Incentives favour franchisee attorneys defecting from their clients’ interests

The good grasp of the academic disciple of Law and Economics is necessary in understanding franchising.

Economics is (almost) all about incentives: A highly unified profession, serving a highly centralized, tightly disciplined franchisor-dominant industry  would lead the observer to predict very high levels of attorney-generated opportunism (self-interest + deceit) at the expense of their clients: individuals and groups of franchisees. The rational lawyer defects because that decision makes the best of a highly imperfect information situation.  The new franchisee bar member quickly realizes that economic survival depends on his or her obedience as a gatekeeper for the “team”, in stark contrast to a Canadian justice system that is more and more sympathetic to franchisee arguments.

Hadfield is required reading for franchisees considering contracting for such high-risk legal services (credence goods).

The Price of Law: How the Market for Lawyers Distorts the Justice System

Gillian Hadfield
USC Law School and Department of Economics
October 1999
Michigan Law Review, Vol. 98, No. 4, 2000

Abstract:
This paper begins with the question, Why do lawyers cost so much? The analysis is an investigation of the imperfections in the market for lawyers, imperfections that have been largely overlooked by focus on either the model of perfect competition or the impact of artificial barriers to entry into the provision of legal services. The paper catalogues multiple sources of imperfection: the nature of the incentives and mechanisms at work to determine the level of complexity in the system; the extent to which complexity and uncertainty make legal services into credence goods par exellence; the winner-take-all and tournament nature of the competition among lawyers; the sunk costs of lawyer-client relationships and hence the potential for opportunism and the limited potential for conventional market mechanisms to control opportunism; the incremental nature of legal fees–which structures legal expenditures as a sunk cost auction in which the cost of services can easily and rationally exceed the amount at stake; and three sources of monopoly–the familiar monopoly established by artificial barriers to entry, the “natural” monopoly arising from the limited supply of individuals in the economy with the cognitive skills necessary to engage effectively in competitive legal reasoning, and the state’s monopoly over coercive dispute resolution.

The analysis uncovers deeply disturbing implications for justice from the economics of the market for lawyers. The price dynamics of the system operate within the framework of a unified profession/unified legal system that essentially puts individual clients–with justice interests at stake–into a bidding contest with corporate clients with efficiency (more generally, market) interests at stake. Corporations by definition are aggregations of individual wealth and, as a consequence, are able to bid for the resources; they also are a richer feeding ground for the wealth extraction generated by the imperfections/monopoly aspects of the market for lawyers. This is not an ethical critique of lawyers; it is the implication of ordinary economic response to incentives structured by a non-competitive market.

The economic dynamics of the market for lawyers operate like a vacuum, drawing the resources of the system into the corporate sphere, in the service (from a public perspective) of efficiency, and away from the individual sphere, in the service of justice as in the relationships between the individual and the state, the market, the family, the community and so on. This stands on its head the lexicographic relationship between efficiency and justice: efficiency is of normative significance only to the extent it promotes individual welfare through just social relations.

The implications of the economic analysis in the paper are supported by the empirical evidence we have about the structure of the legal profession and the changes over the past several decades. The profession is roughly divided into two segments–one serving business clients and one serving individual clients. The business segment is populated by lawyers who graduated from elite institutions, who are well-connected and influential in the profession, who charge high fees and earn high incomes, and who are perceived to be in short supply. These lawyers work in large firms or high-end boutiques and are increasingly likely to be specialized. Their work is perceived to be of the highest level of prestige by all members of the profession. The personal segment is populated by lawyers who graduate from lower-tier schools, charge lower fees and often flat fees set in apparently competitive fashion providing largely routine, non-contested legal services such as house closings, uncontested divorces and wills. Their work is perceived, by them and the rest of the profession, as low prestige. Lawyers in this segment tend to work in solo practice or small general practice firms. The supply of lawyers in this segment is perceived to exceed demand, and there is evidence of un/underemployment and falling prices.

The allocation of total hours spent by lawyers on legal work is increasingly skewed towards the business segment of the profession, and thus towards the efficiency and away from the individual justice goals of the justice system. [my emphasis]

Number of Pages in PDF File: 84

Accepted Paper Series

Download from SSRN here.

 

Reebok, adidas franchisees take protests into India’s streets

It is not hard to understand what this is all about: franchisees in any language are the least likely 99% protesters in the world.

1. Franchisees protest at company’s doorstep, Business Standard, Aughust 31, 2012:

Excerpt:

The tussle between a section of Reebok franchisees and German sports-goods maker Adidas took an ugly turn today, with about 100 people protesting at the gates of the company’s headquarters in Gurgaon.

The franchisees from the National Capital Region (NCR) were protesting against the new terms proposed by the German sports goods major for operating stores in India. The company had given an ultimatum to about 70 franchisees in the NCR region to either accept the new terms, or shut shop by August 31.

Together, these franchisees operate about 125 Reebok stores in the NCR region. The franchisees, who have formed a consortium called Delhi Reebok Franchisee Association, say the new terms and conditions aren’t viable. These terms seek to do away with the minimum guarantee (MG) model the franchisees were operating on so far. Under the MG model, franchisees were assured a minimum amount from the company, irrespective of sales. It was because of this model Reebok was able to set up about 900 stores in 325 cities and towns, becoming the largest sports-wear brand in India.

