Franchise networks are not immune from disputes. Typically, actions commenced by a franchisor against a franchisee involve one or more of the following areas: unpaid royalties, advertising contributions, or other fees; in-term or post-term non-compete provisions; use and disclosure of confidential information; failure to report revenue in order to artificially reduce royalties; compliance with applicable law and system standards, including standards relating to quality, cleanliness, health, safety, and welfare of customers; and post-termination de-identification and closure of the
franchised unit. Typical claims asserted by franchisees against their franchisor concern failure to provide support, territorial encroachment, violation of applicable state registration and disclosure statutes, violation of applicable franchise relationship laws, wrongful termination or nonrenewal, and the ever-popular breach of the implied covenant of good faith and fair dealing. With this background, based on our experience as a law firm focused on franchising for over 40 years, we present here some thoughts on how best to represent a franchisor at trial.
1. Educate the judge about franchising. Although franchising is ubiquitous in the modern economy, the legal aspects of the relationship are not well known by most people — including attorneys and judges. Popular misunderstandings in the news media abounded, for example, in the early days of the COVID-19 pandemic, when new organizations drew no distinction between large franchisors of brands and the small business franchisees who benefited from PPP loans. Indeed, even judges presiding over commercial cases are rarely presented with sophisticated franchise-specific cases for trial, and in virtually no court in the country is there a judge who routinely hears franchise cases. As a result, while a judge may be competent and even sophisticated in his or her understanding of general commercial law, it is unlikely that the judge has a sophisticated understanding of the legal and business underpinnings of a franchise relationship. Because these legal and business issues will be central to nearly every trial between a franchisor and its franchisee, counsel must take every opportunity to educate the judge in advance of and during trial. Counsel must communicate to the judge the applicable statutory framework in which the parties’ franchise agreement arose; the existence of and content of the franchisor’s legally required pre-sale disclosure document and the parties’ franchise agreement; the nature of the “control” exerted over the franchisee by the franchisor to protect its trademarks and system; the franchisor’s responsibility to maintain and enforce its uniform standards throughout the system for the benefit of the franchisor and all other franchisees; the impact that noncompliance with the system by a franchisee has on the entire system and all of the franchisees within it; and, the impact that an adverse determination of the issues presented at trial will have on the franchisor, its system, and its remaining franchisees. The tricky part is doing so quickly, effectively, and early on in the trial and the process leading up to it. Franchisor counsel should seek to educate the court on these principles, as applicable, from the very beginning of the action through trial, including, as appropriate, through pleadings, motions to dismiss or for summary judgment (or both), motions in limine, pretrial memoranda, opening statements, testimonial evidence, closing statements, and post-trial memoranda.
2. Educate the jury about franchising. Although one has a much shorter time period in which to accomplish this goal, it is likewise crucial to educate the jury, if there is one, about the fundamental legal and business underpinnings of the franchise relationship. To the extent counsel participate (either directly or indirectly through the submission of voire dire questions to the court), jury selection is a good opportunity to begin to educate potential jurors about the nature of the parties’ franchise relationship.
Certainly, in opening argument, franchisor counsel should explain the nature of the franchise relationship, generally, and the nature of the relationship between the parties. Counsel should emphasize, when applicable, that the franchisee was duly disclosed well in advance of the franchise sale with a Franchise Disclosure Document (FDD) (which imparts virtually all information a prospective franchisee would find material to its investment decision) and a sample franchise agreement, and that the franchisee then reviewed and signed the franchise agreement, which established the entirety of the parties’ rights and obligations with respect to each other (to the extent not superseded by statute). Counsel’s description of the parties’ franchise relationship in the opening statement is the prism through which all of the testimony and evidence received at trial will be viewed by the jury. In addition, it is important for franchisor counsel to inform the jury at the outset that this case affects not only the franchisor and the franchisee in the courtroom but also the entire franchise system, specifically the entirety of all other franchisees that have made substantial investments in, and earn their living from, the franchised system.
In the field of franchising, our firm mainly represents franchisors, including at court. In doing so, we have seen time and again the importance of moving away from the “David versus Goliath” stereotype and getting the jury to understand that an adverse verdict will affect not merely the impersonal franchisor entity but also numerous other franchisees who support and indeed constitute the franchise system. In other words, franchisor counsel should make very clear to the jury that its verdict will affect the entire franchised system and not merely the (perhaps sympathetic) individual franchisee sitting in the courtroom.
3. Use experts at trial. We believe it is essential to provide expert testimony at trial concerning the unique nature of the franchise business relationship. Independent experts can provide compelling information about the structure of the franchise relationship and the effect of the dispute on the entire franchise system. Further, jurors view such experts as independent from, and not beholden to, the franchisor offering the testimony at trial.
