Lessons for Both Sides of the Table from the Recent Jackson Hewitt Franchisor Liability Cases

June 16th, 2010

Even in the best of franchise relationships, franchisors must be wary of litigation and potential liability arising out of their franchisees’ business operations. Where a franchisor imposes and exercises substantial controls over its franchisees’ operational and administrative methods and procedures, the franchisor may well find itself a defendant in lawsuits brought by customers and employees of its franchised outlets, claiming that the franchisor’s exercise of control makes it liable for its franchisees’ negligence or misconduct.

Two recent cases involving employee and customer claims against Jackson Hewitt shed light on this issue. In one case, a customer of a Jackson Hewitt franchised tax center in Louisiana filed suit against the franchisor based upon a privacy breach committed by the franchisee. In the other, an employee of a Jackson Hewitt franchise in Pennsylvania sued the franchisor for sexual harassment based upon the alleged actions of certain owners and managers of the franchise. In asserting their claims against the franchisor, both plaintiffs relied heavily upon language in Jackson Hewitt’s franchise operations manual and other documentation, and also the direct involvement of Jackson Hewitt representatives in the operations of its franchisees. The courts in both cases were willing to consider the plaintiffs’ claims against Jackson Hewitt despite clear admonitions in the Franchise Agreement and Operations Manual that the franchisee and its employees “shall not be considered or represented [by the franchisee] as [Jackson Hewitt’s] employees or agents” and that franchisee has exclusive responsibility over hiring and matters relating to personnel.

Jackson Hewitt provided its franchisees with detailed mandatory policies and procedures for center operations. It required all franchisees to provide customers with a copy of the “Jackson Hewitt Privacy Policy” promising that the confidentiality of personally identifying information (e.g., social security numbers) would be safeguarded. It also provided franchisees’ employees with a Code of Conduct, which made no reference to the existence of franchises, and which included numerous references to the reader as an “employee” of Jackson Hewitt. Jackson Hewitt also operated an Intranet site through which franchise employees could apply for employment positions with other Jackson Hewitt offices, could obtain Jackson Hewitt policies, and could communicate with Jackson Hewitt representatives. In addition, franchise employees were directed to call Jackson Hewitt’s corporate office to resolve issues with tax returns. All of these factors weighed in favor of establishing a sufficient level of control over franchisees’ operations to impose liability on Jackson Hewitt. The court also found significant control in the Jackson Hewitt system relating to training and termination of employees of the franchises.

The conclusion to be drawn from the Jackson Hewitt litigation is that franchisors are essentially presented with two options when drafting their franchise agreements and operations manuals. The first option is to impose significant operational controls over their franchisees’ operations, similar to those described above, and assume the attendant risk of facing liability for third-party claims arising from actions taken in accordance with the operational mandates. The other option is to limit the franchise operations manual to providing examples, general guidance and non-mandatory recommendations for operating procedures and specifications.

The first approach allows franchisors to impose greater control over, and have more say in, their franchisees’ operations—which is an attractive proposition for many franchisors. In addition, franchisees may perceive greater value in a franchise system that provides strict operating standards and procedures, which may help to distinguish the franchisor from competing brands. If the franchisor chooses this approach, it should consider increasing the minimum policy limits required for franchisees’ insurance policies and the types of required policies. It may also want to explore direct insurance coverage for the franchisor for all claims arising from franchised operations.

The advantages of the second option are demonstrated by a recent court decision from Illinois, Braucher v. Swagat Group, LLC, Bus. Franchise Guide (CCH) ¶ 14,355 (Mar. 19, 2010), in which Choice Hotels International, Inc. avoided liability in a wrongful death claim for the alleged negligence of one of its franchisees in maintaining its indoor swimming pool and whirlpool. Choice provided very limited operational guidance and controls with regard to swimming areas, and this approach allows a franchisor to avoid potential liability associated with imposing mandatory operational controls over franchises. However, it also carries the potentially negative business implications of allowing franchisees a measured level of discretion in running their businesses under the franchised brand. The term “measured” is important, because the franchise agreement should still include rights of termination or other remedies for acts or omissions that have the potential to cause material detriment to the franchise system’s goodwill. In addition, franchisees may view a franchisor that employs this approach as providing very little in terms of affirmative guidance and support, not acknowledging that the information and non-binding recommendations of a franchisor can provide value in and of themselves, irrespective of whether compliance is deemed mandatory.

