Franchise companies represent excellent vehicles for money
laundering, drug distribution networks, and, indeed, far higher and more
dangerous opportunities for those whose inclinations are such.
And, in the main, few if any franchise companies even have an eye on the
potentiality for takeover by infiltration on the part of subversive/mob
interests, or are represented by counsel, or have access to security
facilities, capable of addressing these issues. In the main, the scenarios
by which adverse infiltration would/can/will take place are not novel. It is
just that now criminal organizations are looking at the franchise industry
as a target rich environment with greater seriousness.
What, in any franchise system, would constitute sufficient critical mass
which, if controlled by nefarious interests, would have the potentiality to
grasp control of the franchisor itself? The answer may be derived through a
combination of qualitative and quantitative analysis. The two must be used
together. Only a quantitative or only a qualitative value would not fully
address the issues.
To date, the industry has addressed this problem only indirectly and feebly
through contract draftsmanship. Franchise agreements purport to prohibit
transfer of ownership/control interests in a franchise to any entity not
first approved in writing by the franchisor. More sophisticated agreements
seek/purport to deal with this by requiring approval of any borrowing that
would create security interests convertible into franchisee ownership.
Twenty years ago that was thought to be truly sophisticated draftsmanship.
Its failure of efficacy lies in the superficiality of due diligence by
franchisors when exercising their rights under such provisions, the fact
that more franchisees are of sufficient scale to be publicly traded, in
which instance limitation of capital share ownership is really not
controllable, and in the fact that such draftsmanship is na´ve -- there are
too many other ways to control franchise operations that can be used in
tandem with the exploitation of these enumerated weaknesses.
If a franchise system is profitable and has a valuable 'franchise', it is a
target in itself for that value. Depending upon its financial statement, it
may be in a position to leverage far beyond anything ever considered by
current management. That is an infiltration invitation in itself, just as
low debt companies were in the instance of hostile tender offers. The
interest of the infiltrator is in the fund borrowed, not in paying it back.
Repayment is simply not in the cards. It is hit and run.
Even if a franchise system is not very profitable and not highly
leverageable, its dealer network is a real plum for the distribution of
drugs and other contraband and for money laundering.
The bottom line here is that diligence at the franchisor corporate level is
not sufficient to deal with this threat. System misuse infiltration is
potentially detectable if you know what to watch for and have in place the
appropriate protocols to enable you to stop it.
The red light here is greatly brightened by the impact of technology upon
'white collar' and organized crime, and the advent of the Russian mafia
heralds an enormous escalation in the toughness of the element you are
dealing with. If the franchisor is very lucky, the infiltrating element will
be a group of franchisees who believe they can further the success of the
enterprise better than present management, and they are probably correct and
indeed a blessing for the system, though they are not seen as a benign event
by those whom they will quickly replace if they can.
Contract provisions that are made less stringent in terms of the control
options of the franchisor by the SBA and other so-called 'fairness' factions
actually facilitate infiltration. Concerns for lessening franchisor control
of franchisee management to avoid/reduce risks of vicarious liability for
franchisee negligence also smooth the way for the infiltrator. How far to go
and how much protection can yet be preserved in the contexts of these issues
is a question more of art than of science.
Patterns of franchisee conduct will emerge which, if noted, tell you when
something like this may be afoot. To be sure, there are one size fits all
signals, but in each company and in each system there can and should be
customizing of the list of things to watch for. Most of these things have as
much potentiality to be benign, and further examination is called for to
determine whether what is being observed is or is not an invasion.
Similarly, patterns of franchisor management conduct frequently are telltale
signs of infiltration. Key personnel can become compromised in the same
manner in which corporate integrity can become degraded in any non-franchise
environment. Management personnel can and will be targeted specifically for
the nature of their function in the company and/or specifically for their
potential weaknesses. Moreover, this is frequently a two front attack, at
the system level as well as at franchisor management level. The presumed
identities and affiliations of those with whom you deal, internally and
vendors, can change or become compromised on very short notice and totally
without bubbles on the surface, especially if you aren't looking and don't
know where to look in the first place.
We are living in an age where the assumptions that gave us comfort in the
past are proving more and more frequently to be untrue or unreliable. Sixty
years ago we worried about submarines off our coastlines. Thirty years ago
we watched the skies and our early warning went down to twenty minutes.
Today we worry about threats that are already here and ready to be used to
our extreme detriment. There is an infiltration and takeover of business
threat that is equally as insidious. It may have been put in place already
over several months or years without the company having the slightest clue.
The parallels between military threat to our nation and infiltration threat
to our companies are compelling for the reason that they are identical in
the suddenness of onset and the potentially devastating impact. Just as FEMA
could never evacuate New York City in any emergency, franchise systems lay
stretched before infiltrators with serious capabilities, unprotected and
without easy possibility of resurrection in a real case scenario.
