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There are several different ways a franchise dispute can be resolved. This article explains some of the ways franchise disputes get resolved. At the end of the article I also discuss termination of franchise agreements.
1.Mediation / Arbitration and Court
In my experience, clients commonly misunderstand mediation or get it confused with arbitration.
Mediation is an alternative method of resolving disputes. It is alternative to two other more traditional methods: litigation (going to court) and arbitration.
Mediation is a vastly different process from either court or arbitration.
Litigation
In laymans terms this is a process where by a party (a plaintiff) brings a dispute to Court against a defendant and asks the court to resolve that dispute.
Advantages of Litigation
The court imposes a final decision which can normally be appealed from.
Ideal for parties with strong cases who may not wish to mediate or settle because they have a very strong case and do not want to compromise.
Disadvantages of Litigation
expensive
delays - 1 to 2 years, plus.
involves an investment of time, particularly at a trial. Ie time away from your business.
It is a win or lose situation, there is no control over the outcome.
If the parties are in an ongoing contractual relationship, that relationship can worsen in the time it takes to resolve the dispute through court.
You cannot choose the Judge
Unsuccessful court cases can make for bad publicity. The decision in the case is a matter of public record.
Abitration
This is a process where by a plaintiff brings a dispute against a defendant and asks a paid arbitrator to resolve that dispute. This process does not take place through the Courts. The parties separately arrange for their own arbitrator.
Advantages of Arbitration
The arbitrator imposes a final decision although it is harder to appeal from.
You can choose your arbitrator.
Can be dealt with much quicker than going to Court
Get agree on some flexibility with normal court procedures.
Can be cheaper than court although often is not
Parties with strong cases may not wish to mediate or settle because they have a very strong case and do not want to compromise.
Disadvantages of Arbitration
Involves a large investment of time, particularly at an arbitration hearing.
It is a win or lose situation, there is no control over the outcome.
Difficult to appeal (this can however be a pro!)
If the parties are in an ongoing contractual relationship, that relationship will worsen in the time it takes to resolve the dispute through arbitration.
Can be as expensive as going to court. On top of the lawyers costs, you pay for an arbitrator.
Mediation.
Where a party raises a dispute with another and they agree to use a mediator to help them resovle their dispute, by agreement.
Where Mediation is vastly different from Court or arbitration is that is is a process whereby the parties meet and use the assistance of a mediator to negotiate an out of court settlement regarding their dispute. Mediation is a common form of dispute resolution with Employment disputes where the parites usually want a quick resolution and do not wish to spend alot of money. It is also popular in franchising.
Advantages of Mediation
Cheaper than court or arbitration
Control over the outcome
Negotiated settlement
Can be arranged very quickly
Confidential
Disadvantages of Mediation
A party with a strong case may end up compromising their case on terms that would not occur if the case went to court.
Mediation can lend itself to franchising and employment disputes where there may be an ongoing relationship and the parties want a quick solution without having to go to court or arbitration. Also, brands can suffer when their cases go to court and they lose
Mediation’s primary attraction to clients in my experience is that it can be organised quickly and brings a quicker and cheaper end to a dispute than going to court.
Do you have to mediate?
In short, normally, “no”.
To secure mediation as a method of resolving a dispute, you need the other party to agree. Often that agreement already exists in the franchise agreement.
So the first port of call is does the agreement actually compel mediation?
Some dispute resolution clauses in mediation agreements do require the parties to compulsorily attend mediation.
Some however take the following form: Require the parties to set out the nature of the dispute in writing and then to make every effort to resolve it by mutual negotiation within a certain time period. Thereafter one party “may” notify the other that it seeks to have the dispute resolved by mediation and the other “may respond”.
This is not a compulsory mediation clause because of the presence of the word “may”.
A party wanting to compel mediation would not be able to do so under this clause.
