International Franchise Association

47th Annual Legal Symposium

May 4-6, 2014

Chicago Marriott Downtown Magnificent Mile

Chicago, IL

Making the Business Case

for Franchise Standards

Beyond Because I Said So

Theodore P. Pearce

Nexsen Pruet, PLLC

Charlotte, North Carolina

Robert F. Salkowski

Zarco, Einhorn, Salkowski & Brito, P.A.

Miami, Florida

Kevin S. Reeve

Ruby Tuesday, Inc.

Maryville, Tennessee

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Table of Contents

Introduction

I. What are Standards

A. Health, Welfare and Safety Items including Insurance

B. Quality issues in existing franchise program

C. Operations of units

D. Upgrades to system / repair and maintenance / remodels

E. Changes to the Franchise System (New Standards)

F. Trademark(s), trade dress and brand elements

II. What Standards are Not (or shouldnt be)

A. Arbitrary means for dispensing favoritism

B. Basis for franchisor micromanaging

III. Where are brand standards found

A. Franchise Agreement

B. Operations manual

C. Lanham Act

D. Course of dealing / actual operations

IV. Why does a franchise system need standards

A. Uniformity and consistency of customer experience

B. Trademark integrity

C. Attracts franchise investment / creates value

V. Setting franchisee expectations in maintaining brand standards

A. Mission and vision of the franchise system

B. Franchise Disclosure Document

C. Who are the prophets to spread the word on brand standards

1. Senior executives

2. Operational coaches

3. Peer pressure

4. Other third parties

5. Professionals- franchise system convention

VI. The consequences of neglecting standards enforcement

A. Vicarious Liability

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B. Claims by franchisees that the franchisor failed to uphold the system

standards

VII. Judging whether standards are being met

A. The quality report

B. Customer surveys

C. Mystery shoppings and audits

VIII. How quality assurance surveys, reports and audits stand up in court

IX. Methods of enforcement

A. How to convince the franchisee the standards are good for its business

B. Positive methods to enforce standards- incentive programs

C. Enforcement through contract rights

D. The use of the injunction before termination

E. Termination

X. Legal Issues related to standards enforcement - Vicarious liability

XI. Is termination an effective tool to enforce standards

XII. Changes to the franchise system that become the new set of standards

A. Unilaterally enforced by the franchisor

B. Making the case to the franchisees

C. Using the systems FAC as a means to implement change

D. What help can the franchisor provide to the franchisee

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Introduction

Blessed is he who expects nothing, for he shall never be disappointed.

--Benjamin Franklin

High expectations are the key to everything.

--Sam Walton

East is East, and West is West, and never the twain shall meet.

--Rudyard Kipling

Cant we all just get along?

--Rodney King

It is axiomatic that franchising has been concerned with standards from its

earliest iterations. Whether you attribute its origins to pharaohs licensing the designs of

the pyramids, to the practice of barony in medieval England, to the German brewers

who franchised exclusive rights to their beers in the 1800s, to Isaac Singers clever

distribution process for his sewing machines, to Martha Matilda Harper and her

hairdresser parlors, or to Ray Krocs milk shake machine scheme, or to Coca-Cola,

franchising has ever been distinguishable from other commercial ventures because of

its focus on making money based on (and inherent perceived value in) the licensed

standards of a particular brand, service, process and/or product.1

It is also axiomatic that simply using the word axiomatic is an inadequate

means of proving the truth or compelling nature of a thing or argument. As lawyers, we

ply our trade in words. So, let us ply.

Franchisors and Franchisees, though both have vested interest in franchise

standards, come at them from different and sometimes conflicting perspectives.

Franchisors understand the Solomonic wisdom of keeping up a good reputation and

therefore insist upon standards to make money directly through their sales channels

and indirectly through license/franchise royalties.2 Franchisees, for their part, recognize

1 See A Brief History of Franchising, www.franchise-law.com/PracticeAreas/Brief-History-of-

Franchising.asp; History of Franchising, franexcel.com/resources.php?id=32; History of Franchising: Franchising in the Modern Age, www.franchising.com/howtofranchiseguide/history_of_franchising_part_two.html; and undoubtedly a slew of other intro pages to organizations or firms offering franchise-related services for a fee. Wikipedia still doesnt rate, correct? 2 A good name is more desirable than great riches; to be esteemed is better than silver or gold.

Proverbs 22:1, New International Version.

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the value of such standards and prove this recognition by agreeing to pay monthly

royalties and related fees to build their businesses on the foundations laid by the

franchisors. Once they have signed the franchise agreement, however, they will

naturally tend to place an equal if not higher premium on the business acumen and

executional prowess they have applied to the franchisors standards. This can and

does lead to squabbles when the franchisor wishes to audit the franchisees compliance

with or introduce new and often costly components to the franchise standards.

Cant we all just get along? Yes, Rodney, we can, and in the spirit of this hope,

we present the following case for how to build a franchise standards program that

serves not only the interests of the franchisor and franchisee, but to their consuming

public as well.

I. What Are Standards

Unlike obscenity, we have to approach and articulate franchise standards with

more particularity than I know it when I see it.3 This is not merely a pragmatic

consideration; as we know, and will discuss below, it is mandated by federal and state

law and further buttressed by the necessary strictures inherent in stable contractual

relations.

Interestingly, given the interplay of franchising with U.S. trademark law, the word

standard is firstly associated with something that predated trademark law but perhaps

presaged it.4 It visually and physically expressed the quality of an army, a kingdom, or

a country. Those who doubted the quality associated with a standard only had to

engage in battle to prove whether his doubt was well founded.

Standards, by common understanding, represent a certain level of desired

quality, achievement, success, or operation.

In modern commerce, where we frequently employ the parlance of warfare to

express our passion, the stakes, or how far we will go to win, we use standards to

signify the unique source of what we offer, be it goods, services or both. In a specific

sense, we have just described what a trademark or servicemark is.5 In a more general,

day-to-day sense, standards are the prescribed and proscribed written obligations that

3 Apologies to Justice Stewart.

4 Standard: a conspicuous object (as a banner) formerly carried at the top of a pole and used to mark a

rallying point especially in battle or to serve as an emblem. Merriam-Webster dictionary. 5 www.uspto.gov/trademarks/basics/definitions.jsp

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guide a franchisees actions and decision-making so that its licensed business will be

successful and at the same time maintain the good name (literally, the standard in the

previously noted defined sense) of the franchisor.

A. Health, Welfare and Safety Items including Insurance

Standards encompass and are reflected in various ways within a franchise

system. One type of standard has to do with protection and safety. These will, of

course, be dictated both by laws/regulations and common sense and further vary due to

the type of business franchise. In a food or beverage related industry, there will be

standards related to the sourcing of quality ingredients, the handling of food and drinks,

hand washing of employees, preparation methods, avoiding food-borne illnesses,

allergens, and safe and responsible service of alcohol.6

It is well settled that franchisors may use the courts to obtain franchisee

compliance with system standards, and they routinely do so.7

Some requirements will be aimed at protecting the franchisees employees in the

conduct of their duties, while others will be more customer-focused.8 Although safety

concerns have become synonymous with 24-7 convenience stores, they pose interesting

questions beyond the unfortunate victims of violence; namely, who is in the best position to bear

responsibility for lax security? The franchisor, who establishes the security standards, or the

franchisee, who must physically mind the till during the wee small hours in which violence

typically occurs? While courts will look at factors such as the level of control the franchisor has

over the franchisees day-to-day operations, a plaintiff will usually find a more pragmatic basis

for targeting blame.

Minimum insurance requirements as well as standard indemnification language

serve to underscore the costs and risks at stake if a franchisee is lax in meeting

franchisor standards.

