How to promote franchisee compliance and deal with non-compliant franchisees
Whether you're a new franchisor, emerging brand, or 200+ unit franchise system, it's inevitable, you are going to have non-compliant franchisees. When confronted with non-compliant franchisees, what franchisee compliance systems should you be implementing.
Franchisee Compliance Systems are the operational and legal systems, steps, notices, and actions that you put in place for addressing franchisee actions that violate operational standards, performance requirements, and legal obligations. It's your game plan for dealing with non-compliant franchisees and should be focused on:
- maintaining brand standards
- coaching and encouraging franchisee compliance and performance
- documenting noncompliance actions and events
- enforcing the terms of your franchise agreement
- protecting the long-term value of your franchise system
Your compliance systems, practices, and actions should be fair, consistent, legally compliant, and proactive.
Steps for Dealing with Non-Compliant Franchisees and Building your Franchisee Compliance Systems
Your franchisee compliance systems should evolve over time as your franchise system grows and as you encounter events of franchisee non-compliance.
Even as you work with legal counsel to prepare legal notices, review franchise agreement obligations, and address franchisee compliance issues, it's important to be focused on the primary goal of growing your franchise system, creating successful royalty producing franchise outlets, and, for the right franchisees, using instances of noncompliance as opportunities to educate, coach, and improve performance.
Although legal default notices are never the primary goal, for certain franchisees they will be inevitable and require early and thorough enforcement of your franchise agreement.
When dealing with non-compliant franchisees and building your franchisee compliance systems, follow these steps:
- Categorize the Non-Compliance Event
- Evaluate Franchisee Status as Either a Good-Faith or Bad-Faith Actor
- Apply Consistent Standards and Avoid Disparate Treatment
- Ensure your Actions Are Legally Compliant
- Proactively Focus on System Growth Goals
Below we discuss each step.
1. Categorize the Non-Compliance Event
Franchisee non-compliance events include a broad range of actions or inaction ranging from a franchisee's inadvertent failure to meet operational standards to an intentional and outright breach of a franchisee's obligations under the franchise agreement.
Generally, non-compliance events should be classified within one of the following 4 categories:
Payment Default
Payment defaults occur when franchisees fail to pay royalties, brand development fund fees, and other financial obligations required under the franchise agreement.
Payment defaults always necessitate a legal notice but, depending on the cause of the default and whether or not a franchisee is acting in good faith (i.e., they are following system standards and are trying but the business is not performing) or bad faith (i.e., the franchisee is not following system standards or is intentionally withholding payments) may require coaching and, potentially, some form of additional support such as additional on-site support or economic assistance such as a payment plan.
Examples: A franchisee's failure to pay royalty fees, brand development fund fees, technology fees, contact center fees, and other financial obligations specified by the franchise agreement.
Course of Action: Legal Default Notice + Coaching and Assistance if Franchisee is Acting in Good Faith.
Operations Default
Operational defaults occur when franchisees fail to maintain franchise system standards that relate to the operations of the franchised business.
To rise to the level of an operational "default" as opposed to an operations "non-compliance event" (see below) the action or inaction of the franchisee should relate to an operational standards or requirements that materially impact performance, brand standards, customer experience, or the integrity of the franchised business.
Depending on the terms of your franchise agreement, operational defaults can also include a series of minor or less significant "non-compliance events" that the franchisee has been notified of but has failed to cure.
Examples: A franchisee's failure to: timely lease an approved franchise location; develop and open the franchised business; complete training; operate the business in accordance with system standards; purchase inventory and product from designated suppliers; sell approved products and services; timely pay lease obligations; timely pay suppliers; honor gift cards; and maintain required operational hours. Instances where a series of "operational non-compliance events" remain uncured such as an on-site inspection where franchisee is notified of a failure to meet operational standards, is advised of corrective measures, but where the franchisee fails to rectify and cure the operational failure.
Course of Action: Legal Default Notice + Coaching and Assistance if Franchisee is Acting in Good Faith + Review Operations Manual to Ensure that Operational Standards are Clearly Stated and Current.
