10 Common Issues in Franchise Disputes

The most common franchise disputes involve breach of contract, franchise termination and non-renewal, intellectual property rights, territorial encroachment, royalty and fee payments, franchisor support obligations, and violations of state franchise laws such as the New Jersey Franchise Practices Act. Franchisors and franchisees can often resolve these conflicts by providing written notice detailing the dispute and desired outcome, followed by the dispute resolution procedures set out in the franchise agreement, which typically include mediation, arbitration, or litigation.

Key takeaways:

• Franchise agreements govern the relationship and cover IP rights, royalties, operational standards, territory rights, termination and renewal, and dispute resolution.
• State franchise laws can override the agreement itself; the NJFPA is among the most pro-franchisee statutes in the nation and requires good cause for termination or nonrenewal.
• Most disputes start with written notice and informal discussion before moving to ADR or litigation.

Understanding the Franchise Business Model

Franchising is a unique and often extremely lucrative business model. In a franchise, a business (the franchisor) licenses its brand and business methods to an individual or business entity operating within a specific territory or location (the franchisee). Under a franchising agreement, the franchisee agrees to operate its business in accordance with the contract. In return, the franchisor typically provides the franchisee with franchising support.

The franchisee generally pays the franchisor a one-time initial franchise fee, as well as a regular royalty fee for the use of the franchisor’s trade name and operating methods. The franchisee is responsible for the day-to-day management of its independently owned franchise and assumes the risk of loss associated with its performance.

Franchise agreements govern the relationship between franchisors and franchisees. These  complex contracts contain a variety of important provisions, including those governing:

• Intellectual property rights
• Marketing and advertising
• Royalties and fees
• Operational standards
• Termination and renewal
• Territory rights
• Dispute resolution

Before entering into a franchise agreement, both parties need to conduct thorough due diligence on each other and to have a clear understanding of their respective rights and obligations.

Common Franchise Disputes

A variety of conflicts often arise in the franchise relationship. Some of the most common include:

1. Breach of Contract

Disputes often arise when one party alleges that the other has breached the franchise agreement. Examples include failing to pay royalties, making unauthorized use of trademarks, failing to meet revenue goals outlined in the franchise agreement, or improperly terminating the franchise.

2. Franchise Renewal

Disputes often occur when the initial franchise term ends. Most franchise agreements give the franchisor significant discretion in deciding whether to renew. Often, however, state franchise law provides the franchisee with rights that may override the specific terms of the agreement. If the franchisee believes that a franchisor’s non-renewal decision is unreasonable, it can lead to a lawsuit.

3. Franchise Termination

Franchising agreements generally establish the grounds for terminating a franchise, such as an alleged breach. The agreements also outline the termination process that the franchisors must follow, including providing notice and an opportunity to cure the breach. Allegations of wrongful termination can arise if the franchisee challenges the alleged grounds for termination and/or compliance with the required termination process.

4. Fraud/Misrepresentation

Claims of fraud or misrepresentation can arise when one party believes the other provided false or misleading information, such as a franchisor exaggerating potential earnings or a franchisee misrepresenting its financial condition.

5. Intellectual Property

Disputes over intellectual property (IP) rights, including trademarks, trade secrets, and copyrights, are also common. Franchisors may allege infringement or unauthorized use of their IP, while franchisees may contend that the franchisor has improperly enforced its IP rights.

6. Territorial Disputes

Franchise agreements grant franchisees exclusive rights to a certain territory. Disputes can arise if a franchisor allows one franchisee to encroach on another franchisee’s territory.

7. Franchisor Support

Franchise agreements typically require franchisors to provide support, such as training, marketing, processes, or remodels. Issues arise when the franchisee believes the franchisor is failing to fulfill its obligations under the contract.

8. Royalties/Fees

Disputes over royalty payments, advertising fees, and other fees are common. Claims by franchisors include underreporting or non-payment, while franchisees might challenge the basis or calculation of these fees.

9. Supplier/Distribution

Franchise agreements typically require purchasing goods and services from approved suppliers. Disputes can occur if one party allegedly breaches these requirements or engages in unfair or anti-competitive practices related to suppliers/distribution.

10. Violation of Franchise Laws

Most states have regulations specifically governing the franchise business model. For example, the New Jersey Franchise Practices Act (NJFPA), which is one of the most pro-franchisee acts in the nation, regulates certain aspects of the relationship between franchisees and franchisors. For instance, the NJFPA provides that a franchisor may not terminate or refuse to renew a franchise absent good cause.

Resolving a Franchise Dispute

Franchisors and franchisees can both benefit from being proactive when a dispute arises. In most cases, the first step is to notify the other party in writing, detailing the nature of the dispute; the outcome you want; and what action will settle the dispute. As with any business dispute, focusing on the facts, rather than emotion, increases the likelihood of resolving the conflict amicably.

If informal discussions do not resolve the franchise dispute, your franchise agreement should outline the next steps. In many cases, the contract will require the parties to engage in a form of alternative dispute resolution (ADR), such as mediation or arbitration. If ADR is unsuccessful, your franchise agreement will also likely outline the next step in the process, which may be litigation.

Consult With an Experienced Franchise Attorney

A skilled franchise attorney can help you resolve franchise disputes before they cause significant issues for your business. At Scarinci Hollenbeck, we represent franchisors, franchisees, and other business owners in franchise and distribution disputes.

Our multidisciplinary Franchise & Distribution Group has successfully resolved disputes over ownership rights, distribution of franchise revenues and profit, Federal Trade Commission and other regulatory oversight issues, and franchise disclosure documents. Our clients operate across a wide spectrum of industries, including retail, restaurant and hospitality, childcare services, healthcare, and fitness.