B. Quality Issues in Existing Franchise Program

6 See, e.g., as obtained from the first page of my Google search using the terms, sample franchise

operations manual, www.wingerycorp.com/Library/MANUALS/Operations%20Manual%202-2011.pdf. The level of detail that a franchise operations manual can see at first glance to be insultingly detailed. But the level of presumed knowledge cannot be understated. Just ask McDonalds. See (Liebeck v. McDonald's Restaurants, P.T.S., Inc., No. D-202 CV-93-02419, 1995 WL 360309 (Bernalillo County, N.M. Dist. Ct. August 18, 1994)) 7 See Dunkin Donuts Inc. v. Priya Enterprises, Inc., 89 F. Supp. 2d 319 (E.D.N.Y. 2000)

8 For a recent example of the intersection between standards and safety in the franchise context, see

www.nj.com/south/index.ssf/2014/01/south_jersey_7-11_robberies_wo.html.

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While perhaps less dramatic or newsworthy, of no less importance to the

franchise system are those standards that are indicative within the franchise system as

created by the franchisor. The prospective franchisee can glean a certain amount of

information from the franchisors Franchise Disclosure Document (FDD), but unless

quality issues have led to lawsuits or generated negative publicity, she will have to

largely rely on her own brand perception.

As a consumer of brands, we instantly make value decisions when faced with a

choice between, say, Coca-Cola and RC Cola. It may have to do with price points, it

may be the establishments we know to serve the brands, it might lean heavily on the

advertising messages and media utilized by the competing companies, it likely involves

the perceived comparative quality of the product offerings.

These same judgments are made about a franchise system at every touchpoint

with which a consumer (or franchise prospect) interacts. The type of real estate the

franchise business operates on. The trade dress of the brand. The catchiness of the

commercial jingle. And particularly, the extent to which a consumer experiences

significant variation in experience between franchise outlets.

The astute franchisor invests in keeping abreast of such perceptions through

research and development and tweaks the system appropriately. Many franchisors are

likely homeblind to one or more of these consumer perceptions, and their brands may

be perceived as tired, outdated, or on the wane as a result.

At any rate, it is clear that there are levels of quality, and lack of, throughout a

franchise business operations. Some of these standards are inherent in the choices

the franchisor makes over time about the necessary level of investment in the

components of the system.9 Some come to light in how the system operationally

applies and executes.

C. Operations of Units

These standards are primarily comprised of how a franchised unit interacts with

consumers. A franchisor can articulate, audit and reemphasize standards all it chooses,

but the real test of standards is at the guest/consumer level. There are many ways to

evaluate how well franchisees are complying with franchise standards, from secret

9 McDonalds, with its Sensory Evaluation Center to evaluate the consistency and quality of its products, is

one example of a company that has staked its growth and success on attaining and maintaining a guest experience that can be replicated over and over again. See www.mcdonalds.com/us/en/food/food_quality/trends_innovation/barbara_booth.html.

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shoppers to guest surveys to online pollsthe most important likely being sales and

customer traffic data.

D. Upgrades to System / Repair and Maintenance / Remodels

The cover page of the FDD lists the total investment necessary to begin

operation of an offered franchise. This is like looking at the Total Amount Borrowed

section of a mortgage agreement and is not for the faint of heart. From there, Items 11

and 16 and the fine print of the franchise agreement are the portions of the FDD

prospective franchisees and their advisors scour for clues as to what will be expected in

terms of capital outlay to comply with franchise standards. A franchisor may expect

new point of sale systems every five years or whenever a certain percentage of the

system has upgraded, whichever comes first. Another may require that franchisees

enter into repair and maintenance contracts to ensure that equipment, facilities,

landscaping and parking areas are kept up to system standards. Another may require a

complete remodel of a physical store, internally and/or externally every certain number

of years. These are tremendous sources of relational discord, and lawsuits are not

uncommon.10

For obvious reasons, franchisors are advised to avoid vagaries in their FDDs and

communications with franchisees. Good communication covers over a multitude of sins

in this area.

E. Changes to the Franchise System (New Standards)

This gets even trickier. When a franchisor decides to implement a new

standardeven if the FDD said all along it could do so and the franchise agreement

specified it was completely within franchisors discretionyou can almost hear the

collective WHUMP! of every franchisee in the system simultaneously opening up the

heavy FDD/franchise binder that had for years probably been collecting dust in her

attorneys offsite client file storage facility.

While it behooves a franchisor to draft agreements with as much leeway possible

to introduce new elements, products, services and offerings that it reasonably believes

will be beneficial to the success of the system, a franchisee may rightly question

whether such broad discretion, as applied to the facts of an actual system change would

have been material enough to cause her to not have purchased the franchise in the first

10

See, e.g., KFC Corporation v. JRN, Inc., (U.S. Dist. Ct. for Western Dist. of KY, Civil Action No. 3:11-CV-260-H, Order January 19, 2012)

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place. And we all know where questions of fact go to be decided. If franchisors can

reasonably tie the new standards to contractually granted discretion and a systemic

benefit, they can sustain challenges.11 But this of course can backfire if the franchisors

policies and discretion are not reasonably uniformly enforced.12

The smoothest introductions of system-wide changes will include:

Reasonably sticking to the letter of the franchise agreement regarding the scope

of change

Researching the results of other systems that have made similar changes and

utilizing lessons learned from their experiences

Good and regular communication with franchisees

Introducing incentives to franchisees to increase receptivity, be it through

financing, rewards for speed of compliance, discounts on or free training

opportunities, etc.

F. Trademark(s), Trade Dress and Brand Elements

Though these may be considered to be subsumed in one or more of the above

mentioned categories, given the primacy that the franchisors trademarks and brand

elements represent to the franchise system, their importance cannot be overstated. As

we will discuss further below, maintaining strict compliance in the franchisees use of a

franchisors intellectual property is as important as any defensive strategies that the

franchisor employs against third party infringers. With the trademark being the heart of

the license, a weakened mark, be it through improperly allowed laziness with standards,

encroachment by other marks, dilution or worst all the dreaded genericide, is death to

a franchise.13

11

See Burger King Corporation v. E-Z Eating, 41 Corporation, (U.S.Ct. App. 11th Cir., 2009), where

agreement granted right to introduce changes to the standards, specifications and procedures as franchisor in the good faith exercise of its judgment believes to be desirable and reasonably necessary; see also La Quinta Corporation v. Heartland Corporation (U.S. Ct. App. 6

th Cir., 2010), involving new

required computer reservation system, where agreement granted franchisor right to amend, modify, delete or enhance any portion of the System. 12

See Stuller Inc. v. Steak N Shake Enterprises, Inc., (U.S. Ct. App. 7th Cir., 2012), in which issues

regarding maximum pricing and allowing exceptions to certain other franchisees torpedoed the franchisors claims. 13

See www.inta.org/TrademarkBasics/FactSheets/Pages/TrademarksvsGenericTermsFactSheet.aspx, www.independent.co.uk/news/business/analysis-and-features/genericide-when-brands-get-too-big-2295428.html.

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II. What Standards Are Not (or Shouldnt Be)

A. Arbitrary Means for Dispensing Favoritism

Reason has always existed, but not always in a reasonable form.

--Karl Marx

Man is a reasoning rather than a reasonable animal.

--Alexander Hamilton

Well, many insane people and seriously mentally ill people seem reasonable.

--Alan Dershowitz

Franchising, like any contractual construct, a relationship of sorts. But given the

potential to be in a relationship that may last decades, involves large expenditures of

money, time and energy, and is fraught with potential conflicts, it is one that rightfully is

entered into with careful consideration, legal and financial advice, and at least a gut test

as to whether there is sufficient chemistry to make the relationship work.

Because it is a day-to-day, all-encompassing endeavor, it is no wonder that

franchisors frequently engage in the vernacular of relationship, even going so far as to

refer to the system as a family.14 This is meaningful on a few levels. Obviously, it

stresses strong bonds and a presumption of support, encouragement, and mutual

dedication to a common goal.

But anyone who has ever had a sibling understands that some degree of

favoritism is inevitable. And in franchising, the more successful the brand is, the more

likely that a franchisee will have a slew of sibling peers vying for the attention and favor

of Mama/Papa Franchisor.

