For individuals looking to own their own businesses, the franchise model can provide a good opportunity. Franchising offers many advantages over starting a business from scratch, but the franchise relationship is fraught with potential pitfalls as well. The contract between franchisor and franchisee can contain provisions that favor the franchisor to the franchisee’s detriment, and that can have a significant impact on future litigation between the parties.
Advantages and disadvantages of the franchise relationship
In a franchise arrangement, a franchisee typically pays an initial fee and ongoing royalties to a franchisor in exchange for the ability to use the franchisor’s trademarks, its system of operation, sell the franchisor’s products/services, and obtain the franchisor’s ongoing support. According to Entrepreneur, a primary advantage of this arrangement is the reduction of risk resulting from the right to use proven business systems, trademarks and products/services. Other advantages include access to national and local advertising and financial assistance.
The primary disadvantages of the franchise relationship arise from the control the franchisor may exert over the franchisee through the franchise agreement. And when disputes between the parties arise, the franchise agreement may limit the franchisee’s options for enforcing its rights.
Franchise agreements often contain provisions limiting a franchisee’s right to sue the franchisor. Some of these provisions include:
- Mandatory arbitration clauses, which may preclude litigation and require all disputes to be submitted to binding arbitration;
- Forum selection clauses, which may require any lawsuits to be filed in a venue convenient for and favorable to the franchisor;
- Clauses that may limit the amount of damages available to a franchisee; and
- Clauses that may waive a franchisee’s right to a jury trial.
Litigation between franchisees and franchisors
Franchisees often bring the following claims against franchisors:
- Earnings claims: The Federal Trade Commission’s Franchise Rule requires franchisors to provide potential franchisees with extensive information about the franchise under consideration, which may include projections about the franchise’s earning potential. If the franchise fails to live up to this potential, the franchisee may sue. However, certain language in the franchise agreement can be interpreted to bar such suits where the agreement disclaims any promises about future earnings.
- Encroachment: If a franchisor sells a new franchise too close to a current franchisee’s location, the existing franchisee’s business may suffer. Often, the franchise agreement will explicitly deny the franchisee the right to an exclusive territory and allow the franchisor to expand at will. A franchisee, however, may base a claim on the implied covenant of good faith and fair dealing contained in all contracts, arguing that the franchisor should not be allowed to put the franchisee out of business regardless of the language in the contract.
Potential legislation in Pennsylvania
Pennsylvania currently has no statutes that specifically govern the franchisor/franchisee relationship. That may change, however, as the Legislature is currently considering HB 1346, the Responsible Franchise Practices Bill. Noting that existing law does not do enough to protect franchisees from the unfair practices of franchisors, the bill’s sponsor says that its goal is to “provide a framework for fair, equitable and responsible franchise practices.”
Consult a Philadelphia business lawyer
The commercial litigation lawyers of The Kim Law Firm, LLC are experienced at representing businesses in a wide variety of civil litigation matters. We accept cases on a nationwide basis, and we work tirelessly to resolve matters in the best interests of our clients. If you have questions about a franchise agreement, or are in a dispute with a franchisor, contact us for a consultation today.