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FRANCHISE INSURANCE

GETTING MOST

OUT OF YOUR

ATMPg. 1 IntroductionPg. 2 AssessPg. 4 TransferPg. 7 ManagePg. 8 Single Source Solution

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Introduction

Running any business is risky. Running a franchise comes with all those risks, plus certain others not faced by most businesses.

Franchises involve an intricate business model where franchisors and franchisees must work together toward their mutual success. To avoid conflicts that can lead to costly claims and even class action lawsuits, franchisees and franchisors should have an equal understanding of their risks and how to manage them. This involves securing appropriate insurance to cover your property and liability exposures, implementing safety and loss prevention procedures to curb potential conflicts and finding qualified service providers who have hands-on experience in the complex franchise arena.

An easy to remember three-step formula called ATM can guide your efforts.

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Whether you’re a franchisor or franchisee, having a strong foundation is critical to a stable future. For franchisors, a strategically tailored insurance and risk management program is the primary way to prevent and reduce risk to your brand. For franchisees, a well designed program can greatly enhance your business.

Assessing the risk involved in the franchisor/franchisee partnership is imperative to the success of the entire relationship. This begins with reviewing your Franchise Disclosure Document for concealed risks.

Franchise Disclosure Document (FDD)1

This document discloses extensive information about the franchisor and the franchise organization to potential franchisees so they have enough information to make educated decisions about their investments. There are 23 categories of information called “Items” that comprise the FDD.

Twenty one of the Items contain information primarily pertaining to the franchisor, but unfortunately, only two of them contain information pertaining to the performance of the franchise itself that is being offered for sale. Item 19, “Earnings Claims,” is an optional disclosure under Federal Trade Commission (FTC) and State FDD regulations that divulges the performance of the franchise in terms of unit earnings. These are material facts that should be disclosed to new buyers by the seller of the franchise who profits from the sale. Item 19 will be addressed in more detail when the process of transferring risk is discussed.

Developing compliance protocols for FDD insurance requirements and adhering to them is crucial to both the franchisor and the franchisee. Compliance with FDD insurance requirements is something franchisees should welcome and take seriously. There are numerous examples where the franchisor didn’t require certain

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Risk Assessment Checklist for Franchisors

Thorough review of the FDD

Development of an insurance program

Establishment of risk control procedures that include:

Contract analysis

Safety training

Accident tracking and reporting

Analysis of franchisees’ insurance to ensure compliance with FDD requirements

Ongoing monitoring of franchisees’ insurance certificates

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insurance coverages of their franchisees, leaving them exposed and out a significant amount of money or forced out of business as a result of a claim. Franchisors are often also impacted when they’re named in a claim, which takes their time away from growing the brand. Some are affected because claims frequently result in negative publicity.

But how do you know what insurance requirements to include in the FDD? Franchisors must assess their risk to identify their unique exposures and gaps in protection. That will determine what insurance you need to cover them. It’s often a good idea to involve an insurance broker who can assess the franchisor’s total operations to pinpoint vulnerabilities and craft a coverage plan that supports the franchisor’s financial considerations and risk tolerance.

TREND ALERT

Class action lawsuits filed by franchisees against their franchisor are becoming more common because of their many advantages for franchisees, like:

• If a problem exists between one franchisee and franchisor, it’s likely to also exist with other franchisees and that same franchisor.

• Filing as a class allows for the entire group to share the costs.

• Skilled attorneys and law firms are more likely to take on class actions due to higher payouts and compensation.

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Once franchisors have assessed their risks and know their property and liability exposures, they can transfer their risk by purchasing insurance policies, whereby the insurer assumes a portion of the financial risk.

Franchisor’s Errors & Omissions (E&O) Insurance2

There are a number of insurance policies that franchises should consider, but chief among them is Franchisor’s E&O coverage. The primary intent of Franchisor’s E&O is to protect franchisors from a variety of claims filed against them by current, former and prospective franchisees.

Common Pitfalls That Trigger Franchisor’s E&O Coverage:

• Alleged misstatements and misrepresentations in the FDD: These could be an Item 19 misrepresentation, a promise of a certain amount of territory, a misrepresentation in the cost to open or all of the above, along with other false statements. It’s not typically a black and white issue concerning a single misrepresentation in the FDD, but a combination of factors. Essentially, Franchisor’s E&O provides coverage for alleged misstatements in the FDD that were made in good faith.

• Statements made during the franchise development process: As new prospects research a franchise concept, they will speak with the organization’s sales representatives and likely take note of promises or representations made during this process. They will compare these against the FDD and with their own perception of reality once they become franchisees. Disagreements about what was said or allegedly said during this process can result in financial claims against the franchisor.

• Non-compete claims: Sometimes things don’t work out—that’s the nature of owning a business because there’s risk involved. But with franchising, sometimes franchisees want to stay in business, just not with that particular franchise. For example, because of real or perceived issues with the franchise brand, a franchisee may prefer to stop franchising and re-open with the same business concept under a new name. Franchisors have the right to restrict that from happening per the terms of the FDD. However, this can also lead to a franchisee making multiple claims in an effort to get out of the non-compete.

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Claims for damages can stretch into the hundreds of thousands of dollars. So, it’s imperative to address these E&O issues early on. Typically, but not always, these issues occur with newer, emerging franchises because they’re working hard to grow, to improve their system and support services and to validate their concept nationally. But, every franchise should take a serious look at Franchisor’s E&O coverage, and it’s nearly imperative to have it in force prior to any significant upcoming business events, i.e. fast growth, changes in personnel, operational changes, etc.