Whats a franchisor to do? Act reasonably and consistently and in conformity to

the written agreements and any promise of offers you make. The franchise agreement

will typically include a provision that, on one hand, reserves considerable discretion to

the franchisor to discontinue, revise, create, and enforce new standards in the franchise

14

E.g., depalmasitaliancafe.com/Depalmas_Franchise.pdf, www.shipleydonuts.com/p-franchise, www.franchise.org/7-Eleven_Inc_franchise.aspx, www.auntieannesfranchising.com/Portals/1/docs/Auntie-Annes-Franchise-Kit.pdf, www.bar-b-cutie.com/bbq/franchising/franchising-info/, www.goinpostal.com/shipping_store_franchise_info.htm, www.learningexpress.com/franchises/.

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system. It will also include a provision that, on the other hand, creates a duty of

reasonableness (one that often originates in state relationship laws and generally is

buttressed by state common law).15 Between these two provisions there is often

enough room to drive a bitter lawsuit through.

What does reasonable look like? To come back to the family theme of

franchising, if it is something you would feel comfortable doing to a family member,

theres a good chance its reasonable. A family member from whom you are not

estranged, divorced, or with whom you are locked in a contentious dispute, anyway.

The Golden Rule should apply.16

Reasonable doesnt look like:

failing to involve franchisees in key decisions regarding system changes

punishing one franchisee using a failure to meet standards rationale when allowing

another franchisee to ignore or fall short of compliance with the same standard17

applying different standards to company-owned outlets vs. franchised units

B. Basis for Franchisor Micromanaging

Franchisors typically state in their franchise marketing materials that they are

looking for entrepreneurs. Start-up costs for a new franchise can be up to $5 Million or

more.18 Operating a franchise can involve hiring and managing up to dozens of

employees per outlet, navigating the intricacies of federal, state and local regulations,

and jockeying successfully for market share in areas in which the franchisor often has

no experience. Put another way, franchisees are expected to be bright, self-starting,

motivated, hard-working, passionate people with a track record of making money and

good decisions.

15

See, e.g., ARK. CODE ANN. 4-72-204(1), HAW. REV. STAT. ANN. 482e-6(2)(C), 815 ILL COMP. STAT. 705/18, IND CODE ANN. 23-2-2.7-2(5), WASH REV. CODE ANN. 19.100.180(1), (2)(c), WIS. STAT. 135.03. 16

Matthew 7:12 17

Always, always, always presume that all your franchisees are talking to each other. After all, you likely encouraged them to do so (or should have) when they were considering the brand at the outset. 18

http://www.franchising.com/howtofranchiseguide/the_cost_of_opening_a_franchise.html

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Franchisors say that they want these types of people and organizations to

represent their brand, but the application of franchise standards will reveal whether this

is true of if good executors that dont ask questions are really what a franchisor is after.

Franchise standards should provide a blueprint for successful operations that,

combined with a strong brand, effective marketing, regular training, and meaningful

support, should help all franchisees in a system be successful and garner well-earned

royalties for the franchisor.

Franchisors that are lazy, complacent, untrusting, or simply view the franchise

sector of their businesses as second-class citizens, are apt to use their standards as a

means to micromanage the system. This naturally breeds poor relationships with

franchisees, but it also opens up the franchisor to legal claims of vicarious liability in a

variety of contextsslip and falls, robberies, sexual harassment.19 These cases hinge

on the level of control the franchisor hasboth contractually through the franchise

agreement and operations manual and de factoover they day-to-day operations and

decision making of the franchisee.

III. Where Are Franchise Standards Found

A. Franchise Agreement

In the ideally sacred but sometimes profane relationship that is the franchise, the

franchise agreement is the bible that governs the relationship. It establishes the

covenants between the parties.

The Federal Trade Commission Franchise Rule defines a franchise as follows:

(h) Franchise means any continuing commercial relationship or arrangement, whatever it may be

called, in which the terms of the offer or contract specify, or the franchise seller promises or represents, orally or in writing, that:

(1) The franchisee will obtain the right to operate a business that is identified or associated with the

franchisor's trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor's trademark;

(2) The franchisor will exert or has authority to exert a significant degree of control over the

franchisee's method of operation, or provide significant assistance in the franchisee's method of operation; and

19

See, e.g., Temple v. McDonalds Corp. (U.S. Dist. Court ED Penn., 2012), Folsom v. Burger King (958 P. 2d 301, 135 Wash. 2d 658 - Wash: Supreme Court, 1998), Myers v. Garfield & Johnson Enterprises, Inc., et al., 2010 U.S. Dist. LEXIS 3468 (E.D. Pa. January 14, 2010).

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(3) As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate.

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Essentially, all a franchise agreement must contain to fall under the definition of

franchise are these three elements: (1) trademark, (2) significant control or assistance,

and (3) required payment.

Of course, to be a federally compliant franchise, the remainder of the FTC Rule

provides the remainder of the items which must be fleshed out, if only to populate the 23

items and attachments that comprise the Franchise Disclosure Document.21 It is

therefore expected that the franchise agreement will include information about the

specifics of the license offered, the payments to be made and, restrictions on

products/services, franchisee obligations regarding compliance with standards and

policies/operating manual, maintenance, appearance and remodeling requirements,

insurance, records and reports, staffing, inspections and audits, training, intellectual

property and other items.

Practically speaking, the franchise agreement is most consulted at two junctures in

the franchise lifecycle, first during the pre-signing phase, when the prospective

franchisee and her advisors are culling the voluminous FDD materials from the

franchisee and deciding whether its worth rocking the new relational boat to push for a

few modifications.22

Once the agreements have been inked, the franchise agreements typically are filed

until one of the following occurs:

1. The franchisor institutes an advertising fund or announces a change to the

advertising fund contribution;

2. The franchisor announces the signing of a new franchise development

agreement to a third party that seems awfully close to the territory or existing units of

another franchisee;

3. The franchisor announces an audit of the franchisees books;

4. The franchisor announces it will be creating new franchise concepts;

5. The franchisee wants to sell some or all of its units;

6. The franchisor wants to buy one or all of a franchisees units;

7. The franchisee wants to add new investors or key management personnel;

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16 CFR 436.1(h) 21

16 CFR 436.3, .4 and .5 22

To which the franchisor or franchisors counsel inevitably used to respond that its called the Uniform Franchise Offering Circular because the offering is the same for all franchisees, hence no changes. This argument, lame as it was, became weaker still through the change of name to the Franchise Disclosure Document.

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8. The franchisee wants to create its own marketing/advertising materials;

9. The franchisee wants royalty relief;

10. The franchisee wishes to cease development and/or shutter open units;

11. The franchisee questions the purpose and use of the advertising fund;

12. The franchisee wishes to operate what it characterizes as noncompeting

concepts in addition to its franchised units;

13. The franchisee balks at paying for franchisors training personnel fees, travel

and/or expenses;

14. The franchisor announces a mandatory system wide remodeling program;

15. The franchisor announces a mandatory point-of-sale system upgrade;

16. The franchisee questions the value of or existence of support for which it is

paying monthly fees;

17. The franchisor doesnt like the fact that the franchisee is questioning fees;

18. Come to think of it, the franchisee wonders whether some of the things

franchisor told her during the sales phase might have been improper earnings claims;

19. The franchisor wonders whether the franchisees operators are fully engaged in

the operations of the business as required in the operations manual;

20. The franchisee mutters that her operations are 10 times better than those of the

franchisors company-owned units;

21. The franchisor seeks to confirm whether the franchise agreement default catch-

all failure to meet any other of the franchisors written standards or procedures

provision could conceivably cover the consistently crappy attitude franchisee has had

lately;

22. The franchisee recalls the franchisor once said at an owners conference that

she could expand her territory at any time, just say the word, but no need to document

that just now, we will honor that, I promise you;

23. The franchisor announces that it is buying back all the franchise territories

contiguous with the franchisees territory;

24. The franchisor gets a letter from franchisees apparent new legal counsel

inquiring about improper earnings claims and alleged failure to support his client and

opining wildly about damages and rescission of the entire franchise relationship.

