Krispy Kreme Franchisor Liability MemorandumTo: Demanding PartnerFrom: Adam AndersonRe: Franchise AgreementQuestion PresentedThis memorandum is intended to examine the following aspects of Krispy Kreme’s draftfranchise agreement: 1) What provisions could potentially expose them to liability for acts of thefranchisee? 2) How could the form be modified to more effectively mitigate such risk? 3) Whatprovisions of the agreement are particularly effective in insulating Krispy Kreme from liabilityfor acts of the franchisee?In answering these questions it is important to establish the general rules and standards acourt uses in imposing liability in the franchisor/franchisee relationship. This memorandum willfirst explore these rules and standards concerning liability and the avenues most often used inimposing them upon a franchisor. I will then apply the rules to the document at hand and discussthe specific provisions that most readily place Krispy Kreme at risk of liability. Finally, I willexamine the provisions that best insulate Krispy Kreme from liability and suggest alterations tothe form that I feel could further mitigate the risk thereof.Applicable RulesA franchisor is subject to vicarious liability for the acts of the franchisee if it can beshown that an agency or apparent agency relationship exists between the two. Through a
thorough examination of relevant case law I have established the following principals governingthe existence of agency and apparent agency relationships.Three elements must be established in order to create an actual agency relationship: 1)there must be mutual consent (either express or implied) between agent and principal; 2) theagent must be subject to control by the principal; 3) there must be some agreement that the agentacts on behalf of the principal. In franchise agreements the element of control is especiallycrucial in establishing an agency relationship. In analyzing the control element the Court willseek to determine whether the franchisor had the “right to control both the means and details ofthe process by which the franchisee was to complete his task.” In re Caroline PaxsonAdvertising, Inc., 938 F.2d 595, 598 (5th Cir. 1991). This doesn’t mean a franchisor can’timpose mandatory standards on their franchisees. Specific standards may be imposed so long asthey are “not intended as a means to control the time, manner and method of performing thedaily operations of the franchise, but as a means of achieving a certain level of quality anduniformity within the system.” McGuire v. Radisson Hotels, Intl., 209 Ga. App. 459 (1), 486S.E.2d 684, 742 (1987). Under some unique circumstances court’s have found the existence ofan actual agency relationship between franchisor and franchisee, however, due to agency’s morerigid requirements of either express or implied mutual consent and sufficient control, it is morecommon for a court to impose liability based on the theory of apparent agency.Apparent agency refers to “that authority which a principal holds his agent out aspossessing or permits him to exercise or to represent himself as possessing, under suchcircumstances as to estop the principal from denying its existence." Nevada Power Co. v.Monsanto Co., 1994 U.S. Dist. LEXIS 20504, 12-13 (D. Nev. Nov. 9, 1994). An apparentagency relationship can be established if a franchisor, either through its action or inaction, leads
a third party to reasonably believe a franchisee is acting as its agent, or that in conductingbusiness with the franchisee, they are dealing directly with the franchisor. If the third partyreasonably relies on the misrepresentation to their detriment, the franchisor can be heldvicariously liable for the damaging acts of the franchisee. In O’banner v. Mcdonalds Corp. thecourt outlined the elements of apparent agency as follows: “(1) the principals consent to orknowing acquiescence in the agents exercise of authority, (2) the third partys knowledge of thefacts and good-faith belief that the agent possessed authority, and (3) the third partys detrimentalreliance on the agents authority.” OBanner v. McDonalds Corp., 273 Ill. App. 3d 588, 593, 653N.E.2d 1267, 1270 (1995). Due to the prominent presence of company trademarks in everyfranchise location, the doctrine of apparent authority presents a major risk to all franchisors. It isinherently important in every franchise agreement to be particularly mindful of this risk and tomitigate it as much as possible.Provisions Exposing Potential Liability and Mitigating the RiskActual Agency:In order to prevent the potential establishment of an actual agency relationship betweenKrispy Kreme and its franchisees it is essential that any provisions in the franchise agreementconcerning control on the part of the franchisor be construed solely as efforts to maintain brandand product quality as opposed to mandates controlling the means and details of performing thedaily operations of the franchise. The first provision in the agreement creating the potential foran actual agency relationship is found in section 4.4.1-4.3 are high risk provisions because they require compliance to a franchisor mandatedset of manuals and system standards. In Parker v. Domino’s Pizza the court held the franchisor
