Does Litigation Indicate Growing Rift Between Franchisees and Franchisors?

This posting was written by John W. Arden.

A recent Wall Street Journal new story, describing how difficult economic times have resulted in contentious franchise litigation, has caused a controversy about the financial health of franchising and relations between franchisees and franchisors.

The February 9 article (“Tough Time for Franchising: As Business Disputes Spark Tensions, Some Franchisees Take Franchisers to Court” by Sarah E. Needleman) stated that “[t]wo closely watched disputes now playing out in the courts are shining a light on a growing rift between franchisees and franchisors.”

The article cited:

(1) A suit brought by an association of 185 U.S. franchisees of Cold Stone Creamery Inc., claiming that the franchisor refused to provide detailed information about funds that the franchises believe should be set aside for their benefit in a marketing fund, and

(2) An action filed by a group of franchisees against Edible Arrangements, claiming that the franchisor abused it discretionary authority by mandating that all franchises be open on Sunday and an additional two hours every other day of the week. Another recent action filed by Edible Arrangements franchisees is seeking to stop the franchisor from collecting a two percent royalty on orders placed over the Internet, a fee implemented last month.

These disputes, and others like them, were attributed to financial problems, “At the end of the day, it just boils down to profitability,” said Eric Stites, managing director of a franchise market research company. “When franchisees aren’t making money, that’s when you see them form associations and sue the franchisor.”

“Litigation sends a signal to the franchisor and others that something is wrong,” said John Gordon, an independent chain-restaurant analyst.

IFA Response

In response to the article, Stephen J. Caldeira, President of the International Franchise Association (IFA), published a Letter to the Editor, charging that the article “overlooks significant economic evidence and ignores that more than 90% of franchisees renew their contracts with franchisers at the end of their terms.” The IFA is the oldest and largest trade group representing franchising.

“By focusing on litigation by a small percentage of franchisees, you cast aside the more than 2,000 franchise systems in the U.S. today that are healthy, thriving, and creating jobs and that have franchise relationships that are strong and effective.”

Caldeira asserted that the number of franchised establishments and jobs are predicted to meet pre-recession levels this year and that franchisors have focused on increased collaboration with franchisees during the economic downturned.

“Differences arise,” Caldeira concluded. “Franchise advisory councils are the best approach for addressing those issues. Working within the system is the true essence of what makes the franchise model so successful.”

Growth Predicted for 2012

After three years of decline in the number of franchises, franchising is expected to experience modest growth in the number of establishments, employment, output, and contributions to the U.S. gross domestic product (GDP) in 2012, according to a study recently released by the IFA.

The number of franchise establishements is expected to increase by 1.9%, from an estimated 735,571 to 749,499. The number of direct jobs will increase by 2.1%, from 7,934,000 jobs to 8,102,000 jobs, according to a report prepared by IHS Global Insight. The output of franchise businesses is predicted to grow by 5%, from $745 billion to $782 billion, and the growth of GDP originating in the franchise sector is expected to increase by 4.8%, from $439 billion to $460 billion.

A press release on the study appears here on the IFA website.