Franchisee 101: Indemnification Woes

Lewitt Hackman

[co-author: Caitlyn Dillon]

A federal appellate court held that a franchisee must indemnify a franchisor for its litigation defense costs, vacating a district court’s order of summary judgment for the franchisee.

Aaron’s Inc., a home furnishings retailer and franchisor, required the franchisee to indemnify Aaron’s for litigation expenses incurred due to the franchisee's conduct. A franchisee’s former employee sued the franchisee and Aaron’s for wrongful termination. The franchisee’s insurer retained counsel to defend both the franchisee and Aaron's.
During the litigation, Aaron's hired its own attorney and settled with the franchisee’s former employee. Aaron's then demanded indemnification from the franchisee for expenses of defending itself and settling. The franchisee contested Aaron's claim that the franchise agreement required the franchisee to indemnify for Aaron’s defense and settlement costs. The franchisee argued that the franchise agreement was ambiguous about the duty to indemnify when Aaron's replaced franchisee’s chosen counsel with Aaron’s own counsel. Aaron's argued that the franchise agreement required indemnification because it did not say that Aaron’s decision to change counsel forfeited its right to indemnification.
The court agreed with Aaron’s, concluding the franchise agreement was unambiguous. The franchise agreement required the franchisee to indemnify Aaron's from all claims resulting from action or inaction by the franchisee or operation of the franchised store. The franchise agreement also provided that Aaron’s “shall have the option, in its sole discretion, to defend any action or to allow Franchisee to defend such action with counsel satisfactory to Franchisor.” The court found this unambiguously required the franchisee to indemnify Aaron's regardless of Aaron’s replacement of the franchisee’s chosen counsel.
Franchisees should review indemnification provisions of the franchise agreement with counsel prior to signing to understand the scope of their duties in the event of a third-party claim, which can be costly. Indemnification provisions often require the franchisee to reimburse the franchisor for attorneys’ fees and expenses of counsel chosen by the franchisor, let the franchisor control settlement decisions and do not let the franchisee use its insurance carrier for litigation before the franchisor chooses its own counsel.

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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