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The Dangers of Noncompliance

Failing to make compliance a priority at the outset of a relationship can result in bigger issues later, some that can be insurmountable. 

Amy Cheng is a co-founding partner with the Chicago law firm of Cheng Cohen LLC and represents franchisors on the structuring and operation of their franchise programs through all phases of development.

Amy Cheng is a co-founding partner with the Chicago law firm of Cheng Cohen LLC and represents franchisors on the structuring and operation of their franchise programs through all phases of development.

New and emerging franchisors often rely, sometimes primarily, on selling franchises as a way to increase their unit count and grow their brands.  As a result, their focus can easily and understandably shift to training new franchisees, helping them get the new business up and running.  Once a franchise unit is open, however, one of the most important tasks for the franchisor is to ensure a consistent experience for consumers and that means enforcing compliance by franchisees with system standards.  This can be a challenge because it is easy for a franchisor to turn a blind eye to noncompliance while focusing on brand growth.  Failing to make compliance a priority at the outset of a relationship can result in bigger issues later, some that can even prove to be insurmountable.

Contractual Risks – Waiver of Rights

Franchise agreements are fairly universally written to allow the franchisor to control the brand, often giving the franchisor many more rights than it would normally expect to exercise.  Failing to enforce or inconsistently enforcing those rights can not only impact the brand itself, but also arm franchisees with claims of waiver, retaliation or discrimination.

The requirement to submit financial statements is a common example.  Even though franchise agreements typically require the franchisee to submit monthly financial statements, franchisors − particularly those with small support staffs − rarely enforce that obligation at the outset.  Since reviewing a franchisee’s financial statements is often the only way a franchisor is able to help the franchisee to increase profitability, there will likely come a time when the franchisor finds it important to ask for financials.  Having failed to require compliance with this obligation from the outset, the franchisor may be deemed to have waived such right, even in the face of a so-called “anti-waiver” clause.

Also, a franchisee who has not formed the habit of generating these financials and submitting them to the franchisor will likely view this as a “new” obligation and resist it, creating additional strain on what is probably, at this point, a tense relationship.  Courts can and do rule that the parties’ conduct has caused the “anti-waiver” clause to be amended.  Reliance on “anti-waiver” clauses is no substitute for consistent enforcement of contractual commitments, especially those relating to system standards.

Reliance on “anti-waiver” clauses is no substitute for consistent enforcement of contractual commitments.

Brand Risks

System-wide uniformity is crucial to a franchise system.  Consumers visit franchise locations because they liked the last experience and know what to expect from the next.  A system that fails to deliver on those expectations will not survive. A franchisor who does not deliver, because of failure to enforce compliance or anything else, can put the entire system squarely in the failure zone.  The success of every franchisee in the system depends on the franchisor’s ability − and willingness − to maintain uniformity in the system.

Because franchisees might not make the connection between the success of their own businesses and system-wide compliance, it is the franchisor’s job to educate franchisees. It is crucial that franchisees understand how important it is to hold every franchisee accountable for delivering a consistent product, service and customer experience in accordance with the system standards.  Franchisors who achieve such understanding and consensus among franchisees will find that the system polices itself.

Financial Noncompliance

A franchisee who fails to pay royalties is often experiencing financial trouble.  A franchisor who simply ignores this failure to pay may think that it is doing the franchisee a favor, but this is not so. Unless the franchisor intervenes, the franchisee can get into a situation where the costs of exiting the system are less than repayment.

It is imperative that a franchisor engage at the first sign of trouble and work with the franchisee.

It is imperative that a franchisor engage at the first sign of trouble and work with the franchisee to identify the problem, develop solutions and help the franchisee implement them.  If a franchisee is simply not a good operator, the solution may be to help the franchisee exit the system.  It is easier to help a franchisee exit when who is just starting to experience financial difficulty than after the franchisee has incurred insurmountable debt.  And an early departure is certainly better for the franchise system as a whole.

Litigation

Franchisors sometimes shy away from system standards enforcement out of a fear of litigation and related costs. In reality, it is often the failure to enforce system standards that leads to litigation.  If franchisees see that the franchisor tolerates noncompliance, they will certainly have no motivation to comply.  Eventually, this culture of noncompliance will snowball and force the franchisor’s hand. This often results in terminations and more far-flung defensive litigation, precisely the scenario the franchisor sought to avoid in the first place.

Franchisors cannot afford to tolerate noncompliance.

Worth the Price

Enforcing system standards demands resources from franchisors and, at times, may entail uncomfortable and even difficult confrontation with franchisees.  But over the long term, those costs pale in comparison to the damage that can be caused by a systemic lack of enforcing system standards.

Simply put, franchisors cannot afford to tolerate noncompliance.  It results in consumer dissatisfaction, reduced sales, declining profitability, closure of units, litigation and, eventually, the failure of the brand.  Franchisors must adopt and implement a consistent compliance program, as well as educate each franchisee about why compliance with systems standards is vital, not just for the brand’s health, but for their own success and prosperity as an individual business owner and franchisee.

Amy Cheng is a co-founding partner with the Chicago law firm of Cheng Cohen LLC and represents franchisors on the structuring and operation of their franchise programs through all phases of development. Find her at fransocial.franchise.org via the directory.

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