Bet-the-System Disputes: When Minor Issues Can Get Out of Control

“I can see turning a dispute with a small number of franchisees into a class action for settlement purposes,” Wittrock said. “But probably I would first fight a class action [by citing] a clause in the franchise contract.”

Kevin Adler is associate editor of this newsletter.

It's not common that a franchise is embroiled in a dispute that has the potential to disrupt or force operational changes to the entire system. But when those situations arise, franchisors are faced with the unpleasant decision whether it's worth taking on the “bet-the-system” challenge.

At the 42nd annual IFA Legal Symposium in May, Quentin R. Wittrock, Gray Plant Mooty (Minneapolis), and Robert Zarco, Zarco, Einhorn, Salkowski & Brito, P.A. (Miami), discussed how to identify, avoid, and, if necessary, win bet-the-system disputes. In an entertaining and informative session moderated by Pat Meyers, chief legal officer for Consumer Capital Partners, parent company of Quizno's Corp., the panelists often disagreed about the motivations of franchisees and the tactics of their attorneys.

Meyers, Wittrock, and Zarco encouraged attorneys to watch out for seemingly minor litigation that could rise to the level of bet-the-system. They also suggested creative strategies for resolving disputes that potentially would have systemwide impacts.

“You can't always tell when a dispute will rise to the level of bet-the-system,” Meyers said. “Sometimes it's the dollars involved, but that varies depending on the size and maturity of the system, as well as the franchise's insurance coverage, and its ability to fund litigation. There are many factors.”

A situation confronting Burger King right now is a good example of a seemingly small issue that could have a big impact, said Zarco. In that dispute, three Miami-area franchisees filed a lawsuit in Miami-Dade Circuit Court to stop the company from implementing a new rule that all franchisees extend their hours. Burger King called the longer hours a competitive necessity, and it said that the franchise agreement gave it the right to set minimum hours of operation. The franchisees argued that the contract only gave Burger King the right to reduce the hours below the minimum, not to raise them. The lawsuit was dismissed in November, but it has been appealed (see FBLA, November 2008, p. 8).

“The legal decision will have systemwide ramifications, but the lawsuit only has three plaintiffs,” said Zarco, who is the attorney for the plaintiffs.

The Burger King lawsuit reflects franchisees' claims that the franchisor is not engaged in good faith and fair dealing, and the panelists identified other areas in which potential systemwide disputes can arise:

• A franchisor's failure to provide support to franchisees, especially in the current economic climate;
• Name changes caused by merger, sale, or consolidation (which generated litigation by franchisees of Mail Boxes Etc. and American Express/Ameriprise Financial);
• Internet sales;
• Price fixing, in the wake of the U.S. Supreme Court's Leegin Creative Leather Products, Inc. v. PSKS, Inc. , 551 U.S. 877 (2007) decision;
• Inadequate disclosure in FDDs; and
• Misuse of ad funds.

At the start of a dispute, the franchisor must think about the possible impact of litigation on the entire franchise system, said Wittrock. “If it's a big case, what type of 'win' are we aiming for?” said Wittrock. “Are we seeking to win in trial and a possible appeal, or should we consider settling the case?”

Sometimes, winning in court might not be the end of the problem, added Meyers. If the franchisees win, the decision will likely set precedent that will be imposed across all of the system, Meyers said. But if the franchisor wins, it won't necessarily be granted that precedent in all jurisdictions where franchisees raise the same complaint.

Attorneys for franchisees must make their own calculations, said Zarco. First, they have to understand how strong their client's case is. Then, they have to figure out what their client is seeking to gain. Tactics are different for a client who wants to remain in the system than for a client who is seeking release from a contract and a monetary settlement. “We always have to think about the endgame ' A win can be a pyrrhic victory; often, you can settle in a way that's better for a client than even winning in court,” he said. “You have to consider the damage to the franchise system that comes from having a public dispute and the loss of confidence by other franchisees.”

Motivation and Tactics

Franchisees are highly disgruntled by the time they consider a lawsuit, said Zarco. A franchisor that respects franchisees' side of the story will go a long way toward diffusing ill-will that can send a minor dispute over the top. “The plaintiff files because he's ailing, almost like a patient,” he said. “The respect that a franchisor grants to the franchisee has a tremendous impact on the vigor with which they will pursue litigation.”

But from a franchisor's perspective, emotions should have little to do with the problem, said Wittrock. “Contracts and litigation are about control or the money at stake, not about personality,” he said.

When those two worldviews collide, disputes are hard to settle. Sometimes, a franchise association can be a pressure-relief valve to help resolve the problem ' but sometimes its presence can fan the flames. “If you shut the door on a franchise association, you are just leading the [franchisees] to my door,” said Zarco. “It's better to work with them, make contact with them.”

But Wittrock responded that a franchise association that inserts itself into a dispute can be neutralized by the right arguments. “We respond that the franchise association is being run by renegades who are not speaking for most of the franchisees,” he said. “We also will bring happy franchisees into court.”

In addition to using franchise associations, tactics in bet-the-system litigation often include making extensive discovery demands. Discovery can yield “gems,” especially in e-mail messages, according to Zarco. “I'll take a U-Haul of 850,000 documents and have our associates go through it,” he said.

“When we get this type of request, it just gets the backbone of our client up,” responded Wittrock. “I see many [law] firms trying to use pressure tactics to get settlements for franchisees. They ask for every document in discovery, and they want to depose the CEO. They are not really preparing for court; they want to intimidate us for a settlement.”

Settlement is an option, but Meyers noted one major problem with settling with a few franchisees: “We don't want to open the door to other plaintiffs.”

Arbitration potentially can sidestep some of those problems, Meyers said, and he strenuously argued for enforcing arbitration clauses in bet-the-system circumstances. “Arbitration is private, and it avoids collateral estoppel and class actions,” he said.

Not surprisingly, Zarco said that he “hate[s]” arbitration. He uses it when he has a “ weak case or a pro-business court,” because he finds that arbitrators “are trained in achieving some level of equity, so at least we will get something for our client.”

Blimpie took the settlement route in 2007 to resolve litigation with 13 franchisees about alleged misappropriation of vendor rebates. Blimpie agreed to convert the litigation to a class action, and then settled; but, as the panelists noted in their written paper, it took four years of litigation and two weeks of arguments in front of an arbitrator before the settlement was reached.

“I can see turning a dispute with a small number of franchisees into a class action for settlement purposes,” Wittrock said. “But probably I would first fight a class action [by citing] a clause in the franchise contract.”

Kevin Adler is associate editor of this newsletter.