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whether you're a new franchisor or an emerging brand or 200 plus unit franchise system it's inevitable you're going to have non-compliant franchisees so how do you deal with them how do you enforce your franchise agreement and how do you put in place a robust franchise compliance framework and system for getting your franchisees to comply to enforce your franchise agreement and to grow your franchise system [Music] franchisee compliance there's so much more involved than just sending legal notices default letters non-compliance events and attorney disputes franchisee compliance it's about the stability and growth of your franchise system it's how you treat your franchisees how you coach them when there's events of non-compliance how do you get them to conform to your requirements and how do you legally protect your franchise system and so when we talk about non-compliant franchisees where we're talking about franchisees that either are violating an Express term or provision in your franchise agreement or they're not operating the right way they're not following your system standards they're not following the specifications in your operations manual they're just not operating the business the right way so those are non-compliant franchisees and how we deal with them as a franchisor is what I'll call our compliance systems so right now as a franchisor you should be working with your franchise attorneys to map out document and create an ever-evolving uh compliance system for addressing non-compliant franchisees and what are these compliance systems well they're the business steps the operational steps and the legal steps that you have in place that you're going to take to dress and deal with non-compliant franchisees from everything as basic as an operational default that may not be impacting system standards to significant defaults where the franchisee is not using proprietary products or just outright breaching and violating their franchise agreement so our compliance systems it's our process how do we address non-compliant franchisees how do we document their non-compliance when do we Elevate their issues to a default illegal default notice and how do we maintain and Safeguard our overall franchise system ultimately with the goal compliant franchisees following system standards great customer products and services a growing franchise system increasing royalty Revenue expansion and growth that's the ultimate goal how do we approach franchisee compliance what are some safeguards we need to put in place when we're developing a compliance system well there's four factors we should be fair we should be consistent we should be legally compliant and we should be proactive so those are the four things I want to focus on those are things we focus on with our clients as we develop different scenarios of how to respond to franchisees what type of notice we're sending when do the notices escalate to a legal default and potentially termination of a franchise agreement so as you develop your franchise compliance process I want to keep those four standards in mind fairness consistency legal compliance and being proactive and then map out and this is going to happen and evolve if you're a new franchisor or an emerging brand this is going to evolve over time as you encounter franchisee non-compliance events you're going to work with your franchise Council and we're going to map out different strategies and processes and systems to put in place now when dealing with non-compliance I think it's important to understand there's really two levels there's non-compliance events and then there's defaults a default is when a franchisee reaches a level where there's a clear violation of the franchise agreement and legally we're confident as franchise councils say hey we can send out a specific legal notice notifying the franchisee that they're in default of their franchise agreement and the next step is for them to cure if it's a curable default and if not potentially to terminate the franchise agreement whereas operational on compliance maybe it hasn't risen to the level of a default yet or maybe it'll be multiple non-compliance events that create a default but generally it's helpful to consider when you're dealing with non-compliance operational non-compliance and then things that rise to a level of a default and in fact I would say there's four categories of non-compliance that you should be considering a payment default an operations default and operations non-compliance event and what I'll call a technical non-compliance event and let's discuss these payment default that's pretty clear your franchise agreement states franchisee has certain payment obligations royalties brand fund fees technology fees so payment default is a very clear breach of the franchise agreement the franchisees require to pay something to you a royalty brand Development Fund fee and they just haven't paid the fee and so it's a very clear default it's objectively provable franchising hasn't paid their payment obligations that's a payment default and operations default is also a clear breach of the franchise agreement where it's very clear franchisees not meeting system standards and is jeopardizing the uniformity of the brand or is jeopardizing brand standards where they're going to not only impact their operations but also the reputation of the franchise system as a whole so in operations default they're just not doing what they're supposed to do in the operations and these could be a bunch of things these could be some defaults specified in the franchise agreement or or franchisees failure to follow standards in your operations manual examples pre-opening franchisee fails to obtain a lease on time franchise agreement may say franchisee needs to lease an approved location within nine months we're at month 12. well that's an operations default after that the franchisee fails to lease a location on time operations default once the franchisee is operating are they not following brand standards are they substituting proprietary products are they not spending their local marketing dollars the way they should be or the in the amounts they should be are they not following operation our standards right are they closing the business these are all operational elements that could rise to levels and operations to fall now operations non-compliance is one step below an operations default it's where franchisees not following standards but maybe it's not impacting the brand or maybe it doesn't relate to our proprietary products and examples being they're not meeting certain service standards maybe when we do an inspection they're not meeting inspection standards maybe as to non-proprietary products things that aren't proprietary to our system but we designate a specific vendor they're not purchasing from that particular