June 2008
Is the Franchisor Liable if a
Franchisee's Customer Sues?

Operations ManualAt the most recent the International Franchise Association (IFA) Legal Symposium, one of the most interesting programs concerned when a franchisor is responsible legally for the actions of a franchisee.  The program was worth summarizing for this newsletter.

There are two points of distinction here with regard to liability:  “Apparent Agency” and “Actual Agency.”

Apparent Agency means that a customer reasonably believes that the he or she is being served by a particular company or “principal.”  For example, when you are buying a Whopper® do you have reason to know that the restaurant is not owned by Burger King Corporation?  To avoid this type of liability, a franchisor should require each franchisee to notify the customers that the business is independently owned and operated.  Any written marketing materials, contracts, or invoices provided to the customer by the franchisee should say that the business or office is “independently owned and operated” and, where possible, specifically identify the franchisee as the local owner.  Franchisors also should require franchisees to file a Trade Name (or “doing business as”) disclosure with their state to put others on notice that, for example, the operator of the Burger King at “123 Washington Road” in Baltimore is “ABC Burger, Inc.,” not Burger King Corporation.

Disclosure is not the only issue here, however.  Control over the actions or delivery of service by the franchisee is also important to avoid liability under a theory of “Actual Agency.”

Specifically, franchisors should closely examine the way in which operations manuals and other procedures are written.  If they prescribe specific step-by-step requirements that the franchisee must follow in a wide variety of areas, the franchisor could be held responsible if the franchisee is sued by a customer.  (This is comparable to an employer being responsible for any poor service or negligence on the part of an employee, because the employer has direct, day-to-day control over how its employees perform their jobs.)

It is far safer for the franchisor, from a liability standpoint, to set forth performance requirements that the franchisee must meet (i.e., a customer satisfaction rating of at least 75%) and then use the operations manual to provide advice on ways to achieve that required score.  Consider a statement such as:  “These are simply suggestions, but ultimately it is up to you, the franchisee, to design a program to reach stated goals.”

But there is an exception to this recommendation.  While operations manuals in general should not be too prescriptive, in matters that directly concern the health and safety of the ultimate customer it is important to provide specific requirements, because it is very possible that a court may hold the franchisor responsible unless it made reasonable efforts to protect customer’s health or safety.

For example, for companies which provide services in individuals’ homes or private offices, courts have held that franchisor have a duty to require that their franchisees engage in  any pre-employment background checks and not hire employees who have criminal records or even references that indicate a violent or sexually abusive temperament. In those types of businesses, the franchisor need a process for ensuring the checks are being done by the franchisees on a regular or random basis.   It is appropriate for the franchisor to request records or invoices for such background checks to ensure the requirements are being taken seriously.

Franchisors who wish to have a review of its operations manual should contact the firm.

Column: Q&A with David Cahn

Q:  My franchised business is losing money -- can I just quit the franchise?

A:  Of course, the answer is "Maybe."

As a practical matter, the most important issue is what you plan to do with the business if you leave the franchise system. Your legal situation probably will be most risky if you continue to operate the same type of business from the same location as an "independent," since most franchise agreement have a Covenant Not To Compete that forbids you from operating a similar business at that location or within a certain distance from it for a specified period of time after termination. Depending on the terms of this agreement and your particular state's law, — Read More

CopyrightCOPYRIGHT: Who Owns Your Work?

Most franchisors and employers generally have been taught that they should not seek to register a copyright in documents, such as operations manuals, they want to keep confidential and proprietary.

However, in some cases that is “old-school thinking” which can deprive you of a valuable weapon against former franchisees or employees who become competitors.

The U.S. Copyright Office allows the creator of a work to submit the document (print or electronic) for registration with up to half of the content “redacted” or removed to preserve confidentiality of information that is truly commercially sensitive, and then secure copyright registration over the entire document.  The redacted version must be sufficiently complete to be understandable by the reader, but could remove information such as recipes, lists of approved suppliers, or pricing formulas.  Copyright registration gives the creator of the work the ability to sue for specific amounts of “statutory damages” as well as costs and attorneys’ fees in obtaining damages or an injunction, all of which can be valuable weapons – particularly in states which refuse to enforce covenants not to compete against former franchisees or employees.

On the subject of copyright, franchisors and franchisees alike should be sure to ask any vendors who produce work for them to assign the copyright to them.  Otherwise, that website or brochure you paid for may, in fact, belong to the designer/writer.  A simple document can be written to assign the copyright to you, so protect yourself!

Contact the firm if we can assist with copyright submission or documentation.

News Notes

David Cahn participated in a roundtable discussion at the National Restaurant Association Convention in Chicago last month.  Other panelists included consultant Richard Sharoff (FranPoint Partners) and restaurateur Shawn Foster (Foster’s Grill in Virginia).  The panelists addressed the Benefits & Pitfalls of Franchising as a growth strategy for restaurant owners.  For more details on the event, contact David.

Jeremy Robinson has joined the firm as a paralegal.  He is a third-year law student at the University of Baltimore, and has worked for firms in Maryland and Pennsylvania before coming to work at Franchise & Business Law Group.