Ten Rules for Franchisors to Reduce Litigation Risks

A franchisor's first and best safeguard against litigation risk is a successful system filled with competent, profitable, empowered (and thereby happy) franchisees. For reasons that go far beyond litigation avoidance, a franchisor wants to run an elite franchise system that leaves it, its franchisees, and its customers fully satisfied.

These 'Five Habits of the Highly Successful Franchisor' identify the main philosophies and practices that separate the best franchise systems from the rest:

• Maintain an undying devotion to the brand. A franchisor's brand is more than just a trademark. It is an important tool for communicating to customers. The franchisor must not only protect its brand; it must identify and communicate ' constantly ' the promise of that brand. The brand promise must be instilled in every aspect of the franchise system.
• Balance the interests of the franchisor, franchisee, and the system as a whole. Highly successful franchisors establish a culture of voluntary compliance with system standards, while vigorously enforcing compliance by errant franchisees to ensure the success of the system as a whole. Franchisors must know when to work out a mutual solution and when to take a stand.
• Stack the deck with 'ace' franchisees. Highly successful franchisors understand that franchise recruiting is a separate business from their operational enterprise. They develop, and then faithfully
  follow, a system that focuses on recruiting high-quality franchisees. Development practices must be energetic and creative, but still rigorously compliant with the law. Franchisors need to know when to walk away from marginal candidates.
• Obsess over franchisees' bottom line. A franchisor is only as successful as its franchisees. Franchisors must provide regular, ongoing support to franchisees, assist franchisees to improve performance, and demonstrate concern for franchisee operations. The highly successful franchisor usually has well-developed and objective tools to monitor compliance with system standards.
• Empower franchisees. Highly successful franchisors empower franchisees to participate in the present and future direction of the system, while maintaining franchisor control over decision-making. When franchisees are not following the system, these franchisors ask the 'Why not?' question, rather than the more reflexive 'How dare they?' question.

Rule Number 2: Teach Your Children Well ' That Is, to 'Write Smart'

Sometimes how a franchisee-v.-franchisor lawsuit ends (or indeed whether it ever escalates from a business disagreement into a lawsuit) can turn on the language used in an agreement, a system communication, letter correspondence, or an e-mail. Many different individuals may communicate for a franchisor to franchisees, typically without much forethought about the impact of those communications. For example, how many times do franchisor representatives: 1) write communications for posturing purposes rather than finding common ground, or 2) fail to recognize that recollections of a conversation or event are not the truth, but rather an interpretation of the truth?

Harsh words from a franchisor representative in the heat of the moment are likely to create hard feelings by the franchisee. When those harsh and spontaneous words are memorialized in writing ' even in an e-mail message intended to be something less than 'on the record' ' they can speed the breakdown of a relationship and cause problems for the franchisor (and its lawyers) in the resulting litigation.

Lawyers understand the importance of the words, and they are trained to select words carefully in the contracts and briefs they write or the oral arguments they make. And while top franchisor management may habitually exercise the same care, those instincts are not necessarily present with all who communicate on the company's behalf. Franchisors and their lawyers need to emphasize to all potential communicators the importance of 'smart writing.' The stakes are simply too high to be careless, sloppy, or impulsive. Of course, everyone on the franchisor side would much prefer creating an 'exhibit that wins the case' rather than 'loses that case.' But businesspeople, preoccupied with meeting that day's business challenges, are not always thinking that way.

Emphasize smart writing every day, not on the eve of litigation. We recommend providing writing training to all franchisor representatives, including the CEO and senior management, that is similar to franchise sales training or franchise legal compliance programs. For the smart-writing trainers (optimally the franchisor's lawyers, whether outside or in-house) the exercise can double as a great opportunity to make friendly contact with all of the company's potential future witnesses, and to learn much more about the company's business.

We are not suggesting that franchisors do anything underhanded when following smart-writing principles. If a franchisor has a problem, it should address it. The proper way to address the problem, however, is not an e-mail chain with dozens of people copied ' many of whom feel the need to 'C' their own 'A's on the issue. 'CYA memos' too often begin a round-robin blame game inside the company: Operations blames marketing, which blames development, which blames operations, and round and round.