They can be out to get you even if you are paranoid.
When the traditional lawyer thinks of the menu of events that would be found
if s/he knew how to do the due diligence to find it in the first place, s/he
immediately thinks of the RICO statute in the United States, that
legislative construct originally aimed at the Mafia. And that is the
scenario the statute was conceived to deal with. However, as it has been so
misused by the litigating bar, seeking to apply it to every business pattern
mistake that can happen in any commercial setting, that the courts have
severely circumscribed its application. It is now more difficult than ever
to use the RICO statute in a private civil litigation setting. Moreover, the
entry onto the scene by competent trial counsel would have had to be far in
advance of the normal retention mode for trial counsel. Normally, trial
counsel is summoned at the moment of battle. In this scenario, creative
approaches to evidence must already have been in place as the normal modus
vivendi of the target business, so that the absence or reluctance of
witnesses may be remedied by records of regularly performed activity that
are kept in the normal course of the target company's business may be used
as exceptions to the hearsay evidentiary rule. Without that advance
planning, proofs may be quite difficult to come by. That is another reason
why infiltration defenses need to be thought of as something done far in
advance, just as poison pill articles and by-laws have been used to thwart
tender offer activity. Very few franchise lawyers have ever had experience
that could prepare them to perform this kind of work. Franchise company
infiltration defense planning is a very discreet sub specialty, the members
of which could currently hold their annual convention in any telephone
Other statutory schemes should be screened for usefulness, especially the
securities regulation laws if the franchisor or the relevant franchisee is
publicly held. Securities regulation rules governing manipulation and proxy
information may well be applicable to conduct not customarily thought of in
this context. Economic espionage statutes may also provide jurisdictional
and substantive opportunities.
State law claims should not be ignored here, but it is important that
litigation of these issues occur in Federal court. The issues are
complicated and not likely to be familiar to elected state court judges who
frequently lack time and resources to deal with multi-issue business cases
and lots of legal research. It will usually be harder to get to meaningful
relief in a state court than in Federal court in this kind of case. State
law claims should be thought of mainly as pendant jurisdiction issues.
Arbitration clauses in franchise agreements need to be revisited to prevent
them from being obstacles to relief when relief is most needed.
Current practice arbitration clause drafting does not answer the issues
presented by this problem except in rare instances.
In any normal case evaluation, the need to depend upon third party witnesses
who have no dog in the fight reduces the prospects for success. In many
instances, third party witnesses actually have an interest in the truth of
the matter not coming to light. Illustratively, if a manufacturer of
hospital diagnostic or surgical equipment had engaged in nefarious conduct,
hospital personnel would be excellent witnesses to the conduct and to its
detrimental effects. However, to do so could expose the hospital and its
doctors to liability for malpractice arising from their knowing application
of the dangerous instrumentalities to the treatment of their patients. Thus,
obtaining this testimony would be quite difficult to say the least. There
are many other illustrations of this evidentiary problem in many different
settings. In the context of this article, one would assume that witnesses
were either hostile or that they have been compromised through inducement or
threat. Admissible documentary evidence must be already in hand to fill this
testamentary void. It will, therefore, have to be part of an extant business
records system when the suspicion of infiltration first arises. It will,
therefore, have to be part of the long-term records management protocols. In
these days of electronic data management, file boxes of paper need not clog
warehouses. The generation and management of the requisite data is greatly
facilitated, but a careful eye must be focused upon the preservation and
integrity of the data for reasons of demonstration of reliability under the
new evidentiary rules for electronically generated and preserved evidence.
At some point it must be recognized that this project is to be multi
disciplinary. Lawyers alone cannot complete the job properly. Accountancy
types and investigators will be working in tandem with and under the direct
supervision of the lawyers, especially if any qualified privileges of
attorney work product are to be preserved. To be sure, the data itself will
not be privileged, but the management of the effort should be considered a
confidential endeavor in every sense of the word.
A good trial lawyer can teach a lower level accountancy person to become
forensic without compromising the integrity of the work. It is not a matter
of coaching toward a specific result. If the result is compelled by the
data, that would be unnecessary. If the desired result is not compelled by
the data, the witness will be destroyed on cross-examination by a competent
opposing trial counsel. The job is to teach the accountancy person to
testify truthfully in an effective communicator mode. Judges and jurors will
quickly tune out the boring accountancy witness if s/he is dull, no matter
how high the quality of the data. The lawyer must have a good understanding
of the data as well. The lawyer must lead the accountancy projects, not
simply turn over a vague and generally described project to accountants and
expect them to produce good data. Their discipline teaches them to do many
things that are simply evidentiary 'noise'. They need to be schooled to
eliminate the noise without compromising the professionalism of the product,
and the lawyer must be able to be the professor.