vicariously liable for damages caused by the franchisee’s delivery driver due to the existence ofan actual agency relationship. The court established this relationship using the franchiseagreement and the operations manual that it required franchisees to use. The manual in questionoutlined delivery guidelines and required compliance to the “30 minutes or less” standard. Sincedelivering pizza was a part of the franchise’s day to day operations the court held that an agencyrelationship existed between franchisee and franchisor. Parker et al. v. Dominos Pizza et al., (Fl.App. Ct. 1993).In the Krispy Kreme agreement, Provisions 4.1 and 4.2 both demand compliance to themanuals and system standards “solely for use in operating the store.” This is the kind oflanguage we should attempt to avoid. The phrase “operating the store” could give rise to aninference that like Domino’s, Krispy Kreme is attempting to control the daily operations of itsfranchises. This sentence could easily be replaced with the less intrusive phrase “In the effort ofmaintaining brand standards and quality.” Section 4.3 goes on to allow Krispy Kreme to enforcecompliance with the manuals and standards through on site inspections. This serves toemphasize the control issue created by section 4. Krispy Kreme has every right to ensure thequality of its products and trademark by setting and enforcing standards, however, it would bebeneficial to make perfectly clear that is their only intention. To this point, I feel it would bebeneficial to exchange the phrase in provision 4.3 “to determine whether franchise is incompliance with this agreement” with “to ensure franchise is in compliance with all standards ofbrand and product quality.” Although alterations in wording can mitigate the potential liabilitypresented by section 4 to a degree, risk is inherent wherever any level of control exists.Therefore, I feel it would serve Krispy Kreme well to insert an express provision in section 4describing with specificity the intended nature and level of their desired control.
Section 5 of the agreement also gives rise to liability due to its potential to create anactual agency relationship. Provisions 5.1-5.3 mandate that the franchisee exclusively useproducts provided by Krispy Kreme. The franchisee can only use another supplier by submittinga request subject to approval by Krispy Kreme. This is a very sensitive area of the agreementbecause dictating which supplies the franchisee will be using on a daily basis draws even closerto controlling the “day to day operations” of the business. Section 5.3 mentions that thecompany has the right to periodically inspect products bought from other suppliers to determineif they meet company specifications, however, the section never expressly identifies maintainingbrand quality as its purpose. I would suggest Krispy Kreme clarify its intent by adding anexpress provision denoting maintaining brand quality as the section’s sole purpose.Section 7 of the agreement presents a similar hazard. Section 7 allows Krispy Kreme toimplement mandatory training programs for the franchisee’s employs. If an employee doesn’tpass, Krispy Kreme disallows the franchisee from hiring them and has the right to designate theirown replacement. The franchisor placing a hand into the hiring process draws the company evercloser to the line of actual agency through the control of day to day operations. Krispy Kreme’sinterest here must again be perceived as maintaining their brand and product quality. Thisagenda should again be expressed more clearly throughout the section. In order to distance itselffrom a furthered sense of control, Krispy Kreme may also want to consider funding employeetraining expenses as mentioned at the end of 7.1 on its own. After all, its interest is inmaintaining its own trademark quality, not obtaining money for training its franchisee’s potentialemployees or creating any further fiduciary relationship than is necessary in this regard.Finally, provision 9.2 grants Krispy Kreme a seemingly overbroad sense of actualauthority over its franchisees. This section contains a no-compete clause that disallows the
