Lessons for Both Sides of the Table from the Recent Jackson Hewitt Franchisor Liability Cases

Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees’ business operations. Where a franchisor imposes and exercises substantial controls over its franchisees’ operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor’s exercise of control makes it liable for its franchisees’ negligence or misconduct.

Two recent cases involving employee and customer claims against Jackson Hewitt shed light on this issue. In one case, a customer of a Jackson Hewitt franchised tax center in Louisiana filed suit against the franchisor based upon a privacy breach committed by the franchisee. In the other, an employee of a Jackson Hewitt franchise in Pennsylvania sued the franchisor for sexual harassment based upon the alleged actions of certain owners and managers of the franchise. In asserting their claims against the franchisor, both plaintiffs relied heavily upon language in Jackson Hewitt’s franchise operations manual and other documentation, and also the direct involvement of Jackson Hewitt representatives in the operations of its franchisees. The courts in both cases were willing to consider the plaintiffs’ claims against Jackson Hewitt despite clear admonitions in the Franchise Agreement and Operations Manual that the franchisee and its employees “shall not be considered or represented [by the franchisee] as [Jackson Hewitt’s] employees or agents” and that franchisee has exclusive responsibility over hiring and matters relating to personnel.

Jackson Hewitt provided its franchisees with detailed mandatory policies and procedures for center operations. It required all franchisees to provide customers with a copy of the “Jackson Hewitt Privacy Policy” promising that the confidentiality of personally identifying information (e.g., social security numbers) would be safeguarded. It also provided franchisees’ employees with a Code of Conduct, which made no reference to the existence of franchises, and which included numerous references to the reader as an “employee” of Jackson Hewitt. Jackson Hewitt also operated an Intranet site through which franchise employees could apply for employment positions with other Jackson Hewitt offices, could obtain Jackson Hewitt policies, and could communicate with Jackson Hewitt representatives. In addition, franchise employees were directed to call Jackson Hewitt’s corporate office to resolve issues with tax returns. All of these factors weighed in favor of establishing a sufficient level of control over franchisees’ operations to impose liability on Jackson Hewitt. The court also found significant control in the Jackson Hewitt system relating to training and termination of employees of the franchises.

The conclusion to be drawn from the Jackson Hewitt litigation is that franchisors are essentially presented with two options when drafting their franchise agreements and operations manuals. The first option is to impose significant operational controls over their franchisees’ operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates. The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications.

The first approach allows franchisors to impose greater control over, and have more say in, their franchisees’ operations—which is an attractive proposition for many franchisors. In addition, franchisees may perceive greater value in a franchise system that provides strict operating standards and procedures, which may help to distinguish the franchisor from competing brands. If the franchisor chooses this approach, it should consider increasing the minimum policy limits required for franchisees’ insurance policies and the types of required policies. It may also want to explore direct insurance coverage for the franchisor for all claims arising from franchised operations.

The advantages of the second option are demonstrated by a recent court decision from Illinois, Braucher v. Swagat Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,355 (Mar. 19, 2010), in which Choice Hotels International, Inc. avoided liability in a wrongful death claim for the alleged negligence of one of its franchisees in maintaining its indoor swimming pool and whirlpool. Choice provided very limited operational guidance and controls with regard to swimming areas, and this approach allows a franchisor to avoid potential liability associated with imposing mandatory operational controls over franchises. However, it also carries the potentially negative business implications of allowing franchisees a measured level of discretion in running their businesses under the franchised brand. The term “measured” is important, because the franchise agreement should still include rights of termination or other remedies for acts or omissions that have the potential to cause material detriment to the franchise system’s goodwill. In addition, franchisees may view a franchisor that employs this approach as providing very little in terms of affirmative guidance and support, not acknowledging that the information and non-binding recommendations of a franchisor can provide value in and of themselves, irrespective of whether compliance is deemed mandatory.

