You may be familiar with this type of issue: A franchisor is sued by multiple franchisees claiming misrepresentations in the FDD and statements made during the franchise development process. They are asking for damages above and beyond the cost of the franchise, claiming that these alleged misrepresentations have caused them significant financial harm.
As a franchisor you can be exposed to lawsuits against you from franchisees claiming misrepresentations were made during the franchise development process and/or in the Franchise Disclosure Document. These franchisees’ businesses are often not successful and are claiming that your actions or inactions led to the demise of their franchise business. What you may, or may not, know is there is specialized insurance coverage tailored to the franchise model that can provide coverage to the franchisor should this situation arise.
This coverage, called franchisor’s errors and omissions (E&O) insurance protects the franchisor from alleged mistakes, exclusions or negligence in their professional services to franchisees. If this type of coverage appeals to you, it’s important to work with an agent or broker who specializes in writing this coverage for franchisors and knows how to tailor the policy to cover this unique exposure.
Here are some examples of where and how Franchisor’s E&O would help a franchisor:
- Alleged Misstatements and Misrepresentations in the FDD: These could be an item 19 representation, a promise of a certain amount of territory, a "misrepresentation" in the cost to open, or all of the above along with other issues. Typically it is not black and white concerning a single misrepresentation in the FDD but rather a combination of factors. Franchisor's E&O provides coverage for alleged FDD misrepresentations, errors or omissions made in good faith.
- Statements Made During the Franchise Development Process: As new prospects research your concept they speak with salespeople who represent your organization. (These could be independent contractors.) Many "promises" or representations made during this process are remembered differently by the opposing parties after a franchisee has opened their business. They will compare these against the FDD and with their own perception of reality once they become franchisees, and bring allegations over both real and perceived inaccuracies.
- Noncompete Claims: Sometimes things don't work out. That is just the risk of owning a business. A unique trait of franchising is that sometimes franchisees want to continue in business but just not with that particular franchise. The FDD provides a way for the franchisor to stop this from happening, although this has led to counterclaims as a result of an effort to get out of their FDD obligation.
- Network Security/Cyber Liability Coverage: As a franchisor you are holding a lot of confidential information on prospects and franchisees, such as financial, banking and family information, etc. You could be held liable if it is alleged you failed to protect this information. Franchisor's E&O can be amended to include coverage for your obligation to protect this confidential data.
- Defense Costs: As you know, franchisor-franchisee disputes can be challenging and costly to resolve. Franchisor’s E&O policies provide coverage for legal fees to defend and settle these claims. Often times your current franchisor counsel can be included in the policy as defense counsel.
As you can see, franchisor's E&O is an important and highly-specialized coverage and only a few insurance firms know how to properly craft these policies. Just as you understand the value of utilizing legal experts with franchise experience, so, too, should you have a franchise insurance agent craft your franchisor's E&O policy and provide guidance on franchise risk and insurance issues.
If you would like to learn more about franchisor’s errors & omissions coverage, or ways to reduce risks to your franchise system, don’t hesitate to contact me.