2. Reebok’s Delhi franchisees cry foul over notice to close shop, SmartInvestor.In, August 26, 2012

“Now they are asking us to close the shop in just 15 days. They are saying that once the goods are transferred, it is our responsibility,” Delhi Reebok Franchisee Association spokesperson told PTI.

The franchisees claimed that they received notices from Reebok India’s parent Adidas Group on August 13 for closing down their stores by August 31 if they do not accept the new terms of the agreement.

“They are purely holding us on ransom and are not ready to settle our claims at all,” they alleged.

And…

In May this year, Reebok India had filed an FIR, alleging that its former Managing Director Subhinder Singh Prem and Chief Operating Officer Vishnu Bhagat were involved in a Rs 870-crore fraud by indulging in “criminal conspiracy” and “fraudulent” practices over a period of time.

Currently, Serious Fraud Investigation Office and the Income Tax Department are probing the alleged financial irregularities in Reebok India Company.

Opportunity Knocks and Liars’ Loans: required reading to understand modern franchising

John Lorinc wrote the book on franchising from a franchisee’s investor viewpoint.

I’m glad to see it is still available to buy online and is in many Canadian libraries.

The hidden banking side is revealed in Chapter 4, The 90% Solution: Franchise Economics, some of which I excerpted in a WikidFranchise.org post.

What did the business press have to say about Lorinc’s work?:

1. National Post: Opportunity Knocks: The Truth about Canada’s Franchise Industry, is an impressively researched look at the myriad of franchises that mushroomed across the country in the past decade. An award-winning magazine journalist, Lorinc has produced an engaging account that charts both the spectacular successes of some franchisers and the utter failure of some franchisees. How franchises seduce those with the most to lose, Jennifer Lanthier, November 2, 1997
2. Globe and Mail: At its worst, Lorinc says, franchising is a haven for the unscrupulous who prey on the unwary – typically recent immigrants willing to labour long hours in dreary businesses, unaware that those operations have little chance of prospering – using them as pawns in a shadowy real estate game. Rather than reflecting an insatiable consumer demand, he inquires acidly, is it possible that all those new doughnut shops may reflect a quiet understanding between landlords and franchisors that the best way to fill fallow commercial property is to sell franchises to credulous investors? Franchise book of interest to anyone who pays taxes, Ann Finlayson, November 1, 1997

Finlayson strikes a cautionary note, specifically about the hinted at misuse of the Canada Small Business Financing program, CSBFP:

Does all this matter to you? Yes, it does. In 1993, in the wake of vigorous complaints by small-business owners that Canadian banks were reluctant to finance them, Ottawa raised the ceiling on loans guaranteed by the Small Business Loans Administration to $250,000 and its guarantee rate from 85 per cent to 90 per cent, sparking a bank lending rush to franchisees and shifting the risk of franchise investments onto taxpayers’ (your) shoulders.

The Risk: Only a fraction of the Liars’ Loans are ever claimed by the banks, thereby grossly understating Industry Canada’s default statistics (Franchised v. Non-Franchised loan performance). The franchisee thinks he signed a government-backed loan but it never gets registered as such. As their bankruptcy, loss of life savings, marital and family breakdown escalate over the life of their 12 to 18 month franchise career, the franchisee NEVER looks to Box 9 of the CSBFP loan application form (Projected Sales ) as the source of their trouble; where the lie is put into the “Liars’ Loan”. The proceeds of these engineered-to-fail loans is split upfront by the franchise banker with the bank, banker, franchisor and sales agent. If questioned, the bank shreds the paperwork and waits for the lawsuit.

And, seriously, how many of these Immigrants as prey losers could or would ever sue a Schedule 1 chartered bank?

• Only one I know of: a father and son PhD/B.Eng. team I worked with. The  Oudovikines (pronounced: ou-doe-VEE-kin), RCMP Commercial Crime Unit affidavit, Country Style, CIBC, lawsuit

The Return: Smashing quarterly earnings goals, record profits, high turnover in the small business division of each of the banks, and making franchise lending the most lucrative form of commercial lending in Canada. Private gain/public loss enabled by a criminogenic environment, moral hazard, regulatory capture…

Lorinc carefully mentions the “windfall profits” in this arrangement of churning:

What’s more, some banks and franchisors have put the SBLA program [predecessor government guaranteed loan program] to questionable use during foreclosure actions against franchisees, says one former owner who has been through the process. When a bank calls a loan against a non-performing franchisee, the 90% guarantee effectively relieves the bank’s receiver from trying to get the best possible value while disposing of the owner’s assets. With most of the loan covered by the Canadian taxpayer, the assets – fixtures, kitchen equipment, inventory, etc. – can be sold quickly at a deep discount, possibly below market value. This allows the franchisor too step in and buy back the property at better-than-firesale prices, thus generating a windfall profit when the store is later re-sold to another franchisee.