A compulsory mediation has its downsides. A party considering itself in a strong position may not want to mediate because it does not want to compromise. It may have other reasons for wanting to present a strong front. That is not an uncommon occurrence in my experience. Frequently in franchising it is the franchisor which is in the stronger position. In this instance, it works well to have a mediation clause which imposes an obligation to try and resolve or explore the dispute (that is an easy threshold to meet legally) but does not impose compulsory mediation, only gives it as a possible method of resolution.
From the perspective of the weaker party to the contractual arrangements, a compulsory mediation clause however is a good idea. With little outlay, you can force the other party to come to the negotiating table. I have seen this result on one occasion over the last year where the franchisee has very little money to involve itself in a court case, however had the resources to mediate. The franchisor came kicking and screaming to the mediation and its lawyers pronounced “we will not settle”, however after the mediation the franchisor client directly contacted the franchisee and settled the case. It seemed the ones who did not want to settle were the lawyers not the client!
How to prepare for a mediation.
It is a serous mistake to assume that the event will be non-adversarial, a gentle chat around a table. Mediations can given rise to considerable animosity.
It is also a serious mistake to come under prepared. The same level of preparation as going to court needs to go into a mediation. If the case involves the need for expert opinion, bring the expert. Prepare a claim and have all the information at your fingertips. Clients needs to be as prepared on the facts as the lawyers. Remembering a crucial piece of information the next day will be useless.
You do not need to convince the mediator that your version of events is correct (unlike going to court) but it certainly helps.
Similarly, the other side (their client and their lawyer) are ready targets of persuasive discussion. Unlike court, where you convince a judge, part of the job in a mediation is getting the other party to see things your way.
Structure of a mediation.
They can be as informal or formal as you want. Lawyers do not need to be there.
It is necessary to draw up an agreement at the end of the mediation once agreement has been reached. Do not reach agreement and then go away and hope to record it later. More likely than not it will not happen.
You can be at mediation for as long as you want. Normally they can take up to a day.
You can choose whoever you want as a mediator. There is often debate on whether it should be a person with knowledge of the industry or a lawyer. Mainly, it just needs to be someone skilled in listening, discerning quickly the relevant facts of a dispute, and facilitating the parties to see things from their opponent’s point of view, even if they do not agree with it.
TERMINATION OF FRANCHISE AGREEMENTS 1. Introduction A franchise agreement is a ”relational contract” in that it is one where the parties have an ongoing relationship for the duration of the term and any renewal. This particular feature of franchise agreements give them a slightly different dimension from a “normal” contract. This article is intended to give some guidance on the issues which arise when the “relationship” is steering towards termination and on the issues which arise in the (sometimes rocky) aftermath. 2. Termination of franchise agreements Generally, this tends to occur by one of two methods:
a The agreement has come to an end by “natural causes”. b For breach on the part of the franchisee.
Agreement has come to an end 2.1 This is potentially the least problematic method of termination. A few scenarios emerge here. The first is that either there is no clause in the agreement allowing for renewal of the term and the franchisor does not wish to grant a fresh term to the franchisee. The second is there is a renewal of term available to the franchisee but the franchisee does not wish to exercise its right of renewal. A third is that the parties by agreement agree to terminate the agreement. 2.2 An issue about whether an agreement has in fact terminated even though the termination date has come and gone arises where the agreement has technically come to an end but, for whatever reason, the parties have treated the agreement as still being on foot. This could happen in a variety of situations including:
a) The franchisee simply forgetting to exercise their right of renewal, although fully intending to do so, and/ or the franchisor not maintaining adequate systems regarding renewal dates. b) The agreement containing a renewal clause which is to be exercised on terms that do not make it clear the renewal will be on the then current agreement, thus leaving leeway for negotiation and delay. In the meantime, both parties continue to observe the terms of the franchise agreement, hoping they will reach an agreement.
