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Weathering the storm

on Tuesday, 04 March 2014. Posted in Legal

Laying down a few ground rules can go a long way to protecting a franchisor’s brand, says Nicola Broadhurst of Stevens & Bolton

Weathering the storm

A key element of every franchise concept is the trademark or brand. The success of a franchise is entwined with the reputation of the brand and in time, if sufficient goodwill has been acquired in the brand it can become an extremely valuable asset in its own right. This in turn can be licensed with great effect in a number of different market sectors. A clear example of such a super brand is Virgin.

However the converse is also the case and where the brand is called into disrepute by the actions of the franchisor or franchisee, this can have dire consequences for the profitability of the franchised network as a whole.

In many franchises, the franchisor will be the owner of the brand. However, it is increasingly common for a company wishing to expand its business through franchising to seek to ring-fence the liability, should the franchise concept fail, by establishing a separate company to be the franchisor. In such circumstances the franchise agreement should make it clear who owns the brand and that the franchisor is licensed to use and sub-licence the use of the brand and other intellectual property to the franchisee. A franchisee should check what the position is and ensure that the franchisor is appropriately licensed where applicable to ensure that there is no issue over its authority to use the brand. Where the franchisor is not the trademark owner, evidence of a trademark licence is another requirement of membership of the British Franchise Association.

As a trademark owner, a franchisor has a duty of care to ensure that it upholds the value of the brand. If a franchisor’s actions diminish the reputation of the brand to the extent that a franchisee could demonstrate that it was losing custom then a franchisee could seek to bring a claim against the franchisor for derogation of the grant of rights which had been given to the franchisee in the franchise agreement. More often however it is a franchisee’s actions that bring the brand into disrepute and the extent to which the damage to the brand can be contained will largely depend on the crisis management abilities of the franchisor.

A well-drafted franchise agreement will contain clear protections for the franchisor on the use of the brand by the franchisee. Typical controls include:

(i) a restriction on the franchisee using the brand in its own corporate name;

(ii) that the branding can solely be utilised for the purposes of the business and not for any other reason;

(iii) all usage of the brand must be in accordance with the franchisor’s instructions;

(iv) all advertising and promotional material which displays the brand must be pre- approved by the franchisor;

(v) the right for the franchisor to have total control over any proceedings for allegations that the brand infringes another’s intellectual property with the obligation on the franchisee to cooperate;

(vi) a general obligation not to do anything which could bring the brand into disrepute.

In response to the increasing use of social media, franchisors are increasingly extending the scope of restrictions and controls in the franchise agreement to cover the use of social media by franchisees. Often the franchisor will have a social media policy in its operations manual which must be adhered to and will sometimes insist that it has administrator rights to any social media site which a franchisee intends to use.

Other franchisors will seek to prevent a franchisee from having its own website or other social media sites by insisting that the brand cannot be used in any domain name or displayed on a website without the franchisor’s consent. Such clauses can however be open to challenge if, in fact, they amount to a ban on a franchisee having a website at all to promote the franchised business, as this could fall foul of competition law as amounting to a ban on passive selling.

Well-established franchisors often circumvent this issue by offering an extremely sophisticated website with a microsite or web page for its franchisees, thereby hoping to eliminate any desire on the part of the franchisee to do this themselves.

It is essential however that a franchisor does monitor effectively the use of social media in connection with its brand and sets up the appropriate alerts to ensure that it can react quickly should something negative or inappropriate be posted. In cases where comments are posted which the franchisor consider to be defamatory, this can often be dealt with by an appropriate letter to the relevant ISP provider; most of whom will take down a site or remove material if there is even a hint that it may be libelous in order to avoid being held liable.

The controls and obligations placed on the use of the brand in the agreement are usually also backed up by giving the franchisor the right to terminate the agreement with immediate effect where the brand is brought into disrepute by a franchisee.

The wording of this termination right must be carefully drafted however, to ensure that it does not result in a counterclaim for wrongful termination by the franchisee if the actual diminishment of the brand cannot be proved. If a franchisor is entitled to use its discretion then this allows the franchisor greater scope to terminate the agreement.

Termination should, however, be the last resort and reserved for those cases where the damage to the brand is severe and/or deliberate. Often swift action by the franchisor can limit the damage and the provision of further training to the franchisee and its staff can be sufficient to ensure that such mistakes are not repeated.

An example of this can be seen with the Auntie Annes’s cheese incident in the US in 2013. Here a customer complained to an employee of an Auntie Annes’s franchisee that the wrong cheese dipping sauce had been provided. The employee did not take kindly to the complaint and threw cheese sauce at the customer. The story was picked up on social media and went viral. The potential damage to the brand was severe.

However, the franchisor was swift to respond by providing an apology from its president to the customer concerned and offering a free cheese dipping sauce day across certain locations. This had the desired effect of mollifying the customer and limiting the damage to the brand. However, it does demonstrate that, despite the fact that much is made of the fact that the franchise relationship is independent and there is a separation of liability between the franchisor and the franchisee, where the brand is concerned the line is blurred and the franchisor has little choice but to step in and assume responsibility for the franchisee’s actions. In this case, the franchisee in question remained within the Auntie Anne’s franchise network but had to work closely with the franchisor to ensure that its staff were thoroughly re-trained.

It should not be forgotten that most franchise agreements contain a broadly worded indemnity in favour of the franchisor in respect of all losses and costs incurred by the franchisor as a result of any act or omission of the franchisee. Therefore, even where the franchise agreement is not terminated, the franchisee may still be facing a hefty bill for the costs of the crisis management incurred by the franchisor.

Franchise agreements are not even-handed. By allowing a franchisee access to its brand and other intellectual property the franchisor is opening itself up to risk. The actions of a franchisee does not just affect its own business but can impact the entire franchise network. The franchisor is the guardian of the brand and this should be borne in mind by franchisees when reviewing the extent of the controls imposed by a franchisor. 

Nicola Broadhurst is a partner and head of franchising at Stevens & Bolton, the law firm.

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