Other Key Insurance

While it’s essential for the franchisor to develop a strong insurance and risk control plan, it’s equally important for the franchisee. Both parties should secure these coverages.

Property

This is the insurance that protects your physical property and equipment against loss from theft, fire or other perils specified in the policy.

Business Income/Interruption

This is part of a property insurance policy that covers lost income suffered by a business when damage to its premises by an insured loss causes its operations to be interrupted. Typically, it includes profits, fixed costs, extra expenses like moving to a temporary location and sometimes salaries of key employees.

General Liability Insurance

Commonly called GL, it protects against liability claims for bodily injury and property damage arising out of premises, operations, products and completed operations as well as advertising and personal injury liability.

Commercial Auto

This insurance covers the use of cars, trucks, vans and other vehicles in the course of business. Coverage may include vehicles owned or leased by the company, hired by the company or employee-owned vehicles used for business purposes.

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FRANCHISOR E&O CASE STUDY:

A franchisor terminates a franchise agreement with one of its franchisees for failure to make royalty payments. The franchisee makes a counter-claim against the franchisor for breach of contract. The franchisee claims it was not able to make royalty payments because the business was failing due to the franchisor’s failure to conduct sufficient advertising and to provide promised training.

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Workers’ Compensation

This insurance covers employees’ medical costs and lost wages resulting from a work-related injury. Its purpose is twofold: to protect employees when they experience an injury on the job and to provide coverage to employers for liability to employees that suffer work-related bodily injury or disease.

Additional Insurance for Franchisees

Directors & Officers (D&O) Liability

D&O insurance protects the individual directors and officers, as well as the entity, from third party claims from investors, debt holders, competitors, customers, etc. who allege mismanagement.

Employment Practices Liability (EPL)

EPL protects the entity from claims alleging wrongful employment practices, including harassment, discrimination, wrongful termination and more.

Cyber/Data Privacy

A cyber insurance policy protects the entity from claims alleging privacy violations, but also provides for first party costs in the case of any breaches of personal or corporate data.

Employee Benefits/Group Health

Health insurance is one of the most important benefits that can be offered to an employee. Coverage for medical, dental and vision are just a few of the many core coverages an employer can offer.

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Now that you understand what needs to be done to assess and transfer your risk, how do you go about doing it? And how do you find time to do it properly while still operating your business? The cost of a mistake is too high to go it alone. A qualified insurance broker should manage your risks. Here are a few things to look for when choosing a broker.

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Industry Expertise

Not all industries need the same insurance protection. Franchisors need an insurance agency that is well versed in the franchise sector. Having access to insurers and market clout is key in the placement of insurance so that you have coverage options and negotiating power. But more than just placing insurance, franchisors should look for a broker who can assist with all facets of managing their risk. What happens in the event of a claim? You’ll have peace of mind if your broker has the capability to handle your claim and serve as your advocate with the insurer.

Franchise Contract and Certificate Management

The FDD dictates what insurance coverages that franchisees must have in place. Monitoring their compliance and checking that their certificates of insurance have proper language must become routine. Otherwise, franchisors and franchisees can experience coverage issues that lead to out-of-pocket losses, claims with the insurer, increased premiums and even uninsurability. Managing certificates of insurance involves much more time and expertise than most businesses have available in-house. Ask your insurance agency whether it offers certificate management, and if it doesn’t, find a service provider to take the burden off of you.

Loss Prevention

The fast-paced franchise environment creates safety hazards that put employees and customers at risk and threaten your reputation and bottom line. Partnering with an insurance agency that offers risk control and loss prevention services tailored to the franchise industry is another key component to managing the overall program.

Some services to inquire about include:

• Safety training and safety program development

• Contract review (FDD and franchisor/franchisee agreements)

• Claims management

• Franchise communication web portal

• Risk management information system

• 24/7 claims response

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Sources: 1. Doug Imholte, Franchising Risk Specialist. (2013, May 1) How, When

and Why a Franchisor Should Buy Franchisor’s E&O Insurance. 2. Franchise Disclosure Document. In Wikipedia. Retrieved June 12,

2015, from https://en.wikipedia.org/w/index.php?title=Franchise_disclosure_document&oldid=654792301

Higginbotham is a single source solution for insurance and financial services that has served thousands of businesses and individuals since 1948. We represent more than 100 highly rated standard and specialty insurers to give you coverage options and buying power. After we place your coverage, we maximize the efficiency of that coverage and your budget with the full range of risk and administration services.

Insurance Brokerage Consultation & Support

• Business Insurance• Employee Benefits• Retirement Plans• Executive Benefits• Life Insurance• Home & Auto Insurance

• Safety & Loss Prevention• Contract Review• Certificate Management• 24/7 Catastrophe Response• Risk Management Information

Systems• Benefit Communications• Health Risk Management• Compliance• HR Technology

Higginbotham has a unit of tenured insurance experts who understand the risks inherent in the franchise industry. As one of the largest insurance brokerage firms in the nation, we have the resources necessary to manage large national and international franchise programs, as well as smaller, regional programs.

We partner with Swett & Crawford, a CGSC Company, for access to insurers that provide cost-effective niche coverage to franchises. Swett & Crawford is a wholesale insurance broker doing businessfor over 100 years.

Craig Harbuck(817) 347-6962charbuck@higginbotham.net

Brian Schneider, CIC, CLCS(817) 347-6964bschneider@higginbotham.net

Why choose Higginbotham?

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Our franchise team is your single source for every ATM service in all 50 states. Contact us to learn more or schedule a free consultation.

www.higginbotham.net800-728-2374

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