Walking the Line


Walking the Line: When are the Franchisor’s In-House Counsel’s Communications or Advice to a Franchisee an Ethical Violation?

By James M. Mulcahy and Douglas Luther on January 23, 2019

*Originally published in the Franchise Law Journal, Spring 2018 edition.

Introduction

A wide assortment of rules and laws guide the franchisor counsel in deciding whether and how to communicate with and advise franchisees. The Model Rules of Professional Conduct (Model Rules) set the guidelines for attorneys’ ethical obligations.[1] The Model Rules are created by the American Bar Association and have been adopted in at least thirty-nine states.[2] However, each state’s ethical rules may vary from the Model Rules.[3] Notably, no separate rules exist for in-house counsel.

The franchisor’s in-house’s counsel’s client is the franchisor, which is typically a corporation or other business entity. The franchisor acts through its officers, directors, employees, and shareholders.[4] Generally, in-house counsel’s clients are any of the franchisor’s representatives with whom counsel works as long as they are pursuing the best interests of the entity.[5]

Because a franchisee is a separate legal entity and not an agent of the franchisor, a franchisee is not the in-house counsel’s client. How, then, is an in-house counsel to approach a franchisee? This article explores how the franchisor counsel’s interactions with the franchisees are guided by pertinent rules of professional conduct, ethical opinions, and case law.

Section I explores what sort of advice in-house counsel can provide the franchisees. When is advice business or legal and what issues arise with providing legal advice? Section II explores some of the areas where counsel should tread carefully: where the franchisee seeks advice related to a third party, where litigation is anticipated or commenced, where the franchisor owes a fiduciary duty, and where the franchisor has engaged in fraudulent conduct. Section III explores how in-house counsel should approach franchisees represented by counsel. Lastly, Section IV provides some parting advice for in-house counsel in deciding whether and how to communicate with franchisees.

I. PROVIDING ADVICE TO FRANCHISEES

The role of the franchisor counsel often entails communicating directly with the franchisees or the franchisees’ counsel. In both circumstances[6], counsel may find him or herself asked to provide legal advice with regard to the franchise agreement or franchise relationship, including disclosure obligations, marketing plans, trademarks and trademark infringement, product pricing, restrictions on suppliers, kickbacks, restrictive covenants on employees, development agreements, territorial encroachment, non-renewal, transfers, termination and constructive termination, among other issues.

A. Concerns with Providing Any Advice to a Franchisee

Although attorneys’ professional liability is typically limited to clients[7], an attorney is held to certain guidelines in communicating with nonclients. If the franchisor counsel violates a duty to the franchisee, assuming a duty has been established under the Model Rules or the Restatement (Third) of the Laws Governing Lawyers[8] (or more likely state statutes reflecting those rules), the franchisor counsel could be held liable and/or face disciplinary action.[9] Thus, counsel should take the following steps to ensure any advice comports with ethical guidelines.

  • Counsel Should be Careful in Disclosing the Franchisor’s Confidential Information

    Prior to giving the advice, counsel must consider whether it regards confidential and material information. The Model Rules require that counsel not reveal the franchisor’s confidential information without the franchisor’s consent.[10] In an in-house context, the franchisor counsel will be implicitly able to reveal information or an evaluation based on counsel being an agent of the franchisor.[11] However, where the information at issue is more material and sensitive, counsel should discuss the issue internally with the franchisor executives prior to communicating with the franchisee.[12]

    For example, the franchisor may create a development plan for a state specifying possible locations and anticipated opening dates. At the same time, the franchisor counsel may be communicating with a franchisee with regard to the franchisor’s development. Counsel should be careful not to reveal the development plan unless and until the development executives have approved it for disclosure. This is particularly important because the development plan may only be a draft and therefore not be a proper articulation of the franchisor’s development strategy.

  • Counsel Must do its Due Diligence Prior to Communicating Facts or Law

    The franchisor counsel needs to engage in whatever due diligence is necessary to have a reasonable basis for any advice given. Counsel can be liable to a franchisee (or any third party) for a “reckless as well as [a] knowing misrepresentation.[13] It will not necessarily suffice for the franchisor counsel to simply rely on the franchisor’s business agent’s representations[14], particularly if the franchisor counsel has not previously relied on that agent’s representations. Counsel, especially if in doubt as to the veracity of a fact, should seek independent or third party verification before communicating it to a franchisee.[15]

  • When Communicating with the Franchisee, the Franchisor Counsel Should Make It Clear that Counsel Represents the Franchisor Only

    Due to the close relationship between the franchisor and the franchisee, the franchisee may expect that the franchisor’s counsel has some sort of duty to be fair to everybody rather than a duty of loyalty to the franchisor.[16] The franchisee may view counsel as more of a go-between the parties than someone zealously advocating on behalf of a client, the franchisor. The franchisor counsel must take reasonable steps to clarify any confusion on the part of the third party as to the lawyer’s role.[17]

    Even where advice is more or less innocuous, it still may advantage the franchisor. It is rare that an attorney is not addressing an issue in a way that does not, at the very least, implicitly benefit the client.[18] Thus, the franchisee should be reminded that counsel represents the franchisor and is acting for the franchisor’s benefit.[19]

  • Counsel Must Not Make Any False Statements of Fact or a Fraudulent Omission to a Third Person

    The franchisor counsel is obligated to be truthful in statements with others.[20] “It is professional misconduct for a lawyer to . . . engage in conduct involving dishonest, fraud, deceit or misrepresentation.”[21] The Model Rules bar attorneys from making “a false statement of material fact or law to a third person.”[22]

    Nor can counsel make a material omission. Attorneys “shall not knowingly… fail to disclose a material fact when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client.”[23] This can include information that the lawyer had in mind but failed to disclose even though it was material[24] to the issue at hand.[25] Thus, a franchisor counsel must take the steps necessary to ensure that any advice (or communication) is accurate and that there are no material omissions. Otherwise, counsel and the franchisor may be liable.

