The Collectively Bargained Franchise Agreement
An up-close look at a franchise agreement developed with the ambitious franchisee in mind.
To make its system more attractive to ambitious franchisees, Taco John's took a radical step: it brought them in on the development process
Let's say you're looking to buy a fast-food franchise. So you send away for a bunch of marketing brochures, including one from Taco John's International, a chain of 427 Mexican restaurants with sales of $165 million. Initially, the Taco John's material reads no differently from everything else you have spread out across your kitchen table. The literature is peppered with cloying references to "Taco John's and You" and even quotes from satisfied customers and (no kidding) restaurant critics. Standard fare. Then you get to the following passage: "[The Taco John's] Franchise Agreement is one of the most progressive in the industry . . . the first ever to be developed cooperatively with a franchisee association." Big deal.
Actually, it is.
In most franchise systems, the franchisee signs an agreement that boils down to this: you either do what the franchisor says, or you stuff someone else's tacos. But increasingly sophisticated franchisees have begun to challenge that patriarchy, demanding more accountability (for example, in how their advertising contributions are spent), flexibility (multiple vendors for supplies), and exclusivity (protected territory) from their franchisors. The upshot: franchisor/franchisee relations are often mired in an oh-yeah-says-you mentality not unlike what you'd find at a grammar school playground or a congressional hearing.
In 1992 Taco John's decided to take steps to avoid the legal cat fighting. Its executives hoped a new agreement would also remedy some costly inefficiencies. Since its founding, in 1968, Taco John's had modified its agreement several times to comply with mounting regulations from the Federal Trade Commission, eventually finding itself bound to eight different documents. The varying language made enforcing operational standards difficult. Different agreements also caused franchisees to grumble about inequities.
The folks at Taco John's also sought to add some sizzle to its franchise-unit growth, which had been stagnant for about three years. A more progressive agreement, executives figured, might make Taco John's more appetizing to a more ambitious breed of franchisees. "If someone wants to invest in fast food, they look at the big ones first," says Barry Sims, chief financial officer. "They're never going to look at us in the same light as McDonald's."
Rather than simply presenting new guidelines to franchisees, Taco John's chose to get franchisees more involved. Each side appointed representatives, including Sims on the franchisor side, and Dennis Batteen, president of the Taco John's franchisee association, owner of seven franchises in the South Dakota area, and a practicing lawyer. All agreed on one point up front: they didn't want their attorneys to control the process.
Even so, at one point the negotiation nearly reached an impasse. The subject, interestingly enough, was conflict resolution. Both sides agreed that arbitration was the preferred route. But they differed about how to resolve "class action" cases. Sims was leery. "If a majority of franchisees got together, it could hurt the whole system," he says. But the franchisees wanted to be able to pool their claims.
Eventually, they found compromise in "consolidated" arbitration. This allows claimants to pool together, as long as they don't exceed 15% of total restaurants. Both sides accepted that arbitrary percentage as large enough for the franchisor to take notice, but not so large as to imperil the entire company.
Sims's goal, however, was to avoid arbitration entirely by increasing franchisees' involvement, partly through the franchisee association, which the new agreement formally recognized. The agreement also reorganized the operations committee to include four franchisees. "Franchisees get an early-on look at future product development, and aboveboard disclosure of product markup," says Batteen. "So we deal with any operational problems before they get out of hand." The result: Taco John's has reduced the lawsuits listed in its offering circular from four pages of suits to four suits in toto. And whereas many franchisors retain a lot of in-house counsel, Taco John's has a legal staff of one.
Sims also reports that operational standards have improved: the average quality, service, and cleanliness (QSC) score for franchisees has risen from 70 to 80 (out of 100). Batteen says 85% of franchisees have voluntarily signed the new document, an indication they're happy with it. "And if you have happy franchisees," he adds, "you have a lot fewer problems to deal with."
Here's how Barry Sims and Dennis Batteen resolved the toughest issues in writing a franchising agreement:
"We will not establish, operate, or grant a franchise for the operation of a Taco John's Restaurant within the 'Protected Territory.' . . . In the event . . . we or a prospective franchisee identifies a location within one (1) mile outside the boundary of your Protected Territory which we believe to be suitable for the development of a Taco John's Restaurant; or we or a prospective franchisee identifies a location within your Protected Territory which we believe to be suitable for development of an Affiliated Business (as defined below) . . . we shall first offer you a franchise for such location under the terms and conditions of our then-current franchise agreement for a Taco John's Restaurant. . . . [Y]ou may exercise your right of first refusal by identifying another accepted location in that trade area within the sixty (60) day notice period."
Protected territory is always a thorny issue. Franchisors want (and often have) the power to open new franchises nearly anywhere they want -- even right across the street from an existing franchise. Franchisors call it "market penetration." Franchisees call it encroachment and have been demanding some kind of exclusive territory. Under the old Taco John's agreements, most franchisees did not have protected territories. Territory is now generally defined as a five-minute-drive radius around the store, plus an additional one mile wherein the franchisee has right of first refusal. Sims knew this might hamper the growth of Taco John's, but he believed franchisees would act sensibly. Says Batteen: "If they can make the case that there should be another store in my area, I say go ahead. I'll put it in myself."
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"We will not allow the distribution of [our] products . . . through a retail outlet located in your Protected Territory unless we receive the approval of the majority of those franchisees in whose protected territories such retail outlets are located. . . . An 'Affiliated Business' as referred to above shall be defined as a Mexican food restaurant or other Mexican food distribution outlet (other than a Taco John's Restaurant as defined below) which is operated by us or our affiliates under the Marks or other marks where we or our affiliates have the right to grant franchises for such restaurant or outlet."
