Before you make the decision to buy a franchise, it is important to look into the company’s background. By law all franchisors must provide prospective franchisees with a Franchise Disclosure Document (FDD), a document that contains significant information about the company. One of the most essential components of this disclosure report is any history of litigation and bankruptcy related to the company or its executives.
Understanding the origins of the legal conflicts that arise between franchisors and franchisees is the first step toward learning about franchise lawsuits. Franchisors, for example, generally instigate litigation when a franchisee has not met contractual obligations. Franchisees, on the other hand, initiate legal action generally because they are unhappy with their business. Maybe they’re disillusioned with the franchisor or they’re not making enough money. The problem for franchisees, however, is that franchisors are often more careful when it comes to meeting their obligations, which don’t include assuring that the franchisee is happy or a financial success. You can minimize your chances of entering litigation by fully understanding and evaluating the disclosure document before purchasing a franchise.
Here are some of the most important points to remember:
- Do some math. You don’t want to uncover a lot of litigation between the franchisor and its franchisees. Regardless of which party has instigated litigation and why, the percentage of franchisees in litigation should be small. Take the total number of litigations listed for the past two years. Ideally, less than 1 percent is what you want to find. If it is more than 4 to 5 percent, you will want to seriously consider another franchise option. Why go into business that hints at trouble? Still, even if the total percentage is between 1 and 3, do some more digging to determine the nature of the litigation.
- Determine who is instigating litigation and why. If you’re finding that it is mostly the franchisees that are instigating litigation, you should conduct a thorough examination of the financial performance of the business. You should question, for example, the franchise system’s ability to make money. Franchises that are doing well generally do not initiate litigation. Franchise owners may be successful but want to try something else, in which case they often sell their business and get into another area. Litigation that is started predominantly by the franchisor may indicate that the company, like many others, tends to turn to its lawyers to fix problems.
- Initiate a conversation with the franchisor. Even if you uncover a small amount of litigation, you should still find out what you can about the disclosure. Getting both sides of the story is a good start. A franchisor should not have reservations about providing an explanation for the litigation unless it is ongoing and the franchisor is acting under an attorney’s advice. If a franchisor is reluctant to provide a history of the lawsuit or to at least talk to the company’s lawyer to determine what it can reveal, then that should give you reason to proceed no further.
- Talk to other franchisees. Just as you might speak with representatives of the franchise company about litigation, you’ll also want to discuss these issues with the franchisees involved to hear their points of view. It’s still true that there are two sides of every story (sometime more), so you want to give yourself the gift of as much information as possible. First-person accounts often reveal more about a situation than what might be found on paper.