.
A franchisor may sue a franchisee for breach of a non-compete clause if a franchisee opens a competing business shortly after termination. Franchisors should define these clauses clearly and ensure they comply with state laws regarding enforceability.
When franchisors draft these provisions, consulting legal counsel to mitigate potential litigation is a good practice. Suitable and enforceable non-compete clauses can protect the franchisor's business while reducing the likelihood of future fights.
If a business owner is considering franchising your brand, you must know why franchisors sue other companies. You can navigate franchising more effectively if you know about fraud, fee disputes, territorial rights, contract breaches, and post-termination. Fostering transparency and open communication between franchisors and franchisees can help reduce legal conflicts and pave the way for a successful franchise system.