2.4 Ninety nine times out of a hundred, these scenarios are not going to give rise to a problem because it is likely that if the franchisor has allowed the franchisee to continue trading post termination, it has done so because it is not dissatisfied with the franchisee’s performance. 2.5 However, where, say the parties have embarked on a negotiation which has continued post termination but that negotiation has not resulted in an agreement being entered into, some ambiguity may arise if the franchisor now wants the relationship to end and the franchisee does not. In these circumstances, the legal status of the relationship can potentially be murky. 2.6 A franchisor wanting to best protect itself in this situation needs to ensure that it has not taken any steps, written any emails or made any comments which could be seen to be creating a legitimate expectation on the part of the franchisee of a continuance of the franchise (notwithstanding that a formal renewal has not been signed). Depending on the length of the negotiation and the degree to which it is nearly successful, a franchisee could well develop an expectation that a renewal will eventuate and make business decisions or incur costs in reliance. This is in turn likely to present a potential legal hurdle to a franchisor wanting to evict a franchisee at a later point in time. 2.7 The other thing a franchisor wanting to best protect itself in this situation should do is to ensure its franchise agreement contains a “holding over” provision, not dissimilar to that in a lease. In this way it is spelt out in the agreement itself that the fact that the franchisee is allowed to “stay in possession” of the franchise post termination does not give rise to any legal rights on the part of the franchisee. 2.8 The importance of getting this right is that not only could it lead to difficulty in evicting the franchisee if some ambiguity develops about when the agreement comes to an end but also, in terms of enforcement of restraint of trade clauses, the franchisor is arguably eating into the restraint of trade term by allowing the franchisee to continue in possession of the franchise post termination and not doing anything about restraining the franchisee from competing. This is because the restraint time runs from the date of termination. 2.8 The practical message is clear. If the agreement has come to an end and a new agreement has not been signed but is or may be negotiated, a franchisor needs to move quickly to get the new agreement signed up. Any delay will only ever ultimately count in favour of a franchisee. Termination for breach 2.9 Franchise relationships are generally paved with good intentions. As with most contracts, at the beginning, no one ever expects the deal to go wrong. Unfortunately, in most systems there will come a time when there is a break down in a particular relationship that may result in a premature termination of the franchise. In most franchise systems the question will then be raised in the mind of the franchisor as to the effect on a franchise system resulting from that termination. 2.10 Franchise agreements contain provisions in them which enable the franchisor to terminate for certain specified breaches. Generally these breaches require an opportunity to remedy first, ie a breach notice must be served notifying the franchisee of the breach and giving an opportunity to remedy. 2.11 Unlike the USA, where, in many states, the franchisors must show “good cause” for termination, here, there is no legislation which so restricts the franchisor’s right of termination. 2.12 Some franchise agreements provide for a right of termination in circumstances which could be seen to be relatively minor, eg non payment of a small sum of money and variouis minor transgressions. 2.13 It is debatable under US law whether such minor breaches would be “good cause”. In New Zealand of course we are not so restricted. Having said that, it must be borne in mind that there is a growing body of opinion that franchise agreements are relational contracts and that they are therefore subject to an implied obligation of good faith. It would be bad faith in my view to terminate a franchise agreement for a minor breach or on some technical point. By way of example, I am aware of one situation of a franchisor issuing a breach notice where the franchisee director had been “rude” to one of the representatives of the franchisor. The rudeness consisted of retorting “what do you want??” when the franchisor representative phoned. I am sure we have all heard worse! The agreement provided there could be termination upon two breach notices being served. The breach notice was never followed up with a second notice so the issue never ultimately arose but in my view two such notices being used as grounds to terminate a franchise agreement would be wholly wrong and in utmost bad faith. It would be a brave franchisor who sought to terminate based on such flimsy instances of “breach”. 2.14 I think the message is that the best course (where there is a choice of breaches) is to terminate on the “safest” breach available. Where a fight is envisaged, terminating for reasons which will be open to debate because there is a factual dispute about whether the agreement has been breached or because the proposed grounds of termination are relatively minor will never be wise. Non payment of money remains one of the safest grounds of cancellation because it is always indisputable. 2.15 The importance of getting right when it comes to correct termination of the franchise agreement comes into sharp focus when one considers the unhappy consequences of wrongful termination. Those consequences include:
a. A claim by the franchisee for damages (being all losses flowing from the wrongful termination – see International Direct Ltd v Preston); Downside, dragged into potentially years of litigation, bad publicity, bad for business. b. An injunction to restrain the franchisor from terminating the franchise agreement. Downside, dragged into potentially years of litigation, bad publicity, bad for business.