General smart-writing rules include:

• Don't write any unsolicited (or even solicited) opinions on any issue. Stick to the facts. When opinions are solicited, deliver them face-to-face when possible, and certainly not by e-mail.
• Recognize that e-mails, especially responsive ones, are often drafted casually and emotionally, with some mysterious and powerful impetus to launch themselves into cyberspace immediately ' as if the social norms of conversation (such as 'long pause = rudeness') applied. Urge all communicators to let their drafted e-mails to franchisees sit unsent for a few hours, with a final review before transmission.
• Strive constantly to mean what you communicate and communicate what you mean. A franchisor should not try to bluff a franchisee by sending a message it doesn't intend to follow-through upon. Successful franchisors trade in franchisee trust, which is easily squandered if franchisees are unsure whether a franchisor's words truly mean anything.

Rule 3: Include a (Facially Symmetrical) Arbitration Clause That Works for Your System

Franchisors can control the parameters of their lawsuits with franchisees ' and they may even be able to deter some litigation ' if they fully exercise their option to include a comprehensive dispute resolution provision in their franchise agreement. Some franchisor lawyers (including some of the authors) are less than fully enthusiastic about arbitration as it is most typically conducted; that is, by one of the large arbitration agencies under cookie-cutter contract provisions. In that context, the utility, speed, and cost-effectiveness of arbitration over court litigation is sometimes more theoretical than real. Still, there is no disputing that a thoughtful and comprehensive alternative dispute resolution provision in the franchise agreement ' if informed by a franchisor's clear view of what kind of process will work to its benefit ' is of significant value.

The ideal dispute resolution clause will always read symmetrically; its provisions will be, in theory at least, of possible benefit to either the franchisee or the franchisor (or both). But in crafting such a clause a franchisor can preserve the ground rules that it believes will serve it most favorably, given the realities of its system and the likely context of the dispute. Each particular franchisor should consider:

• Dictating the number, scope, and timing of any mandatory settlement or mediation steps before the arbitration hearing;
• Controlling the locale (typically your home state), format (length of hearing; number of arbitrators), and process (limits and logistics of testimony and other evidence) of the arbitration hearing itself;
• Limiting the fight to only this franchisee by precluding class actions or any joinder of these claims with others;
• Outlining the arbitrator qualifications and other steps to secure the decision-maker(s) the franchisor wants;
• Tailoring the pre-hearing steps (documents, written discovery, depositions, experts, dispositive and other motions) to secure the most favorable parameters for the anticipated disputes;
• Specifying the relief (including interim injunctive relief) that may be sought elsewhere, as well as the relief (types of damages, costs, attorneys' fees) that the arbitrator(s) may award; and
• Creating a post-hearing review or appeal process more extensive than the Federal Arbitration Act ('FAA') provides.

One important caveat to all this: A generation of firmly entrenched pro-arbitration bias (extant in all courts since the Supreme Court's 1980s-era FAA decisions) now shows signs of slippage, to a degree that has yet to be fully determined. First, at least in some western states, the Ninth Circuit's Nagrampa decision casts doubt on the routine enforceability of franchise agreement arbitration clauses, at least the ones asymmetrically tilted in favor of the franchisor. Second, The Arbitration Fairness Act currently alive in Congress seeks to void pre-dispute arbitration provisions in a number of industries, including franchising, by enforcing agreements to arbitrate only in the limited context where franchisor and franchisee ' after the dispute arises ' agree to arbitration. Third, the viability of arbitration clauses that call for some enhanced level of post-decision review is in doubt pending the Supreme Court's forthcoming decision in Hall Street Associates, LLC, v. Mattel, Inc.

Nonetheless, the comprehensive, intentional, and evenhanded dispute resolution clause will likely remain an important tool for franchisors in controlling litigation risks.

Next month's installment will discuss the remaining Seven Rules to reduce litigation risks.

John Edward Connelly, William L. Killion, and Brian B. Schnell are partners in the Minneapolis office of Faegre & Benson, LLP. They can be contacted by phone at 612-766-7000.

Part One of a Two-Part Series

No American commercial enterprise can reasonably hope to enjoy complete, long-term freedom from all litigation. But for franchisors who do business consistent with a few critical (and largely common-sense) rules, freedom from excessive lawsuits and from truly damaging litigation results is not out of reach.

