Contract Litigation

In today's world, where it's more competitive than ever to be a franchisor or franchisee, there is now one more thing to worry about: contract litigation. It is more prevalent, complicated, and prohibitive ' and worse yet, according to the Bureau of Justice Statistics of the U.S. Department of Justice, one-in-three plaintiffs (33%) lose their contract disputes at trial. From construction contracts, to supply contracts, to equipment leases, franchisors and franchisees might face the problem of litigating numerous legal disputes simultaneously. This, of course, can be devastating for a business, whether big or small. So what can you do to avoid these pitfalls?

First, know your risks. Too often, both franchisors and franchisees assume they are exempt from certain liabilities. Take the recent decision in Massachusetts against the franchisor Coverall North America, Inc., a national commercial cleaning service. It chose to pursue a business model that treated its franchisees as independent contractors, reducing its costs and increasing flexibility, but a U.S. district court judge disagreed. Of course, many have argued that the judge's ruling was overreaching; nevertheless, Coverall was exposed to significant risk.

Beyond employment and compensation issues, another common area of poor risk management is arbitration clauses. While found in many contracts, such clauses do not guarantee you won't end up court. For example, the Ninth Circuit in Nagrampa v. Mailcoups Inc., 469 F.3d 1257 (2006), found that an arbitration between a franchisor and a franchisee was both procedurally and substantively uncontainable.

Regardless of the validity of the Coverall ruling or the specifics of an individual arbitration clause, the point remains the same: The better you understand your risk exposure as a franchisor or franchisee, the less likely you are to end up with liability.

Another development altering the risk landscape for franchisors and franchisees is the growth of predominately “loser pays” jurisdictions and the spread of “loser pays” or prevailing party provisions. (Loser pays provisions are, of course, borne out of the English model, where the plaintiff is required to pay the adversary's legal fees in the case of an adverse ruling.)

Numerous mini “loser pays” systems are emerging in the United States, such as in Oregon and Alaska. As a result, a franchisor with a regional footprint needs to be aware of the full extent of its liabilities if it sues a franchisee and loses. Similarly, franchisees should take the existence of “loser pays” systems into account when deciding to do business. Regrettably, both the legal and business communities have been paying little attention to this steady but significant change to American legal habits. Some would argue this trend discourages frivolous claims, and while that would be a positive outcome, it still remains an area of risk exposure.

How to Hedge Against Risk

As any good businessman knows, effectively managing your risk can be the difference between a profitable and unprofitable year. There are several steps that franchisors and franchisees can take to increase the chances of prevailing in suits. First, the importance of jurisdiction is often underestimated. If you are bringing a suit, is there a choice of where to file the case? Which courts are congested? What is a reasonable estimation for a time to trial? Which registration states are going to limit your venue to their courts? These facts are important to know, as an expedited resolution greatly reduces risk exposure compared to a far-off trial date.

Second, once a complaint has been filed and a judge assigned, it is crucial to learn as much about the jurist as possible. Obtain judicial profiles of your judge. Seek information from lawyers with experience litigating before your judge. It is also important to understand your judge's practices and attitude toward demurrers, summary judgment motions, motions in limine, and other critical pre-trial matters. Has your judge made prior rulings on the kinds of contractual disputes at issue? Are there any appellate decisions involving your judge's rulings at trial?

Third, research the elements of your claims and make sure you have the facts to satisfy each element. This may sound like “Litigation 101,” but in a franchise system that might be facing several litigation proceedings simultaneously, this can often get overlooked.

Lastly, staying up-to-date on the latest risk-management tools and best practices will ensure that franchisor and franchisee have all possible resources available at their disposal. For example, today there are insurance policies available to cover attorneys' fees awarded under “loser pays” provisions. This contract litigation coverage can be purchased within 60 days of the commencement of litigation and covers all attorneys' fees in an adverse ruling.

Franchisees and franchisors face risks on multiple fronts, including litigation. But by taking steps to prepare for and mitigate liability, the business will be in a better position to grow and thrive.

Kevin Martin is the founder and chief executive officer of Sonoma Risk Insurance Agency (http://www.sonomarisk.com/), a litigation insurance company based in Los Angeles. He is a former partner of Bingham McCutchen LLP and was senior counsel with the Securities and Exchange Commission Division of Enforcement.

