When franchisees go rogue

By Deirdre Watson, Barrister, September 2017.

I have recently acted for franchisors in a range of very different franchise systems who have each been confronted with what to do when a franchisee “goes rogue”. In each case, the franchise agreements were strong and gave plenty of protection to the franchisors, on paper at least.

Each case was however a good example of what can happen when franchisees choose to ignore their legal obligations, no matter how watertight those obligations are. In these instances, if a franchisor is not prepared to act promptly in response to franchisee malfeasance, they risk losing ground when it comes to getting interim injunctions[1], they lose negotiating power[2] and they miss the opportunity to send a strong message to other franchisees, who might equally be contemplating the same behaviour.

In each case, the outcome was not so much dictated by the strength of their agreement but by the actions the franchisor chose to take when confronted with the issues.

This article contains a short summary of three of such cases and their outcomes.

Case 1

Case 1 concerns the iconic Para Rubber Franchise system.

The franchisee’s agreement came to an end and the franchisor did not want to grant the franchisee a new agreement. The reasons are probably irrelevant to the outcome except to the extent that the declinature of a fresh agreement clearly paved the way for the emotions which then fuelled what came next.  

In anticipation of there no longer being a franchisee in the territory, the franchisor secured a new franchisee for the territory. The premises for the new franchisee were only around 1 km away from the old franchisee’s premises. Trading for the new franchisee was to commence at the same time of the exiting franchisee’s closure.

The franchisor had not only the benefit of a restraint of trade clause but they also had the right to call for an assignment of the old franchisee’s lease, if they so chose.

The franchisee responded to this turn of events (not discovered by the franchisor until after the new franchisee had commenced trading) by “selling” the lease, equipment and stock of the its Para Rubber business to the brother of one of the directors of the franchisee. They had taken legal advice prior to doing so and, somewhat implausibly,  attempted to argue this was an arm’s length transaction.

The franchisor moved into action swiftly upon learning of those events. Alter a short period spent surveying the trading activities of the new business, collecting evidence and getting their ducks in a row, a without notice injunction was filed seeking an order that the franchisee not trade in breach of its restraint but more importantly that the new business owner not sell the products it had bought from the old franchisee, on the grounds that those products, their identity, nature and characteristics, were all part of the confidential information belonging to Para Rubber.

In limited cases, where there is the threat of irreparable harm, the Court will make an order on a without notice basis, meaning the order is made without notice to the defendants prior to an order being made.

The outcome: The Court granted the without notice order. This had the effect of stopping the new business from trading because all the products it had for sale fell into the category of confidential information belonging to Para Rubber. This lead to a negotiated settlement and then a final order being put in place. The business no longer trades as a competitor to Para Rubber which was a fantastic outcome.

Lessons from the case were the need to act promptly, whilst at the same time taking the time and being careful to get the necessary evidence and plan the case properly. Asking the Court to make orders that were achievable was also crucial. I have seen franchisors overreach and miss the mark, thus losing advantage. Finishing the case with final Court orders was also crucial, enabling the franchisor to show those orders to other franchisees and send a clear message throughout the system.

Case two

The second case concerns the Select Franchise system. This is a well-known New Zealand home services system. It is highly successful both in New Zealand and Australia.

A prospective franchisee and her husband signed a confidentiality agreement with Select, declaring they had no interest in any other cleaning business at the time. This proved to be false, as the husband then had his own cleaning business, albeit a fledgling one. The couple appeared to be attempting to secure the confidential information of Select to “learn the ropes” and no doubt then make a break on their own.

Again, the franchisor sought and got a without notice order preventing the husband from having anything to do with the Select business, and preventing any misuse of Select confidential information. This put Select in a strong position and it then negotiated a very favourable resolution, with final orders once again being put in place. Neither the husband or the wife remain in the system.

This was a case of blatant lying by a franchisee. Again, a swift response was needed. The case however highlighted the need to be vigilant with checks of prospective franchisees. In the end, it was companies office searches, which could have been done at the outset, which revealed the existence of the husband’s business.  

Case 3.

This case involved another Home Services System.

The franchisee had been a difficult franchisee, over a two year period. Breach notices had been served relating to performance issues but performance had not improved. The franchisee was particularly belligerent on a personal level and over time it had made dealing with her hard. Things had fallen “into the too hard basket”.

Eventually matters came to a head and the franchisor recognised they needed to act. Following a breach notice asking the franchisee to turn up for fresh training, which was not complied with, the franchisor terminated the franchise agreement. In the meantime, it turned out the franchisee had “given away” her business to an employee, who was now attempting to run it.

Legal threats were delivered thick and fast to both the franchisee and the “new” business owner. They were met with plenty of belligerence. The franchisee held considerable animosity towards the franchisor. She felt entitled and fully justified in her behaviour.

The franchisor swung into action in the market, fighting to keep the business. The franchisor contacted every customer of the ex-franchisee and managed to get every customer to stay with their system. The customers had not of course realised the new business was no longer part of the franchisee. Most of them expressed complaints about the franchisee anyway, something the franchisor had not previously known. Not taking action to move the franchisee along earlier had done a lot of brand damage.

Lessons from this case show the need to act swiftly, but not to confine the efforts to the legal channels. The franchisor stepped in and acted promptly, fighting the case on two fronts, one through legal channels and the other through action in the market to secure all the clients. The case also however showed the downside and brand damage that can occur when there’s a bad egg in the basket. Allowing franchisees who are routinely in breach, particularly in providing the franchised service, only ruins the franchise brand in the end. No-one remembers the franchisee, they only remember the brand name.

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[1] These are orders made by the court to prevent someone from doing something. As such they are not granted where a party delays in bringing their application. Applicants must act swiftly.

[2] The results of the latest Franchise survey tell us that 90% of disputes are dealt with by either mediation or solicitors correspondence, meaning that most disputes in franchise settle following negotiation.