Franchise Liability 101: Who is Liable for the Franchise?

The question of franchise liability can be a cause of concern for prospective or newly fledged franchisors and franchisees. However, the good news is that the rules are fairly simple. Let’s break them down.

Franchise Liability: What are You Liable for As a Franchisee?

There are two key concepts you need to be aware of as a franchisee.

1. The “Dreaded” Personal Guaranty

It may sound scary, but it really isn’t. It is standard practice for franchisors to request a personal guaranty from their franchisees. This guaranty is set out in the franchise agreement and requires you to back your financial and contractual obligations to the franchisor with your personal assets.

Most franchisors will be unwilling to waive the personal guaranty, but they may be open to negotiating certain provisions.

Any landlords, creditors, or lenders you deal with in your capacity as a franchisee are also likely to request a personal guaranty.

2. Limited Liability

But why would a franchisor specifically ask for a personal guaranty in the first place? Isn’t the franchise agreement binding enough? It is – and it isn’t.

Here’s the great thing about franchise liability: it’s limited.

Franchisors generally allow their franchisees to operate as legal entities (rather than as natural persons). The most popular legal structure with franchisees is the limited liability company.

What that means is that you can benefit from limited liability when dealing with third parties, including customers, employees, vendors, suppliers, and just about anyone else who isn’t the franchisor.

If a third party sues the franchise, your personal assets – such as your property and the savings in your personal bank account – will be insulated.

Are Franchisors Liable for the Acts of Their Franchisees?

If you are a franchisor, you won’t typically incur liability on behalf of your franchisees. That includes their contracts, debts, or any other obligations.

The whole point of a franchisee is that it is an entirely separate entity. The franchisee purchases the right to use your name, trademark, copyrights, trade secrets, and marketing system as an independent business.

However, there is one exception where you may be liable for a franchisee’s obligations: when a court establishes that you have retained a high degree of control over their business. In such cases, the law will treat the franchisee as your agent or employee, and you will incur vicarious liability.

Examples of situations where a court may find a relationship of agency include:

• The franchise agreement sets out stringent rules that govern the day-to-day operation of the franchisee
• The franchisor carries out regular inspections of the franchisee facility
• The franchisee shares profits with the franchisor instead of making royalty payments

Are You Worried About Franchise Liability?

There are legal risks in setting up a franchise. It’s important to do your due diligence and consider whether franchising is right for you.

To weigh up the pros and cons of entering the franchise business, contact Franchise & Business Law Group today.