Rule Number 1: Follow the 'Five Habits of the Highly Successful Franchisor'

A franchisor's first and best safeguard against litigation risk is a successful system filled with competent, profitable, empowered (and thereby happy) franchisees. For reasons that go far beyond litigation avoidance, a franchisor wants to run an elite franchise system that leaves it, its franchisees, and its customers fully satisfied.

These 'Five Habits of the Highly Successful Franchisor' identify the main philosophies and practices that separate the best franchise systems from the rest:

• Maintain an undying devotion to the brand. A franchisor's brand is more than just a trademark. It is an important tool for communicating to customers. The franchisor must not only protect its brand; it must identify and communicate ' constantly ' the promise of that brand. The brand promise must be instilled in every aspect of the franchise system.
• Balance the interests of the franchisor, franchisee, and the system as a whole. Highly successful franchisors establish a culture of voluntary compliance with system standards, while vigorously enforcing compliance by errant franchisees to ensure the success of the system as a whole. Franchisors must know when to work out a mutual solution and when to take a stand.
• Stack the deck with 'ace' franchisees. Highly successful franchisors understand that franchise recruiting is a separate business from their operational enterprise. They develop, and then faithfully
  follow, a system that focuses on recruiting high-quality franchisees. Development practices must be energetic and creative, but still rigorously compliant with the law. Franchisors need to know when to walk away from marginal candidates.
• Obsess over franchisees' bottom line. A franchisor is only as successful as its franchisees. Franchisors must provide regular, ongoing support to franchisees, assist franchisees to improve performance, and demonstrate concern for franchisee operations. The highly successful franchisor usually has well-developed and objective tools to monitor compliance with system standards.
• Empower franchisees. Highly successful franchisors empower franchisees to participate in the present and future direction of the system, while maintaining franchisor control over decision-making. When franchisees are not following the system, these franchisors ask the 'Why not?' question, rather than the more reflexive 'How dare they?' question.

Rule Number 2: Teach Your Children Well ' That Is, to 'Write Smart'

Sometimes how a franchisee-v.-franchisor lawsuit ends (or indeed whether it ever escalates from a business disagreement into a lawsuit) can turn on the language used in an agreement, a system communication, letter correspondence, or an e-mail. Many different individuals may communicate for a franchisor to franchisees, typically without much forethought about the impact of those communications. For example, how many times do franchisor representatives: 1) write communications for posturing purposes rather than finding common ground, or 2) fail to recognize that recollections of a conversation or event are not the truth, but rather an interpretation of the truth?

Harsh words from a franchisor representative in the heat of the moment are likely to create hard feelings by the franchisee. When those harsh and spontaneous words are memorialized in writing ' even in an e-mail message intended to be something less than 'on the record' ' they can speed the breakdown of a relationship and cause problems for the franchisor (and its lawyers) in the resulting litigation.

Lawyers understand the importance of the words, and they are trained to select words carefully in the contracts and briefs they write or the oral arguments they make. And while top franchisor management may habitually exercise the same care, those instincts are not necessarily present with all who communicate on the company's behalf. Franchisors and their lawyers need to emphasize to all potential communicators the importance of 'smart writing.' The stakes are simply too high to be careless, sloppy, or impulsive. Of course, everyone on the franchisor side would much prefer creating an 'exhibit that wins the case' rather than 'loses that case.' But businesspeople, preoccupied with meeting that day's business challenges, are not always thinking that way.

Emphasize smart writing every day, not on the eve of litigation. We recommend providing writing training to all franchisor representatives, including the CEO and senior management, that is similar to franchise sales training or franchise legal compliance programs. For the smart-writing trainers (optimally the franchisor's lawyers, whether outside or in-house) the exercise can double as a great opportunity to make friendly contact with all of the company's potential future witnesses, and to learn much more about the company's business.

We are not suggesting that franchisors do anything underhanded when following smart-writing principles. If a franchisor has a problem, it should address it. The proper way to address the problem, however, is not an e-mail chain with dozens of people copied ' many of whom feel the need to 'C' their own 'A's on the issue. 'CYA memos' too often begin a round-robin blame game inside the company: Operations blames marketing, which blames development, which blames operations, and round and round.

