An integral component of many (if not most) larger franchised systems is the franchisor-administered system-wide advertising fund. Typically, franchisees pay a percentage of their weekly or monthly revenues into the fund, and the franchisor-either alone or with input from franchisees-spends the contributions on marketing to build awareness and the reputation of the brand. In some systems, the franchisor commits to deposit additional monies into the fund, such as a portion of vendor rebates.
This sounds well and good, except that the franchisor generally does not have to answer to franchisees on its decisions on system-wide advertising, and most franchise agreements state that individual franchisees are not guaranteed to see any benefits whatsoever from the expenditures of the marketing fund. This is why I always counsel prospective franchisees to speak with existing franchise owners in their geographic area to find out whether and to what extent they are seeing benefits from the marketing fees they pay.
Still, or perhaps as a result, franchisor-franchisee disputes over marketing fund expenditures are relatively rare in comparison to other issues that tend to manifest in unhealthy franchise relationships. When they do arise, they typically do so in connection with the franchisor’s one primary real obligation relating to the fund (in most systems): the obligation to disclosure records of fund expenditures to franchisees.
Indeed, this is one of the primary issues underlying a Cold Stone Creamery franchisee association’s recent lawsuit against the ice cream chain’s franchisor. In the lawsuit, the franchisee association claims that the Cold Stone franchisor, Kahala Corp., has improperly failed to disclose data relating to what percentage of vendor rebates it allocates to its “Flexible Marketing Program.” If the franchisor has been retaining funds that are contractually required to be earmarked for system-wide marketing campaigns, this, the franchisees claim, causes them harm and diminishes the value of their association with the Cold Stone empire.
In the Cold Stone case, the franchisees are also seeking information relating the pricing of the supplies on which the franchisor is receiving the vendor rebates. If it turns out that the prices that vendors charge franchisees are artificially inflated in order to allow for payment of these “kickbacks” to the franchisor, then the franchisees no doubt will assert additional claims in their lawsuit against Kahala. Such claims may include fraud for inadequate or misleading disclosures in the Cold Stone FDD (if in fact information was withheld – at this point, we don’t know who is right or wrong).
The Cold Stone case will be an important one to watch for franchisees and franchisors alike. If the franchisees are able to sustain their lawsuit, I wouldn’t be surprised to see similar suits filed against other franchise systems as well.
Jeff Fabian is a franchise and trademark lawyer who represents both franchisors and franchisees. He can be reached at 866.545.7859, or online at www.fabianlegal.com. You can also follow Jeff on Twitter @jsfabian.
This article is provided for informational purposes only, and does not constitute legal advice.