Top Six Ways Franchisors Can Reduce Vicarious Liability

October 29, 2012

You have a growing franchise system and work hard to build your operations, support structure and unit economics. You are excited for the growth and have new franchises springing up around the country; the future looks bright. Suddenly you start hearing the term vicarious liability more and more as you add locations. What does that mean and how does it affect you?

Vicarious Liability is the term given to the fact that you, the franchisor, could be held liable for acts arising out of your franchisees’ activities or inaction. In fact, franchisors are being targeted more regularly than in previous years as a result of issues that happen at the franchisee level.

Today, vicarious liability issues against franchisors can and do extend to virtually every area of the franchise system. Here are just some of the issues where claims or lawsuits against the franchisee have risen to the franchisor:

  • Personal injury to a customer
  • Franchisee fraud
  • Claim of bad or deceptive business practices by the franchisee
  • Product or service liability
  • Loss of personal customer data
  • Employee discrimination and harassment claims
  • Claim of slander to a customer or competitor by a franchisee or franchisee employee

There is increased risk today of a plaintiff attempting to impose liability on you for the acts or omissions of your franchisees (or your franchisees’ employees). It is imperative that franchisors understand, address and manage this issue as they continue to grow and develop their brand.

Before we move on, however, I think it is important to know three things:

  1. I am NOT an attorney, so it is important that you speak with your franchise attorney to structure your agreements properly. I know many good ones if you need a referral.
  2. I am addressing this article from a risk management and insurance standpoint. 
  3. Vicarious liability is important to both franchisors and franchisees. I’ll address both.

So, as a franchisor, what are some of the steps you should take to prevent, reduce and mitigate vicarious liability concerns.

  1. Know and understand the “moving parts” in your business model. Honestly, too many franchisors try to draw a line and say their only role is to sell franchise rights, and that the franchisees have to worry about those risks. Au contraire….Your franchisees’ risks, and thus yours, vary by what product or service you deliver. If you are an in-home care provider, a quick service restaurant, a system that uses independent contractors, or provide any number of products or services you need to understand where the risk lies for your franchisees, and what you, collectively are doing to prevent and reduce that exposure. Ignorance of the risks of your business model is not a defense.

  2. Control vs Guidance: There has been much written on this subject. This is a hot topic in the industry, and since I am not an attorney I will leave the legal guidance to their expertise. However, as I mentioned above, ignorance of the risks your business model creates is not a defense should an insurance claim occur. I have a lot of discussions with franchise executives and I regularly ask, “Are you better off knowing what your franchisees are doing or not?” I would prefer to know and to try and guide, without controlling, so that standards, compliance and services are similar across the brand. Implementing the proper business best practices will help prevent potential risk to your franchisees, and thus your brand. (That’s the short answer and I think you might see another blog post on this soon.) 

  3. Write insurance requirements that meet the risks and exposure of your business model. I can’t tell you how many Franchise Disclosure Documents (FDDs) I’ve read where it appears that the insurance requirements section has been copied and pasted from another franchise organization’s FDD. Risk is different across all systems and your insurance requirements should be written to contemplate the risk facing your unique business and model. 

  4. Maintain system-wide compliance with FDD insurance requirements. It’s not enough to write the proper insurance requirements and put them in the FDD, you need to monitor your franchisees to make sure they are adhering to these standards.

  5. Track your franchisees’ Certificates of Insurance (COI). These certificates quickly show you whether franchisees are in compliance with the FDD insurance requirements. Just as important, they will list whether you, as the franchisor, are listed as an Additional Insured under their insurance policy. On our typical franchise system audit, we usually find 75% of franchisees are not in compliance. Often it is as simple as not listing the franchisor as Additional Insured, but many times it is more significant such as a reduction in limits, or missing or incorrect coverage.

  6. Finally, you should build and implement a business insurance program specifically tailored to your franchise system. By doing this you can feel comfortable knowing that the proper coverages are in place, they are consistent across the brand, franchisees are in compliance and you are providing peace of mind (and purchasing power) for your franchisees. Ultimately, this frees up time to focus on more important tasks, such as growing top line revenue.

Those are just a few suggestions I make to franchisors to prevent and reduce their Vicarious Liability issues. Most of these are items as they are addressed will bring consistency to the franchise system and will help to prevent and reduce risk.

In my next post, I'll discuss why vicarious liability matters to a franchisee.