Class Actions in Franchising: Strategic Considerations in Confronting System-Wide Disputes

 

Franchisee association leaders confront potential system wide disputes in many key areas such as:

  • Involuntary change to the brand, concept, or products
  • Merger or consolidation issues
  • Franchise agreement issues – interpretation of terms, or changes to the agreement over time
  • Advertising fund issues
  • Price gouging for mandated product purchases
  • Software issues, such as the failure of POS or reservation systems
  • Less tangible matters, such as a general failure to keep up with the competition

Note that this list focuses on issues most likely to affect existing franchisees, i.e. your constituent members, under their existing franchise agreements. Claims arising in the sales process, e.g. fraudulent inducement or registration/disclosure violations, may also be system-wide affecting franchisees that purchased in particular time periods.

What is the best way to proceed legally? There are three choices:

  • Class actions
  • Associations as the plaintiff
  • Test cases

Determining the best way to proceed involves questions of time, effect, and cost, as well as political considerations with respect to your membership:

  • What is the quickest way to resolve the problem?
  • What is the least costly way to resolve the problem?
  • What legal option offers the strongest potential impact?
  • What legal option will draw the greatest support from the franchisees?

 

I. CLASS ACTIONS

Advantages

  • Potentially the largest recovery on behalf of all affected franchisees
  • Potentially the greatest “buy in” from franchisees, who will be members of the class

Disadvantages

  • Increased prevalence of class action waivers
  • Selecting the best named plaintiffs
  • Costs of notice (possible shifting to defendant)
  • Delay and difficulty of obtaining class certification
  • Avoiding conflicts of interest by different subclasses
  • Pressure to settle by contingent fee attorneys

Class Action Certification Issues

  • Numerosity & Impracticability of Joinder (100+)
  • Commonality – the claims must depend on a common contention, the truth or falsity of which can be resolved the same way for each and every member of the proposed class.
  • Walmart v. Duke (U.S. Supreme Court, June 10, 2011)

Plaintiff employee claims for discriminatory employment decisions are not “common” where “the plaintiffs wish to sue about literally millions of employment decisions at once.”

  • The Walmart decision arguably does not affect franchisee claims where the claims arise out of common contract terms or common franchisor practices.
  • However, the questions of “individual reliance”, “individual impact” and “individual damages” might still remain.
  • Common issues must predominate over individual issues.
  • Differences in contract language from year to year must also be considered.
  • Typicality – similarity of legal theories and claims.
  • Adequacy of representation

 

II. ASSOCIATIONS AS PLAINTIFF

Advantages

  • Potentially the easiest case to manage

Disadvantages

    • Usually the Association cannot claim damages for its members. Claims for declaratory or injunctive relief are more appropriate.
    • Delay and difficulty establishing association standing:

(i) Whether the members of the Association would have standing to sue in their own names;

(ii) Whether the issues presented are germane to the Association’s purpose in protecting and enhancing the economic rights of its members; and

(iii) Whether the claims asserted or the relief requested by the Association requires the participation of individual members.

  • Franchisors are likely to question whether the Association truly speaks for “all” or “most” franchisees.
  • The courts have discretion to deny association standing for “prudential” reasons going beyond the three-part test above.

 

III. TEST CASES

Advantages

    • Avoids the procedural issues inherent in class actions or association plaintiff cases, hence, may be the quickest and most cost effective solution.
    • The principle of “offensive collateral estoppel” means that a franchisor can be bound by the result in one case, when other franchisees present similar claims.
    • Well-suited to renewal issues.
    • Well-suited to “individual impact” cases.
    • Franchisors are likely to react to these claims and even to potential claims – e.g. the Grill-n-Chill cases.
    • They may not give the association credit, but they will react!

Disadvantages

      • Selecting the right cases.
      • Getting a franchisee to step up to the plate.
      • Getting other franchisees to support the funding.
      • “Offensive collateral estoppel” after arbitration is generally not available.
      • Statute of limitations concerns.

 

IV. SOME RECENT 2011 SUCCESSES

A) Protection of Renewing Franchises and Franchisee Assets

In a successful regional lawn care system, the franchise agreements had historically provided that the franchisees themselves owned their customer lists, which is the most important asset of their business. In recent years the franchisor changed the franchise agreement to provide that the franchisor owned the franchisee’s customer lists. Long term franchisees coming up for renewal faced these new agreements, as they would be required to sign the “then current” franchise agreement as a condition of renewal.

Upon being retained, we created an independent franchisee association seeking a negotiated solution to protect the franchisee’s ownership of their customer lists. When the franchisor initially refused to negotiate, we filed suit on behalf of two “test case” franchisees alleging that the franchisor had breached its duty of good faith and fair dealing in purporting to require a renewing franchisee to sign a new franchise agreement that would result in the transfer of assets to the franchisor without consideration. After the briefing of cross-motions for summary judgment, the franchisor relented and agreed to new contract language for its renewing franchisees that would protect their equity in the value of their customer lists.

B) Win-Win Settlement for a National Brand Independent Franchisee Association

Following an evidentiary hearing and closing argument in arbitration as lead trial counsel, we have negotiated a win-win settlement that preserves the independent association’s ability to attend and monitor all meetings of the franchisee advisory council, which the franchisor sponsors, including the FAC’s private dinner meetings and or other executive sessions from which the franchisor had sought to exclude the association’s representative. This settlement achieves the association’s key goal of transparency, i.e. that all FAC activities must be transparent for the benefit of all system franchisees, thus creating “checks and balances” to prevent the franchisor from exercising undue influence over FAC members and to keep the FAC from becoming a rubber stamp.

C) Protecting Franchisees When The Franchisor Files Bankruptcy

When Giordano’s (a popular Chicago pizza restaurant brand) filed for bankruptcy protection due to financial problems being experienced by its shareholders, the majority of franchisees retained a bankruptcy counsel to protect their interests. The bankruptcy attorney then enlisted CDC to defend the franchisees from the Trustee’s complaint that the franchisees had failed to pay royalties and to allege counterclaims in the adversary proceeding, alleging that the franchisor had breached its contracts (and the duty of good faith and fair dealing) by requiring the franchisees to pay above-market prices to a franchisor-owned commissary for basic ingredients such as cheese, sauces and dough. In negotiating with the Trustee, a comprehensive settlement was reached whereby the franchisees will receive significant protection against unfair pricing including the freedom to shop elsewhere and to prepare their own sauces and dough. The franchisees also receive 10-year extensions of their franchise terms and reform of the advertising program.

Contact Us Today For A Confidential Assessment Of Your Case*

*Filling out this form does not establish a client attorney relationship.




[recaptcha]

Start typing and press Enter to search