    General rules of law with regard to negligent misrepresentations and omissions are equally applicable to attorneys.[26] For instance, the Restatement (Second) of Torts [27] states that:

    One, who, in the course of his business, profession or employment, or in any transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused to them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information.

    This section of the restatement has been held to be applicable to attorneys.[28]

    Furthermore, there is possible liability because of reliance. Franchisees, especially unrepresented ones, are likely to rely on a franchisor’s counsel’s statements. They will act on that reliance. Thus, counsel is going to be held to a higher standard of communicating truthfully and accurately.[29]

    Not all statements, however, constitute a misrepresentation. Counsel may generally give his or her opinion much like a salesperson would. “Certain statements, such as some statements relating to price or value, are considered nonactionable hyperbole or a reflection of the state of mind of the speaker and not misstatements of fact or law.”[30] For example, counsel may tell a franchisee that counsel believes that the franchisee is well suited to expand because of the franchisee’s commitment to the brand and performance to date. Such comments would be nonactionable fraud.

    Although it may be obvious that counsel may not blatantly make false statements, whether an omission or reaffirmation of a statement constitutes fraud can be a more complicated inquiry. For example, in one case a Haagen Dazs franchisee alleged that a franchisor’s former president participated in an alleged fraudulent misrepresentations and omissions.[31] The court held there was evidence that the former president swore to the truth of the franchisor’s offering circulars, which contained inaccurate start-up cost figures, that the former president may have participated in a conspiracy to supply misleading profitability information, and that the president knew of and approved of the alleged misrepresentations.

    Under such a standard, the franchisee could similarly sue any attorney involved in similar communications for fraud. The case is also notable in that the officer is being held potentially liable on multiple grounds: both supplying false information and reaffirming and approving a misrepresentation. For these reasons, when providing advice to franchisees it is important to communicate accurately, clearly, comprehensively and use qualifiers when necessary.

B. The Continuum of Business to Legal Advice

Whether a communication constitutes business or legal advice is a preliminary question in deciding whether the advice meets certain ethical guidelines. Some advice is purely business. For example, where counsel communicates that a location is ripe for a franchisee to open a new unit because of the demographics and retail mix. Some advice is purely legal. For example, where counsel communicates that the placement of a new unit does not violate the territorial provisions of the franchise agreement.

Communications, especially emails, often are in part business advice and in part legal advice. Typically, the portion of the communication that is legal versus the portion that is business can be distinguished.[32] Advice becomes entirely legal when “the legal purpose so permeates any non-legal purpose that the two purposes cannot be discretely separated from the factual nexus as a whole.”[33]

The issue comes up frequently when courts are adjudicating the attorney-client privilege.[34] Those cases can provide a framework for understanding whether advice is business or legal for ethical rules purposes.[35] In re Human Tissue Products Liability Litigation[36] is illustrative. In that case, a corporation retained counsel for the purpose of conducting an investigation of facts and to make strategic recommendations with respect to the corporation’s business relationship with another corporation. The U.S. District Court for the District of New Jersey held that the documents relating to the lawyers’ tasks on that assignment pertained to business matters, rather than legal services, because: (1) “none of the documents appear to contain any legal research or analysis”; and (2) the work could have as easily been performed by non-lawyers.

The court’s decision necessitates an important point: that if counsel is acting in a role and providing advice that could have been given by a non-lawyer (someone without legal expertise), the advice is likely to be business advice. In contrast, where the franchisor gives legal analysis or research, it constitutes legal advice.[37] For example, by the time a franchise comes up for renewal, the franchisor will very likely have revised its franchise disclosure document (FDD). An attentive franchisee may ask the in-house counsel about those changes. The revisions to the FDD could be factual in nature, such as an item 7 representation as to the estimated costs of opening a franchise. In-house counsel may explain that the revised costs were based on additional data reviewed in the past year. That is a business communication.[38] If an item 12 representation as to territory is changed because of a recently litigated encroachment case, the explanation of the change likely constitutes legal analysis. If counsel states that he or she believes that that the revised language is consistent with a state’s law, counsel is providing a legal opinion.

C. Ethical Concerns Regarding Providing Legal Advice

The franchisor counsel is not prohibited from giving a franchisee, either represented or not, legal advice.[39] An older ABA Code of Professional Responsibility Disciplinary Rule 7-104 stated that an attorney shall not “[g]ive advice to a person who is not represented by a lawyer, other than the advice to secure counsel, if the interests of such person are or have a reasonable possibility of being in conflict with the interests of his client.” The later Model Rules dropped the prohibition on advice,[40] and instead merely restricted the giving of advice where the parties are adverse.[41]

That being said, courts and ethics committees tend to closely scrutinize situations where an attorney provides legal advice to a nonclient. As set forth below, if in-house counsel is to provide the franchisee with legal advice, it must be done with appropriate disclaimers and within a limited scope.

  • Stating the Franchisor’s Legal Position is not Providing Legal Advice

    It is important to consider what is and is not legal advice. Providing legal documents such as franchise disclosure documents, franchise agreements, and development agreements for signature does not amount to advice.[42] Further, if counsel is simply explaining the franchisor’s position then the communications do not constitute providing legal advice.