An important work that, depressingly, is as relevant in 2012 as it was in 1995.

______

Disclosure: My lol pecuniary interest here and here. Cross posted on FranchiseBanker.ca.

“Revolutionary Decisions” happen only when franchisees persist

Canadian courts are willing to expand protections to the most vulnerable in franchising.

Very well-respected franchise journalist Janet Sparks reports at Bluemaumau.org: Revolutionary Decision against Dunkin’ Donuts Awards Owners $16 Million.

MONTREAL – In a harshly-worded ruling in favor of franchisees, a judge chided Dunkin’ Brands Canada Ltd for its incompetence, negligence, and lack of support to store owners. He then ordered the international sub-franchisor to pay the 21 former franchise owners, operating 32 Dunkin’ stores, C$16.4 million (US$16M) plus legal fees.

The lawyer for the franchisees is absolutely correct in emphasizing the need for persistence by franchisees:

Frédéric Gilbert of Fasken Martineau, who represented the franchisees, said the Tingley decision will have major repercussions on how franchisees are protected and how franchisors’ responsibilities are defined. “Justice Tingley has issued a rigorous judgment that has all the makings of a landmark franchising case in Canada. This decision will become a reference tool for setting the basic guidelines governing contractual relations between parties,” stated Gilbert.

Gilbert believes that the determination and solidarity of the group of franchisees suing Dunkin’ played a key role in this legal action. “These people courageously overcame the many negative repercussions of what has been a very long saga. They valiantly confronted the countless financial and human pressures that are often seen in battles pitting David against Goliath. Even at their weakest moment they never gave up the fight, which is all to their credit.”

While being appealed, this decision may become a landmark in franchising.

Resources

• Superior Court of Québec’s Justice Daniel H. Tingley’s decision: Bertico Inc. v. Dunkin’ Brands Canada Ltd.
• Globe and Mail article: Court rules in favour of Dunkin’ Donuts franchisees
• Canadian Lawyer Magazine article: Judge takes a bite out of Dunkin’ Donuts

Capital must accumulate and patiently wait

A for-profit, multi-share  corporation is the only effective means of preventing future franchisor opportunism.

Only got non-profit, dues-supported IndFA after 3 years?

• License for impotence at best, failure at worst.

Only interested in a Band-aid solution to franchisor over-reaching?

Write your issue bitch on a post it and put it on the wall.

Choose the most severe one and sue your franchisor.

• Won’t they just take the $ back via another way in a few months?

Thirty problems? Hell no: 1 problem with 30 manifestations.

The 1 Problem: Opportunism

• the unfair exercise of franchisor discretion within the necessarily incomplete contract.
•  self-interest with deceit.

To stop opportunism: create and maintain an indexed document database/wiki that is owned by a well-run and monitored franchisee association.

• Indpendently, command the information high ground and you’ll buy your business back rather than rent a few $ in short-term litigation.

Otherwise, Dance band on the Titanic.

Due diligence cannot prevent much greater post-sale risks

Risk assessment is a snap-shot.

Franchising favours the house (franchisor).

If you play a Game of Chance know before you begin

If you are benevolent you will never win.

– William Blake 1757 – 1827

Franchising: Trap for the Trusting by Harold Brown

Written in 1969; franchisor opportunism has become worse.

Inside cover:

This book is designed to inform the public and the legal profession of the egregious imbalance that exists in the franchise relationship and to suggest various forms of redress by means of litigation and legislation. By discussing (and printing) the contents of the usually secret franchising contract in complete detail, the author makes the reader thoroughly familiar with such inimical and routine restrictions as the covenant not to compete, the informer clause, supplier kickbacks, the “bad boy” clause, the “yellow  dog” clause, arbitrary termination, the suspension clause, and many other forms of contractual coercion, both stated and implied.

For too long the law has permitted franchisors to invoke “quality control” and “sanctity of contract” to ruthlessly enforce their unjust agreements…

Until definitive franchising legislation is passed, FRANCHISING: TRAP FOR THE TRUSTING can show the reader how to avoid the pitfalls of the standard franchising agreements or provide his attorney with a blueprint for seeking relief through existing statutes and case law. Arguments and citations from the franchise related fields of fraud, equity, securities regulation, Anti-trust, and labor relations are included.

Still Unsafe at any Brand.

Franchising creates and enforces a caste system

Franchisor opportunism can be both very rare and effective in enforcing obedience.

Obedience is enforced by controlling intra-species and inter-franchisee communication and contact.

Annual meetings, bulk emails, newsletters, site visits and faux franchisee-friendly social sites get the lesson out:

stay in your place or suffer the consequences.

The means may change but the objective stays the same.

[What was Jim Crow?, Jim Crow Museum of Racist Memorabilia]

Opportunism during wartime is a very old idea

Franchisors controlling the price of needed supplies is an evil.

This central fact is true no matter if the public or franchisees understand they’re being gouged. Similarly, a state of war can certainly exist before it has been declared.

Every franchisee is at war with their franchisor over tied buying provisions, irrespective of the profits that each may or may not make.

Winsor McCay 1867 – 1934

[Golden Age Comic Book Stories]