All around the country local franchises are closing their doors due to lack of sales. This has led to a proliferation of franchise lawsuits and arbitrations filed by franchisees claiming they were promised support, equipment, and in some cases guaranteed revenue, which never materialized.
A number of federal and state laws carefully regulate the franchisor-franchisee relationship. Both federal and state law generally prohibit fraud. Federal law also prohibits franchisors from predicting future earnings to perspective or actual franchisees. Despite the legal framework in place, the Federal Trade Commission, however, rarely takes action against franchisors for abuses.
State enforcers do occasionally sanction companies. In 2005, for example, a Maryland Securities Commissioner found that the Coffee Beanery made significant misrepresentations in violation of state law and ordered the company to let Maryland franchisees out of their contract without any penalty. In January 2008 the Illinois Attorney General issued a similar decision involving Coffee Beanery. In fact, the number of complaints and state actions has increased over the last year and a half. As increasing numbers of people have sought to use their retirement or severance packages to become their own bosses, “crooks are coming out of the woodwork,” says Texas franchise lawyer Richard Solomon, as quoted in the April edition of Mother Jones Magazine.
A recent arbitration involving a Coffee Beanery franchisee serves as a cautionary tale to anyone considering a franchise. Deborah Williams and Richard Welshans of Annapolis, Maryland, paid $25,000 in 2003 for a 15-year Coffee Beanery franchise. Three years later, they sued Coffee Beanery in federal court in Maryland, claiming that Coffee Beanery failed to disclose that most of their franchises had already gone bust within three years of opening, leaving their owners deep in debt. According to Williams’ and Welshans’ complaint, 40 franchises had gone under before they signed their franchise agreement. Since that time, 60 more Coffee Beanery franchises have failed.
In order to develop the “perfect location” for their franchise, Williams and Welshans invested an additional $430,000 through a combination of SBA loans, home equity loans, and personal savings. Soon after they were up and running, however, they realized that the Coffee Beanery franchisor made money by selling franchises, not coffee. Williams and Welshans started getting bills for surveillance equipment, a music system, an obsolete $14,000 lighting system, an ice machine that was far to large for them, a faulty pastry display case, and a buggy cash register, all of which they were obligated to purchase under their franchise agreement.
The court enforced a binding arbitration clause in the agreement and ordered the parties to arbitrate. After 11 days of hearings, despite the State of Maryland’s previous fraud findings, the arbitration panel concluded that Coffee Beanery had provided adequate disclosures and excellent training. All of Williams and Welshans’ losses were attributed to “operator inexperience.” Not only did Williams and Welshans lose, but also the arbitrators ordered them to pay almost $200,000 in legal fees and other costs incurred by Coffee Beanery.
Many months later, the arbitrators’ award was reversed by the Sixth Circuit Court of Appeals, which held that the arbitrators had ignored state law by disregarding the fact that the Coffee Beanery’s Vice President had been convicted of grand larceny in 1987. Coffee Beanery has appealed that decision.
The entire saga underscores to the importance of conducting due diligence before entering into a franchise agreement. When franchisors lie or otherwise violate the law in selling franchises, however, both the regulatory and the civil justice systems appear ill-equipped to handle the disputes efficiently and effectively. Experienced counsel, however, can help litigants avoid common pitfalls and maximize their chance of prevailing.
Page Perry and its attorneys have experience representing franchises in connection with disputes involving franchises. The firm also has over 125 years of collective experience representing investors in investment-related litigation and arbitration. For further information, please contact us.