Ok, so maybe its not so seldom consulted as noted. But the point is, its not

typically utilized until its needed as a sword or shield by franchisee/franchisor. The

day-to-day document that guides the franchise operations is more likely the operations

manual.

B. Operations Manual

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Once upon a time, this was an actual physical document, and apparently it was

great trouble and cost to reproduce, and franchisors routinely described in Item 6 of

their FDD what the cost would be for a Replacement Operations Manual.23 And then

we had computers and the Internet. Franchisors often maintain this compilation of

standards, policies and procedures on a secure intranet website for the franchisees,

which enables them to seamlessly update them without incurring printing costs.

The instructions for Item 11 to the FDD require that, at a minimum, the franchisor

disclose the table of contents for the franchisors operating manual, unless the

franchisor has made the manual physically available to the prospective franchisee prior

to buying the franchise.

This is where you find out exactly what the Colonels 11 secret herbs and spices

are! Or the key ingredient to McDonalds secret sauce.24 Since the franchise agreement

is a document you only visit when youre angry, scared or both, its the operations

manual that literally provides the soup to nuts to the franchised business experience,

in all its ultimately rather banal but necessary glory. Here youll find recommendations

on hiring and firing, how to clean the grease trap, keeping exterior awnings looking fresh

and new, and how to cook a hamburger to safe temperature.

Any franchisor will say to guard the operations manual with the franchisees life,

subject to vaguely threatening confidentiality related provisions in that franchise

agreement binder you havent picked up since the last time you were angry or scared or

both. The franchisor will say that the manual is a trade secret, highly confidential, and

represents a valuable business asset which if freely disseminated would result in

irreparable harm to the franchisor. And thats mostly true, at least once the common

sense items are sifted out. The key items from a value perspective are the how-tos of

recreating the consistent brand experience that drew the franchisee to the brand in the

first place.

C. The Lanham Act

The Lanham Act, which went into effect in 1947, is the source of federal

trademark law in the United States.25 Based on the premise that is focused on

23

Sometimes as much as $500 or more! Seriously. Franchisors also required a certain expenditure for the franchisee to obtain a Yellow Pages business listing. The Yellow Pages! Remember that? Dinosaurs roamed the earth. 24

Its just ketchup and mayo? Oh, never mind. 25

15 U.S.C. 1051 et seq. It was named for Rep. Fritz Lanham of Texas. Wikipedia is downright scant on information about Rep. Lanham beyond the fact of his namesake legislation, which may be enough.

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protecting the consuming public from being confused as to the source of goods or

services, the Act provides for registration of trademarks and servicemarks so long as

the marks continue to be actually used in interstate commerce and continue to function

as permissibly registered marks.

The reason the Lanham Act may be rightly considered a source of franchise

standards stems from the fact that the franchise is based on the license of a registered

trademark. And a trademark must be used in very specific ways to maintain its

perception in the consuming publics mindnamely, that it continues to denote or point

to the owner of that mark as the specific source of the goods or services bearing that

mark, and not as a mere description of a type of goods generally or confusingly similar

to other registered marks.26

If a trademark owner fails to adequately police the infringing actions and marks of

third parties, the mark that is the lifeblood of the franchise may cease to operate as an

effective indicator of source, subjecting the mark to opposition and cancellation. Or, as

has happened to once stalwart trademarks like aspirin and linoleum, the mark may

through negligence over time be allowed to represent in the consumers mind not the

owners specific identity as provider but a mere generic type of product that may come

from a number of other sources.27

Thus, the trademark act is of more concern to the franchisor than the franchisee,

at least directly. But the franchisor will take care to ensure that the operating manual

reflects those procedures necessary to ensure that the franchisors trademarks and

servicemarks continue to be robust.

D. Course of Dealing / Actual Operations

This category, vague by its definition because its not specifically articulated

(though can be cobbled together through memos, emails, audit reports, etc.), can over

time come to represent the largest source of a franchisors standards. This is

particularly true if the franchisors operations sector consider the operations manual

something to be something it put together just to appease the franchise lawyers.28 Even

if this is the case, it is recommended that franchisors include language in the franchise

26

Id. at 1052. 27

Genericide. Thats bad. Xerox spent large sums over the years prodding its customers to use Xerox as an adjective, not a verb. We use a Canon copier at our offices. 28

It happens.

17

agreement that specifically incorporate by reference all written standards and

exhortations by franchisor in any form as being part of the operating manual.

Course of dealing, as with the franchise agreement, is more likely to come up

when there is discord. A franchisee, for example, will use course of dealing to counter a

contrary standard articulated in the franchise agreement or operations manual. A

franchisor might use course of dealing to expand upon a standard contained in one of

those sources.

As such, a franchisor would be well served to revisit the franchise agreement,

FDD and operations manual on a routine basis to make sure that they all reasonably

match up not only with each other, but so as to be reflective of the actual day-to-day of

the franchise operations.

IV. Why Does a Franchise System Need Standards

As long as its making money for everyone and no ones getting sued, who

cares?

A. Uniformity and Consistency of Customer Experience

To answer that question, think about what happens when you walk in an Apple

store.29 Youre in a strange city on a client matter or, hey, for an IFA conference! You

visit a mall that youve confirmed through your phone in fact has an Apple store. You

enter through a common area and, making your way through mobile phone kiosks and

5-minute massage tables, you scan the open hallway for that familiar glass front wall

and the iconic lit up logo. Yes, there it is. Your stride speeds up a little, because even

though you know you already have a MacBook thats only 8 months old, last years

version of the iPad, and the latest iPhone, theres a chance that there might be a new

gadget to play with.

You walk up to the entrance. You see the sets of plain, Ikea-esque long tables

stretching back toward the back of the stores Genius Bar. You see the walls lined with

software, accessories, headphones, mega-data storage units. The tables are adorned

with rows of sleek, slender, metallic glowing joy boxes. A small army of blue-shirted,

thoughtful-looking hipsters in skinny jeans tends to customers with impossibly endless

patience, helpful suggestions and a distinct lack of overselling.

29

Put aside for a second any hang-ups you have about being a PC person, as applicable.

18

The walls and floors are so superfluous as to be unnoticeable. The lighting is

fluorescent and unimpressive. The showcase is simply whats on the plain tables. You

are drawn in. The credit card will swipe. Oh, yes.

You can recreate this narrative with a myriad of successful brandsSouthwest

Airlines, Disney World, the Ritz-Carlton, Costco, McDonalds. What these and many

other brands have in common is a consistent, expectable customer experience. And

they are not achieved by accident. It involves a commitment to strategy, culture,

customer understanding, design, measurement, and all these things are incorporated

intostandards.30

We know uniform and consistent brand experiences intuitively because those are

the brands that get our money. Study your favorite brands, watch what they do,

emulate. And write it down and commit to reinforcing those traits with your franchisees.

They want you to provide them with these valuable ideas. If they already had access to

that kind of experience, they would not be paying you money to license your business

model and intellectual property. Give them something for their money.

B. Trademark Integrity

Your marketing department or your clients marketing department will roll their

eyes whenever you get on your soap box about this, but simply remind them: without

that , youve got to secure a lot more faith and trust from a licensee that they are

probably willing to give (and pay for).

One thing you can do to empower them (and avoid some future eye-rolling

interactions) is work with them to produce a brand standards manual. If you are not

sure whether your company or client has one, you/they probably dont.31

A brand standards manual removes any guesswork about how franchisees may

use the franchisors trademarks, servicemarks, brand elements like logos, fonts, type

treatments, color schemes, trade dress, etc. Good brand manuals will border on fascist

attention to compliance. With good reason. Think again of the Apple store. The golden

arches. There are no accidents in brand strategy and execution with the companies

that readily receive our money.32

30

See www.fastcompany.com/3000798/6-disciplines-behind-consistently-great-customer-experiences. 31

Send a quick text to inquire. We will wait 32

For some examples of brand standards manuals, see, e.g., www.merrillshop.com/century21/cvd/resources/pdf/BrandGuidelines.pdf,

19

C. Attracts Franchise Investment / Creates Value

From a customer perspective, loyal returning customers will say they keep

coming back to a brand because I know what Im getting.

