Hashim and Walker Provide Valuable Insight on Franchise Agreement and Relationship Priorities

May 20th, 2013

David Cahn

David Cahn

In the opening General Session of the International Franchise Association (“IFA”) Legal Symposium on May 6, 2013, Aziz Hashim, President & CEO of NRD Holdings, LLC (Multi-Unit Franchisee of Popeye’s, Checkers, and Domino’s Pizza) & the IFA’s current Secretary, and Kenneth L. Walker, formerly IFA Chairman and the Chairman of the Board of Driven Brands, Inc. (franchisor of Meineke Car Care businesses), commented on franchise agreements and franchise relationship management in an interview-style program moderated by Joel Buckberg. Their comments, which are summarized below, demonstrate both the promise and the challenges inherent in franchising.

Franchise Agreement “Turn-offs”: Hashim’s “bad marks” when evaluating franchise agreements all relate to the security of the franchisee’s equity investment in the business, and are:
1. Franchisor’s right to a liquidated damages award following termination for any reason;
2. Unlimited personal guarantees required by the franchisee’s owners, particularly after an approved sale of the owner’s interest in the franchisee;
3. Franchisor’s right to require the buyer of a location to sign the franchisor’s then-current form of franchise agreement, which might have higher fees or weakened territorial rights;
4. Franchisor’s right to require “periodic” remodeling, without limitations on the frequency, timing or cost of the facility changes.

Walker did not list any concerns with franchise agreements, which is not surprising given his background as a franchisor executive. However, he did emphasize that one of his biggest “turnoffs” when he was CEO (from 1996 until 2012) was having the first contact in a negotiation coming from a franchisee’s lawyer rather than the franchisee executive himself. He was much more likely to negotiate an issue with a franchisee who first approached him directly, even if the final agreement might be worked through by each party’s counsel.

Use of Marketing Funds: Walker expressed a preference for wide franchisor discretion in deciding how to use franchisee contributions, as long as the uses were devoted to growing franchisees’ businesses. Hashim agreed, but with the caveat that franchisees had to be actively engaged and consulted as to the franchisor’s proposed uses of the monies. Hashim objected to use of such funds to cover part of franchisor’s executive salaries (such as for a Chief Marketing Officer) or to conduct product development analysis. He supported flexible uses such as contributing towards the remodeling and rebranding of franchisee restaurants. Walker agreed that franchisee engagement and “buy-in” is critical, on the basis that it is better to have a somewhat flawed marketing plan that is widely executed than an outstanding plan that the franchisees refuse to implement.

Territorial Rights: With regard to franchisees’ territory protections, Walker argued that if the brand as a whole is losing market share to competitors with its existing network of locations, then it should be able to “backfill” with additional franchises. Hashim seemed to agree, as long as the plan protected franchisees who were properly executing the system and meeting expected revenue targets.
Supply Chain Controls: Hashim argued that franchisors should not require purchases of commonly available supplies or ingredients from more expensive sources, if the franchisees can obtain the same items less expensively through other means. He said that at a minimum, there should be clear disclosure to prospective franchisees of how the franchisor makes money from the supply chain.

Facility Remodeling and “Upgrades”: The panelists agreed that it is critical for franchisors to efficiently monitor the quality of goods and services being provided and to discipline franchisees who are not meeting such standards. However, Hashim argued that franchisors need to “make the business case” as to how facility updates or remodeling are going to benefit the profitability and value of the franchisees’ businesses rather than just drive revenue growth. He also believes that “smart franchisors” help fund the costs of facility updates to obtain rapid adoption by most franchisees.
Transfer: Walker emphasized the need to make sure that approval of a transfer is unlikely to harm the viability of a location. Hashim said that it is critical that the franchisor’s rules for obtaining approval are clear, objective and disclosed to active franchisees, and if the criteria are changed the franchisor should be able to explain why change is necessary. Hashim recommends this simple test: “If you would sell this person a new franchise, then you should approve a transfer to that same person.”

Training and Operations Support: Walker believes that in-person, live training and conventions continue to have value in fostering a team spirit among franchisees and an exchange of best practices information, as compared to Internet “webinars” or recorded trainings. Hashim expressed frustration that the ratio of franchisor field staff or “business consultants” to franchisees has been decreasing over time, and the experience level of those consultants has been decreasing. He said that periodic visits by qualified field representatives play in important role in franchisee satisfaction and success.
Termination and Damages: Despite his broad disapproval of personal guarantees and liquidated damages, Hashim agreed with Walker that, if a franchisee is not in financial distress but simply wants to quit the franchise to stop paying royalties, then it is appropriate to require that franchisee to pay termination compensation to the franchisor.

Concluding Comments: Hashim made the following noteworthy comments to franchisors:
1. Recognize that you are not bestowing franchise rights, but rather recruiting important business partners;
2. Don’t make your franchise agreement so harsh that it scares of good prospective franchisees, since quality franchisees drive a brand’s success;
3. Poll your best franchisees to find out their thoughts about the brand and franchisor staff;
4. Mystery shop your franchise salespeople, to find out what they are saying (and failing to say) to prospects; and
5. Employ a true ombudsman to address franchisee complaints and concerns before they mushroom into disputes.

In many ways this program showed the best that the IFA has to offer, since it brought together franchisor and franchisee perspectives for the purpose of furthering industry best practices. It also highlighted Aziz Hashim as a rising leader in franchising who bears watching in the future.

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