Similarly, the use of investigators is an effort that must be controlled by
counsel. Typical notions of competent investigator resources are frequently
off the mark in this kind of case. Lawyers who use investigators in their
work are mostly specialists in catching the errant spouse flagrante in
delicto at some tryst, and specialists in surveilling disability claimants
to catch them climbing ladders, cutting down trees and fixing their roof.
Assumptions that former FBI agents or former police department detectives
will know what to do once you tell them what you are looking for are not
reliable. These too must be schooled to achieve investigative focus and to
eliminate 'noise'. Here again, the lawyer must know what to do in order to
instruct the investigative resource what to do, and, with equal importance,
what not to do.
When you believe you have uncovered something that could smack of
infiltration, either of the franchisee(s) or of the franchisor company, the
issue of remediation arises.
Here again, notions of touchy-feely, fair dealing and second chance to screw
up, which are the typical approach of the franchise company, may need to be
re-examined. Omelets are not made without cracking eggs, and in any real
battle, throats must be cut. Weak franchisees are natural targets for
predacious elements. In this day and age, you are potentially dealing with a
compromised dealer who, if not terminated, will get your company name in the
paper next time in an article dealing with drugs and prostitution.
Provisions in franchise agreements that permit multiple defaults before
summary termination is provided for should be revisited in this context.
They may need to be tightened up to provide intensified visitation and
supervisory interim remedies, notwithstanding that a default is cured when
notice is given. Slow broom opportunities for defaulting franchisees to take
forever to get their acts together need to be eliminated. Delayed access to
information may need to be a summary termination trigger in itself. A 'right
to hack' provision may be appropriate in your franchise agreements, for they
would allow you to get at information clandestinely, before it is
compromised upon receipt of a notice of audit letter.
Large, multi unit franchisees are also natural targets for infiltration.
Their ownership profiles may indicate areas of exploitability. Executives
with reputations for aggressive celebratory tendencies and womanizing are
easy prey for the syndicate to compromise and control. Indiscretion is the
hallmark of the infiltration pigeon, and lavish ostentation is a neon sign
invitation. There are many such people in every successful franchise system,
and they need to be considered as potential weak links and dealt with
accordingly. The tendency of franchisor management to accept rides in their
private jets, and to participate in their lavish 'events' as their guests
should be re-examined with an eye to how evidence of such camaraderie will
play out later before a jury. Infiltrators will usually attempt to use the
compromised large, multi unit franchisee as a cat's paw for the furtherance
of their agendas. When one thinks, for example, of how much revenue
potential is accounted for by control of franchisee purchasing source
discretion, the obvious temptation should not be overlooked in the context
of this article. This kind of franchisee may not be in default under the
customary standards of franchise agreement draftsmanship today. Where are
the mechanisms to deal with adverse relationship issues for the
non-defaulting major franchisee? They are needed.
To be sure, there are also issues of compromised franchisor management as
the avenue of infiltration at the franchisor company level itself. Where
there is suspicion of potentially compromised management conduct, the most
obvious mandate is that suspected personnel should not be made aware of any
concern or decision to investigate. Sometimes it may eventuate that the
situation that is causing concern is not some organized crime infiltration,
but merely a friend or relative of one or more executives being placed in a
position to exploit the relationship. It is important to deal with this, to
be sure, but it may well be easier to deal with if it is identified as such
and it appears that it is not a true organized crime infiltration agenda. On
the other hand, people who are exploiting executive relationships are
themselves targets of organized crime, for obvious reasons. Usurping those
relational opportunities are major goals of the criminal influence.
Immediacy of action is, therefore, extremely important. The operational
integrity of the company and of the system is as degraded by inappropriate
management executive opportunism as it may be by criminal infiltration, and,
to be sure, the one frequently leads to the other.
The selection of the lead counsel for this kind of project is extremely
sensitive. A company's customary counsel, even if experientially qualified,
may be so involved in the general governance of the affairs of the company
that its being in charge of this kind of project may compromise
relationships and duties of long standing confidence that have preserved
their usefulness to the company over the years. This is, in most cases,
special event work that should be delegated to a firm that has no other
potentially impacted relationships within the company or its franchise
system. That counsel should also be able to recommend appropriate protocols
for how much information about the project and its progress is shared, how
often, and with whom.
These are traumatic events in any company, and they should be dealt with
decisively and with appropriate sensitivity to the wide range of interests
and issues upon which they may impact. This is not yet, and will not become
for some time, an area of law practice for the corporate generalist or even
the franchising generalist.