Litigation Insurance: Is Your Franchise Protected?

At a recent franchise industry event, a group of franchisors sat around a table, joyfully exchanging local-store marketing success stories. Everyone was eager to offer anecdotes and have a turn to brag about how their brilliant marketing team helped turn a weak location into a sales superstar. The discussion flowed freely, featuring inside jokes and frequent laughter until a curious onlooker decided to join the table.

"Hey, anybody here had any experiences with franchisor litigation insurance?" he blurted.

"Uh, not so much," answered one franchisor. Meanwhile, within 20 seconds, the rest of the group dismantled, glancing down at their watches and making excuses about why they needed to move on.

Unprotected from Franchisee Lawsuits

While franchise system insurance policies might not be a topic that tops the popularity charts, it technically should be. Shockingly, 80 percent of franchisors are currently without proper coverage, according to Cherry Creek research, leaving them unprotected from franchisee lawsuits, such as territory issues, training, advertising or other support services disclosed in the franchise disclosure document which exposes them to huge costs involving claims and legal defense costs related to disputes. Much has been written and spoken within the franchise industry regarding strategies to help avoid franchise litigation. However, despite all the best prevention efforts, the reality is that it does and will occur. Unfortunately, many franchisors are in the dark about how to proactively protect their systems with the right type of litigation insurance coverage.

Most franchisors operate under the false belief that franchisee lawsuits are covered by general liability insurance. When a major dispute arises, they're forced to pay expensive legal fees to resolve the case. In fact, a defense from one of these lawsuits can cost as much as the franchise litigation insurance policy's annual premium in just four to five months. Franchisors need to protect themselves from a variety of sources, including franchise owners. At the same time, they also must ensure protection for their franchise owners. Frequently, the franchisor will adopt a directors and officers insurance policy, coverage for certain wrongful acts that may result in a claim against directors, officers or the entity. It's a common assumption within the franchise world that D&O insurance covers all of the organization's needs. However, D&O will protect the franchisor from litigation when a board member or employee sues, but can fall short when an outside entity, such as a franchisee, files suit against the company. D&O typically excludes suits brought against the franchisor by the franchisee relating to specific operations/functions of the franchisor.