    The franchisor counsel may even communicate why counsel believes that the franchisor’s position is in congruence with the law without it being construed as legal advice.[43] The Model Rules note that counsel may “explain the lawyer’s own view of the meaning of the document or the lawyer’s view of the underlying legal obligations.”[44] For example, counsel could send a letter or email to a franchisee’s attorney noting the franchisor’s intent not to perform a term of the franchise agreement because of the legal analysis that it’s not enforceable, and it would not be legal advice.[45]

  • Counsel’s Legal Advice Cannot Conflict with its Duty of Loyalty

    Counsel should not provide any legal advice to any nonclient that conflicts with its obligations to the franchisor.[46] It goes without saying that if the franchisor counsel is going to be giving the franchisee legal advice that has the potential to hurt or conflict with the franchisor’s interests, counsel should refrain from giving any such advice.

  • Counsel Should Give General Rather than Specific Legal Advice

    Counsel should keep any legal advice given to the franchisee of a general nature. The franchisor counsel should always remember that he or she is not the franchisee’s attorney. If the franchisee asks counsel to apply a certain law or the attorney’s knowledge to specific facts facing the franchisee, the franchisor counsel can advise that he or she is not here to offer specific legal advice.[47] Counsel should refrain from advising the franchisee based on a fact-specific application of the law. Instead, counsel should tell the franchisee to seek independent counsel.

    Similarly, the franchisor counsel is also better off not directing the franchisee as to a course of conduct. When counsel provides business or legal advice as applied to the franchisee’s situation, counsel can run into ethical troubles.[48] For one, there is the risk, set forth in more detail in Section II.A, of creating an inadvertent attorney-client relationship. Second, giving advice as to a course of action is more likely to have negative ramifications if for any reason the advice does not pan out and the franchisee sues. In such a circumstance, counsel should consider discussing the issue with the franchisor’s business agents and having them communicate it to the franchisee.[49]

  • Franchisor Counsel May be Liable for Providing Wrong Legal Advice

    One of the largest concerns with providing legal advice is that it may result in liability. If the legal advice provided by the franchisor’s attorney is not accurate, and the franchisee relies on it, the franchisor could subsequently be liable for the actions the franchisee takes based on the inaccurate information.[50] This could lead to a claim against the franchisor and/or the attorney.

    Franchisor counsel should be aware that when providing legal advice outside of the litigation context, those statements can subject counsel to liability. By contrast, in litigation, attorneys and parties are protected by the “litigation privilege” in exercising their legal rights and setting forth legal opinions when communicating with opposing counsel and/or parties.[51]

    When giving legal advice that a franchisee is relying on, counsel will generally owe a duty of care to the franchisee.[52] The Restatement of the Law Governing Lawyers concludes that a lawyer owes a duty to use care to a nonclient where (1) the lawyer’s client invites the nonclient to rely on the lawyer’s opinion; (2) the nonclient so relies; and (3) the nonclient is not too remote from the lawyer to be entitled to protection.[53]

    Whether a franchisee relies on a statement of the law may depend on the setting the advice was given in (both when and where). Statements in a formal office setting carry more weight than general advice given at a conference or lunch.[54] Where the franchisee is given advice significantly prior to the franchisee engaging in a course of action, the franchisee will have time to ask other parties, including lawyers, whether they agree with the advice. In contrast, counsel’s advice is likely to have a greater impact on a franchisee if made in the middle of a negotiation or at the time of signing a document.[55]/

    Liability is particularly an issue with franchise disclosure documents drafted by in-house counsel. Franchisees occasionally attempt to sue the franchisor’s counsel, in addition to the franchisor, for any alleged misleading statements or omissions in the FDD.[56] At least one court has held that a misrepresentation in the franchisor’s offering circular was grounds for a claim of negligence against the franchisor’s counsel.[57]

    There is an expectation by franchisees and franchise practitioners that the franchisor counsel should be properly advising the franchisee.[58] Their basis is that this would result in full disclosure and the franchisee being better informed. The franchisor’s counsel is, in fact, more knowledgeable about the franchise system and applicable laws and thus can be a resource to franchisees. Others dispute this, arguing that courts should encourage potential franchisees to undertake their own due diligence and seek their own expert advice.[59]

    Counsel should be aware that where the franchisee seeks legal advice, and counsel does not respond, franchisee’s counsel may in any subsequent litigation claim that the franchisor’s counsel concealed important information and kept the franchisee in the dark. However, if the franchisor’s counsel does provide information and it is inaccurate, then counsel and the franchisor face a potential fraud claim.[60]

    Ultimately, the franchisor counsel should generally err on the side of not providing legal advice to franchisees and encouraging franchisees to consult independent attorneys. However, if the advice is accurate, generalized and not specific to the franchisee, a franchisor’s counsel’s legal advice to the franchisee could potentially redound to both parties’ benefit.

II. PROBLEM AREAS FOR IN-HOUSE COUNSEL

A. Where the Franchisee Seeks Advice Relating to a Third Party

Franchisees may seek the franchisor counsel’s advice with regard to third parties. For example, the franchisee may have a legal issue regarding the renewal of a lease and seek the franchisor’s advice on how to handle it. Maybe the franchisee asks the franchisor’ counsel how to interpret the lease agreement. Counsel must be very wary about getting involved in such a situation.