4. Present evidence of the applicable franchise agreement provisions forcefully. Typically, particular terms and conditions set forth in the parties’ franchise agreement will be compelling, if not controlling, evidence in a franchisor-franchisee dispute. Also typically, because these agreements are drafted by the franchisor, they quite often favor the franchisor’s position. However, handing a 50-page, single-spaced franchise agreement to a juror is not compelling. For that reason, we would suggest that counsel use whatever presentation methods are available to bring attention to the specific franchise agreement provisions applicable to the issues presented at trial. There are several ways to bring attention to the provisions at issue: having a physical enlargement of the provision on an easel in the courtroom; presenting the provision on a large screen, with the ability to highlight, blow up, and otherwise manipulate the controlling language; and providing a hard copy of the agreement with applicable provisions highlighted. Remember, the average attention span of most jurors—indeed, most citizens—is decreasing, and their familiarity with viewing information on screens in increasing. We strongly encourage the use of visual presentations, even when presenting the otherwise dry evidence of the terms and conditions of the franchise agreement.
5. Cross-examine the franchisee’s principal and operators. Obviously, the nature of the cross-examination of the franchisee’s principal and operators is somewhat dependent on the issues presented in the case. Franchisor counsel need to elicit appropriate testimony concerning the breach of the parties’ franchise agreement or other wrongful act or omission from which the action arose. However, in nearly all cases, it is critical to establish in the mind of the judge and jury that the franchisee is not a poor, defenseless individual in battle with a huge franchisor entity of unlimited resources such that the franchisee should not be held responsible for all of the terms and conditions contained in the lengthy franchise agreement prepared by the franchisor and imposed on the poor franchisee on a “take it or leave it” basis.
One way to do that is to demonstrate, through cross-examination testimony, the nature of the offer and sale of a franchise. As noted above, federal and state law requires a franchisor to prepare and deliver an FDD to the prospective franchisee in advance of the execution of the franchise agreement. The FDD contains a detailed description of the franchise system and the parties’ respective rights and obligations under the offered franchise agreement. The FDD also attaches a copy of the proposed franchise agreement and any other agreements to be entered into by the prospective franchisee. Thus, at trial, a franchisor counsel should ask the franchisee whether:
- The franchisee received the FDD;
- Whether the franchisee read the FDD;
- Whether the FDD disclosed facts relevant to the dispute (identifying such relevant disclosures for the jury);
- Whether it attached the prospective franchise agreement;
- Whether the franchisee actually read the attached specimen franchise agreement;
- Whether the franchisee thereafter received the actual franchise agreement from the franchisor;
- Whether the franchisee read and reviewed the franchise agreement and whether he or she reviewed it with an advisor or attorney; and
- Whether the franchisee signed the franchise agreement.
While written, signed acknowledgments about these sorts of facts were previously quite common in franchise agreements, they have now become much less common in the wake of the North American Securities Administrators Association (NASAA) commentary on franchise acknowledgments and questionnaires, as laid out in its Sept. 18, 2022 Statement of Policy Regarding the Use of Franchise Questionnaires and Acknowledgments. However, such acknowledgments may still be elicited in the context of a trial. In any event, the FDD and the parties’ franchise agreement should be extensively reviewed during cross-examination of the franchisee, both to educate the judge and jury on their contents and to establish that the franchisee has a certain level of sophistication and awareness of the terms and conditions they contain.
6. Introduce graphic evidence of noncompliance in standards cases. One of the most important things a franchisor can accomplish at trial is to enforce system-wide standards of operation, because uniformity of operation under the franchisor’s trademark is the foundation of a successful franchise system (and a lack of uniformity is the beginning of the end of an unsuccessful system). The system-wide standards are often comprehensive and extremely detailed, and when a franchisee materially disregards the proffered standards of operation, a franchisor must be prepared to take any and all steps necessary to obtain compliance, including termination (which often results in litigation and ultimately a trial concerning the franchisee’s noncompliance).
At the trial, the franchisor must be prepared to present graphic evidence of the franchisee’s noncompliance to justify termination. When the noncompliance materially affects the franchisee’s ability to comply with its obligations under the franchise agreement and, even more compellingly, when it adversely affects the consuming public’s perception of the franchised location (and therefore all locations within the franchise system), termination is justified. In such circumstances, it is trial counsel’s responsibility to present evidence at trial to persuade the judge and jury that the noncompliance not only constitutes a material breach of the parties’ franchise agreement but, left unchecked, will materially and adversely affect the entire franchised system.
As a result, if a franchisee has failed the franchisor’s routine inspections or has failed a department of health or other governmental agency inspection, the franchisor must gather vivid evidence of such noncompliance. Testimony and reports by independent inspectors, health department officials, and the franchisor’s managers must be presented, together with photographic or video evidence of noncompliance. In such cases, pictures are indeed worth a thousand words, and video even more so. Also, the franchisor should present detailed operational standards, usually set forth in its operations manual and other materials delivered to the franchisee, and tie those obligations directly to provisions in the franchise agreement. Finally, franchisor counsel should present the testimony of other, nearby franchisees that the adverse publicity and customer experience in the noncompliant franchisee’s location has directly and adversely affected their businesses.
If you would like to discuss litigation regarding franchise matters from the franchisor’s perspective, please reach out to us.* Call Kevin M. Shelley at 212-705-0814 or email [email protected].
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