Reducing Brand’s Exposure to Liability

sharing-knowledge-franchisingFranchisors are often sued for injuries occurring on the premises of their franchisees simply because the injured person and his attorney do not understand the nature of franchising.

Most franchisors prescribe standards for operation by their franchisees that are designed to produce the highest quality product or service in a clean, safe environment. However, franchisees do not always follow these standards, and even when they do, accidents happen. With some personal injury lawyers suggesting that every injured person has someone he can sue for his injuries, it is inevitable that lawsuits will arise and the franchisor will be named in the lawsuit simply because its trademark was on the door. This article will explain how a franchisor can reduce its exposure to liability for these actions.

The Theory for Suing the Franchisor

Franchisors are often sued for injuries occurring on the premises of their franchisees, or caused by a franchisee’s actions simply because the injured person and his attorney do not understand the nature of franchising.

They believe that every McDonald’s or Burger King restaurant is owned by McDonald’s Corporation or Burger King Corporation. That is why a telephone call to the plaintiff’s attorney is always the first step in defending these actions, as the attorney may be willing to drop the franchisor from the lawsuit when they learn the franchisor was not the owner of the business.

However, there are two legal theories by which franchisors can be liable for these actions. One is the concept of “actual control,” where the franchisor controlled the action that led to the injury, or exercised so much control over the overall business that it is treated as owning that business. The other is a theory known as “apparent authority,” meaning the customer thought this was a company-owned location.

Actual Control

The law has always recognized that if you have an employee or agent who acts at your direction, you are liable for their actions. A franchisee is not an employee, but if he is acting at your direction, and that direction causes injury to the customer, then you are liable to that customer, even though it was not your business. For example, if you tell a franchisee to cook food at a certain temperature, and that temperature is too low to kill bacteria, then you will likely be liable for the consequences of your franchisees’ actions when they follow your directions.

The theory of “actual control,” also arises when you control so much of the business activities of your franchisees that you are truly controlling the business. While you need to prescribe standards that relate to the delivery of your service or product, review your operations manual to be certain you are not trying to control other aspects of the business.

A good rule of thumb is that you can prescribe standards for everything the customer sees (with exceptions for pricing), but you should do no more than suggest “best practices” for aspects of the business that a customer does not see. The latter would include hiring practices, compensating and overseeing employees, dealing with suppliers of products and services not central to the system, and similar matters.

Likewise, your standards for producing and delivering your service or product should typically be minimum standards, including specifically addressing policies designed to prevent injuries, but giving franchisees discretion to go beyond your minimum standards or requirements where it is appropriate to do so (particularly in providing a safe environment for employees and customers).

Injured persons will often point to your operations manual, and the requirement of your franchise agreement that franchisees must comply with the operations manual, as evidence of your control of the business. Thus, beyond reviewing your manual and deleting unnecessary controls, you should include in your franchise agreement an acknowledgment by the franchisee that the manual is designed to protect your standards and systems, and your names and marks, and not to control the day-to-day operation of the business. If your manual includes suggested best practices, your agreement should also make clear that the franchisee is only required to comply with mandatory provisions of the manual.

Apparent Authority

Even when you do not control the franchise business, you can be held liable for the actions of your franchisees if the public (or an employee) does not know that you do not own the business. There are, however, a number of ways to protect against such a claim.

In a business such as a restaurant, hotel or retail store, which has a physical location, there should be a prominent sign showing the name of the owner of the business and the fact that they are a franchisee of your brand. For example: “This Amy’s Lemonade stand is owned by Local Franchisee, LLC, an independent franchisee of Amy’s Worldwide, LLC.”

Some franchisors will even present the sign to their franchisees at the conclusion of the initial training, as a plaque recognizing they are ready to open their business. For this sign to be effective, the franchisee must place the sign in a prominent location where every customer will see it, such as on a front door, or by a front desk, ordering station or cash register. If the business has multiple points of entry, or a drive-through window, it would be a good idea to have a second sign.

For service businesses and franchises that are not destination businesses, this notice should be placed on proposals, order forms, and contracts with customers, preferably at the top or just above the customer’s signature. Further, any contract the franchisee signs with its customers should contain the legal name of the franchisee with whom the customer is contracting.

Consumer advertising is also a place where you can make clear to consumers that you do not own the business they are patronizing. Phrases such as “each location independently owned and operated,” on all advertising materials (including your website), tells prospective customers that you do not own every location. While it only takes one notice to alert a customer that an independent franchisee owns the business, the more places you can put these notices, the less likely someone will credibly claim they thought you owned the business.

When All Else Fails

Despite your best efforts to select qualified franchisees, establish policies designed to prevent injuries, avoid controlling the business of your franchisees, and educate the public as to the ownership of the business, you may still be named in a lawsuit. There will also be plaintiff’s attorneys who refuse to understand the franchise relationship or demand payment of “ransom” to go away. Your franchise agreement should have a provision requiring your franchisee to indemnify you in these situations.

Because franchisees do not always have the resources to make good on their indemnifications, your franchise agreement should contain provisions requiring your franchisees to obtain insurance and name you as an additional insured. It generally costs nothing for franchisees to name you as an additional insured, and when they do, you will be able to tender the claim to the franchisee’s insurance company, rather than to your own attorneys. Review your insurance provisions with a qualified insurance broker to be certain the insurance requirements are sufficient for your particular business.

Obtain an annual certificate of insurance from your franchisees, confirming they have purchased the required coverage and named you as an additional insured. Doing so is a final safety net in trying to avoid the high cost of litigating these vicarious liability claims, and bearing the ultimate responsibility for the actions of your franchisees.