A prospective franchisee can also glean guidance from the information provided above. When evaluating a franchise opportunity, a prospective franchisee should seek to review the franchisor’s operations manual, even if its table of contents is provided in the Franchise Disclosure Document (“FDD”). It is acceptable for a franchisor to require the prospect to sign a non-disclosure agreement with regard to the Manual. If the operations manual provides detailed mandatory specifications and procedures, the prospective franchisee should be wary of the likelihood that the franchisor will pursue rigorous enforcement, to account for the assumption of the significant liability risks described above. While the “deep pocket” franchisor’s potential “joint and several” liability for third-party claims may seem like a benefit to the franchisee, the prospect should be aware that indemnification and contribution provisions in the franchise agreement is likely to shift the ultimate financial burden back to the franchisee, unless it can prove that the franchisor’s actions caused the third party’s claim.

If the operations manual provides only examples and recommendations for franchisee policies and operational procedures, as opposed to detailed mandates, the franchisor may be attempting to avoid any direct performance obligations to its franchisees, or it may simply be attempting to limit its exposure. In performing its due diligence, a prospective franchisee should attempt to gain as much information as possible from the franchisor and its active franchisees to discern the quality and operational support the franchisor actually offers.

The operations manual and other forms and operational materials can be valuable tools for franchisors and franchisees alike. But, depending on how they are written, they can expose the franchisor to liability and raise serious questions in the minds of franchisees as to the benefit to be derived from subscribing to a particular franchise. Parties on both sides of the table should be sure to carefully evaluate these documents to ensure that they serve and meet their needs and expectations.

The “Litigation Hold” and the Importance of Electronic Document Retention

The “Litigation Hold” and the Importance of Electronic Document Retention

As email and text-messaging have become standard means of communication in the business world, issues relating to document retention are more and more complex. When you become aware of a lawsuit filed against your company, or when you are exchanging heated telephone calls or e-mails and think a lawsuit might occur, it is critical for you to take measured steps to ensure that all relevant electronic documents and communications are preserved. Failure to preserve documents, and to comprehensively and timely comply with an opposing party’s discovery requests, can lead to both monetary and non-monetary sanctions. Non-monetary sanctions, which may include an instruction to the jury to make an adverse presumption based on your improper failure to produce requested documents, can have a substantial and devastating impact on your ability to pursue or defend against a lawsuit.

A 2004 case issued by the United States District Court for the Southern District of New York provides guidance on the steps that need to be taken in order to adequately preserve electronic data and avoid these types of sanctions. Zubulake v. UBS Warburg, LLC started out as a simple employment discrimination case that ballooned into a three-year battle over UBS’s failure to preserve emails relating to the employee’s termination. Through evidence obtained from depositions and re-depositions (at UBS’s expense), and inferences drawn from emails that were produced, the plaintiff was able to show that UBS had at least negligently, and perhaps intentionally, permanently erased relevant emails and discarded backup tapes, which would have preserved the emails even after their deletion from UBS employees’ active computer systems. As a result, the Court ordered UBS to pay the costs of the plaintiff’s motion, and also to pay for additional depositions and re-depositions of its employees so that the plaintiff could ascertain the contents of the deleted emails. The Court also held that, as to the emails that were lost or deleted, the jury would be instructed to infer that they contained information that was damaging to UBS.

To avoid sanctions like those imposed on UBS in Zublake, parties facing pending or likely litigation or arbitration must institute a “litigation hold” in order to put officers, employees and representatives on notice that documents and data relevant to the suit must be preserved. This should be done with the cooperation and advice of an attorney in order to ensure that all affected individuals receive proper notice regarding the documents that need to be maintained. In addition to emails and active documents, deleted and archived files must be preserved, and potentially relevant backup tapes from servers may need to be segregated in order to ensure they are not recycled. While “key players” and information technology personnel certainly need to be actively addressed, all employees who could potentially have relevant information must be contacted as well. Document retention policies will also need to be preserved and likely produced, though mere reliance on an internal retention policy without affirmatively enforcing the litigation hold will be insufficient to protect against sanctions. Moreover, the litigation hold will need to be consistently reinforced and updated throughout the duration of the lawsuit.

Document retention is a serious matter that weighs heavily in the outcome of litigation. While the temptation to hit “delete” on damaging emails might be strong, the force of sanctions, and perhaps even contempt of court proceedings, should be stronger. Compliance with the “litigation hold” requirements will help to ensure that you are in the best position possible to protect the interests of your company in a dispute. For specific advice regarding document retention and “litigation hold” matters, please contact us by telephone or e-mail.

Copyright Franchise and Business Law Group, 2009