By giving advice to the franchisee, particularly with regard to third parties, the franchisor counsel risks creating an inadvertent attorney-client relationship. If the franchisee asks the franchisor counsel to provide legal services (e.g., advice) and the franchisor counsel consents without adequate disclosure, an attorney-client relationship may be formed.[61] Notably, a franchisee can assert an attorney-client relationship regardless of whether franchisor counsel intended one.[62] A court would consider what the reasonable expectations were for the franchisee and if the franchisee was right to rely on the attorney’s opinion.[63]

To alleviate this risk, the franchisor counsel should clarify that he or she is not the franchisee’s attorney and that any advice is not intended to create an attorney-client relationship. This clarification should preferably be in writing. Doing so will provide evidence that any advice was limited in scope and did not create an attorney-client relationship.[64]

B. Where the Franchisor Owes a Fiduciary Duty to the Franchisee

Should in-house counsel approach a franchisee differently in states where the franchisor owes the franchisee a fiduciary duty? In most states, the franchisor does not owe the franchisee a fiduciary duty.[65] A minority of states hold otherwise, concluding that either a fiduciary duty exists as a matter of law or else that it may be established by the facts.[66]

Where the franchisor owes the franchisee a fiduciary duty, it does not mean that the franchisor counsel owes the franchisee a fiduciary duty.[67] An in-house counsel owes a fiduciary duty only to its client, in this case, the franchisor.[68] However, the franchisor counsel may be liable in some states for aiding and abetting a breach of fiduciary duty.[69] Claims alleging that an attorney aided and abetted a client’s breach of fiduciary duty are becoming more common.[70] As of 2017, some twenty-three states allow for such a claim.[71] These include the following states where courts have held the franchisor may owe the franchisee a fiduciary duty: New York, Ohio, Oregon and South Dakota.[72]

>Aiding and abetting claims have been brought against attorneys where the attorney acts outside of the scope of representation. This includes actions taken beyond the agreement of the two parties [73], actions without prior written consent from an employer[74], or actions which aid a client’s unlawful act.[75]

Where a fiduciary duty exists, the franchisor may have higher expectations with regard to disclosing material information regarding the franchise, or there may be heightened obligations as to self-dealing, encroachment and termination, among other issues. Furthermore, a franchisee may be owed greater care in being dealt with “fairly,” particularly with regard to discretionary provisions or implied terms in the franchise agreement.[76] Thus, counsel should be aware of the potentially expanded obligation for disclosure when communicating or advising franchisees in fiduciary duty states.

C.Role where the Parties Interests Conflict

Where franchisor counsel knows or reasonably should know that the interests of the franchisee are in conflict with or adverse to the franchisor, counsel should not give legal advice.[77] Note, however, that this does not prohibit counsel from negotiating with the franchisee or settling a dispute.[78] Thus, counsel may still communicate with the franchisee under the guidelines established above. However, counsel must be careful not to provide legal advice.

For example, in one case[79], Safeguard distributors had account protection rights. The distributors understood their agreement to give them the right to all commissions on sales to accounts they had been the first to make a sale too. The franchisor, who had brought two company-owned distributors into the market, disputed this and surreptitiously allowed the company-owned distributors to sell to the other distributors’ protected accounts. When the unrepresented distributors heard of some of the infringing sales, they contacted Safeguard’s general counsel. The general counsel met with one of them. When the distributor asked whether she should consult an independent attorney, Safeguard’s general counsel told the distributor “no” and that the conversation they would have was business related. The Safeguard general counsel proceeded to advise the distributor, who had adverse interests, that the distributor was not entitled to commissions on company-owned distributor’s sales and then falsely claimed he did not have the sales information. The court pointed to the conversation as one of the grounds for allowing the distributors to pursue punitive damages. The court noted that there was evidence that the general counsel had acted fraudulently and in an extreme deviation from reasonable standards of conduct.

D.Situations where the Franchisor has Engaged in Fraudulent or Illegal Conduct

If the franchisor counsel suspects that a representative of the franchisor has engaged in fraudulent or illegal conduct toward a franchisee, counsel must tread carefully with providing advice or responding to a franchisee’s related inquiries. In determining how to respond to such conduct by a franchisor’s agent, counsel should consider the seriousness of the violation and its consequences.[80]

The franchisor counsel owes its client duties of loyalty and confidentiality. As set forth by the Model Rules, “[w]hen constituents of the organization make decisions for it, the decisions ordinarily must be accepted by the lawyer even if their utility or prudence is doubtful. Decisions concerning policy and operations, including ones entailing serious risk, are not as such in the lawyer’s province.”[81]

However, where an agent’s actions threaten to substantially injure the franchisor, counsel must “proceed as is reasonably necessary in the best interest of the organization.”[82] The franchisor counsel can attempt to remedy the conduct internally.[83] Barring that, counsel is responsible for reporting up to the highest authority for the franchisor, potentially up to the board of directors, depending on the seriousness of the violation, in order to prevent harm to the franchisor’s interests.[84] Counsel’s primary objective is to assist the franchisor even if the franchisor’s objectives are inconsistent with the goals and objectives of some of its representatives, including chief level officers.[85]

Outwardly, counsel must ensure that its actions do not aid or abet fraudulent or illegal conduct. Counsel must weigh its duty of loyalty and zealous advocacy to its client against the duty of candor toward third parties.[86] This can be a tough balancing act. An attorney is ethically required to keep a client’s secrets and generally cannot communicate any wrongdoing uncovered.[87] However, counsel cannot assist a client in perpetrating a crime or fraud, and counsel may be liable if it does, even if acting on behalf of the franchisor.[88]

In limited situations, the franchisor counsel may be permitted to reveal confidences to remedy a fraudulent representation or omission.[89] The Model Rules authorize lawyers to disclose even confidential information to prevent “the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another”.[90] Counsel can make the disclosure before the fraud has even occurred, if disclosure might prevent the injury to the franchisee.[91]

For example, say a franchisor represents in its franchise disclosure document that ninety percent of the marketing fund goes to actual advertising and ten percent goes to administrative costs (e.g., salaries of employees). The representation is false because the executives are using ninety percent of the marketing fund for their own benefit, such as bonuses and lavish trips. If the franchisor counsel finds out about the misrepresentation, he or she must counsel the client to disclose the actual numbers.

