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What causes franchise disputes?

Franchise contracts are ‘relational’ and are left incomplete on purpose. Influence of these relational aspects of franchise agreements are discussed.
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Franchise relationships are formalised through contracts. These are known as relational and are left incomplete on purpose. This is because it is impossible for either party to know what issues they will have to deal with over the course of a relationship that could last many decades. Courts, however, often struggle to understand incomplete contracts. Franchise disputes also reflect the fact that at every level in franchise systems there is a tension between ownership and control.
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In a non-franchised business, ownership and control are largely in the same hands. The business owner owns the assets and makes the decisions about which direction a business will go and how it will get there. In a franchise system, the franchisor makes most of the strategic decisions, particularly those that affect the brand. Master franchisees may make local decisions, but the franchisees themselves often have little input, even though their assets are the ones at risk. Some franchise systems have devised ways of ceding some control to franchisees through franchise advisory councils. You’ll find a paper in the readings for this module that will explain franchise advisory councils in more detail.
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At the system level, poorly communicated information can lead to disputes, so can ongoing tensions about the associated costs franchisees must bear when the franchisor mandates continual improvements or insists on maximising market coverage. Disputes can also arise if the master franchisee or area developer is not meeting contractual development targets. Professor Kalnins has done some interesting research on this topic. He found that most master franchisees do not meet performance targets. His article is in the reading section of this module. Whenever someone lodges a claim, the response is often for the other party to lodge an even larger counter claim. A franchisor might, for example, claim that the franchisee has not been paying royalties on time.
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In return, the franchisee might claim that it has not been receiving the promised support or that the claimant misrepresented the franchise opportunity. Franchisors often approve suppliers of goods and services from fit out companies and software suppliers to those they will purchase merchandise from. This can lead to another source of disputes, failure to deal with the approved suppliers. Of course, trademarks are a key brand item. Misuse of them during or after the end of the franchise can lead to disputes. The same goes for confidential information.
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Remember that a franchisor will usually have no privity of contract with the franchisees in another country. They will have a contractual relationship with their master franchisee. The master will have the contractual relationship with the unit franchisees. Franchisors may be able to negotiate the right to inspect the franchisee’s premises and to audit their records. Franchisors need to pay attention to the requirements of specific jurisdictions to understand what obligations and rights the laws of different countries provide them with in the absence of direct contractual relationships.
Franchise relationships are formalised through contracts. These are known as ‘relational contract’ and are left incomplete on purpose. This is because it is impossible for either party to know all the issues they will have to deal with over the course of a relationship that could last for many years.
In a franchise system, the franchisor makes most of the strategic decisions – particularly those that affect the brand. Master franchisees may make local decisions but the unit franchisees themselves often have little input. The success of a franchise system partly depends on balancing competing franchisor and franchisee objectives. Franchisors seek to maximise their market coverage, while franchisees seek to grow profitable businesses.
A common misconception of new franchisees is that they believe becoming a franchisee will allow them to be their own boss and incorporate their own entrepreneurial flair in their business. In reality, as franchised systems are highly standardised, there is typically little opportunity for franchisees to change the processes or product/service offerings.
Common causes of disputes that arise between franchisors and their overseas franchisee include:
  • Miscommunication: the franchisor tells the master franchisee area developer franchisee one thing but master franchisee/area developer/franchisee hears what they want to hear.
  • The franchisor wants to continue to improve the brands competitive position by making system changes. The franchisees resist change because of the implementation costs.
  • The franchisor wants to maximise system market coverage and promote competition between stores. The franchisee resists intra-system competition.
  • The franchisor wants system-wide uniformity. The franchisee resists because they believe this will not improve their profitability.
  • The franchisor does not provide adequate ongoing training and support.
  • The franchisor makes representations that do not come to fruition.
  • The franchisee exits the system and works in a similar business, leveraging off their experience and insight into the franchisors business, possibly in breach of post- term covenants.
  • The development schedule is not complied with by the master franchisee/area developer.
  • There are disagreements over the quality of inputs and stock. Franchisees want to source cheaper products while the franchisor wants standardisation of quality which may require more expensive inputs. There may also be difficulties in importing products from the franchisor’s home country to the target country. While in some instances, the target country may stipulate that local products must be used.
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International Franchise Law: the World is Yours

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