Spadea Lignana: How to Deal with Non-Compliant Franchisees

Franchising doesn’t always go as planned. Every franchisor, both big and small, will inevitably encounter situations where franchisees fail to meet expectations. Non-compliance manifests in various ways, ranging from franchisees facing financial difficulties and lagging in their fiscal responsibilities to those who resist embracing the franchisor's culture and vision, opting to operate in their own manner.

To address non-compliance, it should be considered as any other aspect of franchising, with a transparent and equitable system in place to ensure all parties understand the rules. By adopting a systematic approach and avoiding capricious actions, franchisors can tackle these challenges efficiently and effectively. In a recent webinar, Tom Spadea, founder of franchise law firm Spadea Lignana, shared some tips, tricks and guidance on how franchisors can build a compliance program for their franchisees. 

“This is one of those areas of franchising that is always difficult to talk about, and as franchise attorneys, that is where the rubber meets the road,” said Spadea. “We work with both established and emerging brands. Inevitably, there comes a time when a franchisee isn’t the right fit — maybe they didn’t do the right due diligence or they are having financial problems they didn’t expect. For whatever reason, at some point as a franchisor, you may have a franchisee that is non-compliant. That is why you need to be prepared.” 

Categorizing Non-Compliance

To start, Spadea says franchisors need to understand that there are several different types of non-compliance. “There are two big buckets that people fall into: intentional non-compliance and unintentional non-compliance,” he said. “As a franchisor, you should always have empathy — peel back the onion and ask why are these franchisees non-compliant. Were they used to the corporate structure and they froze? Or were they a bad actor who got into it on false pretenses?”

On the intentional side, it could include bad actors or those in financial default who are repeatedly ignoring critical brand standards. On the unintentional side, it could be first-time business owners or those in non-financial default who are just making small mistakes.

“When an issue comes up, your first step in analyzing the problem should be asking why,” said Spadea. “From there, categorize the type of non-compliance and build a specific strategy based on that category. It is no different than any other franchise process. You need to build a plan.”

Creating a Consistent Process

As a franchisor, Spadea says that it is essential to have consistent processes and standardized practices in place — if you expect franchisees to follow a process, you should also adhere to established processes as a franchisor. “That is why you need to have a non-compliance strategy from the moment you sign your first franchisee agreement,” he said. “You need to set up your system on the right foot.”

Once a plan is set up, franchisors need to train every member of the team to recognize non-compliance and the different categories it can fall into. From there, it is all about documentation. 

“The first notice will provide franchisees with a timeline for a cure,” he said. “You have to be reasonable. As a franchisor, you have a goal of ensuring everyone is operating on the same page, happy and making money. So, if someone steps out of line, the way you discipline says as much about you as a franchisor as anything else does. If you send a default letter for $17, it will create animosity with franchisees and escalate the situation. Instead, have empathy and send them a warning.”

If franchisees blow off the first letter, Spadea recommends sending a second notice. “Most people want to do a good job — they don’t want to be on the business end of these notices,” he said. “So maybe there was a misunderstanding. 90% of non-compliance issues are solved by the first letter. But if they ignore it, it may mean it's time to take it further.”

The third notice, Spadea says, should be the default letter. “Plan for the worst case scenario — they will bring that letter to their lawyer and may write something nasty back,” he said. “It is a game of chess. Your reader of this letter is not just the franchisee, it is also the attorney and eventually the judge.”

Overall, Spadea says creating a consistent process is important not only for the franchisor, but also for the franchisee, so they know what to expect should an issue arise.

Avoid Unnecessary Escalation

When it comes to dealing with non-compliance, Spadea says the biggest common mistake, especially for emerging brands, is unnecessary escalation.

“Think it through. The franchisee is upset — if you send an initial nasty letter, they are going to go to an attorney, tell their side of the story and that professional is going to escalate the situation,” said Spadea. “Take a deep breath. Relax. The franchise agreement is important, yes, but you have to think about the equity around the situation. You are the big bad franchisor and they are the poor franchisee. Those are always the optics. Don’t get personal, mad or overly upset. Don’t write the email back to them when you are angry. Create a standard form that you send and let that discipline you. You have passion, that is why you are a franchisor, but you have to check that at the door or it is going to blow up and come back at you.”

As part of this strategy, Spadea recommends franchisors don’t lawyer up too early, as that puts people on the defensive. 

“The most important thing is to have empathy for the franchisee,” said Spadea. “You are the leader. You are the coach. Take ownership of that. Don’t just push it back and say: ‘Hey, you signed a contract, you better comply!’ Play the long game. How you deal with these tricky situations will help you avoid traps down the road. Plane crashes happen when 17 mistakes are all made in the exact right sequence. Non-compliance is the same. There are so many chances to avoid the issue and to get on the path to solve the problem.” 

Finding a Solution

So, what are some of the ways franchisors can solve the problem the right way? 

One option is to talk to the franchisee about selling. “If a franchisor goes to the franchisee and is honest, it can be a big wake up call for them,” Spadea said. “Franchisees will often say they were just trying to be helpful. Have that conversation. Explain to them why compliance is important for franchising. Non-compliance hurts the whole system. We can help you transition the business. If they do want to sell, waive the transfer fees. You want to coach them out of the system.”

Another solution is to provide extra training. “Maybe they are just bad business owners,” said Spadea. “Many non-compliance issues with franchisees stem from the fact that they have never owned a business. Are you giving them the support they need to reach compliance? Don’t put your head in the sand. If you see smoke, you have to go find the fire and put it out.”

If the situation seems unfixable, franchisors can also just write a check to force the franchisee to exit the system. “Just settle it,” said Spadea. “Come up with a number, be done with it and move on. If they aren’t adhering to your vision, they may need to leave the system.”

The last option, which hopefully won’t need to happen, is to fight it out for the good of the system. 

“While 99% of non-compliance issues should not be escalated, there is 1% that is worth fighting,” said Spadea. “You might have a bad actor who is not paying royalties, for example, or they are ignoring the trademark agreement or creating a competing system. Those are the fights you have to fight, and they are hard. But the sooner you document it and know how to win, the better. Remember, every franchisee is watching, so you have to dig in and protect the brand that both you and them are invested in.”

At the end of the day, Spadea says the majority of franchisors don’t ever end up in litigation. “I am a big believer in franchising,” he said. “It should never be an us vs. them mentality. You are essentially renting your business model so someone can build wealth for their family. You are taking a bigger risk as franchisor, and you have more responsibility. That synergy is what drives the industry. But you have to remember that people may be non-compliant. If that does happen, don’t take it personally. Find a solution. Be bigger than the problem. Put the fire out and move on. Your goal is to create generational wealth for yourself and for your franchisees, so once you have a strong system and process in place, you can play the long game and solve 95% of all non-compliance issues.”

For more information, visit: https://www.spadealaw.com/