vendor maybe even things like their customer reviews or when you do an on-site inspection they're not meeting standards those are operational non-compliance events and those are events that typically you want to notify the franchisee about provide an inspection report advises to where there was a failure to meet standards advise us to corrective actions but doesn't yet rise to the level of an operations to fall now maybe over time one two three four operations non-compliance events their failure to cure what they're required to cure or change their state can rise their level of a default and the last category they suggest you use is technical non-compliance the franchisee in operationally is not meeting every standard but the standards they're missing are very technical they're not impacting the brand they don't impact supply chain maybe they're promoting and adjoining businesses they're engaged in activities really not harming the brand but something you don't like now when I how would you gauge a technical non-compliance event well where if we're before a judge they'd say well that's really not that big of a deal certainly not serving our proprietary products or not buying our proprietary products from our designated supplier we're not buying even non-proprietary products from a designated supplier in time becomes a default four categories I want you to keep in mind a payment default that's obvious and objective they just didn't pay what they're supposed to pay and operations default where hey you're seriously violating our standards and you're impacting our brand and jeopardizing the quality of our product and our reputation or even operations default you you didn't do it you're supposed to do you didn't lease a location you didn't open up on time you're not open during the hours we specify you close the business for a certain number of days you're not serving our proprietary products you're purchasing inferior product from an unapproved vendor those are operations default and then we have operations non-compliance events they're important they could impact our brand but it hasn't risen to a level of a default yet and we want to notify we want to create Conformity by the franchisee we want to educate and Coach them and then technical non-compliance events where hey we could notify the franchisee but we don't want to go to war over it right we don't want to provoke litigation and certainly we want to coach our franchisees to success so consider those four elements or those four types of non-compliance events payment default operations default operations non-compliance and Technical non-compliance so what are the best practices what's the best way for dealing with our franchisees when we're faced with these situations well when we build out our franchise compliance process and we consider okay how do we respond to this franchisee how do we notify the franchisee what instruction do we give the franchisee does this rise to a legal letter from you Charles where your firm is sending a default notice or should this come from our team and notify the franchisee hey we're sending you this operational notice you failed to meet specifications on items a b and c or you fail to pass our inspection on on this date attaches our inspection report and here's the corrective measures we'd like you to take and these are all forms and processes we build out with our clients based on your specific brand so what are the boundaries how should we approach our franchise compliance framework and processes well we want to be fair we want to be consistent we want to be legally compliant we want to be proactive and we want to do all these things with the primary goal of creating successful franchisees and growing our franchise system and with the secondary goal of Legally protecting you as a franchisor so let's start off fairness everything we do every note as we give the franchisee from a compliance perspective will have a legal impact and a system impact legally a franchisee attorney and naturally we don't necessarily care what franchising attorneys think except we want to discourage them from looking at our franchise system we don't want them to be encouraged to sign a retainer with our franchisees to harass us so everything we do from a compliance standpoint on fairness consider it'll be viewed by the franchisee potentially a franchisee attorney and If eventually we get to any litigation by a court so we want to create a record of fairness second is system impact how we treat a franchisee will be viewed by other system franchisees and your franchisees need to see and perceive that as a franchisor you're acting fair so we want to be fair how do you do that every franchisee is different well I think we need to distinguish between severity of the franchisees action are we dealing with something that's a clear default and a very high magnitude right because that's objectively provable is very clear you didn't pay your fee you're in default you didn't open on time you're in default versus a non-compliance event where franchisee didn't hit system standards maybe it was cleanliness in a restaurant maybe with Service delivery maybe was following up on customer leads those are not as objectively provable as say a payment default so we got to distinguish between defaults and non-compliance events evaluate the severity right the more severe the franchisee action the more severe our action should be and second is we need to evaluate whether or not the franchise is acting in good faith or bad faith is this the franchise's first violation or is this the second third or fourth violation if the franchise is acting in good faith even with things like a non-payment default and they're trying and maybe their default is just simply that the business is not performing but they're making every effort to meet system standards well from a fairness standpoint especially if this is the first time we need to treat that franchisee differently from the repeat offender the franchisee acting in bad faith the franchisee who's been told on numerous occasions that they that they're purchasing you know non-proprietary products or they're not meeting system standards or that they fail three four or five system evaluations or on-site inspections so we want to evaluate the severity of Are We dealing with a default or non-compliance event and we want to know about the good faith or bad faith of the franchisee so step one we're evaluating fairness if the franchisee is acting in good faith if this is their first offense well then maybe our compliance systems the practices that we set down together and the or that you set down with your franchise counsel maybe and and one that I'm going to recommend is let's not send a default notice on day one let's document the default or the failure on the part of the franchisee let's send them a friendly notice maybe a non-compliance