2.16 A word about interim injunctions. Interim injunctions are interim remedies. They are orders put in place by the Court to restrain a particular act, say termination of the franchise agreement, pending the Court having sufficient time to hear a substantive case. The Court hears interim injunctions after reading affidavits and hearing from counsel. It does not resolve factual disputes. Its focus is on:
a. Is there a serious question to be tried? This is a reasonably easy threshold to meet. In layman’s terms, does the party bringing the case have a reasonable case? b. The balance of convenience and overall justice of the case. This is the main focus of an interim injunction hearing. It involves a weighing up exercise of whether the franchisee will suffer irreparable harm if the interim injunction is not granted, balanced against any irreparable harm that may be suffered by a franchisor. Whether either party has an adequate remedy in damages is also considered.
2.17 Because the consequences of termination of an agreement are so drastic and irrevocable, where a franchisee can point to an argument that the notice is or could be wrongful, given the interim injunction hearing is not the final say on the matter, a franchisor is going to be hard pressed to resist an interim injunction. 2.18 By the exclusive nature of the franchise arrangement, the franchisee business operation depends on the economic relationship established by the franchise agreement. The franchise relationship is the lifeline of the franchisee’s business, the franchisee’s investment of capital, time and effort in promoting the franchisor’s goods or services – to the general exclusion of competing goods and services. An award of damages in this situation is considered to be an insufficient remedy for the franchisee. 2.19 The purpose of the Court at the interim injunction stage is just to preserve all interests until the case can fully be heard. In most cases, those factors are likely to point to a restraint of termination being an appropriate remedy. The message is that termination, once embarked upon, is something to get right. Consequences of termination. 3.1 Most franchise agreements contain a battalion of post-termination obligations on the franchisee for his disengagement from the system that are meant not only to protect a franchisor’s intellectual property rights, but also the franchise system in general. If franchisees can ignore their post-termination obligations, then the argument of an individual franchisee will be “why can’t I?”. Without the ability to enforce the post-termination obligations, a franchisor risks a general unraveling of its franchise system. 3.2 Some individual post obligation provisions are worthy of individual comment as they come up over and over again. Restraints of trade 3.3 Apart from the more obvious forms of pirating the franchise system such as trademark infringement, the franchisor must be wary at the termination of the franchise agreement of former franchisees unlawfully using the franchisor’s proprietary information and good will after termination by continuing to trade. 3.4 Where a former franchisee has had a successful business venture, it may be tempted to continue to operate the business under substantially the same system as that of the franchisor but using a different name or making slight changes. Any prudent franchisor should be prepared for handling such a rebellious franchisee. 3.5 During the term of the franchise relationship, franchisors provide franchisees with know-how, training, confidential and proprietary information. When that relationship has ended, one of the franchisor’s top priorities is likely to be to re-establish another franchisee in the territory. Permitting the renegade franchisee to use the franchisor’s know-how and training to establish its independent business in the same territory undermines the value of the brand and the system, is unfair to other franchisees and to an incoming franchisee. 3.6 It is therefore crucial that as close as possible as can be achieved, a realistic restraint of trade clause is drafted before the contract is signed. By realistic, I mean a clause that is going to stand a reasonable chance of being upheld by the Courts. 3.7 The difficulty is that restraints of trade clauses are not enforceable unless the party to seeking to rely on them can prove that they are reasonable as to both time and territory and in protecting the franchisor’s interests. What is a valid business interest? 3.8 The first step is that to be enforceable, a restraint of trade must be formulated to protect the franchisor’s valid business interests. Those interests are typically:
a. The franchisor’s confidential and proprietary information and its goodwill;
b. Other nearby franchisees who need protection from unfair competition; and c. The franchisor’s ability to secure another franchisee at or near the location served by the former franchisees.