A prospective franchisee can also glean guidance from the information provided above. When evaluating a franchise opportunity, a prospective franchisee should seek to review the franchisor’s operations manual, even if its table of contents is provided in the Franchise Disclosure Document (“FDD”). It is acceptable for a franchisor to require the prospect to sign a non-disclosure agreement with regard to the Manual. If the operations manual provides detailed mandatory specifications and procedures, the prospective franchisee should be wary of the likelihood that the franchisor will pursue rigorous enforcement, to account for the assumption of the significant liability risks described above. While the “deep pocket” franchisor’s potential “joint and several” liability for third-party claims may seem like a benefit to the franchisee, the prospect should be aware that indemnification and contribution provisions in the franchise agreement is likely to shift the ultimate financial burden back to the franchisee, unless it can prove that the franchisor’s actions caused the third party’s claim.

If the operations manual provides only examples and recommendations for franchisee policies and operational procedures, as opposed to detailed mandates, the franchisor may be attempting to avoid any direct performance obligations to its franchisees, or it may simply be attempting to limit its exposure. In performing its due diligence, a prospective franchisee should attempt to gain as much information as possible from the franchisor and its active franchisees to discern the quality and operational support the franchisor actually offers.

The operations manual and other forms and operational materials can be valuable tools for franchisors and franchisees alike. But, depending on how they are written, they can expose the franchisor to liability and raise serious questions in the minds of franchisees as to the benefit to be derived from subscribing to a particular franchise. Parties on both sides of the table should be sure to carefully evaluate these documents to ensure that they serve and meet their needs and expectations.

  1. michael webster - July 20th, 2010 at 12:48 am

    Thanks for the interesting article! However, this analysis focuses only on the franchisor wishing to minimize legal liability – but there was damage to the Choice brand precisely because the franchisor wanted to minimize legal liability and so failed to provide adequate recommendations to its franchisees.

  2. Alan Poliner - July 22nd, 2010 at 1:04 pm

    Thank you for the update on these recent franchising-related cases. There are two theories of why a franchisor can be held liable to third parties by exerting control over franchisees.
    1. By exercising such control, an agency relationship (apparent or otherwise) is imputed.
    2. By exercising such control, the franchisor is being held liable for its own bad acts, i.e. the franchisor was the party that required its franchisees to act in a way that caused harm. (Think of the McDonald’s coffee case – the franchisor told its franchisees to serve coffee at 190 degrees, rather than the industry standard of 140.)

    A defense is that the area of control must be directed at the harm. For example, strict control over most of a franchisees operations may have nothing to do with a slip and fall on a franchisees premises.

    Alan Poliner, Esq.
    Kim & Bae, P.C.

  3. David Cahn - July 22nd, 2010 at 2:00 pm

    I appreciate the comment, and agree with your basic explanation of the agency analysis, which is discussed in all of the cases described. The interesting thing about the Jackson Hewitt employment case from Pennsylvania is that the franchisor was kept in the case under the theory that it was the “joint employer” of the plaintiff, and not on a traditional vicarious liability theory. The issue was not whether the franchisee was Jackson Hewitt Corp.’s actual or apparent agent, but rather whether the direct interaction between Jackson Hewitt corporate personnel and the plaintiff made both franchisor and franchisee the employer as a matter of law.

  4. David Cahn - July 22nd, 2010 at 2:09 pm

    Thanks for reading, Michael! I agree that Choice does expose its brands to a risk of unfavorable publicity by taking a minimalist role in supervising ongoing operations. This allegedly “hands off” approach shoudl be of some concern to diligent franchisees, since they want Choice to protect the brands by preventing practices that endanger customers’ health and safety at the hotels.

    There also is an irony, as Choice has been known to terminate franchisees for violations of brand standards (for example, on the physical appearance of the hotel) and then seek liquidated damages after depriving the franchisee of its investment in the brand — a practice that is hard to defend unless the condition of the hotel is so awful as to pose a risk of SUBSTANTIAL brand tarnishment or a risk to public health or safety. The case described seems like one where immediate termination should have happened and the franchisee should have been liable for the liquidated damages, plus the franchisor’s costs to defend against the customers’ claims.