Managing 'Perfect Storm' Litigation for a Franchise System

1. Identify that the confluence of the litigation and other events creates a perfect storm environment. Management's recognition that the litigation is extraordinary is key. The perfect storm will be apparent in some circumstances, such as when the system is suddenly confronted with an unpredictable judgment large enough to be fatal to the system. The crisis will be less obvious and unpredictable in other circumstances, such as when the perfect storm is the confluence of litigation and multiple, exogenous forces, such as dramatic changes in the system's market or new governmental regulations.

2. Create a litigation management team that includes trial counsel, inside counsel, and management. When the franchisor's existence is threatened, day-to-day decision-making becomes more significant, and management must be deeply involved. A litigation management team should be responsible for managing the perfect storm litigation, updating the plan and goals in the litigation, and coordinating with others in management, when necessary.

3. Create a special litigation plan. One of the first tasks of the litigation management team is the creation of a plan for the litigation. While trial counsel always has a plan for litigation, perfect storms require a different scope of planning that includes the roles of the team members, a litigation timetable, the goals for the litigation, and the specific means of achieving those goals.

4. Continuously update the special litigation plan. While attorneys always recognize that plans will be updated as circumstances change in the case (such as when the court issues a key ruling), when the franchisor's existence is at risk, it is not sufficient to wait for major events in the case to make changes in the plan. The special litigation plan should be updated continuously, even daily, with the updates communicated among the litigation management team and to the rest of management, when appropriate.

5. Seek third parties to fund or indemnify for the litigation. Whenever a franchisor is sued, trial counsel and management should seek third parties, such as insurance companies, to fund the defense of the litigation and the payment of a judgment. In a perfect storm setting, the potential for a third party paying defense costs or a judgment is more significant. Coverage litigation may be necessary in order to preserve the system. The team managing the litigation should consider employing coverage counsel with the expertise and the focus on evaluating, prosecuting, and obtaining insurance coverage. Coverage litigation involving the system's insurer may be necessary, given the down-side risks in a perfect storm. In this setting, coverage questions typically will arise out of the particular policy language in the multiple primary and excess insurance policies implicated by the litigation.

6. Identify and evaluate alternative settlement options. In routine litigation, the franchisor may not have a need or motivation to explore settlement procedures beyond the normal settlement conference in court or private mediation. However, when the company's existence is at risk, then the litigation management team should look more deeply and creatively at alternatives. These might include alternative procedures or methods of settlement other than the payment of a fixed-dollar amount to the plaintiff. It is a mistake to limit settlement to a private mediation in perfect storm litigation.

7. Take into account the possibility that the plaintiff will never settle. It is common for trial counsel to assume that a case will settle because more than 90% of cases are settled. However, the franchisor cannot handle perfect storm litigation based on assumptions, because statistics oftentimes do not apply to extraordinary cases. Also, given the potentially devastating impact of an adverse ruling, relying on the likelihood or the possibility of settlement is not prudent.

8. Prepare for worst-case scenarios, such as bankruptcy and claims by franchisees and third parties. Even though an adverse judgment in perfect storm litigation could be uncertain and not final for several years, the litigation management team should identify and prepare for worst-case scenarios that may arise from the judgment. For instance, if the system would be unable to pay a large impending judgment, then the team should consult with bankruptcy counsel and explore other actions that may be necessary if the potentially fatal judgment is entered. Other and new claims against the system that could arise out of the litigation should be considered as well, such as claims by franchisees, individually or collectively, contending that an adverse judgment against the franchisor has devalued their franchises.

9. Prepare to advise management to make dramatic changes in the company's business. A system's routine litigation will not implicate the basic business operations of the system and its franchisees, but perfect storm litigation may. The team should be evaluating options and preparing to recommend fundamental changes to the company's operations, such as changing the mix of the system's basic goods and services, how the system's goods and services are marketed, or how new franchisees are recruited and brought into the system.

10. Focus on the system's primary goal. Oftentimes the goal in perfect storm litigation is not “winning” the case, but rather the survival of the system and its fundamental business and structure, while minimizing the costs and damage to the system that are necessary to achieve that goal. Survival of the system is not a common goal for trial counsel. Trial counsel is accustomed to the goal of “winning” the case. The litigation management team should focus its efforts, including trial counsel's, on avoiding an adverse ruling that will irreparably damage the system and minimizing the costs to the system in doing so.

Jeffrey L. Fillerup is a partner with McKenna Long & Aldridge LLP in San Francisco. He can be contacted at [email protected]. James A. Goniea is vice president and general counsel of American Driveline Systems, Inc. He can be contacted at [email protected].

A “perfect storm” is a detrimental or calamitous situation or event arising from the powerful combined effect of a unique set of circumstances. A confluence of events, including major litigation against the franchisor, can create a “perfect storm” setting for a franchise system. In this setting, the franchise system may find itself in a no-win situation in which all potential solutions or avenues of escape lead to a result that is tantamount to death of the system: bankruptcy, closure of the system, or a dramatic change in the system's business and sources of revenue. When the litigation cannot be settled or otherwise resolved, management of the franchise system and counsel must take extraordinary steps to manage and solve the problems.