notice from your corporate team that we'll work on together advising the franchisee of his or her obligations under the franchise agreement advising the franchisee how he or she defaulted and Advising the franchisee as to the corrective measures they need to take also for this good faith franchisee I'm going to recommend that your corporate team contact and communicate with them and say hey we're going to send this notice to you it's not a default notice right now it's a non-compliance notice that we're sending to you you haven't done a b and c or you violated one two and three we want to check in and see how we could help you we want to document what's going on and see if we could take corrective measures together that's how I'd recommend dealing with that good faith franchisee and that even may be the case if it's a payment default right this is their first time defaulting on payment or maybe multiple and we need to examine if we need to support them better and if there's some corrective measures that we could help with conversely if we're dealing with a bad faith franchisee second third fourth offense it's clear they're not following system standards they're just shutting the business down weeks at a time they're serving unapproved products they've received operational or non-compliance notices and they haven't taken any corrective measures well in that case the next step is going to be a legal notice and what we would be doing is evaluating is it a default is it an operational default are we required to give them cure so from a fairness perspective as we're implementing your franchisee compliance program and processes we want to number one evaluate the magnitude of the violation is it serious is it objective can we objectively prove it or is a high level operational default that we need to notify them now because they could damage the brand and brand reputation and then two is the franchisee is there a first offense are they oper acting in good faith are they trying but maybe we have some business issues versus a bad faith franchisee someone who's received multiple notices so in our compliance program that's how I recommend we evaluate fairness and our fairness evaluation is going to evaluate what triggers when do we send a legal notice from our firm or from your franchise Council when do we send operational non-compliance notices how do you follow up about coaching do we go straight to Legal second step that you we need to your framework we should always keep in mind as we're building out franchisee compliance processes and and systems is we need to be consistent consistency is key the number one complaint whether legitimate or not that franchisees and their legal counsel make when they're attempting to attack a franchisor is somehow that that franchisee is being treated from others they love to use the word disparate treatment there's a legal reason a certain state laws prohibit disparate treatment and so we want to keep that in mind but franchisee attorneys franchisees every other word will be disparate they will bring up five other instances where you didn't pursue another franchisee and you're only pursuing them so you need to be consistent and and I see this issue often with new and emerging franchisors there's that lack of consistency because you build some trust with franchisees you let things slide you don't document processes you think a franchise is going to conform they don't and then all of a sudden a year later everything repeats and now it starts escalating but you never documented your prior practices and you're not being consistent I've seen Brands where they have a problematic franchisee and they may claim a default either the franchisee didn't renew the franchise agreement on time or the franchisees not following system standards or a host of other actions that the franchisee may or may not be taking and as a franchisor you want you're incentivized to pursue a default against them because you feel like the franchisee is not good for your system but if you're not consistent how you treat each of your franchisees it will become a defense that a franchisee will raise their attorney will raise and if it goes to litigation that a court would consider why are you defaulting this franchisee on a if you have three other franchisees doing the same thing so you want to be consistent in what you're doing next is you need to be legally compliant the most important thing for legal compliance when you're dealing with franchisees whether or not they breach the franchise agreement not meeting operational standards not compliant is you need to document you need to document even if we're not defaulting a franchisee you need to create a record that you advise the franchisee that they're not meeting system standards that you contacted them you gave them corrective measures and that they didn't perform so earlier I mentioned one of the biggest issues we see start a franchise relationship a franchisee doesn't comply with certain elements you have a conversation with them but you don't document it in writing you have a conversation they start complying again six months passes they fail to meet system standards again you have another conversation you talk to them they're problematic but you're not documenting it they comply again this goes on and on for another year two years later these defaults continue the franchisee gets worse and you're fed up and you tell your legal counsel let's send a default notice and hypothetically say you do send the default notice that franchisee will act as if this was the first time you ever communicated this to them they'll ignore or forget that over the past two years you've consistently communicated with them they haven't complied and now you're fed up two three years later and sending into fault notice the problem you have as a franchisor is you didn't create a record think about it if you ever got to litigation over this issue or if the franchisee the franchisees attorney contacted me or your legal counsel and say why are you defaulting my client imagine how powerful it is if I say well look over the past two years we've sent six operational non-compliance notices to this franchisee advising of this exact same issue and Advising them of the corrective measures and they haven't taken it or they did and now they're in violation again and so now they're in default we're in a much stronger position because we've documented all of these steps so I recommend as your franchise compliance process should be about documentation even if you don't want to default to franchisee even if we're dealing with an operational non-compliance event that you believe will be cured or had a great conversation with the franchisee it should be documented a non-compliance notification a non-compliance report with corrective measures even a polite phone call to the franchisee saying hey this isn't a legal