General smart-writing rules include:

• Don't write any unsolicited (or even solicited) opinions on any issue. Stick to the facts. When opinions are solicited, deliver them face-to-face when possible, and certainly not by e-mail.
• Recognize that e-mails, especially responsive ones, are often drafted casually and emotionally, with some mysterious and powerful impetus to launch themselves into cyberspace immediately ' as if the social norms of conversation (such as 'long pause = rudeness') applied. Urge all communicators to let their drafted e-mails to franchisees sit unsent for a few hours, with a final review before transmission.
• Strive constantly to mean what you communicate and communicate what you mean. A franchisor should not try to bluff a franchisee by sending a message it doesn't intend to follow-through upon. Successful franchisors trade in franchisee trust, which is easily squandered if franchisees are unsure whether a franchisor's words truly mean anything.

Rule 3: Include a (Facially Symmetrical) Arbitration Clause That Works for Your System

Franchisors can control the parameters of their lawsuits with franchisees ' and they may even be able to deter some litigation ' if they fully exercise their option to include a comprehensive dispute resolution provision in their franchise agreement. Some franchisor lawyers (including some of the authors) are less than fully enthusiastic about arbitration as it is most typically conducted; that is, by one of the large arbitration agencies under cookie-cutter contract provisions. In that context, the utility, speed, and cost-effectiveness of arbitration over court litigation is sometimes more theoretical than real. Still, there is no disputing that a thoughtful and comprehensive alternative dispute resolution provision in the franchise agreement ' if informed by a franchisor's clear view of what kind of process will work to its benefit ' is of significant value.

The ideal dispute resolution clause will always read symmetrically; its provisions will be, in theory at least, of possible benefit to either the franchisee or the franchisor (or both). But in crafting such a clause a franchisor can preserve the ground rules that it believes will serve it most favorably, given the realities of its system and the likely context of the dispute. Each particular franchisor should consider:

• Dictating the number, scope, and timing of any mandatory settlement or mediation steps before the arbitration hearing;
• Controlling the locale (typically your home state), format (length of hearing; number of arbitrators), and process (limits and logistics of testimony and other evidence) of the arbitration hearing itself;
• Limiting the fight to only this franchisee by precluding class actions or any joinder of these claims with others;
• Outlining the arbitrator qualifications and other steps to secure the decision-maker(s) the franchisor wants;
• Tailoring the pre-hearing steps (documents, written discovery, depositions, experts, dispositive and other motions) to secure the most favorable parameters for the anticipated disputes;
• Specifying the relief (including interim injunctive relief) that may be sought elsewhere, as well as the relief (types of damages, costs, attorneys' fees) that the arbitrator(s) may award; and
• Creating a post-hearing review or appeal process more extensive than the Federal Arbitration Act ('FAA') provides.

One important caveat to all this: A generation of firmly entrenched pro-arbitration bias (extant in all courts since the Supreme Court's 1980s-era FAA decisions) now shows signs of slippage, to a degree that has yet to be fully determined. First, at least in some western states, the Ninth Circuit's Nagrampa decision casts doubt on the routine enforceability of franchise agreement arbitration clauses, at least the ones asymmetrically tilted in favor of the franchisor. Second, The Arbitration Fairness Act currently alive in Congress seeks to void pre-dispute arbitration provisions in a number of industries, including franchising, by enforcing agreements to arbitrate only in the limited context where franchisor and franchisee ' after the dispute arises ' agree to arbitration. Third, the viability of arbitration clauses that call for some enhanced level of post-decision review is in doubt pending the Supreme Court's forthcoming decision in Hall Street Associates, LLC, v. Mattel, Inc.

Nonetheless, the comprehensive, intentional, and evenhanded dispute resolution clause will likely remain an important tool for franchisors in controlling litigation risks.

Next month's installment will discuss the remaining Seven Rules to reduce litigation risks.

John Edward Connelly, William L. Killion, and Brian B. Schnell are partners in the Minneapolis office of Faegre & Benson, LLP. They can be contacted by phone at 612-766-7000.