Posted on: 4/26/2012
William F. Jones, Moye White
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The tough economic
conditions in our country have had a significant impact on most businesses, but
the impact felt by franchise systems has been particularly acute. The continued
slow pace of economic growth has placed, and continues to place, additional
pressures on franchisees, particularly food and retail franchisees operating in
industries with tight profit margins.
These economic realities
can manifest themselves in unexpected ways. One way is an upswing in claims
against franchisors for tort liability arising out of the actions or inactions
of its franchisees or its franchisees' employees. Although a franchisor may
think of its franchisees as independent businesses that will be responsible for
their own tort liability, the plaintiff's bar sees things differently.
Particularly in tough
economic times, a franchisor makes an attractive target for plaintiffs seeking
to impose tort liability for the benefit of an injured client. Plaintiff's
counsel suing franchisors for the alleged torts of its franchisees generally
fall into three categories. First, franchisors typically represent the
proverbial "deep pocket." The very success that a franchise system
obtains in increasing the strength of its brand and marketing has the converse
effect of having it appear to be an attractive "deep pocket" to the
plaintiff's bar.
Second, the economic
pressures on a franchisee may make the franchisor the only viable tort target.
Although most franchisees are required to carry insurance coverage, one
byproduct of the tough economic times is that many more franchisees are failing
to meet this obligation, failing to pay premiums, and going out of business.
This situation may mean that the franchisee is no longer a viable target for a
tort suit, leaving the franchisor as the only viable target for plaintiff's
counsel.
Third, plaintiff's
counsel often include a franchisor in an attempt to obtain some money for the
"hassle factor." Whereas most franchisors limit the scope of
litigation with franchisees through forum selection clauses in the franchise
agreement, those venue and governing law provisions have no application to
third-party tort claims. The prospect of being dragged into state court in any
number of jurisdictions also places pressure on the franchisor to attempt to
offer a nominal settlement to avoid the cost and expense of litigating in a
far-away forum. Plaintiff's counsel often recognizes this reality, and takes
advantage.
It is standard practice
in a franchise agreement for a franchisor and a franchisee to agree in writing
that the franchisee is an independent business operating free from direct
control of the franchisor. Most franchise systems recognize this reality in
their operations, and franchise systems see their franchisees as independent
businesses. This perception and the specific terms of the franchise agreement,
however, are not the primary considerations of a court assessing whether a
franchisor has liability for the torts of a franchisee or the franchisee's
employees.
Most courts do not have
extensive experience with franchises and franchise litigation. Consequently,
case law tends to focus on traditional concepts of agency law to examine
whether a franchisor bears tort liability for the acts of its franchisee. The
courts examining these questions tend to focus on concepts of actual and
apparent agency in making their determination.
Actual agency applies
the traditional principal-agent doctrine to the franchisor-franchisee
relationship. In essence, courts examine whether the franchisee is merely the
"agent" for the franchisor. As with most traditional analysis of
principal and agent concepts, the dispositive factor comes down to control. The
courts examine the extent to which a franchisor exercises the requisite
"control" over its franchisee.
Under an "apparent
agency" theory, the analysis differs in several important respects. Courts
examine whether or not the franchisee was held out as the agent of the
franchisor. Particular concern is given to what actions the franchisor as the
putative principal took to clothe the franchisee as an agent for purposes of
the tort victim. Again, the key consideration in which courts engage is to
determine what "control" the franchisor ultimately exercises over the
franchisee in its interaction with the tort victim.
The "Control"
Test
In addressing potential
tort liability of a franchisor for the acts of a franchisee, courts analyze the
degree of control that a franchisor exercises over "day-to-day"
operations of the particular franchisee. Analysis includes determining whether
a franchisor controls the daily business operation and practices at a
franchisee, including hiring and firing employees, supervision of cleanliness and
hygiene standards, and implementation of employment and other policies. It is
within these examinations of the actual "control" exercise by a
franchisor that a natural tension arises between the franchisee's status as an
independent business and the franchisor's legitimate concerns in protecting the
integrity of its system.
