Three Types of Franchise Risk

January 22, 2018

The franchise model offers unique benefits for both the franchisee and the franchisor. The franchisee gets to own and operate an independent business. The franchisor gets to grow the brand and earn another stream of income. But these rewards come with risks.    

Reputational Damage

Franchisees are investing in a business model, but they’re also investing in a reputation. Likewise, franchisors are depending on the franchisee to maintain that reputation. When one party does something that damages this reputation, both parties can suffer.

Because many franchises are restaurants, food poisoning is a major concern. If one location’s poor standards result in illness, many customers will associate all locations with food poisoning, even if those locations are separately managed.  

Reputational damage is not limited to food quality, however. As Hurricane Irma approached Florida, a Pizza Hut manager sent a notice to employees informing them that they were required to show up to their shifts despite evacuation orders. When this got out on social media and various news outlets, people were outraged. Pizza Hut responded with a statement clarifying that this was not in line with the company’s policy and that the local franchise operator had addressed the situation.  

Reputational damage is bad enough, but missteps can also result in legal battles. If a franchisee is sued, the franchisor may be held accountable due to the standard of vicarious liability.

Joint Employer Liability

Labor violations have proven to be an especially complicated issue for franchises. When a franchisee is accused of violating labor laws, the franchisor might be on the hook. However, the standards used to determine whether a franchisor is a joint employer keep changing.

In 2014, The National Labor Relations Board (NLRB) determined that McDonald’s was a joint employer in complaints against McDonald’s franchises. In other words, the franchisor was partially responsible for the employment practices of the franchisees.

In 2015, the NLRB revised its standard for joint employer status. According to a statement from the NLRB, “Two or more entities are joint employers of a single workforce if (1) they are both employers within the meaning of the common law;  and (2) they share or codetermine those matters governing the essential terms and conditions of employment.”  

On December 14, 2017, the NLRB announced that it had overruled the previous decision and reinstated prior joint employer standards. As a result of this decision, entities are considered to be joint employers “if there is proof that one entity has exercised control over essential employment terms of another entity’s employees.”

FDD Compliance Issues

Under the Federal Trade Commission’s Franchise Rule, franchisors must provide a Franchise Disclosure Document to potential franchisees before a contract is signed. This document contains detailed information about the franchise, including its litigation history, financial performance, advertising requirements and training requirements.

This document is important for both parties.

The franchisor must provide all the required information, and that information must be accurate and complete.

The franchisee, on the other hand, is expected to review the document carefully, and business decisions should be based on the information within. This became a crucial point in one lawsuit involving Big O Tires and a franchisee who claimed the company had used deceptive practices to entice him to purchase a franchise. Forward Franchising reports that the franchisee lost the lawsuit because the document provided by Big O Tires contained the necessary facts – and the franchisee had not read it.  

Limiting the Risks

Before entering into a franchise agreement, both parties need to understand the risks as well as the rewards. Heffernan’s Franchise Channel Division helps businesses manage franchisor-specific needs and risks. Learn more about the program here