Failing that, counsel may consider taking the matter into his or her own hands and disclosing the actual numbers to the franchisee.[92] Under the Model Rules, counsel is permitted, although not obligated, to disclose such information to ensure that he or she is not assisting the client in conduct known to be fraudulent.[93] This does not mean that counsel should tell the franchisee that fraud was committed (e.g., provide fact-specific legal advice). Instead, counsel could state that there was an error and that the actual numbers show that ninety percent of the marketing fund goes to administrative expenses. Alternatively, counsel may withdraw from representation by leaving the franchisor counsel role.[94] If the situation is bad enough, counsel may even consider both withdrawing and disclosing the issue to the franchisee.[95]

In most instances, the wiser course of conduct is to refrain from communications with the franchisee, unless absolutely necessary to ensure that counsel is not perpetuating a fraud. The communication should not come until an effort has been made to resolve the matter internally. The corrected disclosures or representations should come from the franchisor’s business agents. If counsel does respond to franchisee entreaties, the communication must be carefully crafted to ensure that it either rectifies the misrepresentation or otherwise does not continue it or omits material information.

III. COMMUNICATING WITH REPRESENTED FRANCHISEES

Franchisees, especially single unit franchisees, typically are not represented by counsel either at the commencement of the franchise relationship or during its duration. One study showed that in negotiating a franchise agreement, only twenty-six percent of franchisees had counsel represent them.[96] However, larger franchisees may have an in-house attorney of their own. And smaller franchisees may utilize an attorney in specific circumstances such as when signing the franchise agreement, where there are relationship troubles, or where the parties are disputing a termination of the relationship. When a franchisee is represented, the franchisor counsel should follow certain guidelines in communicating with the franchisee.

When a franchisee is or may be represented on an issue (or generally), the franchisor counsel should direct his or her communications to the franchisee’s attorney. The franchisor counsel may not communicate about the subject of the representation directly with the franchisee.[97] The same rule applies even if the franchisee initiates a communication with the franchisor’s counsel.[98] Where an attorney represents the franchisee on a single issue (e.g., signing the franchise agreement), it does not preclude the franchisor counsel from later communicating directly with the franchisee. However, if the attorney represents the franchisee as to all issues, all communications must go from counsel to counsel.[99]

Many of the same rules discussed in Sections I and II apply where the franchisee is represented. One important distinction, however, is that the franchisor counsel has greater latitude in providing specific legal advice. For example, the franchisor counsel could give a legal opinion that a new location does not encroach on a franchisee (e.g., violate the terms of the franchise agreement) and that the franchisee has no valid legal claim as to a breach of the franchise agreement. Further, the franchisor counsel can now advise the franchisee as to a course of conduct without the concern of inadvertently creating an attorney-client relationship. Thus, the franchisor counsel can advise the franchisee to take specific actions (e.g., “don’t file a claim because it has no legal merit”).

What if the franchisee’s counsel is not providing effective legal representation and giving bad advice to the franchisee? This can arise in situations where a generalist attorney rather than a franchise practitioner is representing the franchisee. In that situation, the franchisor counsel generally does not have an obligation to remedy the ineffective representation or to suggest that a franchisee seek different counsel.[100]

However, the franchisor counsel cannot take “unfair advantage” of a mistake made by the franchisee’s counsel. For example, in an ABA Informal Ethics Opinion [101], the hypothetical is posed wherein the attorney for party A discovers that the lawyer for party B inadvertently omitted a material provision of an agreement between the parties, a provision without which party B would not have agreed to the contract. The opinion advises that the lawyer for party A has an obligation to correct the error and not to allow his or her client to take unfair advantage of the mistake.[102]

Further, when negotiating with the franchisee counsel, the franchisor counsel must be forthright on proposed changes to any document at issue (e.g., the franchise agreement, development agreement, settlement agreement). For example, in such negotiations, it may be considered a “false statement of material fact” not to disclose last minute alterations to the document at issue.[103] Thus, the franchisor counsel may not mislead the franchisee counsel into missing a key detail.

To the extent that the franchisor counsel does not want to deal with the franchisee’s counsel, any communications would have to go through the business agents. Where both parties are represented, the franchisor’s business agents can still reach out to the franchisee directly.[104] In such a situation, the franchisor counsel can advise the franchisor’s business agents about the subject matter of the communication, although scripting the communication has been considered over the line.[105]

IV. HOW IN-HOUSE COUNSEL SHOULD APPROACH COMMUNICATIONS WITH FRANCHISEES

In-house counsel would be well served to consider (1) whether the franchisee is represented by counsel; and (2) the nature of the communication or advice to be given to a franchisee. The best way to avoid liability is to make sure any representations or advice are accurate and not misleading. Counsel should undertake the due diligence necessary to have a reasonable basis for any advice or communication.

Counsel should set and enforce clear boundaries with the franchisees. The franchisees need to know that the franchisor counsel is not a disinterested party, represents the interests of the franchisor and is not the franchisee’s attorney. If the parties are adverse on an issue, counsel should recommend that the franchisee seek independent legal counsel.

The franchisor counsel may give the franchisor’s legal position and understanding of its obligations. Where a franchisee is represented, counsel can provide legal advice or opinions as to the merits of the franchisee’s position. However, unrepresented franchisees should generally not be given legal advice specific to their situation. And counsel should take care in providing advice outside of the litigation context, because such communications are not protected.

