Franchising Is A Fast Growing Commerce With One Opening Every Eight Seconds But Dangers Lurk – Apparently Especially For McDonald’s Franchise Owners
Newport Beach Attorney Nick Frudakis Helped One McDonald’s Franchisee Initiate A Winning But Tragic Case Against The Burger Giant
By Cass J. Edison
From carpet cleaning service and pool halls to bouncy house rentals and wildlife control companies, franchising is a growing business in the US. According to Financial Times, if sales by U.S. franchise businesses were translated into national product, they would qualify as the 7th largest economy in the world.
For the first time in nearly 30 years the Federal Trade Commission has revamped their regulations designed to rein in unruly franchisers.
“There are so many options — nearly 900 new concepts in the past three years, according to the industry — that picking the right one can be daunting,” wrote Richard Gibson of Dow Jones newswires. “Moreover, information about varying franchises is often inconsistent.”
Now, the government wants to help. The Federal Trade Commission is calling for greater disclosure by franchisers. A primary intent is to ensure that prospective franchisees “avoid harm” in their shopping, the FTC said in publishing the revisions, which would become mandatory next year.
[The growing interest in the business of franchising has given rise to another growth industry — Law firms like Haynes and Boone and Zarco Einhorn, Salkowski & Brito, P.A. that specialize in franchising transactions.They represent franchisees in disputes against major franchise systems in the hotel, restaurant and service industries.]
For the first time in 12 years, the California State Bar has added to its list of bar-certified legal specialties, this time in Franchise and Distribution Law. The inaugural Franchise and Distribution Law exam, which marks the first step toward achieving certification, will be given Aug. 12 of this year.
“Given the complexity of law in this area and the importance of franchise and distribution law to consumers in this state, we thought it was important to establish this specialty,” said Stafford Matthews, chairman of the Franchise Law Consulting Group for the California State Bar.
Matthews noted that besides being a complicated and expanding area of law, more than 50 percent of “normal, everyday transactions have some franchise component.” The definition of franchise, he added, “is very broad and can apply to normal commercial relationships where both parties aren’t even aware that they’re franchises under the statutes.”
Jan Gilbert, partner with the DC law office of Haynes and Boone said, “It is big news because they have not amended the regulations since 1970 in any material way at the federal level.” Some states, including California, have had stricter policies in place to encourage fair dealings for franchisees but even then there is no guarantee. Large corporations are backed by armies of attorneys loaded with voluminous contracts, packed with confusing legalese in fine print that still almost always guarantees the upper and sometimes heavy hand for the franchisor.
The Good, the Bad and the Ugly
Success can be had in owning a franchise. But, it takes a lot of hard work. And it is often, in effect, as if the franchisee is simply paying a company to become a manager of one or more of the company’s units. Statistics on success are unreliable and so much of the long term success or lack thereof depends on the franchisor and THE CONTRACT — a document that can make or break a franchise’s business. Many experts recommend employing an attorney, at least for the contractual stage.
The word “franchising” is from the French for honesty or freedom. But don’t count on it. The following is a classic tale of what can go wrong will go wrong — and did go wrong for one woman in California who literally went to her death fighting the behemoth burger franchisor- McDonald’s Corporation. Well known by junk food consumers for its “secret sauce” and its mammoth-footed clown, the “All-American” icon is generally not revealed as a bully in the media. A fact that helps the mega burger company lure in a host of new franchisees every year.
Sandra Darling worked at or owned McDonald’s franchises for more than 30 years. She began working at a franchise her father owned in 1966 and, after undergoing McDonald‚s management training and five years of management experience, she became director of operations and chief financial officer for all three of her father’s franchises.
In 1983, Darling Management Company (DMC), a corporation she formed with her husband James Darling (James), purchased those three franchises from her father. Darling, who was president and 51 percent owner of DMC at that time, thus became the first female franchisee for McDonald’s. Under her management, one of those franchises became one of the four highest performing franchises in Southern California and one of the top 10 franchises in the nation. Ultimately, at the urgings of McDonald’s senior management, Darling would acquire three more restaurants.
A new policy cooked-up by the burger chain’s management in the mid-1980s to take over the top franchises and bring the profits in-house, combined with a vigorous dislike of any criticism of their company — and an unofficial misogynistic attitude — eventually led to Darling’s downfall.
McDonald’s corporate management began to covet Darling’s highly profitable Fontana store, which Darling had made clear she did not want to sell back to the company.
As an outspoken member of various corporate committees and organizations, Darling was declared a persona non grata by company executives for criticizing some of McDonald’s franchise “rewrite” policies. On one occasion, in 1992, she approached McDonald’s Chairman, Mike Quinlan, to complain about the company’s rewrite procedures. Quinlan told her that he did not appreciate her saying anything, especially about that topic.