Operations Non-Compliance
Operations non-compliance events relate to a franchisee's failure to meet operational standards that do not yet rise to a level of an "Operations Default." Non-compliance events are initially treated as operational issues that do not yet rise to the level of a legal issue and are documented and communicated to franchisees with the primary goal of coaching and improving system operations while also documenting the non-compliance event in the case that violations continue or the franchisee acts in bad faith.
Examples: A franchisee's failure to: purchase non-proprietary products from designated vendors; meet product or service standards that do not jeopardize core product and service standards; maintain operational standards that may of not been clearly communicated in your operations manual or training.
Course of Action: Non-Legal Operations Notice, including, potentially, inspection reports and grading, where franchisee is advised of operational non-compliance issues required corrective measures + Coaching and Assistance if Franchisee is Acting in Good Faith + Review Operations Manual to Ensure that Operational Standards are Clearly Stated and Current.
Technical Non-Compliance
Technical non-compliance events relate to instances where a franchisee is technically violating an operational or system standard but where the operational or system standard is minor, does not impact brand standards, does not impact customer experience and, essentially, represents your preference as a franchisor.
Examples: A franchisee allowing another local business to place business cards at the franchised location or allowing a non-controversial charitable organization to raise funds on-site.
Course of Action: Conversation and coaching + potentially a non-legal operations notice if franchisee is acting in bad faith.
2. Evaluate Franchisee Status as a Good-Faith or Bad-Faith Actor
Once you classify the non-compliance event, it's time to evaluate the intentions of your franchisee, whether or not he or she is acting in good faith, and the overall goals of your franchise system. Questions that you should be evaluating, include:
- Whether or not the non-compliance event is a first time occurrence?
- Whether or not the franchisee is following system standards?
- Whether or not you've properly communicated system standards?
- Whether or not you've previously notified the franchisee of similar non-compliance events and advised them of corrective measures to be taken?
The strength of your franchise system is dependent on well performing franchisee's that validate, achieve sales goals, and grow. If a franchisee is acting in good faith we recommend that you adopt a communication and coaching first course of action that, initially, avoids legal tension and is focused on informing and coaching, while also documenting the non-compliance event, and notifying the franchisee of appropriate corrective measures.
If the franchisee is acting in bad faith or a repeat offender, we recommend that you adopt a legal first approach that also includes communication and coaching but clearly communicates a legal default and creates a strong record.
3. Apply Consistent Standards
When a dispute arises, the most common complaint, defense, and pretext that franchisees and their lawyers raise is that they've been treated differently. That there is disparate treatment as to how you treat your franchisees and how you apply your system standards. They claim that you have not pursued and are not pursuing other franchisees that are also non-compliant and are doing the very same things.
Whether it's the renewal requirements that you establish, secret shopper programs, or inspections and training requirements that you enforce, it's important to apply consistent standards across your franchise system. Applying consistent legal standards and system requirements will improve overall performance and create a strong legal foundation for enforcing your franchise agreements.
4. Ensure your Actions are Legally Compliant
Your legal notices and compliance process should be mapped out and pre planned with your franchise counsel. Your legal and noncompliance notices must be consistent with the default and notice requirements of your franchise agreement, the system requirements identified in your franchise agreement and operations manual, and must be consistent with state franchise laws.
Before any legal notices are sent to your franchisees, you should review with your lawyer whether or not state specific franchise relationship laws are complied with. Certain states have enacted franchise relationship laws that are designed to enhance the rights of franchisees and override certain provisions of a franchise agreement. State franchise relationship laws will commonly supplement a franchisees legal right to cure defaults, and enhance renewal and other legal rights.
Some of these franchise relationship laws also impose a blanket prohibition on disparate treatment of franchisees. If the franchised business is located in or a franchisee is a resident of a state that has enacted franchise relationship laws, these laws must be carefully reviewed with your legal counsel.
5. Proactively Focus on System Growth Goals
Your legal strategy and approach in dealing with non-compliant franchisees must always be synchronized with the overall growth goals of your franchise system.
Learn more about franchisee compliance, enforcing your franchise agreement, and dealing with non-compliant franchisees by calling (800) 976-4904 or contact us.