By following these guidelines, the franchisor counsel can have a productive and beneficial relationship with the franchisees.

Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.




* James Mulcahy and Douglas Luther are attorneys at Mulcahy LLP, a boutique firm in Orange County, California specializing in franchise and distribution litigation.

[1] See generally Model Rules of Prof’l Conduct (2015); Pam Jenoff, Going Native: Identity, and the Inherent Ethical Problem of In-House Counsel, 114 W. Va. L. Rev. 725, 734 (2012).
[2] Jenoff, supra note 1, at 734.
[3] Counsel should review their state model rules and local bar opinions for additional clarity as to counsel’s ethical obligations.
[4] Model Rules of Prof’l Conduct R. 1.13 cmt. 1; Susanna M. Kim, Dual Identities and Dueling Obligations: Preserving Independence in Corporate Representation, 68 Tenn. L. Rev. 179, 180 (2001); Susan Hackett, Corporate Counsel and the Evolution of Practical Ethical Navigation: An Overview of the Changing Dynamics of Professional Responsibility in In-House Practice, 25 Geo. J. Legal Ethics 317, 320 (2012).
[5] Hackett, supra note 4,at 320-21.
[6] Even represented franchisees may seek the advice of in-house counsel as many franchisees are represented by a generalist rather than an attorney knowledgeable in franchise law. SeeRobert W. Emerson, Fortune Favors the Franchisor: Survey and Analysis of the Franchisee’s Decision Whether to Hire Counsel, 51 San Diego L. Rev. 709, 719 (2014).
[7] Gregory M. Duhl, The Ethics of Contract Drafting, 14 Lewis & Clark L. Rev. 989, 1017 (2010) (“Because attorneys generally do not have a fiduciary relationship with non-clients, the traditional rule is that they are only liable to third parties in cases of fraud or improper motive.”).
[8] Restatement (Third) of The Law Governing Lawyers (2000).
[9] Emerson, supra note 6, at 741; Restatement (Third) of Agency § 7.01 (2006).
[10] Model Rules of Prof’l Conduct R. 1.6 (2015).
[11] Id. at R. 2.3 cmt. 1.
[12] Susan R. Martyn, Accidental Clients, 33 Hofstra L. Rev. 913, 950 (2005) (“The lawyer’s loyalty obligation to the client comes first, and only when the client decides to provide information or benefit to a third party is the lawyer’s duty of competence to that third person triggered.”); Model Rules of Prof’l Conduct R. 2.3.
[13] Restatement (Third) of The Law Governing Lawyers § 98 cmt. c (2000); Duhl, supra note 7, at 997.
[14] “A misrepresentation can occur through direct statement or through affirmation of a misrepresentation of another, as when a lawyer knowingly affirms a client’s false or misleading statement.” Restatement (Third) of The Law Governing Lawyers § 98 cmt. c.
[15] Jared R. Ellis, Liability to Non-Clients, How to Mitigate Risk, 46-SEP Colo. Law. 18, 20 (2017) (“[W]hen an attorney-client relationship is not as well established, or where the client has a history of stretching the truth, the attorney may need to independently ensure that factual information communicated to third parties is accurate and complete to avoid claims of fraud or misrepresentation.”).
[16] This is often seen in analogous areas like joint ventures. See William H. Horton, Serving Two (or More) Masters: Professional Responsibility for Today’s In-House Healthcare Counsel, 3 J. Health & Life Sci. L. 187, 206-07 (2010).
[17]Id. at 208-09; see also Model Rules of Prof’l Conduct R. 4.3; Russell Engler, Out of Sight and Out of Line: The Need for Regulation of Lawyers’ Negotiations with Unrepresented Poor Persons, 85 Cal. L. Rev. 79, 91 (1997).
[18] Horton, supra note 16, at 209-10.
[19] The franchisor’s counsel’s duty of loyalty would arguably obligate counsel to communicate any material facts that redound to the benefit of the franchisor back to the franchisor. See e.g., Horton, supra note 16, at 210; Nancy J. Moore, Conflicts of Interest for In-House Counsel: Issues Emerging from the Expanding Role of the Attorney-Employee, 39 S. Tex. L. Rev. 497, 525 (1998) (“the individual should understand that there can be no expectation of confidentiality; all information given to the attorney will be shared with the company and vice versa”).
[20] Model Rules of Prof’l Conduct R. 4.1; D. Ryan Nayar, Almost Clients: A Closer Look at Attorney Responsibility in the Context of Entity Representation, 41-WTR Tex. J. Bus. L. 313, 322-23 (2006).
[21] Model Rules of Prof’l Conduct R. 8.4(c).
[22] Id. at R. 4.1.
[23] Id.
[24] One definition of materiality that has been given is “information that, ‘would or could significantly influence the hearer’s decision making process.” In re Summer, 105 P.3d 848, 853 (Or. 2005).
[25] Id.
[26] “[A] lawyer is subject to liability to a client or nonclient when a nonlawyer would be in similar circumstances.” Restatement (Third) of The Law Governing Lawyers § 56 (2000).
[27] Restatement (Second) of Torts § 552 (1977).
[28] McCamish, Martin, Brown & Loeffler v. F.E. Appling Interests, 991 S.W.2d 787, 791 (Tex. 1999).