From a franchisee perspective, the language is a little different, but its the same

idea:

its a proven system

a proven process

a unique support system

makes you feel you are part of a team

stability, ease of operation, good execution

prevent beginner errors

they covered everything

continually doing research and surveying customers to make our services better.

good training, great processes and models to follow33

Good franchises build value and demand on their ability to create a replicable

quality customer experience. Franchise standards articulate how to do this clearly, step

by step, leaving nothing to imagination and everything to energetic execution.

Standards become the gospel for success. They are trained into franchisees

early and often, measured and confirmed through brand audits, and further encouraged

through incentives (carrots) and when necessary, discipline (sticks).

V. SETTING FRANCHISEE EXPECTATIONS IN MAINTAINING

BRAND STANDARDS

Franchise Agreements provide franchisors with an arsenal of remedies to combat

recalcitrant franchisees that refuse to maintain the brand standards of the franchise

system. Franchisor contract remedies range from requiring additional training at the

franchisees costs to seeking injunctive relief to require the franchisee to adhere to

those standards.34 The ultimate weapon, which I term the nuclear option, the franchisor

www.jiffylube.com/brandstandardsguide/assets/brandstandardsguide.pdf, www.servicemaster.com/sites/default/files/resource/FM_Brand_Guidelines_final.pdf, www.heavensbest.com/assets/pdfs/marketing/standardsmanual.pdf. 33

ifranchisenews.com/category/franchisee-testimonials/, www.franchise.com/franchisee-testimonials.cfm,

20

can terminate the franchisees franchise license. There is abundant case law that

supports the franchisors right to employ both judicial options.35 However, if a franchisor

is forced to use this draconian measure on a regular basis, while it may be able to

enforce those standards, it may create a culture of resentment towards what the

franchisees will perceive as heavy handed repressive tactics used by the franchisor to

govern its chain. Losing non-conforming franchisees many not be as severe as losing

the trust of the franchisee base.

If the franchisor is forced to use these weapons then it is likely that the franchisor

has not instilled within its franchise system a culture of compliance. The franchisor

likely has failed to manage the expectations of the franchisees as to the importance of

brand standards. While franchisees often portray themselves as independent

businessmen they are very dependent upon the franchisor to protect its trademark and

its associated goodwill. Most franchisees understand that consistency of its products

and services will enhance the customer experience, which will translate into higher

revenues for both the franchisee and the franchise system. Yet while most franchisors

understand the importance of brand standards as being a cornerstone of the franchise

system, it devotes precious few resources to instill a brand sensitive culture within its

franchise system.

A. Mission and vision of the franchise system

From the perspective of the franchisor, quality and consistency must be the

bedrock of the franchise system. The first step in building a brand culture is for the

franchisor to be guided by a mission and vision for its company. By including your

employees in the drafting of these pronouncements a franchisor will already be instilling

a brand sensitive culture within its organization. If the mission and vision does not

contain language emphasizing the need for consistency and quality within the system,

then the company will find it problematic to instill that culture within its organization and

its franchise system.

B. The Franchise Disclosure Document

From the first contact that a prospective franchisee has with the franchise system

it should understand the importance of quality control and consistency of the brand.

From the franchisors perspective this starts with what is contained in the Franchise

Disclosure Document (FDD). From the outset, item 1 of the FDD describes the

34

See Retaining and Improving Brand Equity by Enforcing System Standards, Joseph Schulmacher, Edward Wood Dunham and G. Adam Schweikert III, Franchise Law Journal, Number 1, Volume 24, Summer 2004 35

Id., Pg. 4

21

franchise concept. In this section the franchisor would be well advised when describing

its franchise concept to explain that the concept is built on customer satisfaction and

consistency of the products and services that make up the franchise offering. Then in

describing the trademark in item 13 the franchisor, again can insert a sentence on the

importance of consistency. In Item 11 there is another opportunity for the franchisor to

advise the prospective franchisee of the importance of quality control and consistency.

In this way the franchisee will from the outset understand that the success of the

franchise concept is built on the customer enjoying consistent service or products.

During a franchisees due diligence process it will have the opportunity to view the other

franchises within the system. If the condition of these facilities does not convey a feeling

of quality and consistency then the prospective franchisee either will be turned off by the

franchise opportunity or belief that the concept does not emphasize consistency and

quality control. The Franchise Rule does not permit franchisors to steer prospective

franchisees to specific franchisees, so it is imperative upon the franchisor to develop a

culture among its franchisees the importance of clean and up to date facilities.

C. Who are the prophets for Quality Control in the Franchise System?

1. Senior Executives

The very first people that must be the prophets of the system are the senior

executives of the franchisor. Corporate philosophy should start at the top. If the

corporate executives do not subscribe to this philosophy then others in the franchisor

offices and the franchise system are not likely to support the importance of system

standards. Catchy slogans and other published documents will help the franchisor to

instill this philosophy throughout the company36

2. Operational Coaches

A franchisor should use its operations team to communicate its culture of brand

awareness directly to the franchisees. The key to these communications is to advise

the franchisees the importance of the brand standard. The concept of Check, Coach,

Check, and Enforce37 was recommended by one author on this subject. It cannot be

36

As an example when Meineke Car Care Centers was under the leadership of Ken Walker one of the first things that he did with his senior executive team was to have them draft a mission, vision, and customer covenant with everyone signing onto the covenant. The covenant was displayed for every employee and franchisee to see when coming into the lobby of the corporate offices. Another aspect of this philosophy was to come up with a guiding slogan for the company, At Meineke customer satisfaction starts with ME. While appearing to be corny ever employee within the company was guided by that little phrase.

22

over emphasized The importance of using the people within a franchisors organization

to coach the franchisee to develop a cultural awareness of the brand standards cannot

be over emphasized. Remember, franchisees expect their franchisor to protect the

brand for their benefit, even if at times they prove to be recalcitrant in carrying out brand

initiatives. The franchisor employees that are the closest to the franchisee are best to

instill that culture. While franchisees may be resistant to the words or pronouncements

issued by the franchisors senior executives, operational representatives will have more

frequent and personal contact with its franchisee. Most franchisors will assign to an

operations representative or coach so many franchisees within a market area. Among

the responsibilities of the operations representative or coach should be to coach or work

with the franchisee in operating its unit franchise, including imparting the need for

system compliance. In this situation system compliance can include quality control as

well as the institution of new products or services or procedures. An operations

representative that understands its market, the needs of the franchisor, as well as the

concerns of the franchisee, will be well placed to explain to the franchisee the reasons

why abiding by quality standards will improve its business. Over time, a culture of trust

should develop between the operations representative and the franchisee such that the

operations representative is not only able to coach the franchisee into compliance, but

also, if necessary, will be able to check whether the franchisee is in compliance with the

standards. While it is usually not the operations representatives place to enforce the

standards, it can warn the franchisee of the risks of non-compliance. A franchisor that

skimps on resources to support competent operations representatives will miss a great

opportunity to enforce system standards without having to bludgeon this compliance

through judicial means or even termination of the franchisee to the economic detriment

of the franchise system.

3. Peer Pressure.

Franchisees, like others in society, respond to peer pressure. Most franchisees

are sensitive to what other franchisees in the market say about the operation of their

business. This is most pronounced when markets share advertising contributions.

Those franchisees who arguably do not contribute their fair share to a cooperative

advertising fund will hear discontent about their operations from other franchisees in the

market. Likewise, if a franchisee in a market is offering sub-standard products or

services other franchisees in the market will likely tell that franchisee how its operations

is hurting their business. A franchisee in a market that does not abide by system

standards can adversely impact or bring down the value of a market. In fact, there are

37

See Retaining and Improving Brand Equity by Enforcing System Standards. Joseph Schumacher, Edward Wood Dunham, and G. Adam Schweickert, III, Franchise Law Journal, Number 1 Volume 24, Summer 2004.

