Franchise Review - Oct 2013: Best Practices


In This Review:

Tips on Drafting Arbitration Clauses

By  Mary Paterson

Resolving a dispute through arbitration can be faster, cheaper and more confidential than doing so through litigation. If the arbitration clause is not properly drafted, however, the dispute resolution may be slower, more expensive and aired in public because the parties ask a court to decide preliminary issues that have no impact on the real dispute. To avoid losing the benefits of arbitration, the arbitration clause should address at least these seven issues:

  1. Appointing an arbitrator: The arbitration clause must set out the process by which the arbitrator is appointed. If the clause does not explain how this critical first step is accomplished and the parties are unable to agree, they will end up in court asking a judge to appoint the arbitrator. If the parties are using an arbitral institute to appoint the arbitrator, make sure the institute (a) exists, (b) has a process for appointing a qualified arbitrator reasonably quickly, and (c) charges reasonable fees.
  2. Jurisdiction: The arbitration clause must grant the arbitrator the jurisdiction to decide the dispute in question. The courts have taken a highly technical approach to interpreting arbitration clauses, so parties should use simple, clear language. Finally, if one or both parties could potentially need urgent relief (e.g., an order requiring the franchisee to return confidential information), the clause should expressly give the arbitrator the jurisdiction to grant interim relief.
  3. Consistency with other agreements: The arbitration agreement could incorporate disputes under related agreements (i.e., leases, assignments and guarantees) to ensure that the entire dispute is arbitrable. Parties should also consider whether any other individuals should be party to the arbitration agreement (such as guarantors) to ensure that all of the necessary people are bound by the agreement.
  4. Confidentiality: Include provisions ensuring that the parties preserve the confidentiality of key documents, such as operating manuals.
  5. Location, location, location: Three locations matter in arbitration: the law governing the franchise agreement, the physical place of the arbitration hearing and the procedural law governing the arbitration (also known as the “seat” of the arbitration). The three locations can be different. The arbitration clause should specify the procedural law that applies (so that the parties know which law governs appeals and other procedural rights) and the physical place of the arbitration (including the option to hold the hearing by phone or video conference). If the arbitration clause refers to an arbitration statute, make sure it is the right one because provinces have both a domestic and an international statute.
  6. Appeal rights: The arbitration clause should specify whether parties can appeal and, if so, to whom (e.g., another set of arbitrators or a court) and whether appeals are limited to questions of law. Arbitration clauses cannot prevent all appeals (because courts retain jurisdiction to overturn arbitration awards that offend natural justice), but appeals can be limited.
  7. Status quo clauses: If it is important that the parties continue to perform their obligations while the dispute is being resolved, the arbitration clause can require that the parties continue to carry out the agreement in good faith regardless of the dispute.

If arbitration is the right approach to resolve disputes in the franchise system, make sure that the arbitration clause is drafted to generate all the benefits that arbitration can offer.

Independent Franchise System Ombudsman Programs

By  Frank Zaid

Some leading franchisors in the United States have established independent franchise system ombudsman programs; and the trend is becoming more common in Canada as a means of resolving potential problems or disputes between franchisors and their franchisees. How do these programs work, why are they attracting attention and what are the benefits for both franchisors and franchisees?

Commensurate with the growth of franchising in the Canadian economy, franchise legislation is now in force in five of the ten provinces in Canada, with a sixth committed to introduce legislation in early 2014. Also commensurate with the growth of franchising is the increasing number of franchise disputes between franchisors and their franchisees. Most of the franchise disputes heard by the courts are on an individual franchisee/franchisor basis. But some disputes involve issues common to virtually all of the franchisees within a system, past and/or present, and actions may be commenced on a group or multi-plaintiff basis under class action legislation. Given this activity, franchisors should be focusing more attention on ways to avoid or resolve potential litigation at an early stage.

Another incentive for franchisors to resolve disputes at an early stage, and particularly before they become lawsuits, is the impact of disputes on franchise disclosure documents. One of the required items to be included in franchise disclosure documents under all provincial franchise legislation is a statement, including details, regarding whether the franchisor or a director, general partner or officer of the franchisor has been convicted of fraud, unfair or deceptive business practices or a violation of a law that regulates franchises or businesses, or whether a charge is pending against the person involving such a matter. Further, a disclosure document must contain a statement, including details, regarding whether any such person has been subject to an administrative order or penalty imposed under a law of any jurisdiction regulating franchises or businesses or whether the person is the subject of any pending administrative actions under such a law. Finally, a statement, including a description of details, must be disclosed indicating whether any such person has been found liable in a civil action of misrepresentation, unfair or deceptive business practices or violation of a law that regulates franchises or businesses, including a failure to provide proper disclosure to a franchisee or whether a civil action involving such allegations is pending against the franchisor.