[29] Charles E. Fuller, Attorney Liability (or Non-Liability) for Opinions and Opinion Letters to Non-Clients and to Clients, 34 No. 1 Prac. Real Estate L. 47, 49-50 (2018).
[30] Restatement (Third) of The Law Governing Lawyers § 98 cmt. c.
[31] Schwartz v. Pillsbury Inc., 969 F.2d 840, 843 (9th Cir. 1992); see also Am. Casual Dining, L.P. v. Moe’s Sw. Grill, L.L.C., 426 F. Supp. 2d 1356, 1365 (N.D. Ga. 2006) (court allowed claim to go forward where franchisee claimed that the franchisor negligently misrepresented the food and labor costs in running the restaurant franchise).
[32] See e.g United States v. Chevron Texaco Corp., 241 F.Supp.2d 1065, 1076 (N.D. Cal. 2002)(distinguishing between privileged communication regarding tax consequences of a transaction and non-privileged communication regarding the implementation of the transaction); Dewitt v. Walgreen Co., No. 4:11–cv–00263–BLW, 2012 U.S. Dist. LEXIS 125493, at *8-9 (D. Idaho Sept. 4, 2012) (distinguishing between non-privileged questions about business and economic factors for implementing exceptions to a policy from privileged questions about legal reasons or language of the policy).
[33] Phillips v. C.R. Baird, Inc., 290 F.R.D. 615, 629 (D. Nev. 2013).
[34] Counsel should also be aware of what advice is legal or business in determining whether internal communications are privileged. See William E. Matthews, et al., Conflicting Loyalties Facing In-House Counsel: Ethical Care and Feeding of the Ravenous Multi-Headed Client, 37 St. Mary’s L.J. 901, 913-914 (2006).
[35] In-house counsel should also be aware that where they are communicating internally about what business advice to provide the franchisee, their communications will likely not be privileged. See, e.g., United States v. Chevron Texaco Corp., 241 F.Supp.2d 1065, 1076 (N.D. Cal. 2002) (“Corporations may not conduct their business affairs in private simply by staffing a transaction with attorneys.”).
[36] In re Human Tissue Prods. Liab. Litig., 255 F.R.D. 151, 161 (D.N.J. 2008).
[37] United States v. Halifax Hosp. Med. Ctr., No 6:09–cv–1002–Orl–31TBS, 2012 U.S. Dist. LEXIS 158944, at *9 (M.D. Fla. Nov. 6, 2012) (“The content of the message must request legal assistance, and the information conveyed must be reasonably related to the assistance sought.”).
[38] Dewitt v. Walgreen Co., No. 4:11–cv–00263–BLW, 2012 U.S. Dist. LEXIS 125493, at *16 (D. Idaho Sept. 4, 2012).
[39] Engler, supra note 17, at 84-85. [40] Model Rules of Prof’l Conduct R. 4.3 (2015). [41] Id.
[42] Engler, supra note 17, at 95.
[43] That being said, counsel would potentially overstep into giving legal advice by referring to the strength of the franchisor’s legal position as opposed to the weakness of the franchisee’s legal position. See Engler, supra note 17, at 95.
[44] >Model Rules of Prof’l Conduct R. 4.3 cmt. 2.
[45] Restatement (Third) of The Law Governing Lawyers § 57 cmt. G. (2000) (“As with other advisors to a contracting party, lawyers are protected against liability for interfering with contracts or with prospective contractual relations or business relationships … Thus a lawyer may ordinarily, without civil liability, advise a client not to enter a contract or to breach an existing contract. A lawyer may also assist such a breach, for example by sending a letter stating the client’s intention not to perform, or by negotiating and drafting a contract, with someone else that is inconsistent with the client’s other contractual obligations.”).
[46] >Model Rules of Prof’l Conduct R. 1.7, 4.3; Martyn, supra note 12, at 928.
[47] Martyn, supra note 12, at 923-27.
[48] “In one of its earlier formal opinions, arising in the divorce context, the ABA held that an attorney may not give an unrepresented party ‘legal advice’ in an attempt to secure the latter’s consent to a course of action; the proper course for the attorney would be to tell the adverse party of the proposed action and recommend that he or she consult independent counsel.” Engler, supra note 17, at 85-86, 97; ABA Comm. on Ethics and Prof’l Responsibility, Informal Op. 1034 (1968); ABA Comm. on Prof’l Ethics and Grievances, Formal Op. 58 (1931).
[49] It is important to note that counsel still has a duty of care to ensure that the franchisor’s business agents communicate accurately. See George J. Ziser, et al., Lawyer Liability to Non-Clients under the New Restatement of Law Governing Lawyers, 65 Def. Couns. J. 361, 363-65 (1998).
[50] Emerson, supra note 6, at 760-61; Eugene J. Schiltz, Civil Liability for Aiding and Abetting: Should Lawyers Be “Privileged” to Assist Their Clients’ Wrongdoing, 29 Pace L. Rev. 75, 87 (2008).
[51] Ellis, supra note 15, at 19.
[52] Jay M. Feinman, Liability of Lawyers and Accountants to Non-Clients: Negligence and Negligent Misrepresentation, 67 Rutgers U. L. Rev. 127, 136-37 (2015).
[53] Restatement (Third) of The Law Governing Lawyers §§ 48, 51-52 (2000).
[54] Engler, supra note 17, at 100.
[55] Id.
[56] Alexander M. Meiklejohn, UFOCs and Common Law Claims against Franchise Counsel for Negligence, 25 Franchise L.J. 45, 61 (2005).