franchisee to have any competing interests anywhere in the entire world. A clause thisburdensome on the franchisee could give rise to a large sense of actual authority on the part ofthe franchisor. Krispy Kreme should consider rendering this provision to a regional restrictiondisallowing competing interests in the southeast United States, where Krispy Kreme is mostcompetitive.Apparent Agency:As mentioned above, the elements required to establish apparent agency are somewhatless rigid than those of actual agency. This broadens the scope of liability under the doctrine.Any representation made by Krispy Kreme that leads a third party to reasonably believe that theyare conducting business with either the company itself, or an agent thereof, could subject KrispyKreme to liability. This presents a problem since the Krispy Kreme trademark is present on thedoor of every franchise location. It is imperative for Krispy Kreme to take great care inconstructing a franchise agreement that avoids requirements that could unnecessarily heightenany sense of apparent agency.In Crinkly v. Holiday Inns, Inc the court held that an apparent agency existed because thefranchisor permitted itself to be represented to a third party as the entity with which the partywas conducting business. The court held that Holiday Inns had failed to properly distinguishbetween franchisor and franchise owned hotels. Crinkly v. Holiday Inns, Inc., et al., (4th Cir.1988). Section 17 of the agreement requires franchisees to place signs in their locationsnotifying customers that they are independent contractors as opposed to agents of Krispy Kreme.This is the best approach available to prevent any similar mistake on the part of third partieswithin its franchise locations. Sec. 8 however, deals with a more difficult situation, a scenario in
which third parties could potentially conduct franchise related business with franchisees beyondthe walls of a franchise location.Sec. 8 deals with advertising materials and grants the franchisee the ability to seek outthird parties to create advertisements for the franchise, subject to submission to Krispy Kreme,approval before use, and a total forfeiture of all “moral rights” to the material on the part of thefranchisee and the third party. This gives rise to a scenario in which a franchisee could acquireadvertising samples from a third party with no prior knowledge of this franchise agreement. Thismeans that a third party could supply a person they assumed to be an agent of Krispy Kreme withtheir intellectual property and forfeit all rights to it unknowingly once it was submitted to thecompany. This could potentially subject Krispy Kreme to liability through apparent agency solong as the third party was damaged by the loss and reasonable in believing they were dealingwith an agent of Krispy Kreme. This problem could be rectified simply by prohibiting the use ofthird party material or adding a provision to sec. 8 requiring that Krispy Kreme not only benotified of any advertising material obtained from a third party, but that they be put in contactwith said third party to confirm their awareness of the forfeiture of their intellectual propertybefore the material is sent in for approval.Effective Insulating ProvisionsLike most franchise agreements the most effective insulating provisions of the KrispyKreme draft are its indemnity clauses. One in particular, provision 17.1, should be highlyprotective against establishing apparent agency in claims brought by the franchise’s day to dayconsumers. Section 17.1 requires that franchisees “conspicuously and prominently place suchother notices of independent ownership on such forms, business cards, stationery, advertising
and other materials as Company may require from time to time.” This gives Krispy Kreme theright to demand that franchisees place signs in their stores notifying customers that the businessis owned by an independent contractor not acting as an agent of Krispy Kreme. Such signsshould help to combat two elements of any apparent agency action brought by a Krispy Kremecustomer injured within the walls of a franchise. First, so long as Krispy Kreme required signsto be prominent and visible to customers, they could eliminate any claim that the injuredconsumer reasonably believed they were dealing directly with Krispy Kreme or one of theiragents. Second, so long as the signs were in place before the injury occurred, they couldeliminate any claim that the consumer reasonably relied on that agency relationship. Specificslike sign dimension, placement and quantity could be added directly to this provision to make iteven more effective, however, as it stands it should provide Krispy Kreme with a shield againstthe dangers of multiple consumer based apparent agency claims.Additional Provision to be AddedI feel Krispy Kreme would also be wise to add a provision to their agreement requiringthat franchisees obtain general liability insurance on their franchise and that they name thefranchisor as an additional insured on the policy. According to the court in Hayman v. RamadaInn, having the franchisor’s name on the insurance policy does not subject them to vicariousliability for the acts of the franchisee, furthermore, it provides coverage if the franchisor is in factheld liable in a claim resulting from such acts. Hayman v. Ramada Inn, Inc., 357 S.E.2d 394(N.C. Ct. App. 1987).