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In our October issue, the status of franchising in China, Craig Tractenberg of Nixon Peabody, top notch franchise attorney, offers insight into the dispute resolution process and strategy. Tips for selecting franchisees and the latest best sellers from Business Week.

Ed Teixeira, Publisher - Carol Moccia, Editor

China Franchise Update

A recent issue of the China Chain Store and Franchise Association Newsletter included an article I wrote in 2005 entitled "China Franchise Update." After seeing the article I was prompted to revisit the subject of foreign franchising in China. I'm sorry to say that not much has changed since I wrote that article.

The International Franchise Association continues to lobby Chinese officials, regarding the Franchise Measures, which were enacted in February, 2005. The most controversial provision of these regulations, requires any company either foreign or domestic to have operated a minimum of 2 locations for a period of 1 year ( the 2+1 requirement) before the company is allowed to franchise in China. The locations must be similar to the units which will operate as franchises. Another provision considers firms, which operate product distribution networks, where the only payment is for product, to be included under the Franchise Measures. This is a significant departure compared to U.S. franchise definitions for product distribution firms. There are other onerous provisions under the Franchise Measures dealing with disclosure, the obligation of a franchisor to provide a proforma financial statement or "earnings claim." A franchisor which designates a supplier of products or services to its franchisees can be held liable to its franchisees for the quality or lack thereof of the products supplied.

Another problematic aspect of the Franchise Measures may lie in its implementation, which will be set by national and provincial agencies in China. Currently there is no firm timetable for implementation.

At this time China presents the most challenging climate for franchisors when compared to other developed countries. For those franchisors with the capital to invest and the patience to persevere the opportunities are endless. However for many others, franchising in China is a daunting task. There are other options such as joint ventures which can address the aforementioned 2+1 requirement. For further information regarding an alternative approach and U.S. law firms doing business in China, feel free to contact me directly.

"He who asks a question is a fool for 5 minutes; he who does not ask a question remains a fool forever." Chinese Proverb

Copyright 2006, FranchiseKnowHow, LLC

Click here to read China Update article

"B-Schools" Reading List From Business Week

Business Week online has updated their 2000 reading list of favorite books gathered from professors of some of the leading business schools. The new list features recommendations from over 30 professors and practitioners from leading B-Schools.

The article includes the biographies on the participants along with their recommendations. You can search through the listings and discover what made these books inspirational and influential in their thinking and careers.

"I am grateful for my problems. I became stronger and more able to meet those that were yet to come." J.C.Penny

Click Here and Read This Interesting Article

Five Steps For Choosing The Right Franchisees

Perhaps the two most often discussed subjects in the franchise industry are: how to select the right franchisees and how to improve franchise relations. Is this mere coincidence or could there be some relationship between the two subjects? In my experience the answer is a resounding yes. Doesn't it then follow that the more successful a franchise program is, the less possibility that issues will arise between franchisors and franchisees?

Those of us who have had the benefit of working in the franchise industry for a number of years have experienced what can happen when a franchisor selects a franchisee who doesn't fulfill the requirements necessary for success. The pressure to add units and grow the system can sometimes cause a well intentioned franchisor staff to take a chance. I've been in that position and can relate to the need to deliver results. Typically, results in the franchise industry are measured by more franchisees, higher unit revenues and franchisee satisfaction. So long as franchisors rely upon new franchise sales to grow their system so to will there be risks when selecting franchise candidates.

Despite all of the personality tests and profile screens there is no risk free way to select franchisees. I've seen enough ways for qualifying and selecting a franchisee to fill a book. The real objective is to follow a course that will minimize the risks and avoid the temptation to compromise standards. There is no way that a franchisor can be correct every time a new franchisee is approved. Since people are being judged and future performance predicted, based upon limited information, the important thing is to focus on those characteristics that really matter.

Five Steps to Improve Your Selections:

1. Identify your criteria for financial and vocational requirements. Don't stray off course and take unnecessary chances. Most franchisees fail because they are under capitalized
2. Assemble a cross section of 4-6 members of the management team to serve as the franchise selection committee. After meeting a candidate compare notes and respect each members opinion. I recall situations where a department manager who reported to me had more insight into the qualifications of a franchise candidate than my franchise salesperson.
3. Have 2-3 of your successful franchisees interview a franchise candidate and get their feedback. I've found most franchisees have a real interest in successful franchisees joining the network, I have had existing franchisees tell me to pass on a candidate. By the way, if you are overly cautious about existing franchisees speaking with candidate you have bigger problems then you think.
4. Request a business plan from your candidates. Even a simple action plan will indicate how capable your candidate is.
5. Don't talk yourself into accepting a candidate that you feel has risks. A rule I will never forget was often used by a CEO I once reported to. His simple test would be to ask one of our operations people the following: " If you owned your own franchise would you feel comfortable having that franchise candidate run your operation?" Try it, sometimes it works.

To summarize: There is no risk free method for selecting the right franchisees. However, franchisors can minimize the risks by establishing standards and adhering to them. Lastly, there is one important point to remember, namely, regardless of how thorough the process is for selecting new franchisees, the franchisor is only responsible for one-half of the relationship.

Dispute Resolution Solutions for Experts by Craig Tractenberg

How do you resolve disputes in your franchise system? Which options are best for you now and tomorrow? As your system grows will your dispute resolution regimen serve you as well when you have more geography and points of distribution? What can we learn from systems that are maturing? Strategic implementation of mediation, arbitration and litigation will serve your enterprise well, but only if used with flexibility with the goal of advancing the growth plan of the system. Every dispute resolution decision should clinically ask “how does this strategy make the system better in the long term.” Without this discipline, the system will resolve disputes based on short term outcomes, which may haunt growth initiatives in later years.