In today's world, where it's more competitive than ever to be a franchisor or franchisee, there is now one more thing to worry about: contract litigation. It is more prevalent, complicated, and prohibitive ' and worse yet, according to the Bureau of Justice Statistics of the U.S. Department of Justice, one-in-three plaintiffs (33%) lose their contract disputes at trial. From construction contracts, to supply contracts, to equipment leases, franchisors and franchisees might face the problem of litigating numerous legal disputes simultaneously. This, of course, can be devastating for a business, whether big or small. So what can you do to avoid these pitfalls?

First, know your risks. Too often, both franchisors and franchisees assume they are exempt from certain liabilities. Take the recent decision in Massachusetts against the franchisor Coverall North America, Inc., a national commercial cleaning service. It chose to pursue a business model that treated its franchisees as independent contractors, reducing its costs and increasing flexibility, but a U.S. district court judge disagreed. Of course, many have argued that the judge's ruling was overreaching; nevertheless, Coverall was exposed to significant risk.

Beyond employment and compensation issues, another common area of poor risk management is arbitration clauses. While found in many contracts, such clauses do not guarantee you won't end up court. For example, the Ninth Circuit in Nagrampa v. Mailcoups Inc. , 469 F.3d 1257 (2006), found that an arbitration between a franchisor and a franchisee was both procedurally and substantively uncontainable.

Regardless of the validity of the Coverall ruling or the specifics of an individual arbitration clause, the point remains the same: The better you understand your risk exposure as a franchisor or franchisee, the less likely you are to end up with liability.

Another development altering the risk landscape for franchisors and franchisees is the growth of predominately “loser pays” jurisdictions and the spread of “loser pays” or prevailing party provisions. (Loser pays provisions are, of course, borne out of the English model, where the plaintiff is required to pay the adversary's legal fees in the case of an adverse ruling.)

Numerous mini “loser pays” systems are emerging in the United States, such as in Oregon and Alaska. As a result, a franchisor with a regional footprint needs to be aware of the full extent of its liabilities if it sues a franchisee and loses. Similarly, franchisees should take the existence of “loser pays” systems into account when deciding to do business. Regrettably, both the legal and business communities have been paying little attention to this steady but significant change to American legal habits. Some would argue this trend discourages frivolous claims, and while that would be a positive outcome, it still remains an area of risk exposure.

How to Hedge Against Risk

As any good businessman knows, effectively managing your risk can be the difference between a profitable and unprofitable year. There are several steps that franchisors and franchisees can take to increase the chances of prevailing in suits. First, the importance of jurisdiction is often underestimated. If you are bringing a suit, is there a choice of where to file the case? Which courts are congested? What is a reasonable estimation for a time to trial? Which registration states are going to limit your venue to their courts? These facts are important to know, as an expedited resolution greatly reduces risk exposure compared to a far-off trial date.

Second, once a complaint has been filed and a judge assigned, it is crucial to learn as much about the jurist as possible. Obtain judicial profiles of your judge. Seek information from lawyers with experience litigating before your judge. It is also important to understand your judge's practices and attitude toward demurrers, summary judgment motions, motions in limine, and other critical pre-trial matters. Has your judge made prior rulings on the kinds of contractual disputes at issue? Are there any appellate decisions involving your judge's rulings at trial?

Third, research the elements of your claims and make sure you have the facts to satisfy each element. This may sound like “Litigation 101,” but in a franchise system that might be facing several litigation proceedings simultaneously, this can often get overlooked.

Lastly, staying up-to-date on the latest risk-management tools and best practices will ensure that franchisor and franchisee have all possible resources available at their disposal. For example, today there are insurance policies available to cover attorneys' fees awarded under “loser pays” provisions. This contract litigation coverage can be purchased within 60 days of the commencement of litigation and covers all attorneys' fees in an adverse ruling.

Franchisees and franchisors face risks on multiple fronts, including litigation. But by taking steps to prepare for and mitigate liability, the business will be in a better position to grow and thrive.

Kevin Martin is the founder and chief executive officer of Sonoma Risk Insurance Agency (http://www.sonomarisk.com/), a litigation insurance company based in Los Angeles. He is a former partner of Bingham McCutchen LLP and was senior counsel with the Securities and Exchange Commission Division of Enforcement.