[57] Courtney v. Waring, 237 Cal. Rptr. 233 (Cal. Ct. App. 1987).
[58] Meiklejohn, supra note 56, at 63-64.
[59] Id. at 64; Emerson, supra note 6, at 764-66.
[60] Meiklejohn, supra note 56, at 68.
[61] Martyn, supra note 12, at 919 (“A lawyer who renders legal service or advice to a person under circumstances which make it reasonably foreseeable that harm will occur to that person if the services are rendered negligently will be accountable to that person, even in the absence of any overt agreement to provide services or promise to pay.”); Edward S. Cheng, An Attorney’s Duty to Non-Clients, 37 New Eng. L. Rev. 55, 57-58 (2002).
[62] Ellis, supra note 15, at 19.
[63] Id.; see also Restatement (Third) of The Law Governing Lawyers §§ 26, 51 (2000); Moore, supra note 19, at 501-02.
[64] Ellis, supra note 15, at 20-21.
[65] See William L. Killon, Annotation, Existence of fiduciary duty between franchisor and franchisee, 52 A.L.R.5th 613 (1997 and Supp. 2018).
[66] States where courts have applied a fiduciary duty to franchisor-franchisee relationships include Maine, Mississippi, Missouri, New York, North Carolina, Ohio, Oregon, South Dakota and Utah. Id.
[67] Emerson, supra note 6, at 740.
[68] >Restatement (Third) of Agency § 8.01 (2006) (“An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship”); see also Restatement (Third) of The Law Governing Lawyers § 16, cmt. b.
[69] Katerina P. Lewinbuk, Keep Suing All the Lawyers: Recent Developments in Claims Against Lawyers for Aiding & Abetting A Client’s Breach of Fiduciary Duty, 8 St. Mary’s J. Legal Malpractice & Ethics 158 (2017).
[70]Id. at 160; see also Restatement (Third) of The Law Governing Lawyers § 56, cmt. h (“[l]awyers are also liable to nonclients for knowingly participating in their client’s breach of fiduciary duties owed by clients to nonclients”); Schiltz, supra note 50, at 81-82.
[71] Lewinbuk, supra note 69, at 160-61.
[72] Compare Killon, supra note 65 with Lewinbuk, supra note 69, at 160-61.
[73] Lewinbuk, supra note 69, at 165-167.
[74] Id. at 167.
[75] Id. at 165.
[76] See, e.g., Arnott v. Am. Oil Co., 609 F.2d 873, 880-81 (8th Cir. 1979).
[77] >Model Rules of Prof’l Conduct R. 4.3 (2015); Horton, supra note 16, at 208-09; Moore, supra note 19, at 504.
[78] >Model Rules of Prof’l Conduct R. 4.3 cmt. 2.
[79] The authors represented the distributors in Thurston Enterprises, Inc. v. Safeguard Business Systems, Inc., No. CV-OC-1416400 (Idaho Dist. Ct. Sept. 21, 2016) (memorandum decision and order on motion to amend complaint to add claims for punitive damages).
[80] >Model Rules of Prof’l Conduct R. 1.13 cmt. 4.
[81] Id. at R. 1.13 cmt. 3.
[82] Id. at R. 1.13 cmt. 4.
[83] Id.
[84] Id. at R. 1.13 cmt. 5; Kim, supra note 4, at 181.
[85] Kim, supra note 4, at 191.
[86] >Model Rules of Prof’l Conduct R. 4.1; Randolph C. Park, Ethical Challenges: The Dual Role of Attorney-Employee As Inside Corporate Counsel, 22 Hamline L. Rev. 783, 784 (1999).
[87] >Model Rules of Prof’l Conduct R. 1.13 cmt. 2 (“When one of the constituents of an organizational client communicates with the organization’s lawyer in that person’s organizational capacity, the communication is protected by Rule 1.6. Thus, by way of example, if any organizational client requests its lawyer to investigate allegations of wrongdoing, interviews made in the course of that investigation between the lawyer and the client’s employees or other constituents are covered by Rule 1.6.”).
[88] Id. at R. 1.2(d); Park, supra note 86, at 783; >Restatement (Third) of Agency § 7.01 (2006) (agent liable for commissions of tortious fraud even when acting on behalf of principal).
[89] >Model Rules of Prof’l Conduct R. 4.1 (barring lawyers from “fail[ing] to disclose a material fact to a third person when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client”).
[90] Id. at R. 1.6(b)(2).
[91] Id. at R. 1.6(b)(3).
[92] Duhl, supra note 7, at 999.
[93] >Model Rules of Prof’l Conduct R. 1.6(b)(6) (2015) (permissive exception “to the extent the lawyer reasonably believes necessary… to comply with other law or a court order.”); id. at R. 1.2(d) (lawyer’s obligation not to assist the client in known fraudulent conduct).
[94] Id. at R. 1.16(b) (“[A] lawyer may withdraw from representing a client if … the client persists in a course of action involving the layer’s services that the lawyer reasonably believes is criminal or fraudulent.”).
[95] Duhl, supra note 7, at 1000.
[96] Emerson, supra note 6, at 718.
[97] >Model Rules of Prof’l Conduct R. 4.2.
[98] Id. at R. 4.2 cmt. 3.
[99] Id. at R. 4.2.
[100] Horton, supra note 16, at 210-11.
[101] ABA Comm’n on Ethics & Prof’l Responsibility, Informal Op. 86-1518 (1986).
[102] Duhl, supra note 7, at 1001-03.
[103] Id. at 1006-07; >Model Rules of Prof’l Conduct R. 4.1(a).
[104] >Model Rules of Prof’l Conduct R. 4.2 cmt. 4.
[105] Holdren v. Gen. Motor Corp., 13 F.Supp.2d 1192, 1196 (D. Kan. 1998); >Model Rules of Prof’l Conduct R. 4.2 cmt. 4.

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