Franchising World: Avoid the Worst Through Collaboration

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For years, HR training has taught us that people typically do not wake up and say, “I think I will be at my worst today.” The same holds true for franchisees and franchisors. I have never met one franchisee whose goal it was to fail. And I have never worked with a franchisor that did not truly believe that it had/has a formula for success that it wants to share. I have also never worked for a franchisor or other attorneys who thought that issuing notices of default or termination should be their first position. However, as we have all experienced, things do not always go as everyone plans.

Whether or not things go as planned, developing processes and brand standards is critical to the success of the system, as is consistently enforcing those processes and standards. When planning, franchisors are at their best when all departments (legal, operations, marketing, training, HR, etc.) work together when developing processes or making decisions about certain legal requirements. This collaboration helps everyone understand the “why” behind the others’ requirements and requests – the role such processes and standards play in the success of the system. Having this information not only gives those who implement processes and enforce brand standards credibility when working with franchisees, but also helps the legal team understand the issues the business teams may be facing when attempting to enforce certain system requirements. With this knowledge, the franchisor’s legal team can review existing provisions in the franchise agreement and determine if language in future agreements should be changed, added, or deleted, with the goal being to protect the brand and the system, which is in the best interests of all stakeholders. Attorneys can also use the information it gains through collaboration when providing business teams a risk/reward analysis relating to system changes the franchisor wants to implement.

For example, I have never read a franchise agreement that did not contain a provision that requires franchisees to submit financial reports/statements to the franchisor on a monthly/quarterly/annual basis. I have also never worked with a franchisor that did not struggle to get franchisees to comply with this provision, and in some cases, simply give up trying. But this requirement is a good example of how planning for the best may help the system avoid the worst. It also demonstrates the importance of the collaboration the legal team should have with other departments.

Let’s elaborate on the example mentioned above and the link between enforcing a process or standard to avoid the worst and the benefits of the franchisor’s attorneys collaborating with the other business teams.

What is the standard/process? It is the provision in the franchise agreement that states that franchisees must provide the franchisor a complete set of financial statements within 30 days after the franchisees’ fiscal year end.

What is the “why” behind the requirement? Is it really important to the success of the system, or is it just something the attorneys said needed to be in the franchise agreement? Is it a data collection burden that the franchisor decides not to undertake? If the franchisor never collects the information or never looks at it, should the requirement be removed from the franchise agreement? Or does the “why” behind the requirement offer more to the system and deserve a closer look and better understanding by all stakeholders?

First, having the language does provide the franchisor legal leverage, if it needs it; so in some regard, it is just something the attorneys said needed to be in the franchise agreement. But unfortunately, sometimes the business teams need to reference this leverage in order to achieve certain goals. Franchisees often balk at giving franchisors their financial information for many reasons. Some franchisees do not prepare financial statements, or least not in a timely manner. Others do not want the franchisor or their own employees knowing the true financial strength or weakness of the business.

Why does the franchisor need this information? Having this information should help guide the franchisor when it is making systemwide decisions and changes, and can help everyone plan for, or in some cases avoid, the worst possible outcome.

There are many historical examples of franchisors requiring franchisees to undertake major branding and image overhauls, which resulted in bankrupt franchisees, or in some cases, an otherwise extremely financially weakened system. In these instances, the franchisors most likely had the long-term good of the system in mind — things do change and the way an outlet looks has to stay current with the times. However, had those same franchisors known the true financial health of the system, they may have chosen a more measured approach when implementing the changes; an approach that may have prevented a financial system meltdown. Could a financially devastating outcome have been avoided if the business teams and the legal team had worked together to ensure the consistent enforcement of the financial requirements provision and discussed the risks and rewards of moving forward with the reimaging program?

Additionally, not all franchises have the ability to drive top line revenue through national advertising or new product news. For these types of businesses, it benefits the franchisee, and ultimately the franchisor, to share its financial information with the franchisor so that the operations and marketing teams can provide the franchisee the targeted, hands-on support needed to increase revenue and/or “manage the middles” of the P&L. In this scenario, having the requirement and enforcing it can help the franchisee turn around a financially distressed business. If this help and support is the franchisor’s goal, and if the franchisee is not providing the needed information, is it in everyone’s best interests to issue the franchisee a notice of default and threaten termination of the franchise agreement? Or, is the system better off if the franchisor’s legal department and business departments collaborate to find a solution that avoids damaged relationships, legal wrangling, and attorneys’ fees?

The financial requirements provision discussed above is only one example of a legal provision being used to strengthen the system. Every franchise agreement has hundreds of provisions, but when the legal teams and the business teams collaborate, the chances for avoiding the worst case scenario for all involved dramatically increases.

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