notice but it's important for us to document our processes and our systems and are working together and so you send them that notice that becomes part of your compliance record that becomes very important if the franchisee falls out of compliance in the future and it's also important the documentation for informing and coaching your franchisees remember the first goal shouldn't be let's legally default them we want to create compliance is nothing better than a written statement advising them of the non-compliance event corrective measures and certainly by putting it and writing increases the magnitude of importance it's important for you you've documented it it'll be more important for the franchisee so we want to be legally compliant and part of legal compliances we need to document to inform and coach and create a record other measures we need to evaluate for legal compliance we need to check our operations manual while your franchise agreement includes certain clear standards about operations and service standards and Retail standards and how you want the business to operate many of your system standards will be identified in your operations manual itself and so to be legally compliant we want to make sure our operations manual is consistently updated that it's clear that it's communicated to the franchisees that it's available to the franchisees other issues legal compliance before our firm ever defaults a franchisee there's two things we check number one what does your franchise agreement say is this a payment default if it's a payment default do we have to give 10 days notice or 30 days notice and let's send out our notice is it an operations default if it's in operations default can it be cured under the franchise agreement if it can be cured is there a notice period is it 10 days notice is it 30 days notice who are we sending the notice to who are the owners what's the notice address for the franchisee so we're checking the franchise agreement there's another thing we need to check though depending on the franchisee state of residence and depending on where the franchisee operates the franchise business we need to check that State's franchise relationship laws so just like we have franchise registration States and many of those franchise registration States and others have franchise relationship laws and these franchise relationship laws are laws at the state level they're designed to supplement and enhance protection of franchisees for example States like Illinois prohibit disparate treatment right earlier we said be consistent New Jersey is New Jersey franchise Practices Act which requires certain notification requirements before you could terminate a franchise agreement and there's a number of other states that have franchise relationships laws so just because your franchise agreement says you could terminate or terminate on 10 days notice that may not be the case because if you're in a state or if a franchise relationship law governs your relationship you need to check those laws because they may supersede the terms of your franchise agreement now in our framework of creating our franchise compliance program and practices we want to be proactive you don't want to be reactive we don't want to have a non-compliant franchisee who's making a number of operation non-compliance events over the past year or past two years or past six months and then 12 months later attempt to send them a default notice and attempt to terminate the franchise agreement although maybe that's going to be an option but that's not achieving the overall goal we want to be proactive so we coach and guide franchisee Behavior franchisee expectations the appearance of fairness with other franchisees to improve our franchise system ultimately we don't want to be litigating or defaulting franchisees we want compliant franchisees that are performing paying royalty is increasing system value and building a better organization and better brand so we want to be proactive so much so to the point where we we have clients where even before the franchisee opens the franchise business they start asking for a p l may have very little activity well number one it's good to see what the franchisee is spending pre-opening construction build out and things like that but the most important element of that is you're coaching a franchisee into compliance you're teaching the franchisee that they need to report to you that they need to maintain records right so the worst thing to do is to not be proactive or not be consistent where one day you don't request reports or you're not following up with franchisees and the next day or six months later you have all these new requirements and franchise these are getting mixed signals about what the franchise system is all about and what their obligations are so keep in mind we want to be proactive we want to be proactive to the goal of coaching franchisees and their behavior to elevate and grow the franchise system ultimately franchise compliance practices and programs it's all about avoiding legal disputes making our franchise system less attractive to franchisee attorneys disincentivize them from looking at our franchise system documents so they see there's a clear record of documented history consistency fairness proactive and overall that enhances the Enterprise value of your franchise organization so the elements of a good franchise compliance process well number one we want to understand the magnitude of what we're dealing with payment defaults operational defaults operational non-compliance Technical non-compliance and how we address and deal with those events well number one we want to be fair we want to consider who the franchisee is and whether they're acting in good faith or bad faith we want to be consistent in our actions in our requirements how we treat franchisees we want to avoid disparate treatment we want to be legally compliant which means we need to document and keep documenting and then we need to follow our franchise agreement franchise relationship laws and we need to be proactive this is not about litigation this is not about legal arguments as franchise counsel to many Brands my primary goal is to avoid litigation You're Building a franchise system you're building an amazing brand you want to improve lives you want to improve the lives of your franchisees we want to be avoiding disputes we want to elevate there it's almost inevitable you're going to have non-compliant franchisees you're going to have franchisees where we're terminating their franchise agreement hopefully it's a mutual thing hopefully it's amicable but we want to build our system and we want to build our processes so we legally protect your franchise system and a franchisee attorney or franchisee attorneys don't interrupt or interfere with the entrepreneurial journey of your franchise system and your compliant franchisees