A hypothetical example of perfect storm litigation is a system that relies on a group of patents that provides franchisees with a competitive advantage in the system's market. Patent litigation is instigated by a national competitor that asserts infringement claims based on its own patents and also seeks to invalidate the system's primary patents based on inequitable conduct when the patent applications were first filed. While there is often significant uncertainty in patent litigation, the franchise system being sued might be facing a perfect storm if it cannot settle. A jury trial that results in a judgment in favor of the plaintiff and invalidity of the system's patents may be a risk the system cannot take.

Below are 10 litigation management measures that outside counsel and the system should take to manage perfect storm litigation.

1. Identify that the confluence of the litigation and other events creates a perfect storm environment. Management's recognition that the litigation is extraordinary is key. The perfect storm will be apparent in some circumstances, such as when the system is suddenly confronted with an unpredictable judgment large enough to be fatal to the system. The crisis will be less obvious and unpredictable in other circumstances, such as when the perfect storm is the confluence of litigation and multiple, exogenous forces, such as dramatic changes in the system's market or new governmental regulations.

2. Create a litigation management team that includes trial counsel, inside counsel, and management. When the franchisor's existence is threatened, day-to-day decision-making becomes more significant, and management must be deeply involved. A litigation management team should be responsible for managing the perfect storm litigation, updating the plan and goals in the litigation, and coordinating with others in management, when necessary.

3. Create a special litigation plan. One of the first tasks of the litigation management team is the creation of a plan for the litigation. While trial counsel always has a plan for litigation, perfect storms require a different scope of planning that includes the roles of the team members, a litigation timetable, the goals for the litigation, and the specific means of achieving those goals.

4. Continuously update the special litigation plan. While attorneys always recognize that plans will be updated as circumstances change in the case (such as when the court issues a key ruling), when the franchisor's existence is at risk, it is not sufficient to wait for major events in the case to make changes in the plan. The special litigation plan should be updated continuously, even daily, with the updates communicated among the litigation management team and to the rest of management, when appropriate.

5. Seek third parties to fund or indemnify for the litigation. Whenever a franchisor is sued, trial counsel and management should seek third parties, such as insurance companies, to fund the defense of the litigation and the payment of a judgment. In a perfect storm setting, the potential for a third party paying defense costs or a judgment is more significant. Coverage litigation may be necessary in order to preserve the system. The team managing the litigation should consider employing coverage counsel with the expertise and the focus on evaluating, prosecuting, and obtaining insurance coverage. Coverage litigation involving the system's insurer may be necessary, given the down-side risks in a perfect storm. In this setting, coverage questions typically will arise out of the particular policy language in the multiple primary and excess insurance policies implicated by the litigation.

6. Identify and evaluate alternative settlement options. In routine litigation, the franchisor may not have a need or motivation to explore settlement procedures beyond the normal settlement conference in court or private mediation. However, when the company's existence is at risk, then the litigation management team should look more deeply and creatively at alternatives. These might include alternative procedures or methods of settlement other than the payment of a fixed-dollar amount to the plaintiff. It is a mistake to limit settlement to a private mediation in perfect storm litigation.

7. Take into account the possibility that the plaintiff will never settle. It is common for trial counsel to assume that a case will settle because more than 90% of cases are settled. However, the franchisor cannot handle perfect storm litigation based on assumptions, because statistics oftentimes do not apply to extraordinary cases. Also, given the potentially devastating impact of an adverse ruling, relying on the likelihood or the possibility of settlement is not prudent.

8. Prepare for worst-case scenarios, such as bankruptcy and claims by franchisees and third parties. Even though an adverse judgment in perfect storm litigation could be uncertain and not final for several years, the litigation management team should identify and prepare for worst-case scenarios that may arise from the judgment. For instance, if the system would be unable to pay a large impending judgment, then the team should consult with bankruptcy counsel and explore other actions that may be necessary if the potentially fatal judgment is entered. Other and new claims against the system that could arise out of the litigation should be considered as well, such as claims by franchisees, individually or collectively, contending that an adverse judgment against the franchisor has devalued their franchises.

9. Prepare to advise management to make dramatic changes in the company's business. A system's routine litigation will not implicate the basic business operations of the system and its franchisees, but perfect storm litigation may. The team should be evaluating options and preparing to recommend fundamental changes to the company's operations, such as changing the mix of the system's basic goods and services, how the system's goods and services are marketed, or how new franchisees are recruited and brought into the system.

10. Focus on the system's primary goal. Oftentimes the goal in perfect storm litigation is not “winning” the case, but rather the survival of the system and its fundamental business and structure, while minimizing the costs and damage to the system that are necessary to achieve that goal. Survival of the system is not a common goal for trial counsel. Trial counsel is accustomed to the goal of “winning” the case. The litigation management team should focus its efforts, including trial counsel's, on avoiding an adverse ruling that will irreparably damage the system and minimizing the costs to the system in doing so.

Jeffrey L. Fillerup is a partner with McKenna Long & Aldridge LLP in San Francisco. He can be contacted at [email protected]. James A. Goniea is vice president and general counsel of American Driveline Systems, Inc. He can be contacted at [email protected].