[From virtually that point on, Darling’s days as a McDonald’s franchisee were numbered. At about the same time that she confronted Quinlan, McDonald’s senior management initiated a complex and illegal plan to acquire the Fontana franchise and oust Darling from the franchise system.
Ultimately, it would be shown that McDonald’s succeeded in forcing Darling into an untenable financial position, caused her to fire her long-time accountant and hire a firm “recommended” by McDonalds. That firm failed to file necessary periodic reports to McDonald’s on Darling’s behalf, mainly to cover up the fact that at least one of the accountants handling Darling’s accounts was busy stealing several hundred thousand dollars from the restaurateur. McDonald’s declared Darling in default of her franchise agreement and stripped her of all her restaurant franchises, leaving her without any means of earning a livelihood and driving her into bankruptcy.
When it became apparent to Darling that she had been dreadfully wronged, she approached an old friend and asked his advice. Nick Frudakis, an independent attorney in Newport Beach, knew immediately she had a case against McDonald’s. He empathized with her, particularly since his family had had a long-standing cafe on the famous Long Beach Pike taken away through unscrupulous business practices. He was aware of the fact that Darling was suffering from a terminal lung illness and decided to help her vindicate herself.
Aware of the enormity of beginning litigation against such a large corporation, Frudakis shared Darling’s story with another lawyer in Southern California about handling the case on contingency. “I called Nick Reckas, a cousin of mine and told him about Sandra,” Frudakis said. “I pointed out that, as sons of emigrant Greeks who started up their own small restaurant businesses here in America and were successful enough to send us to law school, we sort of owed our services to a fellow American restaurateur who needed help.”
Frudakis reminded Reckas that a desire to right wrongs was the main reason they had both opted for a career in law. Reckas agreed and took on the case. With help from just two other attorneys, the pair set out to face McDonalds and their, literally, dozens of lawyers.
On April 29, 2003, a Los Angeles County Superior Court Jury found McDonald’s guilty of fraud in its dealings with Darling. In a detailed finding, the jury awarded $6.5 million to Darling in compensatory damages. Following a separate hearing on the issue of punitive damages, the jury awarded her and additional $10 million.
McDonald’s appealed the verdict and judgment of the court, posting a bond of $24,750,000 on November 10, 2003 to carry the case forward.
“I suspect the ramifications [of this case will be] none,” said Los Angeles attorney Mitchell Shapiro of the firm of Jenkens & Gilchrist, speaking on behalf of the International Franchise Association. “McDonald’s and other franchisors win 98 percent of the time and will probably win this one on appeal,” he said in an article written by Amy Garber in a May 12, 2003 issue of Nation’s Restaurant News.
In the same article, McDonald’s responded to the verdict in a statement that “the facts and the law simply do not support [Darling’s] claims. We are confident the decision will be overturned. McDonald’s has more than 2,400 franchisees in the U.S. They are supported by a company that cares about them and recognizes their value to business.”
However, last year the Second District Appellate Court did indeed uphold the verdict of guilty on all fraud charges. The issue as to the “ownership” of the damage awards was clouded by the fact that the plaintiff was forced to borrow money against any possible claims in order to fight the McDonald’s appeal. Therefore, the monetary award was later overturned in part and remanded in part by the appellate court.
The battle continued over the ensuing year, in which time Sandra Darling passed away March 10, 2006, at the age of 60. The case was only recently settled out of court with undisclosed terms.
McDonald’s media representatives have not responded to requests for information on the Darling case, as of the publication date of this article. As additional information becomes available, it will be published here.
Charles Daff, the Chapter 7 Trustee who handled Darling’s bankruptcy said of the final outcome, “God Bless her, a lady who finally got justice. The process worked and she ultimately prevailed.”
This is not the first or last instance of outrageous and what some would consider criminal behavior for this business.
In 2001 the company was fined £12,400 by British magistrates for illegally employing and over-working child labor in one of its London restaurants. This is thought to be one of the largest fines imposed on a company for breaking laws relating to child working conditions (R v  EWCA Crim 1094). In April 2007 in Perth, Western Australia, McDonald’s pleaded guilty to five charges relating to the employment of children younger than 15-years-old in one of its outlets and was fined $A8, 000.
McDonald’s has been involved in a number of lawsuits and other legal cases, most of which involved trademark disputes. The company has threatened many food businesses with legal action unless they drop the Mc or Mac from their trading name. In one noteworthy case, McDonald’s sued a Scottish café owner whose name was McDonald, even though the business in question dated back over a century (Sheriff Court (Glasgow and Strathkelvin), 21 November 1952)
History (according to Wikipedia)
Franchising dates back to at least the 1850s; Isaac Singer, who made improvements to an existing model of a sewing machine, wanted to increase the distribution of his sewing machines. His effort, though unsuccessful in the long run, was among the first franchising efforts in the U.S. A slightly later, yet much more successful, example of franchising was John S. Pemberton’s franchising of Coca-Cola. Early American examples include the telegraph system, which was operated by various railroad companies but controlled by Western Union, and exclusive agreements between automobile manufacturers and operators of local dealerships.