23

cases where effected franchisees have sought protection and damages from a

franchisor for failure to enforce system standards.38 The language in the franchise

agreement can dictate the efficacy of such claims. If the franchise agreement promises

franchisees that it will police the standards of other franchisees within its system then

franchisees will expect the franchisor to do so.

4. Other third parties

Beyond one-on-one peer pressure, independent franchisee associations or

dealer advisory councils often will act on behalf of the franchisor to assist the franchisor

in detecting instances of franchisees not complying with system standards. In some

instances, the bylaws of the dealer association will prevent a franchisee from serving on

the governing board of the association if it is not in compliance with the franchise

agreement. Franchisee associations understand that one of their value propositions is

to work with the franchisor to build a better and sustainable franchise system. While a

franchisor cannot rely solely on the franchise association to entreat franchisees into

compliance, the use of the dealer association or franchise advisory council is another

arrow in the franchisors quiver to convince franchisees the importance of standards

compliance to the franchise system. Moreover, when a franchisor wishes to change

certain standards in its system, once it has received buy-in from its dealer association or

its franchise advisory council then there is no better vehicle to use to obtain buy-in from

the franchisee body.

5. Professionals franchise system convention

Other effective ways to instill a culture of compliance within a franchise system is

through the use of professionals. A great venue in which to use these professionals is

at an annual or bi-annual franchisee convention sponsored by the franchisor. In this

relaxed environment pleasure is mixed with educational sessions that should always

include customer service seminars or other seminars touting the need to maintain brand

standards. In this relaxed environment franchisees are likely to be more receptive to

these suggestions. And a franchise convention is an especially good venue for

franchisors to roll out new products, services, policies and procedures. One post-

convention exercise that has proven successful in convincing franchisees the value of

attending a franchise convention is to track store sales results immediately after the

convention between those franchisees that attended the franchise convention vs. those

that did not. It will be no coincidence that franchisees attending a convention will see

marked improvement of their sales vs. those franchisees that did not attend.

38

See, Creel Enterprises, Ltd., et al v. Mr. Gattis, Inc. BUSINESS FRANCHISE GUIDE 9825 U.S. District Court, N.D. Alabama (1990)

24

VI. THE CONSEQUENCES OF NEGLECTING STANDARDS ENFORCEMENT.

The cornerstone of a franchise system is its trademark. Over time franchise

systems spend millions of dollars growing and enhancing the reputation of its brand.

The trademark is a symbol of the goodwill associated with those marks.39 A franchisee

is granted the right to use the trademark as part of its grant to use the franchise system.

The franchisor expects that the franchisee will contribute and not detract to the goodwill

that is associated with its brand. The customer expects that the brand offer a consistent

experience. A franchisee that does not comply with the brand standards, will dilute the

value of the brand. By the same token, a franchisor that does not police the brand may

see claims from both third parties that have been injured by the brand as well as

franchisees that claim that the franchisor is not policing the brand to their detriment.

The Lanham Act40 requires that a trademark owner maintain sufficient control of

its brand. Often controlling the brand requires policing it through the enforcement of

brand standards with respect to its franchisees. A trademark owner that does not police

its trademarks risks losing its right to the trademark.41 While the Lanham act does not

specify how much control or what control a licensor must use in controlling its mark,

courts require that the licensor use reasonable means to control the quality of the

goods and services flowing from the mark and the actual use of the marks. A major

part of that control requires a franchisor to establish and implement quality control

standards (enforcement standards) for the users of its marks. If the grant of the license

by a franchisor to use its marks is not accompanied with the right to control them all that

the franchisor grants to the franchisee is a naked license, which may result in the

trademark losing its significance and thus may be construed under the 15 U.S.C. 1127

as an abandonment of the mark42

The franchise agreement usually provides the franchisor with the tools to enforce

quality control or brand standards, but as suggested in the previous section, to the

extent that a franchisor can undertake this responsibility by means of the carrot instead

39

See Retaining and Improving Brand Equity by Enforcing System Standards. Joseph Schumacher, Edward Wood Dunham, and G. Adam Schweickert, III, Franchise Law Journal, Number 1 Volume 24, Summer 2004, 40

15 U.S.C.1125 et. Seq. 41

See Retaining and Improving Brand Equity by Enforcing System Standards. Joseph Schumacher, Edward Wood Dunham, and G. Adam Schweickert, III, Franchise Law Journal, Number 1 Volume 24, Summer 2004, page 2. 42

Supply and Distribution Issues, Ted Pearce, Steve Feirman, Eric Yaffe, 37th Annual International

Franchise Association Legal Symposium Volume 2, Tab 17, May 2004.

25

of the stick will find its policing responsibility easier. If however, it must resort to legal

enforcement or termination there is ample legal authority to support those options.43

A. Vicarious liability.

One of the consequences of not enforcing brand standards can are having to

defend against third party claims. Damages or injuries suffered by a third party as a

franchised establishment are likely to include a claim against the trademark owner.

These vicarious liability claims can be a real threat to a franchisor. As with most of

these claims courts will review them in the context of the franchisor-franchisee

relationship. A court will take into its calculus the various control factors that make up

the franchise relationship. There is no bright line test as to what constitutes control over

the franchisee. Franchisors in most cases will take the position that the control

exercised over its franchisees is grounded in its responsibility to police its trademarks.

Courts use a multitude of standards to determine whether control actually exists over

the franchisee. Whichever test a court uses the inquiry will be fact intensive.

B. Claims By Franchisees That The Franchisor Failed To Uphold

System Standards.

In addition to third party claims, franchisees may initiate claims against its

franchisor alleging that the franchisors failure to police its brand caused damage to the

franchisees business. 44 Courts, however, are loathe to hold a franchisor accountable

to a franchisee for its failure to enforce system standards against a third party

franchisee, unless it can be shown that there exists an enforceable third party

beneficiary relationship. In the case of Creel Ltd. V. Mr. Gattis the court ultimately

dismissed a franchisees claim against its franchisor for failure to enforce its system

standards because there was no showing that the franchisor obligated itself to police

the system. Moreover, since the franchisee was not a part to the contract between the

other franchisees and the franchisor, it had no standing to bring its claim against the

franchisor.45

43

See, e.g. Dunkin Donuts, Inc. v. Patel, 174 F. Supp. 2d 202, 212 (D.N.J. 2001) 44

Creel Enters Ltd. V. Mr. Gattis BFG (CCH) 9825 at 22,239 (N.D. Ala. 1990) affd 933 F2d 1022 (11th

Cir. 1991) 45

Creel Enterprises, Ltd., et al v. Mr. Gattis, Inc. BUSINESS FRANCHISE GUIDE 9825 (U.S. District Court, N.D. Alabama (1990)

26

Conversely, in a case where the franchisor promised in its franchise agreement

to continue its efforts to maintain high and uniform standards of quality, cleanliness and

service at all its stores, an allegedly injured franchisee could bring a claim for breach of

contract.46 In this case however the franchisee was not able to sustain its claim because

it could not prove its damages.47 While in this case the proof of damages proved to be

the obstacle to recovery, the case illustrates the point that the wording in the franchise

agreement can obligate a franchisor to enforce its system standards as a matter of

contract.

VII. JUDGING WHETHER STANDARDS ARE BEING MET

In todays very sophisticated market place franchisors have a large battery of

options to judge whether system standards are being met. In an earlier age many

franchisors would limit their standards inquiry to tests and investigations done in house.

Often less sophisticated than the array of outside services available today, the use of

those procedures would have limited value in todays market place. Today, with the

advent of social media, consumers have countless means of judging brand quality.

Therefore, it behooves a franchisor to be able to judge its standards as effectively as its

patrons. In addition to in-house quality assurance inspections, franchisors rely upon

outside surveys, audits, mystery shoppers, customer surveillance, and private

investigators, all armed with the latest technology.48

A. The Quality Report

Most franchise systems provide franchisees with quality assurance reports or

periodic report cards to show them their compliance within the franchise systems.