3.9 The Courts have found that franchise systems are valid business interests worth protecting, but establishing a valid business interest is going to be dubious where a particular system has become run-down, and where little is being done by a franchisor by way of marketing, brand development and updating its systems. 3.10 Having established a valid business interest on the part of the franchisor, the next enquiry is does the clause go further than necessary to protect those interests? For example, if a franchisor’s interest could be protected by a restraint against contacting previous customers of the franchise, then a restraint which prevents the franchisee from being associated or working in the industry generally will go much wider than is necessary to protect that valid interest. 3.11 It is crucial that a realistic assessment is made when the clause is drafted of what is the interest that requires protecting and what measures genuinely need to be put in place to protect that interest. A restraint of trade clause that is unduly wide and onerous is simply not going to be upheld. 3.12 The next enquiry is that the restraint of trade must be reasonable as to:
a. Time – duration; b. Geographical area;
3.13 As to duration and geographical area, again, the answer to this will depend on what is necessary to protect the franchisor’s interest. It is unreasonable where a franchisee has been operating in a particular area, to restrain the franchisee at the termination of the agreement from competing in the whole of New Zealand. 3.14 Note that the Court does have power to modify a restraint of trade clause that is considered unenforceable (or illegal), however the safest course is to ensure at the outset that the clause is realistically drafted. It stands a much better chance of being upheld, particularly on an interim basis. 3.15 Other issues which will tax the Court in terms of whether or not it decides to grant interim relief to enforce a restraint of trade clause are:
a. Whether the franchisee is obtaining its sole livelihood from operating the offending business; b. Whether the competing business or industry is one in which the franchisee already had, well prior to the grant of the franchise, considerable training, knowledge and expertise. For example, a veterinary practice which had been operating at a particular location servicing customers in a particular area, may choose to come under a franchise umbrella. On the termination of that type of franchise, where there has been no real change to the geographical location or general customer base, on an interim basis, it may be considered unreasonable to restrain the franchisee from undertaking any work at that practice.
Obligation to return operations manuals / property / intellectual property. 3.16 Franchise agreements always provide that certain property and intellectual property be returned to the franchisor. In practical terms, how does a franchisor get that property back, where a franchisee is not complying? 3.17 In a perfect world there is agreement reached on an orderly changeover, but the world is sometimes not perfect. What should a franchisor do where a problem arises because a franchisee is obviously not going to be compliant? 3.18 Resist the urge to play Indiana Jones is good advice. Even where the franchise agreement expressly provides that the franchisor may enter into the premises of the franchisee (and often this is not provided in a franchise agreement) for the purposes of removing certain information products and other items from the franchisee on termination, a franchisor should always move with the utmost of caution in endeavouring to exercise such rights, where is it likely there is going to be debate. This is because the franchisor needs to be careful to ensure that it does not act in breach of the criminal law, such as breaking and entering premises if doors are locked, entering onto premises when access has been refused or taking property that simply does not belong to the franchisor. All of these steps are criminal offences. In short, the safest course is that such rights should be exercised with due notice being given and, where a fight is envisaged obtaining a court order. 3.19 A franchisor may feel that this leaves them powerless but in the event of there being a serious threat of destruction of the franchisor’s property, injunctive relief is always available at short notice to protect the position of a franchisor. In some circumstances, it can obtain that relief on an ex-parte basis, which means it can obtain an order without the Court hearing from the other side in the first instance.
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