Modern franchising came to prominence with the rise of franchise-based food service establishments. This trend started as early as 1919 with quick service restaurants such as A & W Root Beer. In 1935, Howard Deering Johnson teamed up with Reginald Sprague to establish the first modern restaurant franchise. The idea was to let independent operators use the same name, food, supplies, logo and even building design in exchange for a fee.
The growth in franchises picked up steam in the 1930s when such chains as Howard Johnson’s started franchising motels. The 1950s saw a boom of franchise chains in conjunction with the development of America’s Interstate Highway System. Fast food restaurants, diners and motel chains exploded.
“In an interview with failuremag.com, Peter Birkeland, author of ‘Franchising Dreams’ researched the business of franchising from the inside. By spending three years working in the franchise units of three different companies identified in Franchising Dreams by the pseudonyms King Cleaners, Sign Masters and Star Muffler, Birkeland gained unique insight into the often confrontational relationships between franchisers and franchisees, and why it often takes a monumental effort to make a franchise successful,” said Jason Zasky in his interview with Birkeland, also president of Birkeland Institute.
“There was a myth in the 1980s that franchising is much more successful than owning your own business, that there is a ninety-five percent success rate. That’s a myth that is quite beneficial to the franchiser in enticing people to come in and buy a franchise unit. It‚s almost fail-safe. ‘Hey, give us your money and you’re going to be successful, not a problem.'”
“Now, if you ask people at the regulatory level to give estimates of franchise success they will not answer that question. I don’t think it’s a dirty secret, but the success of franchising compared to owning your own independent retail operation might not be overwhelming in favor of the franchise business. People don’t really talk about success rates at all. They used to in the ’80s, but now those numbers are hard to find. It was one part of their past that was not really truthful and no one is talking about it anymore.”
Options for Assistance
There are other protections available to franchisees. According to their Web site, the American Franchise Association (AFA) was formed to improve the business conditions for franchising generally, while working to protect the economic interests of franchisees. The AFA accomplishes this goal by providing two additional avenues to resolve potential conflicts. First, the AFA constantly advocates the franchisee’s position. Second, the AFA communicates with federal and state lawmakers about the scarcity of rules/laws governing the franchisor-franchisee relationship
But there are reasons why a franchisee wouldn’t join the AFA, according to the organization’s Web site. The first is fear of retaliation by the franchisor. Many franchisors use aggressive intimidation tactics to routinely deny their franchisees a basic constitutional right–the freedom of association. Many franchisees decide the internal political pressure from their franchisor outweighs any benefits they may gain from joining the association. Second, some franchisees receive favors from their franchisor in the form of additional locations or other special deals so long as they tow the company line and stay politically correct by not joining a trade association of fellow franchisees.
The FTC rulings will also help new franchisees
“The commission also wants to reconcile federal and state regulations,” continued Gibson in the Dow Jones Newswire article cited above. The latter are set out in what’s called the Uniform Franchise Offering Circular, or UFOC, a document that franchisers seeking to do business in those states must file.
“Among the most significant revisions is how a franchiser reports turnover in its system. Considerable churn — a high number of franchisee terminations, for example — could be a tip-off of problems. Current UFOC tables can be confusing.
“The existence of confidentiality agreements, or gags, preventing current or former franchisees from talking about their experiences would have to be disclosed under the FTC’s new rule. Regulators often recommend that would-be franchisees contact former or current franchisees to get their takes on a business. The FTC wants franchisers to provide information about associations of franchisees operating under a trademark (McDonald’s, for instance) so prospective franchisees can learn more about the pros and cons of a system.
“Franchisers also will have to reveal lawsuits they brought against their franchisees. The FTC’s original rule only required that franchisers disclose litigation filed by franchisees. (As is evident in McDonald‚s aggressive legal habits.)
“‘The nature of the relations between the seller and the purchaser, as reflected in litigation, is of central importance in assessing a major investment such as a franchise‚’ the commission concluded.
“Other forthcoming requirements include disclosure as to whether a franchise will operate in an exclusive territory. Franchisees may think they won’t have to worry about similar shops opening up down the street, only to find they’re not protected.
“Another subject Shay (Matthew Shay is the president of the International Franchise Association), is pleased that the FTC addressed is the recognition of advances in technology, such as e-mail and the Internet, that have changed the way franchising communicates. For example, many prospective franchisees search for possibilities on the Web. Also, the old rule didn’t tell franchisers to disclose the type and cost of computer equipment their franchisees would need, whereas the new one would,” reported Gibson.
The new FTC rule become mandatory in July 2008, but franchisers may comply beginning this July 1.
“Taken together, each of these amended disclosures…will enable prospective franchisees to better assess the quality of the franchise relationship and their likely success as franchisees,” said Gibson.