What Is the Franchisors Legal Liability? What Franchise Brands Need to Know

Franchisors and franchisees are supposed to operate as separate businesses. In practice, though, that separation can get murky. It gets a lot less clear once a brand starts overselling the numbers or getting too involved in how the business runs day to day.

That is why understanding the franchisor’s legal liability matters for both emerging and established brands. It affects how a system grows and how much risk the brand may be carrying along the way.

Where Franchisor Liability Usually Begins

Jeff Monahan, founding partner of Next Era Legal, said most franchisor liability issues tend to come back to two areas: financial misrepresentations and vicarious liability. “The franchisor makes financial statements in its franchise disclosure document filing, and franchisees rely on that information when they decide to buy a franchise,” he said. “Some financial performance representations include build-out costs, gross sales ranges, COGS and profit margins. When those numbers are off, they become easy targets for litigation.”

This tends to matter most during the sales process, when prospective franchisees are deciding whether to invest. If the numbers in the Franchise Disclosure Document are weak, exaggerated or not well supported, they can later become the basis for misrepresentation claims.

How Control Can Increase the Franchisor’s Legal Liability

One of the biggest pressure points in these cases is where brand standards end and operational control begins.

“It is all about control,” Monahan said. “Franchisees are independent contractors by default under the franchise agreement. But if the franchisor controls the manner and means of how the franchisee runs the business, like the Domino’s delivery app, then the franchisor can be held responsible. This is a heavily, heavily litigated area of franchise law.”

Courts usually care less about labels and more about how the relationship functions in real life. A brand may be aiming for consistency across the system, but too much control can make liability claims easier to bring.

The Most Common Claims Franchisors Face

The claims vary depending on who is bringing them. Franchisees often sue over breach of the franchise agreement or misrepresentation in the FDD. “Customer claims are almost always under a vicarious liability theory, holding the franchisor responsible for the franchisee’s negligence, because the slip and fall or other injury occurs at the franchisee’s location,” Monahan said.

Even when something happens at a franchised location, plaintiffs may still try to bring the franchisor into the case by arguing that the brand had enough control to share responsibility.

How Franchise Systems Try to Manage Risk

Franchise brands cannot eliminate risk, but they can make decisions that reduce it. The hard part is finding the right balance. A brand needs enough control to protect itself and maintain consistency, but not so much that it undercuts the franchisee’s independence.

“It’s a double-edged sword because franchisors pursue competing interests of avoiding liability while also designing a specific system for running a profitable business under the brand name,” Monahan said. “Franchisors require specific insurance requirements in their agreements so a safety net is always in place, they disclaim as much responsibility as possible in the franchise agreement and let franchisees challenge it later, and they make broad financial statements in the franchise disclosure document to make them harder to challenge.”

Those steps can help, but they only go so far. Insurance requirements and disclaimers may reduce exposure. Careful disclosures can help too. None of that changes how a system actually works day to day.

Misconceptions About Franchisor Liability

A lot of the confusion starts with how people understand the relationship between the franchisor and the franchisee. “Franchisees are not legal experts, so they may not understand that the franchisor actually can be held liable for their mistakes in some circumstances,” Monahan said. “The general public may not understand the difference between a franchisee location and the franchisor parent company.”

That misunderstanding is one reason the issue gets oversimplified. Liability is not automatic. At the same time, it’s not completely cut off just because a location is franchised.

Practical Steps Franchise Brands Can Take

For franchise brands looking to reduce exposure, a few practical steps stand out:

• Review operational control. Brand standards are necessary, but systems that dictate the manner and means of daily operations may invite more scrutiny. 
• Check FDD financial statements carefully. Make sure the numbers are accurate and supportable.
• Keep legal, operations and franchise development aligned. Growth plans shouldn’t create liability issues down the line.

At its core, franchisor liability is about knowing where risk starts to build inside the system. Brands that stay disciplined about control and disclosure are in a better position to protect the business and the franchisees operating under the brand.

Want to learn more about how 1851 helps franchisors grow their franchises with confidence? Visit www.1851growthclub.com and see what we can do for you.