Franchisors would prefer not to have descriptions of these matters (especially civil suits) included in their franchise disclosure documents because of the negative effect on prospective franchisees and, in certain cases, because such actions may disentitle the franchisor from relying on an exemption from the requirement to disclose financial statements. If a franchise dispute is resolved without court process, the dispute will be confidential and private to the parties, and may not be subject to inclusion in a franchise disclosure document.

In an effort to resolve disputes at an early stage and to minimize the negative effects of litigation on the parties and the franchise industry in general, both the Canadian Franchise Association and the International Franchise Association have established ombudsman programs for franchisors and franchisees to use, at no charge.  However, as these programs have limitations on time and resources, some franchise systems have created their own independent franchise system ombudsman programs for use only by the franchisor and franchisees within the system.

An ombudsman is a neutral, independent resource who provides informal, confidential assistance to help with the resolution of concerns and complaints. In a franchise relationship, as in any business relationship, there is the potential for disputes. An ombudsman program provides the services of a confidential and neutral third-party ombudsman to help resolve problems as early as possible in an amicable and expeditious fashion.

The ombudsman helps facilitate a resolution by discussing the issues and facilitating possible solutions. If a solution cannot be reached, where possible the ombudsman may suggest and refer unresolved complaints and problems to alternative methods of dispute resolution, such as mediation.

In franchise systems that have established their own independent ombudsman programs, franchisees do not pay for the use of the program. The ombudsman is typically under contract as an independent contractor, and not an employee, and his or her services are paid for by the franchisor. The ombudsman must be impartial and neutral, and not take sides. There are no formal investigations, no formal decisions and no repercussions to franchisees. From the franchisor’s perspective, an ombudsman program can act as an early warning system of franchisee concerns.

The ombudsman, as a designated neutral third party, must maintain privacy and strict confidentiality concerning matters that are brought to his or her attention unless given permission otherwise. Usually the only exception, at the sole discretion of the ombudsman, is when there appears to be a threat of serious harm. The ombudsman must take all reasonable steps to protect any records and files pertaining to confidential discussions from inspection by other persons. The ombudsman should not testify in any formal judicial or administrative hearing about concerns brought to his or her attention. When making recommendations, the ombudsman is responsible for suggesting actions or policies that will be equitable to all parties.

A franchise system ombudsman should have franchise industry experience and must become familiar with the system involved. The person must not have any conflict of interest and must be respected by both sides. In effect, the ombudsman operates as an intermediary, meeting with each side independently in order to understand the facts, consider the problem and attempt to facilitate an effective solution. Often the first conversation is used to identify the root of the problem and discuss options. The ombudsman cannot provide legal advice, make management decisions or advocate for anyone in a dispute. For the program to be successful, senior management of the franchisor must commit to it and the franchisees must accept it. Endorsement of the program by a franchise advisory council is highly recommended – if a council exists. The ombudsman must have ongoing access to a dedicated senior member of the franchisor’s management team who has authority to make decisions or to obtain instructions quickly and effectively.

There are a few key steps that must be taken to design the ombudsman process. After the requirements for the program have been determined, the key stakeholders must be committed to the program and funding must be undertaken by the franchisor. The terms of reference for the process and procedure must be resolved, in writing, and enshrined in the franchise agreement, in an ancillary document or in a policy adopted by the franchisor. Provincial franchise legislation requires that the program be described in the franchisor’s disclosure document.

Before the program gets underway, the parties should determine how to assess the metrics that will apply to determine the success of the program. There should be some periodic (and confidential) reporting on the utilization of the program, on a generic basis, to the stakeholders. In addition, at least annually, the ombudsman should report on the success of the program, based on the metrics adopted by the parties. The parties may also decide to give the program a stated term, with a determination at the end of the term whether the program will continue and whether modifications will be made.

Clear benefits of a franchise system ombudsman program are the increased integrity it brings to the franchise system, the proven success factor and the relatively minor cost when compared with the direct and indirect costs and risks of litigation that might have been avoided. Franchise litigation can be very uncertain, costly and disruptive for both parties. Results may take months in the case of interim orders or years in the case of trials. Costs can easily run into hundreds of thousands of dollars. Disputes involving current franchisees can and most often will have a negative effect on the ongoing franchise relationship and, if publicized, can diminish consumer loyalty and franchise system revenues. The downtime involved for franchise executives can be staggering. The resolution of a dispute at a very early stage through an independent franchise system ombudsman program will allow the parties to focus on their ongoing business needs rather than disputes.

In light of all of these factors, and with the continuing interest of the print and electronic media in reporting on franchise disputes, particularly those involving well-known systems, more franchise systems should consider introducing an independent franchise system ombudsman program in the future. Such a program clearly falls into the category of best practices in franchising today.


Topics:  Arbitration, Arbitration Agreements, Canada, Franchise Agreements, Franchises

Published In: Alternative Dispute Resolution (ADR) Updates, General Business Updates, Franchise Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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