2. 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.
Getting the Most Out of Your ATM | 1
1Assess
Transfer
2
Manage
3
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3. 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
1
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4. 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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5. 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.
2Transfer
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6. 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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8. Getting the Most Out of Your ATM | 7
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.
3Manage
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
9. 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 business
for over 100 years.
Craig Harbuck
(817) 347-6962
charbuck@higginbotham.net
Brian Schneider, CIC, CLCS
(817) 347-6964
bschneider@higginbotham.net
Why choose
Higginbotham?
Getting the Most Out of Your ATM | 8
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.net
800-728-2374
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