These reports at the very least should be used to benchmark a franchisees

performance and should be viewed against their sales performance. The reports can

be used by the franchisees operational representatives to reinforce to the franchisees

the strengths of its operations and to show them where improvement is needed. If

dealing with a recalcitrant franchisee the reports can serve as a shot across the bow to

the franchisee to let them know that if performance does not improve it risks

enforcement actions being taken against them by the franchisor. Franchisees

sometimes are sensitive to in-house quality assurance reports. They believe that they

are being used to pick-on the franchisee. From their position they believe that the

franchisor is discriminating against them. For the franchisor, therefore, it is critical that

46

Dunkin Donuts, Inc. v. Patel, 174 F. Supp. 2d 202, 212 (D.N.J. 2001) 47

Id. at 212 48

Fiona Burke, Ted Pearce, Robert L. Zisk, A Practical Guide to Franchise Audit and Compliance Investigation Programs, American Bar Association 28

th Annual Forum Meeting, October 2005

27

these reports be completely objective. Moreover, it is important that all franchisees be

judged on the same objective standards.

B. Customer Surveys.

Third party customer surveys has always been an effective manner to judge a

franchisees ability to follow system standards. With todays social media venues like

Facebook and Yelp, the use of these surveys has become self-executing. In addition to

these informal surveys franchisors can use telephone surveys, in-store comment cards

and interactive voice response, The simple use of survey cards whether done in hard

form or electronically Having the franchisee confront third party comments about their

business is similar to peer pressure. If, however, a franchisee does not react to these

surveys then the franchisor will know that the time has come to remove the franchisee

from the franchise system either through a resale or termination.

C. Mystery Shoppings and Audits

If a franchisor perceives that a franchisee is not complying with system

standards, including not reporting all of its gross sales, it may use a variety of targeted

investigatory techniques like mystery shoppings and audits. As an example a

franchisor may use a mystery shopper to shop a recently re-flagged hotel to see if the

new franchisee is using any of the trademarks of the former franchisor such as clothes,

hangers, displaying the hotels name.49 Mystery shoppings also can be used to support

an unfair advertising claim. See, for example, in the case of Surdyks Liquor v. MGM

Liquor Stores where in making the allegation of false advertising, the plaintiff relied upon

the mystery shoppings of three private investigators to determine whether the

advertised wines were in stock at the liquor stores that claimed to participate in the

sales.50

While franchisees may question the reliability of mystery shoppers the industry

has undergone modernization to allay such concerns. One organization called the

Mystery Shopping Providers Association (MSPA) was formed to render more

legitimacy in the industry. Started in 1998 with only 70 member companies, today the

49

Id at 5 50

Surdyks Liquor v. MGM Liquor Stores, Inc. 83 F. Supp 2d 1016, USDC Minn., 2000

28

organization is nationwide and boasts more than 300 members.51 One of the key goals

of this organization is to upgrade the quality of mystery shoppers. One of the

advantages of the MSPA is that it gives mystery shoppers a venue to police themselves

using vehicles like on-line chat rooms and websites as communications channels.

VIII. How Quality Assurance Reports, Surveys and Investigations Stand-Up in

Court

Before tackling the issue of the effectiveness of quality assurance reports,

surveys and investigations in court, it is important to understand that privacy issues will

implicate how these procedures are undertaken. The use of mystery shoppers while

being very attractive for the franchisor to obtain first- hand information on whether a

franchisee is complying with system standards, it must understand that there is an

expectation of privacy of these conversations that is governed both by federal and the

more restrictive state law. In the first instance, it must be established whether a mystery

shopper is invading a public or private space. A customer shopping at a public

restaurant may be seen differently than one going into a venue that does not have the

same public exposure.

The scope of protection of a conversation between a mystery shopper and a

franchisee will be governed by the protection afforded to the conversation by state

statute. Most states require the consent of only one of the participants of an oral

conversation that is recorded. Some states, like New Hampshire make it a felony to

record or intercept an oral communication without both parties to the conversation

consenting.52 To alleviate this two-party permission requirement a franchisor should

inform its franchisees that mystery shoppings will be conducted on a regular basis and

that the conversations will be taped. The franchisor should advise the franchisees

employees that they also will be taped.

Franchisors may use quality assurance reports, mystery shopping reports,

audits, or private investigations to support a case against a franchisee for judicially

mandated compliance or termination. In using this evidence the keys to their successful

use will be determined upon the credibility of the person proffering the evidence and the

quality of the evidence itself. Depending upon the skills possessed by the in-house

person regarding the subject matter that is being investigated will determine the

51

The MSPA website explains the services that the organization offers. http://mysteryshop.org/about 52

See Section IV A. Privacy Issues-Wiretapping and Eavesdropping statutes, Fiona Burke, Ted Pearce, Robert L. Zisk, A Practical Guide to Franchise Audit and Compliance Investigation Programs, American Bar Association 28

th Annual Forum Meeting, October 2005

29

credibility of the person and their report. In addition, it is important that the franchisor

have a record of treating its franchisees similarly so that there is no claim that the

franchisor has discriminated against other franchisees.

Beyond in-house reports, franchisors may use customer surveys to prove that a

franchisor is not complying with system standards. To best use these surveys they

need to be designed so they show an objective review of the customer experience. The

survey must contain objective questions, and ones that customers have the ability to

answer. Testing technical portions of the operations may not be a suitable subject

matter for a customer survey. Customer surveys are frequently used as part of proof for

proving underreporting at a specific franchise unit. In that survey the franchisor often

will ask the customer whether it received a customer receipt. If it did not then that fact

may constitute direct evidence of a un reported transaction. The survey will likely need

to be accompanied by an affidavit of the customer to verify the survey. While there may

be a hearsay objection to the survey and affidavit, the burden of proof will be on the

franchisee to show that it provided the customer with a customer receipt, especially if

the franchisee gave the customer an alternative to a receipt, or a counterfeit one, that

was signed by the franchisee, often for warranty purposes.

As discussed earlier in this paper, franchisors often will use mystery shoppers to

conduct investigations of failure to adhere to brand standards. The credibility of these

shopping reports will be a function of the professional nature of the shopper. Many

shoppers are not considered to be professional shoppers so there reports are more

likely to be void of certain crucial or specific objective information that is often needed to

prove that the franchisee was non-compliant. More recently, shopping services have

hired more professional shoppers that undertake these services on a full time basis.

Customer shoppers are well used for quality issues, but are likely not as reliable for

issues that are grounded in the health welfare and safety of the customer. That being

said, courts routinely accept mystery shopping reports into evidence provided that a

proper foundation for their use has been laid. In that situation, the shopping service will

be required to testify how the shopping was conducted and the report prepared.

Shopping reports have been used in cases involving trademark infringement,

employment discrimination, and showing that a franchisee would not sell a particular

product line.53

The use of professional private investigators can be the best source to determine

violations of system standards, especially when those standards affect the health

53

See Section IV C. Mystery Shoppers, Fiona Burke, Ted Pearce, Robert L. Zisk, A Practical Guide to Franchise Audit and Compliance Investigation Programs, American Bar Association 28

th Annual Forum

Meeting, October 2005

30

welfare and safety of a customer. The important point about using professional

investigatory services is that the service must have some experience and expertise in

the area of the business that is being investigated. While these investigations may have

a greater degree of reliability in court than mystery shoppers or in-house quality

assurance reports, the attorney hiring the investigator must be cognizant of its states

ethical rules to determine whether there are ethical difficulties in having an investigator

engage in conversations with the franchisee who likely will become an adversary.54

Therefore, such investigations should be conducted well before an attorney is retained

to advocate on the part of the franchisor.

