Ad fund usage a common fracture point in franchise relationship

By Kirsten McMahon, Managing Editor

In the final installment of a two-part series exploring an uptick in franchisee disappointment, Toronto franchise lawyer Joseph Adler discusses how the alleged misuse or misallocation of advertising reserves by franchisors is a common complaint.

Recent class-action lawsuits brought against franchisors by franchisees highlight that allegations of misuse or misappropriation of advertising funds are increasingly forming the basis of plaintiffs' claim, Toronto franchise lawyer Joseph Adler tells

Adler, partner with Hoffer Adler LLP, says franchisees are generally required to contribute two to four per cent of their gross sales to a common advertising fund.

“Some of the larger systems have tens or hundreds of millions of dollars in marketing funds,” he says. “The theory is that if these funds are pooled, the franchisor will have more buying power to advertise across various platforms, such as social media, billboards, television commercials, radio spots, or newspaper ads."

Adler says the franchisor also can control the way the public views the brand through the use of these ad reserves. However, how that money is spent is often a bone of contention among franchisees.

One U.S.-based burger chain that is experiencing growing unrest within its franchisee ranks is currently searching for a new chief marketing officer, and franchisees are “connecting the dots” between the lack of a marketing executive and weak sales.

Closer to home, a group of Quebec franchise owners is suing a Canadian coffee chain, alleging the company has misused a franchisee-funded advertising reserve. At another national coffee chain, a group of franchisees launched a class-action lawsuit over the company’s alleged improper use of a $700 million advertising fund.

“When it comes to advertising funds, franchisees want their franchisor to spend their money in a way that is responsible and defensible. It's their own money,” Adler says. “I can understand why they are scrutinizing the way franchisors are spending these resources.”

He says it’s problematic when a franchisor is not acting appropriately and using those ad funds for their own purposes. “But could they use that money for hiring a marketing director, for example, or is that something that should be on the franchisor's tab? Maybe the funds are used properly, furthermore, but franchisees question the ability and expertise of the marketing team whose campaign fell flat.”

Franchise agreements are drafted in a way to prevent franchisees from having a legal claim on the basis that they haven't received their pro rata proportionate share of the reserves, Adler says.

“Let's say a franchisee is generating $1 million in gross sales and they have to pay 4 per cent into the ad fund. So they have paid in $40,000, but the campaign is launched in British Columbia and not in the franchisee’s province. You can't say ‘where's my money's worth?’”

However, he says there is a growing trend of franchisees banding together through associations to argue that franchisors are not spending the reserves appropriately on behalf of the system.

“They're saying as a group that they have not received the benefit of these advertising fund contributions. It's a little harder to overcome that argument if there's legitimacy,” Adler says.

So what can franchisors do to facilitate a more harmonious relationship with their franchisees, particularly when it comes to advertising reserves? Adler says one solution could be to establish a marketing advisory board.

“This would allow a select group of franchisees to participate in the decision-making of the marketing initiatives. Get more franchisee involvement in the process, and if they are convinced as to the legitimacy of a particular ad campaign, it’s more likely to get buy-in from the other franchisees,” he says.

Another strategy is to provide continuous and detailed reporting of how the fund is being spent.

“In some of these cases, franchisees want detailed reports, and they're not getting them, and the franchisor is looked upon suspiciously,” Adler says. “I would say 'be upfront, and invite more participation and involvement, and make the right decisions,' as easy as that sounds.”

He says there is also the question of whether the franchisees have a legitimate claim.

“Just because somebody makes a claim doesn't mean it's true. Franchisees can say that the ad fund has been misused, but that's not to say that it's objectively true,” Adler says.

“It could be that the franchisor has a logical rationale for the way they've used the funds and only a court decision will be able to tell us at the end of the day whether there is any legitimacy to the complaints.”

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