A franchise agreement
typically specifies that the franchisee is an independent and separate
business. The franchise agreement also typically specifies that the franchisee
is responsible for both the operations of its business and matters relating to
the hiring, firing and supervision of employees.
A closer examination,
however, often reveals that a franchisor is not actually as hands-off in
practice as the language of the franchise agreement may suggest. Franchisors
have legitimate interest in protecting their unique business system by ensuring
that franchisees are in compliance with system requirements. The whole system
of franchising as a business model is that the franchisor creates a business
system consisting of licensed marks, brand recognition and operations to ensure
consistency among its franchisees throughout the system. Although consistency
is a legitimate goal of a franchisor, there are traps for the unwary in a
franchise system which attempts to control the operation of its franchisee's
business too closely. For example, a franchisor may require franchisees to take
certain operational steps to ensure that franchisee businesses across the
country are run in a similar fashion. These methods of business, however, can
be construed to be a level of "control" over the franchisee's
business which could result in imposing tort liability. When courts analyze
these questions, they do not allow the franchisor to have it both ways. If a
franchisor dictates the precise method by which a franchisee operates it
business, this direction may form the basis for establishing the necessary
control such that the franchisor is responsible for the franchisee's tort
liability.
The Causal Nexus
The analysis by courts
of potential franchisor tort liability does not solely relate to a generalized
question of the extent to which a franchisor controls its franchisees'
businesses. Courts examining this question often look for a causal nexus
between the control exercised by a franchisor and the conduct upon which the
plaintiff bases its claimed injury. Even if a franchisor exercises substantial
control over its franchisee's business methods, liability for tort breaks down
if the alleged conduct is separate and apart from the areas of the business the
franchisor controls closely. At a basic level, if a franchisor provides
substantial direction and oversight to all franchisees on the manner on which
they hire and fire employees, that franchisor may be subject to tort liability
for claims arising out of employment issues. This analysis, however, may have
no bearing on a tort claimant whose claim has nothing to do with the hiring and
firing practices of the franchisee. This is an area where defense counsel can take
action to protect franchisors from tort liability. It is crucial that counsel
for a franchise drive a wedge between those aspects of the franchise
relationship where the franchisor exercises control and the specific conduct of
the franchisee which may cause the alleged torts. Without a causal nexus
between control and the alleged injury, franchisors may escape liability for
the acts of their franchisees.
Practice Pointers
For general tort
liability, the majority of applicable law appears to support arguments from the
franchisor which distances franchisors from tort liability for the actions of
franchisees or their employees. If operating in accordance with the franchise
agreement, a typical franchise system minimizes potential liability.
The challenge for a
franchisor and its lawyers is to find a way to raise this issue in court in an
early and effective manner. Often, issues of control are extremely fact
specific, making it difficult for a franchisor to effectively raise its
defenses in the preliminary stages of litigation. This forces the franchisor to
endure substantial costs related to its defense prior to dismissal through a
motion for summary judgment.
To minimize risk, the
franchise system should review as appropriate its insurance requirements on franchisees.
Although insurance requirements may be contained in the franchise agreement, it
is crucial for a franchise system to have procedures in place to review the
applicable insurance and to ensure that the franchisee has the requisite
insurance in place. Requirements for the franchisees to furnish evidence of
insurance, having the franchise system named as an additional insured, or
requiring notification directly to the franchisor of notices of non-payment or
potential cancellation, are several tools that a franchise system can use to
ensure that the franchisee has effective insurance available for potential tort
suits.
Lastly, franchise
systems should take a good hard look at the elements of control they exercise
over their franchisees. Franchise systems should analyze whether the control
actually exercised is consistent with the core business strategy and functions
of the franchise system, rather than control which is not necessary to the
business model. To the extent a franchise system can reduce its control over
the franchisees and their actions in a way that does not detract from the
business model, this change in operation will minimize the ability of the
plaintiff's bar to pursue a franchisor for the tort actions of its franchisees
or employees.
William F. (Billy) Jones
is an accomplished
litigator in Moye White's Trial section, concentrating his practice in complex
civil litigation including franchise, insurance defense and coverage, product
liability, trust and estate, and real estate litigation. He can be reached at
(303) 292-7930, billy.jones@moyewhite.com