Young franchise systems tend to select one extreme of dispute resolution or another. Entrepreneurial founders tend to either rule with a strict, paternalistic attitude, or in the alternative, tend to treat their franchisees like their favorite family members. As the system grows from entrepreneurial to managerial, the earlier strategies of dispute resolution no longer function as well. The system will sustain growing pains unless a flexible and growth oriented dispute resolution program and strategy is implemented.

A dispute resolution program begins with understanding the various options and tradeoff of the options. The next step is selecting these options and drafting a Uniform Franchise Offering Circular with a tight franchise agreement to implement these options. The last step is to exercise the discipline to enforce your rights in a flexible manner for the best for the long term health of the system. The general mechanisms for dispute resolution are meditation, arbitration and litigation, which can be orchestrated together for a tactical advantage, or which can be selected to the exclusion of the others.

I. Mediation Helps Preserve Relationships Mediation is the use of a third party to help facilitate discussion necessary to advance dispute resolution. Mediation may be used at any time during the dispute resolution process. The results of mediation are non- binding, unless the solution proposed is acceptable to all parties involved. Mediation is a voluntary process. The parties must agree to mediate in the franchise agreement or by mutual agreement once the dispute arises. The franchise agreement may be drafted to require mediation in certain circumstances before litigation or arbitration is commenced. Such clauses are drafted to exclude emergent legal relief by the franchisor, such as for underreporting or trademark infringement, from the coverage. The advantage of requiring mediation as a prerequisite to filing a lawsuit or a demand for arbitration is to give the parties a last chance opportunity to work out their differences before their position harden. It also raises and additional hurdle to the parties filing suit if mediation is a prerequisite. Franchisees often find that the cost of a failed mediation may use of funds that could have been used to fight the franchisor.

Mediation need not be conducted by or with lawyers. The parties may agree to use any person they mutually agree upon for mediation, or may chose mediators through commercial dispute resolution companies such as the American Arbitration Association. The cost of mediation should be agreed upon in advance and in some systems is paid by the franchisor entirely. If mediation is desirable, the parties should agree to at least a two hour mediation conference, and if progress is made, decide how much further mediation is productive. Mediation can continue even after a lawsuit or arbitration is commenced. The parties can agree to exchange information to help resolve their dispute or keep everything private and guarded.

II. The Lawsuit-Public Dispute Resolution Lawsuits can be long and expensive. Lawsuits require lawyers, courts and the public airing of grievances. The parties are entitled to a trial by jury unless the franchise agreement properly excludes jury trials. The parties are entitled to discovery which can include depositions under oath and the exchange of documents. The parties typically cannot select their judge and the jury selection process is intended to be impartial. The parties have the right of appeal which can correct errors in the outcome. Many courts may offer the parties the opportunity for mediation during the litigation process by court appointed mediators.

III. Arbitration-Private Dispute Resolution. Arbitration is a procedure to have the dispute resolved by a selected group or person, typically a commercial dispute resolution company. The parties can agree to arbitration at any time, but an arbitration clause is typically included in the franchise agreement by franchisors that wish to avoid litigation. The parties may mutually select their arbitrator or arbitrators. If they cannot agree, the parties may select an arbitrator from a panel familiar with similar cases. Unless otherwise agreed the parties are entitled to less discovery than in a lawsuit. The hearing for disposition can be scheduled for the convenience of the parties. Once the arbitrator renders a decision, an expedited process exists for confirming the arbitration decision in court. This expedited process functions also as a limited right of appeal.

IV. Which Process is Better This depends on your goals and your risk tolerance. Mediation helps preserve or strengthen the relationship, but may not resolve anything. Litigation has the benefit of finality, but a jury trial has certain risks. A jury may be prejudiced against a large out of state company or feel compassion for the underdog. Arbitration does not always live up to its promise of a less expensive and quicker alternative to litigation. Arbitrators sometimes compromise their decisions by “splitting the baby” on the outcomes and at times the process seems more of a risk management tool to avoid runaway juries than a decision on the merits of a case. Unlike litigation, the parties can agree to keep the arbitration and mediation process confidential, but even this agreement is not fail safe where the outcome is challenged in court.

Regardless of which process is selected, proper lawyering in drafting the franchise documents is essential. Because every advantage counts in dispute resolution, the documents need to give you every advantage. Any franchise documents should specify where the mediation, arbitration or litigation should occur. Every franchisor seeks a hometown advantage and it will usually be enforced. The franchise agreement should select the choice of law to be applied so that the state law that is most familiar and predictable will be used to decide the case. The franchise agreement should state who is entitled to counsel fees and under what circumstances.

Dispute resolution is an unavoidable event in franchise growth and operation. It can be even more daunting if it is not well considered at the inception of the relationship rather than when a problem arises. Careful consideration of the options and drafting the franchise agreement will tilt the advantage towards you and will increase the likelihood of a favorable outcome.

Craig Tractenberg is a partner at Nixon Peabody LLP focusing on franchise litigation, insolvency matters, and trademark enforcement litigation. Mr. Tractenberg works in the Philadelphia office. He has been involved with some of the largest and most complex franchise litigation matters, including income reconstruction matters, reorganizations, and mergers and acquisitions. He can be reached at ctractenberg@nixonpeabody.com or 215-246-3525

© 2006 by FranchiseKnowHow.com and/or by the authors. For copyright information contact ed@franchiseknowhow.com

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