In cases involving the underreporting of gross revenues franchisors are wont to

use audits of the franchisees business as evidence of underreporting. While the results

of the audit may show a pattern of unreported sales, there is a certain amount of

circumstantial evidence found in the audit. Accordingly, the audit should be backed-up

with direct evidence showing the franchisees specific conduct, such as a mystery

shopping or other surveillance tools. Most often these audits will be accepted into

evidence either as a business record of the franchisor or as an independent expert

report. To the extent that a franchisor conducts an audit that does not show the

franchisee to be underreporting but later conducts a mystery shopping that uncovers an

instance of an unreported sale then the franchisor still may have to disclose the clean

audit as part of its document disclosures, which may undermine its claim against the

franchisee.

IX. Methods of enforcement

Remember that mindsets cannot be changed through force and coercion. No idea can ever be forcibly thrust upon any one.

--Pervez Musharraf

A franchisor has a variety of different tools available to it that can be used to

persuade or convince a franchisee of the benefits of implementing and employing a

particular standard in its business. Ideally, a franchisor will work in collaboration with its

franchisees, through which the reasons for, and benefits of, a particular standard can be

explained. In the context of a strong franchisor/franchisee relationship that has been

established and built on trust over a period of time, a franchisor may have little difficulty

convincing its franchisees of the benefits that a particular standard will have on the

system and ultimately, their individually businesses. However, when the standard

sought to be imposed requires significant capital expenses or increased operating

costs, or when the relationship between a franchisor and its franchisees is less than

54

Id at 18

31

positive, franchisees are more likely to resist the change, and something more than

mere cajoling by a franchisor may be required. Determining what size tool to use in

order to correct the problem is critical for the on-going success of the

franchisor/franchisee relationship.

A. How to convince the franchisee that standards are good for its

business

Perhaps nothing is more valuable than education as a means to convince

franchisees that standards are good for business. This education should begin as early

as the franchise sales process and discovery day, with the sales broker engaging the

prospective franchisee generally on the issue, explaining why uniformity and

consistency are important. Once the franchise agreement is signed, a vigilant franchisor

must ensure that this education continues, through what many franchisors refer

generally to coaching and counseling. Remember, one of the most important, if not the

most important issue for a franchisee, is its bottom line. This interest may be, and is

often different from, those issues that a franchisor may find critical, and in continually

educating the franchisee, communications will be enhanced and standards will stay top

of mind.55

B. Positive methods to enforce standards- incentive programs

Franchisors often employ a variety of incentive programs in their continuing effort

to enforce standards among franchisees. Importantly, a simple thank you by a

franchisors senior executive, or the recognition of a franchisee who has embraced

system standards during an awards ceremony in which a plaque or trophy is awarded in

recognition of the achievement often serves as a powerful tool in itself. Other times,

when a particular standard a franchisor wants to implement is costly, a franchisor may

consider offering its franchisees financial incentives that serve to off-set the cost of

implementing the new standard. Or, a franchisor may consider increasing advertising

allowances within a franchisees regional or local marketing area, reducing the cost of a

proprietary product required to be purchased from the franchisor or its designated

supplier, or limiting inventory requirements for a limited period of time in order for the

franchisee to absorb the increased costs of the new standard. These incentive

programs are as limitless as a franchisors imagination, and continue to remain a

powerful carrot.

55

Educating franchisees on the importance of standards need not always be done through face-to- face meetings. Internal e-mail blasts, on-line training sessions, conference calls, and bulletins issued by a franchisor are just some of the many techniques that can be used by a franchisor in its efforts to continually educate its franchisees.

32

C. Enforcement through contract rights

Whether because the particular standard sought to be enforced is perceived as

being untested or too expensive, or because a franchisee believes it knows better than

the franchisor regarding what works, there will often be franchisees simply unwilling to

implement the standards required of it by their franchisor. In these instances, a

franchisor must be prepared to utilize its franchise agreement as the means to enforce

the standards, or risk serious and perhaps systemic problems within their system.56 For

this reason, it is critical for a franchisor to continually seek to uniformly enforce its

standards through compliance programs, customer feed-back initiatives, and mystery

shoppers. For those franchisees unable or unwilling to implement and maintain

standards, a franchisor must consider employing the rights afforded it under the

franchise agreement, including notices of default, specific performance, injunctive relief,

and ultimately, termination.

D. The use of the injunction before termination

To prevent a franchisee from continuing to avoid the implementation or

continuation of a required standard, a franchisor may consider initiating a lawsuit

against the franchisee without terminating the franchise agreement. As part of this legal

action, which claims would include breach of contract and specific performance, a

franchisor could also seek a preliminary injunction that would require the franchisee to

take some action required by the franchise system. Before seeking a preliminary

injunction, a franchisor must consider the risks of employing such an approach.

To obtain a preliminary injunction, a plaintiff must establish that it is likely to

succeed on the merits, that it is likely to suffer irreparable harm in the absence of

preliminary relief, that the balance of equities tips in its favor, and that an injunction is in

the public interest.57 Where a preliminary injunction alters the status quo, is mandatory

in nature, or affords the movant all of the relief that it could recover at the conclusion of

a full trial on the merits, a movant seeking such an injunction must make a heightened

showing of the four factors.58 Clearly, if the standards sought to be enforced relates to 56

A franchisor that fails to enforce system standards sends a dangerous message to its franchisees. Franchisees that do not follow the system realize that their conduct has little or no ramifications, and they are free to do what they want. Conversely, those franchisees that seek in good faith to follow the system and the mandates of the franchisor quickly realize that their efforts to uphold standards are futile because other franchisees are not required to meet those standards. See Joseph Schumacher, Edward Wood Dunham, and G. Adam Schweickert III, Retaining and Improving Brand Equity By Enforcing System Standards, Franchise Law Journal, Summer 2004, at 10-17.

57

Winter v. Natural Res. Def. Council, Inc., 555 U.S. 7 (2008).

58 Big O Tires, LLC v. Felix Bros., Inc., 724 F. Supp. 2d 1107, 1116 (D. Colo. 2010).

33

an imminent health, safety or welfare concern regarding the consuming public, a court

would be hard-pressed not to find the likelihood of irreparable harm. Yet, when the

standard sought to be enforced is less critical in nature, for example, when a franchisee

refuses to install a new sign or implement a new color-scheme, a court may be more

hesitant to find irreparable harm sufficient for it to enter an injunction. Sometimes, courts

are reluctant to issue injunctions that are in effect regulatory decrees that require the

continued participation of the court to ensure that the injunction is being followed.59 Or,

a court could determine, based on a limited record, that the franchisor does not have

the right to enforce the particular standard. Regardless of the reason, a denial of a

preliminary injunction could serve to embolden the franchisee and could have serious

ramifications system-wide. Accordingly, a franchisor must consider these risks before

seeking a preliminary injunction against an existing franchisee.

E. Termination

Termination is the ultimate system standards enforcement mechanism: a

franchisee that is no longer in the system cannot violate the franchisors standards. The

advantages of termination are apparent. It permanently enforces the franchisors

system standards as to that franchisee, which is especially useful for repeat offenders

who have consistently failed to maintain standards. It also sends a clear message to

other franchisees in the system that the franchisor takes its system standards seriously

and violators will not be treated lightly. The disadvantages are also clear. Termination

is usually not taken by franchisees sitting down. They risk losing their investment and

their livelihood, and they usually will not go down without a fight. This may result in

counterclaims and delay tactics to put off termination as long as possible. That means

high costs to the franchisor and a long time during which the franchisee may continue to

violate system standards (absent a preliminary injunction). Termination also creates

turnover in the system. The franchisor will have to find and train a new franchisee who

may lack experience.

The first question a franchisor must consider is whether it is appropriate to

terminate. Under most franchise agreements, a franchisee can be terminated with or

without an opportunity to cure depending on the nature of the default. A failure to

59

See e.g., Original Great Am. Chocolate Chip Cookie Co., Inc. v. River Valley Cookies, Ltd., 970 F.2d

273, 277 (7th Cir. 1992)(The first is that the injunction requires the parties to maintain a cooperative

relationship for its duration by enjoining the Cookie Company from failing and refusing to sell cookie

batter, accessories and promotional items as needed and requested by defendants. Such an injunction

imposes a continuing duty of supervision on the issuing court,